What Shell’s deal with Rosneft says about the oil world’s balance of power By Derek Brower, journalist AS A beaten dog loves his master, so Shell loves Russia. However else does one explain the company’s attitude towards the authorities in Moscow? Humiliated last year on Sakhalin, the company’s first response was to grovel words of thanks to its tormentors in the Kremlin. Now it has followed this with a strategic pact with Rosneft, the state-controlled oil company, covering future undisclosed projects in Russia. Everyone knew Shell’s chief executive, Jeroen van der Veer, was being disingenuous late last year in the aftermath of the Sakhalin affair. But the sight of him grinning beside President Putin as an “agreement” was announced to give control of Sakhalin Energy to Gazprom displayed just how much self-respect a businessman is willing to concede on his company’s behalf. Or perhaps he was sincere. Is there a corporate category for Stockholm Syndrome? 
Shell’s van der Veer is happy in Russia Shell emerged from the Sakhalin debacle with a decent price for a stake in Sakhalin Energy that it never wanted to sell: a mixed outcome if ever there was one. But this week’s announcement of the deal between Rosneft and Shell has other implications. First, it suggests that a company previously known for its aversion to risk has suddenly decided to embrace it. After Sakhalin, a sensible strategy for the company might have been to thank its lucky stars that it still had a project on the island, keep its head down, and avoid having its fingers burnt a second time. Instead, Shell is coming back for more. Like BP, brutalised by the Sidanco affair in the late 1990s and dangled over the Kovykta coals this year, Shell has calculated that the upside of Russia’s energy sector (enormous wealth in the ground) is greater than its many downsides (lack of transparency, state interference, resource nationalism and an unpredictable investment regime). Shell says that Russia remains a “growth area” for the company. In itself, that speaks loudly about the state of the world’s energy sector. With the exception of the Canadian oil sands – where Shell already has a substantial position – the large oil plays of the world are increasingly out of bounds for Western majors. Once accused of dominating governments and corrupting international relations, Western majors are now finding life less comfortable as power becomes concentrated in the hands of the resource nations and their erratic rulers. That leaves companies like Shell, under pressure to replace reserves, with little option but to go to countries like Russia, grinning like Jeroen and bearing it like Lord Browne, the former head of BP who set the precedent in coming back for more punishment. For resource nationalists like those in the Kremlin, that puts the Western majors exactly where they want them. Those companies remain essential to Russia. The country can’t hope to develop large projects like the Shtokman gasfield in the Barents Sea without the expertise of foreign partners. Gazprom couldn’t develop liquefied natural gas from Sakhalin on its own; its strategy with Shell was always to retain the Western company’s know-how to develop the project. But in the face of resource nationalism, the majors ought to ask themselves whether collusion is the best course of action. The International Energy Agency (IEA) warned producer countries this week that their efforts to increase control over extraction of their resources would undermine investment in exploration. That will force prices for oil and gas higher. But short-term price gains for the producers will come at the cost of long-term demand for their products. That would have grave consequences for producer countries like Russia, now afloat on oil and gas money. By agreeing to the new rules of engagement in countries like Russia, companies like Shell and BP — which bought a stake in Rosneft at the Russian company’s IPO last summer — are implicitly endorsing that energy nationalism. For those countries, that endorsement risks being as damaging in the long term as, for example, Shell’s implicit support for a succession of governments in Nigeria has been for Nigerians. That’s not to say that the countries that own the reserves shouldn’t have the right to develop them as they wish. Or that the days when Western oil majors dictated terms to foreign governments were any better – morally or politically – than today, when the power has well and truly shifted from the Western companies to the producer governments. But balance for the energy markets should be a common good recognised by all who have a stake in it: the companies, the governments, the consumers and the producers. It is better for Russia, Venezuela, or any other producer that steady growth of demand for oil and gas continues in line with steady investment in the upstream. Crashes happen when those two forces are not aligned. And, as the IEA suggests, investment in the upstream is not at present sufficient – a result of resource nationalism. That will soon put supply and demand out of kilter. The short-term losers in that situation will be the consumers. But the long-term losers are the oil economies themselves, as consumers switch fuels. Judging from their actions, Shell and BP – which wants to pursue projects with Gazprom, the company that muscled in on the Kovykta licence – seem to believe that their only course of action in Russia is to grovel and accept the Kremlin’s diktat, conceding that the principle of balanced relations is unattainable. That betrays a fundamental belief in their own weakness. And such collusion is bad for Russians who hope that their country can develop robust institutions and rule of law. For the abusive husband, sometimes it is better that the abused wife leave. Shell and BP, two companies that have in similar ways been victims of Russian caprices, would have done the world – and Russia – a favour if they had reacted honestly to the deterioration of Russia’s investment regime and sanctity of law. And what, after all, will they get in exchange for their loyalty? It has become clear that investment in Russia’s energy sector by foreign companies will in future only be done through partnership with Rosneft or Gazprom. In effect, that will reduce the role of the majors to that of glorified service companies. In their great quest to replace reserves, that is an awkward position for a Western major to find itself in. Their shareholders would be well advised to look for a note in the prospectus attached to any reserves booked from Russia, one that makes clear exactly how secure those barrels are and who really owns them.
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Dear Mr. Brower,I am very interested in your article.Clearly rule of law is far from being established in Russia and I fully agree that Western corporations – and governments for that matter – should realise that their best interest lies not in bowing to diktats from the Kremlin but in recognising the fact that Russia cannot live without Western money and know-how and must therefore learn to deal with the West in a democratic manner, putting rule of law before anything else. This would also be in Russia’s best interests.The western world does not seem ready to heed lessons from the past. French holders of Czarist bonds have known for nearly a century that Russia has absolutely not respect for the rule of law and will only negotiate when its interests are threatened. Russia has a debt of some US$ 90 billion (conservative estimate as of July 2007) to 316000 French bondholders which it refuses to recognise or publish in its national accounts. As per the investor alert below, French bondholders publicise their intention to pursue their claim until full payment by all legal means and in any jurisdiction they deem appropriate, and strongly advise against any dealings with Russia until rule of law is fully established in that country.RUSSIAN IPO INVESTOR ALERT:French holders of Russian government bonds remind investors that the Russian Federation is still in default today (July 2007) on their estimate of some US$ 90 billion owed to them since the Bolshevik, then the Soviet, and now the Russian Federation governments have all unilaterally repudiated Tsarist debt and refused any form of contact or dialogue with their legitimate bona fide creditors.They also remind investors that in its Sep. 15th 2006 report entitled “Governance matters: a decade of measuring the quality of governance”, the WORLD BANK has rated Russia’s governance comparable to that of Swaziland, Zambia and Kazakhstan. Russia came 151st out of 208 countries in terms of (…) accountability, quality of regulatory bodies, and rule of law, (…). In particular, rule of law (i.e. the courts and the quality of contract enforcement) was judged as effective in Russia as it is in Ecuador, Indonesia, and Bangladesh. Nicaragua, East Timor, and China’s ability to control corruption was judged similar to Russia’s.On February 26th 2007 the St. Petersburg Times, quoting a report from Vedomosti, wrote that “Surgutneftegaz managers covertly hold 72 % of the secretive oil firm” and that Deutsche UFG analysts had had to “raise its estimate number of outstanding shares from less than 26 billion to (…) 43 billion” which “implies a 40% dilution in the value of the stock”.In Paris on April 3rd 2007 to launch the merged NYSE-EURONEXT entity Mr. John Thain, the New York Stock Exchange CEO, warned that he was “very concerned about the quality of corporate governance, the transparency of company financials and the protection of minority shareholders. A number of Russian companies raise serious questions around these issues.”Despite these findings, and the main rating agencies’ knowledge that Russia is in default on US$ 90 billion of Tsarist debt, Russia is rated “INVESTMENT GRADE” whereas it should clearly be in “SELECTIVE DEFAULT”.French bondholders intend to pursue their claim until full settlement at present value, by any legal means and in any jurisdiction they deem appropriate.EVERY POTENTIAL INVESTOR IN RUSSIA MUST BE MADE AWARE OF THESE RISKS.FRENCH CREDITORS OF THE RUSSIAN FEDERATION STRONGLY ADVISE AGAINST ANY FORM OF INVESTMENT IN A COUNTRY WHOSE SOLVENT GOVERNMENT HAS IN THEIR VIEW SYTEMATICALLY REFUSED TO FULFIL ITS NATIONAL AND INTERNATIONAL CONTRACTUAL OBLIGATIONS, REFUSES ALL CONTACT AND DIALOGUE WITH ITS LEGITIMATE BONA FIDE CREDITORS, AND REFUSES TO DISCLOSE LIABILITIES WORTH US$ 90 BILLION.July 2007.
Dear Karloman,Many thanks for your comment and also for telling us about the French debt. I’d heard about the Tsarist era unpaid debts, but had no idea that they were now so high. Do you know what the original total figure lent was?Derek
Dear Mr. Brower,I apologise for my long silence.On December 18th 1964 Mr. Louis JAILLON, député in the French Assemblée Nationale reminded the House that more than 16 billion “Francs-or” had been lent to Russia by French citizens, i.e. 3 times the amount of the French 1914 budget. Of these 16 billion, the journalist Joël FREYMOND claims 9 billion “Francs-or” were lent under the form of bonds issued with a Russian government guarantee (“Les emprunts Russes, de la ruine au remboursement”, éditions Journal des Finances, 1996).The “Franc-or” was the French legal tender in pre-1914 France. In 2006, according to the very official French Institute of National Statistics (INSEE), the present value of one “Franc-or” of 1914 (the last year any significant Russian bond was issued in France) was 3,45 Euros; the average rate of interest on the government-guaranteed bonds was 4,5%, and these were no longer paid after 1917; therefore, in 2006, 89 years later, the total interest due was 4,5% x 89 x 9 billion x 3,45 = 124 billion Euros, to which we must add the capital, i.e. 9 billion x 3,45 = 31 billion Euros.Therefore, the total 2006 value of issues carrying a Russian governement guarantee was 155 billion Euros or 212 billion US$.One must bear in mind the fact that if, instead of summing the annual interest, we had capitalised it (which is the normal financial custom), the outstanding amount would be much greater.The discrepancy between US$ 212 billion and our claim to US$ 90 billion lies in the fact that in the 100 years which have passed since these bonds were issued, a certain number of them have been lost or destroyed or bought back by the Russian government (the bonds are still listed on the Paris stock exchange). How many exist today? We cannot be sure, we can only estimate. The answer lies within the French Ministère des Finances, who conducted a complete survey of French bondholders and their holdings in 1999. French bondholder groups have repeatedly requested disclosure of the results under French freedom of information laws; these requests are systematically turned down on the grounds that this information is classified.The very important amounts involved allow us (force us?) to think laterally and outside French jurisdictions where we are systematically confronted with French governement opposition, and collective action does not exist.On March 29th 2007 Mr. Nicolas SARKOZY, running in the French presidential election and a former Finance Minister, now president of France, wrote to some bondholders stating that the “rights held by French citizens on the Russian government are not extinct”.I hope this answers your question. Thank you for your interest. Do let us know if you require any more information.Karloman.