Daniel Yergin: How Privatization Saved Russian Oil

In Monday’s excerpt, Julian Simon argued that pollution has been in steady decline and living standards have improved over time if you include the ancient pollutants like bacteria and viruses spread by polluted water. In Tuesday’s post, Wilfred Beckerman echoed the point. He argued that economic development improves standards of living, even today. Today’s post from Daniel Yergin’s new book The Quest: Energy, Security, and the Remaking of the Modern World demonstrates how the post-Soviet Russian state rediscovered energy privatization and market forces improved the lives of average Russians.

Natural resources–particularly oil and natural gas–were as critical to the new Russian state as they had been to the former Soviet Union. By the middle 1990s, oil export revenues accounted for as much as two thirds of the Russian government’s hard currency earnings…. Yet the oil sector was swept up in the same anarchy as the rest of the economy. Workers, who were not being paid, went on strike, shutting down the oil fields. Production and supply across the country were disrupted. Oil was being commandeered or stolen and sold for hard currency in the West.

No one even knew who really owned the oil. Individual production organizations in various parts of West Siberia and elsewhere were busily trying to go into business for themselves. The industry was suddenly being run by “nearly 2000 uncoordinated associations, enterprises, and organizations belonging to the former Soviet industry ministry.” Amid such disruption and starved for investment, Russian oil output started to slip, and then collapse. In little more than half a decade, Russian production plummeted by almost 50 percent–an astonishing loss of more than 5 million barrels a day.

One person with clearly thought-through ideas about what to do was Vagit Alekperov… deputy oil minister. On trips to the West, Alekperov visited a number of petroleum companies. He saw a dramatically different way of operating an oil business. “It was a revelation,” he said. “Here was a type of organization that was flexible and capable, a company that was tackling all the issues at the same time–exploration, production, and engineering–and everybody pursuing the common goal, and not each branch operating separately.”

He came back to Moscow convinced that the typical organization found in the rest of the world–vertically integrated companies with exploration and production, refining and marketing all in one company–was the way to organize a modern oil industry. Prior to the collapse of the Soviet Union, his efforts to promote a vertically integrated state-owned oil company were rebuffed. Opponents accused him of “destroying the oil sector.” he tried again after Russia became an independent state. For to stay with the existing setup, he said, would result in chaos.

In November 1992, President Yeltsin adopted this approach in Decree 1403 on privatization in the oil industry… Overall, by 1998, within six years of the collapse of the Soviet Union, the Russian oil industry had gone from a system run by a series of ministries and subordinated to central planning to a system of large vertically integrated companies, organized, at least in rough outline, similarly to the traditional companies in the West. During these years, they all operated largely autonomously from the state. Eventually the Russian Federation would have five large energy companies, each of whose oil reserves were comparable to the size of the largest western majors.

The development of these companies was more than just a wholesale reconstruction of the Russian oil industry. It also brought visible changes in the larger cities. In Soviet times, those few lucky enough to own automobiles had to search out the rare and hard-to-find dingy service stations on the outskirts of the city. But now new, modern service stations were springing up at intersections and alongside the highways, bedecked with shiny corporate logos–Lukoil, Yukos, Surgut, TNK, and a number others. The stations came equipped not only with high octane gasoline of dependable quality, but also in many cases things that people never expected to see, like convenience stores and, even more remarkable, automatic car washes. All of that would also have been unimaginable in Soviet times.

(excerpted from Chapter 1, pages 26-28, 32)