Russian bear ready to maul Western oil majors

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The Independent Online

The biggest Western investment in Russia to date - the $20bn (£10bn) Sakhalin-2 oil and gas development off the Siberian coast - was plunged into further turmoil yesterday after the Kremlin said talks over Gazprom taking a stake in the project had stalled.

The bombshell came as Shell, which is the lead company in the project with a 55 per cent shareholding, faced the very real prospect of being stripped of a key environmental licence for its development of Sakhalin-2, throwing the future of the entire project into uncertainty.

Shell has been in talks with Gazprom for more than a year about swapping 25 per cent of its interest in Sakhalin-2 for a half share in one of the state-owned Russian gas company's onshore fields in central Siberia. But yesterday, Gazprom said the talks with Shell over a possible asset swap were off.

No ifs or buts, just a closed door. The company said there had been "no movement in the past year" and signalled it was no longer worth talking.

Sakhalin, a starkly beautiful island in Russia's far east that is closer to Tokyo than Moscow, is famous for its dearth of good news. Ask a Russian and they will tell you - its crime rate is higher than elsewhere in Russia, it used to be a sprawling Tsarist penal colony, and in 1995 an earthquake killed about 2,000 people.

The question that was being asked yesterday was whether the Kremlin's tough line spelt seriously bad news for Shell or whether it was simply a negotiating ploy to extract better terms from the deal for the Russian government and its people.

For there is no doubt that, having welcomed foreign investment into its oil and gas industry with open arms, the Kremlin is now keen to exercise more influence, if not direct control over its vast natural resources.

At the same time as Shell is under pressure to cede a bigger share of Sakhalin-2 to Gazprom, the country's monopoly gas supplier is also said to be eyeing the 50 per cent stake in TNK-BP, which is owned by a group of private Russian investors. The TNK-BP stake, which is in the hands of three Russian oligarchs, is likely to come up for sale at the end of next year.

The stakes at Sakhalin are high, which perhaps explains why the geopolitical tensions are so high and why the Japanese government intervened yesterday in the dispute on behalf of its two minority shareholders in the project, Mitsubishi and Mitsui.

The UK ambassador to Russia said yesterday he was "deeply concerned", Tokyo warned Moscow that bilateral ties could be damaged, and the European Union's energy commissioner, Andris Piebalgs, said he regarded the situation as "very serious". Sakhalin-2 is due to start supplying Japan and South Korea with gas within the next two years and it is rightly regarded as one of the gems in Russia's energy crown.

A spokesman for the Russian government said yesterday that Shell could have the licence revoked "within a day or two", raising the spectre of work grinding to a halt. The licence relates to Shell's environmental obligations in the area.

The oil and gas it is trying to get at lies under the feeding grounds of critically endangered whales and must be exported through a new pipeline that will criss-cross 1,100 rivers and streams.

Russia's Natural Resources Ministry alleges that Shell has flouted the country's environmental legislation. "We are not against foreign investment," Oleg Mitvol, the head of Russia's state environment agency, said yesterday. "But we are against attempts to make us look like a banana republic."

The revenue-sharing agreement that underpins Sakhalin-2 was signed in 1993 and allows Moscow to get a slice of the profits only when the project finally comes on line.

So far Russia has not received a rouble, apart from the delays, and has been told that the cost of bringing the oil and gas ashore has doubled to $20bn, delaying the moment when Kremlin Inc can begin reaping serious profits still further. Analysts say that Shell seems to think it can act as if Russia was frozen in time in 1993 when the deal was first signed.

The original agreement was inked at a time when Russia was on its knees and when then President Boris Yeltsin was borrowing as fast as he could. With near-record oil prices and a booming Russian economy today the situation is very different though and if there is one thing Moscow is not short of it is capital.

One Western oil expert said: "Shell is in difficulty because when it did the original deal with the Russians it got extremely sweet terms. There is tremendous resentment in Russia about the terms of that deal which are now seen as far too favourable to Shell.

"The oil price was a lot lower and the Russians needed Western investment. Now that the oil price has rocketed the Russians want a better deal and they are determined to get it. They are seeking to achieve it through the medium of their state-owned oil companies."

Adam Landes, an oil and gas analyst at Renaissance Capital, concedes that Russia could have spelled out its concerns to Shell better and like many others, he believes that Russia's environmental concerns are a convenient tool to pile on pressure.

But he believes that Moscow is not behaving unreasonably and that any other foreign government would behave in the same way if it thought it had been badly let down by a foreign investor.

"Shell doesn't have a position to bargain from," he aid. "Russia has realised that natural resources are its greatest asset and that it doesn't have to give them away anymore.

"It has been saying for months now that it doesn't want PSAs (production-sharing agreements) but it strikes me that foreign investors have not been listening. It's not such a terrible thing that's being asked."

BP could be faced with similar uncertainty at the end of next year when the shareholder lock-in at TKN-BP ends. Privately, company executives accept that the dynamics of the joint company will change should Gazprom or Rosneft become the Russian shareholder. The question is in what way.

One of TNK-BP's key assets, for instance, is the giant Kovytka gas field in eastern Siberia which is so far undeveloped. To get the gas to market, TNK-BP will need the support of Gazprom, which controls Russia's gas infrastructure. BP insiders insist that what will not change are the corporate governance rules or legal structure under which the joint company was set up. It is registered in the Virgin Islands and any shareholder disputes have to be settled under UK law.

Mr Landes of Renaissance Capital argues that investors should not take fright but rather realise that Russia has changed and is a very different country from that in 1993. "Russia is signalling that it wants investment, both foreign and Russian, but it wants business done on its terms," he said. For the moment, that message appears to have been lost in translation, though.

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