Companies rethink Russia after new sanctions

Stanley Reed
The flag of Russia.
agustavop | iStock/360 | Getty Images

The downing of Malaysia Airlines Flight 17 over eastern Ukraine — and the tougher round of sanctions against Russia that followed — is prompting some big multinational energy companies to take a fresh look at the ramifications of the crisis.

For months, American and European energy players have continued to sign deals with Russia, maintaining a posture that business was proceeding as usual. But top industry executives are now starting to acknowledge that the escalating tensions could sharply hurt Western oil and gas giants with major investments in Russia, as well as the service companies that are key technology suppliers.

"We are in the heat of a very emotional stage," Robert W. Dudley, BP's chief executive, told reporters on Tuesday. The company warned that further economic sanctions could harm BP's income, production and reputation.

Read MoreRelief rally? Russia markets shrug off sanctions

France's oil giant, Total, which had been among the most committed to Russia, said that since the plane disaster it had stopped regularly adding to its stake in its Russian partner Novatek, a gas producer that was placed under sanctions by the United States this month. Total's chief financial officer, Patrick de La Chevardière, also indicated on Wednesday that the company was considering how the sanctions might affect other projects like a multibillion-dollar natural gas facility it is building with Novatek.

The industry's tenor has changed as Western governments directly target Russia's economic prospects, notably its energy industry. After months of settling for measures that seemed largely symbolic, the United States and the European Union on Tuesday agreed on a new round of sanctions that appear as if they may have real teeth.

"The companies are facing the harsh reality that the United States and the European Union have united on sanctions in a way that two weeks ago would have been inconceivable," said John Lough, a Russia analyst at Chatham House, a London-based research organization.

EU agrees on Russia sanctions
EU agrees on Russia sanctions

In a previous round of sanctions, the United States placed some financial restrictions on Russian energy companies like Rosneft and Novatek. The latest sanctions go further, however, as they try to curb the export of highly specialized equipment needed to develop Russia's new energy frontiers, including the Arctic and shale rock formations in West Siberia.

Companies like Total and Royal Dutch Shell have poured money into Russia in recent years. And a drilling rig to be operated by Exxon Mobil and Rosneft is being transported to Russian Arctic waters.

But Western oil and gas executives, along with their teams of lawyers, are now pondering the impact of the sanctions. It is uncertain what types of equipment or software they may be prohibited from bringing to Russia. "Technology is a very hard thing to define," said Mr. Dudley of BP. "So we will have to read it very carefully."

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Mr. Dudley also said that it was unclear whether BP would be allowed to proceed with a joint venture on shale oil with Rosneft; the companies reached a preliminary agreement over the deal this year. Exxon Mobil, Shell and Total also have shale ventures in the country.

As the companies assess the murky situation, Russia's energy future remains in limbo.

Russia rivals Saudi Arabia as the world's leading oil producer, and it was second in natural gas production last year to the resurgent United States. But Russia's traditional oil fields in West Siberia, which have sustained the country's output for decades, are in decline.

Anadolu Agency | Getty Images

To avoid further drops in production, Russia's industry, which is not yet fully modernized, needs access to the Western technology that has transformed the global oil business in recent decades, allowing oil companies to push into ocean waters more than a mile deep, or produce oil from shale rock. That technology is the main reason Russia has sought help from the global oil majors like Exxon Mobil, which is producing oil off Sakhalin Island in eastern Russia.

"If the new sanctions stay in place for an extended period of months or years they will have an impact on Russia's ability to grow or even maintain oil production," said Richard Mallinson, an analyst at Energy Aspects, a research firm based in London.

Perhaps Russia's greatest short-term hope for increasing production is to extract oil from shale rock. Russia is considered to have huge, albeit unproven, potential.

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But the latest Western actions target shale gas. Any efforts to make the most of these shale formations would be slowed if the sanctions block service companies like Halliburton from bringing technologies including hydraulic fracturing and horizontal drilling that have changed the energy industry in the United States.

The processes are mostly highly adapted versions of practices that have been around for decades, like hydraulic fracturing, or the pumping of water and other liquids down wells at high pressure to break oil and gas free from the surrounding rock. Some analysts say the shale technologies may be hard to block through sanctions because they are essentially adaptations of decades-old techniques.

Arctic and deep water drilling equipment may be easier to restrict, analysts say. The European Union plans to prohibit not only the sale but also the transfer of specially adapted drilling rigs and machinery to Russia, according to an official who briefed reporters on the details of the sanctions.

The official estimated that Russia relied on the European Union for 30 to 60 percent of these technologies. While they represent just 150 million euros in annual sales, they are crucial for projects worth billions.

The European Union is walking a fine line. Heavily dependent on Russian energy, particularly gas, the European Union wants to use the sanctions to target big future projects in shale and in the Arctic without hurting existing production and disrupting global markets. The gas sector will be excluded, which could lead to complications because in many cases oil and gas are produced with much of the same equipment and from the same locations.

Over the last 10 to 15 years, Western companies have become increasingly enmeshed in Russia with the blessing of their governments. Unlike Saudi Arabia, which largely prohibits foreign participation in oil and gas exploration and production, Russia has welcomed Western investment. Without production from Russia, the oil export market would be even more dominated by the Saudis and other OPEC producers.

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Among the Western players, BP may have the most to lose in Russia. In the second quarter of 2014, BP's stake of almost 20 percent in Rosneft produced nearly one-third of the company's oil and gas production and nearly 20 percent of its profits. Total has an 18 percent stake in Novatek.

Exxon Mobil has also plunged into Russia. It has a joint venture with Rosneft to drill in the Kara Sea in the Russian Arctic, which some oil executives think could be a frozen Gulf of Mexico in terms of the oil it holds. The rig operated by the two companies, now sailing toward the Kara Sea from Norway, is expected to drill the first well for the joint venture this summer.

"We are assessing the impact of the sanctions," said Alan T. Jeffers, an Exxon spokesman.