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From Economist.com: Strong-arm tactics

Gazpom Putin

Dec 12th 2006

Russia’s bullying of Shell, over a huge gas project, shows it is becoming a riskier place to do business

THE quest for oil demands flexibility when operating in harsh environments, and big companies are used to accommodating some unsavoury regimes. These days few places are tougher than Russia, where Royal Dutch Shell has been forced to bend over backwards. On Monday December 11th the Anglo-Dutch energy giant reportedly offered to cede control of Sakhalin II, a huge natural-gas project in the east and the country’s biggest single foreign investment, to Gazprom, the state-controlled gas titan. Shell and its two Japanese minority partners succumbed after months of bullying by the government, which has now acquired a big chunk of a private enterprise.

It is a disturbing and unwelcome development, but it should not come as a surprise. Vladimir Putin’s regime shamelessly dismembered Yukos, an oil firm owned by a political rival. And Russia’s government has made little secret that it regards energy as a legitimate tool of foreign policy in an energy hungry world. The grab for Sakhalin is just the latest tightening of Russia’s grip on its oil and gas reserves. The Kremlin is discouraging foreign participation in the exploitation of energy reserves: legislation is planned to limit outsiders, in future, to minority stakes in energy and precious-metal firms.

Gazprom had long coveted a slice of Sakhalin II and had negotiated with Shell to take a 25% stake. But it has gradually become clear that Russia’s government expected more. In September some important environmental permits were revoked, which threatened to halt work on the project. The Kremlin’s new green credentials drew admiring words from environmental groups, but the state was evidently more concerned about flexing its political muscles than protecting nature.

Russia may have had some grounds for complaint over the deal with Shell. It was signed when energy prices were much lower and when the country was desperate to attract foreign capital and expertise. The terms of the production-sharing agreement (PSA), governing the distribution of spoils, were tilted towards Shell. Russia’s government has also been infuriated by huge cost overruns, which led to the breakdown of talks that might have resulted in Gazprom settling for a minority stake. The project may now cost $20 billion, twice the original estimate. And Shell is entitled to recover its investment before paying out royalties.

But where Russia’s government may have had a good case for renegotiating the deal, instead it has resorted to intimidation. Shell had few negotiating levers and had little option but to back down. Though the details of the deal are not clear, some analysts suggest that Shell and its Japanese partners might get $4 billion for the half of Sakhalin II that they will hand over. At least it seems that Russia has not yet torn up the PSA, so Shell can still expect returns on its huge investment.

Other big oil companies may fear similar treatment. Gazprom or Rosneft, another state-run energy firm, may try to elbow their way further into the remaining foreign-controlled projects. Already there have been veiled threats over the other two big ones governed by PSAs—ExxonMobil’s Sakhalin I and Total’s Kharyaga. The Kremlin is also putting pressure on TNK-BP, an Anglo-Russian energy firm whose Kovykta project is north of China.

The risk for Russia, of course, is to its reputation. The government is getting a name for disregarding or unilaterally rewriting agreements when the mood strikes. With global demand for energy so high, oil firms may well decide that the risk is still worth it in Russia. But foreign companies considering investment in other sectors may think again.

Investors eyeing a slew of forthcoming IPOs (among energy firms and others) may now be discouraged. That is not what Russia needs. Thanks largely to high oil prices, its economy has been growing by an average of some 6.5% a year. The best way to sustain that is not to cede control of oil and gas fields to bureaucratic, inefficient and opaque state energy firms. More foolish still would be to scare away investors from other parts of Russia’s still-creaking economy.

This website and sisters royaldutchshellgroup.com, shellnazihistory.com, royaldutchshell.website, johndonovan.website, and shellnews.net, are owned by John Donovan. There is also a Wikipedia segment.

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