No. 2, 2008

Implementation of new sweeping state-private partnership projects is a top priority for the Russian oil and gas complex

The companies whose business policy is determined by the state are now setting the pace in the development of mineral resources in Eastern Siberia and Russia’s Far East. In the meantime, Russian leading economists are certain that efficient development of oil and gas fields in those highly-promising regions is possible only given close cooperation between government corporations and private companies.

Activity at the administrative level

Tapping the mineral wealth of Eastern Siberia and the Far East has moved to the top of the Russian Federation’s economic policy priorities, as evidenced by the latest developments in the country, the oil and gas complex included. Thus, the Eastern Siberia-Pacific Ocean oil trunkline, several gas pipelines and infrastructure facilities are being built and new oil and gas fields developed.

Oil and gas companies like Gazprom, Rosneft and Transneft the controlling interest in which is owned by the government are now particularly active in those regions. They have put forward the controversial initiative to grant subsoil user rights on request. This year, for example, a proposal has been tabled at the legislative level to the effect that Gazprom be formally authorized to prospect for and to produce gas (and Rosneft, oil) on the shelf, and that licenses for shelf sections be granted to them on the sole-source contracting basis.

Already this year, Gazprom applied for a sole-source contracting of 37 gas fields with aggregate resources of 11 trillion m³, including major ones like Kruzenshternskoye (gas reserves in the ABC1+C2 category: 1.67 trillion m³), Chayandinskoye (1.24 trillion m³) and Leningradskoye (1.05 trillion m³). Notably, the government has shown no reaction to these claims on the part of the monopolist.

Leading Russian experts maintain that by staking on “our own” companies and ruling out competition the government risks deteriorating the quality of field development. The subsoil use process will lose its transparency, which is fraught with a drop in its efficiency and, as a result, with a decrease in budget revenues.

In the TNK-BP management’s opinion, things are taking such a turn that government corporations can now have substantial advantages in obtaining rights to the development of mineral wealth and to the use of the existing transport infrastructure.

Surgutneftegaz also voiced its concern about the development of the situation in Russia’s fuel and energy complex and commented that governmentalization should not be to the detriment of other Russian companies’ business. Otherwise it will suppress competition and, accordingly, depress the Russians’ living standards – after all, 56% of direct tax revenues to the RF budget depend on mineral wealth development efficiency.

Commenting on such behavior of government corporations in Eastern Siberia and the Far East, LUKOIL President Vagit Alekperov pointed that “Russia’s resource base demands colossal investments” (at least $300 billion) and that without private capital this process would “skid.”

Initial foreign investments

It is no secret that promotion of the labor-intensive oil and gas business, especially in the Far East with its underdeveloped infrastructure, calls for substantial funds. Let’s face the reality: government corporations have practically no such funds, but are ever deeper in debt. The only way out of the situation is to invite foreign investments in costly cash-consuming projects.

In quest for funds, Rosneft was compelled to open the door to the country’s East for players from Asia. The ONGC of India bought 20% of Sakhalinmorneftegaz’ (a Rosneft subsidiary) stake in Sakhalin-1 project in 2001. And early this year, Rosneft and ONGC signed a memorandum whereby the Indian company receives access to Russia’s mineral wealth in exchange for funding its development, and Rosneft, access to the Indian refining and product sales sector.

Hydrocarbon resources of the Western Kamchatka shelf are estimated at 3.8 billion tons of oil equivalent. Development operations there commenced in 2005. As of now, $90 million have been invested in the project. Another $300 million will be invested in 2008, and full-scale shelf development demands yet more. In 2005, therefore, Rosneft let another Asian partner, Korea’s KNOC, obtain 40% of the shares in the managing company West Kamchatka Holding DV in which Rosneft holds a 60% interest.

The Chinese have scored perhaps the greatest success in building up joint business with Rosneft. The Russian government corporation has given Sinopec access to the Veninsky block of Sakhalin-3. In 2006, Rosneft (51%) and CNPC (49%) set up the Vostok Energy hydrocarbon prospecting and development joint venture in Russia, and their second joint venture will engage in crude refining and product sales in China.

In expert opinion, Rosneft established a special relationship with that East-Asian nation after Chinese banks had granted it $6 billion for the purchase of Yuganskneftegaz which will be refunded by way of oil deliveries to China (48.8 million tons of oil before 2010). Besides, the Chinese consolidated their ties with Rosneft by purchasing its shares floated in an initial public offering (IPO). This year, Vostok Energy has acquired licenses for two Irkutsk fields and gotten down to their development.

Moreover, Gazprom is developing all the large fields in the east of the country jointly with its foreign partners. This does not only save costs but reduces technological risks as well owing to the status of its partners most of whom are major international holdings like Total, BP and Shell having rich experience in on- and offshore operations.

Some experts hold that new large fields contracted out by the government on the sole source basis can be developed only with participation of big foreign investors. Other subsoil users’ chances of winning contracts for the developing of oil and gas fields from the non-licensed Federal stock will be slim – all they can reckon on will be small areas of no interest to Gazprom at all.

Meet challenges together

Although government corporations are vested with all the necessary powers and enjoy support at the top level, analysts often wonder whether the new players are really equal to the ambitious task of developing the east of the country.

There are grounds for doubting the efficiency of government corporations’ work. So far, only the Sakhalin-1 and Sakhalin-2 projects, where foreign companies ruled the roost, have been successful. Gazprom is heavily indebted today, and Rosneft is also in dire straits following a series of major asset acquisitions, which may discourage investment in the region with practically no infrastructure.

The government corporations’ aggregate debt runs into about $60 billion which is almost a quarter of Russia’s expenditure budget for 2007. As such financial difficulties are an omen of potential bankruptcy, civil servants decided to protect government corporations from creditors. The government entered them on the list of strategic enterprises which, in the event of going bankrupt, are put through a special procedure that is, in fact, a panacea from any debts.

Moreover, most experts believe that government corporations are less efficient than private companies because the government vests them with extra political and social functions, with general national interests taking precedence to corporate ones. The corporations are building up their capitalization by buying extra assets without paying due attention to production and to the development of existing facilities.

Certain nuances in the relationship with independent companies apart, market players note that Gazprom’s relations with Rosneft are far from cloudless, either. It happens that instead of acting within the framework of a common coordinated business policy, government corporations vie for subsoil resources and sales assets of the oil and gas complex. For example, Rosneft purchased Vostochno-Sugdinsky section at 25-times the starting rice in order to beat Gazprom.

Ever more specialists are doubting the government corporations’ ability to promote their business efficiently with a view to attaining far-reaching global objectives. The Natural Resources Ministry of the Russian Federation has already pointed out on more than one occasion that it has its misgivings about whether there are enough resources to guarantee the 100-percent load of the ESPO pipeline. Arkady Dvorkovich, head of the presidential staff expert department, warns that “the fashionable practice of the government conquering the market spells reducing economic growth rate to zero. The only way is to promote private business.”

There is no ignoring the fact that at times government corporations seek to take over oil and gas fields uncontested and for token money. This will promptly result in national and regional budget losses. Already today, gas fields are auctioned off at $0.14 a barrel of oil equivalent – a half of the price charged in the West.

In one of his statements Russian President Vladimir Putin noted, concerning government corporations, that “from time to time there arise questions as to whether they operate efficiently enough and whether the tariffs and prices charged when realizing this or that project are fair.”

According to Vladimir Pantyushin, an expert of the Political Studies Center, partnership relations between the government and the business community are not shaping up properly. Experts note the absence of the parity basis characteristic of business practice in Europe or the United States. Analysis shows that Rosneft is going to supply to the ESPO pipeline 25 million tons of oil a year while Surgutneftegaz and TNK-BP, nearly a tenth that amount. The exact size of the quotas will be set by Transneft. Experts voice doubts, however, that private companies will be allowed full access to the pipeline.

Scientists are voicing their doubts, too. For example, Arkady Yefimov, General Director of the Siberian Research Institute for Geology, Geophysics and Mineral Resources, said that the filling of the ESPO pipeline could be guaranteed only if Western Siberia’s explored oil resources amounted to 1.5 billion tons rather than a mere 520 million tons today. In order to solve this problem, the government should grant subsoil users about 200 extra sections for the development of mineral resources. In Eastern Siberia, geological conditions are much more rigorous than those in Western Siberia. It takes nearly a month to drill an oil well in Western Siberia, and no less than a year, in Eastern Siberia. Consequently, new fields will require more substantial investments.

To sum up, most Russian economists and experts convincingly argue that in Eastern Siberia and the Far East, top hydrocarbon field development efficiency can be attained only based on equitable partnerships between government corporations and private companies.