THE BLACK GOLD RUSH IN RUSSIA The former Soviet Union has as much undiscovered oil as the Middle ) East. Chevron's $20 billion project shows how Western companies are scrambling to help develop it.
By Peter Nulty REPORTER ASSOCIATES Paul Hofheinz, Karen Nickel

(FORTUNE Magazine) – THE OLD SOVIET UNION is still a potential superpower -- in oil. The independent republics, particularly Russia, may well have up to a quarter of the world's undiscovered oil, about equal to what's left in the Middle East. They also have more natural gas than any other country, including Saudi Arabia. As a force for stability or a flash point for crisis, oil from the region could have as much impact on global energy balances in the next 20 years as Middle Eastern reserves did in the past 20. As the once isolated republics integrate with the world economy, dozens of Western oil companies are rushing to help -- Chevron, British Petroleum, Royal Dutch/Shell, Exxon, Mobil, Marathon Oil, Conoco, Elf Aquitaine, Total, and Texaco, to name only the top of the barrel. Chevron recently signed one of the biggest deals, a joint venture that will spend $20 billion over 40 years developing a field near the Caspian Sea. If all the republics' energy is developed and brought to market smoothly, it could stabilize global energy balances for decades, reducing Western dependence on Middle East oil and the danger of price spikes. If it isn't, the result could be shortages and higher prices in world markets. The next great energy crisis, should there be one, could originate as easily in Siberia as in the countries surrounding the Persian Gulf. OPEC sees the danger and has considered offering cartel membership to Russia, Kazakhstan, and Azerbaijan. Russia last year produced between 80% and 90% of the region's oil, about 9.2 million barrels a day, which puts it in the same league as the Saudis, who pump eight million barrels daily. The trouble is that the oil industry in the former Soviet Union is in no condition to take on a global role. After years of starvation of capital and maintenance the industry is in rapid decline. Crude oil production peaked in 1988, when the Soviet Union was the world's largest producer, and has since plummeted almost 20%, or more than two million barrels a day. That about equals daily production in Alaska or the North Sea. Exports have fallen from 3.6 million barrels a day to some two million (about 3% of world demand). WHATEVER the Arabs do, the Russians are bound to favor price stability. Because the republics desperately need the foreign exchange oil exports can bring, falling oil prices would be tough to bear. And while rising prices . would bring in more hard currency, they could also be painful: The republics already face a wrenching transition from controlled crude oil prices of about 21 cents per barrel to around $3 (the world price is in the $20 range). Despite the enormous reserves, few people in the West have ever heard of Samatlor, the world's biggest producing oil field, or Tyumen, the Houston of Siberia. Both are in the vast Siberian plains, the heart of the Russian republic. Azerbaijan and Kazakhstan, the republics south of Russia bordering the Caspian Sea, produce most of the rest of the oil. Some oilmen may have guessed at the ultimate potential of the Soviet oil patch, but few suspected that they might be invited to drill there. Now they have been, and what a patch. The former Soviet Union, known as the Commonwealth of Independent States (CIS), has 141 giant fields, more than any other country. The U.S. has 87. Each giant field holds more than 500 million barrels of oil or three trillion cubic feet of gas. The huge western Siberia basin, which includes Samatlor, contains 16% of the world's discovered reserves, but less than a fifth of that is being produced. This turns the standard risk profile of the Western oil industry on its head. In the rest of the world, oil companies worry first about geological risk -- drilling dry holes -- and secondarily about political risk. On the new oil frontier, however, there is little danger of coming up dry, but when it comes to politics, no one knows what will happen next. With luck and the help of Western oil companies, production might stop declining by the mid-1990s and begin growing again by 2000, according to John Blaney, a project manager for the consulting firm ICF Resources in Fairfax, Virginia. But the kicker is conservation. Since oil has been so cheap, much has been wasted. According to one Russian official, almost a million barrels a day (or 8% of total production -- half Alaska's output) is spilled during production and transportation. Besides, when it gets too hot indoors during the severe Russian winters, occupants of buildings and factories typically open the windows rather than turn down the boilers. With conservation and higher production, Blaney thinks that Russia, Azerbaijan, and Kazakhstan could export nearly as much as Saudi Arabia within 20 years. No wonder Western oilmen are dreaming of a good, old-fashioned black gold rush. Most major companies, including BP, Chevron, Exxon, and Royal Dutch/ Shell, have opened offices in Moscow. Sensing a chance to catch up with the majors, second-tier companies like Total and Elf Aquitaine of France, and Conoco and Amoco of the U.S., are in various stages of negotiating deals and starting projects. And some of the smallest companies, such as Anglo-Suisse and Global Natural Resources, both based in Houston, and Canadian Fracmaster of Calgary, have proved quickest of all (see table below). Executives from competing companies often bump into each other on planes or in hotel lobbies, pausing to reminisce about earlier campaigns in, say, the North Sea or the Middle East. What they find in the oil fields resembles the early days of the Texas wildcatters. Some workers in the production towns around Tyumen live in cabins or makeshift huts without plumbing. The Saturday night scene, or any night when the vodka flows, can be wild. When the elite Black Beret military units were pulled out of Latvia and Estonia in 1990, many were sent to Tyumen to keep a semblance of order. The rush by Western companies to get into the game is not lost on Russians, Kazakhs, and Azeris. Since oil is the one commodity easily sold for foreign hard currency, it's worth more than gold. BEFORE the Soviet Union collapsed, the oil industry was run from the sprawling Ministry of Energy in Moscow. Since then, Russia has taken over the ministry, but officials and managers down the chain of command have scrambled to control as much oil as they can. The emerging powers are the ''producing associations,'' the local equivalent of oil companies, headed by bureaucrats, sometimes called oil generals, who used to report to Soviet authorities. There are 12 such associations in Tyumen alone. The largest produces some 1.2 million barrels a day. (Only Exxon, Royal Dutch/Shell, and BP among nongovernment companies produce more.) There are rumors of ''spontaneous privatizations,'' meaning that some local oil generals no longer take orders from anybody. Traders whose operations may or may not be legal are springing up. One such elusive character came to a conference on Russian oil held by the University of Pennsylvania. He related how he shipped 60,000 barrels of oil to a Black Sea port for export but that the oil never showed up at the end of the pipeline. It wasn't clear from his account who got stung, or who did the stinging. Says George Reese, managing partner of Ernst & Young's CIS operation: ''It's like the Wild West at times.'' ; Though a lot of deals with Western companies are cooking, only a few small projects are actually operating. Robin West, president of Petroleum Finance Co., a consulting firm in Washington, D.C., estimates that total Western investment so far is between $150 million and $200 million. That's peanuts in the oil business. Max Pitcher, executive vice president of exploration and production for Conoco, thinks it will take $10 billion by the mid-1990s to halt the decline of the old Soviet industry. Several obstacles stand in the way. The most important is political instability: Who is in charge and for how long? Chevron's long quest for a deal, which finally paid off when Kazakhstan's President Nazarbayev signed an agreement in Washington in May, is the standard by which all frustration is judged. Chevron began discussions in 1987, with the blessings of President Mikhail Gorbachev, and later negotiated with both local authorities and Moscow. When the Soviet Union crumbled, the company had to start over with the government of newly independent Kazakhstan. In another infamous incident, the Russian Republic's oil ministry in Moscow selected a consortium known as 3M -- Marathon Oil, McDermott International, and Mitsui & Co. -- to draw up a plan for developing a 750-million-barrel oil field and a major gas field near Sakhalin Island in the Pacific Ocean. The governor of Sakhalin Island, which is 4,150 miles from Moscow, tried to give the contract to a rival bidder. Moscow overruled him and appears to have won the day -- for now. The struggle between central and local authorities is deep-seated and, according to West of Petroleum Finance, might well get worse. One Russian diplomat recently told an audience of his Western counterparts: ''You will find that now some local authorities behave like big dogs whose masters are nowhere in sight.'' A SECOND OBSTACLE is the absence of a legal framework for any private oil ventures. Working to set some ground rules, the Russian Parliament passed a natural resources code in February that lays out procedures for development, including rules for auctions and licensing. Now the lawmakers are working on codes to govern transportation, the environment, and tax and fiscal policy. A team of Western experts organized by the University of Houston Law Center is advising the Russian energy ministry. The new laws, however, won't necessarily protect against all exigencies of politics. Moscow recently levied a $5-per-barrel tax on exports to raise funds + to pay off debt and replenish hard currency reserves. A worthy cause, certainly, but such a high rate may make some projects uneconomical. For example, White Nights, a small, 9,000-barrel-a-day joint venture created by Anglo-Suisse with Phibro Energy and Varyeganneftigaz of Russia, has halted expansion and put new investment on hold. A third source of delay, and friction, is a distinct difference in point of view between Russian officials and Western oil executives. The Russians want Western companies to rehabilitate old fields or tackle technically demanding, often costly projects. The companies want access to the biggest, cheapest reserves. Western Siberia, for example, has 20,000 wells that are shut because the natural pressure that brings oil to the surface has played out. Western companies have techniques for stimulating such wells -- by flooding the reservoir with chemicals or fracturing the rock so more oil flows. This would give the Russians a quick boost in production (about 500,000 barrels a day for those 20,000 wells alone), but doing so would be far more costly than developing new fields. Says one American executive: ''They are not putting their best deals on the table. They are proposing projects that are economically marginal even before you figure the political risks.'' Still, some companies are going after the deals anyway, in hopes of positioning themselves for the long term. Advises John Kilgore, chairman of Texneft, the subsidiary of Global Natural Resources that operates in Russia: ''Start talking with the people you are going to work with. Their oil people are smart. Once you get their agreement you can work your way up through the politicians.'' Kilgore's company currently is running a small project in Russia to capture natural gas fumes escaping from oil storage tanks. Now Kilgore is negotiating a deal to drill for oil. He adds, ''The gas gathering was just a ticket to the games.'' One of the leaders among the large companies is Elf Aquitaine of France, which has concluded two deals, one with Russia and one with Kazakhstan, to explore and develop new reserves with production beginning in the mid-1990s. The projects will cost ''several hundred million dollars each,'' according to Maurice Mallet, Elf's senior vice president for Eastern affairs, who negotiated the contracts. Mallet says his dealings went relatively smoothly. ''We talked only about what Elf was willing to do,'' he says, ''and kept the negotiations away from politics.'' Mallet may really believe that politics played no role, and then again he may just be displaying the diplomacy he learned in 20 years of dealing with the Soviets as an executive of the French chemical company Rhone-Poulenc. Ednan Agayev, chief adviser on international trade for the Russian Ministry of Foreign Relations, says that French President Mitterrand refused to sign any agreements with Russia until there was a Russian agreement with Elf. He adds, ''So we were under pressure, and that's what happened.'' Though the French government owns 51.5% of Elf, Mallet denies any such assistance from Mitterrand.

Finally, it always helps to be helpful. Max Pitcher says that Conoco has been meeting with local governments in regions where the company is considering projects, and has donated $1.5 million in medical supplies, hospital equipment, and fuel. Says he: ''They want to know what the company can do for the local communities, and that's the same around the world.'' If Russia and the other members of the new commonwealth can continue their transition without too much political turmoil, then the chances are strong that they will maintain their position as a great oil power. With luck they may even enhance it. But is the world ready for Siberian sheikhs?

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: THE FIRST WAVE OF OIL DEALS

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCE: ICF RESOURCES CAPTION: WHERE OIL LIES BURIED IN THE OLD SOVIET UNION Oil production is dropping rapidly in the former Soviet republics, but geologists see great promise in undeveloped oil-bearing regions that dwarf even Texas, outlined at right in the middle of Siberia.