Can Russia's "Noah's Ark" of Oil Stay Afloat, Despite Western Sanctions?
Western sanctions on oil production have had only a limited impact so far. But their effects will show up increasingly as the 2020s move on, in the form of steadily higher costs and delays.
Igor Sechin, the president and CEO of Rosneft, Russia’s national oil company, is a true believer in the future of oil. He is convinced that the world oil industry has made a deep mistake by underinvesting in oil, and he is determined that Rosneft will not repeat that error. Last spring he made headlines with a speech in which he warned that the foolish policies of the United States and the EU would lead to a global economic disaster on the scale of the Great Flood in the Book of Genesis—but that Russian oil would be the “Noah’s Ark” that would save the chosen few.
Sechin may be the most powerful oilman in the world. Yet he is not an oilman by background; in college he majored in Portuguese, and as a young man in the 1980s he served in military intelligence in Portuguese-speaking southern Africa. In the early 1990s he met Vladimir Putin, then deputy governor of Saint Petersburg, on a goodwill tour of Brazil. The two men hit it off, and for the next twenty years Sechin was Putin’s chief of staff and one of his closest allies. In 2012 Putin placed him at the head of Rosneft.
Sechin and Rosneft have their work cut out for them. Before Noah’s Ark can save the world, Russian oil ---and especially Rosneft--must solve two problems. The first, over the next five years or so, is managing the impact of Western sanctions on oil production from existing fields, following the exit of Western oil-service companies and the imposition of sanctions on the import of equipment and technology. The second is developing the next generation of Russian oil, notably from Rosneft’s prize project on Russia’s Arctic coast, Vostok Oil.
This Substack post will explore both challenges. It concludes that the Western sanctions have had only a modest impact to date. Their effects will likely grow after mid-decade, but on balance, the Russian oil industry has the skills and the wherewithal to maintain production. The big question is cost. As Russia’s existing fields decline and the industry is forced to move to virgin areas, its costs will increase. This in turn will cause its net revenues from exports to drop, as well as the tax take of the Russian government.
BROWNFIELDS VS. GREENFIELDS: THE BATTLE FOR WEST SIBERIA:
Even before the invasion, Russia’s West Siberian core, which accounts for 80% of Russian production, had been in decline, forcing the Russian oil industry to move outward toward previously undeveloped fields. In this effort, foreign oil-service companies were indispensable allies. Now, because of the Western sanctions, they will soon be gone. In addition, key parts of the supply-chain of imported equipment and technology have been disrupted. The Russian oil industry now faces its biggest challenge since the collapse of the Soviet Union thirty years ago.
On the eve of the invasion, the Russian oil industry had still not quite recovered from the effects of the pandemic and the associated worldwide decline in oil demand and prices. Spending on oilfield services had declined sharply. 2021 had brought some improvement, but not full recovery. The oil companies decided to concentrate their spending on new fields, while allowing established fields to decline. Many older wells were simply shut in.
This shift in strategy worked to the benefit of the Western oil-service companies. Overall, on the eve of the invasion, the foreign companies accounted for about 18% of the Russian oil-service market. Most of their work was concentrated in newer technologies, such as fracking, horizontal drilling, seismic visualization, and digitalization. These techniques had been introduced by the foreign companies in the first decade of the 2000s, and while the Russian companies had quickly mastered the basics, the foreign companies continued to dominate the more advanced applications. Thus, fracking evolved into “multi-stage fracking,” horizontal wells became “long-reach wells,” and seismic visualization became increasingly refined (enabling operators to “see” bypassed deposits). The foreign companies continued to play the leading roles at the moving edge of technology. Thus their departure will be keenly felt.
The effects of the sanctions will tell in other ways, as foreign suppliers can no longer provide key items of equipment and technology. 60% of all software used in the oil industry, for example, comes from abroad. As another example, Russian industry produces no fracking trucks, which are needed to pump water at high pressure into the wells, thus producing the “fractures” that give this technique its name. Once existing stores of imported equipment are depleted, and foreign equipment in place begins to wear out, their absence will be a growing constraint.
The departure of the foreign companies is often presented in the West as a crippling blow for the Russian oil companies, and thus as a major evidence for the effectiveness of the sanctions. But one perhaps shouldn’t exaggerate their effects. After all, if the market share of the foreign companies was 18%, that means that 82% was Russian. As for the foreign companies themselves, much of their personnel in Russia was Russian too. Over the previous two decades, the foreign companies, especially Schlumberger, had established large training centers. These not only provided Russian specialists for their own operations inside Russia, but had become a major source of trained manpower for their work in the rest of the world.
A major uncertainty at this point is how many of the Western companies’ Russian employees will leave with them. Since these have advanced skills, they will have no difficulty finding jobs elsewhere. In the wake of the war, and especially following the Kremlin’s recent declaration of a “partial mobilization,” there may now be a hemorrhage of skilled oilfield personnel. (There have been recent reports that the oil companies are being pressured to contribute manpower to the war effort, which will presumably accelerate the loss of advanced skills from the fields.) There is as yet no reliable information on these points.
Another uncertainty is the availability of Chinese equipment and manpower. The Chinese do not yet produce fracking trucks, but they have long played a major role in the supply of drilling rigs and other less advanced items. Still, at this writing the overall Chinese contribution remains modest. And despite reports of Chinese workers active in the Russians oilfields, their numbers to date are apparently still small.
In sum, the impact of the exit of the Western oil-service companies and the ban on supply of technology and equipment is probably best thought of as a process of gradual decay rather than sudden shock and collapse. Over the next few years—say, to the mid-2020s—the Russian oil companies will likely be able to compensate by increasing the volume of drilling and the application of techniques they already master, as well as moving out to the periphery of established areas to develop satellite fields. It is over the longer term—say, a decade out—that the absence of Western partners, together with growing financial constraints on the industry, will hamper its capacity to move on to the next generation of oil. The prime test case is a complex called Vostok Oil, to which we turn now.
NOAH’S ARK LANDS HERE: ROSNEFT’S GAMBLE ON VOSTOK OIL
The second challenge is the longer-range one of developing new provinces. Of these the most important is a complex called “Vostok Oil” (or “Eastern Oil”), which covers a gigantic area located to the northeast of Russia’s traditional oil stronghold in West Siberia, near the coast of the Arctic Ocean. Vostok Oil is Sechin’s chief candidate for Noah’s Ark. His vision is to export oil from Vostok Oil eastward by tanker, as the ice melts along the Russian coast of the Arctic Ocean.
Vostok Oil represents a kind of “second-best” strategy. The Russian industry has no capacity to develop the deep offshore Arctic without Western technology. And so far Russian efforts to develop “shale oil” (on the example of the United States), have had no success. Vostok amounts to a “near offshore” approach that lies within Russian capabilities and allows it to develop the eastern export route by marching eastward, developing new areas along the Arctic coast.
But there are two big problems—infrastructure and transportation. Vostok Oil is almost entirely virgin territory. It lacks roads, pipelines and power lines, drilling sites, housing, airports, ports, channels—in short, almost everything required to produce and ship oil. The climate is one of the harshest in the world, made worse by melting permafrost, which causes roads to heave, pipelines to twist, and rigs to sag. All of this translates into huge cost and investment, most of which will have to come from the state.
In a series of one-on-one meetings with Putin in 2020, Sechin made his case for Vostok Oil. He had brought along a bottle of oil from Vostok as a present—“light, sweet oil,” he told the president, “the best in the world.” He also brought along his shopping list: 15 new industry towns with housing for 100,000 workers, two airports, a seaport, 800 kilometers of new pipelines, and a fleet of new ice-class tankers, not to mention the rigs and wells themselves. In return, Sechin promised Putin 100 million tons of oil a year—or 2 million barrels a day, roughly 2% of world production—by 2030. Putin initially hesitated, but he ended up giving Sechin the green light he was asking for.
But that was before the invasion of Ukraine. Now, Rosneft will have to develop Vostok Oil alone, without the Western majors and oil-service companies that were initially involved. Second, Rosneft will be increasingly strapped for money. Even now, the Russian government is calling on the oil companies to contribute to the war effort, in the form of higher taxes and dividends, to make up the growing deficits of the Russian government budget. How much will be left for oil investment is anyone’s guess.
The likely effect will be to delay the development of Vostok Oil, perhaps by a decade. But by then, mounting concerns over climate change may bring a peak in global oil demand. Vostok Oil could turn into one of the world’s largest stranded assets.
The impact of the Western sanctions on Russian oil production can be summed up in two time-frames: in the near- and middle-range (three to five years out), there will likely be a steady decline in existing fields, but it will be largely offset by increases in output from secondary fields. Russian production will remain reasonably stable, but costs will rise steadily.
In the longer-term (five to ten years out and beyond), there will be serious delays in the development of new virgin areas such as Vostok Oil, but less as a result of sanctions than of mounting domestic constraints on infrastructure and finance, especially government subsidies.
In both time-frames, Russia will continue to be a major producer and exporter of oil, but its competitive position will weaken as its costs increase, and its net
export revenues will decline. Noah’s Ark may float, but will it save the chosen few, especially in Russia itself?
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Thane Gustafson is the author and co-author of eight books on Russian affairs, including most recently Wheel of Fortune: The Battle for Oil and Power in Russia (2012), The Bridge: Natural Gas in a Redivided Europe (2020), and Klimat: Russia in the Age of Climate Change (2021), all with Harvard University Press.
I am sure the absence of western technology will be a nuisance but it is hard to believe that a country as advancd technically as Russia will not be able to replicate the necessary equipment and skills. Equally there is nothing to stop highly paid individuals coming to Russia to advise local labour on how to carry out procedures.