Is Russia Capping the Cooperation Well?

Gazprom's spurning of foreign partners for the Shtokman gas field heightens worries that the country favors a go-it-alone energy policy

When Russia took over chairmanship of the Group of Eight (G8) in January, energy cooperation was to be at the very top of the year's diplomatic agenda. Yet just 10 months later, after many high-sounding promises about an "energy partnership" between Russia and the West, the outcome has been a noticeable failure in terms of practical measures to strengthen East-West energy ties.

It has, in fact, been the opposite of a partnership. The fate of the Shtokman field, a large offshore gas project in the Barents Sea, symbolizes the failure of the much-trumpeted energy dialogue. On Oct. 9, Russia's Gazprom stunned Western investors when it announced that it would go it alone to develop the field.

The announcement follows years of negotiations with Western companies—among them Chevron (CVX) and ConocoPhillips (COP) from the U.S., Statoil (STO) and Norsk Hydro (NHY) from Norway, and France's Total (TOT)—which had been vying to own up to 49% of the project.

"It is very significant, because it changes the way we look at how Russia is developing its energy industry and its energy partnerships going forward," says Chris Weafer, chief strategist at Russia's Alfa-Bank. Now, he says, there are question marks about future foreign participation in other big Russian energy projects.


The latest upset comes against a backdrop of already deteriorating energy relations, which shows the very different priorities of Russia and its Western partners. And it comes just a few weeks after Russia withdrew a key environmental license for Sakhalin II, a large oil and gas project in the Pacific where Shell is the lead investor, sparking widespread concern about the deteriorating climate for Western investors in Russia's energy sector (see, 10/2/06, "A Gusher for Big Oil is Drying Up").

True, the significance of the Shtokman decision could easily be exaggerated. While it's tempting to conclude that Russia is barring Western investors from ownership of its energy reserves, counter-examples show that there is no blanket opposition. Conoco has been quietly expanding a partnership with Russia's Lukoil, increasing its shareholding, acquired in 2004, to 20% (see, 10/12/06, "Lukoil: It's Russian for "Fill 'Er Up"").

Gazprom, meanwhile, has been strengthening ties with the German energy companies BASF (BF) and E.on (EON). This year the two companies have invested alongside Gazprom in the Yuzhno-Russkoye field in northern Siberia, an extension of their joint venture to pipe Russian gas under the Baltic to Germany.


The two German companies agreed to swap assets with Gazprom—the model of cooperation Russia favors as the cornerstone of its energy partnership with the West. But the Shtokman case shows that it's a model fraught with difficulties. Western investors are acutely aware of the economic and political risks of investing in Russia, making them reluctant to trade assets of equivalent size.

"Foreigners still consider these [Russian] projects as risky," says Kaha Kiknavelidze, oil and gas analyst at UBS investment bank in Moscow. "They apply a larger discount to the valuation than what Gazprom would apply."

Nor is it clear how much Russia actually needs Western investment to develop its energy resources. With Russian energy companies now awash in cash, they are stepping up their own investments in new reserves. A crucial case in point was Gazprom's decision, announced on Oct. 6, to begin the development of gas fields on the Yamal peninsula, a region of northern Russia containing some 10.4 trillion cubic meters of reserves.


Gazprom has long been criticized for its failure to begin development of the region, not least by the International Energy Agency, a Paris-based organization which advises Western governments on energy supplies (see, 7/31/06, "Can Gazprom Keep the Gas On?"). The decision will go some way toward addressing European concerns about future Russian energy supplies.

When it comes to the U.S. market, though, plans to supply it with Russian energy are effectively dead in the water. Originally, Shtokman had been intended as the cornerstone of Russian-U.S. energy cooperation, with gas from the field to be shipped to the east coast of the U.S. in the form of liquefied natural gas (LNG).

But without U.S. partners, Gazprom will lack the expertise to make major inroads into the LNG market, and Russia has already made clear that it will pipe most of Shtokman's gas to Europe. This means the U.S. will remain dependent, as before, on supplies from the Middle East, and will have to look at alternative gas powers such as Qatar for LNG production.


Even Europe cannot yet rest easy. While the decision to start Yamal development is positive, there are still major concerns about Gazprom's ability to meet its ambitious schedules. Gazprom has promised to begin production in Yamal in 2011, but analysts expect it will be the middle of the next decade before the fields begin to produce significantly.

In the meantime, European concerns about the reliability of Russian energy supplies will probably continue. The Institute of Energy Policy, an independent think tank in Moscow, predicts a 100 billion cubic meter shortfall in gas supplies to Europe by 2010 because of Gazprom's slowness in developing new reserves.

Such fears explain why European governments continue to press Russia to ratify the Energy Charter, a treaty that would help Europe diversify its supplies by requiring Russia to provide use of its pipelines to Central Asian producers and independents. Meeting Russian President Vladimir Putin on Oct. 10, German Chancellor Angela Merkel added her voice to the calls for Russia to ratify the treaty—a sign that even Germany, traditionally Russia's closest ally in the energy sphere, is now putting on the pressure. Russia continues to resist the demands.

Russia brushes the European concerns aside, arguing that it has effectively supplied the continent with gas for 40 years. But coming after other recent upsets, the unexpected decision to exclude international participation in Shtokman will only add to fears about Russia's unpredictability. And if Russia can't deliver, then Europe, like the U.S., may be forced to look elsewhere to secure future energy supplies.

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