Derek Brower: Obeying the new rules

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? jeroen.jpg 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.