The Economist: Gazprom strikes again? BP’s woes in Russia

May 24th 2007
From the Economist Intelligence Unit ViewsWire

Russian regulators are doing a final check of alleged licence violations at the giant Kovykta gas field, which is majority owned by BP’s Russian joint venture. The licence could be withdrawn in a matter of weeks, but it is also possible that a deal could be reached to bring in state gas company Gazprom as the majority shareholder in the field, just as Shell and its partners did at Sakhalin-2. A comparison of the two cases, however, points to an outcome at Kovykta even less favourable for the foreign investor.

Inspectors from Russia’s federal environmental agency have today begun a final check on the Kovykta gasfield, to measure compliance against the licence held by Rusia Petroleum, in which TNK-BP has a 62.4% stake. A previous check, in January, found Rusia Petroleum in violation of its licence terms and gave the company three months to correct them. According to Oleg Mitvol, the deputy head of the natural resource ministry’s environmental agency and the scourge of the Shell-led consortium at Sakhalin-2, the licence could be withdrawn before June. In reality this appears unlikely, as Rusia Petroleum has gone to court to appeal against the findings of the January decision. Until the court has ruled—and the case is not scheduled to be heard until May 28th—the licence cannot be revoked.

Rusia Petroleum has held the licence to Kovykta, which has gas reserves estimated at 1.9trn cubic metres, for the last ten years. This year, the field is supposed to produce 9bn cu metres of gas. However, Rusia Petroleum’s failure to persuade Gazprom to build a pipeline to export gas to China means that there is no market to justify such production levels. Instead, will produce around 1bn cu metres this year for the Irkutsk region; even this is well below the level assumed when the licence targets were agreed. Rusia-Petroleum has gone to court principally to have its licence obligations clarified.

Arm-twisting

Mr Mitvol insists that, in any country, a licence obligation amounts to a promise that, if not kept, results in the loss of the licence. Yet the Kovykta case is not simply a story of a foreign investor who made big promises and failed to deliver.

Gazprom, the state-run gas monopoly, is heavily involved. It wants to have at least majority control of Kovykta. Arguably, its refusal to build a pipeline to link Kovykta with liquid markets–despite TNK-BP proposals over the past two years for deals that would give Gazprom a 51% stake–is the main reason why Rusia-Petroleum cannot meet the licence terms. The sticking point, seemingly, has been that Rusia Petroleum wanted Gazprom to enter the project on commercial terms–but that Gazprom refused to do so.

The broader context, of course, is the drive on the part of the Russian authorities in the last few years to increase the profile of Russian companies, and in particular Russian state companies, in the hydrocarbons sector. Rosneft, formerly a mid-sized oil company, is now Russia’s biggest crude producer, because it has gained virtually all of Yukos’s production assets via state-run bankruptcy proceedings. Rusia Petroleum’s situation is made worse by the fact that Kovykta is a gas deposit, and so it falls squarely within Gazprom’s realm. While Russia’s oil sector is a competitive industry in which private capital still (just) dominates, the gas sector remains dominated by Gazprom—a company that, much more than Rosneft, has a monopoly mentality.

Thus it is possible to envisage Rusia Petroleum losing the licence, which will then be awarded to Gazprom. Viewed from this perspective, it is not in the least surprising that the state gas company is not minded to enter Kovykta on commercial terms.

Sakhalin revisited

This is not the first time that Gazprom and Mr Mitvol have shown interest in a major hydrocarbons deposit under the control of a foreign company. In late 2006 Shell, Mitsui and Mitsubishi agreed to give Gazprom 50% plus one share in the US$20bn project for US$7.45bn. The deal, which has not yet been completed, was made under duress: the foreign consortium came under strong pressure from the federal authorities over huge cost overruns and—crucially—from Mr Mitvol’s agency over alleged environmental violations. Once the deal was announced, Mr Mitvol backed off.

Some observers expect that a similar deal will be struck between Rusia Petroleum and Gazprom over Kovykta. If that is right, the terms are likely to be harsher on Rusia Petroleum than they were on the Shell-led Sakhalin Energy consortium, for three reasons. First, Rusia Petroleum’s claim is weakened by the relatively low level of its sunk costs. To date, TNK-BP has spent around US$200m of the planned US$1bn to develop Kovykta.

Second, the foreign stake in Kovykta is much lower than in Sakhalin-2. In effect, BP has 31% of the field, compared with the 100% of Sakhalin-2 owned by Shell and its Japanese partners. The other shareholders in Rusia Petroleum are the Interros Group (25.8%) and the Irkutsk regional government 10.8%). Moreover, Kovykta is a smaller field than Sakhalin-2 and it has no oil.

Third, Gazprom has much greater leverage in this instance. The Sakhalin Energy partners needed little or no cooperation from Gazprom to export their oil and gas to foreign markets. Rusia Petroleum, by contrast, is utterly reliant on the gas monopoly building pipelines between Kovykta and potential customers.

Sacrificial offering

All these factors point to Rusia Petroleum coming off substantially worse from its brush with Gazprom and Mr Mitvol than did Sakhalin Energy. Indeed, given the explicit threats of Mr Mitvol and Natural Resources Minister Yuri Trutnev, it is possible that the licence could be lost entirely, rather than Gazprom entering on favourable terms and miraculously resolving all the problems with Russian officialdom.

Perhaps the main restraining factor on Gazprom’s behaviour is the company’s need to maintain reasonable terms with BP. After all, Gazprom and Rosneft are believed to be the two front-runners to acquire 50% of TNK-BP if the Russian owners exercise their option to sell from the end of this year—which they may come under official pressure to do. However, BP’s own history in Russia doesn’t necessarily serve as much as a deterrent to Gazprom: TNK stripped assets from an oil company part-owned by BP in the late 1990s, yet in 2003 BP agreed to form a joint venture with the aggressive Russian company.

For BP, Kovykta is a big deal. The field will potentially account for up to 20% of the company’s Russian operations in volume terms, at peak output. Loss of majority control at Kovykta at any price below a market rate would be very painful. However, for the foreseeable future the best guarantee of BP operating successfully in Russia is to be on the right side of the state’s champions, Gazprom and Rosneft. In the long run, given the deteriorating environment for Western oil companies in Russia, a bad deal over Kovykta may be a good deal for BP.

http://www.economist.com/agenda/displaystory.cfm?story_id=9230300

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