When it comes to oil and gas, things in Russia are large—very large. Russia controls more oil and gas reserves than any other single country and is the world’s largest natural gas producer and exporter. Two of the world’s three largest natural gas fields lie within its borders. And as Western Europe, the northeast Asian countries, and the United States maneuver to line up reliable suppliers for the next decade, Russia has gained enormous leverage.
The Russian Federation’s temporary suspension of natural gas shipments to Ukraine last winter, together with plans for a subsea gas pipeline to Germany that will bypass the Eastern European countries, have heightened concerns about whether Vladimir Putin’s government might manipulate energy supplies to achieve larger political objectives. At the same time, foreign investors have had plenty of reason to worry about whether the government is playing fair financially, as it seeks to renegotiate long-term development contracts on terms more favorable to itself. Recent moves by OAO Gazprom, in Moscow, the state-owned giant that is also the largest oil and gas company in the world, have riled Western energy companies already working in Russia [see photo, ”Tough Players”].
Two situations in particular have brought issues to a head: one involves development of gas reserves around Sakhalin Island, just north of Japan, the other in an area in the Barents Sea near Murmansk known as Shtokman, believed to be the third-largest natural gas field in the world. Because of these fields’ remote and hostile environments, Russia will need some of the most advanced technology in the world to exploit them. Major Western oil and gas companies expected a slice of Russia’s energy pie in exchange for their technical expertise and money. But newly rich Russia is proving it has the cash to buy these technologies from other sources and could shut out the West.
The area around Sakhalin Island, the site of a former penal colony and historically a major bone of contention in relations between Russia and Japan, has oil reserves estimated at about 14 billion barrels and natural gas reserves of about 2.7 trillion cubic meters [see photograph, ”Big Stakes”]. Two major combined oil and gas development programs make Sakhalin the target of immense foreign direct capital investment. Development at the field designated Sakhalin-I is controlled by a consortium spearheaded by Exxon Mobil Corp. Meanwhile, Royal Dutch/Shell Group and its partners are developing Sakhalin-II with plans to ship liquefied natural gas, or LNG, to the United States, among other destinations.
In mid-September the Russian government announced that Shell had violated environmental permits while developing Sakhalin-II, threatening to stall production. The controversy came on the heels of an earlier announcement from Shell that its production costs had ballooned to US $22 billion through 2014 from an original estimate of $12 billion. Agreements drafted in the turbulent early 1990s allowed Shell and other major oil companies to develop natural gas fields in Russia and specified that the Russian government would turn a profit from production only once the developers had paid off their investment. As a result, Shell had little incentive to constrain costs, angering the Russians.
The government’s environmental concerns may be genuine: Greenpeace and the World Wildlife Fund have raised strong objections to the damage inflicted on the island as a result of the energy companies’ operations. However, if the Russian government is challenging the companies’ environmental permits in Sakhalin solely to rework contracts to include Gazprom (as most analysts believe), the government is threatening the sanctity of all business relationships that bring in outside companies and capital. ”Law which is selectively enforced is no law,” said former U.S. Federal Reserve chairman Alan Greenspan, speaking at a recent New York City conference on investment in Russia.
Others agreed. ”These rather arbitrary ways of renegotiating these deals is, I think, the central thing that haunts an otherwise fantastic economic story” of Russia’s rebound, said Michael McFaul, a senior fellow at the Hoover Institution in Stanford, Calif. Besides Sakhalin, the Russian government has also threatened to revoke a license for a giant project in eastern Siberia controlled by BP, the British energy company.
The question of foreign investment is not merely a matter of whether huge multinational oil companies are getting a fair shake from the Putin government, but also a question of whether Russia will be able to obtain advanced technology fast enough to develop reserves to meet global demand. The Shtokman disputes exemplify that dilemma.