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Analysis & Opinion
04.03.08 Gazprom’s Sochi
By Graham Stack

On Feb. 21, the CEOs of Russia’s Gazprom, France’s Total and Norway’s StatoilHydro signed a deal establishing the Shtokman Development Company, a joint venture that will develop (but not own) the eponymous gas field in the Barents Sea.

The timing was highly symbolic, ten days before the election of Gazprom’s Chairman Dmitry Medvedev as Russian president and ten days after lavish celebrations of Gazprom’s 15th birthday starring outgoing president Vladimir Putin. The Shtokman project epitomizes Putin’s policy of combining state control over oil and gas with accelerated development. The deal marks a new frontier for the pivotal Russian gas industry firmly under Russian state control.

The energy giant threesome formally established what had been agreed months ago. It is a special purpose vehicle that will develop the field while leaving the license in the hands of Sevmoreneftegaz, Gazprom’s 100 percent subsidiary. In contrast, Gazprom holds a 51 percent stake in the SPV. Total has 25 percent and StatoilHydro – 24 percent.

Gazprom comes up trumps

The creation of the Shtokman Development Company puts an end to a number of intrigues that developed over the past two years. In 2005, initial intense jockeying among foreign energy companies to join the Shtokman consortium resulted in a short list, comprising the Norwegian companies Statoil and Hydro, the U.S. majors Chevron and ConocoPhillips, and France’s Total.

Jaws dropped at Gazprom’s hubris in October 2006, when its CEO Alexei Miller declared that the company did not need any foreign partners to develop Shtokman, but would go at it alone. Then, in July 2007, Gazprom relented and closed a deal with Total, which the Financial Times termed possibly “the worst a foreign oil company has ever accepted in Russia.”

Gazprom retained full ownership of the field and the production license while gaining access to Total’s liquefied natural gas (LNG) expertise. Later the same year Norway’s merging Statoil and Hydro agreed to similar terms.

From the Russian point of view, there was poetic justice in avenging the humiliatingly one-sided Sakhalin PSA deals of the early 1990s. These had just undergone a major revision, and Gazprom cut in on the deal following foreign company harassment by Russian state watchdogs. In this case, the boot was on the other foot.

The deal, which reduced Western oil and gas majors to the role of mere contractors, was seen as catalyzing the era where multinationals would only be able to access reserves in junior partnership to state-owned companies.

Gazprom’s subsequent announcement that all Shtokman gas would go to Europe (without the liquid natural gas supplies previously envisaged for North America) combined with the exclusion of US companies from the project, pointed to geopolitical considerations and caused further irritation.

But this year, the emotional reactions have given way to a calmer approach. Observers were pleasantly surprised to learn that the foreign partners will be able to book the field’s reserves – boosting a key market indicator of long-term economic health of the companies and raising their status.

“They were originally hoping for ownership rights, but it was pretty clear that they weren’t going to get these. They were allowed to book reserves, which surprised analysts. That makes them much more than just contractors,” USB Moscow analyst Dmitry Loukashov said.

“Basically, what the foreigners get from this project is booking reserves proportional to their stakes in the SPV, and secondly, they will be entitled to profits. They will have ownership rights only to infrastructure, not to the field itself or the gas produced,” said Constantine Batunin, an oil and gas industry analyst at Alfa-Bank.

According to French energy expert Pierre Noel, the same results could have been attained through a conventional contract with shared ownership of the field. He argues that the difference is symbolic, but the issue itself, he believes, is all about symbolism of who has the upper hand.

However, one crucial aspect for Gazprom will be far from symbolic. The deal means Gazprom owns the gas, and thus dictates the markets where it will be sold. This secures Russia the extra-economic leverage, the “soft power” it is demanding from its resource base.

The tip of the iceberg

Having decided who will own the gas when it comes on stream, the only outstanding issue is drilling 4,000 meters below an uneven seabed, 350 meters below an iceberg-ridden ocean 550 kilometers from the mainland.

“They simply do not know exactly how they are going to do this,” Batunin said. “Gazprom admits this openly. It doesn’t pretend to hide the fact. But they believe they can do it, and the deadlines are tight, with gas to go on stream in 2010.”

In 1988, when the Soviet Union discovered the sprawling gas field 550 kilometers northeast of Murmansk (on the Kola Peninsula), the super-giant field was estimated to harbor some 3.2 trillion cubic meters, in addition to around 31 million tons of condensate.

The unique features of the field meant that assistance from foreign partners was inevitable. It is technological expertise, and not financial resources or market access that determined Gazprom’s choice of partners.

“It would have been impossible to pursue a project like Shtokman alone both financially and technologically. Total has expertise in LNG and deep sea projects, and the Norwegian companies have expertise in the area, so for Gazprom it is about risk reduction and sourcing technology,” Batunin said. “Frankly, it’s yet to be decided which technologies should be used for this project. It might not even be the Norwegian technologies. This is going to be an incredibly sophisticated project. All similar Norwegian projects are significantly less ambitious than this one, because the field is located very far offshore, and new technologies have to be created. These will be created on the basis of expertise that Statoil has, but they will be new.”

The project is mind-boggling. There are 565 kilometers of open sea between the Shtokman field and the onshore production facilities at the Barents port of Teriberka. A sea populated by icebergs and drift ice with sub-zero temperatures, polar nights, mega-waves and an uneven seabed. A total of 156 wells will be drilled to a depth of 1,900 to 2,300 meters below the sea floor. Four platforms will be built, and forty wells drilled directly from the seabed.

“Gazprom realized nobody would do this sort of job on a contractual basis,” says Loukashov. “The foreign partners will have more responsibility because of the technological demands.” Pierre Noel agrees that it was the technological difficulties that drove Gazprom to share risks.

But the main technological dilemma concerns the pipeline link to the mainland. Statoil managed to cover 160 kilometers from the pioneering Snovhit gas field to their liquid natural gas plant on Melkoya Island. Anything over that has never been attempted.

Is Gazprom up to the challenge? Politicized, bureaucratic and opaque, it would seem that the company is the weakest link in the Shtokman troika.

However, precisely by relegating foreign partners and taking most of the risk upon itself, Gazprom and the Russian government have turned the development of the Shtokman field into a prestige project – Gazprom’s very own Winter Olympics, substituting Shtokman for Sochi and symbolizing national revival. With the Russian penchant for gigantism and Gazprom’s chairman becoming president, this could mean there is too much hinging on the project for it to be allowed to fail.
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