Slick Moves In Russian Oil

The Russian stock market rallied on the news that Russia's government owned oil behemoth Gazprom was buying Rosneft. The combined entity is estimated to control some 117 billion barrels of oil, a sum reported by CBS Marketwatch as being five times as large as the amount of reserves owned by Exxon Mobil.

The Russian government's main selling point, is that the merger will allow foreigners to invest in the Russia oil industry with fewer restrictions.

But, there is little doubt about it, the Russian government is trying to pull a bit of a fast one. In fact, a case could be made for the Russian government using the merger in order to gain a free ride into lucrative Siberian oil exploration.

According to a Stratfor analysis, the timing of the Rosneft-Gazprom merger, is a sign that Russian bureaucrats are making their move, toward self enrichment. Here are the key points in the Strtatfor argument:

Stratfor notes that "Under Russian law, Gazprom holds sole rights to export natural gas from Russia to other countries." But the venture between BP and Russia's TNP has carved itself a niche that has kept Gazprom out of the loop, the Kovykta project. According to Stratfor: "Kovykta is a huge natural gas field far removed from the Russian gas grid, but still on the transport grid in a region relatively close to China. TNK-BP holds majority control in the Kovykta field and hopes -- the final route has yet to be determined -- to construct a $17 billion export pipeline that ultimately will supply natural gas to China and South Korea."

But, there is a game of Russian chicken unfolding, as according to the agreement between the companies and the Russian government, "As part of the project, TNK-BP agreed to construct a local supply network." Stratfor notes though that "not only has construction on the export line not begun, the government has not yet given the go ahead for TNK-BP to export the gas in the first place. Unsurprisingly, TNK-BP has not drilled one production well. No production, no local network."

The net effect is that "Russian Resources Minister Yuri Trutnev said he might cancel TNK-BP's development license for the Kovykta natural gas field in Russia's Irkutsk region, ostensibly because of the firm's failure to build a local pipeline network."

And here is where the free ride comes in, Russian style: "BP often has invited Gazprom to participate in Kovykta, and indeed there is a 36 percent share in Rusia Petroleum -- the TNK-BP led firm that holds the field's license -- which are potentially up for sale. BP's conditions for Gazprom are simple: purchase the available shares, join the consortium and take an equal share of the project's costs and benefits. Gazprom, however, has another idea. Because it holds a monopoly on exports from Russia, it does not believe it should pay anything to join the consortium or build the pipeline and should simply rake in profit from its mere presence. Understandably, BP does not much care for subsidizing Gazprom's presence in what could ultimately be upwards of a $50 billion project."

The net effect is likely to be very negative. Stratfor concludes that although "this is not yet the end of the road for Kovykta," the project's survival is "more than ever dependent upon Putin personally."

To be sure, according to Stratfor "Kovykta has been threatened by internal Kremlin politics (with enthusiastic Gazprom backing) before, and the project most likely continues to exist only because of Putin's personal intervention. The problem is, for the project to go forward, Putin must step in boldly and repeatedly to affirm BP's rights at Kovykta. Not only is this not Putin's style, but the president is now in charge of a one-man state, and cannot be everywhere at once. Nor can he delegate this task: Gazprom's CEO Alexei Miller is one of Putin's most loyal lieutenants and he clearly has his own agenda. Without a firm and steady hand from Putin, Gazprom ultimately will get its way, and Kovykta's gas will remain buried under the Siberian wilderness."

This isn't the first time this year that Russian bureaucrats have been out to extort foreign oil companies. In February, we reported that "ExxonMobil's patience, principles, and guile should be tested by the Russian proposal of a $1 billion dollar fee for the rights to explore for oil in the Sakhalin islands. What makes this more interesting is the fact that Exxon has already been exploring the same field for almost a decade, and has already paid the Russian government some $60 million by some accounts.

We noted then, quoting The Moscow Times that "on 2-5 - Energy Minister Igor Yusufov (stated) that the (Russian) government wants up to $1 billion for a license to explore and develop one of the three Sakhalin-3 blocs that a consortium led by ExxonMobil won in a tender a decade ago. The announcement came a week after the government decided to annul the 1993 tender to explore the gas- and oil-rich project in the Pacific Ocean -- a move that U.S. Ambassador to Russia Alexander Vershbow on Wednesday called worrisome and potentially harmful to U.S.-Russia ties. Yusufov said the state wants to auction off Sakhalin-3's Kirinsky block, the largest of the project's three blocks with estimated reserves of 453 million tons of extractable oil and 700 billion cubic meters of gas."

In February we added "Bloomberg quoted Yusufov as saying that: ["The government must receive money for this field as we cannot live now with the system of closed distribution [of licenses]," adding that "the bloc should fetch $800 million to $1 billion."]

It is quite evident that Putin and the bureaucrats can't have it both ways. Either they form real partnerships with foreign oil, or learn to fend for themselves. Their past record suggest that the foreign partnership route is likely to be more productive.

It's also clear to see why the Russian move toward Democracy is being reigned in by Putin, as bureaucrats, and members of the government, including the police force, mistake the term Democracy with state sponsored anarchy at the business table.

It is an outdated set of rules found in some of the most lawless and remote parts of the world; ironically, some of the same places that have spawned the wave of attacks that have recently drug Russia into the main arena in the war against terrorism.

It's also a sign of the deeper problem with Russia, and a major cause for their increasing vulnerability to Al-Qaeda: internal corruption, and a total lack of understanding of how the real world works. In both respects, Russian bureaucrats and terrorists seem to share a common view.

Good luck Mr. Putin. You're going to need the barrelful.


Iran and Russia are the next hot spots for the U.S. to deal with. There are several common threads. First, Russia is a major supplier of nuclear fuel, know how and technology to Iran. Second, Iran may be closer to having a nuclear weapon than the mainstream suspects. And third, Russian bureaucrats, a synonym for left over communists and thugs in the government, are playing hardball with international oil.

The combination of a Russian oil squeeze and an announcement from Iran that it has a nuclear weapon, could conceivably happen quite close to one another at some time in the foreseeable future.

That could make for a very interesting few days to weeks, no matter who is in the White House.

Oil Roundup

Oil Markets: Trading Range Persists

Crude oil futures were trading near $45 per barrel on 9-15, in very early pre New York action.

Hurricane Ivan is heading toward Alabama, and may hit refineries in the area. Production in the Gulf of Mexico has also been all but extinguished for now. And oil supplies fell according to the latest reports from the API and the U.S. Department of Energy. According to CBS Marketwatch: "The Energy Department reported a drop of 7.1 million barrels in crude supplies for the week ended Sept. 10 to a total of 278.6 million barrels -- the lowest level since late February. Inventories have now fallen for seven straight weeks, according to the government's data. Separately, the American Petroleum Institute pegged the week's crude drawdown at 2.3 million barrels, yielding a total of 279.6 million barrels. Many analysts had expected a decrease of about 2 million barrels."

OPEC has pledged to increase production by 1 million barrels per day.

The crude oil futures are still either making a double top or forming a trading range between $42 and $44 per barrel. Little has changed. Supplies are still tight. OPEC is meeting this week. Event risk remains high.

On the fringe are the rising problems in Baghdad, and the tightening of Democratic rules in Russia are also lurking as reasons to keep oil prices high. Add to the mix, the potential for trouble in Iran, and there is now a slight build in event risk that is being added.

The key remains whether crude can close above $45 per barrel, remain there, and whether the oil stocks can make new highs. If this combination of events takes place, the odds that we are in a new up leg that can take crude above $50 per barrel are on the rise.

The Philadelphia Oil Service Index (OSX) remained inside the 112-115 band. A sustained close above 115 would be very bullish. A break below 98 its 200 day moving average, could send it plummeting to the 88 area in a hurry. For more details on trading the energy sector visit our energy timing page, featuring our highly effective OIH timing model and our Top Ten Energy Stock List.

The Amex Oil Index (XOI) closed above the 660 area, which is now short term support. A sustained close above 660 would be an all time high for XOI. This is still a crucial juncture for the entire oil sector, as a continued failure in the near term could lead to a major top forming. A close below 600 would be a very negative technical development. For immediate analysis, including stock picks, and the latest in technical analysis of the entire energy complex, our subscriber section has a full complement of recommendations in oil service and the rest of the energy complex.

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