Shtokman Could Signal the End of Stability

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Gazprom CEO Alexei Miller's announcement earlier this month that the huge Shtokman gas field in the Barents Sea would be developed without the participation of foreign partners, and that its production would be sold exclusively to Europe, sent shock waves through the investment community. The field, estimated to contain up to 4 trillion cubic meters of natural gas and more than 31 million tons of gas condensate, is one of the world's largest undeveloped known deposits.

Negotiations between Gazprom and five Western energy majors -- France's Total, the Norwegian firms Statoil and Hydro and Chevron and ConocoPhillips from the United States -- to determine which would enter into a consortium with the gas monopoly to develop the field had intensified since the short list of pretenders was announced last year. Because of its size, and the fact that it could open the way for Russian gas (in liquefied form) to penetrate the U.S. market, Shtokman was a crucial issue in Russia's foreign relations. It was also the single largest foreign investment project on the table.

Acknowledging that developing the field represents an enormous technical challenge, Gazprom sought out foreign partners with the technology, specialists and experience it lacked. A consortium arrangement would also have spread the economic risks associated with the project. Gazprom will now have to turn to creditors to finance Shtokman's development, which could cost as much as $50 billion by the time the field comes online. One of the U.S. firms could also have offered marketing connections on the downstream side in North America. In return for a minority stake in the development, Gazprom sought equity in the foreign companies.

One can only imagine the look on the faces of the executives at the five firms when the news came across the wires. Instead of informing the companies directly, Miller chose to drop the bombshell in an interview on Russia Today, a Kremlin-funded, English-language television channel that is often ridiculed as a propaganda mouthpiece in the West.

Immediately after the announcement, analysts with technical knowledge of gas-field development stated definitively that Gapzrom was incapable of going it alone unless the timeframe for the project were pushed back by several years and the cost estimate increased by as much as 15 percent. Even then, doubts remain about the feasibility of the project without foreign help. Gazprom has no experience in the development of a relatively remote offshore deposit of this immense size. Miller himself implicitly acknowledged this when he said the company would hire foreign firms as contractors.

It came as no surprise, however, that one of the five majors soon declared its unwillingness to participate in such an arrangement. Analysts expressed doubt that the market for offshore development contractors could in principle meet Gazprom's needs for Shtokman.

In short, there appears to be no economic logic to Gazprom's decision. So the question that arises is: Why? Since no one knows exactly what the foreign firms had put on the table, it is possible that the move was a not-so-subtle bargaining tactic. It could have been a saber-rattling gesture meant to scare the majors into improving their offers, which could well have been below fair value. Following President Vladimir Putin's confirmation at a news conference in Germany of Gazprom's plan to go it alone, however, the decision seems to be final.

This leaves two possibilities, neither of which bode well for Russia's investment climate. Either Gazprom has decided that economic priorities -- getting the field online according to the current timetable and cost estimates and tapping the U.S. market -- are secondary to total state control, or Moscow has allowed this decision to become hostage to the downward spiral in Russia's relations with the West, and with the United States in particular. Indeed, rumors circulated several months before the announcement that the U.S. firms might be excluded from the consortium because of Washington's perceived intransigence in Russia's WTO-accession negotiations. After Miller's announcement these rumors only intensified.

No matter which of the two explanations are closer to the truth -- or even if both factors played a role -- the Shtokman decision is a turning point in Russia's energy policy. Following the Yukos affair, the state established more or less stable rules of the game for cooperation with Western energy concerns. The primary guiding principle was that the national champions, Gazprom and Rosneft, would participate as majority stake-holders in all new development projects and should also be given shares in deals signed in the Yeltsin era that are perceived by the current regime as unfair. Foreign firms were encouraged to take up minority positions in these developments, as the state acknowledged that their expertise and resources were critical for accelerating the projects. Beyond these major caveats, however, the state preached cold-blooded economic pragmatism and rejected the practice of linking the task of making money to petty political concerns.

While this framework would seem to make Russia an unattractive place for foreign companies to do business, investors were relatively content. They are generally more concerned with the stability of the rules of the game, not their restrictiveness.

Many have argued that such ground rules, if they ever existed, were done away with long ago and that Shtokman fits into a pattern with the recent assault on Sakhalin-2. But Gazprom's intention to take a minority stake in the Sakhalin-2 project has been clear for over a year and fits in with the scheme described above. Shell, the majority shareholder in the operating consortium, was given a choice: Either let Gazprom in or face the consequences.

Shtokman, by contrast, was a clean slate. If Gazprom has decided to proceed without bringing in foreign partners based on political motivations, and despite the economic consequences, the rules have changed and we could be entering a new period of instability in the investment climate. Shtokman might signal the end of the paradigm of cooperation between the national champions and foreign firms, and thus the unraveling of Putin's oft-noted pragmatism in dealings with foreign energy majors. As relations between Russia and the West continue to deteriorate, we could see other key decisions subjugated to the political whims of the Kremlin. The investment climate will inevitably suffer as a result.

The lesson from this episode is that political systems in which power is highly concentrated in the executive branch tend to be incapable of long-term credible commitment to policies necessary for the development of market economies. Of course, the total fragmentation of a political system is also not conducive to economic development, either, and this was part of the motivation behind Putin's centralization drive. But the pendulum may now have swung too far in the opposite direction. The previous period of perceived stability in the investment climate could well have been a short-lived phenomenon.

Samuel Charap, a doctoral candidate at St. Antony's College, Oxford University, is currently conducting research in the political science department of the Higher School of Economics in Moscow.