The Kremlin is king in Russian business

Shell’s experience in the Russian Federation proves the Kremlin has slammed the door on foreign investors who want control of strategic projects—and other investors would do well to take heed, analysts and fund managers said on Monday.

Industry sources have said that Royal Dutch Shell has offered to cede control of its $22-billion Sakhalin-2 project to state gas monopoly Gazprom after months of government pressure.

The project is Russia’s biggest single foreign investment and the only one entirely in foreign hands.

“The Shell case has just highlighted that big projects in Russia are now possible only if a controlling state shareholder is part of it,” said Sergei Glazer from Vostok Nafta, a fund with $3,3-billion of Gazprom stock.

In the past three months, Russia’s Natural Resources Ministry and Prosecutor General’s Office have used threats of administrative measures and licence withdrawals to put growing pressure on Shell and other major foreign investors, including fellow oil majors Exxon Mobil and BP.

The campaign was widely seen as an attempt to force them to accept a greater role for state-controlled companies such as Gazprom and oil firm Rosneft, continuing a trend that began with the downfall of Yukos, which was once Russia’s top oil firm but is now bankrupt and set for break-up.

“Things are getting harder ... it looks from the outside as though the Russian government is keen to gain as much control over its mineral assets as it possibly can,” said Julian Chillingworth, fund manager at Rathbone Investment Management.

Chinks in the armour

The Kremlin’s interests extend beyond energy and into metals, media and aircraft, all of which are considered “strategic”—risky to stray into without a Kremlin chaperone.

“If you’re in one of the strategic sectors, it’s clear what your path of action should be: get on the phone to Gazprom or Rosneft,” said Stephen O’Sullivan, head of equities research at Deutsche UFG in Moscow.

That raises questions for existing foreign projects in strategic sectors. The biggest apart from Shell’s are TNK-BP, a BP joint venture, and the Sakhalin-1 project operated by Exxon.

Many market participants in Moscow think TNK-BP’s Russian shareholders will sell out to the state in 2007, despite denials by the firm and its owners.
TNK-BP has also been under pressure over its vast Kovykta gas field, in which Gazprom wants a stake.

But Gazprom’s arrival as BP’s joint venture partner might not be such a bad thing, some say.

“I believe that a deal on TNK-BP would be positive for all sides, including BP, the Russian shareholders and Gazprom. It will dramatically boost the value of TNK-BP’s assets, especially on the gas side,” said Kaha Kiknavelidze, energy analyst at UBS. “The only concern of minority investors is that they would like the Western management to stay in place.”

In Exxon’s case, it may have won some protection because Rosneft owns 20% of Sakhalin-1. “They have faced less trouble than Sakhalin-2 but nevertheless I have a feeling that the role of Rosneft in the project will grow,” said Glazer. “Rising state control will remain the key element of the political strategy for a very long period of time.”

The chink in Exxon’s armour could be the same fault that made Shell vulnerable: rising costs in its production-sharing agreement that forced it into negotiations with the Kremlin. “It’s not as though Shell is completely innocent here,” said Erik DePoy, strategist at Alfa-Bank in Moscow.

Outside strategic sectors, Russia is still booming and analysts say foreign investors should not be scared off.

“Just look at the planes between London and Moscow, eight planes a day, business class jam-packed, and it isn’t just oil and gas,” said O’Sullivan. There are lots of businesses that can make money in Russia—consulting, retail, design, PR, oil-field services—“that the Kremlin has absolutely no interest in”.

But the headlines about creeping state control reinforce still-fresh memories of the Yukos case, and Shell’s case will just damage investor perceptions further.

“Any company deciding to set up shop here has to realise it’s still an emerging market,” said DePoy. “You have to expect temporary setbacks and pressures. You have to have strong local contacts. A flexible strategy is best.”—Reuters

Additional reporting by Tom Bergin in London

Client Media Releases

FutureLearn welcomes CBDO
Survey: Most Influential Brands in SA
ITWeb's GRC conference set for February 2019
Survey rejects one-sided views on e-tolls
Huawei forms partnerships to boost ICT skills development