Academic journal article Washington International Law Journal

In the Wake of Sakhalin Ii: How Non-Governmental Administration of Natural Resources Could Strengthen Russia's Energy Sector

Academic journal article Washington International Law Journal

In the Wake of Sakhalin Ii: How Non-Governmental Administration of Natural Resources Could Strengthen Russia's Energy Sector

Article excerpt

I. INTRODUCTION

On September 18, 2006, the Russian government set off a firestorm of international criticism when President Vladimir Putin recommended the cancellation of permits for the controversial Sakhalin II development project in Russia's Far East.1 The Sakhalin Project, managed by an international consortium including Royal Dutch Shell, Mitsubishi, and Mitsui, has been developing infrastructure for the removal of Liquefied Natural Gas ("LNG") off the coast of Russia's Sakhalin Oblast since forming in 1994.2 The seeming collapse of the project, just short of its 2007 expected completion date, raises new questions for foreign investors in Russia's energy sector. Namely, how can positive, productive, and responsible foreign investment be encouraged?

Like many foreign investments in Russia's energy sector, the Sakhalin II project was structured under a Production Sharing Agreement ("PSA") between the Sakhalin Energy Investment Corporation ("SEIC") and the government of the Russian Federation.3 Russia's use of the PSA model was a response to the realization that the country's mainline economy was too unstable to attract more traditional forms of investment in an economic sector where profitability only follows from massive front-end capital expenditure.4 Yet in Russia, the PSA model has failed to shield existing investment from domestic politics and consequently failed to encourage new international investment.

This comment will argue that the Sakhalin experience demonstrates deficiencies in Russia's current institutional structure for foreign energy investment. The current structure is unsustainable in a world economy that increasingly demands calculable risks and reliable expectations. A new model for pairing international expertise with Russian resources is necessary to develop a stable, predictable, and profitable domestic energy development and exploration sector.

Part II explores the collapse5 of the Sakhalin II agreement in the wider context of Russia's search for foreign investment, economic and legal stability, and international acceptance as a dominant economic power. Part III addresses the shortcomings of the current approach to international energy contracting under PSAs. Part IV explores the need for Russia to take a new approach to achieve its goals for developing its energy resources through foreign investment. Finally, Part V prescribes a new institutional solution in response to the deficient institutions and political manipulation that led to Sakhalin's demise. The creation of a quasi-governmental Public Leasing Authority, which would stand as a buffer between international investors and the Russian government, would enable Russia to stimulate foreign investment by insulating international firms from the substantial risks and liabilities associated with doing business in Russia.

II. FOREIGN INVESTMENT is INDISPENSABLE TO DEVELOP RUSSIA'S ENERGY SECTOR AND TO DRIVE RUSSIA' s ECONOMIC RESURGENCE

In the last several years Russia has profited from historically high energy prices and an unquenchable demand for the 40% of the world's natural gas that underlies its enormous territory.6 The economic independence generated by energy wealth has prompted an ambiguous government approach to foreign investment in the energy sector. 7 Yet mismanaging foreign investment opportunities threatens to cut off the flow of foreign technology, expertise, and capital, which have been the drivers of increasing production since post-Soviet privatization. In the long term, Russia must develop stable institutions for regulating foreign energy investment to fortify its economy against economic and energy-price instability.

A. In the Long Term, Russia Cannot Rely on Profitable Oil Exports to Underpin its Economy or to Ameliorate the Problems in its Energy Sector

In spite of very real development problems, Russia is an extractive energy powerhouse. The territory of the modern Russian Federation boasts the world's eighth largest proven reserves of oil and is the world's second-largest oil producer after Saudi Arabia. …

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