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Gazprom’s Bullying Has a High Reputational Cost

In response to the news that Royal Dutch Shell has offered to give up control of the single largest energy investment project in Russia, Sakhalin II, to state-controlled Gazprom, observers in Europe and North America have reacted with a healthy amount of skepticism. The Globe and Mail, the Wall Street Journal, the Guardian, and the Times of London (among others) have all characterized the Kremlin’s tactics as excessive and brutal. vanderveer.jpg Jeroen, we have a problem Veer A breaking story from the Economist has also captured the key issue at stake: how state-sponsored business interference can damage the investment environment – which is the last thing Russia needs.

It is a disturbing and unwelcome development, but it should not come as a surprise. Vladimir Putin’s regime shamelessly dismembered Yukos, an oil firm owned by a political rival. And Russia’s government has made little secret that it regards energy as a legitimate tool of foreign policy in an energy hungry world. The grab for Sakhalin is just the latest tightening of Russia’s grip on its oil and gas reserves. The Kremlin is discouraging foreign participation in the exploitation of energy reserves: legislation is planned to limit outsiders, in future, to minority stakes in energy and precious-metal firms. … But where Russia’s government may have had a good case for renegotiating the deal, instead it has resorted to intimidation. Shell had few negotiating levers and had little option but to back down. Though the details of the deal are not clear, some analysts suggest that Shell and its Japanese partners might get $4 billion for the half of Sakhalin II that they will hand over. At least it seems that Russia has not yet torn up the PSA, so Shell can still expect returns on its huge investment. … The risk for Russia, of course, is to its reputation. The government is getting a name for disregarding or unilaterally rewriting agreements when the mood strikes. With global demand for energy so high, oil firms may well decide that the risk is still worth it in Russia. But foreign companies considering investment in other sectors may think again. Investors eyeing a slew of forthcoming IPOs (among energy firms and others) may now be discouraged. That is not what Russia needs. Thanks largely to high oil prices, its economy has been growing by an average of some 6.5% a year. The best way to sustain that is not to cede control of oil and gas fields to bureaucratic, inefficient and opaque state energy firms. More foolish still would be to scare away investors from other parts of Russia’s still-creaking economy.

It is argued almost unanimously that President Vladimir Putin’s popularity is rooted in the performance of the Russian economy and aided by the cohesive yet toxic combination of unrestrained nationalism. But to what extent are the high oil prices that currently keep the country afloat able drive growth in other industries? Given that so many Russian firms are making for the exit before the next election, what are we meant to understand about political risk? There are of course legitimate grievances over the Sakhalin II project, and nobody likes to recognize that they chose the wrong time to sell – but to address these grievances, a government must honor contracts and adhere to international norms and processes (a deal is a deal, after all). The attack on Shell increases macroeconomic instability for Russia, which places more pressure on Putin, and makes his grip on power ever more dependent on the growth of the GDP and the price per barrel of crude. It seems even that those who want the President to remain popular should be advocating against this ham-handed energy bullying, lest the Kremlin insiders and Gazprom elites put him between a rock and an even harder place.