Big Oil MNCs exiting Russia

Why are energy companies like Shell and British Petroleum quitting joint ventures with Russia? What effect will these moves have on the larger economy?

The story so far: British energy major Shell on Monday decided to exit Russia. The company ended its joint venture energy projects with Russian energy company Gazprom including the Sakhalin-2 liquefied natural gas project and projects to develop and explore energy fields in Siberia. Shell is the latest oil company to quit Russia after British Petroleum (BP) on Sunday announced that it will be ending its joint venture with Rosneft. Many other smaller energy companies are also expected to exit Russia soon.

Russian President Vladimir Putin’s decision to send military troops to invade Ukraine last week has led the U.S. and Europe to impose various economic sanctions on the country. These include cutting off a number of Russian banks from the SWIFT network for international payments as well as freezing the Russian central bank’s dollar assets in order to stop the central bank from propping up the rouble.

Many, however, have called for sanctions that directly target Russia’s energy sector, which contributed to more than a third of the Russian government’s budget last year. It should be noted that Russia’s energy sector is heavily dominated by the Russian government with major producers such as Gazprom and Rosneft, which contribute to most of Russia’s energy production, being owned by the Government. These companies transfer their earnings to the Russian exchequer and also play a role in Russia’s foreign policy that uses energy as a bargaining chip. The CEO of Rosneft, Igor Sechin, for instance, is seen as a close ally of Putin and so BP’s collaboration with Rosneft has often been criticised. There have also been calls for western oil companies to quit Russia after the annexation of Crimea in 2014.

Doing business in Russia thus carries significant reputational risk for large western oil companies. However, the massive profits that large oil companies earn from their Russian operations has largely outweighed the reputational costs. Shell’s assets in Russia were valued at over $3 billion at the end of last year while BP derived a fifth of its total profits last year from its investment in Rosneft. This time, however, there has been greater political pressure on these oil companies. U.K.’s Energy Secretary Kwasi Kwarteng, for instance, has been strongly pushing British energy companies to sever ties with Russia.

Most of the impact of Big Oil’s exit from Russia on the country’s economy is likely to be over the long-run rather than in the immediate future. Foreign companies offer important technical know-how which helps in energy exploration and production. They also bring precious capital to fund energy projects in Russia. These can turn out to be crucial determinants of energy sector efficiency in the long-run.

It is not clear, however, how exactly BP and Shell will exit their investments at the moment. The exit could involve incurring significant losses if the Russian government decides to seize their assets.

Western commodity trading houses such as Trafigura and Glencore also play an important role in the sale of Russian energy in the international market. Their exit from dealing in Russian energy assets, if it happens, can affect liquidity and lead to greater volatility in energy prices in the international market.