Can Russian Energy Survive Western Sanctions?

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Break out your old copy of Risk, dust off the board, and have fun mimicking the expansion underway at the hands of Russia's most charismatic dictator, Vladimir Putin.  While the board game actually includes the Crimean Peninsula in the "Russia" space, real life does not function in the same way -- or at least, not without Putin's best efforts to bring the southern tip of Ukraine back into the fold of Mother Russia.  The sanctions levied against the Russian Federation by NATO member states and western allies after the junta took force have delivered all but a knockout punch to the ruble, having collapsed in 2014 and slowly crawling back up through 2015.  Russian banks cannot seek capital from western firms; arms deals with the EU have been taken off the table; most nations will not sell Russia oil technology.  That third sanction has resulted in some creative accounting to keep oil flowing in one direction and capital flowing in the other, but Russia cannot trade goods for oil indefinitely, especially not when energy accounts for 65% of their exports.  Some Russian oil projects have already withered under western pressure.  What does the path to recovery look like for Russia and for oil?

It's Not Rosy For Rosneft

Americans experience oil consumption at the tail end of fierce competition needed to get petroleum out of the ground and into our SUVs.  For many other nations -- including, of course, Russia -- state-owned oil companies dictate the availability of crude and crude by-products rather than marketing the black liquid to customers.  Of the four oil companies that operate in Russia (yes, you read that number correctly), two trade publicly and two enjoy state funding to stay afloat.  The state-run companies have enjoyed the short end of the stick at the same time that the publicly-traded companies manage to stay afloat during the nation's currency collapse.  One company, Rosneft, faces serious questions about the future of their business due to two particular factors: first, the aforementioned currency failure, and second, the difficulty in accessing oil from the Kara Sea.  These two factors weigh heavily on the nation's largest oil extraction and refining corporation, which in turn weighs heavily on oil itself. 

Kerosene and the Kara Sea

Unless you took a geography class in college, most Americans may be forgiven for not knowing anything at all about the Kara Sea, perhaps including the very fact that it exists.  Not only does it exist, but it contains huge reserves of fossil fuels.  Not only does it contain huge reserves of fossil fuels, Rosneft enjoys the rights to extract every drop of oil and every cubic inch of natural gas from beneath the sea floor.  Rosneft won the licensing rights to develop three areas of hydrocarbon reserves, known collectively as the East Prinovozemelsky Field or the Vostochno-Prinovozemelskoye Structure.  An estimated thirty-five billion barrels of oil and ten trillion cubic meters (that's trillion, with a T) of natural gas lie under the waves, ready for extraction in some of the most merciless drilling conditions known on planet Earth.  The Kara Sea poses enough of a problem to Russian energy concerns, as it lies under ice for three-quarters of the year and sends twenty-foot waves crashing into ships and structures for the other three months.  The plan for Rosneft to develop the Kara Sea's holdings in the East Prinovozemelsky Field represents a personal goal of Putin, who openly desires Russian hegemony over arctic energy development while also developing new sources of output to reach new markets.  As of June, however, Rosneft appears to need to put the Kara Sea project on the shelf for at least another three years.  Sanctions against Russian oil interests not only keep the buying power of Russia down, but mitigate the ability of western oil developers to help tap into the vast wealth buried off the northern coast of Siberia.

American Interests and Russian Cooperation

On the surface, you'd think Rosneft and Exxon-Mobile to be unusual bedfellows.  Not only do they do business across rival nations and markets, but both compete annually for the title of the number one oil company in the world based on drilling output.  Economics makes it easy to bury hatchets, however, and any competition between the two nations appeared to be a thing of the past in 2013 when both companies signed an agreement to develop an oil rig known as Universitetskaya-1.  The joint venture resulted in a thorough survey of a field called Pobeda (Russian for "Victory").  Once the black gold came gushing out of Pobeda, it appeared clear that both Rosneft and Exxon-Mobile had lots to gain from their partnership.  At about the same time, however, pro-Russian separatist forces seized control of Crimea with Russian money, guns, and advice.  The international sanctions hammer fell hard on Rosneft and the Pobeda field, mandating that all western companies, including Exxon-Mobile, suspend their projects with state-owned Russian companies.  Exxon-Mobile packed their bags and went to survey new fields, leaving Rosneft behind without the cash to exploit the Pobeda field or open up a second drilling venture.  Today, they lack the equipment needed to capitalize on this oil and with the climate forcing the work schedule to advance only two months out of the year, Russia's newest oil venture appears quite literally dead in the water.

Takeaways: Expanding Gas

The oil and gas recovery of the past six months that followed the 2014 correction requires an absence of new supply to maintain an upward trajectory, even one as painfully slow as we've seen in the first half of 2015.  Russia's energy concerns appear to be a perfect roadblock to new supply thanks to the ample sanctions slapped on Moscow.  It may be three to five years before Russia can develop new oil and gas fields and dump fresh supply on the market, driving the price of fossil fuels upwards as demand continues to grow.  Watch the sanctions slapped on Russian wrists carefully: as soon as the first sanctions vanish in the process of diplomatic healing, it's time to sell oil and gas before they drop down when fresh energy comes onto the market.

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