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The Times: A deal is a deal: Russia threatens Western investors at its peril

More than 3,000 miles east of Moscow, in the remote but not quite pristine wilderness of Sakhalin island and its coastal waters, the Kremlin is fighting its latest battle for control of Russia’s prodigious mineral wealth.

This time the aim is not to rein in home-grown but presumptuous oligarchs. It is to rewrite the terms under which Western oil firms operate in the “supergiant” oil and gas fields of Siberia and the Russian Far East — fields that represent the most plausible long-term hope of weaning the de- veloped world off its reliance on Middle Eastern energy.

Shell, BP, Total and Exxon, among others, have invested tens of billions of dollars since the mid-1990s in production-sharing agreements (PSAs) with the Russian Government. Under these contracts, foreign investors met most of the costs of vast new extraction projects on the understanding that they would recoup those costs before sharing the proceeds with the Kremlin.

The biggest single PSA — and the biggest privately funded energy project in the world — is the Sakhalin-2 gas field, from which liquefied natural gas was to start being shipped to Japan in 2008, bringing Shell and its partners their first returns on an estimated $20 billion investment. 
 
Those returns are suddenly in doubt. Three times in rapid succession this week, Russian ministries and prosecutors have threatened to sink flagship PSAs, first targeting Sakhalin-2 by revoking an environmental permit, then Total and TNK-BP, a BP subsidiary, with warnings that permits for projects in eastern and northern Siberia may be withdrawn on environmental grounds.

Yesterday, Exxon joined the group of once-favoured, now nervous investors: the Natural Resources Ministry cautioned that it would not accept a revised cost estimate for the US firm’s giant Sakhalin-1 project.

The West’s oil giants are not environmental angels, but nor are Russia’s. This flurry of state-sponsored ecological concern disguises a dirtier strategic reality; the PSAs were drawn up when inflation, political chaos and President Yeltsin’s poor health had brought Russia to its knees. Soaring oil prices have since enabled it to pay off foreign debts, fund its own modernisation of the energy sector, and demand, with some justification, membership of the World Trade Organisation (WTO). The Kremlin, dependent on Western firms for expertise, but not, for the time being, for capital, is also demanding more from its investors.

There are two planks to Moscow’s argument. First, since PSAs bring to the Russian budget nothing beyond modest royalties until investments have been recouped, they give investors an obvious interest in inflating their costs; and Shell and Exxon have claimed cost overruns totalling nearly $18 billion. Secondly, these agreements exempted foreign firms from Russian tax laws, which have been reformed beyond recognition in the past decade.

But most PSA cost overruns have been incurred precisely because of the expense of complying with environmental laws. More importantly, bullying your most valued investors is no way to encourage others. Oil prices may fall and, even if they do not, Russia still has a long-term need for Western investment and knowhow. It has modernised enough to deserve a seat at WTO talks. But it will not deserve to be taken seriously if it is not serious about its obligations.

royaldutchshellplc.com and its sister websites royaldutchshellgroup.com, shellenergy.website, shellnazihistory.com, royaldutchshell.website, johndonovan.website, shellnews.net and shell2004.com are all owned by John Donovan. There is also a Wikipedia article.

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