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St Petersburg Times: Russia Plays Rough, Wins Bruising Fight

Issue #1233(99), Tuesday, December 26, 2006
By Sebastian Smith
AGENCE FRANCE PRESS/Bloomberg

MOSCOW — Moscow has savoured victory after state giant Gazprom ousted Royal Dutch Shell from control of the Sakhalin-2 energy project, ending a struggle highlighting changing rules in Russia’s bare-knuckle business environment.

The announcement late on Thursday that Gazprom would take the controlling stake in the $22 billion natural gas development was a milestone in President Vladimir Putin’s campaign to restore state control over the energy industry.

The terms of the changes in the project off Sakhalin island on Russia’s far eastern coast also halved smaller shareholdings by Japanese companies Mitsui and Mitsubishi.

Analysts highlighted the Kremlin’s toughness in campaigning to make Shell surrender its control over the vast and potenially lucrative development, which is intended to provide liquified natural gas to Asia, especially Japan, from 2008.

Under the deal, Gazprom will buy 50 percent of shares, plus one, for $7.45 billion, while Shell’s share is cut from 55 percent to 27.5 percent. Mitsui which had 25 percent retains 12.5 percent and Mitsubishi which had 20 percent retains 10.0 percent.

The deal was couched in business terms, but politics played a big role, with the Russian state widely accused of using environmental probes as a weapon to force Shell’s hand.

The Vedomosti business daily said that Moscow first used allegations of environmental damage on Sakhalin to undermine Shell’s position in negotiations with Gazprom. Then the same allegations were used to knock down the price when Shell agreed to sell at.

“The Putin Discount,” read the headline on the newspaper’s front page. “The ecology was what Gazprom used as a main argument to get a discount,” the newspaper said.

According to Vedomosti, the $7.45 billion paid should have been as high as $8 billion to $10 billion.

And no sooner was Gazprom’s takeover confirmed than worries over the ecological damage — estimated by the state environmental watchdog at anything from $10 billion to $50 billion — as well as Shell’s controversial cost overruns, seemed to evaporate, the Russian press reported.

“Gazprom’s entry into the world’s biggest offshore project immediately removed the intrigue around the costs of the project,” RBK business daily wrote.

The strong-arm tactics have raised concern internationally over the potential difficulties of doing business with Russia, the world’s biggest gas producer and number two oil producer after Saudi Arabia.

In Tokyo on Friday, Chief Cabinet Secretary Yasuhisa Shiozaki urged Russia to “take responsible policies.”

Shiozaki, who is the government spokesman, said: “Our country relies on energy resources from abroad. It is important to see the project go ahead smoothly to secure energy resources and provide stable supply.”

The head of analytical research at Alfa Bank in Moscow, Ronald Smith, said that the Russian government felt strong because of high energy prices — self-confidence that contrasts with the weak position of the state in the 1990s, when the original deal with Shell was struck.

“In this age of resource scarcity all the bargaining power lies with the owner of the assets, so you’d expect the government to have the upper hand,” Smith said. The Kremlin also feels little sympathy for Shell, given the British-Dutch giant’s abrupt revelation in 2005 that costs had doubled from $10 billion to $20 billion.

Under the terms of Shell’s original deal with the Russian state, that change would have meant huge delays for Moscow to receive any income from Sakhalin-2.

“They doubled the cost and didn’t let the Russians know directly. Instead they had to find out through the press. The Russians felt they really got taken advantage of,” Smith said.

Besides, “people who come to emerging markets already have a high appetite for risk,” Smith added. “Any shrinking violet tends to get run out of town on the first down-dip.”
 

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