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The Independent (UK): Energy regulation: Exit, pursued by a Russian bear?

Russia is about to rule on whether to confiscate TNK-BP’s giant Kovykta gas field. Mary Dejevsky considers whether the game is up for Western oil companies in Russia

Published: 08 June 2007

Some time in the next few weeks, once the Group of Eight summit in Germany is safely out of the way, Russia’s energy regulators will announce whether they intend to revoke the production licence granted to BP for the Kovykta gas field in east Siberia. Few are optimistic about BP’s prospects of hanging on to it.

The postponement of the decision, which had been expected shortly before the G8, was widely seen as a diplomatic nicety on Russia’s part, rather than any sign of a last-minute change of heart. Speaking to a group of foreign journalists last weekend, President Putin had dropped a heavy hint that the decision was already taken. Asked about the prospects of BP – specifically, BP’s 50 per cent owned Russian venture, TNK-BP – keeping the licence, he expressed frustration with all the delays in developing the field.

Kovykta, he said, had reserves of 3 trillion cubic metres, equal to almost all the natural gas reserves of Canada. It was of tremendous importance to Russia. “But if the members of the consortium are doing nothing to meet licence obligations, how much longer do we have to tolerate this?” He acknowledged that there were many reasons for the delays. But, he said, “they knew about it when they bid for the licence; they knew about these problems and possible restrictions, and they nevertheless bought the licence”.

BP, for its part, has been cautious in the extreme about making any public comment on the situation. And why should it? One interpretation of the pre-G8 postponement might be that representations are still being made, or that the Russian authorities are in disagreement. It makes no sense for the company to write off Kovykta until it absolutely has to – not least because the actual financial implications for TNK-BP, at least at this stage, are negligible.

Although the value of the field, once exploited, could run to $20bn or more, the licence is worth almost nothing to the company under the terms and conditions that currently apply. Nor, strictly speaking, would the loss of the licence be a huge financial liability for BP. The company neither negotiated the deal nor paid for it; the licence came with TNK, having been negotiated long before BP came on the scene as part of the Nineties carve-up of Russia’s natural resources. None of this means, however, that the decision – when it comes – will have no significance. The reason it has been so keenly anticipated is that it is seen as a crucial indicator of Russia’s intentions towards foreign investment in general, and foreign investment in the country’s energy sector in particular. If, as expected, the licence is revoked, this will be seen as a negative answer to a host of questions that are, just about, still open.

Is Russia really interested in foreign investment in its oil and gas sector? Is it ready to deal with foreign investors on terms that are consistent and regulated by a recognised system of law? And how far is foreign access to Russia’s energy reserves dictated by politics rather than economics? And if the answers to all these questions are also negative, will it then be time for the international oil and gas companies to conclude that they are unwelcome, cut their losses and seek opportunities elsewhere?

The evidence, at least on the face of it, offers little encouragement to foreign operators. For the past three years at least, the Russian oil and gas sector has been in the process of consolidation. In its own plodding way, the giant Soviet-era state conglomerate, Gazprom, has been acquiring ever more assets and bringing more and more smaller companies under its wing. Rosneft, the oil giant created in large part from the wreckage of the ill-fated Yukos, is doing the same for the oil sector. The two companies are clearly being groomed to be Russia’s “national champions”, in a policy which has the full blessing of the Kremlin.

The way this policy has been pursued leaves the impression that Russia is busy securing its own energy “security”, if necessary at the expense of other people’s.

At the end of last year, after exerting pressure for months on Royal Dutch Shell, Gazprom finally took control of Sakhalin-2, the world’s largest combined oil and natural gas project, off Russia’s Pacific coast. Coming at the end of a year which had begun with Gazprom – briefly – turning off the gas tap to Ukraine, the move was generally interpreted outside Russia in the most negative light. Gazprom was seen as nothing more than the tool of a newly assertive Kremlin, which regarded energy as a tool of foreign policy.

In fact, there are many in the international energy industry who, if asked, admit to seeing Gazprom’s takeover of Sakhalin-2 in a slightly different light. They have some sympathy for Russia’s view that Shell’s original deal was almost extraordinarily advantageous, if not actual theft, and reflected the special conditions of the Nineties. Russia was almost bankrupt; its leadership was weak, its energy industry was in disarray, and the international price of oil was $10 a barrel. It was a deal, they say, that could not last. That Gazprom is buying out Shell and shareholders will be compensated is, they argue, proof that times have changed. It is at least better than confiscation.

The other side, of course, is that, ultimately, Shell had no choice. And in forcing the British-Dutch company to give up its majority stake, Russia broke an international agreement – even if it was concluded in unequal conditions. Naturally this reinforced all the existing doubts about Russia’s reliability.

The future of the Kovykta gas field is similarly a more complex question than it might appear. One of the main reasons why the current value of TNK-BP’s licence is minimal is that the assumption underlying exploitation of the field is not now on the horizon. It was envisaged that most, if not all, of Kovykta’s gas would be destined for the vast Chinese market. Now, however, it is required to supply only Russia’s domestic market at the low, state-set price. Under those conditions, it is not viable.

What is not at all clear is whether the Kremlin ordered that the domestic market should take priority because it sought to devalue the licence and so evict a foreign interest from the picture, or whether the change was made entirely for internal, economic and practical reasons. It can be argued, for instance, that it was the Russian government’s decision to switch power stations in the Irkutsk region from coal to gas that dictated the switch, and that it had nothing to do with foreign interests.

Some analysts even suggest that Russia’s atavistic fear of China underlay the decision to divert Kovykta’s supply to the domestic market. Essentially, according to this theory, Russian leaders did not want to sell to China anything that might make it easier for Beijing to “colonise” the empty tracts of eastern Siberia. Such an argument would make the revoking of TNK-BP’s licence a xenophobic decision, to be sure, but not one directed primarily against Western energy companies.

All these theories will be in play if the Russian authorities do decide to revoke TNK-BP’s licence. One aspect, though, seems unarguable. If TNK-BP does lose its licence, it would be clear that even a 50-50 venture with a Russian company is not enough to keep the foreign company’s interests intact. Russia wants nothing less than overall control.

Even this view, though, has its challengers. Some speculate that it is less the BP element of the venture that displeases Russia, than the Russian element – TNK. According to this theory, the Russian government wants its national champion, Gazprom, to control exploitation of what may be the country’s biggest gas field. In that case, BP’s joint venture might not only have failed to serve its intended purpose, but actually have backfired.

Let us then, for the time being, assume the worst: that TNK-BP will lose its licence, that it will lose it because a foreign company has an equal stake, and because the Russian half of the venture is not Gazprom. Even then, however, the worst may not be quite as bad as it seems. The message will at least be unambiguous. Russia is pursuing a policy of national champions in the energy sector. Foreign investors will be tolerated, even welcome, so long as they know their place as minority shareholders.

This would hardly spell the end of foreign involvement in Russia’s energy industry. It would merely mark the end of a chaotic and uncertain phase. Russia needs technology and management expertise, and it knows this. But it might be happier buying it in on a commercial basis, now that it has the money, than ceding control of the resources. But the sector is so huge, and its potential so great, that there will be deals for foreign investors – just not deals that are quite so disproportionately advantageous as they appeared in the 1990s.

This is why warning remarks by Tony Blair, on the eve of the G8, seem ill-judged and unrealistic. Promising “frank” talks with President Putin on matters as various as the murder in London of Aleksander Litvinenko and Russia’s apparent threat to re-target its missiles on Western Europe if the US sites anti-missile installations in Central Europe, Mr Blair said it was “common sense that companies are only going to invest where they believe the investments are secure”. So far, so right.

But he went on to link “security” to what is sometimes termed the “values” agenda. Russia, Mr Blair said, needed to demonstrate its commitment to democratic values. “If not, Russia isn’t going to attract the investment it wants and needs”. No; Russia will attract foreign investment if it can sort out the ground rules and offer a decent return. What happens to TNK-BP’s licence, and what terms might then be on offer to foreign companies, will show just how open Russia wants its energy sector to be. And no one should be under any illusion: this will depend, as it always has done, on Russia’s judgement of its own best interests.

royaldutchshellplc.com and its sister websites royaldutchshellgroup.com, shellenergy.website, shellnazihistory.com, royaldutchshell.website, johndonovan.website, shellnews.net and shell2004.com are all owned by John Donovan. There is also a Wikipedia article.

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