In late December 1991, the Soviet Union split into 15 independent states. The rulers of Kazakhstan, Azerbaijan and Turkmenistan, determined to keep all the profits from their oil and gas, voiced their historic antagonism towards Russia. In Russia itself the managers of the oilfields also dug in, withholding supplies. Caught in the middle of the political battle, Western oil executives became perturbed. Despite their enthusiasm to develop Russia’s riches, the country’s officials were uncertain about their own authority and were powerless to remedy the absence of laws, valuations, taxes and balance sheets as understood in the West. The oil executives’ requests for enforceable contracts and proper accounting to safeguard their investment were met by blank stares, while their intention to earn profits aroused resentment. In that atmosphere, the oil majors reconsidered the risk of investment. ‘When we make multi-billion-dollar decisions,’ said John O’Connor of Mobil, pondering whether to develop oilfields in northern Siberia, ‘you have to have confidence that the system is predictable and stable. All these things are absent.’
By September 1992, paralysis gripped the Russian oil industry. Twenty-five thousand out of 90,000 oil wells had been closed. In the Kremlin, Viktor Orlov, a former natural resources minister and chairman of the government’s oil committee, warned Yeltsin about ‘very irrational and wasteful’ management of the Siberian oilfields. Russia’s production, he suggested, could fall to six million barrels a day, only just over half the rate in 1988. At the beginning of 1993 the forecast worsened. During a meeting in the Kremlin in April, Vladimir Medvedev, the president of the union of oilmen, told Yeltsin, ‘The crisis is deteriorating into a catastrophe.’ With 20 per cent of Russia’s oil wells idle, production could fall in 1995 to four million barrels a day, a million less than the country consumed. Yeltsin’s dilemma appeared insoluble. The country was beset by inflation, unpaid bills, unpaid workers, an unstable rouble and crumbling infrastructure in the oilfields. With Moscow and the provinces disputing each other’s authority, Siberian oil companies were illegally exporting their production, and Russian customers were not paying for their supplies. To increase output by just one million barrels a day, Yeltsin was told, would cost $15 billion. Restoring production to 11 million barrels a day to sustain the country’s foreign earnings would cost over $50 billion and would require Western expertise. Not only was that amount unaffordable, Yeltsin knew, but the country was divided over whether to admit foreign investment. Even part privatisation required the removal of political and legal uncertainties over the ownership of resources. Yeltsin was incapable of resolving that conundrum. ‘Russia has been a big disappointment for many people,’ said Elf’s spokesman in Volgograd. ‘At first people thought it might be the new Middle East.’ In the five years since Russia had opened its doors, the foreign rush had become bogged down by the Duma’s indecision, changing laws and taxes. Oil men were accustomed to problems, and could console themselves with the truism, ‘This is where the oil is,’ but none had anticipated being stymied by three straightforward deals which unexpectedly antagonised Russian sentiment.
In 1992, Marathon Oil signed an initial agreement with government officials in Moscow to exploit the oil and gas on a territory known as Sakhalin 2, a frozen island in the Pacific Ocean, 6,472 miles and seven time zones from Moscow. In the tsarist era, criminals were sent into exile on Sakhalin, and in 1983 MiG fighters flew from the island to shoot down KAL 007, a Korean passenger plane. Across that bleak 28,000-square-mile shelf in the Sea of Okhotsk, oil production was possible only during the summer. Between October and June, storms, strong currents and seven-foot-thick ice packs prevented work.
Oil had been produced onshore since 1923. In 1975, assured by the Russian government that there were between 28 and 36 billion barrels of oil under the sea, a Japanese company drilled some wells, but lacking expertise and money, its quest was soon terminated. A second agreement with another Japanese exploration company in 1976 ended in the early 1980s after the Japanese concluded that the venture was uneconomic. In November 1991, anxious to exploit the reserves, the Russian government issued an invitation to major Western oil companies to tender for a licence. Most were interested, but nearly all became deterred by Russian politics. Valentin Fyodorov, the governor of Sakhalin, demanded that the successful company lend his region $15 billion to develop the infrastructure for a new republic. Reluctantly, some companies agreed, only to become involved in an intense debate in Moscow about whether foreign exploitation of Russian energy should be permitted. Some Russian politicians rejected outright any sale, some opposed catering to Fyodorov’s audacious demands, while others argued that, in the midst of its current financial crisis, Russia had no alternative but to sell its mineral wealth for hard currency.
Eventually, in April 1992, Marathon, in partnership with the Japanese company Mitsui, was allowed to start a feasibility study. Soon after, Mobil and Shell were inserted into the consortium as junior partners. To protect its investment from Russia’s punitive tax regime, Marathon negotiated over the following two years a Private Sharing Agreement (PSA) with the Russian government, giving the Americans a majority stake in the $4 billion venture and excluding any Russian participation. The PSA fixed unchangeable terms for the taxes and royalties payable by Marathon throughout the project’s life. After the agreement was signed in 1994, Russian legislators, officials and ministers, realising that Russia would receive little income from the sale of its own oil until all the costs incurred by Marathon to develop the project had been repaid, began arguing with officials in Moscow’s oil, geology and finance ministries. Marathon anticipated making tax-free profits for 25 years before Russia earned anything. To protect its hugely favourable agreement, Marathon had successfully insisted that any dispute was subject to international arbitration rather than the Russian courts. The Russian negotiators, failing to hire Western bankers and lawyers as advisers, had unquestioningly accepted Marathon’s terms, and were ridiculed for gullibly falling into an American trap to profit from Russian oil. The critics ignored reality. Russia was technically incapable of producing oil in Sakhalin, and without a PSA agreement, no Western oil company could risk developing the island’s reserves. Those arguments eventually prevailed, and Marathon’s deal was approved by the Duma.
Despite the souring mood, Exxon’s Rex Tillerson persuaded the Russian government to sign a second PSA for Sakhalin 1, a neighbouring area, albeit on less favourable terms than Marathon’s. Exxon was allowed only a 30 per cent share of the project, with Rosneft holding 40 per cent. Exxon would receive 85 per cent of the profits, while the Russian government took 15 per cent. Tillerson was pleased. Like Marathon, Exxon had successfully exploited Russia’s misfortunes, with little regard for the consequences. With the support of President Clinton, Exxon had sought to make profits for shareholders rather than to win the Russian government’s trust and thereby secure a lasting balance to OPEC. In Tillerson’s opinion, Exxon’s commercial priorities were paramount. Success in Sakhalin, he hoped, would tempt the Kremlin to allow Exxon’s exploration in the Barents Sea and the Kara Sea, an Arctic zone potentially containing eight trillion cubic metres of natural gas, the world’s biggest reservoir. If developed, the natural gas could be piped through the Yamal peninsula system, another huge Siberian energy basin. Those hopes were to be dashed. After the Russian government signed a PSA agreement with Total of France, PSAs were banned. Resurgent nationalism was stymieing Western oil companies across Russia, and even Chevron’s ambitions in Kazakhstan.
Chevron’s fraught negotiations to develop Tengiz had been stabilised by John Deuss. The trader famous for Brent squeezes was representing the government of the oil-rich Gulf state of Oman. Seeking investment opportunities, Deuss, flying his Gulfstream between Almaty in Kazakhstan, Europe, Washington and Jackson Hole, Wyoming, brokered the ‘deal of the century’ between Kazakhstan and Chevron. His intention was to profit through the financing and ownership of a new pipeline to transport Tengiz’s oil to a port. Chevron’s success depended on the pipeline, which, despite Kazakhstan’s