Royal Dutch Shell Plc  .com Rotating Header Image

The Observer: Kremlin Inc ready to take on the West

EXTRACT:most analysts agree that the mergers of global super-majors are likely to return. Could Shell and BP, both baring the scars of their Russian adventures, be first? 

Its treatment of Shell was so aggressive that the £116bn company agreed to alter the Sakhalin-2 production-sharing agreement, signed with the Russian government a decade ago, to allow Gazprom a majority stake in the venture -into which Shell and its partners had already sunk more than $10bn.


Gazprom, the Russian gas monopoly, began the new year with more sabre-rattling. But strong-arm tactics won’t always serve, says Oliver Morgan

Sunday January 7, 2007

For Kremlinologists and other followers of Russian affairs, 1 January should perhaps have been Groundhog Day, not New Year’s Day. Then, as 12 months before, the mighty Russian bear was growling at a former Soviet neighbour, threatening it not with tanks but with higher gas prices. As with Ukraine in 2006, Belarus was threatened this year with a cut-off if it did not agree to pay more than twice what it had been paying Gazprom, the Russian monopoly, for its gas, as well as allowing that company – in reality an arm of the Kremlin – a 50 per cent stake in its national pipeline network, Beltransgaz. It agreed.

There are differences between the Belarus and Ukraine cases. The Belarusian dictator Alexander Lukashenko is a Putin crony who has done what he has been told rather than pushing through a platform of change, as happened with his freely elected counterparts in Kiev. Also, there was less of a threat to the rest of Europe, as less gas passes west through Belarus than through Ukraine.

Nevertheless, 2006 started on a similar note and turned out to be the year when Western oil companies found themselves publicly intimidated by Russian officials on charges ranging from poor environmental stewardship to bad project management and cost control.

The pressure became so great that names regarded in Europe and the US as the most robust examples of the multinational corporation, capable of dealing with difficult regimes from Indonesia to Venezuela to Nigeria, caved in. They allowed stakes in projects for which they had signed binding contracts to be torn up and their holdings to be made over to Russian companies, mostly Gazprom.

The most notorious example came before Christmas when Gazprom gained a majority stake in the Sakhalin-2 liquefied natural gas project off Russia’s east ern coast, elbowing aside Shell – until then the senior partner in the venture – along with Mitsui and Mitsubishi of Japan. Total, the French oil company, has buckled under Kremlin pressure over a field in the Arctic.

Moscow also acted pre-emptively in the summer, cutting out five international oil companies – at least for now – from developing the giant Shtokman gas field, which is estimated by consultants Wood MacKenzie to contain 83 trillion cubic feet in reserves. So, will 2007 follow a similar pattern?

Chris Weafer, head of strategy at Alfa Bank in Moscow, thinks it will: ‘This year will see a continuation of the Kremlin trying to take control of the energy sector from the well-head to as far downstream as it can get.’

Derek Butter of Wood MacKenzie agrees, but believes the policy of aggressively targeting oil companies may soften. ‘What we have here is a transitional period, where the Russians want to re-establish the control of these assets. Once that has happened, the Russians are not going to be averse to foreign investment.’

According to Weafer, there have been three phases in the transition pursued by Putin. The first was to create national champions, the largest of which are Gazprom and Rosneft, the oil company that floated some 12 per cent of its shares in London last summer, valuing the company at $80bn. The ‘restructuring’ to create these has been highly controversial. The Russian government was accused of handing Yuganskneftegaz – the main operating arm of the Yukos oil company founded by Mikhail Khodorkovsky, the oligarch jailed by Putin – to Rosneft in a ’sham’ auction. Many opposed the Rosneft flotation, claiming it was a form of money laundering.

This year is likely to see the denouement of this restructuring, says Weafer, with the sale of the remaining Yukos operations, Samaraneftegaz in the Caspian, and Tomskneft. Together these can produce up to 650,000 barrels of oil a day, but have been run down to 400,000. Also, a 20 per cent stake in Sibneft (80 per cent of which was sold to Gazprom) could be floated or sold to a trade buyer – experts think Indian oil and gas giant ONGC.

The second phase has been to extend state control over Russian energy assets – largely using these companies, which list Putin allies and ministers on their boards. This is how Shell and Total suffered bear hugs last year. Analysts agree there remain two obvious targets for the Kremlin – Sakhalin-1 and the TNK-BP joint venture – and think Putin will want control of these by the end of the year. He stands down in the middle of 2008.

There was skirmishing last year over Sakhalin-1, which sits on 2.3 billion barrels of oil and 17.1 trillion cubic feet of gas. The IOC consortium, led by Exxon (with 30 per cent) and including ONGC (20 per cent) and Japanese investment company Sodeco (30 per cent) was accused of licence violations by the natural resources ministry. But this year more significant developments are likely.

Butter says: ‘Exxon needs a gas export solution. Gazprom has a monopoly position in gas exports. I would imagine they would be interested in an equity stake.’

That stake would not have to be 51 per cent to secure Russian control, as two subsidiaries of Rosneft already hold a total of 20 per cent. As for TNK-BP, Butter says: ‘It is a 50:50 joint venture. The Russian partners in that are Alfa Access Renova, who are old-fashioned oligarchs, not under government control. There has been speculation that Gazprom would be very interested in controlling this stake.’

Here, Gazprom, as the export monopoly, has leverage too. Chief among TNK-BP’s assets is the giant Kovykta gas field, which has export potential to China. BP has already said Gazprom could take majority control over the field, but wants assets or cash in recompense. Experts say this is proving a sticking point, and BP may find itself subject to pressure similar to that suffered by Shell last year. The ultimate aim would be for Gazprom to replace Alfa Access Renova, and take a controlling stake in the venture.

The third phase is for Russia to expand ‘as far downstream as it can’, or to snap up pipeline capacity and refineries and buy customers in its western European markets via stakes in supply companies.

The most recent pipeline deal was the Beltransgaz element of the Belarus agreement over the new year, but Gazprom is also investing in the £3.4bn Baltic pipeline to Germany (and eventually to the North Sea), and is developing plans for routes across Turkey.

Just as European energy companies have integrated to hedge their reserves with customers, so Russian ones want to do the same. Gazprom currently supplies 25 per cent of European gas, and wants to make that 33 per cent by 2010. So it needs to forge agreements with major suppliers. It has struck deals in some countries already – around a dozen in the past year alone.

Gazprom has also bought into the UK, taking over Pennine Natural Gas, a small operator. But this is seen as a prelude to taking a stake in Centrica, owner of Britain’s largest supplier, British Gas. Experts believe it will not move until Gazprom supplies a greater proportion of gas to the UK, which has become a net importer only in the past two years.

Meanwhile, Lukoil, the largest Russian oil producer, has petrol stations in Europe and in America, where it is rebranding Getty petrol stations in the north east. In November, Gazprom and Lukoil signed a joint venture aimed at acquiring assets abroad.

However, as Weafer points out, there has been opposition to Russian ownership of major European assets. This is why he sees expansion as phase three of the Kremlin’s strategy, following the robust approach to its own resources.

‘I expect 2007 to see high-level talks between Russia and Europe,’ says Weafer. ‘Russia can say: “We are now in a position to develop our oil and gas assets and in principle we have no objection to doing that jointly with European companies. But in exchange we want unrestricted access to investment in Europe.” The window of opportunity is while Putin is there and Germany is in charge of the EU (Chancellor Angela Merkel last autumn held talks with Putin over co-operation).’

So far, Russian moves west have met with resistance. An attempt by a Russian state bank to buy into aerospace manufacturer Eads was strongly resisted, and indications of its interest in Centrica have received a mixed reception here. BP and Exxon can expect further pressure as Putin pushes for an agreement.

Examples of aggression, however, are matched with examples of accommodation. BP, for example, is expected to benefit from its $1bn investment in the Rosneft float through deals or ventures with that company. And Conoco has invested $3bn in Lukoil, and in January last year secured a member on its board.

Perhaps Russia still believes it needs Western companies. As one senior oil and gas analyst says: ‘Does Russia need the IOCs? Not as much as before, because it has gained a lot of technical expertise from them already. But there is a great deal of managerial expertise and best practice they still want. Do the IOCs still need Russia? Yes, but they will not take it on any terms.’

High oil prices mean that the terms of trade have changed. But Russia’s new boldness relies on mutually assured prosperity rather than the mutually assured destruction of old.

The prediction: year of the super-mergers

Russia gave the world’s most powerful oil companies a mauling last year. Its treatment of Shell was so aggressive that the £116bn company agreed to alter the Sakhalin-2 production-sharing agreement, signed with the Russian government a decade ago, to allow Gazprom a majority stake in the venture -into which Shell and its partners had already sunk more than $10bn. Exxon and BP are likely to face similar pressure this year.

Oil companies are feeling the squeeze from Latin America to Nigeria as ownership rights and operating conditions deteriorated markedly last year. The companies have faced aggressive renationalisation before – in the Seventies much of the Middle East was closed off to the multinational operators. The likes of BP, Shell and Exxon, Conoco, Total and Statoil survived, and in the past few years have done well out of soaring oil prices. However, before the surge in prices, most of the global majors joined a round of consolidation that created the super-majors of today: Exxon bought Mobil; BP took Amoco, Arco and Castrol; Total, Elf and Fina merged, and so on. Consolidation was born not of strength, but weakness.

Today, although international oil companies (IOCs) are among the biggest producers of oil and gas they hold only about 20 per cent of the world’s proved oil reserves, while national oil companies, in resource-rich regions such as the Middle East, hold 80 per cent.

With increased nationalism in areas rich in resources, it will be more difficult for IOCs to secure reserves in future. This could have a profound influence on them.

Companies are focusing on higher cost regions, hoping the oil price stays high, as BP is doing off Angola, or Shell in Canada. Linked to this, companies can develop leading-edge technologies to exploit harder-to-find resources. In addition, they must find a way of co-existing with their more nationalist hosts in future.

The price of oil may stay high, but for companies that have traditionally been valued on their ability to increase reserves and therefore production, this may not be the boon it has been in the past. But most analysts agree that the mergers of global super-majors are likely to return. Could Shell and BP, both baring the scars of their Russian adventures, be first?,,1984298,00.html and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

0 Comments on “The Observer: Kremlin Inc ready to take on the West”

Leave a Comment

%d bloggers like this: