Part 2: Articles and current issues

From Russia with tough love
from:Offshore Engineer
by:Derek Brower
Monday, October 29, 2007

Read and translate the article and do the given tasks:

Recent contract disputes between Western operators and host governments on the Sakhalin 2, Kovykta, Shtokman and Kashagan developments suggest a dramatic shift in the balance of power in the global energy arena. Derek Brower looks at the latest evidence of ‘resource nationalism’.

From Siberia to the Barents Sea a new balance of power in the former Soviet Union has put host governments in the ascendancy and could reduce Western E&P majors to the role of little more than service companies on many of the world’s current – and future – large-scale oil and gas developments. Analysts are describing it as ‘resource nationalism’, pointing to the fact that high oil prices have emboldened the FSU governments to renegotiate the terms of long-standing contracts. International oil companies say it amounts to ‘state theft’. The Kremlin argues that Western operators active in Russia got too good a deal in the 1990s when commodity prices were low and Moscow badly needed inward investment, and that it is now time to redress the balance.

There is some truth in each explanation. But on the ground, it has left Shell, Total, BP and Eni, among other Western IOCs, having to adapt to the new order. Shell was first over the parapet. The company’s battle for control of Sakhalin Energy Investment Company, the consortium developing the Sakhalin 2 development in the Sea of Okhotsk and the associated onshore LNG plant, came to a head at the end of last year with Russia’s statecontrolled gas monopoly Gazprom paying Shell and its partners in Sakhalin Energy $7.45 billion in cash for a 50% plus one share stake in the consortium in exchange for a controlling stake in its $20 billion development.

Shell’s partners in Sakhalin Energy, Japan’s Mitsui and Mitsubishi, weren’t happy. Their involvement in Sakhalin 2 was strategic. Japan needs LNG and when the project, which will eventually export 9.6 million t/yr, comes onstream in 2008 it will take the bulk of the cargoes. Handing over control of Japan’s energy security to Gazprom was a bitter political pill to swallow in Tokyo. Shell pretended to be satisfied, but had in reality been backed into a corner, with Russia’s environmental watchdog, Rosprirodnadzor, claiming Sakhalin Energy had violated local environmental regulations. Rosprirodnadzor deputy chief Oleg Mitvol pursued the operator relentlessly, and by December 2006 Sakhalin Energy was faced with $30 billion in fines – or loss of its development licence.

Shell finally bowed to the pressure and its chief executive, Jeroen van der Veer, arrived in Moscow at the end of last year to sign over control of Sakhalin 2 to Gazprom, with Shell retaining the role of ‘technical advisor’. This done – in the presence of Russian president Vladimir Putin no less – and the environmental fines disappeared.

The Sakhalin 2 affair has provided lessons for all of the other Western IOCs operating in Russia. Shell sources briefed at the time of the environmental threat to its licence that its ‘abuses’ had been concocted to strip the company of its operatorship. That might have been true. But what was also true is that Shell had gone beyond the limits of the Kremlin’s patience. By the autumn of 2005, the project’s development costs had doubled to $20 billion. Shell sources now say the true figure could have been as high as $30 billion. The consortium also delayed start-up of the project to 2008. Under the terms of Sakhalin Energy’s production sharing agreement, the partners were entitled to recoup all costs before paying royalties, so each delay or cost overrun would cost Moscow dearly.

So the first lesson from Sakhalin 2 is that slippage in the contracts would not be tolerated. But the second was that the majors still had a role. Gazprom didn’t replace Shell at Sakhalin. It couldn’t, because it still needed Shell’s technology and project management expertise to bring a major integrated LNG project onstream. And the $7.45 billion it paid for its 50% stake was roughly market value, say analysts. Shell accepted the humiliation and agreed to stay on at Sakhalin – effectively paid to provide its services to a Gazprom project.

A few months later and another major was facing down Mitvol and Rosprirodnadzor. TNK-BP, BP’s 50% Russian joint venture, hadn’t developed Siberia’s Kovykta gas field in the way the contract demanded. That was absurd: the contract called for Kovykta to supply a tiny local market with 9bcm/yr of gas. Yet the transgression was sufficient to strip TNK-BP of the development licence. TNK-BP knew this – and that Gazprom considered the field key to plans to export gas to China. Having witnessed what happened on Sakhalin, TNK-BP scrambled to secure a sale of its stake in the field to Gazprom, calling in senior government contacts to make it happen. Given that there were grounds for revoking the licence without compensation, the company did well to receive $700-900 million for its stake.

Having seen BP and Shell put to the sword, companies vying for a stake in the vast Shtokman gas field in the Russian Barents Sea inevitably set their sights low. Gazprom had already disappointed them once. Statoil, Total, Chevron, Hydro and ConocoPhillips were all originally on a shortlist of potential partners at the 3.7tcm field. But in October 2006, Gazprom claimed that none of them had provided a suitable development plan, leaving the company to develop Shtokman on its own.

That was as much to do with politics as it was to do with the technical plans. The inclusion of two US companies on the list allowed Russia to play hardball during negotiations with Washington over Russia’s entry to the World Trade Organisation. A year after it ended negotiations with the shortlisted quintet, Gazprom realised that it would, after all, need a company with offshore expertise to develop Shtokman. But by then, with Sakhalin and Kovykta looming large in the recent memories of foreign IOCs, Gazprom was in a position to dictate terms to Total, the company it chose.

Total’s agreement could be the clearest sign yet of just how weak the majors’ position has become. Details of the deal remain murky but what is known is that Total will take a 25% stake in Sevmorneftegaz, the company formed to develop the field. Gazprom will retain 51% of that company – leaving 24% for at least one more partner, probably Statoil, which it will announce in coming weeks – and own all of the resources. When the field comes onstream, Total will return its stake in Sevmorneftegaz to Gazprom.

Last month, Total chief executive Christophe de Margerie claimed that the contract would allow Total to book reserves from the field. But the company’s shareholders will want to watch carefully to make sure that is true. Gazprom says it owns the gas and has implied that Total will be paid a fee for services. Jonathan Stern, of Oxford’s Institute for Energy Studies, says Total has yet to finalise many of the finer points of the contract.

If a model for this deal could be found elsewhere in the world, it would be in Mexico’s multiple service contract (MSC). There, too, the foreign firm providing the service is prohibited from owning the reserve. Yet in Mexico, the majors have avoided the MSCs en masse. In Russia, it seems, the potential rewards remain sufficiently great to make attractive even a glorified service contract of the kind Total has signed.

Yet it isn’t just in Russia where the majors are being squeezed. In Kazakhstan, Eni’s slow progress as operator of the Kashagan oilfield in the Caspian Sea has erupted in a conflict with Almaty that is reminiscent of Shell’s difficulties in Sakhalin. The difference here is that there isn’t much sympathy for Eni. Kashagan is Kazakhstan’s most important energy development – and one of the world’s most significant in decades. When production peaks, output will be 1.5 million b/d, making it the largest greenfield development to come into production in decades. But the problem for Kazakhstan is that Eni has twice delayed start-up and continues to increase the cost of the project.

The company’s latest estimate, says the energy ministry, is that Kashagan will cost $137 billion, more than double the $57 billion estimated – Eni says phase one development will cost a more modest $19 billion, itself a neardoubling of the original $10 billion price tag. It will now come onstream in 2010, two years later than the most recent deadline and five years after the first. The delays and cost overruns, says Almaty, are contract violations – and serious ones, given that they will affect the country’s economic growth.

The likeliest outcome is that a new royalty regime will be agreed with the companies developing Kashagan, which include Total, Shell, ExxonMobil, ConocoPhillips and Inpex. Eni has ‘violated’ its contract, say some analysts, noting that oil companies don’t want to hear the word, because it destroys their argument that this is about resource nationalism. But it also remains possible that Eni will be stripped of the operatorship, or that Kazakhstan state company Kazmunaigas’ stake will grow. Either way, Eni is in no position to win an argument with Almaty. It can only hope to lessen its losses.

Meanwhile, as the majors find their power being shortcircuited on these frontier developments, their vanquishers – state companies and the well-connected listed firms from resource rich countries – go from strength to strength. While Kazmunaigas has squeezed Eni in the Caspian, it has also been pursuing its own international agenda, buying downstream assets in Romania. Gazprom’s ambitions in the European gas market have become so pronounced that last month the European Commission added a whole new clause to its third package of proposals on the continent’s energy liberalisation that would prevent Gazprom – or any other foreign company – from buying control of assets in the EU unless European companies were also free to do the same in the host country.

It might not come in time to stop Russia’s Lukoil, another company that is proving an exemplar of the shifting power balances in the energy world. Last month it said it had $10 billion to spend on refineries or other assets in Europe and would seek to capitalise on the weakness in the downstream market of Western integrated majors, which hold reserves in Europe that are marginal compared with Lukoil’s 15 billion barrels in the Russian ground. Even in their native markets, the power of the majors seems to be in decline.

Lukoil is a listed company – ConocoPhillips owns 20% of it – but its close ties to the Russian government are increasingly a source of power and persuasion. While president Putin toured Asia and Australia last month selling weapons and buying uranium, he took Vagit Alekperov, head of Lukoil, along for company. In Indonesia, Lukoil signed an upstream contract with Pertamina for ‘several prospective offshore blocks’ that Alekperov thinks could hold up to 150 million barrels. Lukoil, he added, is already the Russian company with the greatest geographical portfolio. And it wants to increase this growing international presence, too.

1. Translate into Russian:

Host governments; resource nationalism; inward investment; Russia’s environmental watchdog; to be faced with $30 billion in fines; production sharing agreements; slippage in the contracts; to strip of the development licence; to play hardball; to finalise finer points of the contract; to pursue international agenda; downstream assets.