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Bloomberg: Russian Regulator Says Its Oil Market Is Maturing (Update1): ‘Shell was hurt by its own arrogance,’ said Mitvol…

By Dan Lonkevich

Sept. 4 (Bloomberg) — Major oil companies interested in Russia’s production, the second largest in the world, should recognize the days of “the Banana Republic” are over, the country’s Natural Resources Ministry said.

Foreign oil companies can no longer cut regulatory deals to enter Russia, said Oleg Mitvol, deputy administrator of the country’s Natural Resources Management. “Those times are a thing of the past,” he said today in an interview in New York.

Royal Dutch Shell Plc’s Sakhalin-2 project shows how a foreign company can run afoul of the changes occurring in Russia, said Mitvol. Shell, the world’s second-biggest oil company, ceded control of Sakhalin-2 last year to state run OAO Gazprom after months of pressure from environmental regulators.

“Shell was hurt by its own arrogance,” said Mitvol, who describes himself as outspoken and blunt. “The company failed to understand the changes that have taken place.”

Spokesmen for Shell in London and Houston didn’t return phone calls seeking a response to Mitvol’s comments.

Shell failed because it tried to make deals with bureaucrats and because it brought in heads of states to put pressure on Russian regulators, he said.

“They tried to intimidate us with lawsuits,” Mitvol said, citing a Shell threat in September 2006 to bring a $10 billion lawsuit against Russia unless environmental inspections were ended.

“Instead they should have focused on the problems” uncovered by the Russian regulators, he said.

Environmental Violations

Gazprom suspended a preliminary agreement to join the venture after Shell in July 2005 doubled its cost estimates for the latest phase to $20 billion. The government complained the overruns would yield less revenue under a so-called production sharing agreement and threatened to suspend Sakhalin-2 permits because of environmental violations.

Russian officials may consider their country more advanced now because in the 1990s, under the leadership of President Boris Yeltsin, many companies were forced to negotiate with local officials, said Amy Jaffe, an energy expert at the James A. Baker III Institute for Public Policy at Rice University in Houston.

The Sakhalin project was such an example, where the governor did the negotiating and then took the agreement to the State Duma, or parliament, for approval, she said. Whether that system was more balanced than today’s environment, where companies have lost licenses and ceded contracts under government pressure, is open to question, she said.

`Not Honoring Contracts’

“Russia wasn’t seen as a Banana Republic then, but they may be more apt to be seen as a Banana Republic now, because people aren’t honoring contracts, and not honoring contracts is something people do in Banana Republics,” Jaffe said.

Mitvol is in the U.S. this week to meet with investors from Capital Research & Management Co., American Century Investments, Fidelity Investments, UBS AG, State Street Corp. and Wells Capital Management Inc. He is accompanied by Igor Maidanov, director of the Natural Resources Ministry’s department for international cooperation.

“Russia wants foreign oil companies to invest in Russian oil companies,” he said. “We would be extremely happy to have them. We are interested in their experience and know-how.”

ConocoPhillips is an example of a company that partnered with a Russian oil company, with a 20 percent stake in OAO Lukoil. The partnerships are a way for Russian companies rich in oil output to access consumer markets in countries such as the U.S., or gain a share in overseas refinery assets, Jaffe said.

Russian regulators now require energy companies that operate in the country to provide project information every three months and allow the country’s regulators to verify their reserves.

To contact the reporter on this story: Dan Lonkevich in New York at [email protected] .

Last Updated: September 4, 2007 14:58 EDT

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