Sakhalin energy and the Russian roulette Sudha Mahalingam | The Hindu| June 8, 2006
http://www.hindu.com/2006/06/08/stories/2006060804311200.htm THE WORLD is witnessing a resurgence of resource nationalism. In May, President Evo Morales' sensational decision to nationalise Bolivia's oil and gas assets sent the already volatile oil markets into a tizzy. Now Hugo Chavez is reining in international oil companies (IOC) operating in Venezuela, forcing them to renegotiate their contracts and warning them that the country's tax regime may not remain stable as promised. Recently, Ecuador joined its Latin American neighbours when it seized an oil field controlled by Occidental, a United States-based international oil company. This resurgence in resource nationalism is not confined to Latin America, which in any case, is veering to the Left. In Angola, Nigeria, Sudan and elsewhere, local protests for a greater share in the nation's mineral wealth have disrupted production frequently. In virtually every oil-exporting country, national oil companies (NOC), which had reluctantly ceded ground to IOCs in the wake of globalisation, seem to be reclaiming lost ground. Nowhere is this tendency more apparent than in Russia, which unlike many other energy exporters, has a fairly diversified economy. Russia's emergence as a formidable petrostate has been the single most important development of the new millennium. Rapidly ramping up oil and gas production in the last few years, today it is a serious challenge to Saudi and indeed OPEC supremacy in global energy markets. Revenues from energy sales generate a quarter of Russia's GDP, a third of its government revenues and two-thirds of the country's export income. President Vladimir Putin is well aware of this potential. Consolidation of state control over energy companies is a card he has played with consummate astuteness. It all began with the much- publicised Yukos affair when Mr. Putin managed to discipline the ambitious oligarch who threatened to become an alternative power centre. Mr. Putin then turned his attention beyond Russia's borders first to those countries that provide transit for Russian energy flowing to the world. Gazprom, Russian gas giant, upped the ante on Ukraine, Belarus, Armenia, Lithuania and others, jacking up the price of gas sold to them. Mr. Putin then ticked off Europe that imports a third of its gas from Russia, threatening to turn Russian energy exports eastward. Already, the first eastward pipeline to the Pacific coast is under construction. A gas pipeline is also on the anvil. Now, a defiant Russia refuses to ratify the Energy Charter Treaty which it had earlier signed much to the discomfiture of existing and potential international investors. It is particularly suspicious of the transit protocol in the treaty that could challenge the supremacy of its NOCs. The Russia-European Union energy dialogue has all but broken down. Russia is also effectively following an invidious strategy, dealing with individual European states bilaterally, even as it cocks a snook at any proposal for cooperation with the European Union as a collective entity. President Putin's political future is closely tied to the fortunes of the country's oil industry. Within Russia, there is palpable tension between Rosneft, Russia's National Oil Company championed by the Siloviki (former and current officials of the Secret Service and the military establishment), and the Kremlin-supported Gazprom, Russia's National Gas Company. It is evident that the star of Gazprom, Mr. Putin's chosen instrument of power and influence, is on the ascendant. And it was the same Gazprom which shut down gas supply to Ukraine in January this year, freezing Europe over, literally as well as metaphorically. Until recently, Gazprom's shares were ring-fenced, but Mr. Putin lifted the ring fence allowing private and notably foreign investors to acquire 49 per cent. But Kremlin is firmly in control, with 51 per cent shareholding. Gazprom is the world's biggest gas producer, exporter and owner of the largest gas transportation system. Its market capitalisation at $100 billion is said to be grossly undervalued. Buoyed by rising international gas prices, Gazprom is on a shopping spree. The company's bid to acquire Centrica, the British retail gas distribution company, sent alarm bells ringing all over Europe. EU and even the U.S. now fear that Russia might use energy as a weapon of blackmail. For India that has its largest overseas investment ever $2.7 billion in Sakhalin 1, Gazprom's growing clout within Russia may not yet be a cause for alarm, but it could be a cause for concern. ONGC Videsh Limited (OVL) has a 20 per cent stake in Sakhalin 1 fields. Exxonmobil is the lead operator, and SODECO of Japan and Rosneft are the other stakeholders. The total development costs of Sakhalin 1 was initially estimated at $12 billion, but now there are reports that there could be cost over-runs. The three fields which comprise Sakhalin 1, namely, Chaivo, Odoptin and Arkutun-Dagy together contain 307 million tonnes of oil and 485 billion cubic metres (bcm) of gas. Production of oil commenced last year. It was envisaged that gas production would commence this year. Exxonmobil was hoping to sew up export markets in time for the anticipated 7.1 bcm of gas to be produced in 2006. Now, however, things seem to have changed. In the summer of 2004, Mr. Putin designated Gazprom as the sole co-ordinator for gas exports to Asia. While gas from Sakhalin 2 is to be liquefied and sent as LNG to Japanese markets, gas from Sakhalin 1 was to be sent through pipeline to China. On April 25, Vedomosti, a Russian business daily, reported that Gazprom wants to buy all the gas from Sakhalin 1 for re-export to China and South Korea at well-head prices that ensure `acceptable profitability.' Exxonmobil has not been able to conclude an SPA (sales-purchase agreement) for 8 bcm/year with China National Petroleum Corporation because it is unwilling to involve Gazprom in the negotiations. China has expressed disappointment over the slow pace of development in the energy relationship between the two countries. In fact, since the Sakhalin production sharing agreement was signed, the property rights, tax and legal regime in Russia have changed drastically. However, Sakhalin 1 and 2 PSAs were `grandfathered' the terms of these PSAs were to be valid even if they were inconsistent with the provisions of the subsequent legal and tax regimes. Sakhalin 2 has not escaped Gazprom's predatory endeavours either. Recently, Gazprom managed to move Shell, the operator of Sakhalin 2, off the shelf so to speak. In April, Shell and Gazprom reached an agreement by which Gazprom will acquire 25 per cent of the Shell's stake in Sakhalin 2 in return for a swap arrangement in another gas field. Thus Shell has lost its status as the lead developer of the field although it continues to be the operator. Without Gazprom's blessings, whether Shell could have fulfilled its export commitments from Sakhalin 2 to the Japanese market is a moot point. Less revenue For Shell, Exxonmobil and BP that operate the Kovykta fields, routing exports through Gazprom could also mean less revenue than they might have realised had they been allowed to export directly. Will Gazprom pay international prices for the gas from Russian fields is the critical question the IOCs are now asking. As for domestic supplies, gas prices in Russia are currently a fifth of the global prices. In such a scenario, how will `acceptable profitability' be interpreted? Asia is the logical market for Sakhalin energy. Speaking at the Asian Oil Ministers' Meet in New Delhi last year, Victor Khristenko, Russia's Oil Minister, said his country hoped to increase the share of gas exports to Asia from the current 5 per cent to 25 per cent. In fact, Asia particularly Northeast Asia comprising China, Japan and South Korea could easily absorb all the gas produced from Sakhalin fields. But since the Japanese economy is programmed exclusively for LNG, only China or South Korea can be the destinations for piped gas from Sakhalin 1. Gazprom will no doubt be eager to clinch the export deal but Exxonmobil is not yet ready to play second fiddle to it. Russia's refusal to ratify the Energy Charter Treaty has not helped either. Energy analysts are of the view that Gazprom's insistence on being the sole export authority for the gas is a violation of the terms of the PSA. On May 26, the Moscow Times reported that Russia is planning to slash foreign companies' stakes in Sakhalin 1 and 2 projects to give majority control to Russia's NOCs, citing a Russian Natural Resources Ministry spokesperson. Delays in project development and cost over-runs have been cited as justification for the proposal that emanated from a study conducted by the Russian Academy of Natural Sciences. Russia is currently in the process of tightening restrictions on foreign investments in the country's energy sector through a long-delayed subsoil legislation. Surely, OVL cannot afford to be complacent in the face of such developments. As of now, Sakhalin 1 will send marginal quantities of gas to Russia's domestic market in Khabarovsk Krai through a pipeline, which will be constructed jointly by Russian oil and gas companies including Gazprom. But markets beyond the Russian border will have to await Gazprom's blessings which Exxonmobil shows no keenness to seek. OVL may have to wait it out until the titans sort out pricing and other issues. That is not the best case scenario for India's largest overseas investment. (The writer is Senior Fellow at the Nehru Memorial Museum & Library, New Delhi.) ------------------------ Yahoo! Groups Sponsor --------------------~--> Protect your PC from spy ware with award winning anti spy technology. It's free. http://us.click.yahoo.com/97bhrC/LGxNAA/yQLSAA/uTGrlB/TM --------------------------------------------------------------------~-> -- This is ZESTGlobal. Post articles on international affairs to [email protected] If you got this mail as a forward, subscribe to ZESTGlobal by sending a blank mail to [EMAIL PROTECTED] OR, if you have a Yahoo! ID, by visiting http://groups.yahoo.com/group/ZESTGlobal/join/ Yahoo! Groups Links <*> To visit your group on the web, go to: http://groups.yahoo.com/group/ZESTGlobal/ <*> To unsubscribe from this group, send an email to: [EMAIL PROTECTED] <*> Your use of Yahoo! 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