An energy story, bigger than Iraq, bigger than Venezuela and Nigeria combined, is unfolding in Russia.

The government of President Vladimir Putin has thrown down the gauntlet at oil “oligarchs”, most prominent among which is Mikhail Khodorkovsky, CEO of Yukos, Russia’s largest oil company and the world’s second largest oil producers, behind Saudi Aramco.

A tacit agreement between Putin, as an incoming government three years ago, and the oil magnates was one of peaceful co-existence: he would not question the dubious means by which former communist bureaucrats and apparatchiks acquired state-owned oil reserves at fire sale prices and, they would not get involved in the politics of the state.

This agreement did not last long. One of the reasons is Russian oil companies have grown by double digits the last few years: Yukos outgrew them all and Khodorkovsky became the country’s richest man by far, with an estimated worth of around $10 billion. It is a widely held belief that he intends to parlay his wealth and power to run for President of the country.

In a metaphorical shot across the bow, the government indicted in late June 2003, Platon Lebedev, Chairman of Yukos parent company and a close associate of Khodorkovsky for a would be embezzlement which ostensibly happened in 1994. The struggle in Russia’s energy scene with the industry accounting for 55% of the country’s economy should be a major concern in the West. Russian oil exports have been the biggest addition to the international oil trade and have served as a considerable reducer of OPEC’s power.

Oil and natural gas have been the news in Russia for a while and they ought to be.

What is ironic is that what was arguably the former Soviet Union’s undoing may offer a sweet revenge for the Russian Federation, and a return to unprecedented global power, a position that the Cold War could never have afforded. In our book “The Color Of Oil” we have made the case that in the early 1980’s, following the deliberate overproduction by Saudi Arabia, prompted by the Ronald Reagan US Administration, and the oil price collapse, caused the internal fractures of the Soviet Regime to become gaping holes because of its almost exclusive dependence on oil revenues for hard currency.

What is missing from conventional news today is the civilization- altering, technologically-disruptive transition of the future fuels of the world economy to natural gas and eventually hydrogen. With by far the world’s most imposing natural gas reserves, which we estimate to be at least 40% of potential world ultimate recovery, Russia will be in the driver’s seat for generations to come and the main reason for its certain geopolitical and economic renaissance.

The transition to natural gas and the de-carbonization of fuels for the world energy mix is a historical imperative that has little to do with environmentalist slogans. There are many reasons for this shift and the most obvious is the overwhelming reliance of planned and under construction power plans on the fuel (in the USA it is almost 100%). The sleeper and emerging reason is the much higher efficiency and greater refinement which will come about by using fuel cells which, we think, are the engines of the future. What the internal combustion engine did to coal-fired steam engines a century ago, natural-gas powered fuel cells will return the favor to the internal combustion engine. This is just around the corner, especially in transportation and such a change will be not just an evolution but a technological and infrastructural revolution and it will take a huge investment and market fluctuations. There is little chance that renewables, such as wind and solar, will play a significant role for decades and perhaps not even then.

In 2002 for the first time in history, natural gas has become the number two fuel for the world, surpassing coal, which held that rank for almost a century. Even the conventional estimates by the Energy Information Administration of the US Department of Energy suggest that while the world energy demand by 2020 will increase by 50%, the market share of oil and gas will increase from today’s 61% to over 67% (with gas providing 27% and oil 40%). We think that the natural gas estimates are woefully conservative and that much earlier than 2020, natural gas will be eating into oil’s market share, actually surpassing oil eventually.

There is a second compelling reason why natural gas. Oil has led to wars. Both World Wars and more recently two Gulf Wars had an obvious oil connection. Oil has always caused geopolitical vulnerabilities for the big energy users, the most obvious the United States. Five of the six countries with 75 billion barrels of oil reserves are in the Persian Gulf: Iran, Iraq, Kuwait, the United Arab Emirates and, the biggest of them all, Saudi Arabia. Almost one third of all transnational oil trade passes through the Straits of Hormuz, perhaps the world’s most worrisome geopolitical choke point. Natural gas will relieve tensions de facto. More than three dozen countries can deliver world-class natural gas supplies and they are as diverse as Peru and Bolivia, Namibia and Cameroon, and practically all former Soviet Asian Republics. None though is more compelling than Russia.

Russia has an added quite important asset. It has a neighbor which, recent SARS notwithstanding, will be an energy market giant. This is of course China whose energy demand increased at an astonishing 110% in the last decade, and a country, which is still quite primitive in its energy mix, with coal accounting for 70%, a figure not seen in the West since the nineteenth century. With natural gas providing less than 3% of China’s energy needs today, that country is perhaps the easiest picking for future natural gas shipments.

None of the above is to say that the future of Russian natural gas will be easy. While the potential is clearly there and, in fact overwhelming, energy transitions are never uneventful and are often painful for both producers and consumers.

There is little question that eventually everything or close variants will be built from the North European Pipeline, to move gas from Turkmenistan, to Azerbaijan’s Shah Deniz project (no matter how Gasprom’s Blue Stream competes with it) and to a formidable multi-pipeline corridor from Russia into China.

Gazprom, Russia’s monopoly has probably already outlived its utility by a decade at least. It is way too big, unwieldy and with enormously diverse assets. It is physically impossible for its management to continue handling Gasprom simply because of the inherent contradictions of its assets. The needs of mature fields are very different from those of new pipelines and enormously different from the modern exploitation of new and challenging fields in the Arctic or offshore. Witness the flight of America’s own companies from its own territories. It would be hard to find a major US company operating today in Texas or Oklahoma. Companies, even the biggest and most powerful of them must focus.

Russian oil and gas industry can benefit a lot from diversification and the acceptance of many lithe and aggressive companies with low overhead and hunger for success. This would not be easy to accept by established Russian companies, which have been moving towards the temporarily easy and understandable opposite direction of consolidation. The future though should surely need new blood and lots of different players.

The country has to recognize this fully, embark on a serious and proactive path, must clearly liberalize its production and enable foreign investment with transparent rules of the game. The recent political shenanigans do not bode well for the future.



About the Author(s)

Michael Economides is a professor at the University of Houston and the Chief Technology Officer of the new Texas Energy Center. He is the coauthor of the best seller The Color of Oil: The History, the Money and the Politics of the World’s Biggest Business.



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