[A-List] Oil company lease trickery

[Michael Hudson <michael.hudson@xxxxxxxxxxxxx>]

Note the relevance for Iraq's imminent oil privatization.
    Michael

Moscow Times
January 19, 2007
Coming Out Negative in the Balance
By Robert Skidelsky
Lord Skidelsky is chairman of the Centre for
Global Studies and professor of political economy at the University of
Warwick.

Russia's temporary halt to oil supplies through
the pipeline crossing Belarus earlier this month
was the latest in a sequence of public relations
disasters for the Kremlin. The West's romance
with President Vladimir Putin's Russia ended with
the Yukos affair and since then Russia has
generally gotten bad press, even when it had a
good case. The Sakhalin-2 affair is a good example.

Early in December, Royal Dutch Shell announced
that it had sold Gazprom a majority stake in the
project to develop the Sakhalin gas field. In its
Dec. 8 edition, The Economist magazine accused
the Russian state of using "minor environmental
infringements" to force Shell and its partners to
sell out to Gazprom at the moment when they stood
ready to receive a "flood of revenues." Such
"loutish" behavior was incompatible with Russia's
claim to be a reliable energy partner. The
Russian case for action, based on the impact of
Shell's cost overruns on the expected revenue of
the Russian state, was simply ignored.

The key point of the original deal signed in 1994
was that the Russian state would only start
receiving a share of revenues from extracted oil
and gas once the Sakhalin Energy Investment
Company -- now Royal Dutch Shell, Mitsui and
Mitsubishi -- had recovered its costs and made a
17.5 percent real rate of return. The contract
had no cost cap nor any indication of what costs
were non-recoverable. This left Shell with no
incentive to exercise cost control. In fact, the
opposite was the case: By inflating its costs and
keeping its rate of return just under 17.5
percent it could prevent the Russian state from
sharing any of the revenues until some indefinite point in the future.

This became more than a theoretical possibility
when Shell announced a 20 percent, or $2 billion,
overrun in 2004, and a further overrun of $10
billion in 2005. The issue became one of whether
costs have escalated because of inherent
difficulties with the project (as Shell has
argued) or whether they have been artificially
inflated to postpone payments to the Russian
state (as Russian officials claim). Either way,
the revenue about to come on stream was not headed in Russia's direction.

After several failed attempts to revise the
contract, the Kremlin cut the Gordian knot by
"persuading" the Sakhalin Energy Investment
Company to sell a majority stake to the state gas
company Gazprom for $7.5 billion. That way the
Russian state secures control over costs and a
share of the revenues as soon as they arise.
Legal harassment over environmental violations
was part of the "persuasion." Western media have
focussed attention on these dubious legal tactics
to force a sale, rather than on the nature of the original deal.

The opinion on the Russian side is that Shell
took advantage of Russia's weakness and corrupt
government in 1994 to negotiate an extremely
favorable contract for energy extraction at a
ridiculously low price. The exploration had
already been done; the profits were assured. The
only real risk for Shell was political risk --
that the Russian government would renege on the
deal. This was already discounted in the price.
So the forced sale of shares in the consortium
should not be seen as a windfall loss to the
shareholders -- it is just the realization of the
risk that Shell and its partners willingly
assumed. This is apart from the fact that Shell
received a fair price for the sale.

Shell's defenders say that the contract did not
reflect political risk but economic risk: The
price reflected the unforeseen hazards of the
project and the fact that the Russians lacked the
technology to attempt the extraction themselves.

This is the nub of the question, but you will not
see it discussed in the Western press. Instead,
most of our commentators have argued that the
Sakhalin-2 "seizure" is part of a deliberate
Kremlin policy to exclude foreign investment and
management from its "strategic sector." This is
clearly untrue. Gazprom is open to foreign
investment; China got a share of the recent sale
of Udmurtneft. And as for the supposed effect of
the Russian action in discouraging foreign
investment, it was announced Jan. 11 that Gazprom
had reached a deal with Chevron, the giant U.S.
energy company, to explore and pursue a range of
oil projects in Russia. Shell is likely to remain
the operator of the Sakhalin-2 project, because
Gazprom has no experience at all in producing
liquefied natural gas. The issue is one of
control, not ownership, of strategic resources.
The problem is that the Kremlin has not so far
defined what it means when it says "strategic
sector." It includes the natural resource sector,
but is apparently not limited to it. This creates
uncertainty in the area of property rights.

Despite the defense that can be made of its
actions in relation to Sakhalin-2, Russia's
energy policy is not coherent. The Economist is
right to note the contradiction between Russia
saying that it will be a "reliable" energy
supplier for Europe and using oil and gas as a
political weapon. It would be far better if the
market for energy were depoliticized. In actual
fact, consumers the world over seek security of
supply, while producers look to extract maximum
advantage from control over a scarce,
non-renewable resource. It is rather hard to
demand that Russia uniquely abstain from this game.

Let me return to the question of why Russia gets
such bad press. First, many of the actions of the
Russian state can and should be criticized -- as
much by Russians as by those in the West. The
country has no understanding of the meaning of
the rule of law. It uses legal devices to obtain
political objectives. This makes it look shifty
and vindictive. Secondly, journalists are often
just lazy. It is much easier to compile lists of
misdemeanors and assert trends than to dig into
the circumstances of particular cases.

Finally, Russia's behavior is often crude. It
badly needs to launch a charm offensive. Most of
its officials sound as if they have never heard
the word diplomacy. Yes, they often talk and act
as bullies. But the Kremlin usually has a better
case than it knows how to present. Partly as a
result, the Western media nearly always attribute
the worst motives to Russian behavior. A modicum
of grace would help bridge the gap between perception and reality.