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Appetite for Risk in Russia Emboldens State Theft and Graft

Today the Economist Intelligence Unit is running an analysis of the situation of BP in Russia, specifically the Kremlin’s campaign to seize majority control of the Kovykta gas field through invented “violations” of its operating license (headed up by none other than the dragon slayer Oleg Mitvol). The writers conclude the obvious: that the most likely outcome of the Kovykta heist will be a negotiation to pass Gazprom a huge stake in the project. The other potential outcome is that the environmental ministry will simply revoke the license, and the Russian state will commit an outright quasi-nationalization (read theft) a la Yukos. The sheer possibility that the Kremlin could even consider an outright theft of Kovykta is entirely based on the cowardly acceptance with which the Western financial community has greeted the mauling of Yukos, the hustling of Shell at Sakhalin, and the pipeline cutoffs to the former satellites.

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From the Economist:

Speaking at a March 6th press conference, Anatoly Ledovskikh, the director of Russia’s federal subsoil resources agency, Rosnedra, said that he was “100% certain” that Rusia-Petroleum would be unable to correct the licence violations at the Kovykta gas field by the May deadline. Rusia Petroleum is 62.4% owned by TNK-BP. For the last ten years it has held the licence to Kovykta, which has gas reserves estimated at 1.9trn cubic metres. Since the Yukos affair, however, the Russian state has used its administrative resources to ensure a greater role for its proxies, Gazprom and Rosneft, in the oil and gas sectors. As the tide of energy nationalism has risen in Russia, Rusia Petroleum’s difficulties have multiplied. It hoped to establish a partnership with Gazprom that would permit the large-scale export of gas from Kovykta to China; Gazprom, however, has thus far refused all offers. Now Rusia Petroleum is in trouble for failing to produce the target volumes specified in the licence, and of having broken Russian norms with regard to pipeline construction. Mr Ledovskikh also alluded to the fact that Gazprom is in negotiations to secure a stake in Kovykta, and observed that he believed the issue would be settled. Negotiations have been held periodically over at least the past two years, as TNK-BP sought to persuade Gazprom to build a pipeline to China so that the majority of Kovykta’s output could be sold profitably, rather than on the low-priced domestic market. BP and its partners in Rusia Petroleum have even offered Gazprom a majority stake in the field in return for the gas monopoly’s participation, which is presumed to come with a guarantee that the official attacks on Kovykta will end. The sticking point, seemingly, is that Rusia Petroleum wants Gazprom to enter on commercial terms—and the Russian giant isn’t minded to do so. … There are a few arguments why outright loss of the licence is a possibility in the case of Kovykta. First, in contrast to Sakahlin-2, the project is not protected by a production-sharing agreement (PSA). Second, Rusia Petroleum has not invested huge sums—a couple of hundred million dollars, rather than billions—so arguably full forfeiture of the licence would be less controversial. Third, Kovykta is purely a gas field and thus is firmly within Gazprom’s primary sphere; Sakhalin-2, by contrast, has a large oil component and the oil sector in Russia is more competitive. Finally, Gazprom has greater leverage over Kovykta because it controls domestic supplies and exports; at Sakhalin-2, Shell and its partners have the ability to export without recourse to Gazprom or another Russian state firm. These factors could just as easily point to Gazprom entering the Kovykta project on highly preferential terms. The major constraint on the ambitions of Russia’s energy nationalists is presumed to be the fear of an international backlash. However, six months ago most observers would have been shocked at the extent of the concessions wrung from the foreign consortium operating Sakhalin-2. Nor has there been much of a downside for Russia as a result of this behaviour: Shell’s bruising experience seems not to have deterred others from seeking greater exposure to the energy sector, as ConocoPhillips’ recent bid to participate in the Shtokman project with Gazprom demonstrates. In this climate, it should not be a surprise if sooner or later one foreign company with a coveted asset loses everything. BP must hope that day has not yet arrived.