Russian Government Set to Renege on ExxonMobil Deal. Big Surprise

In the early-1990s Exxon (XOM) entered into a deal with the Russian government to develop the Sakhalin I project. As part of the deal, Exxon received an exemption from Gazprom’s legal monopoly on exports of gas from Russia. Now, in a shocking development (irony alert), it seems that the exemption is under threat:

The government will step up pressure on U.S. major Exxon Mobil to sell cheap gas from Sakhalin, analysts said Thursday, a day before construction begins on a new gas link to the Pacific. Prime Minister Vladimir Putin will travel to the far eastern city of Khabarovsk on Friday to inaugurate the start of the pipeline to the Pacific port of Vladivostok, which will ultimately liquefy gas from Sakhalin Island for export to Asia.

“I think Exxon Mobil knows that they will twist their arm. It is pure pressure,” said Mikhail Krutikhin, an analyst with RusEnergy.

. . . .

Valery Nesterov, analyst at Troika Dialog, said that despite a growing belief among investors that the government’s grip over resources is easing after deals with Total and Shell in recent months, foreign firms will often remain under pressure.

“Exxon does not have a free choice. Past experience shows that if [Moscow] has a strong desire, the foreign partner has to agree,” he said.

The Khabarovsk-Vladivostok pipeline will run 1,460 kilometers, and Nesterov estimates its cost at $2.9 billion to $4.4 billion.

Sakhalin is already connected to Khabarovsk with a gas link, which is supplying local consumers.

Krutikhin said that even if Exxon is forced to sell all its gas from Sakhalin-1 to Gazprom, volumes will not exceed 7 billion to 8 billion cubic meters per year, while Gazprom is eyeing a peak capacity of up to 47 bcm a year.

“So to fill the pipeline, you need to discover new fields or build a pipeline from Yakutia,” he said.

Bloomberg adds some details:

OAO Gazprom, Russia’s state-owned natural-gas exporter, started building a pipeline in the Pacific Ocean that may damage Exxon Mobil Corp.’s plans to export the fuel to China.

Workers welded the first joint on the initial 1,350 kilometers (840 miles) of the pipeline at a ceremony attended by Prime Minister Vladimir Putin and Gazprom Deputy Chief Executive Officer Alexander Ananenkov. The pipeline will link Sakhalin Island with the mainland city of Vladivostok.

“The development of gas transportation infrastructure in the east will let us diversify our exports,” Putin said today at the event in Khabarovsk, which is on the pipeline’s route. “But I would like to stress that the domestic market will be a priority for the Far East and eastern Siberia.”

I repeat: “The domestic market will be a priority for the Far East and eastern Siberia.” To translate: If XOM has a deal that allows them to export the gas, well, that’s just its tough luck.

So how will Putin bludgeon ExxonMobil into moving the gas to the domestic market–and likely at controlled domestic prices–rather than to a more lucrative export market?

With apologies to Elizabeth Barrett Browning: “How can I screw thee? Let me count the ways.”

There’s environmental laws (Sakhalin II); licensing (BP, various mining firms, and perhaps now MOL); taxes (Yukos, and myriad others); blowing stuff up (Turkmenistan); legal harassment of employees, including accusations of espionage (TNK-BP); legal fraud and theft (Heritage Capital); abusive lawsuits in pocket courts (Telenor). I could go on, but you get the picture. If they want it, they will take it. The only question is what they’ll pull out their bag of tricks.

So why does anyone invest there, let alone go back after getting bashed around before (Shell (RDS.A), most notably). When I gave a talk to some Foreign Service and Civil Service officers with energy-related responsibilities who visited Houston earlier this week, the analogy that came to mind was battered spouse syndrome. Hopefully Exxon will fight this hard, and won’t succumb to the same syndrome.

As I said in an earlier post, I expect that this will all be a prelim to big confrontations between China and Russia on energy. Note that the China angle plays into the Sakhalin I issue. Moreover, China is becoming increasingly aggressive, and successful, in areas that Russia considers its fiefdoms, notably Central Asia (especially Turkmenistan) and now Moldova, of all places. And finally, the big one: the Rosneft/Tatneft-China oil pipeline/loan deal. That one will turn very interesting once the pipeline is done, especially if oil prices are well above those at the time of the signing of the deal. And absent another world economic catastrophe, that’s almost a given.

Comments

[Clovis]

This is nearly impossible for a Westerner to understand but the idea that you must keep your word even if a deal goes sour for you, is strictly a Western concept. The Russians are East Europeans not West Europeans. The Russians have also very artfully developed a reputation for being "just crazy enough to pull the trigger (metaphorically speaking); a lesson every school boy learns on the playground. He learns who will fight and who won't and who you can bluff and who you can't. The US is that really big kid who doesn't dare push you our he will be branded a bully. Which, as any school boy will tell you, is why any little country can spit in our eye and then ask " What's the hold up on our foreign aid payment, the construction of my new palace is behind schedule."

"Gosh we're sorry." Signed, The American Tax Payer

2009 Aug 02 09:54 AM

[Ferdinand E. Banks]

Sort of makes you yearn for the good old days of communism, doesn't it. I gave a brilliant lecture at Cambridge once about Russian gas, and after my lecture a half dozen people in capitalist gear congradulated me on my talk and said that the soviets always honored their agreements. I guess that maybe the hustlers have taken over in that country just as they have in a lot of other places, and so we will just have to get used to these imbroglios.

2009 Aug 02 10:32 AM

[Jimbo]

I understand the dilemma large and small oil companies in the West face when trying to deal with territories (not real stable political systems) run by essentially gangsters. There are very few parts of the world where agreements are kept, but better to operate there rather than be robbed.

2009 Aug 02 11:07 AM

[jerrydd]

Why deal with them at all? If everyone stopped they would diee off soon enough.

What we need to do is become energy independent, not a technical problem but a political one or we'll become a 3rd world country soon.

Best way is to put an oil, coal tax on them to make them pay their real, full costs or we will give all our treasure to Iran, Russia, oil dictators and terrorists.

Vs a tax cut with the above paying most of it in lower oil prices, balance of payments costs, 35% drop in military costs and millions of new energy jobs. Your choice.

2009 Aug 02 11:39 AM

[Nyetnichevo]

If you do business in Russia, prepare for snake bites. They won't play fair no matter what promises they make, they lure you in with illusory dreams then once you get hooked you're cooked.

2009 Aug 02 11:41 AM

[unclej0]

That's a very human trait. It is likely to crop up in almost any setting in which you deal with an entity that's "too big to fail' or big enough to buy the Congress.

Does that concept ring a bell?

2009 Aug 02 12:22 PM

[Gtarras]

Craig
without knowing all of the details of the Russia-Exxon relationship, I, personally, will stay away from any conclusions. These are huge political issues we are talking about here, with big bucks involved. the project parties are engaged in a huge PR campaigns and whatever news hits the public is probably bull. little people like me are always misinformed.

2009 Aug 02 12:50 PM

[Gtarras]

if you dont know that yet, the US does not buy any oil from Russia (well, maybe 1-2%). It buys some natural gas, maybe in the teens % points of all nat gas supply.


On Aug 02 11:39 AM jerrydd wrote:

>
> Why deal with them at all? If everyone stopped they would diee off
> soon enough.
>
> What we need to do is become energy independent, not a technical
> problem but a political one or we'll become a 3rd world country soon.
>
>
> Best way is to put an oil, coal tax on them to make them pay their
> real, full costs or we will give all our treasure to Iran, Russia,
> oil dictators and terrorists.
>
> Vs a tax cut with the above paying most of it in lower oil prices,
> balance of payments costs, 35% drop in military costs and millions
> of new energy jobs. Your choice.

2009 Aug 02 12:52 PM

[notsosmart]

if you deal with dictatorships thats what you get.its your money & if you choose to invest in the "moving goal posts" of these govts dont whine when you loose.what is it that folks cant learn from history?how many times has russia defaulted?have they ever paid their ww2 debt to this country? its tough enough to get some transparency here in our backyard why risk with these folks?

2009 Aug 02 01:37 PM

[Clovis]

Ferdinand,
When the government fails, the bureaus take charge of your life and to get anything you need to hustle, pribe, or con somebody. It gets to be a way of life. I feel sorry for the Russians. Try doing business in Asia and tell me what you think. We keep harkening back to the Knights of the Round Table and a set of values that make no sense to the Chinese. I had a Chinese partner who told me that if a Chinese executive let his company suffer a lose by living up to a bad contract they would think he was utterly incompetent. It isn't bad, it is just different.
Ron

PS What is your take on investing in natural gas in the US?


On Aug 02 10:32 AM Ferdinand E. Banks wrote:

> Sort of makes you yearn for the good old days of communism, doesn't
> it. I gave a brilliant lecture at Cambridge once about Russian gas,
> and after my lecture a half dozen people in capitalist gear congradulated
> me on my talk and said that the soviets always honored their agreements.
> I guess that maybe the hustlers have taken over in that country just
> as they have in a lot of other places, and so we will just have to
> get used to these imbroglios.

2009 Aug 02 03:29 PM

[fxmaven]

This reflects badly on Exxon Mobil. Like Khodorovsky, they believed that their political connections with the US would protect them. Well news flash, US cannot protect anyone anymore due to their lack of resources, massive external deficit, and lack of political capital. No one can protect you when you are in Russia, especially when you are in Sakhalin. I am fortunate enough to get out of Sakhalin after two years on that "Katarga" or "Penal Colony". Neither Shell nor Exxon seems to have had the same luck.

2009 Aug 02 09:45 PM

[cmonbulls]

The Russians paid thier WWII debt with 28 million lives!


On Aug 02 01:37 PM notsosmart wrote:

> if you deal with dictatorships thats what you get.its your money
> & if you choose to invest in the "moving goal posts" of these
> govts dont whine when you loose.what is it that folks cant learn
> from history?how many times has russia defaulted?have they ever paid
> their ww2 debt to this country? its tough enough to get some transparency
> here in our backyard why risk with these folks?

2009 Aug 03 04:31 AM

[lohwengk]

The concept of keeping your word exists even in the East. Unfortunately, there is also an opposing concept which exists in both East and West: you are not guilty if you don't get caught, i.e. you can break your word and stab your partner in the back as long as you can keep anyone else from knowing about it (or believing the stories).


On Aug 02 09:54 AM Clovis wrote:

> This is nearly impossible for a Westerner to understand but the idea
> that you must keep your word even if a deal goes sour for you, is
> strictly a Western concept. The Russians are East Europeans not West
> Europeans. The Russians have also very artfully developed a reputation
> for being "just crazy enough to pull the trigger (metaphorically
> speaking); a lesson every school boy learns on the playground. He
> learns who will fight and who won't and who you can bluff and who
> you can't. The US is that really big kid who doesn't dare push you
> our he will be branded a bully. Which, as any school boy will tell
> you, is why any little country can spit in our eye and then ask "
> What's the hold up on our foreign aid payment, the construction of
> my new palace is behind schedule."
>
> "Gosh we're sorry." Signed, The American Tax Payer

2009 Aug 03 06:45 AM

[A Barrel Full]

Which they did completely altruistically no doubt.

28 Million Russian may have died in WWII, but only because Uncle Joe put zero value on their lives. Don't forget that in return he got a much expanded empire paid for with their blood.


On Aug 03 04:31 AM cmonbulls wrote:

> The Russians paid thier WWII debt with 28 million lives!

2009 Aug 03 09:04 AM

[A Barrel Full]

No it isn't different its bad. I am sure that the vast network of overseas Chinese didn't base their very successful trading on such poor ethics.

Capitalism depends on trust, and santity on contract. Without it we are all much poorer. Hernando De Soto has written extensively about how the inabaility of the world's poor to enforce contract rights has blocked them from becoming richer.

www.cato.org/special/f...


On Aug 02 03:29 PM Clovis wrote:

Try doing business in Asia and tell me what you think. I had a Chinese partner who told me that if a Chinese executive let his company suffer a lose by living up to a bad contract they would think he was utterly incompetent. It isn't bad, it is just different.
Ron

2009 Aug 03 09:09 AM

[WayneS]

During the last political campaign, we heard many promise to nationalize American oil, most notably Pelosi.


On Aug 02 01:37 PM notsosmart wrote:

> if you deal with dictatorships thats what you get.its your money
> & if you choose to invest in the "moving goal posts" of these
> govts dont whine when you loose.what is it that folks cant learn
> from history?how many times has russia defaulted?have they ever paid
> their ww2 debt to this country? its tough enough to get some transparency
> here in our backyard why risk with these folks?

2009 Aug 03 07:05 PM