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Lloyds List: Seeing red over Russian policy

EXTRACT: Russia wants to secure more control over its natural resources through taxation, deceit, bullyboy tactics, cunning and acquisitions. It will achieve this any which way it can and companies clearly need to be on their toes when dealing with the Kremlin.

THE ARTICLE

Published: Sep 27, 2006

AS the Sakhalin Oil ‘ Gas conference begins this week in eastern Russia, delegates will be no doubt be wondering if it is worth investing in the region given the state’s current tendency towards picking gaping holes in the existing project contracts.

Oil majors ExxonMobil and Royal Dutch Shell have pumped billions of dollars into Sakhalin Island to develop offshore fields, build infrastructure and improve the life of islanders.

But with oil and gas prices at sky high levels on the world markets, the Russian government wants to get a bigger slice of the revenues and is willing to use political guile to get it.

Executives from Shell and ExxonMobil will be particularly vocal this week in Yuzhno-Sahalinsk, the region’s capital, no doubt demanding that the state keeps its nose out of projects Sakhalin I and II.

Both projects have drawn criticism from the nation’s Natural Resources Ministry because project costs have soared and there are allegations of damage to the environment.

To hinder construction work, Shell’s joint venture Sakhalin Energy has had its environmental approvals withdrawn, arousing anger from nearby energy hungry Japan and concern from European governments.

Reacting to the demands from Moscow, ExxonMobil has halted oil shipments from the new De Kastri terminal in the Tartar Strait to continue technical checks.

Most analysts and industry watchers see this as Russia’s way of bullying Shell into giving gas monopoly Gazprom a 20% stake in Sakhalin II and a bigger role in selling liquefied natural gas cargoes.

Shell is already negotiating an asset swap with Gazprom, while its Japanese partners Mitsui and Mitsubishi are thought to be offering the gas giant a portion of the project.

Gazprom also has its eye on securing a slice of Sakhalin I and is already talking to ExxonMobil’s Indian partners, despite the state already being represented by oil group Rosneft.

Moscow’s moves are clearly a way of extracting more money from the oil majors at a time when they cannot simply tell them to sling their hook.

The oil majors and their partners are in Sakhalin for the long term. They will not want to waste their huge investments already paid out, and the Kremlin knows this.

Moscow has the oil companies over a barrel and the leverage to exert as much pressure as possible to get what the government wants. But the simple truth is that this will damage foreign investments in the long run.

Both Sakhalin I and II projects are run through production sharing contracts that were signed in the 1990s when oil prices were far lower and the conditions were more generous.

Investments in offshore platforms, pipelines, onshore drilling sites, terminals, processing centres and an LNG plant can be recouped from the production revenues through these contracts and after this the revenues are split with the state.

Shell infuriated the Russian government when it doubled the capital budget for Sakhalin II to $20bn, effectively delaying state revenues for a decade.

ExxonMobil is likely to anger the state further if it announces a capital cost hike to $17bn from the original $12bn, but Russia is already unhappy that the US major is building a rival gas pipeline to China.

Other oil companies are watching these moves very closely and already French oil major Total feels its Kharyaga production sharing contract in Western Siberia is under threat.

BP is one of the largest foreign investors in Russia through its TNK-BP joint venture and exploration work with Rosneft off Sakhalin, so it is feeling a little heat from the state.

Russia wants to secure more control over its natural resources through taxation, deceit, bullyboy tactics, cunning and acquisitions. It will achieve this any which way it can and companies clearly need to be on their toes when dealing with the Kremlin.

Some feel a production sharing contract is still a contract, but the way the government is playing the game, oil companies could be left with nothing.

Investing in Russia is becoming a far riskier prospect than when the country needed help to boost exports.

Frankly it is a wonder that oil companies still want to go there after the rough treatment of Yukos and the ongoing threats on the Sakhalin projects.

Lloyd’s List

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