So Much for Russia as an "Energy Superpower"

Five years ago, when oil prices were climbing steadily and economists were stoking fears about peak oil and gas, it seemed that major energy producers like Russia were holding all the cards. Then-president Vladimir Putin spoke of his country as an "energy superpower" and used energy supplies as a blunt instrument of Kremlin foreign policy. Gas cutoffs to Ukraine caused panic in Europe, while Western energy companies fell over each other to get a slice of Russia's oil and gas fields.

But all that is over. Today, the super-giant Shtockmann natural-gas field under the Arctic sea—Russia's only big hydrocarbon discovery since Soviet times—has just been mothballed due to the towering cost of extracting the undersea gas. At the same time, worldwide demand for Russia's gas has plummeted. And meanwhile, the government has punctured investor confidence by pressuring BP, one of the few major foreign investors left in Russia's energy sector, to hand over a giant Siberian gas field to a government-owned rival. It's time for Moscow to kiss goodbye those dreams of energy hegemony.

One problem is that the recession has eviscerated European demand for Russian natural gas (consumption dipped by 7 percent in 2009). Another is that demand in the United States for imported natural gas has fallen off too. Thanks to shale gas and other unconventional sources like tar sands, the U.S. is now close to self-sufficient in natural gas. It's a nightmare for Shtockmann, where the business plan hinged on freezing the product into liquified natural gas, or LNG, for export to the United States.

That made the Shtockmann field, with reserves of 3.7 trillion cubic meters, seem less like the strategic future of Russian natural gas and more like an M&M that fell behind the couch—tasty, but not strictly necessary and very hard to reach. The $20 billion cost of extracting the deep-buried gas in the harsh conditions of the Arctic has proved prohibitive for Gazprom and its minority partners, Total of France and Statoil of Norway.

That's a problem for Gazprom, which was the main cudgel of Putin's foreign policy just four years ago, when he played one European country against another in their eagerness to lay Gazprom pipelines across their territory. Now the European market seems oversupplied. More worrying still, Gazprom's traditional suppliers (gas fields in the Central Asian nations of Turkmenistan and Kazakhstan) have begun opening their own direct pipelines to China, where gas consumption has a future. And though Gazprom still controls about 17 percent of the world's proven natural-gas reserves, many of its existing fields are beginning to run dry. Getting at the remainder—for instance at the Bovanenkovo field in the remote Yamal Peninsula in Siberia—will need massive investment of cash and know-how. Who wants to sink in that kind of money with no guarantee of returns?

That's why the latest attack on BP is so strange—and so dumb. A time of falling demand, unstable energy prices, and investor nervousness about emerging markets might seem like a bad moment to crack down on one of the few large foreign investors in Russia's energy sector. But that hasn't stopped Russia's Natural Environment Inspectorate, or RosPrirodNadzor, from threatening to throw BP off the giant Kovykta gas field in Eastern Siberia. The official reason for the threat is alleged environmental infractions—the same reasons cited by the Russian state when Royal Dutch Shell was persuaded to sell Gazprom its stake in an oilfield in Sakhalin two years ago for below market value. But the real reason seems to be that the state oil company Rosneft has its eye on BP's field.

This is hardly the first time Russia's government has shaken down BP—or other investors. In 2007 the Russian Natural Resources Ministry threatened to tear up the Kovykta contract because of alleged violations of the exploration timetable. Then, the predator was Gazprom, which wanted Kovykta for a knockdown price and was also at the time hustling to get a slice of a BP gas project in Trinidad and Tobago. That deal stalled on legal wrangling and was ultimately sunk by the 2008 economic crisis, which reduced Gazprom's voracious appetite for expansion. But now, it seems, Rosneft is taking up where Gazprom left off—and in the process reminding investors in all sectors of the dangers of doing business in Russia. The difference is, of course, that in 2007 energy prices were rising and plentiful investment money was wandering the world, desperately seeking high returns whatever the risk. Today, the opposite is true. "It is not just a big gas field at stake here. It is about the country's entire investment climate," says Valery Nesterov, an oil and gas analyst from Troika Dialog brokerage. "Russia has to attract foreigners to develop Yamal and offshore fields."

Russia remains the largest exporter of oil and gas in the world—bigger even than Saudi Arabia. But unlike the Gulf nations, Russia is fast pumping its existing wells of both oil and gas dry. To tap its reserves—and to maintain Russia's status as an "energy superpower"—Russia needs to stop ripping off its investors just because a demand falloff has hurt its bottom line. Gas consumption will come back. But Russia's superpower aspirations won't also rise if Russia has alienated its partners. Without them, its new reserves—like the Shtockmann field—will remain buried in the ground.