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Falling Soviet Oil Production: No Quick Fixes
ntelligence Atseitment
CIA HISTORICAL REVIEW PROGRAM RELEASE AS
Directorate of Intelligence
Falling Soviet Oil Production: No Quick Fixes
An Intelligence Assessment
Thi* paperprepared by
Office of Soviet Analysis, wiih coniribulloni from
Comments ami aueriei are welcome and may be
, SOVA. on
Fallirrg Soviei Oil Production: No Quick Fixes
Keypea kinsoviet oil production has slumped; it dropped slowly
a ilme and thenercenthe decline continued into
prompting. President Gorbachev Io convene an urgent meeting of ibc
CaWrvet ofrogram designed io move lhe Induslry in the dirvxiion of decentralization and marketualion was adopted, bul little ha* been done to implemeol it. We judge that lhe measures enacted sowhich cmphasiic modest decentralization ofnot achieve lhe leadership's goal of stabilizing Ibe rapidly deepening oil crisis. Rather, oil production will probablyoercent ibis year to14 million barrels per day, tbe lowest levelarge-scale labor unrest in the oil sector or supporting industries cooM push oil output even lower.
Even with ihe decline that is likely lo occuril production should be enough to satisfy traditional domestic allocations and providehard currency earnings. Local shortages of specific refined oil products, however, will probably intensify because the center and republic authorities will have less oil at their disposal. Moreover, ihe anticipated decline In production, combined wilh continued high rates of domestic consumption. will cut Soviet oil exports, reducing hard currency earnings and increasing lhe crunces that tbe USSR will have to seek reacheduling of its debt, Ixywcr exports will also reduce the USSR's importance on ibc international market. Soviet exports currently accoonl for leuercent of non-USSR oil demand, aod oil traders have already factored steadily declining Soviet experts into their calculations.esult, tbe anticipated fall inshould notubstantial rise In ibe world price of oil.
ecision io abandon economic reform aod resnl reduce strong central control over the economy, we expect ibc Sovieu lo address tbe fall in oil productionombination of administrative measures lo deal with11crises and continued measures io decentralize control andthe financial independence of production enterprises. Efforts toand clear obstacles to Western joini ventures have been under way since ipring. Successful implemention of lhe measures could pave the waylower decline2f, however. McMOw tries to "storm" out of the declineassive investment programeassertion of rigid central control, the consequences for nreduction could befor lhe remainder of ihe decade
iii
.1
Confcnis
Key Judgment*
Anry to Tremble
Mauirlagaad Lagging Tcctirotopf
Impact ot tWlial
of Paftial Reform* and PcJicy
RcenW
Ntar-Tcnn
rr
Ftarangn*1
ftmpccti far the Leo gee Torrn: Skiwing tbe Dodipt or CollapaeT
Narrtr.rr*g
Re terming tbe
I lie "Storming" Opt too
Reducing
falling soviet oil production: no quick fixes'
Im(uiti) la Trouble
Since peaking4 million barrel) per day) in the third quarteroviet oil produciion hat been opeiorsening slump (iceutput has declined continuoody since the fourth quarter8 aad dropped tharptyben productionercent. Although maturing fields, technological -ucV-ardr.ee and invcatinealmade tome falloff inevitable, the ibarp drop0 win largely tbe result of the economy'" overall decline, political turmoil, and confusion causedoorly conceived and executed plan of reform in the oil sector.
Afanriai OitAttdj mmdWagj Duncg tbe first few decade* that followed World War II. the Soviet! were blessed with an abundance of large, prolific, and easily exploited oilfield* thatramatic rise in oil predudion. When the days of easy oil ended in, however, the Soviet* found themselveswith problems thai had taken the international oil industryears to solve. As older fields matured and catered into decline,method* were required to increase tbe amount of oilukJ be recovered, aad producer* needed more modem ecfaiprneart capable of withstanding the increasingly corrosive conditions within tbe wells tbat resulted from Soviet production practices. In addition, prospective new region* posed serious engineeringin the handling of the oil itself, or in operating in harshwereSoviet capabilities thencnim so today:
The Soviei* are ai leastears away from being able to conduct wjm&cant oi) production operation by ihcmaotvc* ia prcernaing offshore arctic region such at Ihe lisara, and Chukchi Sea*
Soviet equipment and operat nig practice* areto handle the very deep, high pressure, high temperature, and highly corrosive conditionsIn ihc North Caspian Basin
The widening gap between capabilities andba* left Moscowboicc of eitheran .federating decline from natural cause* or striking out in entirely new direction*
artthe eotpoasss on highf current production at tbe eapense of total recovery have compounded tbe Soviets'oieover, in order to nuitmlre output in the near
579ncludingennd*.
icnii. ihe Soviets concentrated on rapidly exploiting outing irwufce* at lhe etpeni* of ordering for new source* They also aesrlectcq major iirrprovemenii in" ploratloo and production technology and the development of production method* tailored tofields and wells-'
The tundard Soviei rraeeJure of irijecting water into Ihe reservoir* from the suit ef tVcM devesotwnt to force oil out ai the highest paaiible rale has bad! aa especially pernicious effect on peed net icq (seehe early watering, out of fields subjectedrater-:liswiiching wells lhat Dow freely from Ihe pressure in (be reservoir to artificial liftpumps, gallhan normal. The changeover increases ibe demand for equipment and raises future rnamtcnancc requirementi Years of neglect of the oil equipment indusuy. however, have left it incapable of keeping op with thb heavy burden. Produeiion of such key ilemt as pumps and drill bits has declined each yearnd Soviet oil equipment has been of low quality and poor reliability
Soviet water injection practices also haveorrosion problem that threatens major pceiioos of (be eaiiting production infrastructure. Tbe high level of water recovered with ihe oil attacks metal components of the wells, artificial lift equipment, gathering lines, and treatment facilities, increasing Ihe demand for spare pans and asaUtenancc.il ofhcials0 pipeline breaks, leaks, aadin known leases of over SIillion worth of oil at current worldthe problem reportedly continues lo grow worse.
Import of Political Diitrrey. Political lurmoil hat not only complicated (he oil industry's technological IwiMgtsn, but abo frustrated theflorts lo courtier them. For dimple, the RSFSR and Karakh-tlan, lhe republics with lhe largest oil resources, have blocked the centraloint-venture rtcgott-aiiont while opening their own. Similarly,0 Ihe Bailie republic* and Bciorussia called home Ihe construction brigades that had been building bousing for West Siberian oil workers. In lateemonstrators ia Ihe Tatar region of the Volga-Uralt protested the shipment of oil from (he Tatar
.-GtetrA'
float* -
Republic, ami la May Ihe Soviet pf cm reported (be sabotagemaO number of wells ia tbe region '
Imtaei mffmnUi Reform, mmJ Polity Errors, The disarray resulting from Ihc incomplete nature of Gorbachev's reforms has alto contributed to Ihe oil industry'! troubles. For example, equipment makers, released from the requirement of selling all iheir produciion lo customers arsigacd by central planners, have refusedake deliveries to oil product km enterprises unless tbey were compensated in hard currency Production enterprises, for their part, bare often proved unprepared to assume responsibilityost of decisions resulting from decentrallulion.esult, elilting supply links have snapped and chains of command have broken down.'
Blunders in ecor-oenie policy, reflecting the attempt to satisfy short-term needs at the espense of long-termave also been significant factors In the oilecent poor performance. Two years ago, for example. In pnspcauig0 budget, the crater hoped to reduce It* rapidly growing budget deficit through sharp cuts in centrally financed investment in the energy sector. The center slashed investment in the indusiry1 billion rubiesillion rubles. Republic* and enterprises were unable lo make up tbe difference, and overall investment declined by almost II percent1 billion rubles. The resultercent drop in drilling.
According to Soviet officials, ihe oil industry needed to bring onf new production to offset depletion Last year. Ely our estimates, however. IbenHTjo meters drilled0 brought7f new production oo line Because of the time lag between investment and prodatexson, moreover,0 mvestmcnt cuts continue to cause production difficulties1
Inn an effort to Increase hard currency revenue, tbe center abo barred International barter deals involving oiloping thereby to force the few enterprises with sorplas oil toperccnt capon tax. The ban oohas subacquently beenthe high exportwhich has been rolled back loemoved
much of the enterprises' incentive to produce aboveimilar tax, applied to oil production joint vent urea, has already caused at least one Western farm to consider pulling out of one of the Soviets' few cce^ocVaddeak-
hile doubling *onsc crude oil prices and triplingon the degree of difficulty ofcenter continued to try to squeeze as much revenue out of the oil industry as it could. Tbe introduction of new accountingdivided crude oil revenue* among theJndthesiUi fewer rubles per ton of output than before and kept them on the brink of insolvency Workerbuoyed by promise* oferious Mo-.
Recent InltlatlTCa
By1 Gorbachev was sufficiently alarmed over the oil crisis to make it the main item of dactasico at the fast nseeting of the new Cabinet ofrogramw tha fell ia oil production reportedly wasew weeks later. Although no detail! of the program have been published, lubse-Qgent tutements by President Gorbachev and oil indusiry officials indicated that it was designed to ddress the oil industry't troubles throughaad the introduction of market meaiures. including:
Transformation of the oil rxeduoion enterprises into independent leasing con ir actors.
Gradual intrcducoon of world prices for crude oil and natural gas aad gradual rcpaacensent of the state order system by delivery contracts between producers and customers
Legislation allowing oil ptoducen to tuipendto republic* or enterprise* that did not fulfill their contracts to the oil industry for equipment, [upptifa. or const
Little was done however, to implement these polkic* because of the center'* deep-seated reluctance to give up control of the sector. Instead, when the West
Siberian oil workers, who produce aboul Iwo-lhirds of Soviet oil. raised (he ihreaitrike if their living conditions were not improved and supply shortages were not remedied, central government officialsto defuse this situation with more traditional methods. In early May oil industry officials were ordered loillion in hard currency, origi-nally dedicated to tbe purchase of high-priority spare
f
its, io the purchase of meal for the oil workers, Jou
Industry otncsals reportedly are trying to0 million to purchase urgently needed oil pumps and Other equipment.
As the threatstrike cootinuod through tbe Spring and the decline in output accelerated, lhe center began lo move in tbe direction of reform. Onay. Gorbachev enhanced enterprise actoitomy when he decreed (hai production enterprises could sellercent of their production on lhe open market after meeting their export quota. This measure alonewill not provide the enterprises with all tbe financial resources they need to carry oui iheir own' produeiion operations and to satisfy the demands of lhe labor force, bul it is an improvement over previous plans whereby enterpriseshare of oil earnings only after (he sectorhole met its production quota. Early indications arc (hat tbemay be having sense effect. The Tyumen'Exchange in West Siberia reported ilIS million tonsays of West Siberianfor tradingune, accord in. to the Soviei press
Near-Term Outlook
Despite lhe many problems oil producers face,still have an outside chance of makingstale order6. especiallyauthorities can restore worker moraleenterprises wiih lhe financial resourcesreliable sources of equipment and serviceswake of the failed August coup. The largewells shut in (drilled but not producing)lack well-completion assemblies ormany as onc-lhitd of lhe wells inaccording tothe
industryizable reserve of proeluction potential that could be brought on line relativelycompared with drilling newthe workers
were rnotivxlcd and equipment were available.ihese wells on line will not address the long-term problems of lhe shdoslry. but ll could stabilizethis year.'
Wc believe It more likely, however, that oil production will fall lo an annual average of41. The rale of decline these figures9oughly the same as during the early monthss compared wilh the same periodeumber of factors argueontinuation1 of this rale of decline. The general economic decline and ethnic strife probably win continue to disruptof equipment and supplies to the industry. The coal miners' strikes in March and April, which involved one-fifth of tbe nation's coal mines, reduced sleel output and will continue toegative impact on ail production as tied shortages ripple through the oil equipment industry. Declines in the production of cable, cement, and building materials, as well as bottlenecks in lhe transportation aod distribution systems, will also compound the industry's problems.ddition, worker discontent will persist andto result In low productivity. The discontent and distrust of ibe workers is deep seated, and they will probablyait-and-see attitude toward any central or republic reform effort.
The downside risks for the industry are great.unrest among lhe oil workers and workers inindustries raises the possibility ofor strikes thai could lead to morein oil output. Because lhe oil workersto more KGB infiltration than any workthe USSR, according to
and because they are dispersed overarge geographical area, it is doubtful they couldtrike of the scale and duration of (he spring strikes by (he coal miners. More likely than industrywide strikes arc activities such at localized strikes, slowdowns, outputnd "working to the rule" by using strict enforcement of environmental regulations to shut down pipelines and oil treatment facilities. Tbe potential effecu of such actions are noi trivial, and oil
rVcre*-
output could be teriously durupied. Forslimale ihat, were the oil worken in West Siberiauspend maintenance activity alone, production would rail by atlter only threeyays, sndy twoased on the Soviei well repair data. *
Stn'Vei. in key supporting industries -especially Oil equipment, steel, andcouldrippling blow to aa oil sector already starred for equipment. Byear relatively free of strike activity,ells were shut ia for lack of equrpnxent, costing (he USSRt average wefl Bow rales,'
Implication*
IT the oil industry keeps production114, the USSR should have (utBcieat oil to satisfy domestic demand and still eaportf cn-dc oil and oil products in the fourth quarter. However, tightening supplies will leave the leadership little room toto address lac sectoral and local ihonages that normally plague tbe Soviet economy Lower export levels, coupled with expected lower prices, will also undermine the USSR'* trade account and internation-al financial standing, leaving it increasinglyon Western economic assistance.
Domtulc Eeonomy Given the continuation of the central government'* current economic policies, wcSoviet ONP to decline Ibb year byo IS percent and, under some scenarios, the economic decline could be greater still. The combined effects of lower demand aaaoeialrd with the expected fall ia Soviet GNP and tbe decline in oil produciion win cause Soviet apparent dorncstic eel4aaveragehi* year. It is unlikely, bow ever, that apparent consumption will fall as sharply as either GNP or production because:
In general, most expert* agree that,ecession, energy consumption doe* not fall a* rapidly as GNP.
' Apparent dmlm UniratU miaoi iir-HU.
AauiluuMiiia mMi-niwi anC tttckpil' ibmjn
w. I r- .i.
> In ihe USSR, in particular, the distribution of oil product*unction of stale tllocation rather thaa market nsodsankin* Boca are oil peod-actaecognircd value within and outside tbe Soviet economy. Arms tbat have reduced theiractivities are not likely to tarn back any "excess" oil but, instead, win hoard or barter it.
Moscow has traditionally absorbed tbe bulkroduction drop by cutting exports rather than domesticexample, production fellercent9ut comuirtptroo droppedercent- "
Although the system of distribution through slate allocation does not perxasote eftcieot oil use, it does enable the government to cut consumption by hat. should it choose to boost exports at the expense of Ihe domestic economy. The probability thai anywilt actually exercise such an option, boss-ever, appears rtsmote because, at present, domestic needs appear to be taking precedence over exports.Soviei documents iodic*ic that,eeceet chop in productionoscow planned fee the delivery of the same amount of crtade oil to domestic refiner* asnd former Prime Minister Pavlov reiterated theof domestic supplies tn early June by stating tbat hit government would not cut dorneaiic oilto support exports because such cuts would aggravate the country's troubled economy. Domestic nescds will continue to receive high priority after the August coup as republic officials seek to deliver on promise* io improve the economy. Indeed, it bihat apparent coo toould go up if the leadership decided to try lo improve tbe rerforniar.ee of key economic sectors, such as agriculture or trans-poita lion, by providing them svtth additional allot-menu of fuel, or ir it decided to build up stocks.
Although tht* year's production should be enough to satisfy overall domestic needs, local shortage* of irsecific refined products will probably inteniifyhave leas oil at their dispcaal io provide relief toided by saddennd problems in the petirung and distribution sector* are creating their own set of difficulties. Scrueezed between higher prices for crude oil and fixed prices for products,
s
aieercr-
refiners have already begun lo refuse toitems, such as diced engine lubricants, wilh Vow pretit margins Distributors, aeaaing growing concern about lightening supplies,een refusing long-term delivery contracts ia fa*or of spot sales,'
Forrig* Trade. Lower volumes cf exported oil and likely sower prices will undermine Moscow's trade account and ability to secure commercial credit aod place the Sovietsosition of growing dependence oo Western aid. Soviet oillikdy to fall lorop ofoerceni from lost year's level, Exports could belower If produeiion is Intemipied bystrikes or if ethnic strife leadsisruption in supplies est oilfield equipment. Suchespecially if world prices remainreduce hard currency earnings and increase the chances, already substantial, that lhe USSR would have toeocheduJing of its debt
Smaller exports will reduce the USSR's importanceworld oil mart et The USSR supplied roughlyof non-USSR world demandndshould drop toercent this year.'have already factored steadily
declining Soviet exports into their calculi lions with the result that world oil price* thould not be affected tignificantly by the anticipated decline.
On the other hand, eipont could be higher if reforms cut back slate orders for oil for dorrseatie use to allow for increased foreign sales. President Gorbachev'sayapparently will allow all oil enterprise* lo market up toercent of their oil outside stale eh lands once they meet compulsory caportincrease unofficial exporti to significant level i.
Prospects for (he Longer Treat Stowing riter Collapse!
Barring the scenarios mentioned in our discussion of the downside production risks, the Soviets thould have lufficicnt oil1 for most domestic needs and for sizable. If greatly reduced, foreign sales. The USSR,aitay of reckoning with regatd lo oil's role in Its economy. Unless tbe leader-thirst of (he various political levels lake anion lo cure the underlying problems of tbe oil sector, or to reduce oil consumption substantially, tbe USSR may cease to beanoileiponer by the
Opriavat, Financial constraints havethe Sonets' options for ttemaung the decline in oil produeiion Tbe center realized as early at (be produeiion drop4 thai its capabiUUea were falling Increasingly short of its planned goals lis response then wat to emphasize short-run maof output by drilling more wdtt and deploying more oil workers in existing fidds, injecting more water into the reservoirs, and turning out ever larger qua millet of low-qualitythan by deceniralizirtg and marketaing to improve (beof the oil industry and to avcdcrniie its equip-escnl base.
Mestcow'i strategy pathed outputeak annual production5ut at an enormous and unaustainaUe cost. Oil Industrymeasured4 rubles, roseillion rublesollUon rubles Inconsuming overercent of all Industrial Invest-ment. Plant0 called for investment lo be higherillionlhe lector actually received1 billion rubles
Competing demands from other sectors aad Ibc de dose cf the economy predodc the ccn tin nation of an oil prod net ion itrategy thai relies on massive increase* ia investment. The solutionhe oil problem inill require the overran! of the oil equipment and supportingas machine building, metallurgy, instrument making, andwdl as (be introduction of new incentives and approaches in Ibc oil industry Ittdf. Such changes cannot be accomplished under tbe central command system
Refermlag the ladutsrj. Polllicail leaden, including SOvict President Gorbachev. Prime Minister Pavlov, and Russian Presidentell ai leadingdes try ofliciab, appear to rtsoogssixe tke neccan'tynd us try reform aadpa acted role foe Western firma Acisscwiag tbeaewell at reaotrifit outer cootcauoui issues ItrvcJving ownership aod oootroloiliiri bowse of oilfigures proeruncniiy ia tbe discussion* ajacsag (be center and tbe republics pari id pa ling ia tbe "rsine-plus-cac" Ulki (tec insetV According to several Sovietomprehenaive oil law thai will delineate tbe righu and respoosibiliiica of allWesternnow being drafled for sabenis-tidn to the Supreme Soviet In September *
s to carsand the limited rights of theand local governments to disposehare of output without regard to quotas established by the center could do much to improve tbe Irving conditions of the workers and case worker discontent. The ability to earn and dispose of hard currency would alsotbe enterprises1 access to oil equipmentworldwide aad facilitate forming ksint ventures with Western firma.
Cootinued progress in clearing the way for Western production ventures would do much to improve the prospects for oil peoductioo- Although the Soviets would have to giveortion of tbe oil produced to the Western partner. Western production ventures are the only way for the Soviets to employ and to learn modern oretbod* of recovery their oil industry needs to face the future. Three joint-venture deals have beenfracturing la West Stoeria bya?
everal West Siberianand developing three small fields in
the Tirnan-rVehora Basin by
progress haa been reported in several others. Several of the smaller deals involving sperihe services could help individual production enterprises alosost immedi-a'.eiy. bsrt many of the larger vent ares arader ditcus-sioo will notirect impact oo oil produciion untildlc to. However, becausedeab would allow the Soviets to coo cen irate their own resources on projects not covered by joint ventures, they could result in more imnsediate boosts to oil ouiput.
If the Soviet* can imminent economic reforms and enlbt the help of Western firms, then chance* of flowing the decline21 arerowing share of Soviet productionto ooe-lhird in somebecoming tied up in the stock of wells shut in because User lack completion assemblica and maintenance. If (he right equipment andorbe acquired, these wells could be brought Into production fairly rapidly and ease the prraiurnt on Soviet drillers.'
Rttarimg (Miuutim Although the tacts* of Soviet energy pUnnen and policymaker* rcrnaitts onthe Sovieu also have option* on the couumpcion side of the energy eqnation, tn addition to mandating cuts in consumption, the authorities could Introduce real market prices, an act that would titer (he Soviet energy landscape beyond recognition. Higher real prices probably would not only cut energy demand across tbe board, but abo would result in greater competition amongas furnace oil. natural gas, and coal in tbe beat and electrical powerwould lead to greater interfuel substitution and more efficient use of all energy supplies
Freeing energy price* completely, however, pose*to an already weakened economy. Price* would jump to world levels almost immediately, increasing both inflationary and recessionary prrasurca.unless the center or tome other political organ retained tbe ability to regulate caportt. otl woaid probably hemorrhage from Use country ia search of bard currency.with Use current strict licensingbe KGB bo* pvbiidy claimed credit for interceptingillion barrel* that were being smuggled out of the country
The Stnrmimg" Option In contrast to the politically (ough but real Option* for boosting production and curtailing consumption, any attempt to trablliie oil output by adopting the tlormlngcentrally directed campaign to increase output rapidly,of lheto item previous declines will, in our view, be ineffective (teelthough no Soviei official* have recently argued openly forourse, flalcmcnlt by former Prime Minitter Pavlov on the need for massive increases in central investment for
TheStormingaftha Mld-lftOs
The Sovietsecline I" oil production that started4 and continued5 by
Increasing drilling, especially of wells In already producing fields.
Embarkingasilre maintenance effort thai returnedhut-In wells to produeiion.
Accelerating the Installation af artificial liftespecial If gas-l'Jt systems and electricpumps. In older fields
Airlifting drilling and matatenonce crews fromregions to West Siberia lo perform the additional labor required.
heavy industry and comments by Deputy Chairman of tbe USSR State Committee for Fuel and Energy Margulov aboul tbe creation of an "energy tupermin-istry" suggest lhai at lean tome senior ofBcttls have not lost faith in the ability of the center to work miracles. As ibe memories of tbe costs of the storming campaign fade and the production decline continues, the appealassive, centrally directed effort lo stem ibe decline could grow among totne tactions of tits leadership
The cost cf attemptingrogram today,would be prohibitive Even if funds could be mobilized, worker discontent and the centers lessened control over the equipment plants and their luppliers would cause the Soviet economy to respond for less effectively to commandsrash effort than it didoreover, storming, with its crrirsbaii* on output at allould perpetuate and magnify the inemciencie* that currently undermine Sovietefforis
These measures allowed the Sovieis to push output95Sercent production gain,percent Increase in Invesimenl47
Barringdecision lo abandon economic tc/otm and itlurn lo (irons centralr tbe economy, we expect tbe Sovieu lo address tbe fall in oil prudiKtionombination of adasiaatrraiiVc meawrc* to deal with ibc crisis of tbe moment, tucfaood or tool tbortagc. and continued reform measure* (bat "ill decentralize control and tire ng then tbe financial Indc-pendeoco of Ibe prod tier, toe enterprises. Tbe Soviets will also step upttract Weston joiat-venture partners. Finally, in an effort to ttetn the eontinuini decline ta esportt renal tine from falling prcductrou and profligate domestic erettnmptioo, tbe leadenfaip mar decide to implement real prices forwouldiant step toward moving Ibe USSRarket economy.
Original document.
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