Russia, the elephant in the EU’s living room
Torna al sommario del dossier

by Bob Schwieger and Giorgio Dodero

Russia’s unimaginable vastness is only suggested by the fact that the country sprawls across nine time zones and 40 degrees of latitude, from the temperate zone to the Arctic. Its endowment of natural resources is similarly vast. In 2009 Russia for the first time dethroned Saudi Arabia as the world’s largest petroleum producer, and its natural-gas production was the world’s second-largest, after the US.

Russia’s coal reserves are second only to the United States’, and its hydroelectric potential is the second-largest after China’s. Its industrial base and educated population support a vigorous nuclear-power industry that is building power plants at home as well as exporting them at a time when the industry elsewhere is struggling back to its feet after decades on the defensive, and may yet be knocked down again in the wake of Japan’s nuclear tragedy.

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Mosca vista da Washington
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Nel 2009 la Russia ha detronizzato l’Arabia Saudita dal suo storico ruolo di principale produttore mondiale di petrolio e ha raggiunto la seconda posizione, alle spalle degli Usa, nelle estrazioni di gas naturale. A questi primati vanno aggiunti quelli nel settore idroelettrico (con un potenziale secondo solo a quello cinese) e in termini di riserve di carbone (solo gli States ne sono più ricchi).

Potenzialmente si tratta quindi di un Paese ad altissimo interesse per gli investitori del settore energia. Non mancano, tuttavia, le criticità. Al punto che nella classifica Best Countries for Business stilata dal Forbes Magazine la Russia scivola in centoduesima posizione, alle spalle dell’Armenia e davanti all’Ucraina. Lontanissima da altre nazioni emergenti dell’Est quali Polonia (38a), Slovacchia (33a), Romania (52a) e Turchia (54a).

Le ragioni? Secondo l’OCSE vanno ricondotte ad una presenza statale ancora eccessiva e un forte controllo diretto, sempre da parte della oligarchia politica, sulle attività private. Senza dimenticare la dilagante corruzione e la mancanza di trasparenza, lascito dell’era sovietica. Solo timori ingiustificati?

Dal punto di vista russo, sì. Ecco, infatti, la sintesi di una pubblicità apparsa di recente sull’Oil & Gas Financial Journal. “La Russia è una superpotenza energetica coinvolta nella sfida dei cambiamenti del ventunesimo secolo. Peccato che ancora molti stereotipi tendano a prevalere e non permettano di vederla come un Paese ricco di opportunità, aperto e trasparente per chiunque abbia intenzione di investire”. Comunque sia, si tratta di una nazione che vale la pena conoscere meglio. Soprattutto dal punto di vista energetico.

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But Russia’s allure for investors is tempered by some sobering facts. The country’s tradition of absolute rule, first by princes, then by czars and the Soviet dictatorship, is expressed today in extensive state control in the Russian economy via both direct state ownership and control over economic activity, says the Organization for Economic Cooperation and Development (OECD).

State-owned enterprises are found across a wide range of sectors and often occupy a dominant position in their industry. Furthermore, there is a pervasive blurring of the line between the public and private sectors, arising not only from the extensive role of state-owned enterprises but also by close ties between government (at all levels) and major private firms. One reflection of this phenomenon is the unusually important role of current or former politicians and senior bureaucrats in business, which gives rise to multiple, distorting and costly conflicts of interest.

Combined with a lack of transparency, these conditions leave outsiders with the impression that Russia’s energy industry appears to be a puppet show cynically staged by the Kremlin for its own benefit. Recent initiatives to strengthen the obligations for politicians and senior bureaucrats to publicize their incomes and financial assets are welcome, OECD notes, but much remains to be done to complete the freeing of the market. The public-sector corruption that allowed the Soviet economy to work has persisted in the Russian Federation, earning the country a rank of 154 out of 178 in the world from Transparency International.

Responding to the negative spin in Western media reports on its business practices, Russia’s government says it is simply seeking fair compensation for its commodities and a fair return for its people on foreign investments in its economy. To its credit, Russia has made real progress in the transition from state socialism to a market economy after a chaotic start.
The privatization of state-owned companies in the oil and gas industry in the 1990s devolved in a tumultuous scramble of insider cowboy capitalism to produce today’s business-scape of energy behemoths with near-monopolistic sway, controlled by hyperwealthy, politically connected oligarchs. In 2008, by contrast, RAO Unified Energy Services, the sole, state-owned electric utility, was broken up in a more orderly fashion into 23 separate companies, in part to make private investment easier.

The Central Intelligence Agency Fact Book describes Russia as a centralized semiauthoritarian state whose legitimacy is buttressed, in part, by carefully managed national elections, former President [Vladimir] Putin’s genuine popularity, and the prudent management of Russia’s windfall energy wealth. Whatever the shortcomings of Russia’s energy industry today, it is at least somewhat open to foreign direct investment, something that could not be said of the Soviet Union.
In the European Bank for Reconstruction and Development’s (EBRD) Transition Report for 2010, which measures the progress of former command economies moving toward market economies, the Russian Sustainable-Energy sector and the Natural-Resources sector each earned a transition indicator of 2 on a scale of 4; the Electric Power sector’s indicator was 3.25, tied with Telecommunications and second only to Capital Markets.

And the Russian government continues to seek a place in the sun commensurate with the country’s potential. In 2006, the ruble was made a fully convertible currency, raising its international status and opening the currency to foreign investment. Two years later, President Dmitry Medvedev announced that Moscow was to become an international financial center. Lucio Vinhas de Souza, a World Bank economist, throws cold water on that boast, insisting that Russia’s attractiveness to investors is not improving in spite of all its striving. But Medvedev and Vladimir Putin, nothing daunted, keep presenting the case for Russia to investors and the world business community.

Opportunity Knocking
In June 2010, Russia began a new run at privatization. After a decade during which the Kremlin focused on gaining control of the country’s strategically important companies and assets and reorganizing them, the government now intends to raise an estimated 50 billion dollars to modernize them by selling stakes, ranging from minority to controlling, via private negotiations with foreign investors. The strategy for modernization and privatization has created an incredibly ambitious, intricate and fragile plan, says a report by Stratfor, an Austin, Texas, US-based analytical service. The plan depends on many variables and could fall apart before Moscow realizes its goal of securing strength for the state and economy for years to come.

Stratfor explains the Russian government’s actions in the first decade of this century as the result of Vladimir Putin’s deliberate efforts, first as prime minister, then as president, and again as prime minister, to reorganize, rebuild and strengthen Russia, overcoming the embarrassment and correcting the mistakes of the chaotic 1990s. These goals affected every sector in Russia, says Stratfor. Economically, Putin began consolidating the main assets that were strategically important to the government by taking them away from the Russian oligarchs or foreign entities that controlled them. After getting them under state control, Putin ordered a reorganization of those firms and assets, eliminating inefficiencies and creating large monopolies that became national champions in the energy, banking, transportation, military industrial, agricultural, telecommunications, and other sectors.

If correct, this reading of events would help to explain why Yukos was destroyed on the dubious pretext of tax claims but Rosneft was allowed to feast on the remains, or why Royal Dutch Shell, Mitsui, and Mitsubishi in 2007 were forced to sell Gazprom a controlling half of their 20-billion dollars stake in the Sakhalin II natural-gas development, violating earlier guarantees. Such incidents seriously compromised Russia’s reputation as a reliable business partner and a safe destination for investment, but they served goals that the Kremlin must have considered to be overriding.

The shock of the 2008 global financial panic shook the Russian economy to its core, says Stratfor. In its aftermath, the government realized that controlling the economy was only a first step; the next would require the modernization of the national champions to ensure their ability to compete globally. For that, they needed technology and cash.
President Medvedev has been securing the technology through deals in western Europe and
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The Country

After the 1991 dissolution of the Soviet Union, the 2,330-percent inflation of 1992, and the chaotic scramble kicked off by the privatization of state assets, the financial crisis of 1998 seemed to deal the coup de grâce to Russia’s economy and pride, producing 85-percent inflation and bank failures that vaporized millions of people’s life savings.
But the 10 years that followed saw the strongest decade of growth in Russia’s history, with real GDP nearly doubling, says the OECD. Inflation was on a trend decline to single digits by mid-2007, and the middle class swelled to comprise a quarter of the population.

The global financial crisis of 2008 hurt Russia worse than many countries because commodities make up nearly 90% of its exports, and commodity prices plummeted as the world economy reeled.

Growth, which had averaged 6-7% for most of the decade, slowed to 5.2% in 2008 and the economy shrank 7.9% in 2009. It is recovering, with growth in 2010 estimated by the World Bank at 4.2%, and the bank is forecasting moderate annual growth for the near term: 4.5% in 2011 and 3.5% in 2012 as domestic demand expands in line with gradual improvements in the labor and credit markets.
Russia’s population statistics paint a troubling picture, with likely consequences for the labor force. The Russian Ministry of Public Health estimated the population at 141.9 million in January 2009, which was a decrease from the previous year.

The Russian government has launched a program to encourage births and improve life expectancy, but in 2008, the US Census Bureau reported, Russia’s population is expected to shrink by 24 million people between 2008 and 2040, a drop of 21%.

Life expectancy is one of the lowest among developed countries, averaging 59.3 years for men and 73.1 years for women, reports the US State Department. Major causes of death among workingage men include cardiovascular diseases, cancer, traffic accidents, and violence, and excessive alcohol consumption and smoking are considered major factors.
Unemployment, about 5.5% in mid-2008, shot up to 9.4% in February 2009. It remained over 7.6% until falling to 6.6% in September 2010. In November 2010, the World Bank forecast an improvement in unemployment later in 2011.

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the US in recent years. For the cash, the Kremlin will raise an estimated 30 billion dollars between 2011 and 2013 by selling minority stakes in a dozen or so large companies as well as controlling stakes in thousands of smaller, strategically less important ones. Rosneft, Transneft, Federal Grid Company, and RusHydro are among the strategic prizes on the block.

In January 2011, it appeared that the oil company already had struck gold when Rosneft and BP agreed on a joint offshore exploration and production program in 125,000 km2 of the South Kara Sea accompanied by a 16-billion dollars stock swap.

The companies touted the agreement as the first cross-shareholding in the global oil industry between a major national oil company and an international oil company, but the deal fell apart when BP’s Russian partners in TNK-BP successfully opposed it before an arbitration panel.
When it was announced, analysts had called the deal an encouraging signal to investors that Russia’s resources are opening up to foreign investors, according to Platts energy newsletters. The effect of its failure remains to be seen.

Possibly taking the cue, French oil company Total and Russian independent gas producer Novatek in March 2011 agreed that Total will take a 12-percent shareholding for about 4 billion dollars in Novatek, possibly rising to 19.4% within 36 months. The deal also will make Total the main international partner on the Yamal LNG project, with 20%.
Other recent major oil and gas announcements have included plans by Chevron and Exxon Mobil separately to collaborate with Rosneft for offshore exploration and production in the Black Sea. And Stratfor’s analysis of the privatization plan notes that Italian energy firm Eni is interested in buying a stake in Rosneft as a way to give Eni more freedom to work in Russia and possibly secure other oil deals previously offlimits to the foreign firm.

As if to emphasize that the Kremlin has changed its ways, Putin in December 2010 said that Russian officials understand that we need foreign investment. At the World Economic Forum in Davos, Switzerland, in January 2011, Medvedev’s theme was Russia’s welcome to foreign investment.

An Attractive Investment Destination, with Caveat
The wise investor will look closely and think twice before leaping into Russia, which UK Prime Minister Winston Churchill famously described as a riddle wrapped in a mystery inside an enigma.
The CIA Fact Book seems to depict Russia as attractive to investors, ranking it 19th in the world as a recipient of foreign direct investment, with an estimate of 256.8 billion dollars in 2009, up from 219.7 billion dollars in 2008. But how one reads the country’s investment climate depends on where one stands. The 2010 Energy Report from the Economist Intelligence Unit writes, The overall investment environment [in Russia] remains problematic, since the legislative framework is inadequate; in particular, there is an absence of a functioning framework for production-sharing agreements (PSAs). In addition, the government is reluctant to allow foreign majority control in the energy sector. Significant exceptions have included the Sakhalin offshore projects, although here too the government has reasserted state control.

A special advertising section in Oil & Gas Financial Journal, however, describes Russia as an energy superpower grappling with the challenge of redefining itself for the 21st century. Part of the problem is that old stereotypes prevail where they should not. Russia is keen today to show itself as a country bursting with potential, as open and transparent as any other market across the globe. Although a lot still needs to happen before the world begins to view Russia in this way, the current situation means that for those who are not risk-averse, the market holds much potential. It is clear that Russia’s key oil and gas decision makers, although focused in different areas and on different challenges and opportunities, are all working towards one common goal: making Russia a strong energy player for the sake of the economy, for business and for its citizens.

If that is Russia’s goal, hard-eyed analysts, surveying the countries of the world and comparing statistics among them, conclude that this work-in-progress is far from finished. Forbes Magazine’s 2011 list of Best Countries for Business ranks Russia number 102, behind Armenia and ahead of Ukraine. That rank places Russia significantly below Poland (38), Slovakia (33), Romania (52) and Turkey (54).
While citing Russia’s progress toward a market-based, globally integrated economy, the CIA Fact Book notes that protection of property rights is still weak and the private sector remains subject to heavy state interference. Forbes ranks Russia’s market performance 8th in the world, but some other ranks - investor protection (74), red tape (79), and technology and tax burden (69 each) - place it in the middle of the pack, while still others - corruption (115), trade freedom (108), and monetary freedom (118) - place it much lower.

The World Bank’s report, Doing Business 2011: Making a Difference for Entrepreneurs, which compares business regulations in 183 economies, ranks Russia even lower: 123rd overall for ease of doing business, behind Slovakia (41), Romania (56), Turkey (65), and Poland (70).
For investor protection, Russia earns a rank of 93; for dealing with construction permits, 182; and for cross-border trading, 162. Its one bright spot in this report appears to be a rank of 18 in enforcing contracts. There does not yet seem to be a well-established legal-political framework for third-party investments in Russia, writes the French Institute for International Relations (IFRI), an independent think tank.

To its credit, Russia is taking steps to harmonize its national accounting standards with the International Financial Reporting Standards. The effort was launched in 1998 and is due to be complete in 2011. But Russia’s integration in the world economy remains incomplete. Its accession to the World Trade Organization is still pending after more than 15 years of negotiation.
WTO membership would… exercise some leverage for making more progress with competition-enhancing reforms, says the OECD. As to foreign direct investment (FDI), inflows have until recently, been robust, but barriers to foreign ownership are estimated to be high in Russia compared to OECD countries. In part, this reflects the enactment in May 2008 of the law on strategic industries, which defines 42 sectors in which control by foreign investors requires prior authorization from a government commission. (…) The emergence of large state-controlled conglomerates with dominant market positions also acts as a barrier to FDI inflows… Beyond explicit barriers to FDI, the overall regulatory environment in Russia is perhaps the most significant impediment to greater inflows of FDI.

But the UK-based risk-analysis firm Maplecroft most concisely sums up the ambivalence toward investment in Russia in its Political Risk Atlas 2011, published in January 2011. The atlas analyzes 196 countries and categorizes 11 of them as an extreme risk. Russia is one of them, in the company of Somalia, Zimbabwe and North Korea, among others. Contributing factors include terrorist attacks and the business environment, including corporate governance and corruption, compounded by an ineffective legal and regulatory system, which includes a lack of judicial independence, says Maplecroft.
Contradicting the World Bank, the firm also warns of the increasing risk of poor contract enforcement and expropriation. Irrespective of these risks, Maplecroft continues, Russia remains an attractive investment destination because of its resource security, infrastructure readiness and education. In addition, it notes, the country enjoys political stability, with a popular prime minister and a trusted president.

Natural Gas
In 2009, Russia published its energy strategy for the period up to 2030. It envisages investment of 565-590 billion dollars to increase its gas production by 33%. Russia has the world’s largest reserves of natural gas, 44.38 trillion m3, or 23.7% of the world’s total, according to the BP Statistical Review of World Energy 2010.
The next-largest reserves, in Iran and Qatar, together make up 29.3% of the world’s total, putting more than half of the world’s gas reserves within Europe’s reach. But they are less accessible for Europe than are Russia’s, which can deliver its production via pipeline. Iran was to have been a source for the Nabucco Pipeline, but the sanctions on the Islamic Republic have precluded that plan, and Qatar’s gas is being delivered primarily via ships in liquid form. That is a principal reason for Europe’s dependence on Russian gas and for the EU’s anxiety over the various pipeline options -Nord Stream, South Stream, and Nabucco, among others - that are being promoted to deliver gas.

Accounting for nearly 85% of Russia’s gas production and owning the gas pipeline network, Gazprom is the dominant force in its industry. As such, it has figured prominently in disputes over gas transmission via transit countries like Ukraine that have led to disruptions of supply to the EU in the dead of winter. Gazprom insists the cutoffs were the result of payment disputes alone, but many Western analysts consider the crises at least partially induced as an exercise in foreign-policy leverage by the government that owns Gazprom.
Gazprom’s two main strategic projects today are the Yamal Peninsula and the Shtokman field in the Barents Sea. Gas reserves totaling 10.4 trillion m3 have been discovered in the Yamal Peninsula, and the Russian energy strategy estimates that capital investments in the range of 166-198 billion dollars will be required to develop them.
Gazprom began drilling at the largest Yamal field, Bovanenkovo, in 2008, 11 years late, aiming for production in 2011 at an estimated cost of 10 billion dollars. Favored as a strategic company under the 2008 law on strategic industries, Gazprom has been able to secure licenses on gasfields in Yamal without public auction, and until recently the company intended to develop Bovanenkovo without foreign participation.

Facing complications both technical and economic, Gazprom has reduced its investment 22%, delaying production until 2012. The apparent change in policy that produced the BP-Rosneft stock swap, however, has also softened resistance to foreign investment in Yamal, opening the door to Total’s purchase of the stake in Novatek, which is developing the Yamal LNG project.
Gazprom announced in 2006 that it would develop the huge Shtokman gas- field in the Barents Sea alone, but in 2007, Total and StatoilHydro were invited to take stakes of 25% and 24%, respectively in Shtokman Development, the company that will design, finance, and build the infrastructure.
Gazprom will retain full ownership of the Shtokman license, however. The rapid development of shale-gas deposits in the US has altered plans for an LNG plant in the Shtokman project. The US was considered to be a primary market for Shtokman production, but the country no longer requires natural-gas imports at their former level. The partners decided in early 2010 to defer a final investment decision on the LNG plant until December 2011, pending completion of a US EPA study on the environmental impact of hydraulic fracturing, the method used to unlock the gas deposits in shale.

The shale-gas development has affected gas prices worldwide because it has removed a large part of US demand from the world gas market. In September 2010, Russia and Norway agreed on a maritime border in the Barents after 40 years of negotiation, opening the area to oil and gas development that had been stalled by the dispute.
The Russian government seems keen to explore the possibility of opening the [Arctic] shelf to private companies, says the O&GFJ Russian ad section, because Rosneft and Gazprom, the only Russian companies allowed to explore and produce there under current law, can’t invest the 207 billion dollars required to do the job in a timely fashion. We’re looking to expand the list of companies allowed to get licenses for development of the offshore fields, said Sergey Donskoy, deputy minister of Natural Resources and Ecology.

Moving the gas to market remains a challenge. Russia’s gasfields are mostly in remote locations and pipelines of extraordinary length are required to deliver the production. Complicating the problem are the transit countries - Ukraine, Belarus, and the Baltic Countries - that lie between Russia and the European market. Europe receives 25% of its gas from Russia, with 90% of that transiting Ukraine. Gazprom’s solution consists of two pipelines, Nord Stream and South Stream, that bypass all transit countries.
At an estimated cost of 10 billion dollars, Nord Stream runs 1,200 km from Vyborg, Russia, under the Baltic Sea, to Greifswald, Germany. The pipe was inaugurated in November of 2011 and is now fully operational. A second pipe will follow a year later. For roughly the same cost, South Stream will cross the Black Sea from Beregovaya, Russia, to Varna, Bulgaria, whence it will split, with one branch running through Greece and Albania to Italy and the other via Serbia and Hungary to the Baumgarten Hub in Austria.
South Stream is still in development, aiming for completion by 2015. Eni of Italy is participating and Électricité de France is negotiating to join the project as a strategic partner with Gazprom, which hinted in February 2011 that other partners might soon be added. Gazprom has proposed expanding its Yamal-Europe gas pipeline with a second line doubling the total capacity to 28.3 billion m3, but disagreement over its route is holding up the project.

An intriguing possibility for a route to the East Asian market is being explored. In August 2010, Russian shipping company Sovcomflot sent a 100,000-deadweight- ton Aframax ship laden with gas condensate, escorted by two of the world’s biggest nuclear-powered icebreakers, from Murmansk to Ningbo, China, via the Northern Sea Route, i.e., around the north and eastern tip of Siberia and then south to China. The trip took 22 days and cut the traditional route via the Suez Canal nearly in half, from 12,000 nautical miles to 6,600 miles. Sovcomflot has announced a program of commercial voyages via the Northern Sea Route for later in 2011 to further test the route’s commercial viability. If successful, it will open an entirely new shipping channel for production from the Shtokman field as well as from the proposed Yamal LNG plant.

The 2030 energy strategy envisages increasing Russia’s oil production about 10% with 609-625 billion dollars of capital investments. The modest goal for expansion reflects the reality that Russia already produces close to its top capacity; the investment will be required just for exploration and production from new fields and to enhance output of fields that are being depleted. Russian oil majors have not been investing enough in the exploration of new fields, many of which are found in remote Arctic regions of eastern Siberia, where exploration and exploitation will be considerably more expensive and technically challenging, says the Economist Intelligence Unit.
Exploration and production will be even more challenging and expensive in the Arctic offshore, where vast reserves are suspected to lie. Given the Russian companies’ limited offshore experience, these areas probably will be more open to foreign investment, as the Rosneft deals with Chevron and Exxon Mobil in the Black Sea and with BP in the South Mara Sea suggest. In January 2010, Natural Resources Minister Yuri Trutnev called for opening Russia’s offshore oil and gas reserves to international oil companies, saying that developing those reserves would take 160 years at the current rate of investment by Gazprom and Rosneft.

ConocoPhillips and BP have long been among the most prominent foreign investors in the Russian oil industry. Conoco acquired a 7.6% shareholding in Lukoil for 2 billion dollars in 2004 and later increased its holding to 20%. The US firm reduced that by half in spring 2010 to improve its balance sheet. The 2003 merger of Tyumen Oil Company (TNK) with BP’s Russian oil assets produced TNK-BP, Russia’s thirdlargest oil producer, of which BP owns 50%. However, that merger has suffered a series of trials that give would-be investors in Russian energy good reason to be cautious. Whether its fortunes will turn under the presumed new policy described by Stratfor remains to be seen.
Russian oil has flowed to Eastern Europe since 1964 via the Druzhba (Friendship) pipeline, which supplied oil to several of the Soviet Union’s Warsaw Pact allies. It is a network that extends from deep in European Russia to eastern Germany, Hungary, and the Czech Republic, with extensions now continuing into other parts of the EU. Several proposed additions are under study, but nothing yet has gone very far beyond planning.

The state pipeline monopoly, Transneft, also has been active in developing new routes for its oil exports, building Primorsk as a Baltic oil export terminal and now adding construction of Ust-Luga nearby as a companion port. The first part of the Baltic Pipeline System became operational in 2001 with the Primorsk terminal. A second trunk line now being added will supply Ust-Luga by 2012. Looking eastward as well, Transneft began exporting oil in 2009 via the Eastern Siberia-Pacific Ocean Pipeline (ESPO). The line then was just 2,694 km long, from Taishet to Skovorodino, from where the oil is being trucked to Kozmino on the Pacific coast near Vladivostok.
Construction of the pipeline is continuing now to Kozmino and is scheduled for completion in 2014, but a spur from Skovorodino to Daqing, China, was completed in 2010, and crude-oil shipments commenced January 1, 2011. But Putin, seeking shelter from the volatility of commodity prices, is urging the industry to produce more petroleum products, and the Kremlin has crafted the tax laws to support that goal. Export taxes on refiners are lower than those on crude suppliers, and the state is preparing to discourage construction of boutique refineries by prohibiting refineries with a depth of less than 70% from using Transneft’s pipelines. Refining depth refers to the quality and range of a plant’s products. The country has 40 large refineries with a total crude processing capacity of 5.4 million bbl/day, according to the Oil & Gas Journal.

Russia’s energy strategy for the period to 2030 envisages the establishment of large complexes for production and refining of oil, gas and petrochemicals in new oil-producing regions. The plan calls for refineries with depth up to 72% in the first phase, ending between 2013 and 2015, with increases to 83% and later 90% in subsequent phases. Expansions are planned for refineries at Tuapse and Kirishinetteorgsintez, and new oil chemical complexes will be constructed in the Republic of Tatarstan and in Primorsk.

The reform of Russia’s nominal 200 GW electricity system was accomplished with much less turmoil than the privatization in the 1990s. Between 2004 and 2008, generation, transmission and distribution were unbundled and Unified Energy System, the federationwide electricity utility, was broken up. Most of the thermal powerplants and combined heat-and-powerplants were grouped, respectively, into six wholesale generating companies, called OGKs, and 14 territorial generating companies, called TGKs, all privatized.
Hydroelectric plants, nuclear plants, the transmission grid, distribution companies and system operator also were grouped in separate companies, but remain state-owned, either fully or with majority state control. The restructuring was intended to attract investment to the competitive parts of the system. The Russian energy strategy forecasts that 577-888 billion dollars of capital investments will be required in the period to 2030 to expand and modernize the system, almost all of which dates from Soviet times, is heavily dependent on coal, and is already at or near the end of its design life.

Buyers of the OGKs and TGKs during the reform undertook an obligation in the purchase to introduce new power facilities within the next 10 years, including 40,900 MW between 2006 and 2010. They are legally bound to begin investing in expansion of the powerplant stock soon, although several have failed to meet their investment obligations, blaming the poor economy.
The government had promised to stop capping electricity prices by 2011, thus adding to the attraction for investment capital. The government also is pilottesting a new system of tariff regulation for grid companies using the regulatory asset base methodology to replace the cost-plus system. If adopted, the RAB tariff is expected to attract investment for the upgrade of the 3.2-million-km transmission system, of which 118,000 km are cables over 220 kV.

The transmission grid’s inadequate condition has caused congestion and is partially responsible for the low capacity factors in the generation system. The Federal Grid Company plans to invest 14.5 billion dollars by 2013 to modernize the high-voltage grid. Siemens has a cooperation agreement for this with FGC, using its high-voltage DC transmission technology.
The dilapidated state of the generation system was glaringly evident when a turbine at the Sayano-Shushenskaya hydropower plant broke apart in 2009, flooding the turbine hall and engine room and claiming 75 lives. Another red flag is the fact that about half of the 31 nuclear reactors in Russia’s 23,200 MW generating fleet use the same RBMK design that was used at the ill-fated Chernobyl plant, and the nuclear fleet operates with a suboptimal 80% capacity factor, although that has been rapidly improving in recent years.

Ten nuclear units now are under construction and probably will replace at least some of the older stock, and an extensive uprating program is under way. One plant, the 2,300-MW, two-unit Baltic Nuclear Powerplant in Kaliningrad is the first nuclear plant to be authorized for construction in Russia with private-sector investment and joint ownership, said Maxim Kozlov, head of the project team for the Russian reactor project at utility Inter RAO UES in an interview with Platts energy newsletters. Rosenergoatom, the nuclear power station operator, will hold 51% of the 6.1-billion dollars plant, but the rest is available for foreign investment.
A Rosatom official added that the utility plans to build more plants in partnerships in the future. In March 2010, Rosatom said it would commission three new reactors per year from 2016 to 2020, and the Russian nuclear power program appears to be shrugging off concerns raised by the tsunami- damaged Fukushima Dai-ichi disaster in Japan.
But these plans took a bit of a hit when Rosatom’s pending joint venture with Siemens was canceled when Siemens announced it would be exiting the atomic energy market. In response, Rosatom signed a deal with Rolls- Royce in late-September to collaborate in the civil nuclear market and is seeking further partnership with Italian utility Enel to fill the void. Rosatom and Italian utility Enel are cooperating on development of nuclear powerplants in Central and Eastern Europe as well. Enel has developed extensive investments in the Russian power sector since 2004, including 54% of electricity wholesaler OGK-5. Germanybased E.ON controls another wholesaler, OGK-4, with a 71% stake.

The 2030 energy strategy projects that non-fuel energy (nuclear and hydro) will double by 2030, raising the combined share of these sectors, now 32%, to at least 38% of the nation’s power supply. As noted, these two sectors remain under state control, but in October 2010, First Deputy Prime Minister Igor Shuvalov said Russia might sell nearly 8% of RusHydro as well as 4.1% of the Federal Grid Company.
Russia has built two of the largest hydroelectric powerplants in the world, but still only 45,000 MW, 20% of the country’s vast hydroelectric potential, has been developed. RusHydro has 6,367 MW of large powerplants under construction; one project, the 3,000 MW Boguchanskaya plant on the lower Angara River in Krasnoyarsk Territory, is obtaining financing from external investors, as are a number of small hydro projects in the Caucasus.

One reason so little hydropower has been developed is the remoteness of the resources from potential load centers. Most of the hydro potential is in Siberia and the Russian Far East, while the population is concentrated largely in European Russia. The Boguchanskaya plant is being developed to serve a greenfield aluminum smelter also now in construction. Future hydropower development may require similar arrangements or the construction of long high-voltage DC lines to deliver the power to distant load centers.

The “new” renewable
Renewable energy, other than hydropower, has gotten short shrift in Russia, but the 2030 energy strategy sets a goal to increase non-hydro renewable energy production from 0.5% to 4.5% of the total by 2020.
The goal for wind alone is 5,000 MW, and several EU-based energy companies have already made their moves. Netherlands-based Windlife Energy in 2008 received approval from regional authorities to build the first 200 MW of up to 2,000 MW of wind capacity in the Kola Peninsula. The developer, Windlife Arctic Power, is a 51/49 joint venture with local shareholders. Construction was scheduled to start in 2011. In June 2010, Siemens, RusHydro and Rostechnologii agreed to form a joint venture to install at least 1,250 MW of wind capacity in Russia by 2015. The next month, Genoa-based ERG Renew and Lukoil agreed to cooperate in developing joint business opportunities in Eastern Europe and Russia, specifically focusing on wind energy.