Renationalization Roulette (ENI)

By Katrina Lamb | August 13, 2007 AAA

The subprime loan market is not the only story of woe in this "summer of risk". Another regular feature on the front pages of the financial tabloids is renationalization - governments taking back previously privatized industries such as natural gas, water supply, transportation and electricity. This trend is taking place in resource-rich countries such as Venezuela and Russia.

The contagion seems to be spreading across Russia's border into Kazakhstan where Italian oil and gas concern Eni SpA (NYSE:ENI) finds itself in the government's cross hairs over its management of a large oil field in the Caspian Sea. Increasingly, Eni finds itself walking a delicate line through the minefields of politics and business that characterize natural resource markets in the former Soviet Union.

Depending on how artfully it manages this balancing act, Eni could find itself either part of a charmed inner circle or on the wrong side of a dangerous game of Russian roulette. (To learn how these companies make their money, check out Oil And Gas Industry Primer.)

Caspian Capers
The latest twist in Eni's adventures in the former Soviet Union concerns the Kashagan oil field, the largest discovery in the Caspian Sea to date with an estimated 13 billion barrels of recoverable reserves. In comparison, Kazakhstan has a bit over 30 billion barrels of proven reserves in total.

Eni is the operator of a consortium developing the Kashagan field that includes ConocoPhillips (NYSE:COP), Exxon Mobile (NYSE:XOM), a handful of other international producers and the Kazakh state-run enterprise KazMunaiGaz.

The story there follows what is by now a predictable script. In the early years following the breakup of the Soviet Union, while oil prices drifted between $15 to $20 per barrel, Western oil and gas concerns moved into the region and formed consortia for exploration and development.

From a position of strength, they negotiated highly favorable terms and conditions, such as a full recouping of investment costs before profit-sharing with the local governments would kick in. Years of cost overruns and delayed production schedules ensued - for example, Eni first estimated that Kashagan would come online in 2005, then 2008 and now 2010.

Local government authorities, with a new $75/bbl swagger in their steps, have stepped up criticism of the cost overruns and delays and loudly proclaimed all terms of the original contracts to be up for "review".

Review, Revise, Renationalize
Kazakhstan has not yet taken this script to the conclusion that has played out in Caracas and Moscow this year, but Kashagan consortium partners Exxon Mobil and ConocoPhillips know that ending all too well.

Back in June, both Exxon and Conoco walked out of negotiations with the Venezuelan government, rather than sign over majority stakes in their local oil projects to the state-run concern Petroleos de Venezuela.

Across the Caspian Sea from Kazakhstan, Exxon Mobil appears to be one of the "specials of the day" on the menu for OAO Gazprom (OTC:OGZPY), the Russian gas export monopoly with a voracious appetite for the majority interests of foreign-operated oil and gas projects.

Exxon Mobil holds a majority interest in a gas project called Sakhalin-1 in the remote SakhalinIslands region off Russia's Eastern Coast. Gazprom already wrested control of another project called Sakhalin-2 from Royal Dutch Shell PLC (NYSE:RDS.A) earlier this year and appears eager to add another Sakhalin trophy to its display shelf.

Partners and Adversaries
While Exxon Mobil may be eying Gazprom suspiciously, its Kashagan partner Eni is doing quite the opposite. The Italian concern has set its sights on being a major player in Russia and sees highly influential Gazprom as its ticket to the inner circle. In November 2006, Eni and Gazprom signed a wide-ranging strategic agreement targeting joint cooperation in upstream, midstream and downstream exploration, development and acquisition projects.

One such effort is a pipeline project called South Stream that aims to run under the Black Sea from Russia to Bulgaria and supply a projected natural gas deficit to European wholesale and retail consumers. Eni sees its Gazprom relationship as providing leverage for growth in Europe, as well as a way to protect its investment interests in Russia.

The South Stream project is controversial in Brussels, Belgium, though, as regulators are concerned about the political implications of Europe's increasing dependence on Russian energy.

Conclusions
There is little question that Russia, under President Vladimir Putin, has moved aggressively to consolidate the state's interests in the natural resources sector. Will Kazakhstan and other oil-rich former Soviet republics such as Azerbaijan follow suit?

For global resource concerns on the other side of this development, the choices are difficult:
1) Pack your bags and leave like Exxon Mobil and ConocoPhillips in Venezuela,
2) Accept the reality of reduced influence and profits like Royal Dutch Shell in Sakhalin, or
3) Hope that a strong local partner will provide you cover in the mode of Eni with Gazprom.

None of these choices is without risk, and I think it will likely be some time before a clear winner emerges.

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