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Thesis - Relationship between Political Decisions and FDI in the Russian Energy Sector.


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Relationship between Political Decisions and FDI in the Russian Energy Sector.

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Thesis - Relationship between Political Decisions and FDI in the Russian Energy Sector.

  1. 1. Relationship Between Political Decisions and FDI in the Russian Energy Sector
  2. 2. Abstract <ul><li>This paper will look at two case studies of Western energy companies doing business in Russia to explore the factors that have the biggest impact on large scale Foreign Direct Investment (FDI) projects. </li></ul>
  3. 3. Outline of Thesis <ul><li>Introduction </li></ul><ul><li>The History of Soviet Energy Policy </li></ul><ul><li>Risk and FDI in Russia </li></ul><ul><li>Case study: Sakhalin-1 - Consortium led by Exxon </li></ul><ul><li>Case Study: Sakhalin-2 - Consortium led by Shell </li></ul><ul><li>Case Comparison </li></ul><ul><li>Conclusion </li></ul>
  4. 4. Introduction <ul><li>Investment climate in Russia is fairly risky </li></ul><ul><ul><li>2008 –Corruption Perceptions Index – Russia was ranked 147 out of 180 </li></ul></ul><ul><ul><li>Government break up of Yukos </li></ul></ul><ul><ul><li>BP cedes control of its joint venture TNK-BP to Russian executives </li></ul></ul><ul><ul><li>Legislative and political risk </li></ul></ul>
  5. 5. Introduction <ul><li>Economy is heavily dependent on the oil and gas sector </li></ul><ul><ul><li>Revenues from this sector account for around 20.5% of GDP </li></ul></ul><ul><ul><li>30% of FDI in Russia goes to this sector </li></ul></ul><ul><ul><li>Oil and gas exports comprise approximately 64% of all export generated revenues </li></ul></ul>
  6. 6. Soviet Energy Policy <ul><li>Within context of a Socialist system </li></ul><ul><ul><li>True prices not known </li></ul></ul><ul><ul><li>Inefficient allocation of resources </li></ul></ul><ul><ul><li>Energy resources were abundant </li></ul></ul><ul><li>Policy was to increase spending to fulfill centrally planned production targets </li></ul><ul><ul><li>Irregardless of prices </li></ul></ul><ul><ul><li>Little incentive to improve technological and managerial processes </li></ul></ul>
  7. 7. Soviet Energy Policy <ul><li>Export revenues subsidized domestic consumption </li></ul><ul><ul><li>Oil and gas at high prices – consumption remained the same </li></ul></ul><ul><ul><li>Oil and gas at low prices – consumption declined due to increase in production to maintain export levels, leaving less oil and gas available for domestic consumption </li></ul></ul>
  8. 8. Risk and FDI in Russia <ul><li>Uncertain property rights – only short term licenses issued for natural resource property rights </li></ul><ul><ul><li>Short term licenses encourage under-investment and short term profit taking. </li></ul></ul><ul><ul><li>This means companies are acting rationally given their operating environment. Not Irrationally! </li></ul></ul><ul><ul><ul><li>Yukos </li></ul></ul></ul>
  9. 9. Risk and FDI in Russia <ul><li>Inherent risks of a Petro-state </li></ul><ul><ul><li>Energy sector main driver of economy </li></ul></ul><ul><ul><ul><li>Revenues account for around 20.5% of GDP </li></ul></ul></ul><ul><ul><li>Addicted to resource rent? </li></ul></ul><ul><ul><ul><li>Abnormal profits increase as production increases due to a resource being non-renewable </li></ul></ul></ul>
  10. 10. Risk and FDI in Russia <ul><li>Inherent risks of a Petro-state cont’d </li></ul><ul><ul><li>Can Russia diversify away from this sector? </li></ul></ul><ul><ul><ul><li>Production declines attributed more to rational political decision making given their addiction to oil and gas rather than authoritarian irrational decisions </li></ul></ul></ul><ul><ul><ul><li>This knowledge can mitigate risk allowing foreign firms to work successfully within this environment </li></ul></ul></ul>
  11. 11. Risk and FDI in Russia <ul><li>Culture </li></ul><ul><ul><li>Regional attitudes toward foreign companies vary tremendously </li></ul></ul><ul><ul><ul><li>Distrust of foreigners vs. need for foreign capital </li></ul></ul></ul><ul><ul><li>Capitalist system with continuing remnants from the socialist system </li></ul></ul><ul><ul><ul><li>Attitudes of politicians, management, and workers toward economic systems </li></ul></ul></ul>
  12. 12. Risk and FDI in Russia <ul><li>Uncertain legal environment </li></ul><ul><ul><li>Uneven application of environmental and tax laws </li></ul></ul><ul><ul><li>Justice is more about who you know and less about working out differences through legal means </li></ul></ul>
  13. 13. Sakhalin-1 <ul><li>Exxon led consortium in Sakhalin, Russia </li></ul>
  14. 14. Sakhalin-1 <ul><li>Largest single FDI project in Russia </li></ul><ul><li>Formed through production sharing agreement (PSA) with Russian government </li></ul><ul><li>Partners: </li></ul><ul><ul><li>Rosneft (Russia) 20% </li></ul></ul><ul><ul><li>Sodeco (Japan) 30% </li></ul></ul><ul><ul><li>ONGC (India) 20% </li></ul></ul>
  15. 15. Sakhalin-1 <ul><li>2006: Exxon announced budget increase. Following events occurred - in order </li></ul><ul><ul><li>Possible cost overruns made known to government </li></ul></ul><ul><ul><ul><li>Would negatively affect Russian government’s stake in the project </li></ul></ul></ul><ul><ul><li>Government accused Exxon of violating environmental regulations and threatened litigation </li></ul></ul><ul><ul><li>Exxon warned Russia to honor PSA as the project was highly visible worldwide </li></ul></ul><ul><ul><li>Government backed off </li></ul></ul>
  16. 16. Sakhalin-1 <ul><li>Natural Gas </li></ul><ul><ul><li>17.3 trillion cubic feet </li></ul></ul><ul><ul><li>No LNG facility </li></ul></ul><ul><ul><li>Gazprom (Russia) wants gas for domestic use </li></ul></ul><ul><ul><ul><li>Will buy at below market prices </li></ul></ul></ul><ul><ul><li>Can export under PSA </li></ul></ul><ul><ul><ul><li>East Asian customers only accept LNG </li></ul></ul></ul><ul><ul><ul><li>China will accept gas but a pipeline needs to be built </li></ul></ul></ul><ul><ul><ul><ul><li>Russia has denied permits </li></ul></ul></ul></ul>
  17. 17. Sakhalin-1 <ul><li>Has met requirements of PSA </li></ul><ul><ul><li>Doesn’t need budget approval from Russia </li></ul></ul><ul><li>Government pressure on Exxon </li></ul><ul><ul><li>Using environmental regulation </li></ul></ul><ul><ul><li>Through state-controlled Gazprom to buy gas at below market prices </li></ul></ul><ul><li>Exxon remains majority owner </li></ul>
  18. 18. Sakhalin-2 <ul><li>Gazprom led consortium in Sakhalin, Russia </li></ul>
  19. 19. Sakhalin-2 <ul><li>Largest integrated oil and gas project in Russia </li></ul><ul><li>Formed through production sharing agreement (PSA) with Russian government </li></ul><ul><li>Partners: </li></ul><ul><ul><li>Gazprom (Russia) 50% + 1 share </li></ul></ul><ul><ul><li>Shell (Netherlands) 27.5% - 1 share </li></ul></ul><ul><ul><li>Mitsui (Japan) 12.5% </li></ul></ul><ul><ul><li>Diamond Gas (Japan) 12.5% </li></ul></ul>
  20. 20. Sakhalin-2 <ul><li>Original owner was Shell with 55% </li></ul><ul><li>Gazprom not originally in consortium </li></ul><ul><li>Gazprom sets strategic objective to gain controlling stake in Sakhalin 2 </li></ul><ul><li>Natural Gas from this project expected to add 5% to global capacity </li></ul><ul><li>LNG facility planned (Opened 2009) </li></ul>
  21. 21. Sakhalin-2 <ul><li>Starting in 2005: </li></ul><ul><ul><li>Gazprom and Shell agree to asset swap giving Gazprom 25% stake </li></ul></ul><ul><ul><li>Shell then unexpectedly announced $10 billion cost overrun. (significantly decreasing revenues to government and Gazprom under PSA) </li></ul></ul><ul><ul><li>2006 - government accused Shell of environmental violations </li></ul></ul><ul><ul><li>Government recoups environmental damage costs by giving Gazprom controlling stake in project </li></ul></ul>
  22. 22. Case Comparison <ul><ul><li>Always had domestic partner </li></ul></ul><ul><ul><li>Informed government and Russian partner of budget issues well in advance </li></ul></ul><ul><ul><li>Strong connections to Russian officials through Rosneft partnership </li></ul></ul><ul><ul><li>No LNG facility </li></ul></ul><ul><ul><li>Remains majority partner </li></ul></ul><ul><ul><li>Did not have domestic partner </li></ul></ul><ul><ul><li>Cost overruns came as a surprise </li></ul></ul><ul><ul><li>Loose connections to Russian officials </li></ul></ul><ul><ul><li>LNG facility </li></ul></ul><ul><ul><li>Lost majority control </li></ul></ul>
  23. 23. Case Comparison <ul><li>Quotes explaining outcomes: </li></ul><ul><ul><li>“ Shell is always resisting, instead of accommodating, they come out with lawyers and try to prove their case.” - Project contractor </li></ul></ul><ul><ul><li>“ The problem is that in the Russian psyche justice and law are not the same thing ” - Senior Russian official </li></ul></ul>
  24. 24. Conclusion <ul><li>Russia not as inclined to respond as strongly to global feedback mechanisms </li></ul><ul><ul><li>Russia seems to be more concerned with securing energy resources than reputation </li></ul></ul><ul><ul><ul><li>Strategic sector to National Security </li></ul></ul></ul><ul><ul><li>Continues to pressure foreign energy firms </li></ul></ul><ul><ul><li>Uses indirect methods of expropriation </li></ul></ul><ul><li>Energy firms not as prone to curtail FDI when compared to other sectors in Russia </li></ul><ul><ul><li>FDI continues to increase in Russian energy sector </li></ul></ul>
  25. 25. Conclusion <ul><li>Legislative risk </li></ul><ul><ul><li>Getting riskier but can work within the system </li></ul></ul><ul><ul><ul><li>Exxon example </li></ul></ul></ul><ul><li>Geopolitical risk </li></ul><ul><ul><li>Can mitigate by understanding history, culture, and operating environment </li></ul></ul><ul><ul><ul><li>Decisions are almost always rational </li></ul></ul></ul>