State Capitalism and Russia’s Energy Strategy in the Far East

While Moscow was witnessing its largest protests in decades last month, a life and death struggle was taking place in the frigid waters of the Russian Far East. On December 18, as the Gazprom-owned Kolskaya rig was being towed across the Sea of Okhotsk to Sakhalin Island, a massive storm swept in. Facing six-meter swells and gale force winds, the small jack-up rig stood little chance. In less than 30 minutes, the rig had sunk, forcing all 67 rig workers into frigid waters 200 kilometers from land. After days of frantic searching, only 14 crew members were rescued. With 53 rig workers dead, the Russian offshore oil and gas industry now faces the largest disaster in its history.

The Kolskaya tragedy is the most recent chapter in Russia’s emerging energy strategy in its far eastern regions. At the center of this tale is the island of Sakhalin. Located in the north Pacific, Sakhalin first came to the energy world’s attention during the Soviet period when a joint Soviet-Japanese exploration project located vast hydrocarbon reserves off its shores. During the Soviet era, these reserves were never tapped: Sakhalin’s combination of seismic activity, harsh winters, and ice-bound water put these resources beyond the capabilities of Soviet engineers.

With the fall of communism and the opening of the economy to foreign investment, however, the Russian government brought in Shell and ExxonMobil to deploy their exceptional technological expertise off the harsh coast of Sakhalin. At first, these deals were very successful: Shell and ExxonMobil brought much-needed technology, money, and expertise to the Russian Far East, a region long-neglected by Moscow.

The New Rules of the Game

The honeymoon period for foreign oil companies, however, did not last. With Vladimir Putin’s rise to power and increasing oil prices, the new regime saw energy resources as a key political asset­ important for both modernizing the country and consolidating state power domestically while also influencing and building relationships with neighboring countries.

Domestic and foreign companies now faced new rules of the game. Perhaps the clearest new rule for foreign energy companies was that the balance of power was shifting: large foreign oil majors like ExxonMobil would be encouraged to participate in the Russian energy sector but they would have to defer to Russian state-owned energy companies.

The Russian Far East was no exception to these new rules. Domestically, state control of hydrocarbon rents could help modernize the region. Internationally, Sakhalin’s offshore reserves promised to be a critical tool for the Russian state in its relations with China, Japan, and Korea.

The two foreign oil majors operating projects in Sakhalin, ExxonMobil and Shell, found themselves under significant pressure. In 2005, the Russian government cancelled a 1993 agreement giving ExxonMobil and Chevron the rights to develop a key block off the Sakhalin Island and gave the field to Gazprom and Rosneft instead. In 2006, Russia used its environmental watchdog to force Shell to cede control of its Sakhalin block to Gazprom. Furthermore, since 2007, the Russian government has forced ExxonMobil to back out of a lucrative agreement to sell natural gas to China, telling ExxonMobil to sell all of its gas to Russia’s state-owned gas export monopoly: Gazprom. Although this dispute is still ongoing, one thing is clear: The only question remaining is whether ExxonMobil will get commercially attractive terms for selling its gas to Gazprom.

But At What Cost?

The Kolskaya tragedy illustrates the growing costs of this state-centered energy strategy in the harsh conditions of the Arctic. Indeed, while ExxonMobil’s project in the region is subjected to withering scrutiny and employs state-of-the-art technology to mitigate risks, state-owned companies like Gazprom act with near impunity. Media reports already suggest that Gazprom ignored warnings that the 26-year old Kolskaya rig was “unfit for the harsh conditions and [would be] too far from rescue crews to be reached quickly in case of an accident.” Furthermore, other accounts suggest that Gazprom disregarded a safety report from the Russian environmental watchdog and was illegally using the Kolskaya rig. Finally, environmentalists warn that the Kolskaya disaster should serve as a warning: in the event of a major oil spill, Gazprom does not have the technological expertise to respond; endangering the region’s delicate ecosystem.

The Kolskaya tragedy strongly suggests that while Russia’s new statist rules of the game might help attain its political goals in East Asia, they alone cannot adequately mitigate the growing risk of the harsh conditions in the north Pacific. Russia therefore faces a choice: As resource exploration and extraction grows more technically difficult and riskier in the unforgiving conditions of the north Pacific and Arctic, will it continue these rules of the game? And, if so, at what cost?