Kremlin Eyes Sakhalin-1?

My regular readers are well familiar with the Russian state’s methodology to extort energy assets under thin legal and regulatory precedents. After the dismemberment of Yukos, the beating on Royal Dutch Shell, and what looks like a ritual humiliation of BP at Kovykta, one would think that we would now be able to see the early warning signs. When I saw today’s news that Gazprom had requested that the government step in and block ExxonMobil’s gas supply agreement with China from Sakhalin-1 (a request that the state rapidly complied with), I thought it might be possible that this is a beginning of a campaign to give a state-owned firm a larger stake in the project. All the typical elements of hypocrisy were present. For example, Prime Minister Mikhail Fradkov said that “Sakhalin gas is meant for Russian consumers – without this gas there will be no regional balance.” However, it seems clear that when the foreign companies signed up to participate in the joint venture (ExxonMobil, SODECO of Japan, ONGC of India, and Rosneft with 20%), they clearly hadn’t been told that the gas would have to stay local. And in the same breath that Fradkov complains about a possible gas shortage because Gazprom hasn’t reinvested a dime in production, the state announces ambitious plans for investment in export routes to China. Perhaps what Fradkov meant to say is that Sakhalin-1 will not be allowed to sell gas to China until Rosneft gets a bigger stake – which we will force you to sell at an extremely discounted price. Stratfor has speculated (see below) that Rex Tillerson at ExxonMobil wouldn’t put up with this kind of monkey business, so it is likely that SODECO will be the group to have to give up the most ground to the state extortion.

Say what you will about ExxonMobil, but few dispute that it is an inordinately well-run corporation with an excellent planning team. Consequently, ExxonMobil sports healthy reserves and has not been forced to make risky decisions in order to keep its share value strong. This means the Russian government is extraordinarily unlikely to be able to replicate what happened at Sakhalin-2 in Sakhalin-1. Should the Russians follow their Sakhalin-2 playbook, ExxonMobil will simply walk away — precisely what the company did a few months ago when it closed shop in Venezuela after President Hugo Chavez’s government attempted to rework contract terms (in essence, what Gazprom did at Sakhalin-2). That would mean Sakhalin-1’s end. Like Shell at Sakhalin-2, ExxonMobil at Sakhalin-1 is the only partner in the consortium with the technological and managerial expertise to keep the project going.

It will be interesting to see if these companies will choose to fight back just one time.