Russia – From Discovery to Perestroika

There is a spring from which gushes a stream of oil, in such abundance that a hundred ships may load there at once. Men come from a long distance to fetch this oil.[1]

– Marco Polo

Foreign interest in the oil-rich sands of Baku was aroused in the mid-15th century. It was the first oil field to be discovered in Russia’s backyard in what is known today as Azerbaijan. It fell swiftly into foreign hands with the occupation of the Black Sea area by the Turks in 1475. With Ivan the Terrible came Imperial control of the northern Caucuses, but it was not until Peter the Great that the oil-rich sands of Baku fully returned to the Russian yoke. In days gone by, petroleum was extracted by using hessian rags and wooden buckets and it was not until the late 19th century that Imperial Russia saw foreign expertise dramatically improve extraction techniques. Alfred Nobel’s father, Robert, arrived in 1873 and soon exerted significant influence in the area as a producer and refiner.[2] A mere decade later, in 1883, Russian production exceeded 1 million tons, virtually all from the wells of Baku. Oil flowed in such unheard of abundance that there seemed to be no need to improve practices, often deemed sloppy and wasteful, or to find other untapped fields. The Baku region was full of foreign operators pumping for profit yet the Tsarist state did maintain some control over their activities. Export tariffs were introduced in 1877 and by 1896 a royalties system was in operation to increase state revenue and sometimes totalled 40%.[3] Yet, despite Baku’s gushing oil, petroleum only generated 7% of Russia’s export earnings, leaving its enormous potential unexploited. Furthermore, foreign investment amounted to US$129.72 million in 1914 (see Table 1); nearly three times the Russian investment.[4] By welcoming vast sums of FDI, the Tsars were learning from foreign extraction techniques and improving their own primitive methods. For this reason, foreign presence was welcomed but controlled. However, revolution would not only change foreign investment, but also the Russian political landscape and the role natural resources would play in the domestic and foreign agenda.

Table 1: Foreign Investment in the Russian Oil Industry in 1914 (in US$ millions)

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Source: Hassmann, H – Oil in the Soviet Union (Princeton University Press 1953), p. 28.

Riots and worker unrest in the Baku region was, in part, led by Stalin and started as early as 1902, but it was the 1917 Revolution under the Bolsheviks that precipitated the demise of some of the most influential oil operators in the Caucuses. From 1918 onwards, Swedish, French, American and British firms fell victim to the formal confiscation of assets and nationalization of the oil fields. The climate had changed. Individuals, especially foreigners, no longer controlled the oil fields. The state was the sole owner and the fields became ‘common property of the people’. Lenin’s revolution, however, was followed by a counter-revolution supported by many foreign powers and private oil firms. They sought to exploit the unrest in the anarchic North to reclaim influence in the oil-rich South. During the Civil War the British entered forcibly with the intention of setting up an independent state of Azerbaijan and negating Russian access to British India. The region was held for some time and the fields were denationalized, but were later returned to Bolshevik control in April 1920. Many firms saw Lenin’s pseudo-legal regime as weak and unlikely to survive. Despite the Marxist rhetoric, it was Lenin who invited foreigners back into the oil fields as production plummeted due to two-thirds of the workforce being lost during the First World War.[5] He recognized that the nationalization of the Baku fields was a grave mistake. Foreigners were granted concessions under his New Economic Policy (NEP) in exchange for expertise. The inefficient ‘cable-tool drilling’ techniques were replaced by the Texan ‘rotary drilling.’[6] This method was not only quicker but required a smaller crew to operate the equipment. The American Barnsdall Corporation, the Italian Societàà Minerere Italo Belge di Georgia, Britain’s BP and a Japanese firm based on the remote island of Sakhalin were called upon to galvanize the “commanding heights of the economy” by introducing these techniques. Soviet production expanded rapidly. With foreign assistance, oil production swiftly recovered, but as it did so, concessions were systematically revoked. All were a thing of the past by 1930. Like many things in Russia, this policy of foreign expulsion was inconsistently applied. Some firms were later recalled and their drilling rights reinstated. Before the Revolution, foreigners had played a salient role in developing Russia’s natural resource extraction and subsequent earnings. During this period the state had played a part, but was to become more involved under the Bolsheviks and the ideological retreat of the NEP. After 1923, foreign involvement in joint ventures and other investments would start to decline as the state grew in strength, presence and, most importantly, knowledge.

In 1922, a commercial syndicate, Neftesyndikat, was established between three local operating trusts, Azneft, Grozneft and Embaneft. The oil fields were back in exclusively state hands. Yet, it joined together in a 50-50 partnership with a British firm, Sale & Company, in 1923 to market Russian petroleum in the UK, but retained the right to buy out the British firm’s shares in 10 years’ time. This was the USSR’s first joint venture with a foreign firm. Neftesyndikat continued to expand, setting up filling stations in Great Britain, Sweden, North America, Italy, Germany and Persia under the guise of foreign partnership. The Soviets now had a network to supply and with demand came an increase in production. According to Gurov, Italy was the main importer of Russian oil,[7] and with hydrocarbon export came the fusion of politics and energy, or rather the abandonment of politics. Mussolini’s fascist government was only refused Soviet oil in 1938 and 1941 when Stalin was aligning the Soviet Union with the Allies and after Operation Barbarossa when the Axis powers first set foot on Soviet soil. Yet, the Coryphaeus of Science, one of his grandiloquent titles, had no compunction about exporting to the rival fascist powers until 1940. There was no more innovation in the areas of exploration or production. Instead, attention was turned to quantitative output and engineers were instructed to squeeze every last drop from every field. On one side of the coin, the Stalinist period saw foreign expertise rendered redundant as the Soviets had all the techniques they needed. On the other, when the Bolsheviks defaulted on foreign debt accrued under the Tsars, many foreign firms were reluctant to invest in the Soviet Union, even if they could. Foreign investment was in mutually assured deadlock. Throughout this period, the Stalinist state created an air of unwavering suspicion towards foreign ‘bourgeois’ engineers, with many held behind bars.[8] Foreign investment into the USSR declined and the last vestiges of Lenin’s NEP were dead.

It was under Stalin that energy became Russia’s largest export and greatest ideological incongruity. Marxism should have precluded the notion of selling to the ideological nemesis of the Soviet Union, but “the principle of ideology was seldom allowed to stand in the way of the principle of profit”.[9] In 1932, energy accounted for 18% of foreign earnings and, with foreign help, it was destined to generate even greater revenue. With the Great Depression severely reducing US production, the Soviet Union reached ‘pole position’ and became the world’s largest oil producer. In the same year Stalin and his colleagues closed the USSR to foreign investment and many other Western influences such as literature, arts and some sciences.[10] In 1948, it was the discovery of the super-giant Romashkino field in Tatarstan that delivered record domestic economic growth and furnished the Soviet Union with a new weapon in its strategic arsenal. The region’s oil also fuelled the Union’s recovery after the devastation of the Great Patriotic War. Oil had become the centrepiece of Soviet foreign and domestic policy. The energy sector was firmly in the grip of the command economy and “foreign financial groups could not invest or participate in the Russian oil industry”.[11] Goldman notes that this pattern and ultimate objective “continued, like so much else, into the 1970s”.[12]

Until the early 1970s, oil and gas production had increased year upon year with minimal foreign influence and Russia was the world’s largest producer in 1975.[13] During this period, the Soviets were dabbling in the international market. They began a tentative move towards compromise with capitalism. Other communist powers denounced the move. The Chinese branded the policy as “revisionist” and dubbed such ventures “Moscow-brand transnational corporations”.[14] Moscow knew that the Soviet Union’s giant Romashkino field would peak by the mid-1970s and that production would decline. The Ministry of Oil and Gas was beginning to look elsewhere for help. In 1972, a joint venture between the Japanese and Soviet governments began exploring the potential of the former penal colony Sakhalin Island.[15] This was the first time a major joint venture had included the far-flung island since the pre-revolutionary era. Two decades later, from 1991 onwards, it would later become the greatest host to foreign investment in Russia. A more speculative venture between the Soviets and the Canadians set out to test the latter’s drilling equipment in the permafrost conditions of the autonomous Republic of Komi in Russia’s far north. These examples stand alone. Foreign investment remained extremely limited throughout the 1970s despite declining production. The Yom Kippur War of 1973 provided the USSR with a substantial windfall and money was pumped into the oil and gas extraction industry allowing Soviet production to increase. By the late 1970s the USSR was the world’s second largest oil producer, second only to Saudi Arabia. Brezhnev used the USSR’s vast energy exports to continue Eastern Europe’s reliance on the Soviet Union. Exports bound for Eastern Europe accounted for two-thirds of the total. However, the remaining third constituted 50 million tons and was sold for hard currency. The late 1970s saw the emergence of energy as the Soviet Union’s most lucrative export and the lynchpin of its economy. The grain sectors had not managed to recover from Khrushchev’s harebrained land reforms of the late 1950s. The Soviet breadbasket was being filled with oil rather than grain and the one-crop economy was now based on energy not agriculture.

[1] Polo, M – The Travels (Penguin 2004), p. 45.

[2] Tolf, R – The Russian Rockefellers (Hoover Institution Press 1973), p. 40.

[3] Goldman, M – Oilopoly (Oneworld 2008), p. 25.

[4] Hassmann, H – Oil in the Soviet Union (Princeton University Press 1953), p. 28.

[5] Dinkov, V.A – Neft SSSR (Izdatel’stvo Nedra 1987), p. 10.

[6] Grace, J – Russian Oil Supply (Oxford University Press 2005), p. 8.

[7] Foreign Trade, September 1967, p. 17.

[8] McCauley, M – Stalin and Stalinism (Longman 1983), p. 25.

[9] Goldman, M – The Enigma of Soviet Petroleum (George Allen & Unwin 1980), p. 30.

[10] Shmelev, N – The Turning Point: Revitalizing the Soviet Economy (New York 1989), p. 221.

[11] Hassmann, H – Oil in the Soviet Union (Princeton University Press 1953), p. 61.

[12] Goldman, M – The Enigma of Soviet Petroleum (George Allen & Unwin 1980), p. 31.

[13] Grace, J – Russian Oil Supply (Oxford Institute for Energy Studies), p. 69.

[14] Press Release, ‘People’s Republic of China,’ United Nations, 9^th September 1975.

[15] Bradshaw, M – Foreign Investment in the Russian Oil and Gas Industry: Lessons from Sakhalin (University of Leicester Press 2003), p. 5.