‘Isolating Russia’ in the Oil and Gas Sector

(Gordon M. Hahn – gordon-hahn@sbcglobal.net – Analyst and Advisory Board Member, Geostrategic Forecasting Corporation, Chicago, Ill, geostrategicforecasting.com; Analyst, Rus Strategic Ltd., Prague, Czech Republic; Senior Researcher, Center for Terrorism and Intelligence Studies, Akribis Group, San Jose, Calif.)

Since the Russia’s annexation of Crimea in March in the wake of the revolutionary takeover in Kiev in February, U.S. policy has rested on a policy of isolating Vladmir Putin’s Russia. Economically, Washington has attempted to accomplish this by instituting a series of sanctions targeting high-ranking Russian state figures. Although some Western firms have been wary about doing business with Moscow, the devil in the details demonstrates that the sanctions’ effectiveness has real limits and may not build the wall Washington hopes to build around Putin’s Russia.

To be sure, the Russian stock market took a serious hit, but much of that came with the outbreak of the Ukraine crisis late last year and not as a result of Western sanctions. Moreover, major Western firms continue to do business with Putin and blacklisted members of his inner circle, especially in the energy sector, where most of Moscow’s bread is buttered. In this way, the West continues to prop up a regime it seeks to weaken if not de-stabilize.

Just in the last few weeks, major Western energy companies have signed large deals both with Gazprom and Rosneft, Russia’s top state-owned gas and oil companies, respectively, despite the sanctions on Russia and direct pressure on Western companies from Washington and Kiev to prevent them from so doing.

A striking symbol of Western energy companies’ continued cooperation with Moscow was the presence of ‘Exxon Mobil Russia’ President Glenn Waller and ‘Exxon Oil and Gas’ Vice President Roger Higham at the June 27th opening of the ‘Berkut’ fixed drilling sea platform’s operation some 135 kilometers off Russia’s Far East coast in the Okhotsk Sea as part of the Sakhalin-1 oil and gas project. Exxon Mobil will receive 30 percent of the Sakhalin project’s profits, and the Berkut offshore well is expected to produce 4.5 million tonnes annually.

During the opening ceremony, the two American CEOs stood next to Sakhalin Governor Aleksandr Khorovashin and Rosneft President Igor Sechin, a target of U.S. sanctions, and they were all connected via telebridge to Russian President Vladimir Putin in Kremlin. Putin congratulated his interlocutors on the high-tech sea platform’s start at the Arkutun-Dagi offshore field and noted the two companies’ “large joint plans, in particular the development of new fields and building liquefied natural gas production facilities.” (“Videokonferentsiya s burovoi platformoi ‘Berkut’,” Kremlin.ru, 27 June 2014, www.kremlin.ru/news/46085.) Putin’s last words referred to a contract extension Exxon Mobil signed in May with Sechin and Rosneft to build a natural gas liquification plant in eastern Russia for LNG export. Exxon Mobil also retains its 2011 deal with Rosneft giving it drilling rights on 11.4 million acres in Russia in exchange for rights given to Rosneft to purchase stakes in Exxon projects in North America. In other words, the Sakhalin projects and the American company’s cooperation with the sanctioned Sechin are moving ahead.

On the same day that the ‘Berkut’ drilling platform began operations, British Petroleum (BP) sign its second deal with Rosneft since the onset of sanctions. The five-year pact gives BP up to 12 million tonnes of refined oil products. (Olesya Astakhova and Katya Golubkova, “Russia’s Rosneft signs further oil products supply deal with BP,” Reuters, 27 June 2014.) In May, the two entities signed an agreement to reconnoit for shale oil in Russia.

Another limit to Western efforts to isolate Russia can be seen in recent attempts to subvert Russia’s $40 billion South Stream pipeline project – Moscow’s effort to circumvent troublesome Ukraine in transporting natural gas to Europe. South Stream will have an annual throughput capacity of 63 billion cubic metres, with the main pipeline extending some 2,446 kilometers (1,500 miles) from Russia under the Black Sea to Bulgaria, Serbia, Hungary and Slovenia and ending in Italy with conduits bringing gas to Austria.

In December, as the Ukrainian crisis was reaching boiling point, Brussels under pressure from Kiev and likely Washington ruled that all bilateral agreements signed between Russia and the seven EU member states involved in South Stream (Bulgaria, Serbia, Hungary, Greece, Slovenia, Croatia and Austria) were in violation of EU anti-monopoly legislation under the Third Energy Package. The TEP forbids companies from monopolizing production and transportation. Initally, the EU said the agreements would need to be renegotiated but then said it would refer the issue to the courts, which would cause a delay Moscow’s cash-strapped Gazprom can ill afford. (Najia Badykova “What Next for South Stream?,” FSU Oil and Gas Monitor, No. 24, 18 June 2014, p. 6.)

Moscow unleashed a diplomatic offensive to secure its South Stream partners’ cooperation. The contest is producing a split within the EU between Western European gas consumers who have access to alternative sources not transported from Russia through Ukraine and Eastern European gas consumers who do not. In June Bulgaria announced it was suspending contruction pending the EU review of the project’s compliance with EU anti-monopoly policy, but since that decision Bulgarian Energy Minister Dragomir Stoynev has emphasized Sofia’s participation in South Steam is “irreversible and important for both Europe and Bulgaria,” which “cannot be hostages of this conflict between Russia and Ukraine.” (Najia Badykova “What Next for South Stream?,” FSU Oil and Gas Monitor, No. 24, 18 June 2014, p. 4.) Serbia, a traditional Russian ally negotiating to join the EU, initially halted construction under EU pressure in May but quickly reaffirmed its support for South Stream, saying it would re-start construction in July. Hungary’s Prime Minister Viktor Orban continues to express Budapest’s strong support for South Stream. (“Russia, Serbia declare continued support for South Stream,” FSU Oil and Gas Monitor, No. 24, 18 June 2014, p. 5.) Hungary’s Prime Minister Viktor Orban also expressed Budapest’s support for South Stream at a mid-June global security conference in Slovakia. (Najia Badykova “What Next for South Stream?,” FSU Oil and Gas Monitor, No. 24, 18 June 2014, p. 4.)

In late June, Putin traveled to Vienna a secured an agreement with Austria’s OMV to construct Vienna’s stretch of South Stream (“OMV, Gazprom sign agreement on Austrian section of South Stream,” FSU Oil and Gas Monitor, No. 25, 25 June 2014). Gazprom and OMV agreed to split the 200 million euro ($272 million) costs of building the 50-km (31- mile) Austrian leg. Austrian President Heinz Fischer speaking of Russia and Gazprom noted that “there will be no such moment when such a country as Austria will not be holding talks with a partner, which has intense relations with us, and will not be ready to negotiate with it.” (Tyler Durden, “Putin Scores Another Historic Victory: Austria Signs South Stream Pipeline Deal in Defiance of Europe,” Zero Hedge, 24 June 2014, www.zerohedge.com/news/2014-06-24/putin-scores-another-historic-victory-austria-signs-south-stream-pipeline-deal-defia.)

In reality, by obstructing South Stream – a fairly distant future fuel source anyway – Europe will only cut off its nose to spite its face, for reliance on Gazprom supplies through Ukraine has again provent to be fraught with difficulty, with the latest cutoff of supplies caused by the Russian-Ukrainian conflict.

An unexpected ray of hope for the isolation policy and European energy security emerged when Nigeria, Europe’s sixth largest source of natural gas, offered to step into the breach and replace any shortfall caused by a Gazprom cutoff any time soon. (Andy Tully, “Nigeria Offers To Step In If Russian Gas To EU Is Interrupted,” Oilprice.com, 26 June 2014, http://oilprice.com/Energy/Natural-Gas/Nigeria-Offers-To-Step-In-If-Russian-Gas-To-EU-Is-Interrupted.html.)

In sum, just like Rosneft’s relations with American energy companies, Gazprom’s business in Europe will continue. Of course, outside Europe, Russia is an even better position. For example, it just concluded the ‘energy deal of the century with Beijing and India is pursuing a comparable deal.

There is irony in all this. The U.S. government has long charged Putin and his inner circle of state oligarchs with enriching themselves through their control of state enterprises especially in the oil and gas sector. Yet Washington’s sanctions over the Ukraine crisis and Moscow’s annexation of Crimea include a loophole for U.S. companies to continue working with Russian state enterprises under the leadership of those very same state oligarch CEOs. The abovementioned contracts do not violate the letter of the sanctions ‘regime’ because entities like Rosneft are not targeted. Sanctions lists only include individuals like Rosneft CEO Sechin, who is under a visa ban and asset freeze from the United States since April. The sanctions allow American entities to work with Russia’s state energy giants and allow sanctioned individuals like Sechin to function as signatories. U.S. companies must only consult with the Office of Foreign Assets Control before concluding contracts with Russian entities tied to individuals designated under the sanctions. (Alan Katz, “Follow the Money to Putin Inc. to See Why U.S. Struggles with Russia,” Bloomberg, 25 June 2014, www.bloomberg.com/news/2014-06-25/putin-pals-dealing-with-u-s-firms-make-sanctions-useless.html.) Thus, such Russian-American projects violates the very ‘spirit’ and purpose of the West’s sanctions regime and reveals why it will have a limited effect on the Russian economy and state.

There is another, more symbolic irony. Although the aforementioned Okhotsk Sea platform was named in 2012, its title – ‘Berkut’ – is one and the same as the Ukrainian special police forces that beat up Kiev’s peaceful demonstrators in November 2013 and were accused of deploying snipers against violent demonstrators on 18-20 February 2014. Thus, ‘Berkut’ invokes the very authoritarian strain in Russian and pro-Russian Ukrainian politics that the West says caused the Ukraine crisis.

For the West, this crisis supposedly demands ending close economic cooperation with Moscow that finances the ‘neo-imperialist’ Russia state. In reality, the sanctions regime and efforts to block Russian projects like South Stream fall short of this goal and facilitate continued Western-Russian interdependence rather than Russian isolation. If the West actually sees Putin’s Russia as a serious threat to regional and global security, as it has claimed, then it must get serious about isolating Moscow. That means sanctioning Russia’s key economic entities.

That means sanctioning Russia’s key economic entities. Washington took a step in this direction in late April’s second round of sanctions which in addition to targeting individuals also included business entities, in particular Russian natural gas pipeline construction firms Stroygazmontazh, Volga Group and its Stroitransgaz subsidiaries. (www.treasury.gov/press-center/press-releases/Pages/jl2369.aspx)
In lieu of major entity sanctions, Washington should forget about isolating Russia, tone down the rhetoric and seek a diplomatic exit from the crisis. Otherwise, its ambiguous policy only serves to prolong Ukraine’s agony and the market anxieties it engenders.