by Tom Bower
Shell’s internal disputes were aggravated by the constant rotation of the executives responsible for the development. Frequently, after a manager at Sakhalin or in The Hague had mastered its complexities, he would be transferred to another post. The only certainty was the dramatic increase in the costs. The financial review undertaken in Moscow by Shell’s manager for Russia John Barry revealed the principal reasons. Steel prices were soaring, the ruble was appreciating in value, and labor costs had exceeded the estimates because Shell’s engineers often refused assignments to the frozen wasteland. Hired contractors, filling the gaps among the 18,000 workforce, showed limited loyalty. Completion was postponed from 2006 to 2008. Van der Veer expected the latest cost review to be completed in September 2005. Alexei Miller had been warned to expect a $3 billion increase, but the accountant collating all the studies called van der Veer on July 20 with unexpected news. “We’re going to be $10 billion over,” he said. “The final cost will be $20 billion.” The discovery of the $10 billion discrepancy, van der Veer knew, exposed fundamental weaknesses within Shell, but there was a more urgent crisis to resolve. “My goodness,” he said. “If this leaks, the Russians will be very angry.”
Legally, there was no immediate reason to disclose to Gazprom that the costs had doubled, but on the eve of the merger between Shell and Royal Dutch, the corporation was obliged to give any new information to the stock market. The Kremlin needed to be warned in advance. Van der Veer placed a call to Alexei Miller. Shell’s indispensability, he hoped, would persuade Gazprom’s chief executive to accept that his ignorance of this new development in London two weeks earlier had been genuine. Miller was on holiday, so a desperate van der Veer telephoned Ivan Solotov, the translator for the Russian department of energy. “Ivan, I’ve got a real problem,” he said. “Sakhalin’s costs have increased by 100 percent. It’s not $10 billion but $20 billion. Believe me, I knew nothing about it.” Solotov drew in his breath. “I believe you, Jeroen, but no one else will.” He passed the message on to Miller and Dmitri Medvedev. Both were furious. Shell, they were convinced, had deliberately cheated. Gazprom would need to earn another $10 billion by selling oil and natural gas before it received a share of the profits from Sakhalin.
Jeroen van der Veer’s offer to fly to Moscow to deliver a full explanation was consistently rejected. He would have to wait until Putin’s state visit to Holland on November 1. Surrounded by other Dutch businessmen, he met the president in the mayor of Amsterdam’s official home. Spotting van der Veer, Putin unleashed his anger about Shell’s untrustworthiness. Van der Veer’s attempts to reply were brushed aside. “I have to meet him separately and alone,” he begged a Dutch politician watching his humiliation. Before leaving the mayor’s house, Putin agreed. In a side room, without interpreters, the two men argued in German for 20 minutes. Van der Veer assumed that Putin understood the background. Shell’s technology, project management and marketing skills were far beyond Russian competence. The Russians working on the project had so far failed to master the skills to produce 3D seismic, horizontal drilling or LNG or to design rigs able to withstand earthquakes and tsunamis. Gazprom’s rawness was equaled by that of the officials at the ministry of natural resources in Moscow. Without Shell, Sakhalin would not be developed, and based on an oil price of $30 a barrel, Russia could expect to earn $80 billion over the project’s lifetime. “You will,” said van der Veer, restraining his emotion, “still get the same, good-quality house, but our initial budget was too low. We won’t do a lousy job, we’ll do the same good job, but it will just cost more.” Putin appeared amenable, but wanted to revise the deal. Negotiations, they agreed, would start in Moscow. Insensitive to the Russians’ instinctive suspicion of the West, van der Veer was convinced of Putin’s gratitude to Shell. The root of his mistake was self-inflicted.
In 1999, Shell had moved its Russian headquarters from Moscow to Sakhalin, isolating the company at the very moment that Putin was reasserting the Kremlin’s authority across the country. Reporting to The Hague via an Italian executive based in the regional office in Dubai, John Barry, Shell’s manager for Russia, was ordered to promote Shell by sponsoring the Bolshoi Ballet, building schools and community centers, and offering foreign trips to influential Russians. Public relations was not a substitute for cultivating relations with government officials and potential enemies, but his excuse was truthful: “In Nigeria I could always get to see the president. Here, I can never see Putin and not even Sechin. It’s impossible to get into that small clique.” Detached from Putin’s revolution, no one in The Hague understood the real background to Alexei Miller’s request to renegotiate the PSA agreement, or that Mikhail Khodorkovsky had persuaded Putin that PSAs were ruinous. In 2000 Putin had received a memorandum from the Russian finance and tax ministry outlining the disadvantages of the PSA agreement with Shell. “The contract should be annulled,” he was advised. Putin disagreed. Russia, he insisted, would always adhere to contracts. He added, “We’ll put Gazprom in and increase our income through Gazprom.”
The original orders from Phil Watts to Malcolm Brinded and Rein Tambeuzer, a Shell executive sent to Moscow, about their negotiations with Gazprom suggested that there was no hurry, even though Watts accepted that Shell would eventually hand over a stake to Gazprom. Assuming that to delay would be shrewd, van der Veer continued drawing out the discussions. After his meeting with Putin in Amsterdam in November 2005, he did not change his tactics, and the negotiations with Gazprom in Moscow were inconclusive. By May 2006 the lack of progress, first by John Barry and then by Chris Finlayson, his successor, was irritating Miller and Putin. The Dutch, Putin was told, were haggling. He decided that Shell should be embarrassed. Officials in the state’s agencies did not require specific instructions to understand the Kremlin’s requirements. No one, especially foreign corporations, could be in Russia for more than a few days without breaking the law. Survival depended on negotiating protection from prosecution with government officials. Until then, Shell had benefited from that understanding, but Putin’s edict removed the shield. “We’ll hit them first, then they’ll listen,” was the order. Shell’s cozy world was about to implode.
Ever since the tsarist era, the Kremlin had shown little concern for Russia’s environment. Siberia’s plains were polluted by oil spills, and the Aral Sea between Uzbekistan and Kazakhstan, formerly the world’s fourth-largest inland body of salt water, had been transformed by drainage for irrigation into a virtual desert. Like his predecessors, Putin had been silent on this subject until van der Veer’s bombshell and the excruciatingly drawn-out negotiations. Government lawyers, responding to Putin’s request for a lever against Shell, spotted that under the original PSA agreement signed with Governor Farkhutdinov, Shell was exempt from Russian taxes and the regulatory courts, but, by omission, was not immune to Russia’s environmental laws. No one in Shell or the Russian government had even thought about the issue. In the customary Russian manner, the Kremlin’s direction to low-level bureaucrats at the country’s environmental protection agency, part of the natural resources ministry, surfaced mysteriously, and was perversely negative: the agency was to cease turning a blind eye to Shell’s activities in Sakhalin. The official deputed to enforce the law was Oleg Mitvol, the agency’s deputy director, an intelligent 40-year-old electronics engineer, previously employed in space research, who had also studied law and accountancy.
In June 2006, Mitvol received an unexpected telephone call from Dmitri Kisitsin, representing Environmental Watch over Sakhalin, a Russian organization previously unknown to Mitvol. Kisitsin expressed his concern about the island’s fate. Until that moment, Mitvol’s office had been unaware of the activities of Shell or ExxonMobil 10,000 miles away, but soon afterward Mitvol received calls from Greenpeace and a Russian representative of the World Wildlife Fund. In unison, they complained that Shell, in constructing the 500-mile pipeline, had felled thousands of trees, causing soil erosion, and had used the wrong concrete. Worse, to save money the contra
ctors had not raised the pipeline over the 1,086 rivers, which was preventing the salmon spawning. The environmental groups also claimed that another pipeline to the offshore platforms was jeopardizing 126 rare gray whales breeding around the island. The death of a single breeding female whale, said the WWF spokesman, would be “catastrophic.” In normal circumstances, Mitvol’s negative response to these protests would not have surprised the environmentalists. For more than a decade their pleas to Russian officials to save the whales had been ignored, but now that changed, and Mitvol, echoing the Kremlin, expressed distress for the mammals’ plight. Very publicly, Shell began to receive a stream of criticisms of its conduct.
Ian Craig, Shell’s director in Sakhalin, had not anticipated the environmental problems. Nor had Malcolm Brinded. As part of Shell’s expensive public relations campaign in Russia, the corporation had published the pledge, “The biggest contribution to sustainable development will come from finding environmentally and socially responsible ways to meet the world’s future energy needs.” Quoting that pledge, Mitvol enjoyed his first contact with Craig. Shell, he said authoritatively, had failed to abide by Russian laws. By this time environmental groups were demonstrating in Moscow, and similar protests were mounted in New York and Zurich. Unusually, an environmental group, SEW, had appealed to a Russian court to order Shell to cease damaging the environment. In early July nearly 50 groups were “spontaneously” protesting against the impact of Shell’s operations on the whales and fishes, and even objecting to their harmful effects on the indigenous population. The emotional onslaught sparked doubts among officials at the European Bank of Reconstruction and Development (EBRD) about its provision of a $300 million loan to finance the development. Including the bank in the lending consortium had been a Dutch idea to give political stability to the project. Instead, the EBRD’s officials in London began an “environmental and anthropological impact assessment” to evaluate how Sakhalin’s development would affect the island and its inhabitants. Shell had merely wanted to borrow money from the bank, but instead found itself encumbered by social engineers promoting “international standards of good governance” and concerning themselves with “the environment and democratic norms.” Although Russian politicians had consistently ignored such matters, the Kremlin was now using them to harass Shell. Van der Veer and his subordinates were struggling in uncharted waters.
Oleg Mitvol was unaccustomed to the spotlight, but in his own words, he felt the hand of destiny urging him to fight for a noble cause. “We want international investment,” he puffed at the outset, “but we don’t want to be made into a banana republic.” Fearful that the Russian government might revoke the permit to develop Sakhalin, and that Mitvol was more than a Kremlin puppet, Shell’s directors had organized a steady stream of callers to his office. Among the first were Russians employed by the Sakhalin Energy Corporation, financed by Shell. “Shell is a friend of Russia,” was a phrase Mitvol heard frequently. Two British diplomats had called to question Mitvol’s relationship with the Kremlin. “I’m completely independent,” he replied. Shell’s directors arrived last. “You don’t realize,” Mitvol told them, “Russia has changed. This new generation of Russian bureaucrats is different.” They did not believe him.
The squeeze on Shell enhanced Vladimir Putin’s authority during his welcome of foreign political leaders to the Group of 8 (G8) summit in Saint Petersburg in July 2006. Rising oil and gas prices had inflated Russia’s importance. Dick Cheney was annoyed about his host’s newfound swagger. Putin’s mood, he observed, had changed during 2005. Russia was no longer just a volume player, but also a price player. Oil had transformed the country’s obsolescent agricultural and industrial economy. Now, with just 3 percent of the world’s population, it controlled 34 percent of the world’s gas and 13 percent of its oil. Cheney confirmed Putin’s belief that his strategy, outlined 10 years earlier in Saint Petersburg, had been successful. Russia, said Cheney accusingly, was using energy as “a tool of intimidation or blackmail,” and backsliding on democracy.
Scenario planners in Washington, considering the options for oil supplies and energy security, questioned a meeting between Mahmoud Ahmadinejad, the Iranian president, and the leaders of China, Russia and eight other central and south Asian nations to discuss “more effective ways of cooperating” in energy. On March 7, 2002, Richard Armitage, the deputy secretary of state, had warned, “We will not stand idly by and watch [Iran] pressure their neighbors.” That threat had proved to be empty. Now, four years later, Putin intended to exploit the Iranian crisis caused by America’s embargo. To prepare for his visit to Tehran for a Caspian summit in 2007, Lukoil and Gazprom were encouraged to offer Iran help against America. At the same time, he was pondering how to undermine the BTC pipeline running from Baku to Ceyhan. Caspian oil, Putin believed, should run through Russia. The new bellicosity emerging in Moscow, Cheney feared, projected through the “Shanghai Cooperation Organization” and the forthcoming Caspian summit, was uncomfortably reminiscent of Hugo Chávez’s threats to endanger Western oil supplies.
Determined that Russia should no longer be compared to Nigeria but to Kuwait, Putin had won applause by declaring during a meeting of Russia’s Security Council on December 22, 2005, that the Motherland was “back on top,” playing a key role in the world. Impervious to protests, he pledged that Russia would act solely in its own interests. Rising oil prices had reinforced the siloviki’s self-confidence. The Saint Petersburg crowd of former KGB and military officers including Igor Sechin, Dmitri Medvedev, the deputy prime minister and chairman of Gazprom, and Viktor Ivanov, formerly of the KGB and now chairman of Aeroflot, the country’s biggest airline, enjoyed reminding the oligarchs after Mikhail Khodorkovsky’s conviction in May 2005 that they had to obey Kremlin Inc. Reasserting control over Russia’s energy was an essential ingredient of Putin’s plan. Sechin had staged a phony auction of Yukos assets during 2005 and organized their transfer to Rosneft, the state-owned company he chaired, embracing 21 percent of Russia’s oil production. Negotiations were under way for Roman Abramovich to sell his stake in Sibneft to Gazprom on January 1, 2006, for an estimated $13 billion. Questions were later asked about whether Abramovich kept all of the money. Billions, some alleged, were earmarked for Putin and his close associates. Energy supplies, prices and profits had transformed Putin’s Saint Petersburg thesis into a crusade. The coercion emerged in Ukraine.
During November 2005, Gazprom announced price rises for natural gas delivered to Ukraine from $50 to $160 and then $230 per unit. The Ukrainian government refused to pay the increases, but continued to take gas from the pipeline crossing its territory from Russia to western Europe. On January 1, 2006, Gazprom turned off the taps. Within hours, in the midst of winter, the pressure fell by 30 percent. European countries were shocked, and their leaders used a G8 meeting about energy security, coincidentally held days later in Moscow, to persuade Putin to agree a compromise and supply Ukraine at $95 per unit. Supplies were restored, but Putin’s demands remained unequivocal. During a meeting with EU officials in the Black Sea resort of Sochi in May to negotiate a European Energy Charter, he demanded that in return for Western investment in Russia, Gazprom should be allowed to invest in western Europe. The EU’s negative reaction, described as “near hysterical” by the Kremlin, confirmed Putin’s suspicion of “totally unfair” discrimination, and he rejected the proposed charter. In retaliation for Europe’s “unprincipled competition,” expressed in its merely “considering” Gazprom’s request to invest, Putin directed the sale of Russia’s energy to Asia. Russia, he announced, was turning to the East. Sakhalin’s oil and natural gas would be part of the new prize for China. In Saint Petersburg, Cheney and the other leading G8 politicians were powerless spectators of Putin’s revenge.
In July 2005, Hu Jintao, the Chinese president, had visited Kazakhstan. For 200 years the Kazakhs had sought alliances with Russia as a defense against the Chinese. Despite that history, a 620-mile pipeline had been completed from
Kazakhstan to Alashankou in northwest China, and the Chinese now wanted to buy a stake in Kazakhstan’s oil reserves. The offer was rejected as a step too far. Hu Jintao’s next stop was Moscow. Despite disappointment over Putin’s cancellation of the 2003 agreement with Khodorkovsky, China had lent Rosneft $6 billion in February 2005 to buy Yukos’s Yuganskneftegas production unit, in return for which a million barrels of oil a day would be delivered to China through a new pipeline to be completed by 2008. Seeking more supplies, Hu Jintao arrived in Moscow just after Putin had returned from a trip to Japan accompanied by 100 Russian businessmen. In Tokyo, the Russian president had reaffirmed his commitment to build a 2,600-mile pipeline to the Sea of Japan costing $11.5 billion. “A new Russian gas region has started to emerge,” wrote Viktor Khristenko, Russia’s industry and energy minister. To balance that pledge, Putin told the visiting Chinese president that 2006 would be “the Year of Russia in China.” During his visit to China in March 2006 with 1,000 Russian business leaders, Putin witnessed the chairmen of Gazprom and CNPC sign a cooperation agreement to pipe natural gas from Kovytka. The ceremony was a charade. Putin lacked the necessary $14 billion to develop the Kovytka field (62 percent of which had been licensed to BP), or funds to finance the pipeline’s construction, but no one dared to call his bluff.