Rus­sia rises on global oil de­mand but tac­tics draw wor­ries

The Washington Times Weekly - - National - By Pa­trice Hill

Sec­ond of two parts

Rus­sia has emerged as an un­ri­valed en­ergy su­per­power in a world thirsty for oil and gas, but the coun­try’s re­cent moves to seize con­trol of strate­gic parts of the en­ergy in­dus­try have slowed growth in pro­duc­tion and raised ques­tions about the le­gal rights of in­vestors and speed of fu­ture de­vel­op­ment.

The 10 per­cent an­nual growth in oil pro­duc­tion that vaulted Rus­sia into the top rank among sup­pli­ers in 2003 and 2004 slowed sharply to about 2.5 per­cent in the past two years in the wake of Rus­sia’s breakup of its lead­ing oil com­pany, Yukos, and the jail­ing of its chief ex­ec­u­tive, Mikhail Khodor­kovsky.

The slow­down in Rus­sian pro­duc­tion helped spur world oil prices to record highs by keep­ing a tight rein on global sup­plies.

Rus­sia this year raised en­vi­ron­men­tal and le­gal road­blocks to Royal Dutch Shell’s $22 bil­lion project to de­velop huge oil and gas fields on Sakhalin Is­land in Rus­sia’s Far East. An­a­lysts be­lieve it to be a bid to in­crease the state’s rev­enue and con­trol in the largest for­eign in­vest­ment in Rus­sia by in­sist­ing Shell in­clude the state gas mo­nop­oly Gazprom as a part­ner. As a re­sult, new in­vest­ment by West­ern com­pa­nies has dwin­dled.

Gazprom also shut Chevron, Cono­coPhillips and other po­ten­tial West­ern part­ners out of a ma­jor project to de­velop the gi­gan­tic Sh­tok­man gas field in the Bar­ents Sea, say­ing it will fi­nance and man­age the en­tire project on its own.

Yet de­spite Rus­sia’s sit­ting on the world’s largest re­serves of nat­u­ral gas, a lack of timely in­vest­ment in new drilling projects caused Gazprom to run short of fuel last win­ter to meet fast-grow­ing de­mand for elec­tric­ity in Rus­sia.

Rus­sian of­fi­cials dis­miss talk of en­ergy short­ages and say they are re­solved to meet­ing their fu­ture com­mit­mentsan­daregearingupto do so. They point to the na­tion’s long his­tory of be­ing a re­li­able en­ergy sup­plier to Europe, even dur­ing the Cold War, and note that other coun­tries such as Venezuela also have been in­creas­ing con­trol over their oil sec­tors.

West­ern in­vestors showed lit­tle con­cern about their le­gal rights as they en­thu­si­as­ti­cally snapped up of­fer­ings of Rus­sian en­ergy stocks this year, Rus­sian of­fi­cials say. The first pub­lic stock of­fer­ing of mi­nor­ity shares in the state oil com­pany Ros­neft in the sum­mer was heartily re­ceived when it opened on the Lon­don Stock Ex­change, de­spite ques­tions about whether state con­trol would im­pinge on earn­ings for in­vestors. Rus­sian elec­tric util­i­ties of­fer­ings last month also were over­sub­scribed by global in­vestors.

But even as the world looks in­creas­ingly to Rus­sia to sat­isfy its en­ergy needs, the In­ter­na­tional En­ergy Agency is rais­ing ques­tions about whether growth in Rus­sian oil and gas ex­ports will be fast enough to keep up with ris­ing de­mand­inEuro­pe­and­com­mit­ments Rus­sia has made to de­liver oil and gas to both Europe and Asia.

“Will the in­vest­ments take place? Will they come on time?” asked William C. Ram­sey, deputy ex­ec­u­tive di­rec­tor of the in­ter­na­tional agency. “Th­ese are costly projects. [. . . ] We’re con­cerned that the in­vest­ment cli­mate now is not con­ducive to bring­ing those re­sources on­line.”

Rus­sia in par­tic­u­lar needs to start de­vel­op­ing po­ten­tially im­mense de­posits of oil in east­ern Siberia that re­main largely un­ex­plored, he said. The coun­try has just started work on a 2,500-mile pipe­line from cen­tral Siberia to the Pa­cific coast that must be in place be­fore the oil can be tapped.

“We need to de­vote money ag­gres­sively to the East Siberian fields,” Mr. Ram­sey said. Be­cause of the long time it takes to build trans­port and drilling struc­tures, “we’re talk­ing about 2017 be­fore we see sub­stan­tial re­sources com­ing out of East Siberia.”

Keep­ing prices high

Vladimir Milov, pres­i­dent of the In­sti­tute of En­ergy Pol­icy in Moscow and a Rus­sian deputy en­ergy min­is­ter un­til 2002, said Pres­i­dent Vladimir Putin’s goal in tak­ing in­creas­ing con­trol of the oil and gas in­dus­try since dis­man­tling Yukos is to keep prices high, to feed the gusher of earn­ings from oil and gas ex­ports that has lifted Rus­sia’s econ­omy and re­vived its in­ter­na­tional sta­tus.

Through the Yukos di­vesti­ture and other ma­neu­vers, the gov­ern­ment has ex­erted con­trol over onethird of the oil sec­tor and may be on course to gain con­trol over an­other third within the next year, he said. The state re­tains near-com­plete con­trol over the gas sec­tor through Gazprom af­ter Mr. Putin killed a plan to pri­va­tize the gas gi­ant Mr. Milov said he had drafted be­fore he left gov­ern­ment.

While Mr. Putin has en­joyed pub­lic sup­port in Rus­sia for the re­na­tion­al­iza­tions, “it was the private sec­tor which caused our re­cent eco­nomic suc­cesses,” Mr. Milov said, in­clud­ing the fast growth in oil pro­duc­tion that un­der­pinned the coun­try’s ro­bust eco­nomic growth and surg­ing in­comes in re­cent years.

De­spite in­creas­ing ob­sta­cles laid down by the gov­ern­ment, the private sec­tor con­tin­ues to out­per­form state-con­trolled com­pa­nies, he said, con­trast­ing Gazprom’s ane­mic 0.1 per­cent out­put growth from 2000 to 2005 with the 12.5 per­cent growth from small in­de­pen­dent gas pro­duc­ers and 8.4 per­cent growth from private oil pro­duc­ers.

Gazprom, at the state’s be­hest, has spent $18 bil­lion re­cently ac­quir­ing the Sib­neft oil com­pany and other, un­re­lated en­ti­ties and has an­nounced in­ten­tions to pur­sue other ac­qui­si­tions, while spend­ing only $12.5 bil­lion on the drilling and pipe­line in­fra­struc­ture needed to main­tain and in­crease gas pro­duc­tion to meet its fu­ture com­mit­ments, he said.

Gazprom has been re­ly­ing in­creas­ingly on in­de­pen­dent gas pro­duc­ers in Rus­sia and pro­duc­ers in Cen­tral Asia to meet its com­mit­ments to Euro­pean cus­tomers.

Faced with se­vere de­clines in Rus­sia’s gi­gan­tic but ag­ing gas fields in west­ern Siberia, Gazprom needs to de­velop the huge fields to the north on the Arc­tic Ya­mal Penin­sula — which alone would cost $70 bil­lion to ex­ploit, Mr. Milov said.

Private en­ergy com­pa­nies are ea­ger to in­vest the tens of bil­lions of dol­lars needed in new drilling and pipe­line projects to tap into the en­ergy riches in re­mote ar­eas of the Arc­tic and Siberia. But the gov­ern­ment’s strip­ping of cor­po­rate rights and as­sets has stul­ti­fied such in­vest­ment and in­stead fun­neled a flood of en­ergy earn­ings into bub­bles in the boom­ing Rus­sian stock and real es­tate mar­kets, Mr. Milov said.

The lack of in­vest­ment by Gazprom is hurt­ing Rus­sian con­sumers, he added. Gazprom had to cut off sup­plies to power sta­tions in cen­tral and north­west­ern Rus­sia for two weeks last win­ter when tem­per­a­tures plum­meted.

Pro­mot­ing ‘na­tional cham­pi­ons’

Mr. Putin also wants to in­crease the power and pres­ence of Gazprom and Ros­neft, the state oil com­pany that ob­tained Yukos’ most prized oil-pro­duc­ing as­set at a bar­gain-base­ment price un­der a sale ar­ranged by the gov­ern­ment in 2004.

They are the “na­tional cham­pi­ons” through which the state now ex­er­cises strate­gic con­trol. The state’s reg­u­la­tory and le­gal ap­pa­ra­tus have been gal­va­nized to sup­port the com­pa­nies at ev­ery turn, Mr. Milov said.

The machi­na­tions over Shell’s Sakhalin II project il­lus­trate the trend. While the gov­ern­ment re­voked Shell’s per­mit for the project, cit­ing en­vi­ron­men­tal prob­lems and ob­jec­tions to cost over­runs, the real rea­son for its ac­tion is it wants to al­ter the pro­duc­tion-shar­ing agree­ment ne­go­ti­ated in the 1990s to in­clude Gazprom as a part­ner, he said. The Shell project is a joint ven­ture with Ja­panese com­pa­nies and is the only for­eign ven­ture in Rus­sia that does not in­clude a Rus­sian share­holder.

“This a se­lec­tive case” show­ing an ar­bi­trary use of the state’s reg­u­la­tory pow­ers to ad­vance Gazprom’s in­ter­ests, Mr. Milov said, con­tend­ing that the dev­as­ta­tion of forests and wa­ter qual­ity cited by the state were po­ten­tial prob­lems from the be­gin­ning and did not pre­vent the project from go­ing for­ward in the ‘90s.

A top Rus­sian oil ex­ec­u­tive, who re­quested anonymity, said Shell opened it­self up to the gov­ern­ment’s at­tack by an­nounc­ing a year ago that its costs on the project had dou­bled. The an­nounce­ment an­gered the gov­ern­ment be­cause it ate into the tax rev­enue Rus­sia re­ceives from the project and put Shell in vi­o­la­tion of its con­tract. That gave the gov­ern­ment an open­ing to rene­go­ti­ate the terms.

“Rus­sia is now a price-set­ter, not a price-taker,” the ex­ec­u­tive said.

The state also has threat­ened to re­voke the li­cense of TNK-BP’s joint ven­ture to de­velop the gi­ant cen­tral Siberian gas field of Kovykta in what an­a­lysts be­lieve is a bid to en­sure that Gazprom gains con­trol over po­ten­tially lu­cra­tive gas ex­ports to China.

ExxonMo­bil’s mas­sive Sakhalin I project is be­ing in­ves­ti­gated for en­vi­ron­men­tal vi­o­la­tions, and ques­tions have been raised about Gazprom’s role in con­trol­ling the project’s gas ex­ports.

Rus­sian Deputy En­ergy Min­is­ter An­drei De­men­tyev said com­ply­ing with en­vi­ron­men­tal laws is not ne­go­tiable. But he made no bones about the state’s in­tent to stand up for Gazprom in ne­go­ti­a­tions with Shell, Exxon and BP over gas projects.

“Our right and the right of Gazprom is to de­velop a sin­gle gas dis­tri­bu­tion sys­tem in the Far East and East Siberia,” he said.

Heac­knowl­edgedthatGazprom has had trou­ble pro­vid­ing the gas needed by Rus­sia’s elec­tric util­i­ties be­cause of the coun­try’s rapid

growth of power use. But he in­sisted that Gazprom is pre­pared to meet its com­mit­ments.

“In the last 30 years, we have never given any­one a rea­son to doubt our com­pe­tence,” he said. “De­spite all at­tempts by the mass me­dia to re­port prob­lems, I hon­estly do not know of any gas con­tract that has not been hon­ored, be it out­side the Rus­sian Fed­er­a­tion, or inside the coun­try.”

Gazprom re­cently said it is near­ing an agree­ment with Shell to join the Sakhalin II project. If it ends up tak­ing the lead from Shell, it would be the first time Rus­sia has ousted a for­eign player in its push to con­trol the en­ergy sec­tor.

“This is a big mis­take,” Mr. Milov said. The full par­tic­i­pa­tion of West­ern oil com­pa­nies with so­phis­ti­cated tech­nolo­gies and ex­per­tise will be needed if Rus­sia is to ex­ploit the en­ergy wealth that lies in re­mote and in­ac­ces­si­ble parts of Siberia and the Arc­tic.

Costly work ahead

Stan­dard & Poor’s Cred­itWeek an­a­lyst Alison Dunn said the dou­ble-digit growth in Rus­sian oil pro­duc­tion early in the decade was due to a re­bound from the de­pressed out­put lev­els of the 1990s and could not have been sus­tained.

But even to main­tain slower growth, Rus­sia will have to make more costly in­vest­ments in re­mote fields and trans­porta­tion net­works, as all the “cheap” op­por­tu­ni­ties for in­creas­ing pro­duc­tion have been used.

Rus­sia is no longer de­pen­dent on West­ern com­pa­nies to fi­nance needed in­vest­ments, she said. “As the Rus­sian gov­ern­ment has been able to col­lect most wind­falls from high oil prices in re­cent years, it has ac­cu­mu­lated mas­sive liq­uid­ity re­serves,” she said. “Rus­sian oil com­pa­nies gen­er­ate sub­stan­tial cash flows and, since 2002-2003, have ad­e­quate ac­cess to in­ter­na­tional cap- ital mar­kets.”

As for­eign in­vest­ment in Rus­sia is “po­lit­i­cally sen­si­tive,” Ms. Dunn ex­pects that it will be lim­ited to mi­nor­ity stakes and shares and will need ap­proval from the gov­ern­ment. Nev­er­the­less, be­cause Rus­sia pos­sesses much of the world’s un­ex­plored en­ergy riches, in­ter­est in in­vest­ment there re­mains ro­bust in the West, de­spite the risks of state in­ter­ven­tion and, in rare cases, con­fis­ca­tion of as­sets, she said.

In­vestors in Rus­sian com­pa­nies such as Gazprom, Ros­neft and Transneft, the state oil pipe­line mo­nop­oly, will have to keep in mind that there is a risk that pow­er­ful in­di­vid­u­als and in­ter­ests within the gov­ern­ment will use the com­pa­nies in po­lit­i­cal or eco­nomic power plays, ac­cord­ing to Stan­dard & Poor’s. But in the long run, the gov­ern­ment re­al­izes it is in its in­ter­ests to be a re­li­able and steady sup­plier of fuel to its cus­tomers in Europe and Asia.

A study by Cam­bridge En­ergy Re­search As­so­ciates said the re­vival of oil pro­duc­tion in Rus­sia’s mas­sive ag­ing oil fields in west­ern Siberia af­ter the 1990s col­lapse was due largely to the ap­pli­ca­tion of oil-re­cov­ery tech­nolo­gies in­tro­duced by West­ern oil ser­vices firms such as Sch­lum­berger and Hal­libur­ton. It ex­pects the fu­ture of oil pro­duc­tion in west­ern Siberia — still the largest-pro­duc­ing re­gion — to con­tinue to de­pend on the work of those com­pa­nies.

Some an­a­lysts and busi­ness ex­ec­u­tives charge that the state’s re­asser­tion of con­trol is aimed at en­rich­ing key gov­ern­ment in­sid­ers who the Krem­lin has placed at the helm of the com­pa­nies it con­trols.

Per­cep­tions of such in­sider deal­ing gave Rus­sia a low rank­ing of 121 out of 163 coun­tries in the 2006 Cor­rup­tion Per­cep­tions In­dex pub­lished by Trans­parency In­ter­na­tional. That rank­ing is be­low China and In­dia and only slightly above Venezuela.

How­ever, the World Bank’s mea­sure of le­gal and in­sti­tu­tional ease of ac­cess in 155 coun­tries rates Rus­sia higher at 79, ahead of China and In­dia.

“By putting en­ergy com­pa­nies in the hands of ri­val bu­reau­cratic fac­tions in the Krem­lin, profit is sup­pressed, in­vest­ment is sup­pressed,” said Robert Am­s­ter­dam, at­tor­ney for jailed Yukos ex­ec­u­tive Mikhail Khodor­kovsky. The big­gest loss has been the rule of law, he said.

“The at­tack on the rule of law in Rus­sia leaves ca­su­al­ties. Men are im­pris­oned. Jour­nal­ists are killed,” and now West­ern oil com­pa­nies are com­ing un­der at­tack, he said. The West de­serves much blame for not force­fully con­demn­ing and try­ing to stop the state’s ex­pro­pri­a­tion in 2004 of Yukos’ key as­sets, he said.

“The at­tack on Yukos was an at­tack on prop­erty rights,” he said. “That at­tack has left us reel­ing, has left BP reel­ing in Kovytka, Shell reel­ing in Sakhalin, and left Exxon un­der the gun.”

An­drei Il­lar­i­onov, a for­mer Putin eco­nomic ad­viser who de­clared that Rus­sia was no longer free and who left the gov­ern­ment af­ter Yukos was dis­man­tled, said the com­pany was tar­geted be­cause it was com­mit­ted to open­ness and free mar­kets in a way that was an­ti­thet­i­cal to pow­er­ful of­fi­cials in the Krem­lin.

It is symp­to­matic of the loss of free­dom and trans­parency in Rus­sia that for­eign in­vestors and ob­servers have be­come con­fused by fre­quently chang­ing rules and po­si­tions, he said.

As many as 15 the­o­ries emerged as to why Yukos was de­stroyed, he noted, and le­gions of an­a­lysts con­tinue to scru­ti­nize the Krem­lin’s words and ac­tions to try to guess its in­tent and to find clues about what is com­ing next.

“It re­quires a new kind of Krem­li­nol­ogy to fig­ure out what’s go­ing on — a science for un­der­stand­ing a non­free coun­try,” he said.

Agence France Presse / Getty Images

Rus­sia has re­cently blocked pro­duc­tion on Sakhalin Is­land, in­clud­ing Royal Dutch Shell’s $22 bil­lion de­vel­op­ment, with en­vi­ron­men­tal con­cerns and le­gal ob­jec­tions.

Agence France Presse / Getty Images

The slow­down in Rus­sia’s oil pro­duc­tion, af­ter the breakup of its lead­ing oil com­pany two years ago, has helped to raise global oil prices to record highs.

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