Russia: So Much For The Oil Giants' Next Frontier

For global oil companies desperate to replace their dwindling reserves, Russia is increasingly tipped as the next frontier. By some estimates, the country may be sitting on at least 200 billion barrels of the stuff, not to mention the world's largest reserves of natural gas. Russian oil is cheap to boot. Acquisition costs are around $1.30 per barrel based on prices paid in recent deals, such as ConocoPhillips' (COP ) purchase of a stake in Lukoil (LUKOY ) in September, compared with $4.90 per barrel in the U.S., estimates Moscow investment bank Troika Dialog. So what's the catch? Unless you happen to be Russian -- or partnered with a Russian company -- many of the country's most valuable resources aren't for sale.

That, at least, was the gist of a recent announcement by Russia's Natural Resources Minister, Yuri Trutnev. On Feb. 10 he sparked worldwide consternation by declaring that only companies that are 51% Russian-owned will be allowed to bid for licenses in six major natural-resource projects this year. Among them are the massive Sakhalin-3 oil and gas field off Russia's Pacific coast, and Sukhoi Log, Russia's largest gold deposit. Trutnev said the ban would likely be included in legislation to update Russia's law on natural resources, which is due to be approved this year. Existing projects will not be affected by the new rules.

The changes could scupper or delay plans by some Western oil companies to make big new investments in Russia. From now on, in any large project that the government decides is "strategic," foreigners will only be allowed to invest as minority shareholders in a consortium alongside a Russian partner. "It could change the opportunities for some of the bigger companies, which will ask if they want to invest billions in a project [that] they're not going to control," says Stephen O'Sullivan, co-head of research at Moscow investment bank United Financial Group.

The restrictions are a setback for BP PLC (BP ). In 2003, BP put up $7.5 billion for a 50% stake in a joint venture with Russia's TNK. The requirement that bidders be at least 51% Russian-owned would exclude the venture, TNK-BP, from bidding for licenses in strategic areas unless it ceded at least another percentage point to its current Russian partners or teamed up with another local outfit. American oil giants Exxon Mobil Corp. (XOM ) and ChevronTexaco Corp. (CVX ) also had been mulling large new investments in Russia. Exxon, for one, may not be deterred by the new rules. "We take a long-term view. We're still interested in Russia," says spokesman Bob Davis.

More barriers to foreign investment may fit in with a trend toward growing state involvement in Russia's oil industry. If foreign investors are excluded from bidding on new fields, it will benefit Russia's two state-controlled energy companies, gas giant Gazprom and oil producer Rosneft.

Russia is playing a high-stakes game. Without outside capital, the country will likely be unable to develop new projects in the Arctic, the Far East, and offshore Sakhalin. Foreign participation is critical if Russia is to keep up its impressive oil-production growth, which has already started to slow as Russian companies cut capital spending because of higher taxes, fears related to the government attack on oil company Yukos, and export bottlenecks.

Perhaps the majors will swallow their protests and follow the rules to get their hands on that precious oil. But if they stay away, Russia's oil dreams will quickly fade.

By Jason Bush in Moscow with Wendy Zellner in Dallas

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