Gazprom wants all of Sakhalin : Is the monopoly too big to handle?

The Russian government may now have a very big headache to deal with in its oil and gas sector, its own creation - Gazprom. The more you feed the giant, the greedier it gets. After the Russian monopoly was given sizable stakes in most natural gas projects on Russian soil, in some cases the stakes were taken away from foreign companies, as well as being granted the exclusive right to export Russian natural gas, Gazprom remains unsatisfied.

Earlier this week, Gazprom's deputy head Sergei Ananenkov stated that because Gazprom would not be able to fulfill the natural gas supply requirements to Russia's Far East before 2014 with its new Sakhalin-3 project, it should be given the right to buy the natural gas produced on Sakhalin-1 (co-owned by Exxon Mobil and Rosneft, among others) who are already in talks of exporting that gas to China.

Many see such statements as Gazprom's attempts to wrest control over all the major Sakhalin energy projects. After buying out Royal Dutch Shell's 50% + 1 share stake in Sakhalin-2 late last year amid active pressuring from the Kremlin to revoke Shell's license for the project outright, Gazrpom with the help of the Russian government's several ministries is seeking to attain control over the Sakhalin-3 project without a formal auctioning process. And now, Gazprom has been complaining about the violation of its unique natural gas exporting right status while the companies controlling Sakhalin-1 plan to export gas to China.

Kommersant cites experts saying Gazprom's statements of a deficit of energy resources in Russia's Far East are only a pretext. Gazprom's real goal is to negotiate export prices to China out of Sakahlin-1 itself (and presumably decide on further allocations of natural gas) rather than let the consortium members do it. Right now exporting natural gas is a much more lucrative business than selling it within Russia, due to a large disparity in prices and government subsidies.

As Vremya Novostey reports, Gazprom's actions are already seeing criticism from the Russian government. Russian minister of Natural Resources Yuri Trutnev has communicated his discontent with the transfer of Sakhalin-3 to Gazprom without a formal bidding process, calling it a procedure not in compliance with Russia's regulations. Russian finance minister Alexei Kudrin called out Gazprom's aggressive actions aimed at preventing its competitors to have any ability to export gas by blocking possible pipeline construction projects.

Yet another interesting development arises in Gazprom's recent statement. Not only is it attempting to affirm its power over foreign-based energy giants doing business in Russia, now it is also battling another Russian state-owned giant Rosneft, a large stakeholder in Sakhalin-1 and a contender for Sakhalin-3. The Russian governmental ministries now find themselves in a delicate position in the middle of a corporate dispute; some as Alexei Kudrin, have already picked sides.

Many have warned the Russian government of ballooning the size of Gazprom to a point when it would be both hard to control and harder to manage. The former is already a fact. Will Gazprom be able to deny the latter is a matter of time. Upon assuming control of Russia's key natural gas-producing projects Gazprom will have to show that it can work as effectively as its foreign colleagues, who have been moved to the sidelines with the help of the Russian government.

Scissors are cutting up the Russian oil & gas industry

Oil & gas companies operating in Russia have been crushed in the past few years by record-high taxation, making their business perspectives seem very unattractive. And given the fact that Russian companies now dominate the sector, courtesy of the Kremlin, Russian companies bear most of the taxation burden.

The taxation, which many have termed "Kudrin's scissors" (after Russia's Economic minister Alexei Kudrin) involves taxing 90% of the revenues (not profits) gained when Russian crude (Urals brand) trades above 25$ per barrel. Given the fact that Urals brand crude oil has been flirting above the $50 mark, the amount of taxation is huge. According to the Financial Times, Citigroup analysts have calculated an internal rate of return of under 10 per cent on a typical new Russian greenfield (undeveloped) project – lower than the hurdle rates for most majors. This means that Russian companies (which constitute the bulk of companies in the Russian oil & gas sector) are forced to pursue projects, that no other Western company would pursue outside Russia.

Investors, meanwhile, are fearful of investing into efficient independent oil & gas companies in Russia, such as Lukoil, BP or Royal Dutch Shell, due to the continuing regulatory problems these companies encounter from the Russian government. This leaves Gazprom and Rosneft as the only choices for investors, both of which have been on a spending spree; but not on investing in new fields, rather on buying out the assets of bankrupt YUKOS and other companies forced to sell their stakes to the government. Gazprom and Rosneft's shopping bonanza has ensured their debt remains at an alarming level for quite some time.

Add the two problems together, and you are left to invest in inefficient state-run companies, with huge piles of debt and little incentive to invest in new projects in Russia due to "Kudrin's scissors" (outside Russia taxation is lower but competition is fierce), and the overall picture for the Russian oil & gas industry so far is not optimistic. Profits for the two most recent quarters have been falling, as global oil prices have not been rising and as local production has been stagnant.

But the troubles in the Russian oil & gas industry may not be all that bad for the Russian economy overall. Investors have been shifting their capital out of oil & gas and into utilities and the banking sector which are scheduled for a booming growth period. The utilities sector has seen a big boost after the launch of the Russian energy trading market; the banking sector has seen a rise as well due to the recent successful IPO of Vneshtorgbank and the additional offering of Sberbank. The growth of the Russian credit market has proceeded at lightning speed recently and will continue to do so.

Overall, the trouble in the oil & gas sector may play well for the goal of diversifying the economy away from oil & gas, but taxation may have to be eased to give companies the incentive to look for new oil & gas projects; otherwise, Russia's production in the sector may begin falling in the near future.

New Rules or Old Methods?

Some interesting snippets from a New York Times article on Venezuelan oil resources and their soon-to-be expropriation:

Consider the quandary facing Exxon Mobil after its chairman, Rex W. Tillerson, recently suggested that Exxon might be forced to abandon a major Venezuelan oil project because of its growing troubles with Mr. Chávez.

The energy world took notice. So did Mr. Chávez’s government.

Only a day later, Venezuelan agents raided Exxon’s offices here in the San Ignacio towers, a bastion for this country’s business elite. The government said that the raid was part of a tax investigation, but energy analysts said the exchange of threat and counterthreat was all too clear. <...>

Mr. Chávez recently decreed that Venezuela would take control of heavy oil fields in the Orinoco Belt, a region southeast of Caracas of so much potential that some experts say it could give the country more reserves than Saudi Arabia. The United States Geological Survey describes the area as the “largest single hydrocarbon accumulation in the world,” making it highly coveted despite Mr. Chávez’s erratic policies. <...>

The oil companies decline to talk publicly about the negotiations, but people in the industry say Exxon and ConocoPhillips, two of the largest American companies in Venezuela, are digging in their heels. The companies, however, lack a united front: Chevron is expected to accept Mr. Chávez’s terms, since it is also negotiating access to a large natural gas project in Venezuela. <..> (New York Times, April 9, 2007)

These methods might sound familiar; familiar they are. In essence they are a more radical and populist way of imitating this:

The Russian government has won another concession from the foreign partners of the oil and natural-gas field being developed in Russia's remote Far East, known as Sakhalin 2.

Last week Gazprom, the Russian energy monopoly, took control of the project when foreign developers led by Royal Dutch Shell agreed to sell 50 percent plus one share to Gazprom, after months of pressure on the company and accusations about environmental issues from a Russian regulator. Critics called the sale a forced nationalization.

The latest twist came Thursday when the Russian government said the private developers had given up their right to recoup $3.6 billion in capital expenses on a priority basis. They were supposed to collect the money before the government began collecting sizable royalties. (New York Times, December 29, 2006)

Oh, I almost forgot this:

Gazprom forced BP's joint venture, TNK-BP, to give up export rights from a major gas field near the Chinese border. Now Gazprom will export from the field, called Kovytka; TNK-BP is selling only to local customers.

If Gazprom gains at least a blocking stake in the Shell project, then it will control all major gas supplies to Asia from Russia, critics say, with the pricing power and political influence that comes with a monopoly. Gazprom would still compete against liquefied natural gas from the Middle East and other sources. (New York Times, September 23, 2006)

Finally, during the last several decades, control of global oil reserves has steadily passed from private companies to national oil companies like Petróleos de Venezuela. According to a new Rice University study, 77 percent of the world’s 1.148 trillion barrels of proven reserves is in the hands of the national companies; 14 of the top 20 oil-producing companies are state-controlled.

Notably, Russian monopolies seem to function more efficiently without a blind pursuit of wasteful spending. However, several commentaries in today's Vedomosti newspaper have suggested that this seeming efficiency is very superficial. Most of the capital being raised in European and Russian capital markets does not flow into capital expenditures relating to existing operations, even less flows into new projects. Despite this, Gazprom continues to show the pure benefits of operating as a monopoly in the Russian market. Its latest move into power-generators, allows it to tap the soon-to-be liberalized energy market, where domestic (Russian) prices are set to rise to match those in Europe. While in control of the actual input resources for power generators, which it is able to acquire at prices of five times below those in Europe, as the market in Russia for input resources is unliberalized, it has the ability to widen the margin on the electricity it sells by several factors. A rough estimate shows that its profits from this venture would see triple-digit growth in the next few years.

However, the similarities in the Venezuelan and Russian scenario highlight the common features under which resource-driven economies operate, the rules that they establish, and the means by which investors operate. By following similar routes, these countries are already serving as an oligopoly in the global energy supply market without any formal cooperation.