The Foreign Service Journal, December 2003

ket signals in the 1970s, with price controls on gasoline retail margins, oil import quotas, crude oil entitle- ments, a bias toward small refiners, differential pricing between “old” gas and “new” gas, all designed to “protect” the consumer and small domestic producers. Price controls removed competition from retail marketing, which led to subsidized wasteful investment and consump- tion. The result was high prices and gasoline lines when the two global oil crises occurred. Deregulation did not start until the Carter and Reagan administra- tions, within living memory of many still in the U.S. government. The specter of high consumer prices was raised in the late 1970s and early 1980s, but never materialized. Instead retail energy prices stabilized at a lower level after decontrol, and energy efficiency improved after price distortions were removed. Many lessons from the U.S. experience may apply to Russia today. Sharing our own evolving regulatory experience with Russian colleagues who are faced with similar challenges can be an important and useful contribu- tion to economic partnership. This is far better than preaching to them on what laws to pass in order to attract American investment, such as the decade-long futile effort on production sharing agreement legisla- tion. The Murmansk project and liquefied natural gas exports are fine to talk about if they advance the reform agenda, but not if they are a replacement for reform or, even worse, diversionary devices to delay reform indefinitely. A Case in Point When one asks U.S. policy-makers at occasions like the St. Petersburg meeting what our government wants more, structural reform of the energy sector in Russia or announcements of megaproject and invest- ment deal signings, one gets the standard answer that the U.S. wants both. However, in practice there is often a tension or, as Russians would say, a contradic- tion between the two objectives. Permit me to cite one simple example to avoid boring non-petroleum industry readers with the many other cases that apply. When Western industry first arrived as major investors in Caspian oil, led by Chevron in onshore Kazakhstan and then BP in offshore Azerbaijan, the companies had in mind using the old Soviet pipeline system through Russia to export their production. This made the most economic sense, deferring billions of dollars of investments that would otherwise be required to build dedicated oil export pipelines. There was surplus capacity in the Transneft system, and Russia would share in the economic ben- efits from new production from newly independent Kazakhstan and Azerbaijan. However, a small technical reform step needed to be implemented in the way the old Soviet pipeline system operated commercially. The Soviet system accounted for oil in tons; internationally, crude oil is traded on a volumetric basis in barrels because this better reflects crude oil’s refining value in petroleum products. International prices are also adjusted according to crude quality, such as the level of sulfur, metals and other impurities. The simple financial adjustment mechanism commonly used around the world is called “quality bank.” Because the Caspian crude oils the major international companies produce are lighter and lower in sulfur than the typical Urals export blend, lack of a quality bank could penalize that production by more than 20 percent of the eco- nomic value of the crude oil in a free market. In the early 1990s, international financial institu- tions like the World Bank and European Bank for Reconstruction and Development and the interna- tional petroleum industry — often with encourage- ment from the U.S. government — tried to convince the Russian government and Transneft to adopt a quality banking system. They offered hundreds of millions of dollars in investments to de-bottleneck the Russian oil pipeline system to accommodate more oil exports, but to no avail. Finally, everyone gave up. Chevron and its partners built the Caspian Pipeline Consortium project at a cost of $2.6 billion. BP and its partners built the Baku-Supsa pipeline, and are now building the Baku-Tbilisi-Ceyhan pipeline pro- ject at an estimated cost of $2.9 billion. Once those business decisions were made, the companies and the F O C U S 38 F O R E I G N S E R V I C E J O U R N A L / D E C E M B E R 2 0 0 3 The luxury of higher oil prices has stalled the reform process in the Russian energy sector.