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CHAPTER3 Rise of the Energy Giants As the price of oil surged during the 2000s, the oligarchs who owned energy assets became even richer—at least at first. It quickly became clear, however, that despite accepting private business in most spheres of the economy, Russia ’s oil industry would be dominated by Putin and his allies. This policy had clear costs in terms of deterring foreign investment and reducing efficiency. But other goals took precedence, above all the need to ensure central political control. More than any other industry, oil demonstrates Putin’s desire for dominance of the biggest revenue streams and patronage networks. Yet Russia ’s energy sector is not a simple story of consolidation and centralization. Even as most oil production returned to state hands, Gazprom’s monopoly on natural gas was steadily weakened, thanks to competition from other oligarchs aligned with the president. Where competition does not threaten political control, it has persisted. But the hierarchy of goals—first, ensuring the Kremlin’s political and financial strength and only second, improving efficiency —has been clear. The oil and gas magnates who retained ownership oftheirenergyassetshavedonesobyensuringthattheysatisfytheKremlin’s political goals before pursuing their own financial self-interest. This was an easy balance to strike when the energy sector boomed during the 2000s, thanks to productivity increases and higher prices. Higher prices wereamatterofluck,butproductivityimprovedinpartbecauseofdecisions made in the 1990s. The Soviet energy industry had pumped millions of barrels of oil per year, enough to keep the country’s economy afloat during the 1970s and 1980s. Yet although its output was impressive, its productivity was not. A 1992 report conducted by a U.S. energy consulting firm found that because of aging equipment, poor management, and inefficient extraction practices, the oil infrastructure that the USSR bequeathed to independent Russia was only 10 to 30 percent as productive as Western levels. In some Rise of the Energy Giants | 39 Year 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 0 2 4 6 8 10 12 Million barrels per day spheres, technology lagged a half century behind. Some oil fields still used equipment donated to Russia through the World War II–era Lend-Lease agreement.1 The years immediately after the dissolution of the USSR were not, however , a period of rapid turnaround. Because ownership rights were unclear, managers preferred to take profits rather than invest in new production. By 1998, annual investment in oil production was $3 billion, less than a third of the 1990 level. This figure probably exaggerates the decline, as a sizeable portion of Soviet “investment” was wasted or stolen.2 But investment did fall sharply in the early 1990s, causing oil production to fall by over 20 percent from 1992 to 1996.3 The years after 1998, however, marked a reversal of fortune for Russian oil firms.Oilinvestmentandproductionspikedhigher,beginningadecade-long boom. Capital investment in the sector tripled between 1998 and 2004. The world oil price hit a low point in 1998, bottoming out at $12 per barrel that year.By2005,however,theoilpricewasoverfourtimeshigher,at$51perbarrel .Russianfirms’productioncosts,meanwhile,fellsharplyin1998becauseof thedevaluationoftheruble.4Thesetwofactorsmadeoilproductionfarmore profitable than in the 1990s. No less significant, however, was that many in the industry believed that ownership rights were becoming clearer.5 As firms thatownedoilfieldsbegantofeelconfidentthattheywouldbenefitfromthe proceeds of their investments, they plowed billions of dollars into modernFIGURE 2 Russian oil production, 1992–2016 (million barrels/day). U.S. Energy Information Agency. 40 | Rise of the Energy Giants Year Percentage of total revenue 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0 10 20 30 40 50 60 izingexistingfields.NewcompaniessuchasYukosandSibneftdoubledtheir production between 1999 and 2004, with other oil majors not far behind.6 DuringPutin’sfirsttwoyearsinpower,thegovernmenttookstepstofoster confidence in property rights in the energy sector. Unlike in the early Yeltsin years,whenthegovernmentlurchedfromnearcivilwarin1993tocontroversial elections in 1996, the years that immediately followed Putin’s ascent were marked by new confidence in Russia’s political institutions. Putin himself publicly emphasized the importance of political stability to energy investment .“IworkedinSaintPetersburgonagreatmanydifferentprojects,”Putin explainedinaninterviewin2000.“Ifwe’regoingfromoneputschtoanother, and no one knows when the next putsch is coming and how it will end, then whowillinvest?Therewillbenolarge-scaleinvestmentuntilwehaveasteady political system, stability, and a strong state that protects market institutions andcreatesfavorableinvestmentconditions.”7Putin’sinitialactionsappeared to match his words. Oil sector privatizations continued during his first years in office, in a more organized fashion than before.8 Foreign oil majors were convinced that conditions had improved. BP announced a $6 billion investment in oil firm TNK, evidently with the government’s...


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