Eco-Kremlin: Russia targets energy giants

Three big foreign-run projects are under fire for violating environmental standards. What's Moscow really after?

Western firms developing Russia's rich oil and gas fields are facing sweeping allegations of environmental abuses. But critics say the charges are a thinly veiled Kremlin power play to renege on 1990s-era contracts now seen as unfavorable for Russia.

Four key projects, all controlled by foreign companies, are under pressure to hand over shares to a Russian state-owned partner or face potentially crippling financial penalties.

The Russian side, supported by environmental groups, insists that the ecological concerns are real. But experts say the government is leveraging those concerns to give a state-run company control over the projects.

"We know that the Ministry of Natural Resources received instructions to launch this campaign," says Mikhail Krutikhin, an expert with Russian Energy Weekly, a trade journal. "They are using the environmental weapon with the aim of either renegotiating these contracts to make them more profitable for Russia, or forcing the [Western companies] to accept [the state-owned natural gas giant] Gazprom as a partner, on Gazprom's terms."

Last month, Russia's Natural Resource Ministry suspended the environmental operating license for Sakhalin-2, a giant international consortium led by Royal Dutch Shell that has invested $20 billion so far in the venture. Expected to bring liquefied natural gas (LNG) from Sakhalin Island to Asia and the US by 2008, the project received environmental clearance in 2003, but Russian officials now say there are massive violations.

In a visit last week to the volcanic Pacific island, estimated to have 45 billion barrels of petroleum reserves, the Ministry's environmental watchdog Oleg Mitvol said Sakhalin Energy has wreaked $50 billion in ecological damage.

"The project must be stopped and all that's been done must be reworked," Mr. Mitvol told journalists. "For every destroyed tree or damaged river, we want to bring a criminal case."

Many independent environmentalists are supporting the Kremlin position. Ivan Blokhov, campaign director for Greenpeace-Russia, visited Sakhalin last week and says the Shell-run project there is "one of the worst I've seen operating in Russia – and I'm not making any distinction between Russian and foreign companies." He says the company has violated a pledge not to drill offshore during the three months each year that rare gray whales come to Sakhalin waters to feed. Pipelines have been illegally rerouted, swaths of trees cut down, and rivers that are crucial to spawning salmon ruined with bulldozers.

Mr. Blokhov and other Russian ecologists insist they're not siding with the Kremlin, but are only doing their job. "I do not suppose that Gazprom would be any better than Shell," Blokhov says. "What is positive is that they are now under huge public attention, and wouldn't be able to work as before."

Last week, Moscow launched a fresh environmental probe into the operations of Sakhalin-1, an international project led by Exxon Mobil Corp. that's already begun production on the island's north side and is expected to put out 250,000 barrels of oil daily by year's end.

Russia's prosecutor-general's office says it's investigating the joint Russian-British company TNK-BP for failing to comply with legal requirements and environmental rules in developing eastern Siberia's huge Kovytka gas field, which has 2 trillion cubic meters of proven reserves. Also under fire is the French company Total's Kharyaga project in Russia's Arctic.

Critics say that though the environmental problems are real, the driving force is the government's desire for more control – and profits.

"The Russian government wants more money from Sakhalin, and Gazprom wants to control all the gas exports from Russia," says Dmitri Koptyubenko, an analyst with RosBusinessConsulting, a Russian firm. "The ecological problems exist, but the Russian government is using these issues for its own ends."

Experts say the underlying issue is growing Kremlin dissatisfaction with the "production sharing agreements" (PSAs) which, in most of these cases, were deals signed by Russia in the mid-'90s, when oil prices were low and Russia lacked the capital and expertise to develop those newly discovered fields on its own.

One particularly troublesome feature of the Sakhalin contracts, say Russian officials – who stress that the PSA deals were "humiliating" – is that the companies won the right to recoup all their investment costs before they begin paying royalties to the Russian government. In practice, they say, that allowed companies to indulge in cost overruns. Last month, Shell admitted that costs on Sakhalin-2 have ballooned from $9.8 billion to $22 billion.

"They are trying to stick Russia with these expenses and naturally we oppose that," Sergei Fedorov, an official of the Natural Resources Ministry told the state-owned Rossiskaya Gazeta last week.

Mr. Fedorov also accused foreign companies of dragging their feet, and complained that cost projections for Sakhalin-1 have also swelled, from $12.8 billion to $17 billion. "That means oil not extracted and, accordingly, profit not received by Russia," he said.

Experts suggest the environmental problems might quickly cease to be an issue if the companies agreed to renegotiate their deals or took on a major Russian partner such as Gazprom.

"The Kremlin is very keen on concentrating the whole hydrocarbon industry into the hands of [state-owned] Gazprom and Rosneft," says Artem Konchin, an analyst with Aton Investment, a Moscow-based firm. "So, it's no surprise that they're using all available leverage to procure a better deal, to get Gazprom into Sakhalin."

Though experts decline to predict an endgame for the current standoff, most say the West is going to have to accept that "Kremlin capitalism," which ensures a tight political grip on all Russia's strategic resources, is here to stay. Just this week, Gazprom shocked world petroleum markets by announcing that it alone will develop the vast Arctic Shtokman field, estimated to contain almost 4 trillion cubic meters of gas, saying bids by foreign firms had proved "inadequate."

"The new rule is that 50-plus-one-percent will belong to Russia," says Al Breach, Russian research director for UBS, a global investment firm.

"It's not about the money per se, it's about control."