As far as hydrocarbons are concerned, a third of the world's gas is held in the Russian Federation, while its 51.2 billion barrels of oil reserves are the world's eighth-largest geopolitical concentration. The Sakhalin 2 project has long been the region's showcase, as first oil was produced in 1999 and the first liquefied natural gas (LNG) shipment should be steaming off to Asia by summer 2008. Sakhalin 2 has reserves of some 150 million tons of oil and 500 billion cubic meters of gas, and includes an LNG plant with 9.6 million tons of capacity, currently half-finished. Costs have outstripped estimates (doubled to $20 billion) and jeopardized the development of the venture. To make matters worse, Shell, whose 50% stake is the largest, was recently informed by Russian gas company Gazprom of its intention to swap 25% of Shell's stake in the project for a stake in its currently undeveloped Siberian Zapolyarnoye gas field, putting Shell in a questionable position. Not to be outdone, Sakhalin 3 has also had an appetite for controversy. In January 2004, the Russian government cancelled the results of a 1993 tender, won by a consortium led by ExxonMobil. State-owned Rosneft replaced the U.S. companies and now holds a 75% stake in Sakhalin 3, illustrating the Russian will to keep a tight control of its most strategic assets, as well as confirming the increasing influence of Russia's two national state-owned champions, oil company Rosneft and gas giant Gazprom. Russia's minister of natural resources, Yuri Trutnev, has indicated that Chevron and ExxonMobil would be given priority if they decide to bid again, this time for 49% of the project and to continue development, presumably with Rosneft. "Having developed infrastructure in place, Chevron and ExxonMobil have certain advantages," Trutnev says. Work at Sakhalin 4, a co-venture of BP (49%) and Rosneft (51%), was shelved due to poor initial exploration results, and Rosneft announced withdrawal from Sakhalin 6 after poor results. In turn, Sakhalin 5, also featuring a venture of BP and Rosneft, is a very promising block, and BP has indicated it would invest up to $5 billion in the development of which more than $150 million will be allocated to exploration drilling through 2008. The mixed picture of what was once presented as the new gas frontier is worrisome: costs estimates are surpassed, tenders are cancelled and poor exploration results are urging the global majors to approach huge upstream investments in the Russian Federation cautiously. Asset development One mega-project is Shtokman. In the Russian sector of the Barents Sea and discovered in 1988, Shtokman is one of the world's biggest gas fields, with reserves of 3.2 trillion cubic meters of gas and 31 million tons of gas condensate. Development plans include an LNG plant for exports to the U.S. and have been put under Gazprom's close supervision. Future potential partners have been queuing up to guarantee their participation. Recently, Gazprom announced that Norway's Statoil and Norsk Hydro, France's Total, and the U.S.'s Chevron and ConocoPhillips have been short-listed to "be invited to intense commercial talks" with a view to select two or three companies to form a consortium in the first quarter of 2006 for field production and transportation operations to the shore. Yet, the final shape of and participants in this $10- to $25-billion venture are still unknown. What has emerged in the last five years is the increasing role played by domestic state-owned operators Rosneft and Gazprom, now deemed unavoidable partners for any large-scale project and are very potent partners. Gazprom is the world's largest gas producer and distributor, while Rosneft has been beefing up its oil reserves and production through a string of acquisitions. The recent reinforcement of these two companies is a clear testimony that Russia is determined to hold on to its underground wealth and is wary of foreign access to its hydrocarbons. At the other end of the spectrum, independents are treading water in some rough seas. Only the fittest have shown resilience and ambition, and have started reaping the rewards of their demeanor. Following the demise of the Soviet Union, many small-scale operations sprung up, most notably in Tatarstan, where voluntary policy pushed by the republic's presidency and the local major Tatneft (Russia's seventh-largest producer) created a haven for independents. Although most of the local minnows benefit either from Tatneft's direct equity involvement, or from the support and stake-holding of the professional association Nefteconsortium, they also enjoy a relatively free rein in their operations. After experiencing a steep decline in production in the late 1980s, Tatarstan's production has risen back to 30 million tons per year, notably thanks to the work of the local independents. Some 5 million tons of those tons will come from 96 oil fields exploited by Tatneft, and 36 fields developed by 28 independents. Nefteconsortium was created to host them under a single roof, and provide administrative, technical and financial support. "We believe Tatarstan is a very specific oil province in the Russian Federation, as there is a genuine local will to see independents succeed, and there is also a good understanding of what their specific needs are, after having seen their birth and rise over the last 15 years," says Fanis Valiev, general director of Nefteconsortium. Largest independent An inspiring story is that of local major Tatex and its successful venture with Ocean Energy Inc. (now a part of Devon Energy Corp.). Tatex is today Tatarstan's largest independent, with expected oil production of 491,000 tons this year from two fields. "Where we contributed in the early days is from the capital side," says Sergey Faerman, Devon's Russia country manager and also president of Texneft Inc, Tatex's U.S. partner. "We made it possible to develop these fields earlier than they would have been developed. In addition to providing capital and technology, we have contributed to the image of our partner as being a company that is not afraid of being looked at as one of the progressive leaders of the industry." Since inception, Tatex was the first independent to successfully implement dual completion works on its fields, hydrofrac operations, as well as sell, install and operate vapor recovery units (VRUs) with more than 150 VRUs now installed all over the Russian Federation. This has helped this joint venture to further epitomize the success of international cooperation in the Russian Federation. Irek Khairullin, Tatex's general director, says the main achievements are "the fact that our company is now cash-flow-positive, has built a great infrastructure and has been paying dividends to the shareholders. These dividends are being reinvested by the shareholders into the company's development, which shows the respect and the trust they place in this company. We now hope to develop further, particularly geographically." Other Tatar minnows are also growing fast and following the integrated model of the majors. Sheshma Oil, established in 1998 with a license for three fields yielding 30,000 tons from unbalanced and underproduced wells, has increased production to 285,000 tons of oil this year from 230 producing wells and plans 25 wells for drilling before the end of the year. With in-house well-workover services, enhanced-oil-recovery capabilities, an electro-chemical pipe-plating workshop and its own construction company, the company has strong potential. General director Rustem Takhautdinov says, "At least 25% of the company's future revenue will be provided by service activities. It is a more difficult activity range than oil production, but the needs in this region are important, and we want to develop our abilities to serve others with what we know the best from our operations." Following the active lobbying of organizations like Assoneft, Nefteconsortium and others, the minnows were finally acknowledged as important actors of the oil and gas sector's dynamism. Yet, until three years ago, the development of independents was severely hampered by a number of factors. The majors' appetite for assets first affected many independents' survival. By limiting access to infrastructure, such as local pipelines, treatment plants and export facilities, the majors in some cases kept a stranglehold on the minnows, sometimes obliging them to give in and sell their assets. London-listed If examples of independents losing the fight abound, there are also cases of struggling, yet eventually successful, independents like Sibir Energy. A Russia-focused, London-listed company, Sibir has been somewhat of an anomaly in the Russian sector. Developing and producing its own oil fields in Siberia, the company has a stake in the coveted Moscow Oil refinery, has engaged successfully in trading activities and is involved in one of the most acclaimed developments of the last two years. Upon completion, this $1.25-billion project, a 50-50 venture with Shell called Salym Petroleum Development (SPD), will be one of the largest foreign investments with foreign capital in the Russian energy sector, with 800 wells drilled and an expected cumulated production of up to 6 million tons per year by 2010. This success is very good news for the two stakeholders: Shell, whose Russian fortunes have been mixed, and Sibir, who has endured a decade of effort, fights and controversies. Henry Cameron, Sibir chief executive, says, "Sibir might be the only independent company of this scale to have survived in Russia. We are a bit of an attraction, and there is now an appetite for investors to see Sibir succeed. We reap a lot of loyalty from our shareholders for all these years of work and effort. Slowly but surely, as the projects matured, the knocks became less important and today, with the success of Salym, we are reaching a turning point of this company...." The next clutch of difficulties for would-be upstream players used to be access to the state pipeline monopoly Transneft. Due to a genuine lack of capacity, coupled with a certain reluctance on the part of state authorities, Transneft wouldn't grant access to its system, therefore condemning small players to sell their crude on the undervalued local market or build their own export infrastructure. In the last five years, the situation has improved greatly and many independents have highlighted that accessing pipelines is easier today than ever, despite a still-crippling lack of spare capacity. Equally, Gazprom was said to have made a lot of effort to grant access to its gas transport infrastructure, here again providing an encouraging signal of the large players' change of attitude. Taxes Still a major concern for many is the tax regime, which penalizes companies at times of high oil prices, as it lacks a progressive calculation mode. This issue has attracted the attention of natural resources minister Trutnev, and reform is in the works. After years of public outcry from the industry, in particular from smaller producers harshly penalized by the current regime, this news is one of the best signals sent to independents during the last five years. Yet, the ill-adapted tax regime, limited access to infrastructure and inapt legal frameworks have never managed to prevent large and small players alike to consider Russia as a priority area for business development. ConocoPhillips' entry to Lukoil's capital or the BP-TNK venture are groundbreaking operations that have helped disperse remaining foreign anxieties born from the Yukos affair. TNK-BP, despite difficulties including the Russian Federation's tax claim (recently reduced to acceptable levels) and unnerving uncertainties on the Kovyktinsky gas field, remains a success story. But the development of the latter issue will be a test of the Russian authority's true intentions for foreign investment. Kovyktinsky, the largest gas field in Eastern Siberia with estimated reserves of 1.9 trillion cubic meters, is developed by Rusia Petroleum, which is majority-owned by TNK-BP. Here again, the notion of "strategic reserves" is crystallizing a great deal of uncertainty about this project and TNK-BP is eager to see the Russian authorities clarify their views. Until then, the venture, along with other large foreign corporations, may see some of their investments questioned. Despite these signals, the attractive potential of the Russian Federation remains very important. Today, about 75% of Russia's ground-oil fields are being developed and are reckoned to be 50% exhausted. The replacement rates are worrying, at around 50%, and exploration capex is only half of what it should be, lagging between $1- and $2 billion per year. But potential for further growth abounds, in Eastern Siberia, the Arctic regions and offshore. The Russian natural resources ministry is expected to put up to 240,000 square kilometers of sea shelf for auction for geological exploration before 2010. Total reserves of these offshore territories are estimated at 90- to 100 billion tons of oil equivalent, 80% gas. These resources will be able to supply a large part of Europe's gas need and some of the United States' for decades. But this will not be possible without close cooperation of foreign players and Russian entities both state and private. This has already been recognized by most of the key operators in Russia, and a lot of the positive changes registered in the last year or so are to be attributed to this recognition. Yet, there are still causes for uncertainty, some of them major. The exact strategy regarding the role and shape of the state-owned upstream operators or the final content of the future subsoil law are only some of these clouds that are taking too long to clear. For the future to be bright and cooperative, Russia has to act clearly and quickly to define the shape of its oil and gas industry of the next 50 years and the degree of openness, serenity and security it is willing to guarantee.