RUSSIAN ROULETTE: International oil company risk in the Russian Arctic These alliances expose IOCs and their shareholders to risks including poor environmental and safety performance, questionable corporate governance, an unpredictable political, regulatory and fiscal regime and a lack of corporate transparency. Introduction The 2012 report ‘Out in the Cold: These alliances expose IOCs and Investor Risk in Shell’s Arctic Exploration’1 their shareholders to risks including explored how the end of easily accessible poor environmental and safety oil from conventional sources is driving performance, questionable corporate international oil companies (IOCs) to governance, an unpredictable political, ever more extreme forms of oil and regulatory and fiscal regime and a gas extraction – with the Arctic Ocean lack of corporate transparency. representing the last frontier. In addition to the increasing inaccessibility of This report: conventional oil and gas reserves, IOCs face a threat from the rise of resource P provides an overview of the Arctic sovereignty in Latin America, the exploration deals that have been Middle East and Russia. Governments made between an IOC and either are increasingly asserting control over Rosneft or Gazprom since 2011; the natural resources located in their territories. In the case of Russia, IOCs P examines Rosneft and Gazprom’s have entered a number of joint ventures environmental and safety performance (JVs) with Russian national oil and gas records, along with their experience companies Rosneft and Gazprom. BP has of offshore drilling at an executive additionally become Rosneft’s largest and senior management level; independent shareholder. These alliances aim to trade western capital along with P provides information on the complex technical capability and expertise for and shifting political landscape in access to oil and gas concessions in the Russia, which will have a direct impact Russian Arctic and continental shelf. on the future of the Russian oil and gas industry and its western participants; Shell’s 2012 Alaskan Arctic multiple operational setbacks, and the P proposes questions that shareholders company’s failure to meet US regulatory in IOCs should ask of those companies requirements on time, serve as a warning to clarify how such risks are about the significant challenges of Arctic being mitigated and managed. oil and gas exploration.2 Shell’s experience in the Alaskan Arctic has had a knock on effect on the exploration plans of ConocoPhillips3 and Statoil.4 However, at the same time, yet more alliances with Russian companies are being announced. Executive summary IOCs face pressure from investors to shareholders to all of Rosneft’s operations Gazprom’s subsidiary Gazflot has drilled achieve a positive reserves replacement and not just specific projects. In addition exploratory wells for Gazprom in the ratio (RRR) – the amount of proven to this shareholding, the companies have Pechora, Kara and Okhotsk seas. In reserves added to a company’s reserve recently announced that they are in talks 2010 as part of the Okhotsk Sea drilling base during the year, relative to the oil and about potential Arctic collaborations.11 programme, Gazflot continued drilling gas extracted.5 These companies are now outside of the approved season18 and targeting Russia’s continental shelf, with its OPERATIONAL RISK without carrying out all necessary government estimated reserves of 76bn As the IOCs carry the bulk of the JV assessments.19 The Kolskaya rig sank, killing tonnes oil equivalent.6 Access to the Russian exploration costs, JV partners and their 53 of its 67 crew20 (see Box 4, p18). Arctic is currently restricted to companies shareholders should be particularly with majority state ownership and five concerned about Rosneft and Gazprom’s Currently no member of the Gazprom board years’ Arctic experience and the only operational capability for successful and safe of directors has specific offshore experience. companies currently satisfying these criteria offshore drilling (see Section 2, p12). Shell’s No director of Gazprom has specific are Rosneft and Gazprom.7 Accordingly, 2012 Alaskan Arctic programme has shown responsibility for offshore projects. The head IOCs can only gain access to Russian that the extreme environment makes it of its exploration and production department, offshore reserves through involvement beyond the capability of even the most and a member of the management board, with one or both of these companies. advanced of IOCs. is Vsevolod Cherepanov, a geologist with 15 years’ experience at Gazprom’s Yamal- ALLIANCES Rosneft has never brought an offshore based (onshore) subsidiary.21 Unlike Rosneft, Beginning with BP’s now abandoned project to extraction stage as operator. Gazprom has shown no sign of addressing the 2011 joint exploration deal with Rosneft, While its subsidiaries had historical lack of offshore drilling expertise or oversight the last two years have seen a flurry of experience of exploring offshore blocks at board level. The company has no senior announcements of deals between IOCs around Sakhalin, it has been reported that, managers with experience of managing and one or other of the Russian national in 1998, Rosneft disposed of its entire fleet offshore drilling and has not made clear who oil and gas companies (see Table 1, p8). and laid off its entire offshore exploration at management board or director board level Exxon Mobil stepped in to replace BP with staff.12 Rosneft has recently sought to oversees its offshore exploration projects. Rosneft, and Statoil and ENI are also in JVs address the lack of offshore experience with the Russian company. Meanwhile, BP at management board level by appointing In addition to a lack of expertise at arranged the sale of its existing Russian to it the former Exxon Russia head, Zeliko board level, wider corporate governance venture (50% in TNK) to Rosneft in return Runje.13 And as part of the BP share concerns have been raised about Gazprom for cash and shares. Post completion of acquisition, BP CEO Bob Dudley will join the including its handling of contracts with this deal, BP will hold 19.75% in Rosneft.8 board of directors.14 However, while these related parties (see Section 4, p28). Recently, Shell has taken further steps appointments show Rosneft attempting towards cementing its own strategic Arctic to build capacity for offshore projects, the LACK OF TRANSPARENCY partnership with Gazprom, including a JV company has some way to go in ensuring Reporting on environmental performance for Arctic exploration,9 featuring the “same sufficient expertise at appropriate levels. and safety practices at both Rosneft terms” as Rosneft’s international JVs.10 This should be of particular concern to BP and Gazprom is incomplete. Rosneft’s shareholders and IOC shareholders where sustainability reports only provide an In these JVs, the IOC provides the majority Rosneft retains operational control in any JV. overall number of oil spill incidents resulting of the capital while Rosneft retains the from pipeline ruptures but not the volume majority stake, and to date its subsidiaries Rosneft was responsible for 2,727 or 75% of oil spilled or spills arising from other have acted as the operator. This exposes of spills in Russia’s largest oil province Yugra causes. Gazprom provides the total the IOC to Rosneft’s lack of offshore in 201115 while extracting only 25% of volume of oil spilled but not the number management experience and questionable the total regional output that same year16 of individual spills. In comparison, Shell operational practices (see Section 2). (according to the results of a report by the and BP report both. Gazprom’s reporting Investors in IOCs should seek clarification as environmental regulator Rosprirodnadzor on injuries and fatalities in its 2010–2011 to which company has operational control. published by the business paper Vedomosti). sustainability report22 entirely omits the Of the four companies featured in the Kolskaya incident in which 53 of 67 crew BP is currently unique among IOCs in holding report, Rosneft had the lowest overall died. Neither Gazprom nor Rosneft will a significant minority stake in Rosneft, environmental safety budget: $563m disclose their oil spill response plans for exposing the British company and its compared to TNK-BP’s budget of $897m.17 offshore projects (see Section 2.4, p20). In this context, an understanding of the Russian political landscape, the key corporate and political personalities and the tensions between them, together with stated government policy on the privatisation of Gazprom and Rosneft, are essential in evaluating the risks of an IOC investing in Russia This lack of public transparency has also The IOCs’ strategic decisions are predicated Currently Russia’s policy in energy, as extended to shareholders in Rosneft or in large part on the current regulatory well as practical control of the energy its subsidiaries. Most recently, Rosneft structure which grants Gazprom and companies, appears to be subject to a has come under criticism from minority Rosneft exclusive access to the Russian doubling up of policy structures. It is shareholders in TNK-BP subsidiaries Arctic and offers an attractive tax regime. contested between the cabinet of ministers (including BNP Paribas Partners) unhappy Accordingly, to profit from their Russian and Arkadaii Dvorkovich (vice PM for about Rosneft’s decision to use $10bn ventures, IOCs need to maintain stable energy) on the one hand, and