Russian oil companies are getting ambitious – they would like to take as much as a 15 percent market share of the U.S. oil market. All the relevant companies have steadily increased their production. With petroleum prices at rarely seen highs, they have every incentive to do so, because domestic prices remain more than 50 percent lower than international ones. The government, too, is more than pleased with the added tax revenues garnered for state coffers.

However, Russia’s Soviet-era pipeline network is approaching full capacity. Increasing oil production was easy; companies were forced to be more efficient and aggressive with the resources under their command. Increasing export capacity is an entirely different proposition. It is also a highly political issue and the two competing projects aimed to increase pipeline capacity have run into a political minefield, pitting almost all oil companies against the government.

Transneft: problem or managed solution?

When it comes to regulating oil exports, the government’s instrument is the Transneft pipeline monopoly. This government-owned entity determines how much oil Russia exports – including how many barrels of oil companies are allowed to export via pipeline. Russian oil companies have become increasingly irritated with this system, while the government has insisted on keeping its hands on the taps of pipeline systems that hope to control the wealth that the Russian economy is so dependant on.

Transneft’s 3.5 million-barrels-per-day (bpd) export capacity is coping badly with the quick increase of domestic crude production. Since the middle of the 1990s, Russian oil companies have gone from producing approximately 6 million bpd to 8 million bpd, with the Fuel and Energy Ministry anticipating that production will reach 11 million bpd by the end of the decade. With exports already around 3.5 million bpd, Russia’s leading oil companies are being asked to consider if pursuing the goal of increasing total production really makes sense.

Signed, sealed – but not delivered

There are already some disturbing indications that production increases may go undelivered. At the start of this year, Fuel and Energy Minister Igor Yusufov claimed that Russia’s oil producers had applied for a total of 8.5 million bpd of transport capacity through the Transneft pipeline network, with the government planning an allocation of only 7.8 million bpd for the year. The math is simple; 800,000 to 900,000 barrels of crude may not make it to the market each day.

Already, this year, Surgutneftegaz made it known that the company was unable to ship 500,000 tons of its oil, while LUKoil, Russia’s second-largest producer after Yukos, has voiced concern that Russia might face a deficit of 8 million to 18 million tons in export capacity by October of this year if Transneft does not respond to the growing oil output of domestic oil producers. LUKoil goes even further, projecting that the deficit will grow to 29 million tons by 2005 and then to 80 million tons by 2010, if new transportation routes are not built.

Short-term solutions not the answer

Improving the existing pipeline does not seem to be the solution to Russia’s oil-export concerns. Transneft’s Chairman Semyen Vainshtock claims that only $3 billion needs to be spent on the existing pipeline network to service all the capacity, but several billion more are needed to build new ones.

Beyond the pipeline upgrades, Russia could quickly increase export capacity by re-opening the Baltic port of Ventspils, with a carrying capacity of 350,000 bpd. This port is in Latvia, and the Latvian government does not see eye to eye with Transneft.

But Transneft has been behaving in a less-than-diplomatic manner with the Latvians. It simply wants to buy the port, at one time the largest outlet for Russian crude on its way to Northern Europe, while the Latvians have shown no inclination to sell. In retaliation, the Russian Energy Ministry decided to halt all exports through Ventspils in January, hinting that return to the previous status would be considered only when the Latvians decide to sell the port.

Solution 1: The Baltics – to serve an established customer base

The most obvious way to increase Russia’s oil-export capacity, at least in the medium term, is to enhance the carrying infrastructure of the Baltic Pipeline System (BPS) located in Primorsk, a city on the Gulf of Finland. The Baltic port is the obvious choice, as the greater part of Russia’s non-C.I.S. oil exports continue to go to Western Europe.

According to Vainshtock, his monopoly is anticipating government approval of a plan to expand BPS’ operations – giving it an increased capacity of from 600,000 bpd to 840,000 bpd or even 1.2 million bpd.

This constitutes a significant increase from the initially planned 120,000 bpd. The project will include approximately $1 billion of investment, including the construction of 700 kilometers of new pipeline from Yaroslav, a city north of Moscow, to the port at Primorsk. Last month, the government looked favorably on the Primorsk port project, expecting capacity output to triple by 2005. While this project can increase export capacity, most Russian oils have noted that the port does have its problems – it freezes over during winter and is not the export point from which Russia can make its position felt in the world. Looking to the West is correct, but looking even further west is probably more lucrative and politically attractive.

Solution 2: Murmansk – aiming at a future with America

At the end of last year, on the back of the American-Russian energy summit in Houston, Russia’s four leading oil companies committed themselves to building, collectively, a new 2 million-bpd Western Siberia-Murmansk pipeline to direct exports to the American market – for the most part, still untouched by Russian oils. Transneft, not surprisingly, is against the construction of this pipeline as – in addition to not owning and controlling it – it has made the dubious claim that there is not enough oil to fill both the proposed Murmansk pipeline and existing pipelines.

The Murmansk export point does have its advantages – it is ice-free year round and Yukos, presently exporting further westward, claims that exporting to the United States is profitable, though many industry analysts have their doubts on the issue.

So far, the government of Prime Minister Mikhail Kasyanov has come out against the idea, though it has not rejected it entirely. Clearly, the government wants to protect its raw-materials-export privileges, even if Russian oil companies fund the project without state assistance. The final outcome of the oil sector-state confrontation is expected in late March.

Solution 3: China – Russia’s wildcard geopolitical future

Yukos has also butted heads with Transneft on the very important issue of oil exports to China and the East in general. Yukos has negotiated an export route stretching from its western Siberian fields near Tomsk to northwest China via a 2,200 km, 400,000 bpd Angarsk-Daqing pipeline. Yukos is committed to build and pay for the Russian portion of the line, with China committed to pay for the length that runs through its territory.

This conflicts with Transneft’s plans for the East. Yukos has big goals, but Transneft’s appear to be even larger. Evisioning supplying Japan, Transneft plans to construct a 1 million-bpd pipeline system of 5,000 km starting from western Siberia and ending in Nakhodka on the Pacific coast. If there is enough oil to fill both Yukos’ pipeline and Transneft’s is open to question. Russia’s future political relationship with China is in doubt as well.

Quiet flows the crude?

Increasing Russia’s petroleum-export capacity may be the most pressing concern facing the government and the countries’ oil majors. It goes without saying that Russian oils very much desire to enhance their bottom line as much as possible, while the government intends to protect its legal right to benefit from export duties. The lack of knowledge of how best to deliver Russia’s petroleum lifeline to the world hurts both the government and oil companies; surely, a compromise will have to be found. As of this report, the government decision on the future of Transneft and planned pipelines has been delayed until May, keeping the market waiting.