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The Economist: Yukos revisited?: Russia must stop strong-arming foreign investors

Sep 21st 2006
From The Economist print edition

Russia must stop strong-arming foreign investors

IT IS natural to be miffed when a deal that seemed shrewd turns out worse than you thought. It is especially galling if it involves a prized asset. The civilised response—if the other party is disinclined to renegotiate—is to shrug and move on. But with the gigantic energy developments on Sakhalin Island, the Kremlin prefers to bully its partners into surrender.

Sakhalin and the seas around it host the two biggest foreign investments in Russia, which are also two of the world’s biggest energy projects. Led by Exxon Mobil and Royal Dutch Shell, the consortia signed “production-sharing agreements” (PSAs) with the Russian government in the 1990s to insure against unpredictable legal changes; another PSA applies to an Arctic development led by Total, of France. Sakhalin has other ominous peculiarities. The Shell consortium is building Russia’s first liquefied natural gas (LNG) plant, to serve markets in North America, South Korea and Japan. It is the only big energy scheme without a Russian partner. The projects are also the only exceptions to Gazprom’s gas-export monopoly—staunchly defended by both the state-controlled gas giant and the Kremlin against European efforts to break it up.
In other words, Sakhalin is potentially crucial in the Kremlin’s drive to recapture its geopolitical clout using energy wealth. Hardly surprising, then, that its state-controlled energy firms want pieces of the island action. Opportunities for foreign firms in energy—the “holy of holies” of the economy, as Vladimir Putin puts it—are now tightly circumscribed. Using Gazprom and Rosneft, a state-controlled oil firm, the Kremlin has recaptured its stewardship of the industry. PSAs were controversial even when they were signed, amid low oil prices and a scarcity of foreign capital and expertise; now that Russia is flush, to some officials they look downright humiliating. (An enormous cost overrun at Shell’s Sakhalin project, which will massively reduce the state’s share of the profits, has bolstered this conviction.) Other countries, Kremlin apologists point out, have redrafted energy deals as the oil price has risen.


But none of that makes Russia’s behaviour right. The Kremlin has opted for intimidation rather than negotiation. This week, the government revoked an environmental approval that may halt the Shell-led consortium’s work—to the ire of Japan, which has already bought much of the anticipated LNG; Japanese companies also own 45% of the enterprise. There are legitimate environmental gripes with the scheme; but the move seems more related to Gazprom’s efforts to barge its way in. Rosneft already has a minority stake in the Exxon consortium, but the Americans have also been the subject of threatening murmurs, as has Total. The Kremlin evidently believes the benefits of this strong-arming outweigh the risks. Global energy reserves being distributed as they are, foreign oil majors will surely take whatever terms Russia offers; anyway, some Russians believe, business always is a grubby affair.

The Kremlin should think again. For all its swagger, Russia still needs outside participation in its energy industry. With Russia looking to raise more than $20 billion from investors in listings in the next 18 months, other parts of the economy need foreign investment even more. Russia’s reputation is still recovering from the Kremlin’s last backdoor appropriation—the renationalisation of much of Yukos. To sustain that recovery, the Kremlin needs to be more civilised over Sakhalin. and its sister non-profit websites,,,,,, and are owned by John Donovan. There is also a Wikipedia feature.

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