THE SHTOKMAN GAS DEAL: AN INITIAL ASSESSMENT OF ITS IMPLICATIONS

Gazprom’s just-concluded agreement with the French firm Total to develop the Shtokman gas field marks a new stage in Russia’s energy strategies and policies. First, it re-defines to Russian unilateral advantage the concept of Western access to Russian energy reserves, by separating access from ownership. Second, it opens the door for a major Russian role on the future global market for liquefied natural gas (LNG) — a move that would compound Russian dominance of markets for pipeline-delivered gas.

Shtokman is deemed the world’s richest known gas field, with reserves estimated at 3.7 trillion cubic meters of gas and 31 million tons of gas condensate. The field is located some 500 to 600 kilometers offshore in the Barents Sea, at depths of more than 300 meters under the surface. Field operations must contend with icebergs, storms, and the arctic night.

Gazprom lacks the necessary investment capital and technology to extract and liquefy the gas from Shtokman. However, Gazprom and the Kremlin successfully played Western companies against each other to enlist their technology and capital for the project, ultimately to Russian unilateral advantage.

On July 13 Gazprom’s vice chairman (acting chairman for the occasion) Alexander Ananenkov, Sevmorneftegaz director-general Yuri Komarov, and Total chief Christophe de Margerie signed a framework agreement on the first phase of Shtokman field’s development.

An unusual arrangement named the Special Purpose Vehicle (SPV) is being set up to function as an operating company at Shtokman. However, this operating company is separate from the hydrocarbon deposit. Total has no ownership rights to the minerals and no right to sell the products. Gazprom, through its 100%-owned subsidiary Sevmorneftegaz, remains the full owner of the Shtokman development license and shall be the full owner of products extracted there. Gazprom itself shall be the sole exporter and seller of the gas.

The SPV consists at this stage of Gazprom/Sevmorneftegaz and Total with stakes of 75% and 25%, respectively. Total shall be remunerated with 25% of the gas produced at Shtokman, to be transported through Gazprom’s pipelines. Gazprom retains the right to cede minority stakes in this project to international companies other than Total, with Gazprom retaining at least 51% of the overall shares in the SPV.

The SPV shall organize the financing, design, and construction operations for field development. The SPV’s country of registration and structure of management are yet to be determined. The life of the project shall be 25 years from the moment of starting commercial production.

The signing of this framework agreement is expected to be followed by a final investment decision in 2009. For its part, Total expects to invest some $15 billion in this project — the first of four planned development phases at the Shtokman field.

The first development phase is estimated to produce 24 billion cubic meters of gas annually from 2013 onward, with liquefaction and deliveries of liquefied gas starting by 2014. First-phase costs are estimated at $15 billion. In the second and third phases, gas extraction is slated to increase to 71.5 billion cubic meters annually; and in the fourth phase, to 94 billion cubic meters annually. Such estimates may well be exaggerated.

Gazprom continues talks with the Norwegian companies Statoil and Norsk Hydro (which are about to merge with each other) as well as with the U.S. company ConocoPhillips as possible participants with minority stakes in the Shtokman SPV. Gazprom had short-listed these companies — along with Total and the U.S. company Chevron — several years ago as possible shareholders to develop Shtokman as co-owners of resources and output, on the basis of production-sharing agreements. However, Moscow changed its intentions several times.

Last year, the Kremlin and Gazprom were considering whether to plan using the Shtokman output mainly for liquefaction and export by tankers to North America or mainly for supplying European countries through the Nord Stream pipeline to Germany and farther afield. In October 2006, President Vladimir Putin and Gazprom announced that the Shtokman output would go mainly to Germany and other European countries and that Russia would develop this field as the exclusive owner of the resources, using Western companies as contractors and service providers. In February 2007, however, Putin and Gazprom announced the intention to export Shtokman gas both through the Nord Stream pipeline to Europe and in liquefied form to global markets.

Total’s entrance ticket to Shtokman is the French company’s willingness to share its LNG technology with Gazprom, which lacks such technology. Thus, Total opens the first door for Gazprom to play a major role on the future global LNG market. Algeria’s Sonatrach and Petro Canada are also competing to share such technology to Russia, motivated like Total by short-term gain with little thought to strategic implications.

The novel SPV arrangement now offered to Total — and potentially to other Western companies — is only slightly better than the position of contractor or service provider. The SPV enables a Western company to receive long-term profits, rather than merely payments for work performed. However, Western companies opting for SPVs would share the high risks, but without ownership rights or decision-making powers. Such an arrangement is especially convenient for the Russian side in the high-risk environment of Shtokman, but also in the Arctic and Siberian environment generally, with reserves increasingly more difficult to reach for depth and distance.

Furthermore, Western energy champions are increasingly hard pressed to replace their reserves — a factor on which these companies’ share value significantly depends. Access to mineral reserves through a SPV may become somewhat acceptable as a form of reserve replacement, albeit a sub-optimal one, as such companies do not actually own the reserves in a SPV.

(Interfax, Agence France Presse, Le Monde, Bloomberg, July 13, 14)