Oil Business Is Big Politics in Russia

Opportunities and Gambles

The largest petroleum companies in the United States and Europe want to invest tens of billions of dollars in Russia's oil industry.

Good idea? Bad idea?

Do they have any choice?

Recent events in Russia have rattled some Western oil investors, who are watching for major new developments.

They may not have long to wait.

Reality for the Russian industry could change, dramatically, after the elections in March.

"I think companies would want to reduce their exposure to Saudi Arabia and that whole area in the Middle East," said William Ratliff of the Hoover Institution at Stanford University. "Russia is one of the most obvious places to go, and there aren't many obvious places."

Ratliff wrote a 2003 white paper issued by the institution, "Russia's Oil in America's Future — Policy, Pipelines and Prospects." In it, he examines the problems and possibilities of Russian oil development, especially as it will affect the United States.

He sees Russia as a magnet for industry investment, despite the problems.

"We don't really have good options," he said. "Russia is probably the best second choice."

Concerned, But Pragmatic

With estimated oil reserves of 60 billion barrels, Russia can't be ignored by the Western oil industry.

But its political, legal and business environments remain unpredictable.

That point came home hard with the October 2003 arrest of Mikhail Khodorkovsky, chairman of Russian oil giant OAO Yukos and purportedly Russia's richest individual.

The unexpected move took the Western industry by surprise. Business reaction was quick and negative, even though Russian President Vladimir Putin tried to reassure markets and potential investors.

Khodorkovsky resigned from Yukos and Putin downplayed the importance of the arrest, calling it a law-enforcement action, not a political one.

Doubt remained about the future independence of Russia's oil companies, however.

"There is no consensus among Western investors on how to proceed efficiently in the rapidly evolving new environment in the Russian energy industry," said Sergey Kuznetsov, a Moscow native serving as international relations representative for ChevronTexaco Corp. in San Ramon, Calif.

"Most of them are wise not to over-dramatize the recent events, and just need more time to sort things out," he said. "But how much time do they have for hard thinking? Not too much, since 32 percent of the world's gas reserves is not something to be kept on the back burner for a long time. Competition will continue to grow, and new energy players from China, India, Japan and even Saudi Arabia may soon challenge super majors on the Russian territory.

"The Russian government will not be threatened by lack of partner choice."

Kuznetsov visited with U.S. State Department officials after the arrest of Khodorkovsky and said, "I felt they were concerned, but they were also very pragmatic."

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The largest petroleum companies in the United States and Europe want to invest tens of billions of dollars in Russia's oil industry.

Good idea? Bad idea?

Do they have any choice?

Recent events in Russia have rattled some Western oil investors, who are watching for major new developments.

They may not have long to wait.

Reality for the Russian industry could change, dramatically, after the elections in March.

"I think companies would want to reduce their exposure to Saudi Arabia and that whole area in the Middle East," said William Ratliff of the Hoover Institution at Stanford University. "Russia is one of the most obvious places to go, and there aren't many obvious places."

Ratliff wrote a 2003 white paper issued by the institution, "Russia's Oil in America's Future — Policy, Pipelines and Prospects." In it, he examines the problems and possibilities of Russian oil development, especially as it will affect the United States.

He sees Russia as a magnet for industry investment, despite the problems.

"We don't really have good options," he said. "Russia is probably the best second choice."

Concerned, But Pragmatic

With estimated oil reserves of 60 billion barrels, Russia can't be ignored by the Western oil industry.

But its political, legal and business environments remain unpredictable.

That point came home hard with the October 2003 arrest of Mikhail Khodorkovsky, chairman of Russian oil giant OAO Yukos and purportedly Russia's richest individual.

The unexpected move took the Western industry by surprise. Business reaction was quick and negative, even though Russian President Vladimir Putin tried to reassure markets and potential investors.

Khodorkovsky resigned from Yukos and Putin downplayed the importance of the arrest, calling it a law-enforcement action, not a political one.

Doubt remained about the future independence of Russia's oil companies, however.

"There is no consensus among Western investors on how to proceed efficiently in the rapidly evolving new environment in the Russian energy industry," said Sergey Kuznetsov, a Moscow native serving as international relations representative for ChevronTexaco Corp. in San Ramon, Calif.

"Most of them are wise not to over-dramatize the recent events, and just need more time to sort things out," he said. "But how much time do they have for hard thinking? Not too much, since 32 percent of the world's gas reserves is not something to be kept on the back burner for a long time. Competition will continue to grow, and new energy players from China, India, Japan and even Saudi Arabia may soon challenge super majors on the Russian territory.

"The Russian government will not be threatened by lack of partner choice."

Kuznetsov visited with U.S. State Department officials after the arrest of Khodorkovsky and said, "I felt they were concerned, but they were also very pragmatic."

European companies appear less worried about the overall political and economic situation in Russia, Kuznetsov noted, giving Moscow additional leverage in dealings with the Americans.

The 'Nationalistic Streak'

Shell and ExxonMobil hold multi-billion-dollar interests in projects on and offshore of Sakhalin Island, off the far eastern Russian coast. BP also has a significant exposure to the Russian oil industry, in the $7 billion range.

Earlier in 2003, BP became 50 percent owner of the newly formed Russian oil company TNK, which combined Russian petroleum assets of BP, Tyumen Oil Co. and OAO Sidanko.

That seemed to settle a long-simmering dispute between BP and some Tyumen Oil shareholders, involving a tug-of-war over Sidanko production.

TNK was followed by a much larger merger. In September, Yukos announced it had finalized an agreement to merge with Sibneft, forming the world's fourth-largest oil company.

When ExxonMobil showed an interest in acquiring part of the merged Yukos-Sibneft entity, Russian leaders may have balked, according to Ratliff.

"TNK had just had a major foreign investment. Some Russians were concerned that foreigners are going to control their oil industry," he said.

Yukos chairman Khodorkovsky is one of a small number of super-wealthy Russian industry owners called "the oligarchs." In Russia, the oligarchs are wildly unpopular and widely distrusted. Russians see their industries as "owned by rich guys who don't have the national interest in mind," Ratliff observed.

"A lot of Russians think this is a problem — that it's a purchase of a major part of their companies by foreign investors," he said. "Russians have a very nationalistic streak."

Khodorkovsky's arrest led to speculation that Putin was removing a potential political rival. Ratliff and other observers of Russian politics dismissed that idea.

"Russians are not going to vote for oligarchs," he said. "Khodorkovsky is not going to win an election. He's not a political threat. He is potentially an economic threat."

An Opportunity, A Gamble

In late November, Sibneft announced that it would walk away from the merger with Yukos, further complicating the picture in Russia's oil industry.

Western oil companies do have other options for investment, and more options may open up soon, according to AAPG member Nahum Schneidermann, ChevronTexaco's manager-international technical relations.

To some extent, U.S. companies are disadvantaged by our government policies, he said.

"If Iraq opens up and develops an internationally accepted government and petroleum laws that are enforced, and it becomes more stable, the international industry will be there," Schneidermann said. "I'm sure, when activities in Libya and Iran will be allowed by the U.S. government, the U.S.-based companies will be there as well. Everyone else is."

Because of higher prices for crude oil on world markets, Russia now depends less on foreign investment, he noted.

Improved income from crude exports, access to Western-style management and company governance models allow Russian companies to "buy Western technology and reservoir management," Schneidermann said.

But Russia's need for capital investment won't go away, according to Ratliff.

"They don't have the pipelines they need. They don't have the sophisticated support they need for the Siberian fields. They need an awful lot of help," he said.

Ratliff views investment in Russia as both an opportunity and a gamble.

Western companies are forced to diversify their investments because they can't foresee the future. As long as the Russian bet is on the table, they almost have to take it.

"No foreign company wants to be left out as those shares and those fields are gobbled up and the more daring companies may prove to be the winners. Or the losers.

"Putin will not last forever, even if he holds power beyond the legal second term," Ratliff said. "Potential investors had better be prepared for surprises and forced compromises if they put big money into Russia today.

"But if they don't put anything in," he added, "they may be the big losers."

Big Business, Big Politics

Kuznetsov said Western investment currently aims toward buying shares of existing Russian oil companies with production.

"Sounds like everyone is talking to everyone else, both in Russia and worldwide," he said. "One can really enjoy discussion of exotic offshore fields in the Arctic or setting up new oil centers in Sakha, but investors are interested in more realistic projects.

"The Russian energy sector always has been a very complex thing, tightly wrapped into enigma," he added. "Our experience with construction of a $2.6 billion CPC pipeline in Russia proves that Big Business is always involved with Big Politics."

Potential investors in Russian oil include Saudi Arabia, according to Ratliff. In September, Saudi Crown Prince Abdullah Al-Saud visited Moscow to confer with Putin.

"To me, one question is whether Putin has struck a deal or is going to strike a deal with Saudi Arabia, in which case the U.S. money becomes almost irrelevant," Ratliff said.

"If the Saudis promised $100 billion or anything like it, then Russian oil is much less reliant on other foreign investment."

Russia's "very rambunctious and rapidly growing oil companies" may be a challenge for Russian leadership in making investment deals with other countries, he said.

"What Putin probably thought when he talked to the Saudi prince was, 'I don't have control of the Russian oil industry,'" Ratliff said.

"By making Yukos an example, Putin may cause them enough trouble that the others (in the oil industry) will become much more compliant."

Even though Yukos has dominated headlines recently, the company's real role in the mature, ambitious and diverse Russian energy industry should be viewed objectively, Kuznetsov observed.

"It is much more complicated than Yukos," he said, "since the Russian oil portrait has a life of its own."

Russia's second-largest oil producer, OAO Lukoil Holdings, has denied rumors that it plans to sell 10-15 percent of its operations to ConocoPhillips.

However, in November Lukoil said it wants to finalize a joint venture agreement with ConocoPhillips. The venture would develop Lukoil's Northern Territories holdings.

ConocoPhillips originally hoped to secure a production sharing agreement (PSA) for the $2 billion venture. But Russia has backed away from offering PSAs, which allow up-front recovery of costs.

To date, ConocoPhillips has invested more that $200 million in the Northern Territories project.

The country's picture also includes the long-expected restructuring of the world's gas giant Gazprom, social policy in energy industry, access to global markets, diversification of export routes, new private pipelines and pipeline access, integration into international energy space, application of European environmental standards, forming an efficient fuel and energy balance, efficiency of subsoil stock, etc., and, finally, sources of $500 billion investments required by the Russian energy industry over the next decade.

And politics, as always.

Kuznetsov senses a change in the wind.

"The substance of the message coming from Moscow is that regions will lose much of their power to license fields," he said.

Western investors should watch the progress of pending bills in Russia's parliament, the Duma, Kuznetsov said. That's where the licensing issues will be decided.

"Then, we should see how they regulate subsoil resources and treat companies in terms of profits," he said.

Elections for the Duma were held in December, and Russia's presidential election occurs in March. At this point, Putin appears almost certain to be re-elected.

Results of the elections will have a profound long-term effect on Russia's business climate and its energy industry, Kuznetsov said.

"After the March 2004 presidential election investors may find themselves in a vibrant and, hopefully, more transparent, predictable and investor-friendly environment," he said. "I believe some federal energy officials will go and the 2020 Energy Strategy will finally enter its implementation stage. The question is, how knowledgeable and professional will be those who succeed outgoing bureaucrats?"

In the best case, experienced petroleum professionals will be appointed, Kuznetsov said. But it's not at all certain that will happen.

Is Western investment in Russia's oil industry a good idea?

Asked if he would invest his own money in Russian oil, Ratliff answered:

"Yes."

"I might invest a little. I wouldn't put all my money in Russian oil, but I'd buy a little," he said.

Is it a good idea to invest in Russia?

Today, the situation in Russia is so fluid, so unpredictable, that no one can know the answer for certain.

Not even the largest Western petroleum companies that want to invest tens of billions of dollars.

"They're going to have to have a lot of faith in God and Putin not to require some sort of controls," Ratliff said.

"And the type of controls they will want are the type that will antagonize the Russians."

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