The energy demand has been on the increase in many countries around the world including Russia and other oil producing countries. The international market for oil and gas has different regulations and market dynamics (Grace 2005, p. 35). The oil and gas market has been affected to a large extent by the regulatory pressure.
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The price of oil at the international market has been rising and this consequently causes an increase in the price of petroleum products such as gas (Grace 2005, p. 35). Despite the price of oil going up, the gas market is relatively stable compared to the oil market.
Emerging economies such as China have increased their oil consumption and in the process increasing the demand for oil at the international market (Grace 2005, p. 35). Refinery capacity of petroleum products has gone down in major countries like the U.S and in the process causing an increase in the price of gas (Grace 2005, p. 47).
Speculators have contributed to the rise in oil and gas prices (Grace 2005, p. 47). The uncertainty in oil prices is influenced by OPEC members such as Russia who have the capacity to produce enough oil to meet the international demand but geopolitical reasons and speculation has caused artificial oil shortages across the world (Grace 2005, p. 47).
Refinery bottlenecks in major oil producing countries have limited the supply of gas at the international market. The growing demand for natural gas has made many countries to start investing in gas infrastructure due to the increasing profitability of gas. Speculators have been unable to link gas prices to oil prices due to the presence of alternative sources of energy such coal (Grace 2005, p. 47).
In 2006, Russia and Ukraine were involved in a dispute over gas prices which clearly indicates that the price of gas at the international market is no longer dependant on a single supplier (Grace 2005, p. 48).
Russia is among the leading oil and natural gas producers but its domestic consumption is also very high (Grace 2005, p. 56). The Russian economy has been growing in recent years which means that its oil consumption has subsequently gone up. The international oil and gas market is largely dependant on Russia for supply because almost 12 % of oil and gas supplied to the international market comes from Russia (Grace 2005, p. 56). Russia is a major player when it comes to oil and gas business with many companies being interested in investing in the Russian oil industry (Grace 2005, p. 56). Increased investment in the Russian oil industry can lead to an increase in oil and gas supply to the international market (Grace 2005, p. 56).
Production of oil has declined in Russia due to lack of capital investment with the old oil and gas infrastructure needing replacement and reconstruction (Inkpen 2011, p. 35). It has been difficult for Russia to exploit the many oil reserves it inherited from the Soviet Union due to lack of investment capital (Inkpen 2011, p. 35).
Limited local investment has made Russia to look out for foreign investors in order to revamp its oil and natural gas production (Inkpen 2011, p. 79). Many foreign investors have been discouraged by the tough legal barriers put in place by the Russian government.
This situation has discouraged many foreign investors from investing in the Russian oil industry because they fear losing their investment. Production sharing agreements (PSAs) is an example of Subsoil laws that protect the interests of foreign investors (Inkpen 2011, p. 79). Many laws on Subsoil Resources are very contradictory and confusing to foreign investors and do not consider their interests.
The PSA law is very vital in facilitating production sharing agreements between the state and foreign investors (Inkpen 2011, p. 79). The PSA contract gives a foreign investor the right to develop and explore Subsoil Resources within the host country within a specified period of time (Inkpen 2011, p. 95).
The host country gets a percentage of the oil produced by the foreign investor and at the same time protects the foreign investor from local legislations that may affect the profitability of the foreign company (Inkpen 2011, p. 95).
It is the responsibility of the host country to ensure that the foreign company remains profitable (Inkpen 2011, p. 95). The PSA contract contains agreements that exempt the investor from the tough foreign investment regulations that may exist in the host country (Inkpen 2011, p. 95).
The PSA law in Russia does not provide foreign investors with the desired protection and certainty which has been a major obstacle for foreign investors willing to invest billions of dollars in the Russian oil industry (Inkpen 2011, p. 95). The PSA law in Russia does not have provisions for a self-contained agreement between the state and foreign investors.
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Foreign investors in Russia are exposed to the hostile legal requirements (Inkpen 2011, p. 95). Laws on Subsoil Resources and foreign investment are applied directly in Russia since the PSA law in Russia refers to them directly (Inkpen 2011, p. 143). Russia’s oil production has fallen significantly in the last ten years and this is not good for the country because it gets most of its revenues from oil exports.
The other reason why declining oil production in Russian is not good for the country is the threat the fuel shortage poses to domestic industries (Inkpen 2011, p. 143). Domestic industries in Russia depend on local fuel that is affordable and accessible.
The amount of oil being produced in Russia is only sufficient for domestic consumption and the quantity of surplus oil for export has steadily declined (Inkpen 2011, p. 143). Lack of investment in oil exploration and infrastructure is the reason for the decline of oil and gas production in Russia (Inkpen 2011, p. 143).
The hostile legal environment in Russia has caused many negotiations between the Russian government and foreign investors to break down (Inkpen 2011, p. 201). The country has ended up losing out on the benefits of foreign investment. The foreign investment law that came into existence in 1991 has for a very long time failed to meet its objectives and goals (Inkpen 2011, p. 201).
Foreign investors can only commit substantial amounts of capital to a host country when the law on foreign investment assures them of protection and certainty in their transactions (Inkpen 2011, p. 201).
The PSA law in Russia exposes foreign investors to supervening legislation that includes a hostile tax regime with no central authority (Inkpen 2011, p. 201). It is very risky for a foreign investor to feel comfortable in a hostile legal environment such as the one in Russia (Inkpen 2011, p. 201).
The local and federal authorities have their own regulations regarding foreign investments with no possible avenues to coordinate the two sets of laws (Inkpen 2011, p. 201). The system of overlapping jurisdiction in Russia is very unfair to foreign investors because they have to pay taxes and licensing fees to both the federal and the local government.
The Russian tax regime and the ever changing legislation on foreign investment have been a major obstacle to foreign investment in Russia (Lyubchenko 2008, p. 16). The PSA subject is very controversial in Russia because the Russian lawmakers are divided on whether the PSA law should become fully operational in Russia or not (Lyubchenko 2008, p. 16).
The current PSA law does not have a provision for dispute resolution. The current PSA law allows the federal and local governments to receive tax and other duties from foreign investors and in the process lowering the profit margin of investors (Lyubchenko 2008, p. 16).
Shell has a plan of investing over $ 10 billion in the Russian oil industry through the Sakhalin II project. The company should go ahead and invest in the very lucrative Russian oil industry despite the legal challenges that the company is bound to encounter (Lyubchenko 2008, p. 16).
This is a large-scale project and the company should take some steps towards mitigating the risks associated with investing a huge amount of resources in a hostile Russian legal environment (Lyubchenko 2008, p. 16).
Russia is a country with great human capital that can be fully utilized by foreign investors to their advantage. Risk taking in business is a common thing and foreign companies should try to invest in Russia despite the many risks that they are bound to encounter (Lyubchenko 2008, p. 16).
There are quite a number of ways through which foreign companies such as Shell can mitigate the risks associated with large scale investment in Russia (Lyubchenko 2008, p. 16). To begin with, the company should only invest the amount of money it can afford to lose in case the business fails to bring the expected returns (Lyubchenko 2008, p. 19).
Shell managers should diversify the Sakhalin II project by making different investments in the energy sector through subsidiary companies as a way of mitigating investment risks (Lyubchenko 2008, p. 19). Shell should invest in the Sakhalin II project with long term goals as a way of shielding the company from the risk of volatility that is associated with many Russian investments (Lyubchenko 2008, p. 19).
Exposure to the neighboring markets such as Latvia and Ukraine is another way through which foreign companies such as Shell can mitigate the risks associated with investing in Russia (Lyubchenko 2008, p. 19).
In conclusion, a steady rise in the consumption of oil and gas has led to an increase in the demand for the two products in the international market. The rise in oil and gas prices in attributed to market speculators and refinery bottlenecks (Lyubchenko 2008, p. 27). Production sharing Agreements are meant to protect foreign investors from the hostile legal environment in host countries.
The PSA law is yet to be fully implemented in Russia and that is the reason why many foreign investors are reluctant to invest in the lucrative Russian oil industry (Lyubchenko 2008, p. 27). Oil producing nations such as Russia should adopt the PSA law in order to attract foreign investors who are willing to invest in the Russian oil industry (Lyubchenko 2008, p. 27).
Grace, J 2005, Russian oil supply: Performances and prospects, Oxford University Press, London.
Inkpen, A 2011, The global oil and gas industry: Management, strategy and finance, PennWell Books, London.
Lyubchenko, S 2008, Production sharing agreements in the Russian Federation and the Republic of Kazakhstan, University of California, Berkeley.