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Globe and Mail (Canada): Russia, pumped

SHAWN MCCARTHY
From Saturday’s Globe and Mail
02/03/07

MOSCOW — This city of 12 million has all the hallmarks of an oil-fired boomtown – traffic snarled at all hours of the day along roadways not built for three million cars, ubiquitous construction cranes hovering overhead, rampant consumerism in the luxury shops of the elite and the more prosaic housewares and electronic stores of the growing middle class.

Gone from the underpasses and Red Square itself are the legions of pensioners who just five years ago were begging and selling off family treasures to put food on the table. Flush with petro-rubles, the government of President Vladimir Putin cannot only pay their state pensions but has increased them.

A decade ago, the monumental GUM department store – which faces Lenin’s Tomb and Kremlin walls across the famous square – offered only drab and shabby local merchandise. Now, it has more in common with New York’s Fifth Avenue, boasting designer boutiques for Louis Vuitton, Mexx, Burberry and Russia’s own Bosco Sport.

And, as in every boomtown around the world, real estate is a hot topic. Many longtime Muscovites have relocated to the suburbs and rent out for small fortunes the downtown apartments that were given to them in the days of the Soviet Union, while the upwardly mobile professionals have seen the price gap between their current dwellings and their dream digs climb beyond reach.

The four-year boom in crude oil and natural gas prices that has supercharged economies as diverse as those of Alberta and Angola has transformed Russia’s as well. Less than a decade ago, the country was virtually bankrupt – unable to pay state workers and beholden to the International Monetary Fund and Cold War rival the United States. Prime Minister Stephen Harper talks of Canada as an energy superpower, but really it’s an energy superstore. Mr. Putin’s Russia is emerging as the real deal.

Not content just to tax the resource riches – the state collects 90 cents on every dollar above $28 (U.S.) per barrel of crude oil – Mr. Putin is transforming the industry that spawned Russia’s renaissance. Critics say that nationalizing oil and gas assets again could undermine growth, and risks derailing the very reasons for the boom.

Clearly, the stakes are enormous. Russia is a vast storehouse of energy reserves, one that western and Asian consumers increasingly rely on to satisfy growing demand. It is the world’s largest producer of natural gas and the second largest source of crude oil, slightly behind Saudi Arabia. And it has vast, untapped reserves that could, if properly developed, keep it a leading oil and gas producer for decades.

Unlike Canadian politicians, Mr. Putin appears ready and willing to use his energy riches for political leverage, reining in both foreign and domestic corporations at home while reasserting Russia’s traditional influence on the world stage with renewed confidence, even aggressiveness.

“I would say oil and gas revenues have helped Russia to overcome the feeling of humiliation that the country had during the nineties and at the beginning of this decade,” Fyodor Lukyanov, editor-in-chief of the influential journal, Russia in Global Affairs, says during an interview in his Moscow office.

“At that time, Russia could not afford to be as aggressive and assertive as now. At last, Russia is really independent.”

Mr. Putin’s political fortunes, aloft on a bubble of oil and gas prices, contrast sharply with those of his U.S. counterpart, President George W. Bush. A former Texas oil man himself, Mr. Bush has warned his country that its addiction to foreign oil is dangerous even as he has mired it in Middle Eastern conflict.

Given credit for the country’s energy-fuelled growth, Mr. Putin and his advisers have tightened their grip on Russian society. Amid allegations of thuggery and anti-democratic tendencies, they have cowed political opposition; gained control over much of the media, and reinserted the state into the economic life of the country.

In the oil and gas sector, they are pursuing a form of state capitalism, in which government-controlled companies will be pre-eminent, but will operate under market principles, often in partnership with multinational oil companies.

The age of the oligarch in Russia has passed. The billionaires, who made their fortunes through dubious privatization deals in the 1990s, once controlled the largest Russian energy companies and media outlets and had enormous political clout. Now, they are scattered and diminished – in jail, in exile or in thrall to the supremely powerful and immensely popular Mr. Putin.

The prosecution and imprisonment of former OAO Yukos owner Mikhail Khodorkovsky and the sale of what was once Russia’s largest oil company to state-controlled firms sent a clear political message. The Putin government was firmly in control and would brook no challenge, as Mr. Khodorkovsky was said to be mounting. The strongman President was prepared to redress what many Russians regarded as the excesses of the privatization period, as he forced privately held assets to be sold off at bargain-basement prices to state-controlled companies.

At the same time, international oil companies that had signed production-sharing agreements in the 1990s, giving them access to Russia’s largest resource developments, have been pressured into yielding control to state-owned companies.

At the end of 2006, Royal Dutch Shell and its Japanese partners sold a controlling stake in the massive Sakhalin II natural gas project to OAO Gazprom, the state-owned energy company whose chairman is Mr. Putin’s deputy prime minister. Now, the French company, Total SA is facing similar pressure over its rich Kharyaga oil and gas field, as the government claims it has failed to live up to the development agreement.

Also, the government is putting the finishing touches on a law that would restrict majority ownership in “strategic” oil and natural gas reserves, as well as mineral deposits, to state-owned companies.

Mr. Putin has long been an advocate of state control over strategic resources. In January, 1999, just before becoming president, he submitted a thesis for an advanced degree at the St. Petersburg Institute of Mining in which he argued that state-controlled natural resources would be crucial to the country’s economic development, as well as its international stature.

At a recent press conference, he said he remains determined to use proceeds from the oil and gas sector – which represent nearly half of government revenues – to attack the vast gap between the nouveau riche and the vast majority of Russians who, he said, “are still living on very modest means indeed.”

To Canadians, his approach evokes the 1970s when Pierre Trudeau created Petro-Canada and the National Energy Program to reduce foreign dominance of Canada’s oil industry.

Russia’s national champions are Gazprom, the world’s largest natural-gas producer; state-controlled OAO Rosneft, which conducted Russia’s largest initial public offering last summer, raising $10.4-billion (U.S.) by selling a 13 per cent stake; and publicly held OAO LUKoil, which is Russia’s largest oil company and is 20 per cent owned by U.S.-based ConocoPhillips Co.

LUKoil has production assets, refineries and gas stations around the world, and offers the best evidence that Mr. Putin is not totally hostile to private, and even foreign capital, so long as it recognized that the state has the final say. It and Gazprom, in particular, are seen as Russia’s leading candidates to compete with the likes of Exxon, Shell and China’s emerging oil companies.

Gazprom now insists that would-be partners in Russian natural gas projects allow it to buy into their operations at the other end of the pipeline. Petro-Canada is currently negotiating a joint venture with Gazprom on a liquefied natural-gas facility near St. Petersburg, but Gazprom has made it clear the price of admission is that Petrocan sell a stake in the LNG terminal it has planned for Gros Cacouna, Que..

LUKoil, meanwhile, has more than 2,000 gasoline stations in the eastern United States, including a monopoly along the Jersey Turnpike. The Moscow-based company is also exploring and developing reserves around the world, including in Venezuela, where President Hugo Chavez recently ordered the expulsion of western energy majors. Last month LUKoil chief executive Vagit Alekperov accompanied Mr. Putin on a trip to Saudi Arabia and Qatar where, among other things, the President mused about forming a natural-gas cartel among major producers.

But Gazprom has run into resistance from European politicians who worry about the loss of their own strategic assets to companies with close ties to the Kremlin.

So far, Russian firms haven’t evoked in North America the kind of backlash that greeted the planned acquisition of U.S. ports by a Qatar company, or the proposed acquisition by a Chinese state-owned oil company of California-based Unocal Corp.

Last fall, the Canadian government signalled its discomfort with major acquisitions by foreign state-owned companies, promising additional scrutiny to ensure they’re in the national interest.

And the Russian presence in North America remains modest. LUKoil has service stations, but no refinery or oilfields. Gazprom has opened a natural gas trading office in Houston, but has no real assets in North America. The test will come when a major Russian company, state-owned or not, undertakes a major U.S. acquisition.

Meanwhile, critics in Russia accuse Mr. Putin of using the naked power of the state to centralize economic decision-making within a small group of advisers, who not only serve in his government but take prominent positions in leading state-controlled companies. The most notable example: deputy premier Dmitry Medvedev, one of Mr. Putin’s two leading potential successors, who also happens to be chairman of Gazprom. His chief rival is Sergei Ivanov, whom the President recently promoted from defence minister to first deputy prime minister, putting him on par with Mr. Medvedev.

Political opponents also worry that Mr. Putin’s nationalistic policies will drive away foreign investment needed to develop the country’s oil and gas reserves which, while vast, are often located in remote, inhospitable locales far from access to markets.

Among Mr. Putin’s most vociferous critics is former prime minister Mikhail Kasyanov, who was a liberalizing force in the president’s first term until he resigned over the prosecution of Mr. Khodorkovsky.

During an interview, Mr. Kasyanov complains in his made-for-radio baritone about the current drift of the government. Mr. Putin is squandering the oil boom, argues Mr. Kasyanov, whose office is in a new business tower atop a bustling middle-class mall, complete with food court.

The impeccably dressed reformist politician has announced his own long-shot run at the presidency next March when Mr. Putin’s second (and last, according to the Constitution) term expires. He complains, however, that he can’t gain access to the Kremlin-friendly mass media, and of the “criminal” approach to politics employed by his former colleagues.

This week, he was visited by special prosecutors investigating an alleged fraud by a former government colleague, a move seen as a veiled hint to the politician that he ought not to be too successful.

Mr. Kasyanov takes a dim view of the Putin re-nationalization: “The major purpose is just to use oil prices to keep power. They are not issuing any reforms but are just increasing spending and making promises to keep popularity.”

He adds that Mr. Putin and his coterie are tapping a deep-seated xenophobia among the Russian population to justify the government’s heavy-handed actions in the oil and gas sector. “The Russian people believe the hungry capitalists would like to eat Russian sovereignty and Russian resources and so on,” he says.

“There is no leadership to make people understand how modern nations interact.”

Liberal analysts in Russia argue that President Putin’s strongman tactics appeal to a dark side of the Russian psyche that is neither democratic nor market-oriented.

Vladimir Milov, an economist with the Energy Policy Institute, appears frequently in the West, and recently made presentations to the European Union and the Washington-based Brookings Institute.

He works out of a small office adorned with posters of Australia and Sydney Harbour, his favourite vacation spot, and inevitably decries the return of state control over the energy sector, arguing that Russia just doesn’t invest enough in its productive capacity.

The former energy department bureaucrat also denounces the President’s approach, which he says will keep the Russian economy from ever living up to its potential. He argues that as well as failing to invest, the state has kept prices artificially low. As a result, the world’s largest natural-gas producer faces the prospect of supply shortages – which some power plants experienced last year.

Mr. Milov predicts similar mismanagement in other areas that come under the state’s sway. “The crisis will spread like a contagious disease. And the authorities have been doing extremely well in terms of hiding the situation from the public by using the control over the media to brainwash people with propaganda.”

But it is the misfortune of Russian liberals – and multinationals that want access to the resources – that many Russians now see the 1990s era of privatization and market-oriented reform as a failure.

The collapse of communism was followed by a decade of low energy prices. As a result, the state was near bankruptcy at times, and dependent on the International Monetary Fund; oil and gas assets were sold off to private investors at prices now seen as criminally low, and pensioners and state employees watched as their living standards dropped precipitously while the nouveau riche who benefited from liberalization partied in luxury in Moscow clubs.

It was in that same bleak period, that then-president Boris Yeltsin approved three production-sharing agreements yielding lucrative development rights over some of the country’s more promising deposits to Total, Royal Dutch Shell and ExxonMobil Corp. Those agreements are now regarded by many as a national disgrace.

In contrast, it has been Mr. Putin’s good fortune to govern at a time when record energy prices have swelled state coffers – oil and gas revenues now account for half of the government’s revenues. The windfall has allowed it to boost incomes for those who depend on the state, to reduce dramatically Russia’s public foreign debt and build a $90-billion (U.S.) stabilization fund, and to promise to end the reliance on foreign capital to develop its resources.

Presidential press secretary Dimitry Peskov leaves no doubt that the administration believes it is restoring Russia’s sovereignty, and international clout, with the financial windfall from record oil prices.

“When you are dependent financially, of course, your voice is not heard in the international arena,” he says in an interview at his Kremlin office. “And, of course, you are not so flexible and so sovereign in taking decisions, even if you are trying to take decisions to take better care of the population.”

But he says the primary aim is to use resource revenues to improve living conditions for the Russian people. Even as it piles up sizeable surpluses, the government has opened the taps, embarking on “national projects” in education, health and infrastructure. Government spending, which had dropped to 29 per cent of gross domestic product under Mr. Kasyanov, who left in 2004, has since climbed to 35 per cent.

“What cannot be ignored are the positive changes in our country that occurred during the last 10 years,” he says. “I would say in general the country is back on its feet, though we have hundreds of problems. The trend is very positive.”

Mr. Peskov says the Putin regime welcomes foreign investment, even in the oil and gas sector, so long as the companies play by the rules. The government has accused western companies of failing to live up to development plans in their earlier agreements, and of massively polluting the environment.

And he insists that the state-owned companies will operate as market-oriented enterprises, without any government mandate for economic or social development.

“Oil and gas is a strategic sector… not only for existing generations but for future generations,” he says.

“And this is the reason for this process that we witness, that things are being brought to order and the role of the state is being enhanced. What is important is that, even if it is a state-owned company, it is being operated under the conditions of market economy.”

Viatcheslav Nikonov, a Kremlin-friendly consultant and frequent commentator on Moscow television, says Russia’s brief fling with wide-open capitalism was an aberration. Most countries in the world, from Norway to Mexico, from China to Saudi Arabia, maintain state-owned energy companies. The exception, he notes, is the “Anglo-Saxon world” – the United States, Britain, Australia and Canada.

Mr. Nikonov acknowledges, however, that the government’s methods in establishing the new regime, both within Russia and with formerly subsidized customers such as Ukraine and Belarus, have been ham-handed and open to misinterpretation. “Sometimes, Russia acts with the elegance of an elephant in a china shop,” he says.

But he defends the efforts to revisit the agreements Mr. Yeltsin signed with Exxon, Shell and Total, deals that exempted the projects from normal taxation and provided a return to the state only after companies accounted for inflated costs. “There will be no more white man-Indian type agreements between Russia and the western companies, that’s for sure,” he says.

It remains to be seen, however, whether Gazprom and Rosneft have the management skill and technology to extract crude oil and natural gas from Russia’s far-flung and forbidding geography. Many of the reserves lie in western Siberia, the High Arctic or offshore in the Far East, where weather conditions are extreme and the wellheads are far from markets.

At the same time, Mr. Nikonov insists there is no need to expand production in a hurry. It’s in consumers’ interests to have Russia ratchet up, but not necessarily in the interest of the Russian people, he says.

The country already has trouble absorbing the resource revenue flooding in – as well as the $90-million stabilization fund, it has foreign reserves twice that amount. The ruble is strong and the country is struggling to expand its manufacturing and processing to diversify and solidify the economy.

Given the country’s vast potential and the difficulty that international companies now face in a growing list of oil-rich countries, Russian leaders appear to believe that even if they limit access and revisit old agreements, the outsiders will have little choice but to invest.

Mr. Lukyanov, the editor of Russia in Global Affairs, worries that such arrogance could backfire.

“Russia has found itself in a situation where we think everybody needs us, but apparently we don’t need anybody,” he says. “That’s an illusion, of course, but it’s an illusion that is very widespread now in the Russian establishment: ‘We have something that everybody needs, so we can do what we want and they must accept it.’”

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