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Russia: Despite Risk, Foreign Investors Eager For Piece Of Energy Sector

Russian President Vladimir Putin and U.S. President George W. Bush discussed energy issues at their February summit in Bratislava. Oil production in Russia has been increasing at a spectacular rate since 2000. But growth in gas production has been relatively modest. The Russian gas industry has been waiting for two things to happen -- the introduction of pricing reform and the large-scale entry of oil companies onto the gas market. So far, neither has happened. Challenges include aging fields, ambiguous laws regarding foreign investment, and the influence of the state monopoly Gazprom on how the production and trade of gas is organized. But as a recent conference of Western investors indicated, Russia's vast gas and oil reserves continue to attract major interest.

New York, 29 March 2005 (RFE/RL) -- Hundreds of potential foreign investors who attended the conference in New York heard warnings that they should clearly calculate their risk tolerance before committing to the Russian energy market.

The circumstances were summed up by Peter Roberts, a partner in the Jones Day law firm, which has extensive operations in Russia and the Commonwealth of Independent States (CIS). Roberts told the conference that the incomplete regulatory framework in the gas industry is a major obstacle for foreign investors.

"There's duplication, contradiction, and overlap, which causes frustration," he said. "The Russian government recognizes this. They have a plan to reform the Russian legislative sector for the period up to 2020. At the moment, it's not very well formulated. It's long on principle but short on detail, but it's a step in the right direction."

A key part of the regulatory framework is the Gas Law of 1999. It helps regulate natural gas development, pricing, and marketing. The law mandates that the state retain ownership of at least 35 percent of common stock of Gazprom, the huge energy company. It also says that foreign investors may not own more than 20 percent of Gazprom common stock, or of regional gas enterprises' common stock.

Antoine Halff, director of global energy for Eurasia Group, a consultancy firm, said that, in Russia, one has to look not only at that gas law but also consider the constitution, the civil code, regulations concerning monopolies, subsoil law, and licensing law.

Halff said that the oil and gas sectors in Russia are still evolving. Russian companies are still trying to find their role within Russia and trying to expand their presence overseas.
"The [U.S.] business community in Russia has, I would say, excellent relations with the government. We feel we have a hearing. We have access to all of the key ministries at every level of decision-making." -- Andrew Somers, American Chamber of Commerce in Russia

"What we are witnessing in Russia is a trend which is not unlike that in other [oil] producing countries," Halff said. "Volumes might go down -- and I think that they are widely expected to go down tremendously this year -- but at the same time the value extracted for each barrel of Russian crude is likely to continue to go up, in line with international markets, but also in line with Russia's own conditions and marketing efforts overseas."

Other participants in the conference said competition for investment opportunities in Russia's energy sector will increase in the next three years. International and Russian oil companies and state oil companies from China and India will continue to drive the pressure for investment.

Andrew Somers, the president of the American Chamber of Commerce in Russia, said that during the recent presidential summit in Bratislava, the commercial energy dialogue between Russia and the United States was endorsed anew by presidents Vladimir Putin and George W. Bush.

"The [U.S.] business community in Russia has, I would say, excellent relations with the government," Somers said. "We feel we have a hearing. We have access to all of the key ministries at every level of decision-making. And despite some disturbing trends in the past year, our access and our efforts to work with the Russian government on business issues has remained, basically, very positive."

Somers said the Chamber of Commerce succeeded late last year in negotiating equal access to Russia's energy transportation infrastructure for smaller American investors who felt neglected in the past. He also said that the Subsoil Law -- how the Russian government will apportion licenses to provide the ability for companies to exploit Russian mineral resources -- appears neutral in terms of foreign and Russian investors and that the latest draft is likely be approved by the Russian parliament.

Other participants said Russia's energy sector is booming but that there have been serious attempts to undermine foreign presence in some fields. For instance, recently there was a proposal of the Russian Ministry of Natural Resources to limit investment in so-called "strategic energy fields" only to companies with a minimum of 51 percent Russian ownership. The proposal sent chills throughout the foreign investors' community in Russia.

Peter Roberts of the Jones Day law firm said foreign investors willing to expand in Russia's gas industry have to consider risks related to the incomplete regulatory framework, the desire of Russian companies to expand overseas, and competition for investment opportunities within Russia. He also underlined the special situation with Gazprom, where the relationship with investors is not clear in practice.

"This is an issue particularly with Gazprom," he said. "It has a huge position within the Russian market, everybody is aware of that. But there is something to be aware of as to how Gazprom aligns itself with foreign investors and how the foreign investors will align themselves with Gazprom."

Roberts said the Russian government's role in Gazprom needs to be clarified in order to give it a good chance to join the World Trade Organization.

Another stumbling block for foreign investors in Russia's oil and gas industry are the so-called production sharing agreements, or PSA. There is no single law regulating them, and there are a dozen pieces of legislation sometimes contradicting each other.

In 2004, for instance, Russian courts nullified a PSA for a gas-production project in Sakhalin won in 1993 by the U.S. companies Exxon-Mobil and Chevron Texaco. The courts ruled the PSA did not qualify for a license. By the time the agreement was nullified, the companies had spent more than 60 million dollars in exploration work.