Russia's Oil Woes: Moscow's Attachment to Statist Economic Policy Is Undermining Its Bid for Global Energy Dominance, Writes Leon Aron. by Re-Nationalizing Its Energy Sector, Putin's Regime Is Slaying Its Largest Golden Goose

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THE IDEA THAT RUSSIA is a new "energy superpower" is all the rage in Moscow, thanks in part to President Putin's vigorous salesmanship. The country holds between 6 and 10 percent of the world's known oil reserves and exports around seven million barrels a day--second only to Saudi Arabia. Last summer, the Kremlin pushed hard to make energy security the centerpiece of the G8 summit in St. Petersburg. Lost in the crash of cymbals, however, is Russia's uncertain ability to keep up with growing world demand--or even to maintain its current level of production, after a dazzling run from 1999 to 2004. While there are several reasons for concern, the underlying problem is sadly familiar in Russian history: a state ideology is poised to undermine the country's progress at precisely the time when Russia seems on the verge of a breakthrough.

The government's campaign to take control of energy firms began in 2004 with the selective prosecution of Russia's largest and finest private oil company, YUKOS. In a series of blatantly rigged trials, Russian courts found YUKOS guilty of corporate sins and tax violations, including the nonpayment of a tax bill far exceeding the company's profits. The company was bankrupted, and its most productive unit, Yuganskneftegaz, was sold through an intermediary to the state-owned Rosneft. YUKOS's founder and principal shareholder, Mikhail Khodorkovsky, is serving a sentence of nine years' hard labor at a prison camp in eastern Siberia. Soon thereafter, another leading private oil company, Sibneft, was purchased by the state-owned natural monopoly, Gazprom. In 2004-2005, the state's share of oil production increased from 10 percent to 30 percent.

By re-nationalizing its energy sector, Russia is slaying its largest golden goose. Between 1999 and 2004, the much maligned "oligarchs," as the young tycoons who became fabulously rich in the privatization of the 1990s are often called, invested over $36 billion, or 88 percent of their net profits, in "greenfield" exploration, drilling, and modern technology. Helped along by the cheaper ruble and an overhaul in the companies' corporate management (which became leaner, more transparent, and responsive to the markets), the private sector's oil production grew by 47 percent. Trillions of rubles were paid in taxes to the Treasury and, for the first time in post-Soviet history, dividends went to the shareholders.

By contrast, during the same five years, extraction by state-owned companies was up by a mere 14 percent. But ever since "acquiring" most of YUKOS, Rosneft--which was an obscure firm about to be put up for sale when Putin's confidant and deputy chief of staff, Igor Sechin, took over as chairman--has aggressively continued to buy oil assets. Gazprom has been on a shopping spree of its own: in just the last three years it has spent $18 billion on acquiring "non-core" businesses outside the gas field (such as Sibneft, for $13 billion)--more than it has invested in exploration and production since 1996.

Thus, some of the most productive assets of the Russian oil industry have been transferred from the most transparent and efficient companies (YUKOS and Sibneft) to the least transparent and efficient (Rosneft and Gazprom). The result? After an average growth of 8.5 percent between 2001 and 2004, in the last two years, the growth in oil production has dropped to 2 percent.

Russia's largest deposits of hydrocarbons lie thousands of miles away from the terminals that can carry them to world markets. The state-owned pipeline monopoly, Transneft, operates over 29,000 miles of pipeline. But of the seven million barrels a day that Russia produces for export, only about four million are shipped via the pipelines. The rest have to be transported much more expensively and slowly, by rail. This year, Russia's production may exceed its total shipping capacity by between 220 and 294 million barrels.

The Russian pipelines are not only short of what's needed, they are also old. …