Streetwise Professor

May 29, 2007

Russia Roundup

Filed under: Energy,Russia — The Professor @ 10:13 am

A few quickies on Russia.

It appears that BP-TNK will soon lose its license to the Kovykta gas project. No surprise. It also goes to show that, as I wrote on April Fool’s Day, dancing to Vlad’s tune won’t save you if you have something he really wants. Hopefully, other western energy companies will finally answer the clue phone and realize that playing go along to get along in Russia is futile. Lord Browne bent over backwards to appease Russia, and it did him and his company no good whatsoever. Going forward, these companies will have to develop a new legal structure to protect their investments in Russia. This will require an exchange of hostages, and a mechanism for adjudicating disputes that is not dependent on Russian courts. But most importantly, they have to learn to Just Say No and walk away if Russia doesn’t want to play by these rules.

I know the arguments–you gotta go where the resources are. But what’s the point of making investments in those resources unless you can protect them against expropriation once you’ve sunk billions into the ground (literally)?

Speaking of BP, one of my sources tells me that in years past, the company worked against the Transcaspian pipeline to protect other gas deals in the region from competition from lower priced gas from Turkmenistan. Turkmenbashi wanted to proceed, but BP (and Turkey) worked against him. When they had a change of heart, Turkmenbashi told them to pound sand. Further evidence of how the divided (and time varying) interests and agendas of western energy companies advance Russian interests and ultimately undercut their own.

And speaking of the Transcaspian, commenter James notes that Iran is likely to veto this project. Yes, James, the Transcaspian is a geopolitical minefield, and there are many obstacles and pitfalls. I didn’t mean to suggest in my original post that getting a deal done would be a diplomatic cakewalk–to the contrary. The very complexity means that getting a deal will be an arduous and complex task–and that the US and Europe don’t seem to be doing the heavy lifting required to get it done.

Money does make the world go round, though. The spread between the price that Gazprom pays Turkmenistan and the price they charge the Europeans represents a valuable rent that can be distributed to attract the necessary support for the venture.

Two major obstacles the US and Europe face in getting things to go their way are moral scruples and legal constraints on how–and to whom–that rent is distributed. According to this article in This is London, Gazprom has employed massive bribes to advance its interests:

Key to this triumph has been Alisher Usmanov and his Gazprominvest Holdings. This [Gazprom] subsidiary is the channel for massive slush funds. In November 2004, for example, a payment of £44million to Gulnara, the daughter of President Karimov of Uzbekistan, secured that country’s gas contracts for Gazprom from under the noses of the US.

In return for the cash, Putin instructed Karimov to kick out a US military base that dominated Central Asia, and Gazprom secured the strategic kingpin to dominate the Central Asian and Caucasus gas reserves.

To reiterate, the struggle will not be an easy one, but it is vital, and requires more assiduous–and creative–efforts than the US and Europe have undertaken heretofore. And the short-sighted actions of some companies–as in the BP example discussed above–don’t help one bit.

In this vein, James also points out that Chevron will benefit from the deal to ship Kazakh oil via Russia. Given the state of play, this is no doubt the rational thing for Chevron to do, but this is just another example of the negative contracting externalities that undermine American and European interests in the region. Friday I wrote about Whinston’s Lectures on Antitrust, and noted that I can think of few practical examples of his models of vertical restrictions (which are driven by contracting externalities) in a commercial context. However, some of these models describe Russian actions in energy to a “T.” Specifically, Whinston discusses models that show that bilateral contracts can have externalities, and can be used as part of a “divide and conquer” strategy. That is exactly what Russia is doing in the energy field; by offering relatively attractive deals to selected parties early on, they reduce the bargaining power of other customers later in the game.

Contracting externalities can best be eliminated by a coordinated, cooperative strategy among customers. It is just this coordinated approach that is lacking in energy. German, French, and Italian firms (often with the enthusiastic support of their governments) have been the worst offenders so far.

These companies and nations would do well to remember what Ben Franklin said at the signing of the Declaration of Independence: “We must, indeed, all hang together or, most assuredly, we shall all hang separately. ” Europe is going to the gallows one at a time; hopefully they will come to their senses soon before they all swing on Gazprom’s rope. After all, isn’t it things like this for which a European Union is truly useful? But no, Brussels bureaucrats seem to be too involved in enforcing politically correct speech and standardizing sausage ingredients to be bothered with such trivialities.

Oh, and one last thing. Make sure you read these two Edward Lucas posts.

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