Mikhelson and sanctions: how "Novatek" irritates the US

A good and very clear example of how Russian companies adjust to the sanctions is the gas giant Novatek. For Leonid Mikhelson's entry into the sanctions list there are more economic reasons than political ones, but this did not prevent Novatek from launching its main project, Yamal LNG.
Origin source
It can not be said that the sanctions imposed on the Russian oil and gas sector in 2014 have become such a new test for him. The Russian oil industry has already been subject to sanctions in the past. In the 70s of the last century, the United States restricted the access of the Soviet oil and gas sector to advanced technologies in the hope of hampering the gas pipe deal. But then the sanctions were narrowly focused, and the European partners managed to significantly reduce their effect, and eventually - almost completely to cancel. With the filing of President Ronald Reagan, the United States also imposed sanctions for the construction of the Pomary-Uzhgorod gas pipeline in 1981. However, the formal reason was the introduction of a state of emergency in Poland. The new sanctions affected the electronic and oil and gas sector: American companies were prohibited from supplying the relevant equipment and technology to the USSR. A little later, an exception was made for a number of treaties concluded before the imposition of sanctions.

But the sanctions turned out to be ineffective due to the large degree of self-sufficiency of the national economy of the USSR, the successful work of various foreign trade firms in acquiring the necessary technology and technology through third countries and their own scientific developments. As a result, the US and other Western producers, instead of getting real money for their inventions and technologies, faced illegal copying and shadowy improvement of advanced solutions and devices. Moreover, the imposed sanctions led to the development of industrial espionage by the USSR and its allies.

The sectoral sanctions imposed on the Russian oil and gas sector in 2014-2017 are mainly aimed at "slowly strangling" the Russian oil and gas industry. So in any case, according to a recent report of the Center for Energy Studies Skolkovo. Recognizing that in the short term Russian oil and gas companies have fully adapted to the US sanctions regime, and by 2020 they retain the potential for production growth from the prepared fields, the authors argue that in the long term (after 2025) the support for the level of oil and gas production becomes at least problematic. The authors also believe that the most critical factor hampering production growth is the ban on the transfer of fracturing technologies ("GRP"), as well as limiting the possibilities of attracting external financing for exploration and the cycle of putting deposits into operation.

There are a number of fundamental factors that call into question these conclusions. First, US hydraulic fracturing technologies can not be mechanically reproduced for the production of shale hydrocarbons in Russia due to the difference in the geological structure of the oil-bearing strata. Secondly, the hydraulic fracturing technology is by no means new, widely used for a variety of purposes in the USSR (from the repayment of fires in the fields before gas extraction), which was also the first country to establish an industrial production of shale hydrocarbons. This extraction was stopped in Estonia in 1980 for reasons of environmental safety. And thirdly, experimental production of shale hydrocarbons of the Bazhenov suite has been started this year using the technologies of the domestic design. Already in 2025 it is planned to start commercial production.

And in general, unilateral sanctions are ineffective. In the early 1990s, the Peterson Institute published a fundamental study on the practice of applying unilateral sanctions. His main conclusion - individual sanctions achieve their goals in about 13% of cases, and the longer they remain in effect, the less effective they are.

A good and very clear example of how companies adjust to the sanctions pressure is the gas giant Novatek.

How Mikhelson created Novatek

The very inclusion of "Novatek" in the US sanctions list (in 2014, sanctions were imposed on the company itself, in 2016 - on several of its "daughters") requires some explanation. It is believed that Novatek and its main shareholder, Leonid Mikhelson F3, were subject to sanctions (no personal sanctions on Michelson were imposed - unlike the second shareholder of Novatek Gennady Timchenko F 5. - Forbes) due to suspicions of the US intelligence agencies about closeness to the country's leadership and personally to Vladimir Putin. But neither the history of the company, nor the entrepreneurial activity of Michelson does not lead to such conclusions any unbiased observer.

Leonid Mikhelson was not born in Leningrad, was not a member of the cooperative "Lake", did not "serve, did not participate, did not consist" in any high-profile business processes of the 1990's and the beginning of the zero ones. Novatek grew out of the Nova construction group and, in contrast to Itera, Igor Makarov, F 46 had no relations with Gazprom and did not increase its resource base due to the generosity of Rem Vyakhirev's team. Mikhelson's name did not flash either in business or in the secular press before the IPO Novatek in 2005 and was known mainly to gas workers and the leadership of the Yamal-Nenets region. Novatek, unlike, for example, Surgutneftegaz, had no special relationship with any traders, sold hydrocarbons produced in the domestic market and did not attract the attention of foreign investors. Attempt of French Total to acquire 25% of the company in 2004 was blocked - at least formally - by the FAS, which was regarded by the business community as a sign of the lack of the necessary level of ties and influence at the federal level. Unlike most Russian oil and gas companies, Novatek has not tried to buy assets outside Russia for a long time, and within its limits it has limited itself to activities in the Yamalo-Nenets Autonomous District.

Novatek also managed to avoid the fate of the more glamorous Itera, which, with the change of management team at Gazprom, had to part with not only a large part of its mining assets, but also an extremely lucrative role as an intermediary in Russian-Ukrainian gas relations . And while the department of property relations of Gazprom collected assets scattered in the 1990s, clarified relations with the European Union and fought against Naftogaz, Novatek actively acquired new licenses, built infrastructure for cleaning and transporting gas, regularly paid taxes, and dealt with consolidation of assets. Nothing at this time could not suggest a special proximity of the company and Mikhelson to those in power.

The first signal about the changing weight of Novatek and the level of Mikhelson's influence was a rather intricate story with the acquisition of a controlling stake in Yamal LNG in 2009. This purchase, of course, had obvious benefits in the form of a practical doubling of the resource base from 4.9 billion in 2008 to more than 8 billion barrels of oil equivalent in 2010. But the purchase of a gas field without an economically feasible connection to the gas transmission system, and even almost the maximum estimate, made sense only if Novatek had an understanding of the prospects for the development of the LNG segment.

Before the shale revolution in the US in 2011-2012, the technology of liquefying gas was used to transport mainly Qatari gas to the EU and Asia. Gazprom's Sakhalin-2 was at that time the only Russian LNG project and was also focused on the Pacific-Asian market. And there are no obvious signs that the LNG segment will not only be the fastest growing part of the gas sector, but will also have a significant impact on pricing.

The ability of Leonid Mikhelson to choose the right partners, to collect a talented team and work for the future played a decisive role in the history of the acquisition of Yamal LNG. Mikhelson's business wisdom also manifested itself in the fact that the acquisition of this asset brought the company to the federal level, and the appearance of a solid partner in the person of Timchenko helped strengthen the position of Novatek and allowed to ensure the economic feasibility of the project through obtaining very serious tax benefits. Mikhelson's business position and reputation were also strengthened by his ability to solve numerous problems that arose during the implementation of Yamal LNG in the difficult conditions of the beginning of the 2010s. What was particularly advantageous was the background of Gazprom's sluggishness and bureaucracy.

Nevertheless, there were no obvious reasons for inclusion in the sanctions list. Novatek did not. One seat on the board of directors and a block of shares that is much less blocking either under Russian or US law do not make the company a subsidiary. Accordingly, "Novatek" from the legal point of view can not be considered a company controlled by Gennady Timchenko, who owns 23% of it. So the allegations of the US Office for the Control of Foreign Assets (OFAC) about the control of Novatek's Timchenko, in all likelihood, are based on unfounded rumors. Moreover, Novatek, whose shares are traded on the London Stock Exchange, is required to comply with the minimum requirements for corporate governance, which consist in ensuring the collegiality, transparency and independence of the board of directors. In all of the accounts, it is Leonid Mikhelson who is listed as the controlling shareholder of the company, who also heads its board.

Democracy versus competition

So what motivated the US to impose sanctions against Novatek? The answer lies in principle with the Yamal LNG and Arctic LNG-2 projects, the implementation of which will create the opportunity to export up to 35.7 million tons of LNG per year to Asia and Europe along the Northern Sea Route and create competition for the American LNG. In addition, in all likelihood, Igor Makarov's American partners in Itera, almost superseded from the Russian gas market, also played their role. Obviously, the special tax regime of these projects could not help attracting the attention of the advocates of world democracy from OFAC. Apparently, having confused the defense of democracy with fair competition, they decided to strangle the rival competitor of American developers with more expensive shale gas fields.

Surprisingly, the acquisition of a regasification project by Novatek in Poland in 2016 did not cause hysteria in the Polish press, which usually arises from the interest of Russian companies in any projects in this country. Even more surprising is that Novatek was allowed to buy this project not only in conditions of sanctions and restrictions, but also in the unfriendly mood of the Polish media and civil society in relation to Russian business. Polish businessmen, familiar with the negotiations, described the relatively calm attitude of the Polish media to this acquisition as a personal achievement of Leonid Mikhelson.

"Novatek", like all Russian oil and gas companies, has been working under sectoral sanctions for the fourth year already. During this time, they significantly reduced their dependence on Western financing, having managed to attract financing for "Yamal LNG" from Chinese and Japanese banks - in addition to the money provided by a consortium of Russian banks. Chinese companies also provided the project with drilling equipment, and part of the financing and works was made by Total, which bought a significant share in the project. And the project "Arctic LNG-2" interested not only the French, but also the Saudi Aramco, the Korean KOGAS, the Japanese Marubeni and Mitsui, the Chinese CNPC, as well as the German Linde. The mobilization of such diverse partners with very different interests and the ability to focus them on project implementation is being put forward by all counterparts and partners of Novatek in credit to Leonid Mikhelson personally.

By the end of 2017 Novatek not only managed to increase its resource base, return to one of the indices of the London Stock Exchange, launch the project "Arctic LNG-2", but, ironically, sell its first LNG cargo from Yamal, closing the need for gas in the "chilled" Boston (in the words of the London Times).

Judging by the experience of Novatek, the "infernal bill" on severe sanctions against Russia, presented by US senators earlier in August, is unlikely to have a significant impact on the Russian oil and gas industry. It contains proposals for large-scale sanctions, including on goods, services, technology, financing and any assistance necessary to enable Russia to extract crude oil and gas.

Since 2014, as the example of Novatek shows, the oil and gas industry managed to switch to the use of technologies and equipment of its own design and replaced partners with companies that are ready to work in Russia despite the sanctions risks. Therefore, even if the proposed sanctions become law, their impact on the Russian oil and gas sector will be limited. This is one of the reasons that Russian stocks have not suffered from news of the intentions of US senators to impose more stringent sanctions against Moscow. Reuters estimated that since the introduction of the bill, the Russian ruble has lost 10% of the value, and bank shares have fallen by 20%. However, shares of oil companies grew by 2%, and compared to the previous year - by 27%. Over the past two months, Novatek shares have been growing steadily in value, with the exception of small declines. If we talk about figures, then the share price during this time has grown by about 27%.

The last one and a half decades of observations of Novatek make it possible to conclude that its survival and success in the difficult conditions of recent years is largely due to the personality of Leonid Mikhelson himself, who (unlike some of his fellow workers) is still interesting to create and build. It is likely that the unsuccessful change of Mikhelson (and all the Russian oilmen of the first post-Soviet wave is far from a young man) at the helm of Novatek can create much more problems for the company than US sanctions, paradoxically though it sounds.