I spoke on this subject in the middle of April, but there is more news coming…

“News of falling oil output has hit Moscow political circles like a bomb.”

So states a recent article in the Hundustan Times, another “go to” source for news about what is REALLY happening in the energy industry.

The Kremlin has invested heavily in Russia’s image as an energy superpower. During the recent Russian Victory Day celebrations on May 9, many commentators referred to Russia’s energy sector as one of the key elements of Russian power. Energy took a top billing, right along with Russia’s traditional military might and still-potent nuclear capabilities.

Russian leaders have pledged to continue increasing the country’s output to meet rising demand, especially in Asia. The first foreign trip by incoming Russian president Dimitri Medvedev was to China, where he made numerous announcements about energy cooperation between Russia and the Middle Kingdom.

But many experts have long pointed out that Russia’s petroleum industry is working under serious constraints:

Most Russian oil fields were discovered in the 1950s, 1960s and 1970s. During those energy-rich times, the then-Soviet developers skipped over all but the largest deposits. Later on, the smaller fields were developed, but these fields cannot make up for the fading giants of the past. New discoveries of any size are quite rare, even in the vastness of Russia.

Much of the equipment and technology in the Russian oil patch is outdated. In recent years, Russia has imported large amounts of Western equipment. Russia has also brought in Western personnel to help maintain oil output. Western oil service firms like Schlumberger and Baker Hughes have a large presence in Russia.

The private parties who acquired many energy Russian assets after the collapse of the Soviet Union made little in the way of long term investment. All along, there was serious doubt about the sanctity or security of the property rights these tycoons acquired in the wake of the collapse of the Soviet state. Hence there was a “boom” mentality that led to rapid exploitation of the easiest resources, with little thought for the long term.

The Russian government imposes confiscatory levels of taxation on the oil industry, with some marginal rates approaching 90%. Thus the high world prices for oil benefit the Russian treasury, but leave little in the hands of oil developers for new investment.

Despite all of this, Russian oil output has been growing at impressive rates for the past ten years or so — in the nature of 5% to 10% per year in some years. But in 2008 that growth has stopped abruptly. Output figures have actually reversed. In absolute erms, Russian oil output is down in the first four months of 2008. Russia may have reached its own “Peak Oil” point, much as the US did in 1970. This has grave implications for the growth of the Russian energy sector, and the larger Russian economy.

If Russian oil output has peaked, we can expect new kinds of both rhetoric and behavior from Russia in its domestic policies, as well as in its dealings with other nations. In all cases, you can expect to see Russia pursue its own security and national interests with a strong hand, if not with a vengeance.

Byron King
Energy and Oil