October 27, 2006 (the date of publication in Russian)

Sergey Pravosudov

DECOLONIZING RUSSIA’S SUBSOIL

The Ministry of Natural Resources wants to instill order in the PSA system

PROTECTING THE ENVIRONMENT

Lately the Ministry of Natural Resources of the Russian Federation has positioned itself as a key element of the government ladder. Aided by the Office of the Prosecutor General it withdrew its order №600 from 07.15.2003 "On the State Environmental Review Office Ratification of the Expert Report on the Technical and Economic Basis of the Piltun-Astokh and Lunskoye Licensed Areas Development (stage II of the "Sakhalin-2" project)".

The reason for this step is "non-compliance with the recommendations given by the State Environmental Expert Review (SEER) and multiple deviations from the project’s guidelines". Namely, according to the MNR statement, "erosion-preventive measures were not adapted to the local conditions; also soil-protective structures were not erected". The Ministry drew attention to the Molikpaq platform oil dumping, which is a violation of the Water Use License of the Russian Federation.

The head of the MNR Yuri Trutnev has voiced concerns regarding not only environmental problems. "We are concerned with the operator’s intentions to add additional financing to the cost of the project estimate and to put off the dividing of produced resources. We can’t ignore this because Russia will lose 10 billion dollars if these plans are carried out. The terms of the PSA (Production Sharing Agreement) are to be complied with by both sides, and the Russian Federation simply must protect its interests. This situation does not mirror a worsening of the investment climate in Russia in any way".

President Vladimir Putin supported the Minister’s position: "Our partners want to double their costs. What does this mean for Russia? According to the production sharing agreements we are not going to receive income before all the expenses are recovered. We are not receiving anything now, despite the fact that oil has been produced for several years now, and if they increase their expenses we are not going to receive anything for the next ten years. Look at the additional expenses. The legal costs have almost doubled, expenses for foreign personnel have slightly more than doubled, and the same applies to expenses for business trips. According to the agreements Russian labour, materials and equipment would make up 70 percent the total. Today the figure is not even at 50 percent."

If this conflict isn’t resolved in the near future Sakhalin Energy may not be able to fulfill several LNG contracts that have already been signed. The clients may demand reimbursement, which will be a heavy burden indeed for their project. At the same time Yuri Shuvalov, an Assistant to the President of the Russian Federation, suggested foreign companies reject PSA and start paying taxes within the overall Russian tax system.

Four months ago MNR published a statement containing harsh criticism of the PSA system and a proposal to transfer the controlling packet of shares of "Sakhalin-1", "Sakhalin-2" and "Kharyaga" into the hands of Russian companies. It came as a surprise for foreign investors, since the PSA has been monitored by the Ministry of Industry and Energy of the Russian Federation rather than the Ministry of Natural Resources. It is obvious that Yuri Trutnev intends to take charge of the program from under control of Viktor Khristenko and he might just succeed…

 

TEN TO NINETY

The idea for a PSA program in oil drilling appeared in the USSR in the 1960s. The Politburo became concerned with the lack of up to date technologies in the development of offshore oil and gas resources, and the decision was made to invite foreign companies already in possession of necessary techniques to obtain them. Sakhalin was chosen to be the experimental ground. Even though Sakhalin is not very far from the US, the administration opposed the sharing of technological knowledge with the Soviet state. Therefore despite the genuine interest of American oil and gas companies negotiations proceeded very slowly and without any hurry on our side. We still had enough land resources very far from exhaustion.

The 1990s saw much more active exploration of this idea. The USSR fell apart, and the new Russian government was eager to please Western countries and especially the United States. In 1993 Boris Yeltsin signed a decree allowing foreign companies to participate in the development of Russian oil and gas fields in accordance with the PSA. In 1995 three agreements were signed: "Sakhalin-1", "Sakhalin-2" and "Kharyaga". Exxon became the lead operator of the first project, Shell – of the second, and Total Fina Elf – of the third. On behalf of Russia these agreements were signed by the Deputy Minister of Fuel and Energy Valeriy Garipov. Today everyone admits that these deals were designed to satisfy western companies at the expense of Russian interests. PSA projects in Russia are not very different from the agreement signed by countries with their colonies in the past.

In the world’s leading oil-producing countries foreign companies are not allowed to drill for oil, the entire extraction process is controlled and carried out by government-owned companies. Where international corporations are granted licenses to drill, they have to comply with very strict regulations. For example, in Peru from every barrel of oil extracted by the foreign company 81% goes to the government of this country.

In contrast to this, in Russia the investor gets 90% of the extracted oil. And the government may not even see a penny of its share because the investor has to cover all production costs first, hence the companies’ attempts to make these costs to appear as high as possible. Exxon included the salary of several hundreds of its Houston employees in the estimate for the "Sakhalin-1" project. The"Kharyaga" agreement allows used equipment to be imported from abroad and included in the estimate at 50% of the price of the new equipment. And so for several year scrap metal was brought into the country at the expense of the Russian government. Foreign "investors" also tend to overestimate their spendings. At Kharyaga the prime cost for drilling an oil well is from 3 to 4 times higher than given by the Russian companies.

It should be noted that politicians responsible for the initial PSA are not in power any more. Valeriy Garipov was forced to resign from the government office after Vladimir Putin became a president. Garipov hoped that Shell would provide him with a secure position (in gratitude for the PSA-related favours). However this didn’t happen and he now sells oil and gas assets under Yuri Shafralik. In 2003 campaign to the State Duma Russian Democratic Party "Yabloko" tried to convince voters that it had been doing something to change the situation in Russia. Sergei Ivanenko used the Sakhalin PSA as an example of a beneficial undertaking, "as a result of which millions of dollars were invested in the Russian economy and life of the people of Sakhalin became much better". As you recall, voters didn’t buy this and "Yabloko" didn’t make it to the parliament.

 

SO WHAT DO WE DO NOW?

Russia can’t just simply withdraw from the PSA deals since this might tarnish our international reputation. Therefore, the MNR has started accusing foreign companies of violating points of the PSA. According to Yuri Trutnev there are major differences between the way the Kharyaga oil field is really being developed by Total Holding and the guidelines in the PSA agreement – regarding the construction of the network of oil wells, allowable amount of production, utilization of associated gas, attaining project rate of oil extraction etc. "We demand that all companies follow the same set of rules. The aforementioned "discrepancies" are serious and must be resolved", - the Minister noted.

The Sakhalin-1project fared somewhat better. The Ministry of Natural Resources merely refused to allow new territories to be developed, hoping to stimulate competition for these areas between several companies. This relative "kindness" is probably the result or the fact that 20% of the PSA belong to the Rosneft, a state owned company.

It’s obvious, foreign investors are being told that the times when Russia agreed to give without receiving much in return are over. As President Vladimir Putin said, Russia wants to know what it’ll get in exchange for its oil and gas "sweet". The rules regarding the development of oil and gas reserves will be brought up to date in the nearest future. A new "Law on Subsoil " regarding the procedures for oil and gas fields development will be passed soon. The conditions under which foreign companies will be allowed to work in Russia will be outlined. Yuri Trutnev has already stated that all reserves containing over 50 billion cubic metres of natural gas will be classified as strategic. This means foreign companies will not be able to develop gas fields on their own and will have to collaborate with Russian companies on such projects. It seems unlikely that investors would be interested in the development of smaller-sized fields, which can only cover the demands of a small town.

 

FOR A CLEANER CASPIAN

The MNR is attempting to influence not only the domestic affairs, but international ones as well. Just before the G-8 Summit began in St. Petersburg a demonstration against pollution of the Caspian Sea by American oil tankers was organized before the US Embassy in Moscow. The protest was coordinated by several ecological organizations and movements. However, it was the MNR that published reports on the course of the demonstration. What’s more, Оleg Mitvol, one of the heads of the MNR, also took part in the demonstration. He said that "all of the dirt, all of the oil stains and waste products are washed towards Russia’s coastline (Astrakhan Oblast and the Republics of Dagestan and Kalmykia)" because this sector is one of the shallowest in the Caspian Sea. Ecologists are especially concerned with the ever increasing amounts of oil transported by neighboring countries via the Caspian Sea, as many tankers lack international safety certificates, protection grades and plans for clean-up in the event of a spill.

That same day (July 13^th) in Ceyhan, Turkey festivities commemorating the beginning of operation of the Baku-Tbilisi-Ceyhan pipeline took place. Ahmet Necdet Sezer, İlham Aliyev and Mikheil Saakashvili (the Presidents of Turkey, Azerbaijan and Georgia, respectively) all took part in the celebration. Obviously, these two events are not unrelated.

You see, of oil tankers transport large quantities of oil from Kazakhstan to Azerbaijan into the Baku-Tbilisi-Ceyhan pipeline the Caspian Sea will become more and more polluted. Azerbaijan just doesn’t have the natural resources to fill this pipeline to capacity. Hence, the US has been trying to negotiate a deal with Kazakh President Nursultan Nazarbaev. Dick Cheney visited this republic earlier this year. In mid-June Kazakhstan signed a deal with Azerbaijan to join the Baku-Tbilisi-Ceyhan project, in accordance with which 3 million tons of Kazakh oil will be delivered to Baku by the end of 2006 and up to 25 million tons annually for the next several years. This is what protesters at the meeting in Moscow were really fighting against. Russia has repeatedly encouraged Kazakhstan and Azerbaijan to export oil via its territory, and to solve the problem of the Black Sea straits by building the Burgas-Alexandroupoli pipeline.

 

DE-FACTO AND DE-JURE

Taking away control over the development of natural resources (especially oil and gas) from governors has been actively discussed in political circles close to the MNR. The governors, in turn, are trying by every means possible to retain this privilege (Yuri Trutnev himself conducted such a policy when he was head of the Perm Oblast). De-jure governors can still decide whether or not to license projects, but de-facto this is controlled by the MNR. The newest edition of the "Law on Sub Soil" grants this right solely to the MNR.

The Minister of Natural Resources recently pointed out that many companies have oil wells that are currently not being used to produce oil, which leads to an overall decrease in production. According to MNR data 30% of the inactive wells belong to TNK-BP and 20% to Yukos.

The MNR expressed its negative attitude to TNK-BP by refusing to reconsider the parameters of the Kovykta gas condensate field in the Irkutsk Oblast. Yuri Trutnev repeatedly said that the deal for Kovykta might be taken back completely. The MNR has also taken a firm stand regarding the development of the Yurubchenko-Tokhomsk zone in Evenkia (belongs to Yukos). It’s possible that the license agreement will be terminated and this zone will be handed over for someone else to develop.

In this context, the fact that Central Commission on Exploitation of Hydrocarbon Deposits was handed over from the Ministry of Industry and Energy to the Ministry of Natural Resources makes sense. This little-known structure validated all of the parameters of oil production at various sites in Russia. Hence government pressure on negligent developers of natural resources will become more effective and coordinated. Companies won’t be able to use to their advantage the contradictions between the MNR and MIE any more.

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