Russia: The Greatest Threat to the Energy Markets

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As Yogi Berra aptly put it, It's deja vu all over again.

The Soviet gulag state is coming back and this time it could wreak havoc on the world's energy markets.

I began my energy career in Russia. Back then it was part of a sprawling Soviet Union. For the past 23 years there have been 15 independent countries in its place.

But these days it sure feels like the Beatles song from the late 1960s, "Back in the USSR."

You see, many governments aren't able to work out how to plot the global energy sector because it becomes too wrapped up in local political machinations.

And the bigger the energy producer, the bigger the impact is on the global picture.

Now the specter of repression is again moving across the Russian landscape - a huge energy producer - in a way not seen since the events I witnessed over there more than 30 years ago.

What's more, the political developments unfolding in Moscow are about to hit the energy markets. And the impact will be significant.

One People, One Voice

First, what's taking place inside Russia has all the earmarks of a Soviet-era consolidation of power. Vladimir Putin has been biding his time when it comes to political dissidents and opponents. But the increasingly heavy-handed moves to silence them are apparent.

The latest victim is somebody I happen to know personally. Sergei Guriyev is a well-known, articulate, and respected economist, director of the New Economic School in Moscow, an advisor to now Prime Minister (and past President) Dmitri Medvedev, and a frequent commentator in the foreign media.

Recently, Sergei was interrogated for several hours, had his office ransacked, and is now "vacationing" with his family in France. His crime was to provide an expert opinion for the defense in the ongoing persecution of Mikhail Khodorkovsky. 

In 2004, Khodorkovsky - then the head of YUKOS, Russia's largest oil company - was the richest man in the country and among the 20 wealthiest in the world.

By May 2005, he had been sentenced to nine years on tax charges. Subsequent charges filed by the state while he was in prison have extended that prison term until 2017.

There now seems little doubt that the Kremlin is orchestrating yet another series of charges against Khodorkovsky. And that put Sergei's testimony, claiming that the initial trials were politically motivated, squarely in the crosshairs of the siloviki, Putin's comrades from the old KGB. They're intelligence service veterans who have been solidifying the president's administrative control ever since his reelection.    

Meanwhile, YUKOS was also gutted, declared bankrupt and dismembered. Most of its assets ended up as part of Rosneft (OTC: RNFTF), now the dominant oil major in the country. Rosneft conducted an IPO on the London Stock Exchange several years ago, and about 25% of its shares now are in free trade.

But don't be misled. Despite now being the world's largest publicly-traded company, Rosneft is a state-controlled behemoth, and it guards the entrance to Russian oil projects like Cerberus guards the gates to Hades. Gazprom (OTC: OGZPY), also trading in the markets -- but firmly under state majority control -- serves the same function in natural gas.    

New Money in Russian Energy Patch

And that brings us back to what will occupy much of my time beginning next week.

There are now major international oil companies like ExxonMobil (NYSE: XOM); Italian ENI (NYSE: E), Norwegian Statoil (NYSE: STO), and BP (NYSE: BP) investing billions in Russian projects.

What is once again lacking is a consistent Western approach to how the energy component is to be viewed as the repressive hand of central government returns in Russia.

Certainly there are caveats here. Each of these international oil majors, along with dozens of other foreign companies, has voluntarily entered into a contract. Those contracts are legal and there is every indication that Russia will abide by the terms.

Each company also knows full well the risk it undertakes in these projects; there is no prospect that Washington, Rome, Oslo or London will be bailing out any corporate player if things don't pan out.

The problem lies elsewhere. The rise of unconventional (tight and heavy) oil is profoundly changing the global oil market. While we tend to focus on the additional reserves emerging in North America, there is actually considerable volume elsewhere in the world.

This is having an effect on OPEC. By 2020, if not sooner, 15%-18% of Saudi oil coming on market will be unconventional. And then there is OPEC member Venezuela, whose vast Orinoco basin reserves are very heavy (high viscosity) oil. 

This is also a Russian necessity. While Moscow will need to move out on the continental shelf, above the Arctic Circle, and out into Eastern Siberia to arrest an accelerating decline in production set to hit over the next few years, its primary move is in places like the Bazhenov.      

This is a vast stratum of very heavy oil, essential to arrest the current drop in Western Siberian production. To exploit the formation, Rosneft needs two essential elements: (1) technology (which the company does not possess); and (2) significant capital investment (which the government cannot afford).

It was access to both that prompted the Rosneft-Exxon mega deal. That accord includes Rosneft obtaining a minority position in Exxon heavy oil projects in the U.S. and elsewhere, with parallel joint development of such fields back in Russia.

That Exxon will foot the bill for field development hardly hurts the Rosneft cause, either.

All of which brings me back to the problem I face beginning next week. How do we set up a realistic cross-border energy policy in the face of renewed heavy handed tactics from the Kremlin bully boys? 

Sergei Guriyev will hardly be the last to feel the brunt of official pressure. His situation surrounded one oil company; my problem involves several existing oil companies that may soon experience the same pressure.

I have no interest in defending Exxon. It will do quite well on its own. My focus is on what happens to publicly-traded companies in general when they are forced to operate in an environment like the one developing once again in Russia. That environment will impact on the broader global oil market with a far more damaging and wide-ranging result.

There are always certain corners of the world containing attacks on genuinely open and competitive capitalism.  To me, it seems ludicrous that corporate bastions of a free market end up being weapons in that market's undoing.   

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About the Author

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle

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