Russian Oil and U.S. Energy Security

March 6, 2003

Transcript prepared from a tape recording

9:45 a.m.	Registration
10:00	Moderator:	Leon Aron, AEI
	Panelists:	Fiona Hill, Brookings Institution
		James Richard, Firebird Management
Noon	Adjournment

Proceedings:

DR. ARON: --Jamie Richard. The last time we heard from him, he was prevented from boarding a shuttle in New York due to deicing, and now I hear that even if he did get through, there is apparently a delay over the Key Bridge. So he will be here, trust me. And Fiona graciously agreed to change the order of our presentations and go first.

In the packets that you have, there are articles by all three of us. Two excellent pieces; one by Fiona in Demokratizatsiya and by Jamie Richard in last year's Foreign Affairs, and my Op-Ed in the New York Times. Together, they look at somewhat different aspects, but I think they provide a sufficient background for delving deeper into this fascinating problem because as with everything connected with oil, it's a peculiarly political commodity, I would say a peculiarly geopolitical commodity. But as I believe Fiona particularly will stress, it is also a very political commodity within Russia which explains a great deal of constraints on Russia's ability to export and the way in which it exports.

Fiona, shall we? Thank you.

DR. HILL: Thanks very much, Leon.

I also want to apologize in advance that my voice is stranger than normal. I do have this impediment of a British accent, but unfortunately I've got a very heavy cold. So if my voice appears very strange, please signal to me, and I'll try to speak more clearly. Anyway, the cold is weighing me down a little bit, so apologies in advance.

What I was going to do today, I was hoping to pick up, from Jim Richards, who we were expecting to give a larger overview of energy security issues, so some of my comments on the domestic situation in Russia may seem a little out of a larger context, but I'm going to proceed and talk about them in any case.

So what I will do, though, is start with some general observations tied into the questions that Leon posed in his description of this event today; the question he posed about whether can Russia save America from dependence on unstable Middle Eastern regimes, he asked some of the questions about what are the long-term technological commercial and political prospects, Russian oil production and what are some of the obstacles to increased investment by American oil companies.

So I'll make a few observations on those, and then I'll get into what I really wanted to talk about in my presentation, which is some of the domestic context for energy within Russia, and hopefully that will give Jim Richards enough time to get himself off the Key Bridge and get in here.

Otherwise, I believe we do have his PowerPoint presentation, so maybe we'll solicit a volunteer from the audience to play the role of Jim Richards and read his PowerPoint. Improvisation is always good.

In any case, we've had so much discussion over the last several months of Russia, and its purported new role in energy markets. I mean, there are many people here who have written about that. There's been a great deal of interest, especially with the new U.S.-Russian energy dialogue, and clearly Russia is a major player in international energy markets, as it was, of course, in the Soviet period.

Now, I would like to say that although in the long term there's potential for still more increases in Russian oil production exports, especially as demand at home remains depressed, and it will do for the foreseeable future, Russia just simply cannot compensate for disruptions in oil supply from the Middle East. I think we've actually started to see that in some of the discussion now in the major papers. We've had a lot of reports about the limitations on Russian oil in the New York Times and elsewhere. So we are seeing a change now in the discussion of Russian energy.

We will, of course, see Russia increase its market share in the United States and Asia, as well as in Europe, but basically Russia has neither the reserves, nor the production capacity, to save America from dependence on the Middle East, so to answer that first question that Leon posed.

In the immediate term, it faces serious infrastructure constraints to increasing its exports. Right now Russia's exports, especially to the United States, are limited by a lack of pipelines and deport or port facilities, and although we've obviously seen a great deal of progress on this front over the last five years, the basic problem persists.

In terms of the much-propounded new U.S.-Russian oil relationship, only limited energy cooperation seems possible in the short term, unless the U.S. itself takes a major policy decision to put the energy relationship onto a new and categorically different footing.

One of the major points to bear in mind when we're looking at the role of Russia in the energy markets is that, for Russians, a lot of this discussion is really a one-way street. The Russian oil companies want more access to the U.S. market and to other markets, not more penetration of U.S. or international oil mergers into their market. They don't simply want to sell oil either to U.S. consumers. They also want to break into refining and downstream operations in the U.S., as well as Europe, and we've seen a lot of Russian oil companies purchasing refinery capacity here in the United States and also in the former Eastern bloc countries.

One major sign of the eagerness of Russian companies to secure a foothold in the U.S. market was the unprecedented proposal late last year by several Russian oil companies--Yukos, LukOil, TNK, Sibnet and also, potentially, Surgutneftegas--to establish a consortium to finance and construct a pipeline system for a planned new deport or port at Murmansk. I think Leon is going to talk a little bit about this later this morning.

Now, this is going to be an unusual collaboration for these rivals, especially as this has a very large price tag. I've heard talk of something around $4.5 billion, although obviously that's unclear at this pint. And the company has also announced in their initial proposal that they'd even be willing for Transneft, the Russian pipeline monopoly, to manage the pipeline system as long as they could have a say in setting the tariffs.

Now, this is a pretty, as I said, unprecedented step for Russian oil companies, and although the project is still up in the air, it really underscores the very serious sense of shared purpose between Russian oil companies and the Russian government itself. The companies want more export terminals, especially those that are going to allow bulk oil exports to the United States, and the Russian government is also very much a proponent of seeing its oil companies break into Middle East-dominated markets and to increase Russian market share specifically in the U.S. market, which will obviously give a further boost to the important U.S.-Russian relationship for the Putin administration.

Now, looking ahead to what a U.S. Russian energy relationship might look like, we have to factor in several issues.

First, in the short term, Russian oil companies are cash and reserve rich. They don't really need a great deal of new U.S. investment, but they will in the long term, especially if they want to try to bring new reserves into production in very hard-to-reach inhospitable areas like the Northern Seas within the Arctic Circle, where there's the greatest potential for major new reserve finds.

They're also going to need a lot of investment for oil services. We've already seen U.S. oil service companies act really quite beneficially in the Russian market, and also investment for the critical issue of infrastructure expansion that I keep stressing.

But for U.S. companies themselves, there's going to be very limited opportunity for those that seek to secure their own reserve base in Russia. We saw attempts at that under the initial production-sharing agreement frameworks of the early 1990s, and the fact that these opportunities are limited is in discord by the fact that two of these early PSA agreements, the production-sharing agreement arrangements, that were initiated not just in Russia, but in the broader area--that's Tengiz project in Kazakhstan linked into the Caspian Pipeline Consortium and Sakhalin-2 in Russia have been experiencing some serious difficulties of late.

Even the threat of the Chevron experience of a renegotiation of their investment in Kazakhstan, that was averted, but anyway this underscores that the PSA framework is in some jeopardy, and in fact it's been repeatedly stressed by Russian government officials and Russian oil industry insiders that new PSAs are not likely to be forthcoming, no matter how much pressure is put on the Russian government by the U.S. government or by international oil companies.

The simple fact is that neither the government, nor the Russian oil companies, really want to share their reserves, and there's considerable resistance, especially in the Duma and in other circles within Russia, given high world oil prices to permit foreign companies to acquire control and ownership of Russian strategic assets.

So the real opportunities for the U.S., in a commercial sense in Russia, are in things like project design, engineering, construction and transportation and in assisting Russian oil companies in building again this new infrastructure, that they need to expand on their crude oil production and export levels.

Now, this is the one area where really the Russian oil companies can't compete, and we've also seen some possibilities for securing equity stakes in Russian companies themselves. Obviously, the biggest development in that area is BP's announcement that they're going to take a 50-percent equity share in a new Russian company which will be a merger of SIDANCO and TNK. So that's obviously something to watch very closely.

A third major point that I want to make in this regard is that we have to bear in mind at all times that the Russian government and its energy policy is also focusing on its own national security and own domestic economic needs and certainly not thinking entirely about the commercial priorities, even of its own oil companies, and certainly not of U.S. or international oil companies.

Energy is going to be the big issue in Russian domestic and foreign policy in the next foreseeable decades. Energy and energy revenues, those are always stressed by Russian government and oil company officials, are critically important to the Russian economy and the Russian budget. Just as a basic rule of thumb, oil and gas account for nearly a quarter of Russian GDP, about half of its export earnings, and around a third of government tax revenues.

Economists, including my colleague at Brookings, Clifford Gaddy, have estimated that every dollar increase in the world market price of a barrel of oil translates into as much as $1.5 billion of additional yearly budget revenues. That's on the high side, but it's roughly about a dollar in the price of oil, plus or minus, and a billion, plus or minus, for revenues for the Russian budget.

And energy is really, and I just want to underscore this again, the one major strategic asset that the Russian state has left, aside from nuclear weapons. It's the one area in which Russia can really punch above its weight in the international arena, and that's both economically and politically. Energy is really what is giving Russia these days its clout in the world economy.

Now, this being said I'd like to use that as a segue to start to talk about some of the domestic ramifications of Russian energy, and I'm going to be talking here about some things that are not usually raised in D.C. when we think about this. It may seem a little esoteric at first, but bear with me because I will bring this right back again to oil.

The basic premise of this discussion is that there are many conflicting demands on the use of energy in Russia itself. There's obviously the demand to fuel Russia's economic development, and that's internally, the hope that Russian energy revenues will also help to provide a boost for other sectors of the economy, to increase Russia's external economic influence and its dealings with other states, to satisfy the aspirations of Russia's own oil companies to build world-class operations.

People like Mikhail Khodorkovsky have said quite repeatedly that they want to turn their companies into the next Exxon, the next Chevron, the next BP--they don't just want to be confined in their own domestic arena--for Russia itself to compete as a unity in world energy markets, and then this is the other point that I want to elaborate on, to support Siberian development and maintain the population there.

Basically, millions of people in Russia could simply not survive in the harsh climate in which they live and work without an abundance of energy at low cost. And this raises a major question in the next year or so about the ability of the Russian government to implement what is seen as the next major stage in its reforms of utility reform outside Moscow and the European Russian Cities.

You probably know that there's a major debate going on now inside Russia, as to how they're going to turn over housing utilities, energy, water, electricity and so on from being subsidized heavily by municipalities and by the central government to having the consumer pay.

Now, if you think that about 60 percent of Russian territory is in Siberia, and obviously I don't have to emphasize how cold it is in Siberia right now because we're also apparently suffering from a blast of cold Siberian air coming via the Arctic and dumping snow on us, and we know our own utility bills are going through the ceiling, but it's going to be very hard for people to basically cover those kind of expenditures, especially when you think that in some places of Siberia, for 180 days in the year you have a very heavy snow cover and extremely low temperatures.

Revenues from energy fuel the Russian economy, and the energy itself are essential in terms of keeping power stations and the domestic heating system going. So energy is the key element in Russia, both domestically and internationally. And, again, energy allows people in Russia to keep going in places they couldn't possibly under other circumstances.

I've actually just finished writing a book, with my Brookings colleague, Clifford Gaddy, that covers all of these issues. It's the result of a two-year research project that we've been doing on looking at the obstacles to Russia's long-term growth. We've basically been looking at the consequences of Russia having operated for 70 years under a Soviet central-planned economy.

What we've really concluded is that one of the major outcomes of 70 years of central planning is a very peculiar and unique Soviet economic geography that's really put Russia completely out of step now with other countries that have just come out of the Soviet era and really put it completely out of step with a lot of the market economic premises that we've expected to see bearing results since 1991.

Basically, the point is that in spite of dismantling central planning and getting rid of the whole Soviet apparatus, Russia still has the legacy of a command administrative economy across its territory. You have people, factories, cities and many other major assets in places where Communist planners put them, not where they would have been attracted into normal circumstances by market economic forces.

Our basic argument is that it's extraordinarily difficult for Russia to build a competitive market economy on this basis, and essential to this is the development of Siberia, which has been a very specific feature of this legacy.

In the instance of Siberia, this huge vast territory that we always associate so closely with Russia, the market was deliberately defied and perversely turned on its head by the use of the gulog system, the extensive prison system, to bring people out to industrialize this territory. Beginning in the 1930s, I mean, we're all familiar with this, of course, we're now on the 50th anniversary of Stalin's death. There's been some discussion of this in the papers recently.

Stalin, in particular, used slave labor to build factories, and cities, and huge industries in some of the most harsh and forbidding places on the planet and where the state could otherwise not have persuaded any of its citizens to go en masse and on a permanent basis.

In the 1960s and '70s, when the gulog system was dismantled, the Soviet planners were then, in their efforts to create permanent pools of labor in Siberia, forced to actually induce people out with extremely high wages and a whole variety of subsidies, and that period also coincided with the mass scale development of oil and gas resources in the region.

So, basically, Siberia has contributed a huge, but very hidden, cost to the state, and really what we see today is the legacy of the gulog and of Communist planning in this whole large development of Siberia which is centered around, in many parts, oil and gas industry.

And thanks to the industrialization and mass settlement of Siberia, we now have literally a third of Russia's population, if you take into account the Ural Region moving further east, that works in particularly inhospitable climatic conditions and about a tenth of the total population working in very cold and very large cities in Siberia where average January temperatures range from minus 15 to minus 14 degrees Celsius. That's plus 5 to minus 40 degrees Fahrenheit.

And given the location of these cities, they depend very heavily on central government subsidies for fuel, as well as obviously for food and other preferential tariffs and things like transportation.

And costs of living in these Siberian cities are as much as four times as high as elsewhere in Russia, and the costs of industrial production is sometimes as much as ten times higher.

So as a result of this centrally planned system under the Soviet period, Russia today is more burdened by problems associated with the costs of cold, as well as distance, than any other state in Northern latitudes, including the United States, Canada and any of the Scandinavian countries.

What I'd like to point out here is that one of the peculiarities of the Russian land mass that some of you may be aware of, but mostly people don't realize, is that it gets cold in Russia the further east you go from Russia, not the further north. So if you were to go in a straight line from Moscow straight off east across the territory of Russia, across Siberia to the Pacific Coast, the temperatures drop off precipitously, and they don't even rise appreciably when you reach the Pacific Ocean. In fact, it's 13 degrees colder on the Pacific Coast in a straight line out from Moscow than it is in Moscow itself.

If you did the same thing in the U.S. going out from New York, heading straight west, of course you get the Pacific Ocean effect there, and it's about 8 degrees warmer. So you don't have the same kind of crazy spikes across the U.S. territory as you do across Russia.

If we look back across the last 10 years, the situation of the problems of cold have not been alleviated by people moving out of these areas. We all expected, after the collapse of the Soviet Union, that, you know, finally, if people were given the opportunity to move, they'd obviously get the heck out of some of these God forsaken places and move somewhere else.

But, unfortunately, people have been constrained in moving. There were no jobs and housing elsewhere, and imagine trying to sell an apartment in somewhere like Magadan--I mean, who's going to buy that?--so that you can move to somewhere like Sochi, which is obviously very nice, very warm and nice there on the Black Sea, Mr. Putin's favorite holiday destination.

So basically people have been stuck in place, and although some people have moved from some of the most marginal areas of this territory, they've mostly stayed within the cold zone by moving to some of the biggest cities.

So the problem is that Siberia means a permanent tax on the economy of the Russian Federation, and the Russian government has, in fact, maintained a policy over the last 10 years of even trying to repopulate and redevelop Siberia precisely because this is the region that contains its richest energy resources, and of course all of the other natural resources for which Russia is well-known.

So this brings us once again back to oil because the men take away from looking at the current economic geography of Russia, where population is located, where industry is located, where some of the biggest cities in the Russian Federation are located. Novosibirsk is, of course, one of these larger cities, 1.5 million people, and one of the coldest spots on the planet. Their energy is the essential element in maintaining this economy that Russia has inherited from the Soviet Union.

Now, if Siberia had not been so rich in energy resources, you could actually make the argument that it couldn't have been developed at all. If there hadn't been so much oil and gas in Siberia, people couldn't simply have moved out there because their oil and gas is also being used to maintain them there, and so energy remains critical to people's survival. You can't just now turn off the heat for millions of people living out in some of this harsh territory, and the Russian government has to simply keep subsidizing them because, as I said, most people in these cold areas couldn't possibly afford to pay their utility bills.

So at home on the domestic market, the Russian government regulates energy prices. It keeps them artificially low, and this has actually become a sticking point in the Russian government's dealings, especially with the European Union. The European Union is pressing the Russian government to bring these differential prices into line, so to have world prices also operating on the Russian domestic market.

This would actually have been an impossibility for the Russian government because it's the low utility prices, the low prices of power that keep most Russian industry and most Russian municipalities in operation.

And securing the revenues to make all of these subsidies possible again comes back to our issue of oil exports. The Russian government needs to keep its companies pumping oil out for exports to again boost the revenues, and high international oil prices then become extraordinarily important for Russia domestically.

High international oil prices, in fact, become even a life-and-death issue for people living in Siberia. Because when one bears in mind, again, as I said, a change in the price of oil by a dollar, that translates to the equivalent of a billion in revenues in the Russian budget.

This becomes extremely important when even a low-ball figure for the estimates for subsidizing fuel deliveries to some of the most harsh climatic zones in the Russian Federation costs $700 million on an annual basis, and that's a low-ball figure for this. In fact, the Russian Duma thinks it's, in fact, much higher. So there you are. That's almost a billion dollars there in terms of fuel subsidies, which the government is going to have to keep paying, it's the sad fact.

Another additional point that I'd like to raise in concluding is that Gazprom, the Russian gas monopoly--Russia, of course, is sitting on the world's largest reserves of gas--unlike the Russian oil industry actually operates consistently at a loss, a quite considerable loss. And the distinction here is that Gazprom is only able to export one-third of its production.

That's a stark contrast to the oil industry. The oil industry exports two-thirds of its production because the demand for oil at home is less. Most of Russian power stations, in fact, are fired by gas or coal, rather than fuel oil, although fuel oil is used in some of the area, but again like here, oil is mostly used in the transportation sector. Of course, that's also expensive in Russia, but it's gas that really keeps the factories and the cities heated and powered.

And for Gazprom to actually make a profit, it would need to have domestic gas prices to rise, but as I explained, these have to be kept depressed because the whole edifice would fall apart. So, in other words, now oil revenues are subsidizing even Gazprom and the whole sectors of the economy because it's only by keeping all revenues high through high oil prices that you're able to keep all of this going.

So, clearly, the point that I'm trying to make here is that this is all a major calculation for the Russian government when it thinks about energy, and so you can't really disassociate Russian oil when you're thinking about it in international arena from this domestic context. There's a lot of constraints and a lot of demands on energy, and even though Russian oil companies may be operating independently and would like to see themselves as the next Exxons or Chevrons, there's an awful lot of pressure on them, internally, from the Russian government, to keep their eyes on the big picture, which is the future of the Russian economy overall and, in fact, these life or death issues of whether people freeze to death or whether they have heating in their homes in Siberia.

I'd like to conclude here. I don't think we've got Jim Richards, have we? Oh, he's coming. That's great, so I don't have to keep blathering on. So what I'll do is I'll conclude with a quick plug for my book, which is called, "The Siberian Curse: How Communist Planners Left Russia Out in the Cold." It's coming out soon, we hope, unless it gets left out in the cold itself. But, anyway, keep your eyes open.

I'd like to advise all of you to buy the next Harry Potter book on Amazon.com because then it sneaks up as a best seller.

[Laughter.]

DR. ARON: Thank you very much, Fiona, for a characteristically brilliant presentation.

Not to just simply fill the gap before Jamie Richard gets here, but let me follow up with a very brief footnote on the Murmansk pipeline.

It's probably too early for a very much in-depth analysis, but let me give you a few factors because this story of the Murmansk pipeline is not only going to be with us I think for at least a few years, but it also is symbolic of the confluence of all sorts of interests, domestic, political, Russia's geopolitical, the relationship with the United States, and Russian long-term strategic, economic and political planning.

The background is very simple. The major oil companies, and I know this firsthand from some of the CEOs, including the CEO of Yukos, Mikhail Khodorkovsky, who was at AEI a few weeks ago, calculated that it would cost them, if the pipelines from Siberia, and also the Pechora Region, are laid to Murmansk, which is Russia's only all-year-round port, as you remember Gulfstream, it's the tail end, and that's why it never freezes, it would cost them about $8 a barrel to bring that oil that's transported to the United States, which is very competitive, they say, with the price of transportation of the Mid-Eastern oil. So it makes sense.

It makes sense, also, with respect to the price dynamics. Again, they calculate that if the price of oil per barrel goes below $20, it becomes economically nonfeasible for them to transport it via rail. It simply, given the tariffs and given the fact that I think if you want to mention, that one of the natural monopolies, so-called natural monopolies still left, in addition to the currently being reformed United Energy System, is the rail.

And here, because of various very serious vested political interests and the opposition in the Duma, the government is even more cautious than with respect to the railways, excuse me, electricity. Because of that, we cannot expect the lowering of our railway tariffs any time soon.

As a result, when the price of oil goes below a certain mark, the oil major simply said we would stop shipping it by rail. They need to ship it by rail now because there is not enough volume in the pipelines. So, with all of that, it makes imminent economic sense to lay down those pipelines to Murmansk.

Now, where is the opposition and why is it such a controversial issue? Well, some of the stuff is predictable. It is ideological opposition simply to surrendering a major foothold, yet another major foothold that the state has in the Russian economy. That, of course, is the position of a lot of mid-level bureaucrats inside the Kremlin.

Secondly, it's an economic interest. A great many people are feeding around those pipelines. What the Russians call "dosta tribar" [ph], is one of the key feeders for all kinds of bureaucrats because they could, even though, according to the Russian anti-monopoly legislation, anybody, any major oil producer must have access to the Transneft, which is the state company that runs all the pipes. In practice, of course, this is not the case. On the black market, the bureaucrats, in effect, sell the right to access the pipeline.

So these are the predictable things. Now, we're getting into the more interesting stuff. Elections. Putin feels that he needs to hold something over the oligarchs so they do not behave the way they used to, in the Yeltsin days, in terms of determining or influencing Russian politics. And the state ownership of the pipelines, obviously, with the ability to close things down, make things more difficult, increase or decrease the volume, is an important tool, which I don't think Putin will actually use, but it would be very nice for him to hold in abeyance against some irrational exuberance of the oil majors in the political field.

We've had meeting, in fact, Fiona was present, I cannot, still, I'm bound by the agreement, and therefore I cannot name the name, but you probably would know, a very, very high Russian official passed through town last week and was a guest at AEI, and I posed that question directly to him. And the sense is this; that at the highest level, Putin, his chief of staff, people around him, and obviously the Gref Kudrin axis, have absolutely no objections. In fact, they would welcome, on ideological and economic grounds, the first ever private pipelines in Russia.

But the opposition comes from those who feel that this is an unwise policy, in terms of the Russian domestic politics. I mentioned some of the factors, but also--and that pertains very much to what Fiona was saying--they simply do not want the Russian oil companies to export too much oil. Partly, it's one of those vicious circles that Russian economy is still very much tangled in. The price of domestic oil and fuel is heavily subsidized. Therefore, it does not make sense economically for the oil majors to sell or to orient themselves onto the domestic market; therefore, they orient themselves exclusively on export, and the government is afraid that if now they get their own pipeline, they would really try to sell more oil on the outside than would be rational, in terms of heavily subsidized and heavily dependent domestic consumption.

So these are all sorts of reasons and all sorts of considerations that go into this seeming impasse. Let me give you a few predictions, and this is where the Russian geostrategic position comes in.

Originally, when the relationship between Russia and the U.S. were very good, until the last month I would say, the scenario was that the issue of the Murmansk pipelines would be raised to the highest level, and when President Bush sees Putin at the then-scheduled, and I'm not sure if now it's going to happen, but let's hope it will, the meeting, first of all, G8 in St. Petersburg, but also a sort of a side trip connected to the 300th anniversary of Putin's birth city, which is St. Petersburg, that the administration, the White House will lean very heavily in favor of the pipelines, and there's been a great deal of lobbying by major oil companies here, and their representatives here, and also in various meetings in town.

Now, Russia's position on Iraq, as it stands today, does not really make for sort of, you know, cozy, heart-to-heart chats between Putin and Bush. The situation is very fluid, by the way, and things could change very quickly because Putin, incidently, has kept silent on the issue of Iraq, and we've known this tradition from the previous Russian administrations, where the truculence of the underlings is often there to provide a grand stage for the president to come over and cut the "Gordian Knot."

So things could change in a different direction. At the moment, however, it seems that the American pressure or, say, the American desire expressed directly at the highest level for those pipelines is not forthcoming as of today or at least been put on hold. Therefore, it seems to me that the issue will then be postponed after two things; after the December duma elections and after the presidential election in Russia in March 2004.

I'm willing to predict that after that, given the sufficient anti-monopoly legislation around the pipelines, something that the highest Russian officials were concerned about because they are afraid that the four majors that are responsible for the pipelines would not allow the access to other oil companies, but if that is resolved, I believe that sometime in 2004, spring/summer, we will see generally a movement in the direction of allowing, one way or the other, those pipelines to begin being constructed.

One of the major concessions made by the four majors that are behind the project is that they would build it, but they would give it to the state to manage. I think that's a very clever, but also very significant concession, and it shows that they are buying Putin's implicit bargain; that is, they remove themselves from the pipeline as a tool of politics. They allow the state to hold that political commanding height. All they're interested in is exporting as much oil as they can.

So I was told that Jamie is on the way and ought to be here any minute. I suggest that why don't we start with Q&A, at this point, to Fiona or myself, and then when he comes, we'll stop Q&A, and then he'll launch into the presentation.

We have a microphone there, right? Please. If you could identify yourself.

QUESTION: Sure, Chow Ching [ph], freelance correspondent.

Leon, you said that oil is political commodity or geopolitical commodity. I think it's more than that. We may say it's like gold.

My question, the first one is this. Since it is like gold, and it's quite demanding, you only talk about their market in terms of U.S., but Europe, non-Russian Europe and China, or any thirsty place, so how about the U.S. in competing with these two?

The second question is this. On coal, where is the coal produced, and what's the volume? And in terms of energy, what's the percentage of the energy in Russia produced by coal?

Thank you.

DR. HILL: You're absolutely right. I mean, we should also be thinking in terms of Russian oil exports towards Europe and Asia. I was clearly beginning, because Leon had posed the question about can Russia save the United States, but, in fact, the bulk of Russian oil exports right now go to Europe. Obviously, that's because of proximity and because of all of the infrastructure constraints we've just talked about. Russia hasn't been able to reorient itself away from those markets.

Now, we're in the midst of some major discussions about Russian energy, not just oil, but also gas exports to China and to elsewhere in Asia. Obviously, the Sakhalin projects are perfectly suited for exports to Asia. It would be ridiculous to think that we might build a pipeline from Sakhalin going in the opposite direction towards Europe. And so we have a whole range of potential exports form Sakhalin, oil, gas, LNG, and this is the big debate now as to whether Russia can conclude contracts, not just with China, but also with Japan and potentially with Korea for long-term exports to the region from Sakhalin, and that's going to be a major issue.

Clearly, China, Japan and Korea are extremely interested in Russian energy. We saw a slight tussle between China and Japan with Russia as kind of the middle man there about where a pipeline might go from Siberia to Angarsk, whether this might pass through Chinese territory or go directly to Angarsk through Russia and serve the Japanese market. It looks right now that it's going to go into China, but all of these things are still open.

So we have to really factor in Russia's role in Asia, as well as in the U.S., and I would argue that, in fact, it makes more sense for Russian energy to go to Asia and to Europe over the longer term than it does to the United States, and gas is going to be a major issue in the next 10 to 20 years, and clearly gas is less of an internationally traded commodity and more of a regional commodity, and I think we're going to have to watch very closely how Russia positions itself on international gas markets, especially as it does have the largest reserves and the largest capacity of gas.

In terms of your question of coal production, coal is actually produced almost primarily to serve power stations in Siberia, in Eastern Siberia. I think--I'll have to check this--but something about roughly 50 percent of power production in Siberia is coming from coal. In fact, the whole coal industry developed precisely because of this point that I emphasized about the industrialization of Siberia to feed the power stations and industry there.

The coal sector is in really big trouble, but the big, major problem for Russia is how to convert all of those power stations from coal, being coal-fired to gas. That's going to be an almost impossible task.

In fact, the former head of UES, in a discussion with me for this book, basically said that it would be cheaper to move everybody out of Eastern Siberia than to transfer all of the power stations over to gas. So that's an impossible prospect for Russia to face, a very difficult one, but obviously the coal industry in Russia, its days are numbered, and this is something that the Russian government is going to have to think about.

Also, for China, this is actually a major problem. The Chinese coal production is still very profitable. I think the bulk of Chinese energy is still on coal, but of course that raises all of the questions about pollution. We know that China wants to move to at least 10 percent in the next 5 years of its power production coming from gas. Obviously, Russia becomes, again, a potential major source of that gas, as well as Central Asia.

So these are all going to be big debates over the next 5 to 10 years involving Russia and many of the adjacent countries.

DR. ARON: If I could just add one thing, and that is a minor--I mean, we are concentrated on the Murmansk because it's such a spectacular project, both in terms of its expense and its influence on the U.S. market, but Yukos, the second-largest oil company, is very seriously considering, and in fact it's running into the same bureaucratic and political problems with the pipeline that Fiona mentioned, which is going to go straight from the Siberian, West Siberian, pipelines into China.

Yukos said it's ready to start building it tomorrow. They have satisfied a rather stringent environmental concerns, including promising to elevate the pipes, rather than bury them in the ground, because they will be going through a couple of national parks.

But, again, the Transneft's, which is the state-owned monopoly, own pipelines is contesting that plan very energetically.

Sir, you've been very patient. Thank you.

QUESTION: [Off microphone.] [Inaudible]--right now the price of oil is very much controlled by the OPEC cartel. Although it's above their window, they would like it to be between $24 and $28 a barrel, but there's a lot of forces that could drive that down considerably, and could drive it down over the midterm considerably, to below $15.

What happens to the Russian oil industry at below $15 a barrel?

DR. HILL: Well, that's a big question for the Russian oil industry. I mean, obviously, Mikhail Khodorkovsky practically lives in D.C. right now, and every time he comes through here, he does kind of emphasize the importance of a certain price range.

Leon mentioned that the Russians have kind of stressed that they need something around $20 a barrel. Below that there comes a lot of problems in terms of the transportation. But as I had mentioned, the issue is not just so much the oil industry itself, but what happens to the Russian economy, and there's a great deal of speculation about what a hit that would make to the Russian economy.

In fact, there's actually a very good article that I would recommend. I don't know the people personally, so I'm not kind of plugging anyone I know here, but the Foreign Affairs this month, March-April, has an excellent article called "Axis of Oil" by David Victor and Nadejda Victor, which covers a lot of these issues extremely well. It's an excellent article. I guess the guy's an expert on sustainable development, and he talks there to some degree about what kind of a hit that this might take to the Russian economy.

In fact, most economists say that they don't really know what the impact would be on the Russian economy because of all of these hidden subsidies. It's very hard to kind of disaggregate all of that and to say what effect this would be on major industrial sectors. But as I have mentioned, as all revenues are really essentially subsidizing the entire economy, when you think about the power sector, the domestic heating sector and everything, you can be sure that it would make a major blow.

And, in fact, we did see in the early 1990s, when Russian oil companies were very eager to bring in international investment, when oil was hovering around $10 a barrel, they were in really serious difficulties. They didn't have the domestic capital to invest in the industry, to increase production, and it was really after 1998 the Russian oil companies took off as oil prices started to rise, and also as a direct effect of the crash of the ruble internally because that, of course, lowered the cost of inputs domestically.

So I think we can be fairly certain that this would be extremely negative for the Russian economy. To what extent it would be is hard to guess, but I think it would have a major impact on growth, and it would be a major political problem for the Putin government because then they would have a very hard time in trying to deal with this question of utilities and what to do about the difference between domestic and international prices.

So it's very much the case that for the Russian oil sector overall, and for the Russian government, high oil prices is where they want to go. And obviously this current environment is very good for them. What happens over the long term, post a war in Iraq, I mean, of course, we've got lots of speculation about how long it would take, in fact, for there to be a reverse effect in oil prices for them to come down again.

I think they're watching that with some trepidation, which is why I think they're very anxious right now to push along with so many of these projects, like the Murmansk project that Leon has mentioned, to try to get a foothold now to break into some of the markets and to present themselves, as much as possible, as a stable alternative to the Middle East and as many markets as they possibly can, including in Asia, not just in the United States.

DR. ARON: In terms of what happens to the economy, let me give you a stark figure that was recently mentioned Aleksey Kudrin, who is Deputy Minister of Finance.

For each drop of a dollar per barrel, Russian GDP, according to him, drops by half a percentage point. You're talking about $15. That's $15 from the current price, say, at $30, 7.5 percent of the GDP is going to drop right there. So, clearly, this is a major, major blow.

Well, may I ask everybody else, who is on my list, to hold their questions.

Now, we have, live from New York, Jamie Richard, and exhausted, perhaps.

[Laughter.]

MR. RICHARD: I didn't know I had to take two planes to get to D.C. from New York. Sorry. I hope it was well worth your wait. I apologize for the delay, and thank you very much for the invitation.

DR. ARON: We're delighted you're here.

MR. RICHARD: I had an ominous notion, when I was first asked to come here, because the last time I tried to give this talk, a version of this talk on the Russian oil industry was last April 4th, at the Vernon Center at NYU, and they had sent out invitations by mail, and it was going to be a chichi wine and cheese event, and then it turns out my dad has to have brain cancer that day. So I knew that it might be pretty bleak, so I can't tell you how delighted I am to be here and to talk a bit about the Russian oil industry and that some of the ideas that I've put forward still resonate even in such a difficult international environment.

[Tape change.]

MR. RICHARD: Let me begin by saying that a few weeks after President Vladimir Putin's telephone call offering condolences and support to a troubled George Bush on 9/11, I was part of en e-mail exchange that focused on a 1998 comment from Osama bin Laden, in which Mr. bin Laden stated that if he were in control of the Arabian Peninsula, oil would trade at $144 a barrel.

Joining the debate, a former Arab Gulf Oil Ministry official gave several thoughtful and lengthy points as to why the United States really couldn't alter its post-9/11 energy policy. He stated clearly the world's largest oil reserves were in the Middle East and went on to say that over the past 25 years, Saudi Arabia had promoted both market stability and low oil prices.

As a student of the Middle East, I knew this point of view very well, but as an investor I also knew that given global oil reserves and their expected useful economic life, a depoliticized barrel of oil shouldn't trade for more than $8 a barrel.

I thought, further, I wondered if cartels were truly market friendly, why hadn't OPEC raised output over the last 20 years? So even still I wasn't too concerned, except for when the writer went on to say that with all of the corruption in Russia and the Caspian, that the region really hadn't panned out as a source of non-OPEC supply.

He wrapped up by stating that because there was no new non-OPEC supply, no new 1980s equivalence of the Gulf of Mexico or Alaska or the North Sea, that there was very little the United States could do to reduce its, let alone global, oil dependency on the Middle East.

I want to challenge some of these assumptions today. And firstly I wanted to discuss the privatization and investment process that is increasing corporate dynamism, oil output and export capacity in the former Soviet Union. I also want to talk about the underestimated reserves of the region and how, in the end of the post-Cold War era, Russian oil firms are better positioned to develop their reserves for the global market.

Looking at monthly production data, back to 1980 for both the former Soviet Union and Russia--I'm sorry--for both the former Soviet Union and Saudi Arabia, you get the sense of the immense change that has occurred in both oil sectors.

During the 1980s, Saudi Arabia, the orange line, was experiencing limited success with its experiment as a long-term swing producer, taking the country's oil production down to just over 2 million barrels a day in 1985.

During the same period, the Soviets, the blue line, were actually the world's largest producer of oil at roughly 12 million barrels a day. However, the unrivaled Soviet production was not particularly beneficial to the burgeoning global oil market, which had only a few years earlier seen prices finally liberalized in the United States.

Now, during the entire Communist period, Moscow lifted most of its oil out of the ground to pump it into the air via some very curious economic activity. As we well know, these environmentally challenged businesses had more to do with the politics of the 5-year plan the creation of wealth, and during this period, the Kremlin only exported about 2 to 3 million barrels a day of its oil production for Soviet hard-currency needs.

At the same time, the Saudi economy ran, and still runs, according to a 5-year plan, with many of the country's prized companies under state control. As I note, the 5-year plan of the early 1980s included a food security policy that saw Saudi Arabia become the world's fifth-largest exporter of wheat.

While agribusiness is controlled by princes who often sold wheat on the world market at 30 percent of the cost of the subsidies that it had taken to produce it, the country was basically exporting petro dollars and immense amounts of its most precious commodity, which was water.

Just as Saudi Arabia's wheat policy became too expensive for the kingdom in the early 1990s, the Soviet Union's oil industry suffered its inevitable fade as well.

Since the deregulation of the U.S. oil market in the late 1970s, the global oil market has lurched forward in fits and starts towards a semblance of a normalized and efficient market. While the market is still inefficient due to its long-term strategic and overly politicized characteristics, the period from 1988 to 1994 did more to free a chunk of the world's oil production and reserves from the control of the state than any since before President Eisenhower began regulating the world's largest consuming country in the mid 1950s.

In 1986, oil prices collapsed to $12 a barrel, from $30 a barrel a year earlier, after the Saudis ended their long-term wheat-producing experiment, which lost them not only revenue, but market share to non-OPEC suppliers such as the North Sea and the Gulf of Mexico.

However, pressure mounted on an increasingly insolvent Soviet Union as well. And soon after the Iraqi invasion of Kuwait and the set-off of the second Gulf War, the Saudis increased production by 3 million barrels a day within a matter of months. The Soviet Union disintegrated shortly thereafter, and to this day Russians have in mind the Saudi increase after 1986. Both collapsed prices and revenues.

After Russia's reformers had finished with mass privatization in the mid 1990s, the largest transfer in human history of property into state hands had occurred. In the oil sector, a handful of the best companies were taken over by emerging financial groups that used state favoritism and loans to seize control of prized assets.

Other oil executives fended off hostile attacks by expanding their patronage networks. Nevertheless, privatization ended Russia's long night of communism for once and for all, and without the rule of law and the institutions that were needed to regulate, protect and build confidence in the market, the reformers hadn't thought much about what would come next.

They did know, however, that the owners of the new companies eventually would manage their assets in a more economically rational way than those who had run before them.

So if we go back to our output chart, and as you can see, by 1995, production had bottomed out, and many of the domestic Ponzi schemes that had been earlier put on a domestic population had ended as well. Even still, in the oil sector, the consolidation process that followed wasn't particularly graceful, and many of the cut-throat schemes that had earlier been played out on unsuspecting Russians were now thrust upon domestic and foreign investors on the stock exchange, in clear view of global media outlets.

Scandals involving minority shareholders' rights, asset stripping, transfer pricing, and run-of-the-mill corruption led many global investors and the oil majors to flee the country after the Yeltsin government defaulted on its own domestic debt pyramid scheme and devalued the ruble in August of 1998.

For years, the new cycle out of Moscow was understandably bleak, but what wasn't being reported was that the limited nature of the rule of law in the country had actually caused many of the scandals. Owners justified their actions as a way to break the hold of managers and shareholders that resisted the transformation of these firms into efficient and legitimate enterprises, and they couldn't take the risk that this wouldn't happen.

In other instances even before ownership was clearly established, management of the Russian oil majors began implementing corporate restructurings that included an adoption of internationally accepted accounting principles, information and technology systems that enabled real-time control of those accounts, professional human resource management, and professionally managed production flows and field practices.

Even though much remains to be done, particularly with regards to corruption, the implementation of good financial and production practices quickly transform Soviet enterprises into rational corporate entities in less than five years.

Just when things appeared to be getting better at the corporate level, the oil price collapsed due to an inter-OPEC feud, which was compounded by weakening demand due to the 1997 Asian crisis.

Let me continue with political and economic consolidation.

The Russian financial crisis of 1998 had profound implications for the political landscape of the economy and the country. The crisis and nonpayment problems that preceded it, focused attention of business elites on a need to find a political equilibrium that could provide stability to enable them to develop the assets they now own beyond a Yeltsin-era six-month time horizon.

Elected in March of 2000, President Putin had an instant impact. As you can see from this chart showing U.S., Russian, and Saudi production since 1997, Russian producers immediately began to invest in production from the money they were accumulating from both a higher oil price and lower costs due to the ruble devaluation.

They also brought in Western technical expertise at an increased pace, and this directly translated to the growth of 1.7 million barrels a day in production over the past three years. For the first time in generations, Russian oil producers had actually helped supply the demands of the global marketplace. And this just-in-time- production increase coincided with the downturn in the global economy and OPEC production cuts aimed at supporting the cartel's $22 to $28 price ban in the face of falling global oil demand.

As you can see from the chart, the Russian increase also came at a time when U.S. production, the green line, was falling, making the world's largest consumer market more dependent on potentially higher priced oil.

Needless to say, U.S. politicians and policymakers welcomed the Russian increase. And, personally, thinking about the supply disruptions in Venezuela since December, I think we would be seeing much higher oil at the moment, even though it is at a 12-year high.

Each day that passes, the tolerance for corruption and incompetence in the Russian oil industry diminishes, and these are the demands of the market. Here are Russia's largest oil producers and their daily production rates. All are publicly listed companies or part of publicly listed groups, except for Rosneft, which is still state owned.

Solid management practices, better corporate governance, and the need for international capital and expertise have changed the way Russian companies exploit their resources. This is the reality as reflected in the simple fact that Soviet producers milk their wells over an inefficient 60-year recovery period due to a complete lack of appropriate incentives and disregard for energy prices.

For comparison, industry standards call for pumping wells at a higher volume over a 20-year period. With the combination of inexpensive Russian drilling equipment, state-of-the-art technology, Western oil servicing partnerships that bring training and know-how, every Russian producer is at or quickly approaching industry standards in their field management practices.

Increasingly, top executives of Russian oil companies are Anglo-American and already have long careers with global energy giants. Today's production growth is a mix of old well-enhancement servicing, new well development and a revival of shut-in wells through an annual estimated investment of $2.5 billion directly from the company's cash flows.

In 2002, Yukos brought on 334 new wells, and today average drilling to production efficiency rates in the Russian oil industry are 165 barrels a day, with Yukos reaching closer to 600.

In this war, jittery, risk-averse investment climate, British Petroleum in February swapped its 25-percent stake in SIDANCO and nearly $7 billion in cash and shares to purchase a 50-percent stake in a Russian oil producer. That new company is TNK-SIDANCO and was formed by a merger of two independent companies. And you can see on the slide that the new company is displayed as TNK-SIDANCO, which was valued at $18 billion.

However, by Russian standards, the new company even has mediocre reserves and lower-than-industry average in new well recovery rates. On Slide 8, you can see BP's annual production gains, and BP will also add the company's 5.2 billion barrels of reserves to its balance sheet.

Undoubtedly, large equity stakes can be purchased for the right price--with a big caveat--but for the right price, in at least a couple of the Russian oil producers, including the largest, Yukos.

The BP-TNK deal and Gazprom's recent $1.6- billion debt placement demonstrates that Russian assets are sought after by global oil majors, as well as financial investors. The demands of the marketplace will keep Russia's oil reserves in efficient production mode for years to come. And while high energy prices are contributing to Russia reaching investment grade, the rule of law, reforms and expanding financial markets will continue to foster the country's long-term development.

Clearly, Russia's and the Caspian's reserves are not as large as the Middle East, but they are being brought on-line at a rate that's twice that of Persian Gulf oil producers.

On Slide 9 you can see the mature and developing exploration market, and you see in the green area the off-shore, future of Arctic off-shore in the Sea of Okhotsk off the East Coast.

Discrepancies remain as to what the exact difference is between the two regions' reserves. However, Russian reserves were always considered state secrets and still remain under wraps, as oil magnates try to buy control of new licenses. Wildly held plutocracy views of Russia only have helped to reinforce this low reserve estimate.

Undoubtedly, as the new owner of shiny, brand-new Russian assets, even BP's annual statistical survey should be more generous with its FSU reserve estimates. Prudently, successive Russian governments have been more interested in cleaning up existing production facilities and operations rather than expanding the oil-producing pie.

In Russia and the Caspian, there are seven major basins, each equal or larger to Alaska, the Gulf of Mexico and the North Sea. Capital-intensive Arctic off-shore productions in the Sea of Pechora, Kara and Okhotsk provide the longest term potential and greatest area for Russia international cooperation.

Some in the industry also want on-shore PSAs in Western and Eastern Siberia, and others believe that the country has the ability to both source this know-how and financing it themselves.

Whether the Middle East is larger by a factor of five or ten times, it's probably closer to five, the U.S.'s Fifth Fleet need not be moved to the Baltic or the Black Sea to protect the free flow of Russian oil. Fortunately, at a much lower cost to the U.S. taxpayer, both in blood and treasure, the former Soviet Union is being squarely placed under the rubric of market-oriented production, and this increasingly understood reality is putting, and will put pressure on OPEC to produce more oil for the global marketplace; if not, the cartel risks being further marginalized.

On Slide 10 you can see what's coming, literally, down the pike. As you see, the white line is millions of barrels per day of total FSU exports on the Y axis and the estimates are going out to 2010. Nearly all of these export routes on green on the map behind the graph are owned and operated by Transneft, the state-controlled pipeline company.

And due to recent Russian oil company and government wrangling over the future of export routes and potential capacity deficits, a point which I'll get a bit more into later, I've given a 10-percent discount to the estimated midpoint Russian oil export forecasts. Even still, you can see that by 2010, FSU crude exports are approaching 9 to 10 million barrels a day. This is even at less than a 10-percent growth rate.

As many of you are aware, the historical bottlenecks of pipelines and port capacities are easing at an increased pace. Of particular note in 2000 was the opening of the Caspian Pipeline Consortium adding transhipment capacity in Novorossiysk, and the Baltic Pipeline System and its outlets in the Gulf of Finland.

CPC gave the Kazak's their first outlet for exports outside of the Russian pipeline system, and in addition, it freed up more Russian crude to be delivered via the Transneft pipe. Due to the glut of oil in the domestic market, over 500,000 barrels a day of crude and refined products are currently leaving Russia via rail cars and river barges.

Since 9/11, Russian and Caspian export infrastructure has attracted increased interest from foreign governments wishing to reduce their dependency on Middle East crude supplies, including the United States, and as a direct result of this, ground was broken on the one-million-barrel-a-day pipeline from Baku to Ceyhan in mid 2002, and it will be ready to load Caspian crude for Western markets by 2005.

Out of the Houston Oil Energy Summit last October, the Murmansk Pipeline and Terminal deal was formally presented as a way for Russia to deliver crude to the United States via supertanker in deep-water ports. Russian oil firms and Transneft are haggling over the control of the Murmansk project, which has a scheduled 2008 completion date. With total pipeline and seaborne transport costs ranging at $3 to $4 a barrel, Russia and Caspian producers could be supplying 10 percent of the U.S. market by 2010.

China, Japan and South Korea are also keenly interested in the Russian plans to develop its oil and gas reserves in the Far East and export these resources to their countries. Last fall, a new pipeline was announced, which will carry a steady supply of gas from Sakhalin, off of Russia's East Coast, to Japan. This project will further decrease Japan's dependency on crude oil imports by 2005.

The other major development in the news these days is the Daching or Nahodka debate. The Daching alternative is supported by Yukos, who would carry oil inland to a captive Chinese market. The Nahodka option is supported by Japan, South Korea and Transneft and would reload seaborne crude to the highest bidder on the international market. Many oil industry experts say that these pipelines are too expensive to be built, but one or more will be likely loading within five years.

Currently, the only levers the Putin administration has over its publicly traded oil companies are via federal tax regimes and Transneft's control of exports. Some companies' high-profile owners and the government are currently in a row over the future of privately owned and operated pipelines. Much of it is focusing on Murmansk and the Far East.

While the oil companies believe that Transneft won't be able to keep up with their production growth and that there will be a serious export deficit by 2006-2007, the government says that it wants its oilmen to diversify their wealth into other parts of the economy.

In Slide 11, you can see why the Russian government is concerned about economic diversification by looking at a rather old, but relevant chart of the World Bank labor market sample that shows small- and medium-sized enterprise development in the former Communist bloc. While the developed economies have super majorities of jobs being held in small businesses, the restructuring of the Russian economy is only taking place at the very top, in sectors such as oil and gas, pulp and paper, metals and mining, the auto industry and an emerging retail sector.

The government is aware that the country's economic progression risks chaebolization, and they are more keen to chase Portugal's economic model than to chase Venezuela's.

Meanwhile, elsewhere in Eastern Europe, and even in the former Soviet republics of Estonia and Lithuania--and I'd just leave Latvia off because it's a mess--banking and legal reforms have advanced far enough enabling small business development and healthy economic diversification. Even still, President Putin and his advisers are more likely using Transneft to make the oil companies "heel" on tax issues and corporate governance problems and, by doing so now, inflicting the maximum paid for not doing so in a high oil-price environment.

Repeatedly in danger of losing its export capacity in recent months--I'd even say weeks--LukOil recently booked a $100-million tax charge due to a loophole that had closed in Kazakhstan. If the country really wants economic development in the long run, the oil industry is not the right place to lead small business development. With regards to the oil industry, even before the 2004 election, there should be some compromise on pipelines. Competition in the country's oil industry has come too far in the last decade simply to be held captive by the state through an anti-market effort.

Clearly, Russia is using its oil wealth to transition the economy's overall economic life away from inefficient operation. The process is only beginning, but President Putin, and his economic advisers, like German Gref and Andrei Illarionov, understand that the economy must become dynamic outside the oil and gas industry. Reforms must continue in the banking sector to enable entrepreneurs to get loans and in the legal system to enable business owners the ability to enforce contracts. As an investor, I think criminals should go to jail for corruption and extortion. That would be a helpful start.

Under President Putin, though, great strides have been made in the industry, and within a few years Russian oil firms will propel their exports beyond Europe and into the global marketplace, particularly with continued development of Sakhalin and a pipeline in the Far East.

Since 9/11, Moscow has increasingly viewed the country's oil resources as strategic assets to be used to garner influence on the world stage. What remains to be clarified is which way the country's path in the oil industry will be further developed, under Transneft or under an open and competitive oil export system. Nevertheless, Russia's contribution to efficiency and diversification in the global oil market deserves to be recognized.

Thanks.

DR. ARON: Jamie, thank you very much. That's one of the most beautiful presentations I've ever been present at, but also of course very substantive.

We have some questioners left over from the previous period. However, let me see if, yes, I will have to mark--Vince, would you sort of take care of the new arrivals, as far as questioning is concerned, sort of take their names, and positioning and so on, and then let me know.

Let's go on with the ones that were left from the previous period, and I will go to Cliff Kupchan.

Of course, please try to incorporate into your questions anything that you feel appropriate from Jamie's presentation.

QUESTION: Cliff Kupchan. Well, first of all, I recently got back from Moscow, and let me commend you, your article was widely read and had a huge influence in sort of the intellectual circles in Moscow.

My question gets back to Leon's fundamental question, which is to what extent can Russia supplant the Middle East as a supplier of U.S. oil? I think that's kind of what makes this topic so hot right now.

If I could state briefly what I perceive to be the U.S. argument, as expressed to me by people who I think are really smart--the U.S. argument on why this is a possibility. Your argument was at the beginning, common wisdom now is "no" is more or less the answer.

The first question in the U.S. point of view is can the Russians get their act together, and that mainly depends on can this consortium take form, and also what do the kind of silent trio of LukOil, Sibnet and Surgutneftegas think of this. We know what LukOil and BP think, we know what the government thinks, but the other three have bad PR, more or less, and we don't really know what they think.

But more to the point, can this all work given the current state of PSA legislation, which seems to be going down the tubes. You can certainly, you know, squeeze these wells hard, but can you do the well "workovers," can you do the Arctic exploration, which you were kind of emphasizing, without PSAs? I mean, Khodorkovsky is against them, even people like Vladimir Mau, you know, liberal economics, economists are against them now. The prospect is very bad.

But if you solve the Russian consortium argument--

DR. ARON: Excuse me. PSA is Product Sharing Agreements, for those of you who--

QUESTION: Let me just finish briefly. If you solve the PSA argument, if you solve the consortium argument, the U.S. government argues that the Murmansk line can supply 1 to 2.4 million barrels a day and that Russia, between the period of 2007 to 2009 could supply up to 25 percent of U.S. imports, thereby making a drastic dent in our dependence on the Middle East.

Could you respond to that.

MR. RICHARD: Frankly, I never, even in our article that we laid out originally in Foreign Affairs, Ed and I, I don't think that we ever thought that Russia could completely displace the Middle East as a supplier of oil. I mean, you know, our--

QUESTION: [Off microphone.] [Inaudible.]

MR. RICHARD: No, and I think that they can, and I think that puts pressure on Middle East producers to think about their own production.

Does that answer? I believe that by--there will be 10, possibly 15, percent of Russian crude in the United States market within 12 years, and that can be sustained for a period of 20 years.

I also want to get back to your question about LukOil and Surgut. Each company has a different corporate structure, and the old adage in, and I've heard this said, actually, from a CFO or a CEO who had negotiated a sale to LukOil, and said it's the only company in Russia where, as you go up on the floors, there are more guns.

[Laughter.]

MR. RICHARD: Because they're trying to protect each other from themselves. As I said, that's what happened in the consolidation period. The owners, the oilmen had to really go wide with their patronage networks to keep control of their assets, and these guys that came in and lost them, they had control from the early days.

So I think that, with LukOil, I mean, it's obviously a cherry of a, you know, every--well, Shell and Exxon-Mobil have to be drooling over the asset. I mean, it's incredibly diversified, upstream/downstream, and gets them into markets that they just probably couldn't get into. But in the meantime, it's being cleaned up, and it's a slow process, but it's very much ongoing.

You read kidnapping stories and things like that in the newspaper, and you know that somebody is making somebody else angry when it comes to the accounts and the way they're being presented. So it's being cleaned up, and you're seeing the consolidation of that process now.

I hope that--

DR. ARON: Fiona, do you want to add to that?

DR. HILL: Actually, I wanted to press Jim a bit further on this. Do you think that Russia is going to forego selling oil to Europe or to Asia to continue to supply the U.S. market or do you think that Russia can actually increase this market share in the U.S. with additional production?

For me, this is a bit of an odd debate because, in many mistakes, it doesn't matter really who you buy oil from, as long as, you know, kind of world supply is secure overall. So the idea that we're going to have lots of big barrels saying, you know, "Yukos" or "Made in Russia" being shipped over to the U.S., it just seems a little--

MR. RICHARD: I think that that's fine, and I've read that as well. But it's almost as if you say that a student doesn't care where the information comes from, just as long as he graduates. I mean, okay, the trader doesn't really care about where the oil comes from, and the end user doesn't really care, but governments care about this all the time, as do--even though the U.S. official policy is we don't really care where this stuff comes from, just as long as it comes out of a pipe, which is probably the healthiest attitude, and it probably comes out of the Vice President's Office.

But I think that also across the energy industry, other major trading houses do care where it comes from as well, and they need to secure those relationships for the long term, and I know there's a lot of strange things happening in the last two years that just were unheard of before because everybody had this perception of Russia in a very negative way.

DR. ARON: But what about the tail end of Fiona's question? Would the 10 to 15 percent of U.S. needs that you predict will be supplied by Russia--

DR. HILL: [Off microphone.] [Inaudible.]

DR. ARON: Will they reduce their market share in Europe and Asia or will that come from the new development?

MR. RICHARD: No, it's new. It's Timan-Pechora, it's increase in Western Siberia. I mean, some of it's going to come out of LukOil's North Caspian shelf, Western Kazakhstan. This is total FSU.

We could see the Kazaks and the Zarys producing up to 3 to 4 million barrels a day for export by 2010.

DR. ARON: Radek, thank you for being patient.

QUESTION: Radek Sikorski, [?] here at AEI.

Two questions. First, to Fiona. It seems to me that keeping energy prices low, in order to subsidize Siberia, is a very blunt way of doing it because you're subsidizing not just Siberia, you're subsidizing everybody else. In Central Europe what happened when world prices for energy were introduced, we found ourselves with 30-percent surplus energy because, clearly, having to pay real prices encourages conservation and savings. So it seems to me there is a major efficiency here that Russia could gain and are there any plans to get it, say, by paying people more so that they can afford the higher energy prices?

And, secondly, to both of you, both the panelists, to what extent are Russian gas and oil companies now really just private companies and to what extent does [?] of Russian geopolitical past? One reads about these debt or asset swaps in Armenia, in Belarus, the moves of some of these companies into Central Europe, to what extent these are purely commercial and to what extent they are political?

DR. ARON: Go ahead.

DR. HILL: On the efficiency issue, Radek, I entirely agree. It would be great if the Russians did become more efficient, and this is obviously a very big debate. We actually have a major problem here. As I said, we've been doing this major research project for the last two years, and the fundamental problem is, of course, that most of these industries out in Siberia are horribly inefficient. In fact, they couldn't possibly operate at any kind of profit with world energy prices.

Also, you have the major problems of municipal heating systems. In fact, if people can't pay their bills, you can't just cut off one person. So if you and I are in an apartment and we don't pay our bill, you have to cut off the entire apartment building to cut off one person because all of these buildings, with these big central heating systems, they didn't just start off and heat a building, but heated whole neighborhoods.

We've got many examples, in fact, in the Russian Far East where a factory doesn't pay its bill, so the utility, their local Energo, cuts them off, and they cut off hospitals, schools, and all of the apartment buildings all around, which then, of course, has lots of pensioners writing to Putin, and the heating comes right back on again the very next day. In fact, there was something recently I think in the paper about this, about a little old lady who wrote to complain to the president that her heating had been switched off, and it was switched back on immediately. So there's an awful lot of political pressure there to keep those utilities low.

It's probably true that in Moscow people can afford to pay their utility bills. This is where, of course, the boom in the economy is taking place. But if you actually look at the economic situation of most Russian cities, there's a [inaudible] of jobs. Most industries are [inaudible]. If you look at the profit-making enterprises, the bulk of those are all in Siberia and the Russian Far East.

In fact, Moscow itself, its economy, with the take-off in retail and all of the new industry that Jim was talking about, is heavily subsidizing the rest of the economy, too. So you might be able to institute it as a pilot program, greater efficiency in Moscow itself, and in some other selected areas, but you're not going to be able to do it across the whole country.

In fact, there have been a number of initiatives to try to make buildings more energy efficient, but the big problem is the bulk of the infrastructure in Siberia was built in the '60s and '70s. It was built in a hurry. It was built with substandard construction materials. There was no insulation. In fact, the Canadians have seen their potential profit-making opportunity here by importing Canadian model villages, but you can't turn Novosibirsk, with a population of 1.5 million people, over into a Canadian-model Arctic village any time quickly.

[Laughter.]

DR. HILL: So you have major inefficiencies in the system. I mean, essentially, most of Siberia is like the situation where you've got freezing cold, but you can't regulate the temperature inside, so you're opening the window and letting all of the heat out. In fact, we've got some horrific problems in some Siberian cities, where the groundwater is now coming up into the buildings, turning them into literally cubes of ice, internally, clunking heating systems breaking down.

There was an estimate by one of the municipal governments it would cost about $40 billion just to try to deal with some of these inefficiencies, and that's in the Murmansk and Northwest Region, where, in fact, because of the oil industry, there's a lot more capacity for economic development.

So this is a major problem that the Russian government faces, and I think it's going to be extremely hard, although you can, on the margins, improve efficiency, but to do the same things that you did in Eastern Europe because the scale is so much larger--

MR. RICHARD: And the climate is different.

DR. HILL: Yes, and of course the climate, as I mentioned in my presentation, it gets colder the further East you go, and because of the vagaries of Communist planning and moving some of the most productive people and some of the industries--we all know about how Stalin moved the industries out to the Urals and further East in World War II and that became a trend that continued right up until the 1980s.

You've now got the bizarre fact that some of your key industries are in some of the coldest places on the planet, as if in Canada, everybody's moved to Winnipeg, and that has now become the center of industry. The Canadians might have, of course, handled this a bit better, but this is a fundamental problem.

I'll just make a quick comment on the Russian oil companies and then hand over to Jim. I think what Jim said about the privatization is all very important, and Russian companies are operating like commercial entities, but I think that the sinews of Russian power are really behind the scenes.

And if you look at who is who in the Russian oil industry, they're all cut from the same cloth as who is who at the upper echelons of Russian political power. Khodorkovsky is a frequent visitor to the Kremlin. He has very close relationships with people within the presidential administration. There is a lot of discussion. Khodorkovsky, himself, for example, makes it very clear that he goes in to tell our[?] guys[?], you know, kind of what some of the things that they should be doing.

I mean, I can't imagine the head of Exxon coming in and talking to Bush and getting the same kind of hearing or Lord Brown in Britain certainly doesn't spend most of his time hanging out with Tony Blair at 10 Downing Street talking about the role of the economy.

I mean, the fact is, and I just want to emphasize again, in spite of the great commercial positions now of these oil companies, that this is still the strategic asset. The Russian government isn't going to let everybody go to far, and in fact there's been a great deal of discussion about 5/10 years down the line, depending on what's happening in diversification of the economy, of even trying to rein the oil companies back in. That was a discussion several months ago in Gref's institute, the idea that they may be putting the screws on more on the oil companies to try to create a kind of an escrow account for trying to stimulate the rest of the economy.

So there's a lot of questions still there that I have, just cautions, really, because I do think that the potential of the Russian oil sector is pretty considerable, but we have to remember who these people are and how differently politics in Russia operate from how it does here.

MR. RICHARD: Just to point out Fiona and I have never met. My nickname is Jamie, though, but that's okay.

[Laughter.]

MR. RICHARD: To your question about the purely commercial, purely private, I mean, you have to ask, in this sector, where is there a company that's purely commercial? I mean, the U.S. majors have been locked out Libya, Iraq, Iran for 25 years now almost, and I don't know.

I mean, of course, these elites have access, but I think elites in other countries have access as well, including Lord Brown, who is pushing this Transparency International as a way to get back at Total and ElfFina, you know. It does work somewhat similarly, although, you know, Russia is a very nascent place.

I think that in some companies they are more private and in some companies they are not. I guess, in the long run, I do see them all being more private.

DR. ARON: Ariel?

QUESTION: Ariel Cohen, the Heritage Foundation.

This couldn't be more timely because I'm coming out with a paper on Russian oil, also, and we came out in September with a paper on privatizing the Iraqi oil after the war, God willing, and now came out with the update for that paper, very much building on the experience of Russia, in terms of privatization of energy, which was unprecedented.

However, from your presentation, Jamie, and from your presentation, Fiona, you are seeing how the considerations of [French phrase] or affairs of the state are bumping into the market common sense. For example, you mentioned that Gazprom is exporting one-third, where the oil industry is exporting two-thirds, but Gazprom is also a monopoly, and it's also more heavily owned by the government, by the Russian government, than the oil sector. If, theoretically speaking, Gazprom was further privatized and was allowed to export more, it would be, following this logic, more profitable.

Furthermore, in the North, if you encourage people go leave or subsidize less, you would move to further economic efficiency, although, Fiona, I don't know where you traveled, I traveled to two places in Siberia; one is Barnaul and one is Tobol'sk. And it's not too bad in comparison with the Central European Russia which is crumbling.

So the problem in the North is they want to subsidize, among other things, you did mention, and probably you mentioned it in your book, because they don't want people from Siberia to run because they're looking at China next door, which is quite crowded in comparison to population density, but going through simple economics, it would make a lot of sense to bring Russian energy prices to the global level and then allow Russia to want to be more economically efficient and to export more to maximize revenue.

Do you think that, now that the state is stronger under Putin than it was under Yeltsin, Russia still has a chance to sort of squeeze more economic efficiency through a further privatization and the state retreating or we are past that point, and we are, like in case of Transneft and CPC, where Transneft is now trying to regulate CPC? And I was at the White House several days ago. They are not happy with Chevron being hurt by Transneft [inaudible] there.

So do you think we're past the point where further privatization in Russia can actually squeeze more economic efficiency, put more Russian oil and natural gas for exports, and therefore alleviate the perceived shortage of energy shortages that we're witnessing now because of the war jitters and for other reasons?

Thank you.

DR. ARON: Fiona?

DR. HILL: Yes, I'll ask Jamie--sorry about calling you Jim--

MR. RICHARD: No, that's all right.

[Laughter.]

DR. HILL: --to comment on some of the commercial aspects of this.

But in terms of Gazprom, I mean, there's a great deal of discussion about this in the Russian government, I don't think they actually can afford to privatize Gazprom because of many of the reasons that I outlined. I mean, there was a big discussion when the oil sector was privatized about Gazprom, but as I mentioned, the state of Gazprom and the state of all of the industry and the population in Russia are very closely tied together.

And, in fact, a number of Russian economic analysts have basically been stressing again that they don't think they can go down the path of demonopolizing Gazprom precisely because many people's very survival would be jeopardized if they kind of tried to move over into world prices for gas.

Now, clearly, I mean, if Gazprom were privatized, in an ideal situation, and it weren't saddled with this huge cold territory, Gazprom, if it exported more, could become more profitable. The fact that it has to contend with extraordinarily low prices on the home market is a major factor in terms of its loss.

Now, you mentioned the fact of moving people out. I said in my presentation that, in fact, fact people have moved from the most marginal areas, and often there was a very small population. The World Bank has actually been instrumental in some pilot programs. But people can't move to where they want to in European Russia because there's nowhere for them to move to.

There's no housing, and there's no jobs, except in Moscow. As we all know, there are a great deal of concerns from Luzhkov in Moscow about large numbers of people moving in, in an unregulated fashion. They are trying to impose restrictions again on where people can live.

You mentioned Barnaul and Tobol'sk. Those are in Southern Siberia. It's actually not that cold in Barnaul and Tobol'sk. In fact, they were settled in the old Czarist period.

MR. : [Off microphone.] [Inaudible.]

DR. HILL: Well, it's there's "cold" in this cold area. There are some places in Siberia where it hits minus 90 degrees Fahrenheit--it has three times this century--and regularly dips below a minus 70 in Siberia. Because average temperatures don't take into consideration the daily spikes.

So Novosibirsk, for example, is, on average, about minus 24 degrees Celsius in January. It falls much far below that in on a regular basis, and of course heating is regulated by the ambient temperature. So, I mean, you cannot turn off the heating in places like that. You can imagine that people on fixed incomes cannot afford to pay their utility bills, and pensioners can barely afford to pay their utility bills this month in Washington, D.C.

[Tape change.]

DR. HILL: --problems are compounded there.

It would be wonderful if Russia could move into a more efficient position. You are absolutely right that one of the imperatives for the Russian government to try to stop people from moving out of the region is precisely because of this fear of China. In fact, there's a great deal of emphasis now on trying to move people right back out there into this cold zone.

Again, the problem of the inefficiency of most of the economy there, it's all focused on mining, extractive industries, and larger scale processing plants and things that were basically put there by Communist planners, but without any kind of sense of where the market would be.

Today, most of these enterprises, beyond the new burgeoning service sector in retail, have no markets for their products, and they kept afloat because of these low imports, in terms of energy, and because people are paid very little.

So, again, you get back to the problem that you can't really kind of generate enough high wages in a market, through market methods, to get people to be able to pay their utilities. You get back again to the issue of subsidies.

Even within Gref's ministry right now, there's a big discussion about this, about how to contend with it. It's a major problem that the Russian government is going to have to face, and it's not being discussed at a high enough level, which is why we tried to do this project.

MR. : [Off microphone.] [Inaudible.]

DR. HILL: Exactly. And, of course, all of these cold areas, coincidentally, are the rust belt, the old belt. So this is major Communist Party supporters.

And Mikhail Margelov, who was through Washington recently, who is with the party of power, Putin's party, was saying that their major concern for the 2004 elections is going to be the resurgence of the Communist voters who are concerned, you know, the old-age pensioners and others, who are concerned about just these issues of utility bills, as we've seen elsewhere. So this is going to kind of collide with Russian domestic politics.

It's obviously true that if we had an ideal world, we could get more economic efficiencies, but, unfortunately, Russia is saddled with a rather difficult legacy.

Further privatization, and as I said I think Gazprom is going to be a big question. UES has the same problem. You might be able to privatize some of the utility systems in European Russia, but again, once you get out into Siberia, and the thermal power stations are all operated again by coal, which is extremely inefficient, it's going to be very difficult to privatize that part of the sector because the whole electricity grid in Russia also isn't connected.

The Russian Far East is completely disconnected from the grid and operates on its own system, and that's going to be a difficulty because with this low-population, faltering industry, it's going to be very difficult to make that profitable. And some of the utilities operate on fuel oil in the Russian Far East, which has to be shipped all the way around to ports at incredibly high costs. So that's another difficulty.

Transneft, though, I think is a big question as to whether that can be privatized, and maybe Jamie has some thoughts on that.

MR. RICHARD: Transneft, I have very limited ideas about. Actually, I'm the Middle East guy in the office.

[Laughter.]

MR. RICHARD: Anyway, on Gazprom, the way I see these privatizations is only as an investor. I have some experience, through study and pre-Soviet travel and things like that, but I think that the privatizations, the biggest problems that come up is that the Putin administration sees these guys just seeking rents and wanting to asset strip to their friends or to their industries out in the regions, and that is a problem. And that is a problem because these issues are so politically sensitive.

It's not like these utilities out in the regions aren't semi-private. I mean, they're like 49-percent owned by other shareholders than UES. I mean, they are doing things to bring themselves up to some sort of level of efficiency. And even in, you know, nobody drops this issue of heating pipe infrastructure, and the loops, and the cutoffs and things like that. You know, nonpayments are a very serious issue to this industry, and when they do cut off the factory, that then cuts off the hospital, they generally go out and run a cable around the hospital--around the factory to get to the hospital. So I think in the long run--

But, I mean, the way I understand Gazprom is they are basically renationalizing asset stripping from Etara [ph], and they have done so with Putin, with Miller, and now the Moscow FSB and the St. Petersburg FSB have tight control over the cash flows, and there's still some leakage, but this is a country with huge cash flows--$3 billion cash flow--and there's mostly leakage around construction tenders, which is why investors are still pressing that issue, and Gazprom says that their tenders won't be competitive until 2007 or something, down from 2009.

It's the same thing with UES. I mean, these assets are valuable to industries that are seeking cheap energy, and to maintain a political balance, the government is addressing them. They realize that without investment, in five years, the country is just in a complete mess. And what politician wants to let this continue with that reality?

DR. ARON: Thanks.

Sir, you have been very patient, and then we'll start taking questions, unfortunately, only a few.

QUESTION: [Off microphone.] [Inaudible.] Russia does participate, in an informal way, in OPEC. When, two years ago, OPEC decided to reduce production and try to increase prices, Russia did contribute and reduce their oil production by a certain volume. I would like to know how did the government impose this volume reduction on the private oil companies.

Second, it is true that the higher price does affect increases in budget, but a reduction in production certainly reduces the economic activity through the multiplier effect. So very often what you have, if you reduce production, and the price increases, the economy does suffer.

DR. ARON: Thank you.

MR. RICHARD: The way the Russians originally, I guess it was in 1999, addressed the issue was to have it be in the middle of the winter when production decreases anyway. And they agreed to 150,000 barrels a day of reduction, but as you can see, I think they didn't do anything.

QUESTION: So basically they ignored it. It was just companies, they didn't give any instruction to the companies to reduce production.

MR. RICHARD: Historically, I think the Saudis and the Russians have had quite a sort of adversarial relationship, and I think they're getting to know each other over the last couple of years. So it was really in the market, at the time when Russia said it was cooperate, nobody believed them.

QUESTION: [Off microphone.] [Inaudible.] The high price effect [inaudible]?

MR. RICHARD: Production cut in the multiplier?

QUESTION: Yes.

MR. RICHARD: What was your question? You were just pointing it out.

QUESTION: [Off microphone.] Basically, they didn't reduce production, so there was no trade-off [inaudible].

But I would like to also know, when you talk about subsidizing gas prices, subsidizing in what way--with regard to cost? Do they [inaudible], I mean, with regard to export prices?

DR. HILL: On the domestic market, the costs are regulated. The price of gas is regulated. The price of gas is regulated, but then they're also subsidized in direct ways by the central government gives municipal governments a certain amount of money in the budget. They actually help them to purchase gas and also subsidizing prices on the power sector.

I mean, a lot of these subsidies are actually hidden. It's, in fact, very difficult to kind of go all the way through and find out they're on all kinds of different levels because they're also in transportation tariffs. So, I mean, this is another reason why, you know, you have a state regulation in the pipeline system, because you've also got the gas pipeline system is also regulated. The tariffs aren't, in fact, charged to local utility companies.

It's, obviously, for coal, for the thermal power stations, extremely low transportation costs on the rail. Because in some instances you're getting coal transported thousands of kilometers across the trans-Siberian for use in power stations. So you have all kinds of different levels.

I mean, one of the things that we're advocating in this book is that the government makes all of these subsidies transparent so the people actually know what it is that they're paying for. Because they're hidden at so many levels, it's almost impossible to disentangle it.

So, in many cases, people like Gref and the people in his ministry can't even tell how much the Russian economy or the Russian budget is covering for the different sectors of the economy, which is why we can never really tell properly about how much rises and falls in gas prices or oil prices will affect the economy. Of course, with this differential pricing of gas being sold at a much higher price internationally, it's not even really clear what the domestic market can bear.

I suppose kind of the crudest level will be when people stop protesting in the street when the prices go up, which is obviously something that the Russian government wants to avoid as much as possible.

MR. RICHARD: Could I just add that I think that this issue of the subsidy is being addressed. I believe that there will not be losses by Gazprom in the domestic market within five years. As Fiona says, we'll see what the outcome of that is. They're losing basically a billion dollars a year. The company makes all of its money on exports and subsidizes it that way.

But I think that, you know, Russians are incredibly resilient people, and they've, during the Communist period, nobody really took their job seriously. Everybody had other economic activity going on, and it's hardest on the pensioners, obviously. But there will be at least no loss made on domestic sales in Russia in five years for Gazprom.

QUESTION: [Off microphone.] What do you mean "no loss"? With regard to what? Are you selling on the domestic market below the cost--

MR. RICHARD: The world market price, yes.

QUESTION: [Off microphone.] Okay, something else. The world market price is something else.

MR. RICHARD: Right.

QUESTION: [Off microphone.] You're not losing on the [inaudible] compared to the cost of producing.

MR. RICHARD: Right.

DR. ARON: We have time, I'm afraid, just for one question. Who's been the longest, did you notice?

All right, go ahead.

QUESTION: My name is Yuri Illisiev [ph].

As we have seen from this wonderful slide presentation, a big underlying story for Russia, in the medium term to long term, appears to be increasing production to make up for possibly significantly lower oil prices, assuming that oil prices do decline, assuming, in turn, that in the Middle East things will settle down, more or less, but in any case, the Russians seem to be betting on higher volumes, rather than higher oil prices, in the long term.

Just how competitive are they on the costs versus the Middle East and other oil-producing regions? Assuming that there will not be this political price premium indefinitely because of instability in the Middle East, if we do ever see the time when oil prices are determined mainly be economic factors, will the Russian oil producers be competitive at that point in time? Let's say, 2010, to be optimistic.

MR. RICHARD: Basically, Russian transport costs range between Murmansk, considering depreciation and amortization, everything, would be about $3 to $4 a barrel of transport costs. Currently, crude come out of the Persian Gulf via supertanker is somewhere between $5 and $6 a barrel. You have, you know, the larger the volumes, in terms of what you can ship, the lower your costs.

And certainly overall costs go down in transportation through like Yukos owns its own rail cars, so it can depreciate them. It doesn't even treat them as a cost, and other companies have different balances. But certainly the larger the volumes, the bigger the pipe at the end and closer to market, the better it is.

With regard to production costs, you know, the best companies are incredibly competitive with the Middle East. You know, in the Middle East all you have to do is stick a straw in the ground and oil comes up and goes straight to wherever you tell it to go.

[Laughter.]

MR. RICHARD: I mean, the best companies are down around $3 a barrel, and that is because of what I've said. And that's why 1997, and 2003, and 1998 in Russia have very little to do with each other.

DR. ARON: Jamie, I just wanted to clarify something, because I've given a number based on what Mikhail Khodorkovsky said. He said he could get the oil to the U.S. from Murmansk at $8 a barrel. I assume that that includes production and transportation.

MR. RICHARD: Yes.

DR. ARON: Okay. I just wanted to--because then your numbers square--about $3 to produce, $3 to $4 to ship.

All right, Fiona?

DR. HILL: No, that's it.

DR. ARON: That's it.

All right, maybe one more question.

Yes, please? You've been very patient. Thank you.

QUESTION: [Off microphone.] Thank you. I have one for Fiona. You mentioned the importance of looking at reserves, and I'm wondering, a lot of people are talking about 2009, 2010, looking at the OE figures or any other figures that you have, if you project forward the current amount, maybe project the discovery of Russian oil reserves and the projected amount that is being supplied, produced per year, what percentage of the world oil reserves do you expect Russia to have in 20 years? That's Question No. 1.

Question No. 2, you mentioned how sensitive the Russian economy is to its ability to export oil and, in fact, the price of oil. I'm looking at the threats to oil transport and wondering what happens if you get an oil tanker being attacked by a terrorist and going down in the Bosporus Strait or if you get an oil pipeline--I think you had an article about the Alaskan pipeline down to the lower 48 states--

DR. HILL: [Inaudible.]

QUESTION: That wasn't you. --mentioning how incredibly vulnerable these pipelines are to attack. If a pipeline is attacked in the middle of winter, where it can't be repaired for many months, and the ability of Russia to supply oil is effectively interrupted, so there's a geopolitical effect on Russian economy, so what are your thoughts about that?

DR. HILL: Actually, on the reserves, and I think this is what Jamie was talking about in his presentation,