Oil and Gas in the Capitals

 Vol. 233 No. 10

Russia’s oil and gas sector is now on the verge of a major reshaping, something with ample, possible political consequences. Factors contributing to this situation are now converging, both from inside and outside the country.

Europe’s problems alter Russia’s direction. The European situation is affecting Russia’s hydrocarbon industry. Oil and gas exports are likely to stagnate or even decline in the next year and perhaps into 2014, as the European economy enters a long recession. This is, of course, the result of the Euro crisis. In 2010, we saw Greece, Ireland and Portugal hit by this crisis. In 2011, it was the turn of Spain and Italy. By 2012, even France has been forced into harsh austerity measures. As a result, economic growth went negative and will remain that way through 2012. It is even possible that this recession could degenerate into a full-fledged depression, as the cumulative effects of austerity in a large number of important economies add their weight.

But if Europe is in bad shape, the same can be said of other “big” world economies, like China, India and even the United States. The world crisis is back, with a vengeance. Economic forecasts are bleak for the next two years, a kind of worst-case scenario for Russian authorities. But the story doesn’t end here.

The development of shale oil and gas, along with important progress in exploration, has completely changed the energy market. The ghost of scarcity has receded, even if these new reserves are more costly in the long run than fields exploited in the 1960s and 1970s. One direct consequence of this new situation has been to put a premium on market efficiency. As this is not particularly a strong point for some Russian companies, it is also a major problem. On top of that, Arctic development, mostly on the shelf, has been postponed. This is causing a significant regional development problem for Russia, as authorities were largely expecting such projects to boost the economy of northern regions.

Changes within Russia’s energy structure. These constraints are pretty important. What can be seen right now is their timely accumulation with important changes inside Russia. First, direct competition to Gazprom is increasing in volume and speed, mostly because independent companies (like Novatek) are proving that they can be profitable, even under harsher rules than the state monopoly. Gazprom’s corporate governance model is, to say the least, effective but not efficient. This is not necessarily bad news for the government, which now has ample reasons to put the pressure on Gazprom.

Second, Rosneft could become, in the near term, a powerful competitor to Gazprom. This is not just because there are large, unused, associated gas resources, but also because Rosneft will benefit from its alliance with Exxon Mobil and become the leading partner in developing Russian shale gas and oil. Here again, this will increase considerably the incentives for revamping Gazprom’s corporate governance model.

In this extremely fluid situation, the Russian government faces two different problems. The first one is the hydrocarbon sector’s efficiency. If world prices drop significantly in the next six to 12 months, as is expected, the efficiency issue will become critical. Long overdue reforms should be implemented fast and decisively. But, this would probably alter the subtle political equilibrium between Russian oligarchs and the administration, as well as inside the administration. Since Gazprom will certainly not be dismantled in the foreseeable future, a reduction of its dominance in the Russian hydrocarbon sector will have important political consequences.

The second problem is linked to the Eurozone crisis. If Europe actually enters a protracted recession, something comparable to Japan’s lost decade, Russia must diversify its exports. President Vladimir Putin has explicitly described China and the Far East as a strategic zone for Russian exports in years to come. This would imply massive investments, either in constructing oil and gas pipelines, or in the building of liquefaction plants, and probably both. But where will Russian authorities find the money for this? They could tap the reserve fund, or they could allow some foreign partners to enter their internal market. It is highly probable that they will do both.

Sechin’s ascendancy. The end result of all these new developments, constraints and change, is to prompt a very strong push for reform. But this will be a Russian reform, where changes in political alliances are as important as other aspects, and probably more than most. One man who may emerge as a possible victor in this struggle is Victor Sechin, chairman of Rosneft, chief of a new Russian energy commission, and a close confidant of Putin. Average Russians on the street refer to him as “Darth Vader.”

To a large extent, Sechin has outmaneuvered Gazprom’s leadership, which has been pretty static on governance issues, letting corruption develop fast while badly managing foreign alliances. In contrast, Rosneft’s change of alliance from BP to ExxonMobil, closely supervised by Sechin, himself, has been a brilliant move, but one which has not completely unfolded. We have to see the extent of technology transfers and training, which are still important parts of this agreement.

Sechin will probably avoid making moves publicly. But the position of the Dmitry Medvedev-Alexey Miller duo in Gazprom is now clearly endangered, both from the inside and from the outside, by the fast-growing competition. The two large state companies will still be the centers of Russia’s hydrocarbon sector in the future, but the pendulum right now is swinging more and more in Rosneft’s favor. This is an important change, one that has serious consequences for Russian politics.