Vladimir Radyuhin

India must adapt to the dramatically changed situation in the Russian market if it wants to get broader access to that country's vast oil and gas resources. New Delhi can no longer hope to exploit the rhetoric of a "strategic partnership."

THE YEAR 2006 marked a high point in President Vladimir Putin's seven years in power: following the takeover by Russia's state-owned natural gas monopoly Gazprom of the huge Sakhalin-2 oil and gas project in December the Russian government has reasserted strategic control over the bigger part of the country's energy resources. Sakhalin-2 was the only major energy project in Russia without direct Russian involvement. It and Sakhalin-1 are the biggest new energy projects in Asia, holding between them nearly half a billion tonnes of oil and a trillion cubic metres of gas.

Sakhalin-1, where ONGC-Videsh Ltd. has a 20 per cent stake, and Sakhalin-2 were set up under production sharing agreements signed in the 1990s, when crude was a third of today's price, and Russia did not have funds nor expertise to develop offshore oil and gas fields.

Today when the Russian economy has bounced back and is flush with oil export revenues, the Kremlin sees production sharing agreements as unfair deals. Under PSAs, the Russian government will not start sharing in the profits until after the projects' investors have recouped all their costs.

Russia's tolerant attitude to the PSA deals snapped earlier this year when their operators announced huge cost overruns from an initial $12.8 billion to $17 billion for Sakhalin-1 and from $9.8 billion to $22 billion for Sakhalin-2. Using environmental violations estimated to have caused multi-billion-dollar damage as an instrument of pressure, the Russian government forced Royal Dutch Shell, the Sakhalin-2 operator, to relinquish control of the project to Gazprom.

Initially Shell and its two Japanese partners hoped to buy a reprieve by giving up a 25 per cent share in Sakhalin-2 in exchange for a stake in another field in Siberia, but eventually had to sell the controlling share of 50 per cent for $7.45 billion, about $1 billion less than the market price, and accept cash instead of assets. They also agreed that $3.6 billion of cost overruns would not be reimbursed to them.

Sakhalin-1 has also come under pressure, but not nearly as crushing as Sakhalin-2, probably because it has a Russian partner, Rosneft. The Russian Energy Ministry has denied Exxon, the Sakhalin-1 operator, extension of license territory, cutting the projected output of Sakhalin-1 by around 10 per cent. The Ministry has decided to auction adjacent fields for development under much tougher Russian legal and tax regimes. Media reports said Rosneft was keen to buy out OVL's share in Sakhalin-1. Rosneft denied the reports, but they certainly did not add confidence to the Indian investor.

The sweeping revision of the Sakhalin-2 deal demonstrated just how far Russia has travelled since the heady days of President Boris Yeltsin, when Russian resources were sold for peanuts. Mr. Putin has brought Russia's energy resources back under government control to advance several strategic goals: sustain rapid economic growth, win access to Western technologies, and integrate Russia into the world economy.

In the opinion of U.S. scholar Marshall Goldman, energy resources and control over export pipelines have made Russia more powerful than at any time in its history. "Russia is more powerful now than it ever was during the czarist era or the Soviet era," he told the Jamestown Foundation recently. "In the Soviet era there was mutually assured destruction. They had nuclear weapons. We had nuclear weapons. We didn't use them, because we were worried they would and vice versa. Here you don't have that kind of restraint."

India must learn its lessons from the dramatically changed situation in the Russian market if it wants to get broader access to Russia's vast oil and gas resources. Lesson Number One is that oil assets in Russia are no longer up for sale to the highest bidder. Russia, awash with petro-dollars, no longer needs cash. India was confronted with this stark new reality last year when Rosneft repaid in cash the $1.2-billion loan OVL had extended to it as part of the deal to get India into Sakhalin-1. This dashed OVL's hopes to be paid in crude and reduced the Indian exposure in Sakhalin-1 to $1.5 billion.

In October, Gazprom shocked the global energy market when it dropped plans to give a 49 per cent interest in the Shtokman gas field to Western companies under a PSA arrangement and decided to retain complete ownership of the world's biggest gas deposit in the Barents Sea, bringing in foreigners only as contractors. Explaining the change of Gazprom plans, its head Alexei Miller said: "Foreign companies failed to offer us assets commensurate with the size and quality of the Shtokman field's reserves."

The turnaround on Shtokman showed that henceforth Russia will demand assets and technologies from other countries and companies for access to its energy resources. President Putin bluntly told European nations that Russia wants to buy into their downstream projects and to form strategic partnership with the European Aeronautic, Defence and Space Company (EADS).

Petroleum Secretary M.S. Srinivasan, who accompanied Petroleum and Natural Gas Minister Murli Deora to Moscow in October, told reporters that India would like to buy 50 million tonnes of Russian oil or a quarter of the country's annual oil imports in the next decade. This goal may not be as fantastic as it sounds, considering that Russia plans to increase the share of its energy exports to Asia from the current five per cent to 25 per cent. However, Asia has other avid energy consumers such as China, Japan, and South Korea. The crucial question is what would motivate Russia to sell its oil and gas to India?

During his October visit to Moscow, Mr. Deora offered Russian companies participation in India's downstream energy sector, including a stake in Indian Oil Corporation's proposed $4 billion Paradip refinery and petrochemical project in Orissa. This appeared to be in line with the new rules of the game set by the Kremlin. However, after his return from Moscow, Mr. Deora told The Hindu that India was seeking to invest in the Russian oil and gas sector on the lines of participation in Sakhalin-1, that is, on PSA terms, which Russia has ruled out for future projects.

Lesson Number Two is that India can no longer hope to exploit the rhetoric of "strategic partnership" with Russia to win lucrative energy deals. It worked for Sakhalin-1, when President Putin took a political decision to dump British Petroleum in favour of OVL. But that was five years ago. Hopes in Moscow that the Congress-led United Progressive Alliance Government in Delhi would push the bilateral agenda more energetically have not materialised. Moreover, India has tangibly tilted towards the United States since 2004. With Indo-Russian trade stagnating at around $2-3 billion for years now, there is not much to underpin "strategic partnership" apart from massive purchases of Russian weapons.

Lesson Number Three is that India needs to act more aggressively and consistently if it hopes to expand its foothold in the Russian energy sector. A surge in Indian interest in Russian oil and gas demonstrated by Mani Shankar Aiyar, who as Petroleum Minister paid three visits to Russia within one year, gave way to a slump that is hard to explain. Mr. Deora did not visit Russia until a full 12 months after Mr. Aiyar's last visit, and his trip was so hastily arranged that he could not meet any captains of the Russian energy industry. It was during those 12 months that ONGC missed a chance to cement its cooperation with Rosneft by buying a stake in its initial public offering (IPO) and lost the bid for Russia's Udmurtneft to China's Sinopec.

It does not help much to complain, as Indian officials sometimes do, that India's privately owned companies cannot go in for not-quite-market deals with Russian public sector companies that Chinese state-owned firms can. (In the case of Udmurtneft, Sinopec resold the controlling stake to Rosneft.)

The argument about a mismatch between private and government companies would be at least partly relevant if nationalisation and consolidation of state control over energy resources were a purely Russian phenomenon. But it is a global and growing tendency that one must learn to live with.

India has no time to lose in penetrating the Russian market. President Putin, who personally intervened to get India onboard in Sakhalin-1, will step down in early 2008. The next generation of Russian leaders may not share his Soviet-era soft spot for India. As First Deputy Prime Minister Dmitry Medvedyev, tipped to succeed Mr. Putin, said recently, "We are ready to forge an energy partnership with India... but India has to cover its part of the road."