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. Last Updated: 07/27/2016

Oil Industry Waters Still Muddy

With unresolved ownership disputes, new oil legislation for foreign investors remaining unclear, and June's presidential election, predicting this year's events in the Russian oil industry is comparable to predicting this year's weather -- expect frequent changes.

If the 1996 oil industry is anything like last year's, the weather vane will be spinning around rapidly.

In 1995, the industry was just coming out of its former communist shell when it underwent further reorganization and privatization at an unprecedented pace. Newly formed holding companies used their political clout to garner state-owned companies to form networks handling everything from production to refining to distribution -- known as vertically integrated companies.

Then, just as the reshuffle of companies in the oil industry was slowing, a raft of major shareholdings in the sector was included in the second stage of privatization in the form of the loans-for-shares scheme. Controlling stakes in Yukos, Sidanko and Sibneft, and large lots of LUKoil and Surgutneftegaz, were placed in private hands, a fact that might have drawn universal praise from pro-privatization reformers. But it ended up with accusations of insider trading and conflicts of interest. The result has been lawsuits and speculation that some agreements will be overturned.

The tortuous negotiations to build a pipeline from the new oil fields around the Caspian Sea also will spill over into 1996. Ownership questions were the main sticking point in the failure of the Caspian Pipeline Consortium to get final approval of its project to build a $1.2 billion pipeline to the Black Sea from the Tenghiz field in Kazakhstan. U.S.-based Chevron, which has drilling rights in the Tenghiz field, continues to block the deal, citing the ownership agreement as unfair.

A Western-led consortium along with the Azeri government did come up with a Solomonic decision on pumping Azerbaijan's Caspian Sea oil to the West by deciding to transport the initial output through two different pipelines, one through Russia, the other through Georgia. If the decision is implemented, it will mean that oil from the former Soviet Union will be sent to the West for the first time through a pipeline not controlled by Moscow.

One of the biggest difficulties for foreign investment in 1996 continues to be uncertainties surrounding the new production-sharing agreement, signed by President Boris Yeltsin last Saturday. Investors have said an agreement is essential for clarifying the legal basis for extraction deals, but analysts say the latest compromise bill is so unclear it is little better than the old system.

Opponents of the law say it will not encourage investment because it allows the Russian government to change agreements with foreign investors after they have been signed.

The law also requires parliament to approve every investment in "strategic" zones, but does not define the term. In addition, it allows each deal to be reviewed if conditions -- such as world oil prices -- change "substantially," once again without any more specific criteria being laid down for doing so. Analysts said the new law is not likely to be enough to give the green light to the largest pending deals.

U.S.-based Exxon and Japanese Sodeco have negotiated a $15 billion agreement with the Russian Federation for an offshore gas project called Sakhalin-1. Amoco officials have said they are waiting for a "stable investment environment" before investing in another Sakhalin project, Sakhalin-2, and in the Priobsky project in the Khanti-Mansiisk region in western Siberia.

BHP of Australia and Gazprom are stalled on plans for an offshore field in the Kara Sea in the Arctic. French-based Total has made passage of an acceptable production-sharing law a key precondition to its $1 billion contract to develop the Kharyaga field, north of the Arctic Circle.

Many oil companies are waiting to see what happens in the June presidential elections, said Stephen O'Sullivan, associate director of MC Securities in London.

"The oil industry could become an election issue," said O'Sullivan, warning that even Yeltsin may "play to the gallery" by promising to be more conservative on issues of privatization.

The government could buy back the stakes provisionally sold under the loans-for-shares scheme until Sept. 1. Most analysts, however, said this scenario is unlikely.

"It will be the year when big deals are made, or some firms will pack their bags and go home," said Jean-Christophe Fueg, senior analyst for PetroConsultants in Geneva. "But many analysts said that last year, too. I think some firms will find a way around the production-sharing law and survive the best they can."

In any event, ownership will be an ongoing issue as banks and oil companies battle it out among themselves for strategic assets.

Craig Kennedy, the Moscow representative of Cambridge Energy Research Associates, said: "1996 will be the year dominated by a struggle for ownership of shares in the Western sense. Oil companies will be more vulnerable to takeover strategies by Russian financial groups. Those companies able to mobilize capital will do well, those who don't will lose out."

With all the variables, many analysts predict that oil production, which has plunged by 50 percent in the past five years, will level out. Domestic crude prices are widely predicted to rise further toward world levels, from about 65 percent at present to possibly near 80 percent by year's end. Export levels, though, will depend on export tariffs. Tariffs were halved last year, but there will be pressure to raise them again during the election year, several analysts said.

"On the surface there will be a lot of confusion," CERA's Kennedy said. "But I believe it will turn out good in the end. Overall, I'm positive about the process."