Neither the government nor the emerging Russian business and political classes saw any reason to give up control over any substantial resources to Western companies. They may not have agreed among themselves as to who would ultimately own those resources and control the wealth so generated, but the one thing on which they could all agree was that it should not be the foreigners.
The major Western companies could not operate on any scale (with one major exception) in the core; that is, the traditional areas of current large production, the “brown fields” of West Siberia. Rather it was in those the areas where there was little development and major technical challenges to be overcome and where the Western companies thus had competitive advantage in terms of technology and execution of complex projects.
THE PERIPHERIES
In partnership with Lukoil, Conoco took on a project in the northern Arctic region. Conoco brought the know-how to Russia it had learned from Alaska, where new technologies had been developed in order to minimize the footprint in Arctic regions. Even so, the Polar Lights project was constantly bedeviled by an endless profusion of new tax charges and new regulations. The local regional boss, a former snowmobile mechanic, was known to demand a payment every time a new permit came up. Finally, Conoco had to tell Moscow that it was going to pull out altogether if the “extra-contractual” demands did not cease.14
Both Exxon and Shell went to Sakhalin, the six-hundred-mile-long island off the coast of Russia’s far east, north of Japan, where there was some minor onshore production. While the technical challenges were immense there, so was the apparent potential, especially offshore. Though the region was almost totally devoid of the infrastructure that the planned megaprojects would need, it had other important advantages. Sakhalin was as far from Moscow as one could get and still be in Russia. It was also on the open sea, so that output could be exported directly to world markets.
Exxon became the operator for a project that also included the Russian state company Rosneft, Japanese companies, and India’s national oil company. Within ExxonMobil, some considered this the most complex project that the company had ever undertaken up to that time—working in a remote, undeveloped subarctic area, where icebergs are a chronic problem, winds are hurricane strength for several months a year, and temperatures can drop to −40° or even lower. The conditions were so difficult, in fact, that work could only be done for five months a year. In the middle of development, as new complexities emerged, the engineers concluded that they needed to go back and redesign the whole project. The project, initially scoped out in the early 1990s, took a decade before it produced “first oil” and a decade and a half before it reached full production—all this at a cost approaching $7 billion.15
Shell’s Sakhalin-2 also began in the early 1990s with the same environmental challenges. It would prove to be the largest combined oil and gas project in the world, not just a megaproject, but equivalent to five world-class megaprojects in scale and complexity. Shell faced the additional challenges of building two five-hundred-mile pipelines—one oil and one gas—that had to cross more than a thousand rivers and streams, through terrain frozen in the winter and soggy in the summer. To get the oil and gas to export facilities ended up costing more than $20 billion.
IN THE HEARTLAND
Only one Western company managed to gain a significant position in the heartland, West Siberia. Sidanco was a second-tier Russian major that had been bought by a group of oligarchs in one of the loans-for-shares deals in 1995. It had one jewel: partial ownership (along with TNK) of Samotlor, the largest oil field in West Siberia. BP bought ten percent of Sidanco for $571 million in 1997. Some members of BP’s board thought it was a harebrained scheme; it was hard to make the case that Russia was a country with rule of law. But BP chief executive John Browne argued it was the only obvious way to get into West Siberia, and Russia was central to BP’s overall global strategy. Nonetheless, he added, “we should consider it an outright gamble. We could lose it all.” 16
It soon appeared that Browne’s caveat was even more warranted than he might have anticipated. For strange things began to happen. Under the guise of a newly approved Russian bankruptcy law, subsidiaries of Sidanco kept disappearing in a series of bankruptcy proceedings in various out-of-the-way Siberian courts. It became apparent that these were manufactured bankruptcies. The “creditors” were proving very adept at taking advantage of provisions in Russia’s new bankruptcy law to take ownership of the subsidiaries. It looked as though Sidanco might end up a shell, and BP with little or nothing to show for its $571 million.
In due course it emerged that what was going on was a struggle between two groups of oligarchs who had jointly participated in the original loans-for-shares acquisition of Sidanco and then had a bitter falling-out. The AAR group believed that its partner, Interros, had tricked it into selling out at a greatly discounted price prior the BP deal. And now AAR wanted back in. BP was really a bystander, but its prospects for protecting its position in Russia did not look at all good. Outside Russia was a different matter. AAR also owned TNK. At this point, TNK had very few financial resources of its own but needed considerable investment to maintain and develop its share of Samotlor. So it was turning to Western credit markets to finance its activities. But then Western credit lines, on which TNK depended, were one after another shutting down. TNK could certainly prevail within Russia, but BP held high cards and influence outside Russia. That was sufficient to force the parties to the negotiating table: the dissident oligarchs and their company TNK gained a major share of Sidanco. Yet BP had preserved its role as the only Western company to have found away into a significant position in the heartland of Russian oil—in West Siberia.
By this time, politics in Russia had changed, and so had the position of the Russian government.
“A GREAT ECONOMIC POWER”
With the end of the Cold War, Vladimir Putin, who had been a KGB officer stationed in Dresden in East Germany, returned to his home town of St. Petersburg and joined the city government. When the reformist mayor for whom he worked as a deputy mayor was defeated, Putin was without a job. Then his country house burned down. He enrolled to do a doctorate in the St. Petersburg Mining Institute. His studies there would help shape his view of Russia’s future.
In 1999, Putin published an article in the institute’s journal on “Mineral Natural Resources” that argued that Russia’s oil and gas resources were key to economic recovery and to the “entry of Russia into the world economy” and for making Russia “a great economic power.” Given their central strategic importance, these resources had to be, ultimately, under the aegis, if not direct control, of the state.
By the time the article was in print, Putin himself was already in Moscow, rapidly ascending in a series of jobs—including head of the FSB, successor to the KGB, and then prime minister. On the last day of December 1999 Boris Yeltsin abruptly resigned and Vladimir Putin, without a job just three years earlier, became Russia’s acting president.
In July 2000, two months after his official election, Putin met in the Kremlin with some of the rich and powerful businessmen known by then as oligarchs. He very clearly laid down the new ground rules. They could retain their assets, but they were not to cross the line to try to become kingmakers or in other ways control political outcomes. Two of the oligarchs who did not listen closely were soon in exile.
TNK-BP “50/50”
Once its deal with TNK had been concluded, BP began looking at the possibility of a merger of interests. Given their recent struggle over Sidanco, there was wariness on both sides. After intense negotiations, the two groups agreed to combine their oil assets in Russia with 50/50 ownership of the new firm, TNK-BP. BP wanted 51 percent, but this was never going to be possible. As John Browne later said, “We could not have it.” On the other hand, it could not go ahead in a minority position of 49 percent. The result was equal ownership. President Putin gave his approval, though with a word of advice. “It’s up to you,” he said to Bro
wne. But he added, “An equal split never works.” The deal went forward. At a ceremony in Lancaster House in London in 2003, Browne and Fridman signed documents for the new company, with Vladimir Putin and British Prime Minister Tony Blair standing behind them, overseeing the signatures. The new TNK-BP represented the largest direct foreign investment in Russia. At the same time it was a Russian company. The new combination modernized the oil fields and increased production rapidly. It also increased BP’s total reserves by a third, and it pushed BP ahead of Shell to be the second largest company, after ExxonMobil. But a few years later, bearing out Putin’s adage, a fierce battle erupted over control and as to exactly what 50/50 meant. Eventually, after much tension, the two sides came to a new compromise that modified the governance, shifting the balance toward the Russian partners while preserving BP’s position. Mikhail Fridman became the new CEO.17
YUKOS
By the time of Putin’s election in 2000, Mikhail Khodorkovsky of Yukos was already on his way to becoming the richest man in Russia. He had the reputation as an aggressive and ruthless businessman; but with the beginning of the new century he seemed to be remaking himself. He would compress three generations—ruthless robber baron, modernizing businessman, and philanthropist—into one. He brought in Western technology to transform Yukos into a far more efficient company. By importing Western-style corporate governance and listing his company on Western exchanges, he could greatly increase the valuation of Yukos and thus multiply his wealth several times over. Through his Open Russia Foundation, he became the biggest philanthropist in Russia, supporting civic and human rights organizations.
His spending on politics was also well known, indeed almost legendary in its extent, most notably in the money spent to ensure that deputies in the Duma voted exactly the way he wanted on tax legislation in May 2003. He seemed to be pursuing his own foreign policy. He negotiated directly with China on building a pipeline, bypassing the Kremlin on something of great strategic importance, and on which Putin had very different views. He was moving fast to acquire Sibneft, one of the other new Russian oil majors, which would make Yukos possibly the largest oil company in the world. And he was in talks with both Chevron and ExxonMobil about selling controlling interest in Yukos. When Putin met with the CEO of one of the western companies, he had many, many questions about how a deal would work and what it would mean. For it would have moved control over a substantial part of the country’s most important strategic asset, oil, out of Russia, which ran exactly counter to the principle that he had laid down in his 1999 article.
While moving on all these fronts at the same time, Khodorkovsky let it be widely known that he was prepared to spend money to move Russia toward being a parliamentary rather than a presidential democracy, with the implication that he intended to become prime minister. Selling part of Yukos would give him many billions of dollars that could go into that campaign.
And then there was what turned into a heated exchange with Putin at a meeting with the industrialists that was captured on video. “Corruption in the country is spreading ,” said Khodorkovsky. To which an angry Putin reminded him that he had won control over huge oil reserves for very little money. “And the question is, how did you obtain them?” said Putin. He then added, “I’m returning the hockey puck to you.”18
Several months later, in July 2003, one of Khodorkovsky’s business partners was arrested, and then others. Some of his advisers, fearing that he was becoming increasingly unrealistic, warned him to proceed with care, but he seemed to disregard them. On a visit to Washington in September 2003, he said that he thought there was a 40 percent chance he would be arrested. But he gave the impression that he did not believe that the real odds were anywhere near that high.
In the autumn of 2003, Khodorkovsky embarked on what looked like a campaign swing, with speeches and interviews and public meetings in cities across Siberia. In the early morning of October 23, his plane was on the ground in Novosibirsk, where it had stopped for refueling. At 5 a.m. FSB agents burst in and arrested him. In the spring of 2005, after a lengthy trial, Khodorkovsky was convicted of tax fraud and sent to a distant and isolated Siberian prison camp. In 2011, a second trial for embezzlement extended his sentence. By then, the case had become an international cause, exemplified when, after the trial, Amnesty International selected him as a “prisoner of conscience.”
As for Yukos, it was no more. It was dismantled and became a noncompany and was absorbed into Rosneft, which is now Russia’s largest oil company and, largely owned by the government, the national champion.
“STRATEGIC RESOURCES”
“Strategic resources” came to the fore in other ways as well. ExxonMobil’s Sakhalin-1 project had a Russian company as partner, Rosneft. But Shell’s Sakhalin-2 did not. Gazprom may have been the largest gas company in the world, but it had no representation in liquefied natural gas (LNG), and no capacity to market to Asia. Over several months in 2006, the Sakhalin-2 project was charged with a litany of various environmental violations that carried a variety of penalties, some of them severe. At the end of December 2006, Shell and its Japanese partners accepted Gazprom as majority shareholder. The project thereafter continued on course and in 2009 began exporting LNG to Asia and even as far away as Spain.
OIL AND RUSSIA’S FUTURE
By the second decade of the twenty-first century, Russia was back as an oil producer. Its output was as high as it had been in the twilight of the Soviet Union, two decades earlier, but on very different terms. The oil industry was integrated technologically with the rest of the world; and it was no longer the province of a single all-encompassing ministry, but rather was operated by a variety of companies with many differences in leadership, culture, and approaches. When it was all added up, Russia was once again the largest producer of oil and the second largest exporter in the world.
Once, as Russian production and oil revenues were ramping up, Vladimir Putin was asked if Russia was an energy superpower. He replied that he did not like the phrase. “Superpower,” he said, was “the word we used during the Cold War,” and the Cold War was over. “I have never referred to Russia as an energy superpower. But we do have greater possibilities than almost any other country in the world. If put together Russia’s energy potential in all areas, oil, gas, and nuclear, our country is unquestionably the leader.”
Certainly Russia’s energy resources—and its markets—put it in a position of preeminence; and with a new uncertainty about the Middle East, it took on a renewed salience as an energy supplier and in terms of energy security.
Oil and gas were also what powered its own economy. As Putin had written in his 1999 article, they had indeed been the engine of Russia’s recovery and growth—and the number one source of government revenues. High prices meant even more money flowing into the nation’s treasury. The country’s demographics made those revenues even more critical—in order to meet the pension needs of an aging population.
But the heavy reliance on oil and gas stirred a national debate about the country’s heavy dependence on that one sector and about the need for “modernization,” which meant, in part, diversification away from hydrocarbons. But modernization was hard to achieve without broad-ranging reforms of the economy and legal and governmental institutions, along with a nurturing of a culture of entrepreneurship. Some argued that high oil prices, by creating a cushion of wealth, made it easier to postpone reform. Whatever the progress on modernization, oil and gas would continue to be the country’s greatest source of wealth for some years to come, as well as an arena in its own right for advanced technology.
But the very importance of oil and gas highlighted a different kind of risk: would Russia be able to maintain its level of output or was another great decline in the offing? The latter would threaten the economy. Some argued that Russia would not be able to sustain production without big changes—a step up in new investment, a tax regime that encouraged investment, augmentation of technology, and, of critical importance, the deve
lopment of the “next generation” of oil and gas fields. One of the major targets for that next generation was the offshore, particularly in the Arctic regions, off the northern coast of Russia.
Developing those frontier regions would be challenging and costly and even more complex than the Sakhalin projects. Once again, here was the potential for a significant role for international companies. These would be the projects for which Western partners would be sought, especially the large majors with their capabilities to execute projects on that scale. Yet undertaking them would require considerable confidence on both sides. For these would be very long-term relationships; the development time would be measured not in years, but decades, and their full impact would likely be felt nearer the middle of the twenty-first century, rather than the beginning. But that was still prospect.
For the Western companies—save for those long-range projects in places like the Arctic—there was not much more in the way of large opportunities beyond what had already been launched in the 1990s. As things had turned out, the early expectations about Russia had proved to be much larger than the reality.
When it came to oil and gas, however, there had been more opportunity to be found in the former Soviet Union than just in the Russian Federation. Much more. And it was to the rest of the region that attention had also turned in the late 1980s and early 1990s as the Soviet system was disintegrating.
The Quest: Energy, Security, and the Remaking of the Modern World Page 5