{"id":396,"date":"2009-02-07T13:33:34","date_gmt":"2009-02-07T09:33:34","guid":{"rendered":"https:\/\/www.desertsun.co.uk\/blog\/?p=396"},"modified":"2010-03-24T01:18:00","modified_gmt":"2010-03-23T21:18:00","slug":"russias-descent-into-reality","status":"publish","type":"post","link":"http:\/\/www.desertsun.co.uk\/blog\/396\/","title":{"rendered":"Russia’s Descent into Reality"},"content":{"rendered":"

The summer of 2007 was a busy year for the Russian oil and gas business.\u00a0 In April of that year, the state-run energy company Gazprom finally exerted enough pressure on the\u00a0Sakhalin II consortium to\u00a0wrest control<\/a> of the giant project in Russia’s Far East from\u00a0Shell, who had hitherto been the majority owner and manager of the\u00a0development.\u00a0 In return for a cash\u00a0payment of $7.45bn, at the time seen as a knock-down price, Gazprom acquired a 50% plus one share stake in the project.\u00a0 The deal\u00a0was struck after\u00a0months of\u00a0the Russian environmental\u00a0regulator exerting pressure on the consortium Sakhalin Energy,\u00a0resulting in work being delayed, stopped, and threats being made to withdraw the license\u00a0to continue the development\u00a0altogether.\u00a0 Despite there being genuine concerns regarding environmental damage incurred by the development, not to\u00a0mention\u00a0the doubling of project costs to $22bn, few believed that the governmental pressure exerted on Sakhalin Energy was anything other than a naked attempt by the Russian government to gain control over the project, its resources, and its revenues by force.\u00a0 Sure enough, within weeks of Gazprom taking the\u00a0keys to\u00a0Sakhalin II, the environmental regulator cheerily announced that all concerns had been resolved to its satisfaction and not a peep has been heard from them since.\u00a0 The outcome at Sakhalin II was presented by the Russian government, and\u00a0accepted by many Russians, as a significant victory of the\u00a0resurgent Russian state\u00a0in reversing the exploitations of the foreign powers when they were weak, and regaining control over Russia’s strategic resources, its wealth,\u00a0and its independence.<\/p>\n

Buoyed with confidence from their coup on Sakhalin,\u00a0the month of June\u00a0saw the Kremlin\u00a0use\u00a0alleged breaches of license obligations to persuade<\/a> BP to sell its 62.85% stake in Siberia’s Kovykta development to Gazprom for $900m in cash,\u00a0a figure many people thought better than what was feared, i.e. nothing.\u00a0 Two months later, in August 2007, the Russian government moved to deny<\/a> the Exxon-led Sakhalin I consortium the right to export gas from its development in an attempt to force the\u00a0sale of the gas to Gazprom at artificially low domestic prices,\u00a0after which\u00a0Gazprom would be free to export it via pipeline or LNG carrier\u00a0at international\u00a0prices.<\/p>\n

Now that\u00a0Russia’s foreign-run developments were back under government control or suitably compliant, the government ensured that all future developments would remain similarly tied to the Kremlin with limited foreign influence.\u00a0 In April 2008, the Russian\u00a0parliament\u00a0approved\u00a0a\u00a0new law which\u00a0effectively handed\u00a0monopoly rights for all future developments of the Russian continental shelf to just\u00a0two companies: Gazprom and state-owned Rosneft.\u00a0\u00a0By now,\u00a0the bulk\u00a0of Russia’s enormous hydrocarbon wealth both present and future was firmly in government hands, a situation which was\u00a0looked on with\u00a0gleeful satisfaction by Russians and allowed them to wield considerable influence beyond their borders.\u00a0 Soon followed grand plans for Gazprom to build a pipeline across the Sahara desert<\/a>, buy all of Libya’s gas, and build LNG plants<\/a> in Nigeria.\u00a0 Energy nationalism at home and\u00a0the loudly\u00a0announced forays abroad\u00a0as personified by Vladimir\u00a0Putin helped ensure the Russian population returned approval ratings of over 80% for their then president, now prime minister.\u00a0 Russia had picked itself up off its knees, Russia was strong once more, Russia could once again command respect from others.\u00a0 Russia was back.<\/p>\n

But anyone who was looking closely could see that beyond the grand announcements emanating weekly from the Kremlin, Russia’s oil and gas development strategy was thin on substance and looking more than a little unrealistic.\u00a0 The first warning came in April 2008 when Rosneft’s chief executive stated<\/a> that Russia would need $2.6 trillion to develop just its offshore oil and gas reserves between then and 2050, which equated to a yearly expenditure of $62bn.\u00a0 To put this in perspective, the Sakhalin II project – one of the biggest\u00a0 and most complicated oil and gas projects every attempted and by far the largest in Russia – came in around $22bn and during the peak of construction was costing about $4bn per year.\u00a0 This means that the Russian oil and gas development plans would see the equivalent of about 15 Sakhalin II sized megaprojects running in parallel across Russia for 40 years, executed and managed by just two companies – Gazprom and Rosneft – neither of whom have ever executed a project of\u00a0such magnitude and complexity before.\u00a0 Even a casual observer would think the numbers to be slightly overambitious, and overly reliant on the performance of two companies with an untested track record of project delivery.<\/p>\n

Consider\u00a0the news which appeared in the oil and gas press in June 2008 that Gazprom had stumbled at the first hurdle along its path to becoming the\u00a0pioneer of Russian oil and gas development: a relatively simple topside refurbishment of a second-hand platform, part of the first stage of Gazprom’s much publicised flagship Shtokman project, was overdue<\/a> with the budget blown due to the contractor not having enough skilled workers to complete the assignment.<\/p>\n

Those with an interest in such matters may also have taken note of the enormous debts that the Kremlin’s favoured sons had accumulated.\u00a0 By March 2008, Gazprom had accumulated $41.7bn<\/a> in debt mostly due to acquisitions, and it is estimated that its current debt<\/a> stands at about $50bn.\u00a0 Rosneft was not in much better shape having amassed debts of $23.8bn<\/a>, also largely on acquisitions not least of which was the remains of bankrupt oil form Yuzkos, flogged off the year before in a murky auction.\u00a0 Concerns about Gazprom and Rosneft debts were dismissed by those who would point to the oil price which at the time sat above $140 per barrel generating massive revenues for the two companies, and the fabled wealth of the Russian government in terms of their foreign reserves and the oil stabilisation fund.\u00a0 However, such responses could not hide the fact that both companies were heavily dependent<\/a> on the western financial institutions to whom they owed the debt, and would rely on these same institutions to provide the funding for future developments.\u00a0 It was also becoming more and more difficult to ignore the increased risk premium being attached to loans extended to Russian companies as a result of the government’s contempt for contract law and the unpredictability such behaviour brings.<\/p>\n

Unfortunately for the Russians, by the end of 2008 their lofty position was soon beginning to look less secure than it had been six months previously, and by 2009 it was clear that their position was looking precarious.\u00a0 With the global financial crisis setting in, demand for oil and gas collapsed sending the crude price tumbling by over 70% and taking the Russian energy giants’ revenues with it.\u00a0 And the western financial institutions upon which they depended for debt refinancing and financing their lofty development plans were facing either complete ruin or a desperate struggle to survive.\u00a0 The two companies upon which all the Kremlin’s hopes and dreams depended found themselves with diminished revenues and\u00a0unserviceable debt going cap in hand<\/a> to Moscow for a bailout.<\/p>\n

Unsurprisingly given Russia’s dependence on oil and gas, the collapse in the oil price was matched by a collapse in both the rouble and Russia’s stock market.\u00a0 Gazprom and Rosneft stock plummeted as the market fell<\/a> by 75%.\u00a0 The Russian government, which just months before had harboured deluded dreams of the rouble being adopted as a reserve currency, watched as it fell from a high of 23.1\/$ and raided their foreign reserves<\/a> at a rate of $15bn per week buying roubles in a desperate attempt to keep their currency from collapsing.\u00a0 At the time of writing the rouble has depreciated to 36.2\/$ (-36%) and continues to fall; Russia’s foreign reserves stand at $388bn down from<\/a> $600bn in August, a\u00a0reduction of 35%.<\/p>\n

The Stabilisation Fund, designed to balance the federal budget when oil falls below a certain price, was established in 2004 and thanks to booming oil prices had reached $157bn by January 2008.\u00a0 However, most of the fund was invested abroad and it is doubtful that the investments have avoided the carnage brought about by the financial crisis.\u00a0 Worse, in May 2007 Putin called<\/a> for more of Russia’s oil revenues to be invested in the Russian stock market, including Gazprom and Rosneft.\u00a0 This means that part of the money being set aside for when the oil price falls was being invested in oil and gas companies, whose very fortunes are dependent on the oil price.\u00a0 Speculation abounds as to the whereabouts and value of the money allocated to the Stabilisation Fund,\u00a0and Russians are not hopeful that they will see any of it any time soon.<\/p>\n

In response to the crisis the Russian government\u00a0acted in characteristic fashion: by playing a\u00a0strong hand very badly.\u00a0 Eager to demonstrate its reliability as a\u00a0supplier of energy to Europe, Russia entered its\u00a0annual\u00a0gas dispute with Ukraine\u00a0in no mood to compromise culminating in their shutting off the gas flows leaving European customers shivering in the homes during a cold snap.\u00a0 European Union monitors were somewhat unimpressed at having to provide hard-copy papers<\/a> of their proposed activities to the Russians in advance of their being allowed to work, and the presence of shady third-party intermediary companies<\/a> based in Switzerland in place of presented written contracts probably did little to reassure Europeans that their energy supplies were in good hands.\u00a0 Despite Ukraine sharing a large part of the blame for the dispute, Russia came away with its reputation as being a reliable energy partner shakier than ever, looking incapable of handling business matters without resorting to fiery ultimatums and brinkmanship, and with a $1.1bn<\/a> hole in\u00a0Gazprom’s revenues.<\/p>\n

Seeing its financial position take a sharp turn for the worst, Gazprom is looking to cut costs.\u00a0 Having gleefully helped itself to 50% of the Sakhalin II project, it has now found itself required to stump up 50% of the operating costs.\u00a0 Year-round oil export from the project started in December 2008 but coincided with the lowest oil price in several years, reducing the project’s revenues considerably.\u00a0 First export of LNG to customers in Korea and Japan is likely to take place in early March 2009, but some of the gas was paid for in advance and thus Sakhalin Energy will not see revenues immediately.\u00a0 Faced with the unexpected\u00a0obligation of paying for\u00a0businesses that it owns, Gazprom has ordered $300m cuts in operating costs from the\u00a0development in 2009 and all non-essential projects, such as the third LNG train, have been cancelled.\u00a0 Both expatriate and Russian staff are finding their terms and conditions being squeezed, and many are facing redundancy within the next few weeks and months.\u00a0 Departments vital to the safe and efficient operation of the project facilities are being told to look again at their organisation and come up with ways to cut costs, which normally means do the job with fewer people.\u00a0 The Russians who\u00a0were\u00a0overjoyed by\u00a0the new, assertive Russia when\u00a0Gazprom gained control of the project are now glumly looking at\u00a0what this means in practice: unpaid overtime, reduced wages, and unemployment.\u00a0 The expatriates are rolling their eyes wondering why turkeys vote for Christmas.\u00a0 Whether Gazprom are rueing their decision to effectively stop Shell from paying for the Sakhalin II project (something they seemed quite happy to do until\u00a0Gazprom showed up) can only be guessed at.\u00a0 And Sakhalin Energy’s ability to run the extremely complex offshore platforms and LNG facility – which require\u00a0an uptime of 98.5% – safely and efficiently with Gazprom (whose operational experience is limited\u00a0to running onshore pipelines) calling the shots\u00a0is a test which will be\u00a0watched with great interest by those\u00a0who have worked on the project since its inception\u00a0and are now\u00a0being given the boot by a Gazprom\u00a0HR director parachuted in from Moscow.<\/p>\n

If that was not enough to make those employed on Sakhalin Island gloomy about their employment prospects, Exxon have called a halt to the\u00a0Odoptu field development,\u00a0which was currently under construction as part of the Sakhalin I expansion.\u00a0 The reason behind this decision to demobilise the construction team leaving a facility unbuilt are neither clear nor public, but it is\u00a0widely believed\u00a0that the Russian government was attempting to strong-arm the consortium into accepting conditions not agreed to in the original contract.\u00a0 Exxon has an impressive record<\/a> of not allowing itself to be pushed around, and probably calculated that the Russian government needs the revenues from the project more than Exxon does.\u00a0 What effect this will have on the rest of the Sakhalin I project remains to be seen.<\/p>\n

In other areas of Russia, the Shtokman project is looking to be put onto the backburner as Gazprom officials<\/a> say that the project can only proceed with oil prices between $50-$60 per barrel.\u00a0 Production in Russia is falling<\/a> as the western Siberian fields go into decline with too few new projects coming online to replace them.\u00a0 Employment in Russia is spiralling<\/a> as the economy, so dependent on the export of industrial commodities,\u00a0goes into\u00a0rapid decline<\/a>.\u00a0 Anti-government protests are starting to appear in major Russian cities as opinion polls<\/a> see Putin and Medvedev’s popularity waning.\u00a0 Without the injection of foreign capital into\u00a0developing their reserves\u00a0Russia’s grand\u00a0vision as being a\u00a0global energy provider look to remain as mere dreams unrealised.\u00a0 Perhaps surprisingly,\u00a0the cash rich\u00a0western\u00a0oil companies still have an appetite for investment in Russia,\u00a0and several are showing an interest in partnering Gazprom in the giant Yamal development<\/a> in Arctic Siberia.\u00a0 Without a doubt they will be far more careful the second (and for some the third) time around and we can expect to see guarantees in\u00a0the form of internationally held bonds and cost-reimbursable\u00a0contracts to be commonplace if such\u00a0partnerships go ahead.<\/p>\n

But having\u00a0spent the\u00a0past\u00a0three years assuring its population that Russia is back to being a strong,\u00a0independent country which does not need to partner with foreigners (a refrain which shows no sign of abating<\/a>), how is the Russian government going to explain itself if it is once again signing “unfavourable” deals with western oil giants from a position of weakness?\u00a0 Or will Putin and co. simply allow the Russian oil and gas\u00a0industry to fall into inefficiency, stagnation, and mismanagement and blame\u00a0everything on\u00a0the\u00a0west rather than admit that the policies they have pursued over the past few years have led them to disaster?\u00a0 We will find out soon enough.<\/p>\n","protected":false},"excerpt":{"rendered":"

The summer of 2007 was a busy year for the Russian oil and gas business.\u00a0 In April of that year, the state-run energy company Gazprom finally exerted enough pressure on the\u00a0Sakhalin II consortium to\u00a0wrest control of the giant project in … Continue reading →<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[7,3],"tags":[],"_links":{"self":[{"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/posts\/396"}],"collection":[{"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/comments?post=396"}],"version-history":[{"count":1,"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/posts\/396\/revisions"}],"predecessor-version":[{"id":484,"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/posts\/396\/revisions\/484"}],"wp:attachment":[{"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/media?parent=396"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/categories?post=396"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/www.desertsun.co.uk\/blog\/wp-json\/wp\/v2\/tags?post=396"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}