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Same-Day Analysis

Taking the Pulse of the Russian Energy Sector in 2008

Published: 27 December 2007
With Russia set to elect a new president in 2008—although a true change in leadership appears doubtful—Global Insight takes a look at the issues that the new president is likely to face and makes a few predictions about what will happen in the country's all-important energy sector.

Global Insight Perspective

 

Significance

President Vladimir Putin has tapped Dmitry Medvedev, his first deputy prime minister and the chairman of state gas giant Gazprom, as his preferred successor when Russia elects a new president in March 2008.

Implications

The near-certainty that Medvedev will be elected, and that Putin will retain a leading role in setting Russia's energy policy—most likely as prime minister—ensures that the direction of Russia's energy policy will be virtually unchanged in 2008.

Outlook

The "business as usual" approach to the energy sector, marked by state-led consolidation, slow but steady production growth, and increasing restrictions on foreign investment, has been a recipe for success for Putin's eight years in office, making it unlikely that Medvedev will seek to deviate from this policy—that is, if he has the ability or desire to, which is questionable.

Continuity Expected

For much of the past year, Russia watchers have been engaged in a frustrating game of reading tea leaves, seeking to interpret news from the Kremlin (the presidential administration) as to Vladimir Putin's plans for holding on to power when his second term in office ends early next year and he is constitutionally forbidden to run for a third consecutive term in March 2008. The lack of any heavyweight contenders officially stepping forward, together with Putin's shake-up of the government and replacement of Prime Minister Mikhail Fradkov with virtual unknown Viktor Zubkov in September, effectively ensured that the popular twin parlour games of "Who will succeed Putin?" and "What will Putin do?" have remained active in the media right up through the country's parliamentary elections earlier this month.

However, following that resounding win for the pro-Putin United Russia party—which cemented its ties with Putin by "convincing" the president to run at the top of the ticket, Putin appears to have finally tipped his hand, providing the answer to the question that all of Russia—not to mention the international community—has been eagerly asking. The choice of Dmitry Medvedev, first deputy prime minister and the chairman of state gas giant Gazprom, as his preferred successor means that Medvedev's election in the 2 March presidential poll is a virtual certainty. Medvedev's subsequent request that Putin head up a new government as prime minister appears to answer the second question. Putin's statement to the United Russia party congress on 17 December that he would "be ready" to continue his work as head of the government if Medvedev is elected puts the final piece in place for President Putin to make the transition to Prime Minister Putin. As some have noted, Medvedev's main strength is his weakness. He currently oversees Russia's "national" projects such as housing and education and has no independent power base of his own, owing his rise to his Kremlin position to Putin's coattails, and this suggests that ultimate power in Russia will remain with Putin.

With this (non-)transition of power set to take place in the first quarter of 2008, what, if anything, will be the impact on Russia's energy policy? On the face of it, little can be expected to change. The main tenet of Putin's energy policy as president—a determination to consolidate greater power in the oil and gas sectors in the hands of the state, with resulting impacts on production growth and de facto limits placed on foreign investment in the hydrocarbon sector—is widely anticipated to remain the chief driver of government policy. In fact, the "business as usual" approach to energy policy is likely to be further codified in 2008 with the final passage of legislation that will establish the official rules of the game for foreign investors, limiting the participation of non-Russian oil companies in fields designated "strategic" by the government. Putin's potential move to the post of prime minister could mean that he himself shepherds this legislation through the various bureaucratic entanglements that have delayed its passage in the parliament thus far despite strong government support.

Is Everything Clear Now?

Whereas the direction of Russian energy policy—or rather, how the current Kremlin leader plans to retain power—now appears clear going into next year, just where that policy will take the country is a bit less certain. Of particular interest with Medvedev as president is who takes over the plum position of chairman of Gazprom (assuming Putin sticks to plans to become prime minister). Furthermore, with the former head man at Gazprom now running the show (at least nominally) for Russia as a whole, what becomes of Rosneft, Gazprom's rival for Putin's ear over the past three-plus years and a rising energy superpower in its own right? Is a potential shake-up in Rosneft's management in store, and perhaps more importantly, will the company begin to demonstrate that it was not just a convenient vehicle for the state's campaign to displace Yukos assets but a functional, dynamic, and efficient national oil company (if there is such a thing)?

Herewith, some predictions for the Russian energy sector in 2008:

  • Oil production: Growth continues, averaging about 2.5%, with output surpassing the symbolic 10-million-b/d barrier early in the year, and overall production averaging around 10.12 million b/d for the year. Government tweaks oil taxation system to expand tax holidays and encourage exploration, which is also given a boost from passage of subsoil legislation removing disincentives.
  • Gas production: Growth driven by independents and oil companies, with Gazprom output flat. Higher penalties for gas flaring, together with higher domestic gas prices, translates to more associated gas being produced, putting the oil companies at loggerheads with Gazprom over access to the gas pipeline system. Oil companies begin to lobby the government more openly about third-party access (TPA) and the need for a truly independent regulator to operate the gas network.
  • Electricity sector: Unified Energy Systems (UES) completes its asset spin-off and is liquidated as planned in July 2008, albeit opting to sell several final assets at cut rates in an effort to complete the divestiture on time. Both Russian and foreign investors in the newly privatised gencos begin to outwardly lobby the government and President Medvedev to reiterate their commitment to full liberalisation of the Russian power market by 2011, suggesting that electricity prices for the industrial sector could be freed as soon as 2009. Medvedev demurs, however, sticking to Putin's original 2011 timetable.
  • Consolidation: Medvedev shows that Yukos was not a mere one-off affair, with Russneft bankrupted and its assets sold at auction; Rosneft is again the big winner. Bashneft is also renationalised, coming under Rosneft's widening umbrella as well. Gazprom and BP finally reach a deal on their strategic alliance built around the Kovykta gas field deal, with BP agreeing to reduce its stake in TNK-BP and becoming an equal partner in the joint venture with Gazprom and AAR, the Russian shareholders in TNK-BP. This allows TNK-BP to become a majority Russian-owned company, opening the door to Gazprom and BP co-operating to bid for operating rights for fields on offer that are deemed "strategic".
  • Sakhalin-2: LNG exports are delayed until mid-2009 on higher costs, construction delays, and ongoing environmental issues, ironically this time with Gazprom in charge of the massive project formerly led by Shell.
  • Sakhalin-1: ExxonMobil continues to resist Gazprom pressure to sell gas from the project to the Russian gas giant, prompting Russian government to begin to take steps to make it illegal for the U.S. supermajor to export Russian gas without government consent. ExxonMobil refuses to cede ground, with stalemate ensuing.
  • Eastern Siberia-Pacific Ocean (ESPO) pipeline: Launch of the 600,000-b/d-capacity first phase is delayed until mid-2009 on construction delays, higher-than-anticipated costs, and lack of available throughput in Eastern Siberia for the technical fill. Transneft delays plans for construction of the extension to the Pacific Ocean by a year.
  • Russia's relations with Ukraine: New Ukrainian Prime Minister Yulia Tymoshenko backs down from potential confrontation with Gazprom and Russia over 2008 gas price deal, but following Medvedev's election, both sides agree to work out a new approach for 2009, resulting in a deal under which Russia continues to supply Ukraine with Central Asian gas in 2009, albeit without the use of RosUkrEnergo as an intermediary. Ukraine nevertheless ends up paying US$230 per 1,000 cm for gas from 2009.
  • Russia-EU relations: Medvedev's election leads to a slight thaw in Russia's relations with the European Union (EU), if only for a brief moment, in the hope that Medvedev's reputation as a liberal economic reformer friendly to business interests will mean a depoliticisation of Russia-Europe energy-sector relations. Passage of legislation imposing restrictions on foreign investors in Russian energy sector will indicate that it is really Putin pulling the strings in the Kremlin, with the EU thus pushing ahead with its own investment restrictions that are viewed in Russia as anti-Gazprom.
  • Russia-China relations: Russia and China continue to sign co-operation agreements, only to find themselves still haggling over gas prices and thus stymieing further progress on implementation of their March 2006 gas pipeline deal. Negotiations continue, with neither side gaining traction, as Gazprom does not have the gas to supply the deal as of yet and China does not need the gas as soon as expected in any case.

Outlook and Implications

With Putin retaining ultimate political power, the scope of room for change in Russia's energy policy under President Medvedev looks quite limited. That said, there is a band of optimists that still hopes Medvedev, the man with the reputation as a reformer, actually becomes Medvedev the Reformer as president. His reputation has carried him through thus far, making him a favourite of the business community and a solid choice to succeed Putin from the perspective of foreign investors in Russia's energy sector, but whether he truly is a reformer—rather than just a puppet to appease the investment community and ensure them that Russia will remain a stable place to do business—remains to be seen.

Essentially, the issue can be boiled down to why Putin wants to retain power—is it power for power's sake or is this power geared to achieve something—say, the return of a "strong" Russia to the international community? The optimists hope that Medvedev and Putin will do something more with the power that the state has accumulated in the oil and gas sectors, in particular, than just allow Rosneft and Gazprom to become giant energy behemoths that control the development of (and access to) Russia's oil and gas riches. On the other side, the pessimists no doubt view Putin's plan to stay on as prime minister as merely a convenient way to retain power, perhaps only staying in the position long enough to avert international scorn when he inevitably returns to the president's office. After all, once power is attained, the tendency is to seek to maintain and enhance it. For the Russian energy sector, this could well mean that government energy policy in 2008 looks an awful lot like the last few years of the Putin era; indeed, even with the end of his second presidential term, the era of Putin as Russia's main power player is set to continue.
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