Category Archives: nationalization

The Last Nationalization Domino Tumbles

The Moscow Times reports that having nationalized the oil and gas industry, the Kremlin is now moving on the last remaining area of private ownership, minerals.

Vladimir Potanin’s buyout of CEO Mikhail Prokhorov’s blocking stake in Norilsk Nickel and other assets within the Interros holding company could well lead to state control over the company, one of the country’s last few strategic assets in private hands, analysts said Thursday.

The change in ownership appeared largely to be a surprise to the market, but comes just weeks after Prokhorov was detained by French police during an investigation into a prostitution ring and could be linked to it in some way, analysts said. Under the deal, Potanin, one of the country’s most politically savvy oligarchs who has taken care to stay loyal to the Kremlin, will have a stake of about 55 percent in Norilsk. Potanin and Prokhorov will split their shares in other Interros assets, including Polyus Gold, the country’s largest gold miner.

Shares of Norilsk on the RTS rose 5.74 percent to $175 on Thursday.

Where Potanin will get an estimated $7.8 billion to take over Prokhorov’s share of approximately 27 percent in Interros was not immediately clear. Interros gave no financial details of the buyout in its statement on the issue Wednesday. “There is absolutely no funding now,” said Rob Edwards, metals and mining analyst at Renaissance Capital, referring to estimates that Potanin would need to raise extra cash for the deal. While it is unclear exactly where Potanin will get the money to acquire Prokhorov’s share, it should be very straightforward for him to finance the buyout through loans, said Chris Weafer, chief strategist at Alfa Bank. Servicing the debt could put more pressure on Potanin, however, and may lead to the buyout being a short-term one, with someone else stepping in over the next few months to take over the debts and assets, analysts said. Potanin may also wish to cash in some of his assets, which could lead to higher dividends or share buybacks, Deutsche UFG said in a note to investors Thursday. In any case, Potanin’s move “is not the endgame but one in a chain of events,” Edwards said.

Weafer agreed that the investment was short term rather than long term. The state or a state-controlled buyer, such as diamond monopoly Alrosa, will likely take control — first of a blocking share and later perhaps of a controlling one, he said. Norilsk, the world’s largest nickel producer, is a key strategic asset over which the state would like to have influence, Weafer said. In a note to investors Thursday, Renaissance Capital said it believed control over Norilsk Nickel would never be allowed to shift to a non-Russian or non-favored group.

Russia Kills the Oily Goose

Writing on Leon Aron, a resident scholar and director of Russian studies at the American Enterprise Institute as well as the author of Yeltsin: A Revolutionary Life(St. Martin’s Press) and of the forthcoming Russia’s Revolution(AEI Press), explains that Moscow’s attachment to statist economic policy is undermining its bid for global energy dominance. By re-nationalizing its energy sector, Putin’s regime is slaying its largest golden goose.


The idea that Russia is a new “energy super­power” is all the rage in Moscow, thanks in part to President Putin’s vigorous salesmanship. The coun­try holds between 6 and 10 percent of the world’s known oil reserves and exports around seven mil­lion barrels a day—second only to Saudi Arabia. Last summer, the Kremlin pushed hard to make energy security the centerpiece of the G8 summit in St. Petersburg. Lost in the crash of cymbals, however, is Russia’s uncertain ability to keep up with growing world demand—or even to maintain its current level of production, after a dazzling run from 1999 to 2004. While there are several reasons for concern, the underlying problem is sadly familiar in Russian history: a state ideology is poised to undermine the country’s progress at precisely the time when Russia seems on the verge of a breakthrough.

The government’s campaign to take control of energy firms began in 2004 with the selective prosecution of Russia’s largest and finest private oil company, YUKOS. In a series of blatantly rigged trials, Russian courts found YUKOS guilty of corporate sins and tax violations, including the nonpayment of a tax bill far exceeding the company’s profits. The company was bankrupted, and its most productive unit, Yuganskneftegaz, was sold through an intermediary to the state-owned Rosneft. YUKOS’s founder and principal shareholder, Mikhail Khodorkovsky, is serving a sentence of nine years’ hard labor at a prison camp in eastern Siberia. Soon thereafter, another leading private oil company, Sibneft, was purchased by the state-owned natural monopoly, Gazprom. In 2004–2005, the state’s share of oil production increased from 10 per­cent to 30 percent.

By re-nationalizing its energy sector, Russia is slaying its largest golden goose. Between 1999 and 2004, the much maligned “oligarchs,” as the young tycoons who became fabulously rich in the privatization of the 1990s are often called, invested over $36 billion, or 88 percent of their net profits, in “greenfield” exploration, drilling, and modern technology.[1] Helped along by the cheaper ruble and an overhaul in the companies’ corporate manage­ment (which became leaner, more transparent, and responsive to the markets), the private sector’s oil production grew by 47 percent. Trillions of rubles were paid in taxes to the Treasury and, for the first time in post-Soviet history, dividends went to the shareholders.

By contrast, during the same five years, extrac­tion by state-owned companies was up by a mere 14 percent.[2] But ever since “acquiring” most of YUKOS, Rosneft—which was an obscure firm about to be put up for sale when Putin’s confidant and deputy chief of staff, Igor Sechin, took over as chairman—has aggressively continued to buy oil assets. Gazprom has been on a shopping spree of its own: in just the last three years it has spent $18 billion on acquiring “non-core” businesses outside the gas field (such as Sibneft, for $13 billion)—more than it has invested in exploration and production since 1996.[3]

Thus, some of the most productive assets of the Russian oil industry have been transferred from the most transparent and efficient companies (YUKOS and Sibneft) to the least transparent and efficient (Rosneft and Gazprom). The result? After an average growth of 8.5 percent between 2001 and 2004, in the last two years, the growth in oil production has dropped to 2 percent.[4]

Russia’s largest deposits of hydro­carbons lie thousands of miles away from the terminals that can carry them to world markets. The state-owned pipeline monopoly, Transneft, operates over 29,000 miles of pipeline. But of the seven million barrels a day that Russia produces for export, only about four million are shipped via the pipelines.[5] The rest have to be transported much more expensively and slowly, by rail. This year, Russia’s production may exceed its total shipping capacity by between 220 and 294 million barrels.[6]

The Russian pipelines are not only short of what’s needed, they are also old. Two miles in three were laid over 20 years ago. Breakdowns and leaks are becoming increasingly common. Last year’s survey of the 1960s-era “Druzhba” (Friendship) pipeline, which carries 1.2 million barrels a day to Eastern and Central Europe, found almost 500 “damaged points.”[7] Last July, 11,000 gallons of crude leaked from the Druzhba near Russia’s border with Belarus, briefly shutting down the route and sending world oil markets up to about $75 a barrel.

Four years ago, a consortium of the largest Russian private oil companies offered to build a pipeline that would have carried one million barrels a day over 960 miles from the main fields in west­ern Siberia across the White Sea to the terminals in Murmansk, the only northern port in Russia that does not ice over in winter. The project, estimated at about $4 billion, was to be financed entirely by private capital. By that time, however, economic re-centralization was becoming the dominant state policy, and the Kremlin turned down the construc­tion, in effect vetoing private pipelines in Russia.

With some of its key potential domestic inves­tors expropriated, scared into selling, or forced to reduce their investments because of the increasingly uncertain business climate, Russia needs a massive infusion of foreign capital in order to continue devel­oping its energy sector. Here too, however, statist ideology trumps the country’s long-term interests.

As-yet-unwritten laws (which are understood as effective constraints on firms in the country) limit foreign ownership in joint ventures to 25 percent and bar companies of which foreigners own more than 49 percent from participating in the largest oil fields.

Moreover, Russia has begun to pressure the existing foreign operators of oil and gas fields into renegotiating their agree­ments. Last September, the author­ities were suddenly so concerned about environmental and ecological “violations” that they threatened to halt the construction, led by Royal Dutch Shell, of the world’s biggest liquefied natural gas plant on Sakhalin Island in the Far East. Known as “Sakhalin-2,” the project is the larg­est direct foreign investment in Russia, estimated to cost Shell and its Japanese partners $20 billion. Projected annual output is 70 million barrels.

At the same time, pressure was also brought to bear on ExxonMobil’s offshore Sakhalin production (“Sakhalin-1”) just as it was about to start shipping. That project was expected to cost $17 billion and produce 88 million barrels of oil annually. There is no Russian participation in Sakhalin-2, while Rosneft has only a 20 percent stake in Sakhalin-1. Now that oil and gas are so much more expensive than when the original deals were struck, the Kremlin wants a larger share of profits—or all of them.

It is now widely assumed that the government will pull the license of Russia’s second-largest oil company, half-owned by the British, unless the three principal Russian owners agree to sell their shares to Gazprom. That firm, TNK-BP, is develop­ing the Kovykta, a giant gas field in eastern Siberia. The latest addition to the Kremlin’s hit list is Russia’s largest remaining private company, Lukoil, one-fifth of which is owned by ConocoPhillips. The company, which pumps 18 percent of Russia’s daily production, has been charged by the Ministry of Natural Resources with unspecified “violations” in the development of oil fields and is threatened with the recall of almost two dozen licenses.

These moves are bound to make foreign direct investors think twice before going into Russia—and if last July’s float of Rosneft’s shares on the London Stock Exchange is an indicator, harvesting stock markets might not work either. Intoxicated as they were with high oil prices, investors’ response to the largest initial public offering in Russian history (and the sixth-biggest in the world)[8] was less enthusias­tic than Moscow had hoped for. The interest from international institutional investors, such as insur­ance companies, was weaker than an offering this large would normally produce.[9] The three biggest accounts belonged to the entities clearly seeking to refurbish their Kremlin loyalty credentials: BP (10 percent of the offering), the Malaysian state oil com­pany Petronas (9 percent), and the China National Petroleum Corporation (4 percent). The offering produced half the revenues expected.

By choosing re-centralization and re-national­ization over liberal reforms in energy markets, and opting for state control over direct foreign invest­ment, Russia may stop itself from raising enough capital to sustain the current level of energy pro­duction and transportation, much less to expand it. “Energy superpower” is likely to become an even more distant dream than it is today.

Russia adds insult to injury on Sakhalin-2

The Financial Times reports that the Kremlin has only just begun to steal:

Royal Dutch Shell and its two Japanese partners are to be made to share the burden of the huge cost overruns of Sakhalin-2, it emerged on Thursday, in news that cast a less favourable light on their deal to cede control of the project to Gazprom.

Just days after confirming that Russia would pay the companies $7.45bn to establish its controlling stake in the project, the government said it would require the three foreign owners to meet $3.6bn of the additional costs of Sakhalin-2 themselves.

Jonathan Wright of Citigroup said: “It depends on what you expect for oil and gas prices, but my figures suggest an internal rate of return for the project of 11 per cent. That’s above the cost of capital, but not sufficiently above it, given the region and the risks involved, to be able to say this is an attractive project.

“This news is definitely not making a good project turn bad, but it is making a difficult project slightly worse.”

He added: “This looks like payback for the negotiations last year, when Gazprom reached an agreement on taking a stake in the project, only to be told the following week that the costs had doubled.”

Details of the extra costs to the three companies – Shell, Mitsui and Mitsubishi – in a confidential agreement apparently leaked by the Russians, show the three companies will have to increase risk exposure and reduce the value of this month’s deal.

Earlier this month, they ceded control of Sakhalin-2 to Gazprom, Russia’s state-backed gas giant, after months of sustained attack by government agencies on aspects of the project such as its rising cost and environmental record.

Shell, which owned 55 per cent of the project, Mitsui and Mitsubishi halved their stakes and offered Gazprom 50 per cent plus one share. On the day the deal was signed, the Kremlin said environmental issues would be resolved and agreed to a doubling of the cost to $20bn.

Sakhalin-2 is governed by a production sharing agreement that allowed foreign shareholders to recoup costs fully before sharing profit with the Russian state.

But it emerged on Thursday that foreign shareholders would recoup only about $15.8bn and have to put up $3.6bn themselves. Gazprom, as a new shareholder, would be exempt from this cost increase.

Andrei Dementyev, Russia’s deputy minister for energy, told Vedomosti, a business daily partly owned by the Financial Times, that “foreign investors should take engineering risks upon themselves”.

Shell declined to comment on the agreement. Observers say that Russia, by leaking the information to the media, was adding insult to injury.

The Russian government has now set its eyes on Kovykta, the massive gas field in Eastern Siberia controlled by TNK-BP. Alexei Miller, Gazprom chief executive, on Thursday met with Victor Vekselberg, one of TNK-BP’s Russian shareholders, to discuss “co-operation” between the companies.

The Jamestown Foundation’s Vladimir Socor takes the West to task for making facile, rose-colored assumptions about Russia as an energy partner:

The Kremlin’s confiscatory assault on Royal Dutch Shell and threats to other Western energy majors in Russia on Black Tuesday, December 12 (see EDM, December 13) is the latest in a series of moves disproving Western wishful thinking about Russia’s energy policy.

That wishful thinking burgeoned, ironically, in the wake of the January 2006 Russian gas supply cutoff to Ukraine, which rippled downstream in a number of European countries. While the “wake-up call” for coordinated Western energy policies resounded mainly in the editorial pages after that crisis, most Western governments and energy corporations embraced the set of illusory assumptions that are now being laid to rest by Moscow’s own actions.

Assumption One during 2006 held that Russia and Western consumer countries would benefit through strategic relations of “reciprocal access.” Namely, access by Western energy majors and “national champion” companies to Russian oil and gas deposits in return for Russian companies’ acquisition of Western infrastructure, distribution systems, and direct access to Western consumers. However, by the year’s second half, Russia embarked on a policy of excluding Western investors (most notably in the super-giant Shtokman gas field) and, by the year’s end, threatening confiscatory measures against existing Western projects in Russia (Shell, ExxonMobil, BP) under tax or ecological regulatory pretexts. Meanwhile, turning the “reciprocity” into unilateralism, Russia’s state energy companies rapidly acquired infrastructure and production assets in the West as well as in countries that traditionally supply the West with energy.

The year’s Assumption Two, equally popular and partly related to the first, spoke of “mutual dependence.” It held that the West’s growing dependence on Russian supplies is not particularly risky because it is offset by Russia’s dependence on revenue from Western importers of Russian energy. As the year wore on, this Western postulate shattered against Russia’s active planning for construction of oil and gas pipelines leading to the Asia-Pacific region, setting the stage for Moscow to play Western against Far Eastern consumers in a none-too-distant future. Moreover, the “mutual-dependence” assumption blithely ignored Russia’s advantage as a single-actor exporter versus a multiplicity of eager, uncoordinated, and often competing Western buyers, with ample scope for manipulation by Russian state companies. Mutual dependence might become possible between the European Union collectively and Russia, if the EU develops a common energy policy, which however does not seem to be on the cards for now.

Assumption Three during 2006 held that Moscow cannot afford to exclude or mistreat Western energy companies because Russia’s state companies do not have sufficient means to invest in energy projects on Russian territory. However, Moscow successfully challenged that proposition through the Initial Public Offerings of Gazprom, Rosneft, and other state companies, which quickly raised multibillion-dollar investment funds on Western capital markets. Those IPOs launched a process of transferring Western resources to Russia for energy projects under the Russian state’s discretionary control, and without a real say by Western consumer countries regarding future production levels or the export destinations. When Russian President Vladimir Putin announced the go-it-alone policy on Shtokman, he did so with the argument that Russia does not need to invite Western investors, as it can raise the necessary capital on Western financial markets. The Kremlin took that argument one step further in December by embarking on what is, in fact, a forcible divestment of Western energy majors involved in Russian projects.

The year’s Assumption Four clings to a hope that Russia’s ratification of the Energy Charter Treaty and signing of the attendant Protocol would help the West overcome its collective vulnerability on energy security. It envisages, primarily, that Russian state pipeline monopolies would provide transit of oil and gas from third countries via Russia to Western consumer countries. However, Moscow’s actions during the year showed how risky this proposition is. The Russian government shut off energy pipelines repeatedly in 2006, not only to Ukraine and Georgia early in the year, but also to EU member country Lithuania (adding to the earlier oil pipeline shutoff to Latvia); it blocked access for oil from Kazakhstan via Russian ports or pipelines to EU member countries; conclusively thwarted the Odessa-Brody oil transport project, which was an EU priority; it is attempting to kill the Nabucco gas transit project, also an EU priority; and is blocking the expansion of the Caspian Pipeline Consortium (CPC) line, threatening to transfer its section on Russian territory into Transneft’s control and imposing extortionate terms of transit on the ExxonMobil, Chevron, and other companies on that pipeline.

Thus, the idea of relying on Russia for transit under the Energy Charter Treaty and Protocol has been shown during 2006 to entail unacceptable risks. This idea is partly an excuse for not pursuing direct Western direct access by pipelines to the eastern Caspian basin. Moscow’s refusal to adopt the Treaty and Protocol is a blessing in disguise for the West and should re-focus attention on access to the Caspian basin.

Moscow actively cultivated that set of Western assumptions during most of 2006; but apparently felt strong enough to dispense with parts of that discourse in the latter part of the year, and to resort to overt bullying by the year’s end. The comfortable assumptions about Russia’s energy policy in 2006 should now come to the end of their 12-month lifespan.