The answer: the opportunities seem to far outweigh the risks. The major oil firms are under intense pressure from investors to find new reserves — now. With near record crude prices and Iraq in turmoil, Russia''s vast untapped wealth of oil and gas has never looked more attractive. There are production challenges: many of the reserves are located in remote locations deep in Siberia or above the Arctic Circle. Russia''s Minister for Natural Resources, Yuri Trutnev, has cautioned that extracting Russian oil will become increasingly difficult. Nonetheless, the Western oil companies are eager to export Russia''s reserves, which are conservatively estimated at 70 billion bbl. — more than double those of the U.S.
So the oil companies are piling in. In addition to the Conoco deal, Britain''s BP is investing a whopping $7 billion in a joint venture that controls huge fields in western Siberia, and in September, France''s Total agreed to pay $1 billion for a 25% stake in Novatek, Russia''s largest private gas producer. Many other companies, including ChevronTexaco, PetroCanada and Norway''s Statoil, are trying to get a foothold. All three recently signed preliminary agreements to work with state-controlled Gazprom, an oil-and-gas behemoth in which German power company E.On holds a 6% stake. And there is widespread speculation in Moscow that Sibneft, an oil company with proven reserves of 4 billion bbl., controlled by billionaire Roman Abramovich, could be in play.
Sibneft was scheduled to merge with Yukos until Khodorkovsky''s troubles erupted in October 2003. Abramovich and Yukos jostled for power for weeks afterward, until the merger finally unraveled earlier this year, prompting speculation that Sibneft may be looking for a Western buyer. It''s also possible that a Western oil firm might bid for Yugansk, although that would be asking for trouble. "Whoever buys it will be buying an enormous set of lawsuits," says Stuart E. Eizenstat, a former U.S. Undersecretary of State who is advising Group Menatep, an investment fund created by Khodorkovsky and his allies that owns 61% of Yukos.
Oil-industry executives describe the Yukos crackdown as an isolated event — a Russian oligarch incurred the wrath of the Kremlin because he got too big for his britches — not a concerted attack on the oil sector as a whole. Few top executives will talk about Yukos publicly, and most oil companies won''t comment on their Russian investment strategies. But John Browne, BP''s chairman, has defended his company''s deal. When questioned earlier this year about the possible fallout from Yukos, Browne said: "At present, I would say — and I believe this will continue — that there has been no effect." That ties in with a common theory in Moscow that Khodorkovsky ran afoul of President Putin because he climbed into politics by financing opposition parties in last year''s election.
Whatever the reason for the attack on Khodorkovsky, his supporters say the real issue is the rule of law, which affects all business. They cite what they say are the Kremlin''s numerous violations of both Russian law and general business ethics, including intimidating raids on Yukos offices by armed security forces, harassment of the company''s attorneys and the selective, retroactive application of new legal principles. If the Russian state can come down so heavy-handedly on one firm, the pro-Yukos camp argues, everyone is at risk. "It would be a very brave person that concluded Mr. Khodorkovsky is the end of the trail," says Tim Osborne, managing director of Menatep. Putin has said he wants to encourage Western investment and has no intention of destroying Yukos. Russian officials say the back-taxes claim is based on an official audit.
But Big Oil is also facing renewed Kremlin control of oil-and-gas production. After a period of privatization and deregulation in the 1990s, the pendulum has swung the other way. That doesn''t mean the central government wants to nationalize all energy assets, but it has put an end to generous tax breaks and has introduced other limitations on the private sector, particularly foreign companies. Under the terms of the Conoco deal, for example, the American company can raise its stake in Lukoil — but only to a ceiling of 20%, less than the 25% it needs to be able to block strategic company decisions. BP, by contrast, whose contract was signed eight months before Khodorkovsky''s arrest, has a 50% share in its Russian joint venture. "That''s a deal we won''t see repeated," says Jonathan Stern of the Oxford Institute for Energy Studies. "The climate now is for strategic minority investments by foreign companies in Russian energy." Says William F. Browder, president of Hermitage Capital, an investment group based in Moscow: "For foreigners, the opportunities are dwindling very quickly."
Big Russian firms are stepping in where foreign companies find it harder to tread. Foremost among them is the giant Gazprom, whose gas reserves were recently valued at $78 billion and which is actively pushing to become a big player in the oil market. It is merging with Russia''s seventh largest oil company, state-owned Rosneft, and Alexei Miller, Gazprom''s chief executive, has signaled his interest in another oil producer, Zarubezhneft. Most dramatically, Gazprom has emerged as the best-positioned candidate to acquire Yugansk.
There''s a particular irony in recent developments because it was Khodorkovsky — now behind bars — who first demonstrated to the world how viable Russian oil can be. Back in the 1990s, that wasn''t self-evident. The collapse of the Soviet Union was accompanied by a slide in Russian oil production, from a peak of almost 11 million bbl. per day in 1987 to just 6 million in 1996. Yukos blazed the trail — and helped reverse the oil slump — by investing heavily in existing fields in Siberia, bringing in Western technology and dozens of American and other experienced foreign managers. Partnering with Schlumberger, a U.S.-based oil-field-services company, Yukos became the biggest Russian player, accounting for 20% of total production. At a presentation at a Lehman Bros. energy conference a month before Khodorkovsky was arrested, Yukos boasted that its oil production was growing 20% a year while operating costs were less than half those of the biggest U.S. firms, including ExxonMobil, Chevron and Conoco. With Yukos mired in political trouble, its production gains have ceased. But its five-year run has borne fruit: since 1998, Russian oil production has risen back to more than 9 million bbl. per day, and according to independent estimates, Yukos is single-handedly responsible for more than a third of that increase.
The experience of BP suggests that Yukos'' success with modern production techniques wasn''t a fluke. After a year of operations, BP recently gave the first detailed report about its joint venture, called TNK BP. The surprises are all good: it has revised the level of reserves upward, production growth is well above the expected 7% annual increase, and the firm has decided to double its capital spending to make more of the opportunities it is finding. In the Soviet era, BP officials explain, oil wells were developed in a cookie-cutter approach; by tailoring solutions to each reservoir and well, the officials say, it''s possible to exploit them far more productively.
But BP has also run into the difficulties foreign companies typically face in Russia. The company''s first foray into the Russian market, in 1997, ended badly after Sidanco, a firm in which it took a 10% stake, went bankrupt. At the time, oil was near $10 per bbl., the Russian economy was sliding into crisis, and BP found its stake wasn''t big enough to influence Sidanco''s management. BP also ended up at loggerheads with other Russian shareholders at Sidanco, members of the private Alfa investment group headed by billionaire Mikhail Fridman. But Sidanco got back on its feet, and despite the earlier disputes, BP agreed to team up with Alfa to do the much bigger TNK deal. To help mitigate the political risk, BP took pains to keep the Russian government informed, and the final agreement was signed during a state visit by Putin to Britain. "Clearly, we needed to make sure the Russian state was not surprised by anything we did at any stage," says an executive involved in the transaction.
Yukos, by contrast, says it can''t get through to the authorities, no matter how hard it tries.
