The Kinks In Russia's Oil Pipeline

With global oil prices flirting with a record $44 a barrel, the death throes of Russia's Yukos could hardly have come at a more sensitive time. OPEC producers, whose output hit a 25-year high in July, have little room to ramp up production to meet surging demand. Other global oil players face similar capacity constraints.

In late July the markets panicked when Yukos said its tussle with authorities over billions in unpaid taxes could lead to a halt in production. But a change in ownership -- even some form of renationalization -- doesn't necessarily mean Yukos will stop pumping crude. Oil analysts in Moscow expect the Kremlin will bend over backwards to avoid any Yukos-triggered disruption in Russia's oil production: "The political effects would be astronomical," says Ronald Smith, oil analyst at Moscow investment bank Renaissance Capital. Justice Minister Yuri Chaika rejected Yukos' claims that production would be affected. "I officially declare that there will be no problems," he said on July 28.

Even if there is a production snafu, state-owned pipeline company Transneft could make up any shortfall to foreign customers by increasing supplies from other oil companies. The country, in fact, is doing its very best to supply global customers. According to the U.S. Energy Information Administration, from 1998 through 2003, Russia's output jumped 40%, to 8.4 million barrels a day, and exports grew 62%, to 5.8 million barrels a day. Russia's Industry & Energy Ministry reports that so far this year oil output grew 10%, with exports rising 20%.

But markets should still worry about Russian oil. Unless Russia builds new pipelines, growth in oil exports will slow dramatically as early as next year. Major new pipelines are not expected to be ready for at least three years.

The second issue involves the long-term consequences of Yukos' fall. Russian Economy Minister German Gref said on July 22 that "the government is not contemplating purchasing Yukos assets." But growing evidence suggests that the Kremlin plans to renationalize Yukos' oilfields indirectly. Igor Sechin, a KGB veteran and senior Kremlin aide, was recently appointed chairman of Rosneft, Russia's last remaining state-owned oil company. Analysts think that under Sechin, Rosneft is being positioned to purchase choice Yukos assets in a forced sale of the company's properties to satisfy its huge tax bill. "The government has been pursuing a course that gives them legal justification for taking assets from Yukos," says Chris Weafer, chief strategist at Alfa Bank.

Investment Chill

How would renationalizing Yukos affect oil production? Simple: There's clear evidence that the country needs private companies spurred on by the profit motive to realize its oil potential. According to the Organization for Economic Cooperation & Development, the three largest oil companies owned by private financial groups (Yukos, Sibneft, and TNK) increased their combined production by 90% and exports by 130% between 1998 and 2003. During the same period, however, Russian state-owned oil companies managed increases of just 15% in production and 27% in exports. If Yukos is dismembered, the surviving private companies are bound to think twice before investing. Global oil markets -- and Russia -- would suffer as a result.

By Jason Bush in Moscow

Edited by Patricia Kranz

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