Two elements are necessary to "make big changes" and ensure Russia's long-term successful dealings with Western oil and gas companies: the conditioning of the Russian people to it and a second term of office for Russian President Vladimir Putin.
Both these factors are critical, said James Langdon Jr., partner in the legal firm Akin Gump Strauss Hauer & Feld LLP.
Langdon was moderator of a panel of five Akin Gump associates, including former Ambassador to Russia James F. Collins, who met with the press in Houston Oct. 8 to discuss the Russian energy sector and the long-term prospects of Western companies doing business in Russia.
"Putin is a modernizer," Collins said, expanding on Langdon's comment. "[He] expects Russia to be associated with the industrial democracies. It is very controversial, by the way." Collins said many Russians still need convincing after the energy market crash of 1998, "when the attitude was, 'I told you so. See how getting involved with Westerners can hurt us.'"
For that reason, Langdon said, it was most advantageous that Putin came to New York Sept. 26 to dedicate one of OAO Lukoil's 1,300 US gasoline stations acquired when it purchased Getty Petroleum Marketing Inc. in late 2000 (OGJ Online, Dec. 7, 2000).
"It demonstrated that the Russians are reaching out," Langdon said. Not only did the trip show Putin's support for Russian companies' international investments, but it was especially significant, he said, in that the Russian press came along to get that message across to the Russian public.
US bullish on Russia
"One has every right to be bullish" about the US-Russian business climate, said Collins. "We have the highest possible political endorsement from both countries," which was obvious at US-Russian energy summits for the past 2 years, including the most recent one held Sept. 22-23 in St. Petersburg (OGJ Online, Oct. 1, 2003).
Following the July 2001 summit in Genoa, Italy, US President George W. Bush, had said: "The United States and Russia are working together to ensure that Russia's energy sector can fulfill its potential in world energy markets."
Then, in the aftermath of the terrorist attacks on the US 2 months later, the US knew it should not depend solely on Saudi Arabia for its energy, Collins said, and it began to focus even more on Russia, the world's largest oil producer. "Putin, 2 days after Sept. 11, said he was prepared for Russia to be a stabilizing force" in this area, Collins added.
A decade of changes
There is a vast difference between now and the past when business decisions were the arbitrary control of the government. "Now [the companies] own the oil and gas," Collins said.
Other major changes have occurred there since the breakup of the Soviet Union in 1993, both in attitude and actual business practices as Russia gained a greater understanding of how to do business with the West, and Americans learned the broader political and economic aspects of doing business with Russia. This is true especially within the last 5 years, they said.
Russian businessmen began to develop the attitude: 'We can deal with these foreigners. We can afford to be a part of the world,' Collins said. "That was not a given in the past."
US attitudes also changed, Collins said. "Americans didn't lecture anymore; they got off their pulpits and said 'Here's what we can do with you,'[instead of 'for you']. Americans will be able to provide value added in the areas where there will be huge changes needed," he added.
Russian oil and gas companies have had several years of maturity and growth, Collins said. The fact that they are becoming international, having listings on the London Stock Exchange, having greater access to capital, and that ExxonMobil Corp. is talking to Russia's largest oil company YukosSibneft Oil Co. about investing in the company all lead to the conclusion that Russia has 'arrived,' he said. Langdon added: "[OAO] Yukos has gone from a 2-story building to one of 25 stories or so." It currently is the fourth largest privately operated oil company in the world.
Growth and challenges
The past 5-6 years in particular have seen many positive changes in Russia's business climate, the panel said (OGJ, June 2, 2003, p. 20).
"Russia is going into its sixth year of sustained economic growth," Collins said, "with rising bond ratesUand a [gross domestic product] growth rate of more than 6% [this year]."
"With the new drop to a 15% flat tax," added Akin Gump panelist Todd Gremillion, "[Russians] now know that regressive taxation gets you nowhere. By lowering taxes the government's revenue went up because of the monetary incentives," he said.
Collins agreed, adding that the extractive industries today don't have a bad tax structure, but the value-added tax structure still penalizes expansion. "This is the single biggest challenge they have to face," he said.
Other challenges include the accurate reporting of reserves. "We have to get their reserve reports in the format we are accustomed to see," commented Akin Gump panelist Rick Burdick.
"Reserves are probably understated," Gremillion said.
Russia is the largest producer of oil and the second largest oil exporter after Saudi Arabia. "The difference between internal and external prices is great incentive for Russians to export," said Gremillion. The export market is constrained, so the domestic market is oversupplied, causing the price difference in exports.
There is still controversy over attempts to raise Russian domestic prices to world market levels, however. Collins said that, in a political context, it is one of the most contentious arguments because of potential damage to the economy.
"The government has the ability to hoard resources, said Robert Langer, "but they haven't done it. Russian companies need to catch the margin on the refined product," he added. "They are trying to find refining outlets outside the country."
Mergers to increase
Although Western service and supply companies have been working with Russian companies for years, supplying technology and forming mergers or co-ops, the time now seems ripe for producers to do the same.
Gremillion said that recent developments on production sharing agreement legislation were a death knell for PSAs, with minor exceptions, so the only way Western companies can access Russian reserves is through investments in Russian oil companies.
So the chase is on. "There are few places in the world where E&P companies can go today, and companies such as Yukos see [the infusion of Western capital] as a great opportunity," Burdick said. "For Yukos to be a target for western courting is pretty indicative," he said. "And the fact that BP [PLC] is willing to invest"[in TNK-BP] (OGJ Online, Sept. 8, 2003).
His statement was borne out Oct. 9, when YukosSibneft Chairman Mikhail Khodorkovsky delivered the keynote address to a meeting of the US-Russia Business Council in Washington, DC. Speaking through an interpreter, Khodorkovsky said, on being questioned, that he would support majority ownership of a Russian energy company by a foreign investor. "I think it would be a good thing," he said, "It increases competition."
The panel made the point, however, that investing in Russian companies is different from investing in Western companies. "Buying a minority stake won't give influence in operations but will give you a seat on the board," said Burdick. "If you buy 25% there, you don't get 25% of the board."
Langer pointed out that investors do, however, get certain rights. He suggested: "We should accept what they have and go with it, improve it, not bring in your techniques and expect them to automatically adopt it," he said. "You might not want complete control. You want them to do what they do best."
Legal reforms
Panel members indicated that the December elections would not change the Moscow political scene much. "The Duma will look much like it does now," Collins said. He said Putin will be able "to use the Duma to achieve his goals." And following a successful reelection in 2004, he would use his mandate to launch the next stage in Russia's development—reforming the legal system. Although more laws are now defined, there is much yet to do, Collins said.
"A truly independent judiciary is at least a generation away," Collins said. "Two things will propel it forward—a demand for the use of courts for a judgment, which the government obeys, and a movement to make the judiciary a serious player, whereas before, the Communist Party made such decisions."
In Washington, Khodorkovsky made much the same point—that despite 10 years of impressive reforms, the country "still has plenty of problemsUon individual rights we are way behind modern countries," he said.
He added: "The lack of civil society is not all that much of a big problem for the biggest US companies; they can protect themselves" by talking directly with high-level government officials. But he said Russia's modern economy runs on small and medium-sized companies, "and they are not as easily protected."