Russia's Natural Resources and their Economic Effects














by

Kevin M. Korabik

Geography 128

Dr. Williams

December 1, 1997



Russia's Natural Resources and their Economic Effects

Russia contains over 30% of all the natural resources in the world. Until the fall of communism, these resources were primarily used by the former Soviet Union. Now that communism has fallen, and the Russian economy is in ruins, they have nothing left to do but tap into some of their resources for export to western nations. One problem, they do not have the money to find these resources and develop the areas in the Russian Far East (RFE). One solution is to turn to western investors. This long road to recovery for one of the worlds superpowers is just beginning.

Overview

Russia contains the worlds largest natural gas reserves, second largest coal reserves, and the eighth largest oil reserves (USDoE 1997). To obtain access to these resources, investors, mainly foreign, need to build roads, housing, and any other item necessary to live. On top of this, many of the locations of the resources are in the permafrost of Siberia and Kamchatka. This makes living and working conditions harsh on both man and machine. In addition to building housing, the current methods of transporting oil and natural gas are inefficient. Many facilities were built during the seventies and break down. Others leak and cannot transport the resource to the desired location. The whole pipeline system need to be reworked to connect high output areas with seaports and refineries. Joint Ventures, the backbone of Russia future survival in exporting resources, are the key to success. These ventures involve a current Russian corporation and a western investor to cooperate in exporting the resources. The Russian company provides the labor, while the western firm finances the site.

Market for Exports

Russia is the worlds largest producer of natural gas and the third largest producer of oil. This gives Russia the opportunity to become one of the major hydrocarbon exporters of the world. Many nations like Poland and Austria, are lacking the natural resources to feed their need for fuel. They rely heavily on importing theses goods and since Russia is close to home it makes it even easier to turn to for these goods. Poland imports 100% of its natural gas from Russia while Austria imports 80% and Germany only 30% (Oil and gas field equipment market in Russia 1996). The European market is a prime place to import goods from Russia, but lack of technology is the main problem that keeps Russia from become an exporting superpower.

Vertical Integration

After the breakup of the former Soviet Union the first vertically integrated oil company, Lukoil, was started by the government (Russia's Emerging Oil Companies 1995). This system was developed by the Ministry of Fuel and Energy to begin restructuring the oil industry to survive in a capitalist market. The vertically integrated system was designed around the fact that all Russian refineries, pipelines, and oil fields were privately owned. The Ministry of Fuel and Energy just grouped these small firms together and made them associates. The number of vertically integrated companies has been increasing greatly with the addition of two major companies Siberian oil and Tyumen Oil. The auctioning off of the Russian shares by the government has lead to the creation of many new companies along with the continued dominance of Lukoil. In 1994 Lukoil produced 45.1 million tons of oil, one-eighth of Russia's output and comparable to Exxon's 45.5 million tons of oil(Russia's Emerging Oil Companies 1995).

Another product of the restructuring of the energy industry involved the pipeline system. After the breakup of the Soviet Union, a firm called Transneft, a state run company, emerged to handle the pipelines of Russia. They transport over 90% of Russian crude oil to exporters or refineries all over Russia (Russia's crude oil pipeline organization: Transneft 1995). With over 50.000 kilometers of pipeline in Russia, a state run firm seemed to be the only feasible option. If multiple firms owned the pipelines across the country then service could be disrupted or prices and taxes could get carried away. This way the government has control of the movement of the majority of the oil in Russia.

Joint Ventures

These vertically integrated companies have lead to an increase in the number of joint venture interests. Joint ventures in oil and natural gas are prevalent due to the increased revenue that the western firm brings in. Many American companies such as Exxon, Shell, Texaco and Mobil have joint ventures in Russia and hope to expand their share of the market for oil and natural gas. The joint ventures are necessary for the development of the Russian Far East. They bring necessary equipment that is vital in the mining process. Most of all joint ventures bring in money to help develop and research the oil fields. This is desperately needed since many Russian firms do not have the skill to find and efficiently gather the oil that they find.

Joint ventures are necessary, but also scrutinized by the Russian government. To obtain a joint venture, the western company needs to be licensed, structured, and chartered to meet the specifications of the Russian government (Ostrander 66-69). Once these specifications are meet, then the western firm is allowed to take part in the joint venture. The western firm is not allowed to own any of the resources in Russia, they are just allowed to provide capital and share in the profits. The usual split between the western and Russian firms depends on capital involved. Many Russian firms are only able to provide land and workers. While many western firms end up providing the technology and money necessary for development. Then the two firms decide how to split the profits fairly. Most of the Russian firms own at least half and sometimes up to 80% of the profits in the joint venture. The usual joint venture works by having the Russian firm "sub-contract" the work of the western firm in return for oil or natural gas (Ostrander 66-69).

The first major joint venture involving the US and Russia came in 1994. The venture, called Polar Lights, was a 50-50 venture involving Conoco and Russia's Arkhangelskgeolgia Enterprises. This venture was started to produce oil from the Ardalin fields about 1,000 miles northeast of Moscow. For the first time since the fall of communism that a Russian firm developed a partnership with an American firm. Russian general director Anatoly Kazakov stated "Hopefully, we have paved the way for additional foreign investment in Russia's petroleum sector." This shows that the Russians are hoping that the joint ventures work out and lead to the economic recovery of Russia. The taxes from this development in the Ardalin fields is guaranteed to bring in one billion dollars and could possibly bring in as much a 6.8 billion dollars if the production goes as planned. These funds are badly needed by the Russian government and will aid in their recovery.

Joint Ventures, even though they are badly needed by the Russian economy, only accounted for about 90 million barrels of oil a mere 3.6% of Russia's total oil production for 1993 (Joint Ventures add to Russian oil Production 34-35). This total is more than double the total produced for 1992. Russian oil is still being produced at a high rate despite the lack of contribution by the joint ventures. The total Russian oil output is only 2.5 billion barrels a year which is dwarfed in comparison to the nearly 5 billion barrels a year that were produced at the peak of production in 1988 (Joint Ventures add to Russian oil Production 34-35). Although oil production has dropped of, many believe that outside investors will help Russia regain the oil production numbers of the past.

Problems in thedustr Iny

After the fall of communism, the government in general along with the economy was in ruins. This means that not only did the people of Russia not have any money, but the government also was lacking the necessary funds to keep running. This leads to areas of the government like the energy sector, that did not receive enough money to keep up in maintenance and repair of their equipment. Since this was the case many pipelines and refineries currently need repair or to be updated. This along with government regulations and money in general are all problems in the Russian energy sector today.

Money, is a big problem in Russia today. With inflation now down to around 20%, the lowest rate in five years, money still is very weak. Without a strong currency, international trade is very difficult. This then leads to lack of money for development of the oil and gas fields. Also, if there is no money for exploration, there is no money for repair or overhauling of current machinery. This leads to inefficiency and lower production output in the long run. Without the necessary revenue the company may never achieve an efficient production output with a maximum profit return.

The Russian government is also a big reason that the industry is plagued with problems. The licensing process for obtaining a joint venture or joint stock company is lengthy and unattractive in many cases. Also, the government is to blame for a surplus of refineries that causes a utilization rate of only 60% (Study outline changes required to vitalize Russian oil industry 38-39). In addition to the inefficiency of the refineries, 20% of the refineries are not even connected to a pipeline system. This system is very underdeveloped and relies heavily on transportation by rail from the fields to refineries.

The biggest cause for problems in the industry is the pipeline system that is involved in Russia. Many of these pipelines were built during the seventies and cannot handle the demand of oil flow from the fields. Many of them are either to small in diameter or are lacking pump capacity (Study outline changes required to vitalize Russian oil industry 38-39). These pipelines leak and can cause massive spills like the one in Western Siberia. This caused 18,000 barrels of crude oil to be lost and a fire that took two days to extinguish (Russian oil and gas pipelines plagued by accidents 38). The money is the biggest reason that these accidents occur. The funds are not available to keep up the maintenance on these pipelines.

Possible Solutions

There are many ways that the Russian economy can benefit from the abundance of natural resources in the area. The people can benefit even more if the three major problems that I discussed earlier were solved. If this happens Russia could become an economic superpower once again.

To solve the problem of money in Russia, I propose that Russia start to invite even more joint ventures and joint stock companies into their energy sector. This way the western world could help pay for the recovery of some of the finest natural resources left in the world. Also another idea proposed by Boston Consulting Group London, was to break up storage and retail monopolies to open up opportunities for competition in this market. This along with the fact that the Russian stock exchange needs to be overhauled to make it even easier for a foreign investor to place capital into the Russian economy (Study outline changes required to vitalize Russian oil industry 38-39).

The problem in government could be solved by eliminating the overwhelming power that the Ministry of Fuel and Energy possesses. This way the government could loosen its grip on the industry letting it expand at whatever rate that the market will support. Lack of government power will lead to the end of tough licensing restrictions for joint ventures. The ministry will still need to maintain some regulation over joint ventures so that Russian firms are not swindled out of their money and resources. The government will also need to overhaul the transportation, storage and refining network of Russia. The current efficiency rate is 60% which is pathetic. They need to begin to eliminate some refineries that are not even connected to the main pipelines. This will help increase efficiency along with the building of new pipeline to replace the need for rail transportation of the crude oil.

The pipeline system is probably the most crucial part of the exporting process. This part is also the most troubled part. Many of the lines are too small to transport the amount of oil that is being pumped from the ground. Pipelines also are not able to support the large number of oil fields to transport oil to refineries. This system is old and obsolete. The only hope is that western firms come in and lay their own pipeline that will be able to handle the demand posed by the oil fields. Pipelines for natural gas also need to be laid to connect Russia with countries in Europe that need natural gas. This will cut down on transportation costs and make it easier for Russia to export its natural gas. In addition another pipeline might be needed to link Russia with Southeast Asia in hopes of opening up a market for the largest natural gas reserves in the world.

Conclusion

In conclusion, Russia has a promising future in recovering economically from the fall of Communism. The road to recovery is already beginning with the increase in exports of oil and natural gas over the last seven years as shown in figure one. This figure shows a drop in total oil exports, but an increase in international exports of oil. This shows promise because this will lead to international money entering the Russian economy. Figure two shows the amount of joint ventures in Russia and the Former Soviet Union. These statistics were as of 1996 when over seventy joint ventures were registered in Russia. This shows an interest in Russia by Western investors. This should also show a promising future because as more western firms arrive, more of their money enters the Russian economy and stimulates growth.

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