New York Times - March 28, 2006

In Russia, Ample Supply, Few Pipelines

By ANDREW E. KRAMER

USINSK, Russia — Once a tent camp for geologists, this Siberian settlement is here for only one reason: oil. A train to Moscow takes two days. Grocery stores sell reindeer meat. Summers run from the end of June to the beginning of August. 

Despite its remote location in the far north, Usinsk has some inherent advantages. An export terminal a few hundred miles away on the Arctic Ocean could supply tankers able to reach the United States in nine days. Building a pipeline to Europe would feed the high-quality oil directly to another ravenous market.

But for now, the Russian government controls exports. So instead, oil from here is pumped into a maze of state-run pipelines stretching far to the south, where it is blended with inferior oil and sold at a discount.

"What can we do?" asked Sergei M. Nesterenko, director of Northern Oil, a subsidiary of the state-owned Rosneft. "Once it's in the pipe, we no longer control the oil." 

The failure of this oil-rich location, named the Timan-Pechora Basin, to carve out an economical export route reflects a wider struggle in Russia. The country, considered a great potential source of energy for the world, is trying to bring market mechanisms to its energy industry — but wants to do so without losing government control. 

To become more profitable and influential, Russia's oil and gas industry needs to modernize, analysts say, adding in upgrades like a new northern pipeline. To finance drilling and development, Russia is turning to foreign investors, with Rosneft planning an initial public offering in July. But the pipelines will remain entirely in government hands. "This is Russia," said Eric Kraus, an analyst at Sovlink Securities in Moscow. "You have lots of cacophony on these issues. It won't be resolved soon."

Indeed, Russia is the only major oil exporter with an industry that is neither wholly state-controlled, as it is in Saudi Arabia and most other nations in the Organization of the Petroleum Exporting Countries, nor fully privatized, as it is in Canada and the United States.

Russia could tilt either way. The United States has pushed for greater outside investment and market influence to help expand production, which would give American energy companies a stronger toehold. But the United States knows it must tread carefully. "Countries have a right to develop their energy resources in the way they want to," David A. Sampson, a top deputy in the Commerce Department, said on a visit to Moscow in March. "I'm here to advocate for a role for markets in allocating capital." 

With 72 billion barrels, Russia has the largest proven reserves of conventionally recoverable oil outside of OPEC, according to Nicola Pochettino, a senior analyst at the International Energy Agency in Paris. That puts Russia in seventh place worldwide or eighth if Canada's reserves of oil sands are counted. 

By comparison, Saudi Arabia, including the neutral zone on the border with Kuwait, holds 262 billion barrels of proven reserves, the world's largest known supply. 

But consuming nations parched for oil are hoping Russia still has big reserves yet to be discovered. The United States Geological Survey estimates that Russia holds the largest undiscovered pools of oil in the world. The agency estimated Russia has another 80 billion barrels that are likely to be discovered in coming decades. 

Russian production is growing again, after a drop when the Kremlin effectively nationalized Yukos, once Russia's largest private oil company. But across the country, examples of inefficient energy policies abound, many springing from private companies trying to coexist with the state monopoly on export routes. 

Many, like the settlement in Usinsk, about 1,000 miles northeast of Moscow, are Soviet legacies of waste. City elders still debate whether families should be moved south and the city — a collection of concrete slab houses amid the snow drifts — converted back to a camp for oil workers. That would save a great expense for companies, which are stuck with the bill for maintaining indoor sports centers and other services for residents. Other inefficiencies are Russia's own doing. The Russian government in 2003 vetoed one ambitious plan to build a new pipeline. The project was proposed by an investor group led by Mikhail B. Khodorkovsky, the former Yukos chairman who is now in jail. Meanwhile, the government delayed a state-run alternative for years. A government pipeline planned by Transneft, a pipeline operator, is going forward, but at a slow pace. A terminal on the Arctic coast could deliver oil from the Timan-Pechora to the United States far faster than suppliers from the Middle East and Africa, according to the United States Energy Information Administration. 

Another sign of waste is the practice of burning natural gas at fields. There is no current incentive to tap the gas, because the market in Russia is still underdeveloped. And while private companies have licenses to develop gas fields, Gazprom, the state gas company, has a monopoly on exports. 

Outside Usinsk, at oil fields owned by Lukoil and Rosneft, the pillars of fire burn year-round; satellite images above Siberia capture vast swaths of wilderness lighted up with gas flares, like cities on fire. In one year, Rosneft flares an amount of natural gas equivalent to what a city the size of Denver would consume annually. 

"Unfortunately there's no gas pipeline here," said Andrei M. Uskov, the chief engineer at Northern Oil. "We can't sell it, so we try to use as much as we can to power the field, and the rest we burn." The company says it hopes to ship gas from Usinsk in the future. 

Light and heavy oils are mixed in pipelines throughout Russia. Thus, the Ural Blend crude that flows out of the Druzhba export pipeline to Europe, for example, sells at a discount of about 5 percent to the benchmark Brent crude from the North Sea because the Russian oil is of lower quality, with high sulfur content.

With Russia's oil exports bringing in roughly $500 million a day, the discount costs Russia dearly. 

Politics, analysts say, lie behind the practice. The heavier crude oils are principally drawn from fields underneath the politically restive Muslim enclaves in Tatarstan and Bashkortostan, neighboring states about 500 miles southeast of Moscow. 

Doing away with the practice of mixing different qualities of oil would effectively end a subsidy to these minority Muslims, a sensitive issue in the internal politics of Russia. This winter, President Vladimir V. Putin said he wanted to eliminate the Ural Blend product by separating oils in the pipeline. But no solid plans followed. 

Predictably, the policy of blending oils in the pipeline discourages companies from investing in deposits holding the higher-grade crude sought by energy-hungry refiners in the United States and Europe. 

There is easily refined low-sulfur oil, called light sweet crude, outside Usinsk. But there is no incentive to develop those outlying fields in the tundra, because there is no premium on higher-quality oil in Russia. 

Meanwhile, the collision of old-school Russian state control and the demands of a modern energy industry went on display in Usinsk in March.

Rosneft, eager to show off its prime assets before its initial public offering, invited journalists to fly by helicopter to the Val Gamburtsev field north of town. 

In midflight, near the halfway point, the helicopter swooped in a wide arc to circle back to the original airport, landing in a miniblizzard of snow powder sprayed by the rotors. Without explanation, Russian military air traffic controllers had closed the destination airspace to foreigners, said Yevgeny Fokin, a publicity agent working for Rosneft. 

"They do this sometimes," he said glumly. "Somebody wanted to show their authority."