How crude: Small and large oil companies in Russia and the foreign investment climate

 Attempting to reinvigorate Russian-American business dialogue, develop bilateral energy cooperation and prospects for expanding Chevron’s investment and corporate presence in the Russian market, the Counselor for International Strategy of the Chevron Corporation, Andrey Kalicki, met with First Deputy Minister of Foreign Affairs of the Russian Federation Andrey Denisov this week.

As one of the largest investors in the Russian oil and gas infrastructure, in 2008, Chevron still decided that the western Siberia region lacked commercial quantities of hydrocarbons last year while continuing its strong partnership in Russia in licensing technologies, the crude oil pipeline, hydrodesulfurization from natural gas and refined products, and lubricants.

Russia’s oil giant, Gazprom’s Chairman, Alexey Miller in the meantime met with Phung Dinh Thuc, President and CEO of Petrovietnam State Oil and Gas Corporation. They discussed Vietnam’s continental shelf developments by the Vietgazprom Joint Operating Company. They also discussed joint projects in Russia and third countries within Gazpromviet, which is a joint venture that is being set up. Vietgazprom is a joint operating company of Gazprom and Petrovietnam, which is engaging in geological exploration activities on Vietnam’s shelf. Last October, they signed a 30-year oil and gas contract on the continental shelf envisioning hydrocarbons exploration, development and production.

Chevron and Gazprom have also worked on joint ventures in the past, one of which was between Chevron’s subsidiary Neftegaz and Gazprom’s oil-producing subsidiary, Gazpromneft since 2006. Chevron works jointly with Gazprom in exploring and developing Western Siberian oil fields.

As far as reaching into each other’s domestic markets, in December 2005, the New York Times 
reported that Gazprom, the giant state-owned Russian energy company had announced plans to become a major player in the US and China in efforts to diversify its export markets. President Medvedev, then deputy Chairman of Gazprom, had stated that part of the long-term strategy was to establish a foothold in the U.S. market. Recently, in April, Gazprom partnered up with Royal Dutch Shell in order to get in on the U.S. gas market. Gazprom will ship gas from Sakhalin-2 project (off the Sea of Okhotsk) to a Liquified Natural Gas (LNG) regasification facility in Baja California, Mexico and then transport it to southern California. 

According to the Coalition for US – Russia trade, in 2008, the US imported nearly 170 million barrels of crude oil and petroleum products from Russia – 12% more than the previous year. These figures are based on data from the Department of Energy. Chevron has invested $800 million in the $2.7 billion Caspian Pipeline Consortium (CPC).

The CPC pipeline is 1,510 km long and runs from Tengiz in western Kazakhstan to Novorossiysk. Russia has seen many benefits from the project including $525 million for Russia’s tax system and duties, and funding for charities between 1998 and 2004. The projected completion time for the pipeline is 2014. Politics has deeply played into the CPC pipeline project which has created obstacles to Chevron’s investment in the pipeline, when, for example, the Russian government prevented the expansion of the pipeline arguing that it deserved more revenue from the CPC. In 2007, the dispute garnered the attention of the Wall Street Journal, which reported that the dispute between Chevron and the Russian government was an indicator of the hurdles that foreign oil companies face in energy-rich Central Asia as Russia reasserts itself.  In 2007, according to Martha Brill Olcott, a senior associate at the Carnegie Endowment for International Peace in Washington, many Russian elite believed that the Russian government should control the pipeline. And this has been the sentiment of the Russian government as well. Has that changed in two years?

Well for one thing, Kazakhstan started to meet with Chevron about altogether avoiding the political pipeline obstacles that occur on Russian territory to consider building an alternative route from Tengiz through the city of Karyk, under the Caspian Sea to Baku. In June 2008, Kazakh President Nazarbayev, announced that an agreement had been reached between Chevron and Kazakhstan on the first leg of the alternative route’s pipeline project.

One of the interesting articles in the September/October 2009 European Energy Review, “Kazakhstan wants to break free,” notes the history behind the disagreements between Chevron and Russia. After Kazakhstan’s independence in 1991, with Chevron’s reliance on a Russian controlled pipeline (the Atyrau-Samara pipeline), Chevron could not pipe oil from its newly acquired Tengiz field without avoiding complications. For a month, Russia cut off Chevron’s oil transport in order to “exact a stake in the Tengiz field.” 

The CPC pipeline began construction in 1996. There are several stakeholders in the CPC. Still, its creation did not change much for Kazakh dependence on Russia. And as for the Russian government’s interest in increasing its stake in the CPC? According to the European Energy Review,

One obvious option to increase export capacity, would be to enlarge the CPC. There are plans to increase the CPC’s capacity to 1.3 million bpd in 2011, but no final decision has been made yet. Up to now, the Russian state has been more inclined to expand the capacity of the Atyrau-Samara pipeline, owned by Russian state monopoly Transneft. At the same time the Russians are trying to build up a controlling stake in CPC.  According to a top Kazakh expert in the energy field who spoke to EER anonymously, the parties have already agreed to Russian demands regarding a price increase. But the oil companies involved are still deliberating a second Russian condition. The Russians want to divert 340,000 bpd from the CPC pipeline via tankers to Burgas in Bulgaria where it will continue its journey via a still to be constructed pipeline to Alexandropoulos in Greece. ‘The CPC expansion is not progressing as it should,’ admits the first vice president of KazMunayGas, Maksat Idenov. ‘However, I cannot comment further.’

Since the pipeline under the Caspian Sea has been deemed too hazardous an option, Kazakhstan and Azerbaijan have taken over the transport initiative responsible for the export route. The Kazakhstan Caspian Transport System (KCTS) will employ a sea tanker shuttle system and a new oil terminal will be built in Kuryk. Tankers will transport oil from Tengiz to Baku. The export route might be operational in 2012.

From the perspective of Russia, according to a Carnegie Endowment for International Peace report by Olcott and Nikolai Petrov, “Russia’s Regions and Energy Policy in East Siberia,” published in May, Vladimir Putin has consolidated Russia’s energy industry, “effectively making privately owned firms and regional firms subordinate to Russia’s two state-owned energy giants, Gazprom and Rosneft.” Describing forced shifts of power from the regions back to the central government by Putin in the case of the Irkutsk region and the decision to solve the conflict with what is known as a “good boyar” (an administrator directly pursuing the interests of the federal structures), competing local business interests never achieved a great balance between business and government through the network of federal service allies who were installed in the region.

While providing more insights into the Irkutsk region as well as other regions, the report concludes that even though the regional administration tries to balance competing local interests and concerns, depends heavily on the large enterprises present in the territory, and wants to attract other large businesses for investments in the region, “nonetheless, the main priority for the regional government of Irkutsk – as is true of regional governments elsewhere in Russia – is to attract federal support for economic development plans, and to win federal resources, especially for transportation and communication systems in their regions.” The report also mentions that the regions that the Kremlin favors do better than those that they do not, and that “Putin and his team have had a notion of which regions were key to the overall development of Russia’s future – and which were less essential.” The report shares compelling points on how much control the Russian government would cede to regions when it comes to resource exploitation and local decision making based in part on the strategic approach that Putin favors over a commercial approach.

On May 14, 2009, Chevron made a statement for the record, for the House Committee on Ways and Means, at the Subcommittee Hearing on Investment Protections in U.S. Trade and Investment Agreements, which included the following,

“The United States plays an important role promoting a global investment protection regime.
Chevron believes that the U.S. government’s trade and investment agenda should continue to include a long-term commitment to improved investment disciplines and progress toward investment agreements with critical energy suppliers and consumers, including countries like Angola, Brazil, Cambodia, China, India, Indonesia, Iraq, Kuwait, Malaysia, Nigeria, Russia, Saudi Arabia, South Africa, Korea, Thailand, Venezuela, and Vietnam. The U.S. can retain a leadership role by ratifying pending trade agreements which contain quality investment chapters and by continuing to pursue active BIT (Bilateral Investment Treaty) negotiations with China and willing countries that demonstrate a commitment to economic openness and reform.”

Chevron finds investment protection critically important.

“Investment protection is an issue with real-world implications—a substantial portion of Chevron’s overseas investments are made in countries without high-quality investment protection agreements with the United States, even as many of these countries pursue investment agreements with other trading partners. Sustained progress toward a comprehensive global investment protection regime is necessary to both reduce the risk associated with overseas investments and to ensure that U.S. companies are not disadvantaged against foreign competitors whose investments are protected by such agreements.”

While discussions between Chevron and Russia continue, the Energy Strategy that came out of Russia in August points out some significant targets. The Energy Strategy that the Russian Federation approved for the period up to 2030 was approved in August. It cites that a principal aim in the long-run is a shift from being resource-based and export-oriented to innovative development of the national economy and further integration into the global energy system. In foreign markets, it cites further cooperation with strategic partners, diversification of export directions, development of LNG exports, among other priorities. During the 3rd phase of its strategy, sometime in the early 2020’s – 2030, Russia wants to improve energy efficiency and enhance their use of non-fuel energy sources (nuclear, wind, solar, etc.) in order to boost economic dynamism. It expects the fuel and energy balance for the year 2030 to see an increase in the share of non-fuel energentics consumption from 11.2% in 2005 to 14-15% in 2030. By 2030, non-fuel sources in total electricity production in Russia will grow to 38%.

According to Prime Minister Putin in August, “we must change the structure of the energy balance to increase the share of the so-called non-fuel power generation, non-fuel sources of energy such as nuclear power generation, hydropower generation, and other renewable resources.”

Russia expects to export the volume of primary energy resources by 1.2 the 2005 volume of exports. The national fuel energy complex is targeted to shrink within the national economy’s structure from 30% in 2008 to 18% in 2030. Still, in the short-run before the Russian economy begins to turn toward alternative energy, it will boost production of oil and gas.

The Energy Charter

So far this year, the Energy Charter Secretary General Ambassador Andre Mernier has promoted the importance of the Energy Charter in the wider Black Sea region, Serbia, at a forum at the IAEA, Beijing, Ukraine, Indonesia, before the G-8, and Tajikistan. The Energy Charter Treaty resulted from an international interest in making the energy sector an opportunity for mutually beneficial cooperation to avoid any economic divisions and therefore to establish a commonly accepted foundation. It was signed in 1994, and entered into force in 1998, and to date has been signed or acceded to by 51 states, the European community and Euratom. In enforcing the effective creation a level playing field of rules to be observed by participating states, the Charter contains a system for settling disputes on matters covered by the Treaty.

In May, Eurogas’ President Domenico Dispenza called on Russia to reconsider some of its assumptions in respect to the Energy Charter. He has stated that Russian ratification "would give the country a more robust legal basis to sustain its interests, since ratification implies not just obligations but also a stronger voice to express a country's particular concerns."

This summer, Prime Minister Vladimir Putin refused to join the Energy Charter due to the feared impact of ratification. According to RIA Novosti, Russia fears that the EU could demand an end to the monopoly on access to the Russian pipeline system. 

Dispenza seems to believe that Russia’s concern is that the interests of producers are not fully reflected in the treaty. 

President Medvedev during the 24th EU-Russia summit in Sweden, said, "I once again drew our partners' attention to the energy initiative proposed by Russia in addition to existing energy documents, including the Energy Charter," Medvedev said.

"I'd like to say once again that I think we need to continue our exchange of views on this subject so we can work out an international legal basis for future energy cooperation."

According to Business Week, when US special envoy for Eurasian energy Richard Morningstar was asked if the US was pressing Moscow to ratify the Energy Charter, he said his country was itself not a member of this agreement, but it "certainly certainly supports all of the principles which the Energy Charter represents."

The US has observer status.

The Energy Charter’s investment provisions aim to promote and protect foreign investments in member countries, specifically it protects foreign investors against political risks in order to boost investor confidence and promote open and competitive international energy markets based on transparency and non-discrimination. While it doesn’t oblige countries to open their markets to foreign investors, it does confirm the right of each country to decide which areas will be made available for exploration and energy resources, as well as the rate that the resources can be drawn on.

In 2007, Chevron participated in a conference among a broad spectrum of policymakers that included resource-owning countries and consumers, as well as industry and academic and other stakeholders, including senior participants from Chevron. Chevron, Edison, KazMunaiGaz and OMV Gas, met with the Secretary General of the Energy Charter to discuss how business strategies are coping with evolving patterns of risk. Two years later, Chevron, as a foreign investor in Russia’s oil and gas is operating in Russia without the benefits of the Energy Charter Treaty.

Chevron recommendations to Obama

Last year, Chevron also made a few recommendations to the Obama administration, in a letter dated November 10, 2008, that are helpful to their business strategy in Russia and Central Asia. In terms of Kazakhstan, Azerbaijan, and Turkmenistan, they recommend deepened, non-confrontational ties with regular senior-level outreach to help ensure multiple energy transportation options, including Russian transportation options. With regard to Russia, they recommend that dialogue with Russia be based upon the Sochi Declaration that recognizes the strength of the US-Russia commercial relationship even as it looks to raise the level of two-way investment. In order to strengthen Russia’s domestic investment climate, they see Russia’s WTO accession as significant in becoming a vehicle to support legislative changes that would then fortify the investment climate.

President Medvedev, in a speech given on November 18th, expressed that he is convinced that accession to the WTO is important to both Russia and to the WTO and that the only question remains whether they will join as a Customs Union between Russia, Belarus and Kazakhstan, or separately. He emphasized that the shortest path would be chosen.

A little about the industry and things to learn more about current changes in oil and gas

When you think about oil business and government,  'business as usual' probably also comes to mind. Even when you consider how it could ever be possible to meet the interests of all parties in the oil business, an instrument of power politics, that is used as a leverage by those who have it and those who can produce it and get it to where it needs to go, unlikely and business as usual comes to mind, even for those who wish to lay to rest zero sum games. Anyone who studies business models and how policies change with changing economies and markets might have noticed that companies and governments have been advised not only to focus on the direct benefits when calculating their return on investment (ROI), like sales, but also the indirect benefits, like efficient technologies that make the process for workers easier and therefore increase productivity. Then, of course there are the myriad regulations. Anyone who also studies a little about the exploration and extraction of natural resources and its costs in comparison to what they have recovered due to consumer demand for the specific reserves being considered in evaluating the ROI, might consider whether or not there are enough incentives for businesses to depend on foreign oil. Good questions.  

Another thing to notice is that Russia is providing government incentives to domestic companies for new fields in Siberia through tax breaks. In October, the Russian Ministry of Natural Resources proposed incentives for small private oil companies to bolster crude output in order to restore it to pre-crisis levels.  The Russian government continues to tell oil industry where the incentives are and where development should take place, according to Renaissance Capital oil and gas analyst, Alex Burgansky. Burgansky expects that Russian oil production will not collapse. Burgansky makes a valid point about the difference between the U.S. spot-market (spot market is a cash market that is based on commodities or securities where goods are sold for cash and delivered immediately) and spot pricing (today’s price of a commodity which can change tomorrow) as compared to Europe’s long-term contract based economy, when he says that Russian oil and gas provided by Gazprom to Europe will not be affected since they are long-term contract basis deals, which do not have a spot market.

Burgansky also does not see LNG volumes displacing Gazprom’s gas in Europe. In 2006, John Gass in an interview focusing on what Chevron hoped to get from Gazprom, was asked “What volume of Russian natural gas is Chevron prepared to buy? Is there a shortage of natural gas in the United States?” He stated that “the volume of gas consumption in the US today exceeds its domestic production.” He forecast that the volume of LNG would rise as domestic production stabilizes and then fall when consumption rose and that by 2020, according to research done by the National Petroleum Council, there will be a six fold increase in the volume of LNG imported into the U.S.. And then, he said,

“Chevron and Gazprom can become one of the world’s largest suppliers of LNG, in proportion to its partnership relations at the later stages of the development of the Stockman deposit and the production of LNG, and potentially the largest supplier of LNG on the American market. We are counting on LNG from the Stockman deposit providing about 8% of the predicted import to the U.S. at the initial stage.”

The Stockman deposit is on the continental shelf of the Barents Sea in the Arctic. When asked how Chevron might be helpful to Gazprom in developing the deposit, Gaas said that Chevron developed a drilling technology that set a record for the depth of the drilling of a well at sea and that sharing this experience with partners and using it in joint projects to ensure maximum effectiveness and profitability would be useful in developing the deposit together. However, in 2007, Chevron refused Gazprom’s proposal in the Stockman deposit that would give foreign companies a share in the operating company that owns the infrastructure, but not the license of any natural gas. 

Both the Stockman deposit and the Yamal (which means end of the world in local Nenets language) Peninsula in the Artic have been chosen for future gas production and exports and require enormous investments. According to Ivan Rubanov in October, the Russian government unveiled a new gas strategy in Yamal and for the first time it is making the gas-rich region accessible to foreigners.

“This comes as a surprise,” says Konstantin Simonov, managing director of the National Energy Security Foundation. “The original plan was to let Gazprom broach its biggest project alone.” 

Prime Minister Putin has said that the gesture inviting foreign companies to attend the Salekhard meeting, indicates openness and willingness to work together. The Salekhard meeting a few months ago was an invitation to most foreign oil majors to discuss how to extract the huge gas fields on the Yamal Peninsula. According to Barents Observer, Gazprom has postponed the launch of one of the fields on Yamal because it needs foreign oil company technologies and investment capital. Many of the oil companies hoped for tax incentives and easing of regulations.

Chevron did not attend the September meeting in Salekhard, neither did BP. Oil companies that were invited include: France’s Total, Norway’s StatoiHydro, Angol-Dutch major Shell, Japan’s Mitsui and Mitsubishi, ExxonMobil, ConocoPhillips, Germany’s E.ON, French GDF Suez, South Korea’s Kogas, and Malaysia’s Petronas. 

“Shell, for instance, was forced to give up its share in the Sakhalin project, but it pocketed a multibillion-dollar compensation, and amid the general outcry against the Kremlin, the victim itself remained surprisingly reserved. Now that Shell is among the key Gazprom partners, it is unlikely to bear any grudge – saying nothing of those German and Italian companies that can access Russian assets and earn hundreds of millions from options alone,” said Mr. Simonov. 

At the meeting in September, Putin did mention the creation of favorable taxation for the Yamal area and stressed the difficulties of the region.

Could Chevron and Russia have been talking about improving their foreign investment relationship this week? It might be unavoidable. In terms of why Russia might have warmed up toward foreign investment in Salekhard, according to Daniel Yergin, author of The Prize: The Epic Quest for Oil, Money and Power and renowned energy expert, Russia’s reasons stem from its bumpy relations with its main customer, the European Union, since it has not given Gazprom sufficient recent assurance that its potential gas production will be fully contracted. Yergin believes that Gazprom will have to move from less manageable pipeline contracts to more flexible LNG deliveries.