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The Moscow Times: 2007: The Year of the Inspector

Thursday, December 28, 2006. Issue 3569. Page 6.
 
The Prosecutor General’s Office has made it clear that it’s not pleased with the work of Federal Subsoil Resource Use Agency head Anatoly Ledovskikh, saying that it is not preventing the infringement of environmental regulations. It says that the agency should use its powers more often to revoke the licenses of resource companies that have broken the conditions of their contracts.

The Natural Resource Ministry’s environmental inspectorate got its warning at the beginning of December, when Natural Resources Minister Yury Trutnev criticized its boss, Sergei Sai, for the fact that the number of inspections carried out in 2006 was half that of 2005. The criticism led to a battle within the inspectorate between Sai and his deputy, Oleg Mitvol. It is clear that the main weapons in this battle in 2007 will be inspections, inspections and more inspections.

Russian bureaucrats are rarely fired for their mistakes, and certainly not for overdoing their jobs, so look out for much greater zeal ahead.

It won’t be hard for them to find what they are looking for. Practically every oil and gas company is guilty of at least some violations. According to analysts, the environmental problems that Sakhalin Energy, the operator of the Sakhalin-2 oil and gas project, ran into could hit any company working in the oil and gas sector.
 
State monitoring of compliance with licensing agreements is necessary, as is environmental protection. The concern comes from the conflicts of interest for the state, which are demonstrated clearly by the troubles at Sakhalin-2. The state operates as both regulator and renter. But even more significantly, the most important players in the market, Gazprom and Rosneft, are both state property. Gazprom ultimately bought a controlling stake in Sakhalin Energy at a significant “ecological discount.” It purchased 50 percent plus one share for $7.45 billion, or about $1.5 billion less the price set by analysts.

The threat of more aggressive regulatory activity in 2007 is something all private oil and gas companies will have to accept. Immediately after Gazprom’s Sakhalin-2 deal was closed, we learned that the Federal Subsoil Resource Use Agency was examining the possibility of revoking licenses for the Kharyaga field — one of the three in the country being developed on the basis of production sharing agreements. The agency said that less oil was being produced at the field than planned in the original agreement, meaning that a discount-price sale is in the cards for France’s Total and Norway’s Hydro, which hold 50 percent and 40 percent shares in the project, respectively. Gazprom has long had its eyes on the TNK-BP’s Kovykta field and, as a result of Gazprom’s control over the pipelines, TNK-BP is also unlikely to meet the delivery targets set out in the production sharing agreement.

In mid-December, the Financial Times even published a list of companies that would likely face serious problems in 2007. Appearing alongside TNK-BP was the United States’ ExxonMobil., which operates the Sakhalin-1 project. Inspections at that project by the environmental inspectorate have already begun.

With the kind of leverage that its regulatory powers provide, not giving itself a discount on entering the market would be stupid on the government’s part. The question here isn’t even one of the morality of such an approach. The question is one of its ultimate effectiveness. At some point the rising risks in Russia’s oil and gas sector will outstrip the optimism of foreign investors. The state will be left with a huge collection of assets but without the funds to develop them. Gazprom’s investment plan for 2007 doesn’t even make provisions for the purchase of the stake in Sakhalin-2, let alone for its development.

This comment was published as an editorial in Vedomosti.

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