POLITICAL CHAOS REINS PROGRESS ON NEW JOINT VENTURES IN RUSSIA

Frustration is mounting among foreign petroleum companies chasing business opportunities in Russia.

Political uncertainty continues to block large oil and gas exploration and production deals there.

Most foreign officials believe Russia's transformation from a centrally planned economy to a market economy is irreversible. But enough political, social, and economic uncertainty persists that Russian leaders are hesitant to approve deals with foreign companies.

The lack of certainty among leaders of the former Soviet republic about who controls Russia's natural resources, who can approve contracts, and who determines winners of bid tenders is causing confusion among foreign companies trying to negotiate major E&P deals.

With no clearly successful path apparent for completing large deals, various secondary negotiating strategies are prevailing. Russian industry specialists say those secondary strategies work best for small deals involving relatively small players in less prospective regions.

Meantime, countervailing political forces within the country, the world's top producer of oil and gas, continue to buffet petroleum companies that are negotiating deals or getting projects off the ground.

MORE CONTROVERSY

Reformist and reactionary elements continue to battle over the propriety of Russo-foreign oil and gas joint ventures, as they did over Chevron Corp.'s proposal to develop supergiant Tengiz oil field (OGJ, Aug. 5, 1991, p. 14). Another closely watched joint oil venture in Russia has come under scathing attack from a remnant of the nation's hard line Communist press.

The Moscow newspaper Pravda recently excoriated the White Nights project in western Siberia for "plundering Russia's underground riches." It alleged White Nights has not kept its promises, is frequently wasteful and now virtually bankrupt, and treats its Russian employees as second class citizens.

White Nights is a joint venture owned 50% by Varyeganneftegaz, a Russian oil and gas enterprise, and 50% by Salomon Inc. unit Phibro Energy Inc., Greenwich, Conn., and Anglo-Suisse (U.S.S.R.) Ltd., a subsidiary of Anglo-Suisse Inc., Houston.

White Nights Operating Co. Pres. Marc Rowland said there is no basis for criticisms published by Pravda of the joint venture. Rowland said the person who wrote the Pravda article had no access to information about the financial affairs of the joint venture and lacks the technical training to comment on White Nights' field operations (OGJ, Feb. 10, p. 27).

Another controversy was recently whipped up over the tender for developing oil and gas fields off Sakhalin Island in the Far East. Moscow and local officials muddied the tender process by issuing conflicting decrees.

Key Russian energy officials have taken unusual steps to clarify the status of that tender and press their government's plea for more foreign help in what could become the center of superheated petroleum activity in the coming decade.

BIG DEALS STYMIED

Thane Gustafson, a director of Cambridge Energy Research Associates (CERA), Cambridge, Mass., says none of the criteria is present for Russian and foreign companies to make large oil and gas deals. He lays much of the blame on Russian officials.

Hans J. Horn, managing director of Arthur Andersen & Co.'s Moscow office, san,s the struggle between local and central authorities and lack of a solid legal framework are blunting efforts by foreign companies to tie up large agreements.

Peter M. Kennel, vice-president of negotiations for Amoco Production Co., says as long as Russia is undergoing major economic and legal restructuring, negotiations by foreign companies will be slow. Whatever contracts are negotiated will have to include many stipulations that otherwise would be assured by the legal system.

Meantime, the Russian Supreme Soviet has set a timetable and procedure for enacting a proposed underground resources code (see story, p. 21). The resources law and a specific oil and gas law expected to be passed later this year should remove much of the uncertainty foreign companies are facing.

MISSING CRITERIA

CERA's Gustafson says before large Russo-foreign E&P deals can be concluded, both sides must believe they will profit, each is contributing something of value to the deal, and will be protected if the deal fails.

In the current Russian economic and legal turmoil, none of those three criteria exists, he says. As much as 10 years might be needed to create an environment with all three.

Meantime, he says, most failings are on the Russian side of the table but apparently with good reason.

Russian officials are being asked to function as corporate executives for companies that are bankrupt by any reasonable measure-companies in which they have no stake and from which they could be fired tomorrow, Gustafson says.

"They know the only reason they are still in office is that there is no one above them who has the power to fire them, and that could change overnight."

Changes engulfing Russia are so recent, "officials don't know whether they have authority to make deals and wouldn't know a good deal if they were offered one."

Russian officials don't know whether Russia stands to gain from a deal or how much hard currency it may keep, if any. Whatever it keeps, it will have to fight for, Gustafson says.

"What they do know is they have a great deal to lose, because they're likely to come under attack from many quarters for having sold out, having made a bad deal, having given away the Russian birthright, or having perpetuated Russia's present humiliating position in the world as an exporter of raw materials.

"Many Russian officials probably still hope that if leaders in Moscow can get their act together things will become all right, and they won't have to deal with all these difficult things because Moscow will deal with them."

EDGE OF THE POOL

Gustafson says uncertainty among so many Russian officials has created an impasse in which foreign companies don't know how to start working on a deal, where to focus their efforts, how to shape a deal, or how to finance it.

In that business environment, various strategies will have to be followed, because no one path will assure success. The frustration among foreign companies at their inability to close large E&P deals has been aggravated by the realization that Russian oil and gas reserves are about twice as great as previously believed.

Although about a dozen small joint ventures have been concluded, Gustafson says, "we still have the sense that we're at the edge of the pool."

In view of the lack of large E&P deals, foreign companies are beginning to question the extent to which they will contribute to turning around the Russian oil industry.

"At a time when Russian production is collapsing, many would reluctantly agree that contribution by 2000 is going to be no more than marginal-perhaps 1 million b/d at the very outside."

SAKHALIN EXAMPLE

Andersen's Horn says the struggle between central and local Russian authorities for control of oil and gas deals is illustrated by the uncertain status of development off Sakhalin Island.

Sakhalin development could involve an initial project costing as much as $9 billion, according to various government and industry estimates.

The tender for a feasibility study of Sakhalin development, announced in May 1991, has been marked by conflicting decrees from Moscow and local Sakhalin authorities and often erroneous reports in the foreign media as to the winner and status of the award.

Much of the confusion stemmed from the Sakhalin local administration apparently conducting unilateral negotiations with foreign companies that hinged on massive outlays to modernize the island's civil infrastructure.

The Russian federation signed a letter of intent in late January with the MMM group, a combine of Marathon Oil Co., McDermott International Inc., and Mitsui & Co., for a feasibility study of developing Piltun-Astokhskoye and Lunskoye oil and gas fields and exploring other acreage off Sakhalin (OGJ, Feb. 3, p. 23).

At the time, it appeared that two other Sakhalin offshore development projects were under consideration for international bidding.

Later, Russian authorities apparently suggested that two unsuccessful bidders-Mobil Oil Corp. and Japanese combine Sakhalin Oil Development Co. (Sodeco)-be asked to collaborate in the study (OGJ, Feb. 10, p. 27).

That was followed by reports Russia's Supreme Council had suspended award of the feasibility study to MMM (OGJ, Feb. 24, p. 38). Marathon disputed that report and took issue with reports it had agreed to allow Mobil and Sodeco to participate in the study (OGJ, Newsletter, Mar. 2).

Marathon early this month said MMM expects to complete the feasibility study by the end of March. Plans call for starting negotiations based on conclusions of the MMM study.

Marathon says Russian officials want to start production on the acreage in 1995, leaving little time for award of an exploration and development contract.

Pravda applauded the reported suspension, saving Sakhalin officials were correct in denouncing selection of MMM. The hard line Communist newspaper claimed that instead of just getting rights to develop Lunskoye and Piltun-Astokhskoye fields, MMM could in fact obtain exclusive access to 17,000 sq km of Sakhalin's most promising offshore area.

Under the proposed arrangement, Pravda said, "The business-wise foreign firms might end up with both pie and doughnut, while Russia is left with only pitiful crumbs."

The proposed deal with MMM, Pravda claimed, is far too generous and unprecedented in world practice, giving away many billions of dollars to the combine.

Horn said, "Awarding that feasibilitv study has gotten so messy, and so many committees have become involved-local committees, central committees, administrative committees, parliamentary committees--they've lost control of it."

Horn says the Russian Supreme Soviet has postponed discussion of a parliamentary committee recommendation made in mid-February. At this point, he says, either participation of the MMM group will be affirmed or the entire process will start over, delaying development by 1-2 years.

Russian News Agency Interfax reported earlier this month that the Russian parliament was expected to make a final decision on the Sakhalin tender Mar. 9. However, at presstime last week, there still was no word from Moscow as to a final decision.

In a step marked by an unusual level of candor, three top Russian officials have detailed the twists and turns of the Sakhalin tender process in an article soon to be published in Oil & Gas journal.

The three officials, including Russian Deputy Minister for Fuels and Energy Andrey Konoplyanik, contend, "The uncertainty of a final verdict for the tender announced in May 1991, created predominantly by intervention from the administration of the Sakhalin Region, only led to procrastination in commencing development work on the shelf.

"It also could have discredited Russia, for a long term project of such magnitude is invariably under close scrutiny from the world press and the financial and business community of the industrialized capitalist nations."

ECONOMIC COLLAPSE

Horn says the old Soviet Union's centralized economic system has been so changed that Russia is unlikely to return to central planning.

For one thing, new currencies, each with a different basis for converting Russian rubles, are replacing the old Soviet monetary system.

"Eventually," Horn said, "we will see economic differences among countries that made up the Soviet Union that will be greater than those of western European countries."

However, he warns, unless further economic reforms are undertaken, particularly privatization of state property and Russian membership in the International Monetary Fund, the whole economic package still could collapse.

Russia is scheduled to lift price controls on oil and refined products Apr. 15 as part of that reform effort (OGJ, Mar. 9, p. 40).

Horn says Russia theoretically could join IMF without beginning meaningful privatization-but not without difficulty.

He says economic reform will succeed if Russia increases production of goods and services.

To do so, Russian state companies must privatize.

Russian leaders are having difficulty carrying out privatization, "because so mann, members of parliament and the central bureaucracy still are thinking in terms of a centralized economy."

Also, privatization will be difficult until Russia:

Puts a program in place that allows state companies to become private without having workers and management taking over a majority of company shares of ownership. Passing too much ownership to managers and workers limits availability of capital.
Clearly states valuation principles covering state assets offered to the private sector.

"So far, valuation principles applied when taking assets out of the state sector into private companies have been such that they haven't been able to attract investors willing to pay the asking prices."

Valuation rules are changing gradually but remain a major problem, Horn said.

BURDEN ON CONTRACTS

Given added burdens on contracts negotiated amid current uncertainty, Amoco's Kennel says foreign companies must prepare documents that clearly state rights and obligations of investors and Russian partners and then make sure they are approved by the necessary levels in the Russian government.

"I'm not suggesting that's an easy matter," Kennel said. "But given the large scale of the projects needed, they will have the kind of access to high levels of government to secure the necessary approvals."

Based on the lessons learned by Amoco in negotiating for the right to lead development of Azerbaijan's Azeri field, Kennel offers the following advice to foreign companies that are seeking deals in the former U.S.S.R.:

Contact all levels of government that could be important to the decision making process-local, regional, and central.
Be prepared for an enormous amount of mutual education.
Build trust by building personal relationships.
Create comprehensive, detailed, and clear contracts to avoid misunderstandings.
Recognize that Russians have achieved a great deal and are justly proud of their accomplishments.
Be innovative in structuring deals and don't rely on experiences in other countries or even other deals in Russia.
Be patient and persistent and require the same of the Russian side.

Such essentials make negotiating an exploration and production deal a very laborious process, Kennel said. "But trying to bet on one horse at this point is a risky business."

INVESTMENTS SOUGHT

Speakers at a Philadelphia seminar this month said the Russian government is firmly committed to a policy of using foreign oil companies to increase domestic production despite uncertain tax laws and growing disputes between the central and regional governments.

The seminar was sponsored by the University of Pennsylvania's Center for Energy and the Environment.

Russia's Konoplyanik said Russia wants to increase oil output because "it is one of the few industries in our country that can give us needed hard currency.

He said Russia is developing energy legislation "based on principles used in the world petroleum industry," plans to use more foreign financial advisers to help it attract investments, has formed a government task force to review the controversial export tax, and has asked foreign oil companies to participate in an advisory board on joint ventures.

He pointed out that Russia has the dual challenge of improving energy efficiency, and energy production simultaneously. In the latter area, the initial emphasis will be to increase existing production, then focus on exploration.

"A major task in the short term is dealing with 8,000-10,000 idle wells," he said, adding Russia is considering higher rates of return for foreign oil companies that make short term investments to improve existing production.

Konoplyanik said the government wants to balance risk and rewards for foreign oil companies.

Boris Pughinsky, a foreign ministry trade official, said Russian President Boris Yeltsin "considers foreign investment in oil as being absolutely essential."

Pughinsky predicted the government will grant only production sharing contracts in the future, paying foreign operators with oil, and will offer smaller areas but more tracts for bid.

Konoplyanik disagreed, saying several types of development agreements will be used, depending on the situation.

George Helland, an assistant U.S. Energy Department secretary for trade issues, said he sees "a total lack of understanding by some American oil companies on how to do business in the Soviet Union."

He also said companies increasingly are concerned that there is so much competition for business in Russia that valid proposals will be rejected simply because more proposals are pending.

REGIONAL DISSENT

Several speakers at the Philadelphia seminar noted increased dissension between the central and local governments on oil development issues, citing confusion over the Sakhalin Island concession as an example.

Matthew Sagers of PlanEcon Inc., Washington, D.C., reported an "increased assertiveness" in Siberia. "There's an increased feeling of exploitation there."

He said Russia has a key problem with the 12% production decline in Tyumen province, noting, "What happens in Tyumen is going to have a great influence on what happens to the oil and gas industry overall."

Alexander Arbator, Russian Academy of Sciences, said, "No one doubts the importance of foreign investment in Russia at this time."

He said in the Russian oil industry, expenses have gone up significantly, and production has fallen" for natural and technical reasons. Capital expenses have gone up eight times in Russia overall and 14 times in Tyumen.

He claimed as much as 1 million b/d of oil is lost due to evaporation, leaks, and transportation losses.

He also said foreign investment should be limited to secondary and tertiary recovery projects the Russians can't undertake.

Arbator admitted many Russians fear foreign oil companies will exploit the country's resources without fair compensation.

"Our oil experts aren't necessarily expert in negotiating business agreements," he said.