The Russian legal market can be an unpredictable beast. A history of interfering politicians, corruption and debt crises, both internal and external, have meant that since the collapse of the Soviet Union, law firms in Moscow have struggled to maintain a steady grasp on just what might be around the corner. Despite all the variables, however, there is one constant, and that is the energy and natural resources sector, which dominates Russia’s foreign exports – in 2011 oil and gas revenues accounted for 10.4% of Russia’s GDP (up from 7.6% in 2009). Provided that commodity prices don’t drop for a sustained period of time – particularly crude oil, which has been strong since going above $50 a barrel in 2005 – a decent volume of work can be assured.
This was underlined in 2010, when the Russian state-owned oil producer Rosneft launched projects in the Kara and Barents Seas after obtaining licences to explore four blocks in Russia’s Arctic shelf. Three major joint ventures with the Western energy companies Exxon Mobil, Statoil and Eni were subsequently signed in 2011 and 2012.
For the law firms advising on these massive deals (see ‘Rosneft Arctic Block oil exploration joint ventures and legal advisers’, page 50) it guarantees a tremendous workflow for the future, as all the related development projects properly kick into gear. It is unsurprising then that they retain a fairly sunny outlook.
The market generally is very active and more so than in the previous five years, or even ten years for that matter,’ says Moscow-based Herbert Smith partner Danila Logofet, who advised the Italian energy company Eni on its deal with Rosneft. ‘These deals are the most significant developments since the Russian default in 1998. They are bigger than even TNK-BP. We’re not just witnessing a JV-type arrangement where you have a new business being sold at fair market value, we’re talking about the creation of a new oil and gas province and greenfield exploration and risk. These are projects that can parallel Sakhalin-1 and 2 in size.’
Even for the majority of firms not directly involved in the first round of negotiations, the trickle-down effect is likely to be huge. The infrastructure required to support these projects will inevitably involve contractors and sub-contractors at every level.
‘The market generally is very active and more so than in the previous five years, or even ten years for that matter’
‘At the moment it is just one firm on each side,’ says John Hammond, senior partner at CMS Russia. ‘As the projects move forward, we anticipate there will be more opportunities. Given the capacities of law firms in the market here we expect there to be some really good opportunities for firms in the sector.’
‘People want a piece of this action,’ adds one partner at a major international firm. ‘There is huge interest upstream and that feeds down the chain. There is also interest on the LNG [liquefied natural gas] side, as well as pipeline development, which we are heavily involved in. You are seeing investment at every level.’
It is unlikely that this exploration work will be limited to the Arctic block, and given the scale and long-term nature of the projects in question, it is also unlikely that any short-term fluctuations in oil prices are going to impact on their feasibility. For Russia to maintain its status as the world’s second-largest oil producer after Saudi Arabia, it needs to keep drilling, and that means more exploration. It will also mean more joint ventures, since much of the technology and experience required to develop these fields is in the hands of the foreign majors.
‘Everything easy has been taken out of the ground and now in order to maintain Russia’s position as a leading oil producer and to support its economy it is absolutely vital that Russia undertake new exploration,’ says Laura Brank, head of Dechert’s Russia practice. ‘A lot of the recent developments have been to execute on that plan. There has been recognition that they do need technical expertise from abroad to exploit the more difficult deposits.’
Energy charge
This level of energy-related foreign investment and development work is in stark contrast to the dearth of activity in other practice areas, such as capital markets and mergers and acquisitions. According to a recent report by the accountancy firm KPMG, in 2011 there were 394 Russia-related M&A deals with a total value of $71.1bn. This represents a significant drop from the peak in 2007, when there were 867 deals worth $154.9bn. Year on year, Russian M&A dropped by 28% in value between 2010 and 2011, compared to a 6% decline globally, a fact that re-emphasises the importance of the energy and natural resources sectors when it comes to maintaining Russia’s economy, not to mention deal activity for law firms. In addition, of the ten largest transactions in 2011, only three were not linked to the energy, power and mining industries.
The downturn in deal activity, prompted by the credit crunch and exacerbated by the eurozone crisis, has also highlighted Russia’s vulnerability and over-reliance on the European Union, which accounted for 49% of Russia’s exports in 2010. In 2011, fuel and mining products accounted for 83% of these exports. While Western demand has improved since 2009, eyes have shifted eastwards, towards Russia’s more buoyant and resource-hungry neighbours in Asia.
In September 2012, at the Asia-Pacific Economic Co-operation Summit (APEC), which Russia hosted for the first time in Vladivostok, President Vladimir Putin effectively made it a matter of public policy that Russia would strengthen its ties with China and other vital Asian markets. To do so, the country will prioritise investment into energy and infrastructure in the neglected eastern parts of Russia. A symbol of this is the two-mile long Russky Bridge that was built in Vladivostok at a cost of $1bn and opened in July. A reported $20bn of further improvements were made to the city’s road system and airport. Much of this investment has been spurred by demand for energy and natural resources in China, Japan and South Korea, meaning the creaking infrastructure in the east needs a major overhaul to keep up. Law firms are confident that if this isn’t just empty rhetoric from Putin (and nothing here can be guaranteed), then their energy and infrastructure groups should remain extremely busy for years to come.
Western decline
While Rosneft’s activities in the oil sector look set to provide a huge amount of foreign investment, other corners of the energy market are on shakier ground. The prospects for natural gas, which is one of Russia’s most important strategic industries, aren’t looking strong, for example. The development of shale gas in the US, as well as the discovery of probable reserves in core markets such as the EU, eastern Europe, the Ukraine and China, have meant that Russia’s, and in turn Gazprom’s, dominance of the market appears uncertain.
‘Gazprom, at least outwardly, hasn’t shown any concern at all with regard to the shale gas revolution in the US,’ says Rob Patterson, managing partner of Vinson & Elkins’ Beijing office and former co-managing partner of its Russia practice. ‘It is something that I’m sure internally they are concerned about and they should be. China is also supposed to have among the highest shale gas reserves in the world and if that happens they will have problems on both sides.’
Significant gas discoveries in Israel and Cyprus in the eastern part of the Mediterranean are also likely to provide a strong source of competition. This has meant that the prices Gazprom charges its European customers – based on long-term gas supply contracts – are much higher than those presently found on the spot market. Coupled with this have been proceedings brought against Gazprom by the European Commission for anti-competitive practices. ‘The whole Gazprom question is such a huge issue for the EU,’ says one partner at a major international firm. ‘The politics of Russia is Gazprom. Because the export revenue is so much higher than the domestic prices it is really critical for Gazprom to export to Europe. That and the fact that the US is looking to shale is going to tip the whole equation with Russia and they are very nervous about this. Their whole strategy has been based on the fact that they are going to get a certain amount of revenue from the export of oil and gas and that is changing.’
‘A lot of fundamentals are shifting,’ adds Mathieu Fabre-Magnan, a partner in Salans’ Moscow office. ‘There is the European Commission’s investigation into Gazprom’s supply of gas and the government’s clumsy response. Gazprom has managed some very successful long-term gas supply contracts with European countries, but the prices are much higher than what they are in the market at the moment. This has a lot of collateral impact.’
To compound matters, Gazprom’s August 2012 decision to abandon the development of its flagship Arctic Shtokman field, which it was working on in conjunction with Statoil and Total, was seen as emblematic of the problems that the company faces. Despite the added dimension that shale gas brings to the market, it was ultimately the soaring cost of the project, as well as disagreements with its partners, that made it unfeasible, rather than any short-term reaction to the newly developed market in US shale. Indeed, while Shtokman was a high-profile climbdown for Gazprom, for the time being, the deal flow within the natural gas market is still strong, as exemplified by Total’s $4bn acquisition of a 12% stake in the Russian natural gas producer Novatek, which included a 20% share in the Yamal LNG project.
‘We haven’t seen shale gas issues affect Russia,’ says a partner at a major international firm. ‘Last year was pretty steady in terms of deals, mainly driven by Russian politics rather than the oil price. It is quite clear that Russia is trying to develop as much as possible. There is a perception that everything should be developed and explored, hence the reason for so many projects.’
A good portion of these projects are linked to the Asian market, and for Japan, the demand for gas will only increase, particularly following its decision to stop using nuclear power. A deal announced in September 2012 to sell LNG to Japan, which will include a $13bn LNG and shipping terminal in Vladivostok, is illustrative of this. It is unsurprising then that Putin, and in turn most energy practices, are starting to look east.
Eastern promise
The attractions of the east, particularly when it comes to China, are obvious. Notwithstanding the fact that it is Russia’s largest trading partner after the EU, accounting for 5.3% of its exports in 2010, China is still regarded as a huge and largely untapped prospective market. Russian companies also see their Chinese counterparts as prospective investors and shareholders into their projects. The Russians also acknowledge that there is the need for added technology, something that Chinese companies can certainly bring to the table.
‘Part of the rationale in me coming out from Moscow was that we saw an increasing interest from our Chinese clients in investing in Russia’
For law firms with big energy practices, such as Vinson & Elkins, this increased link-up has already had a bearing on strategy. ‘Part of the rationale in me coming out from Moscow was that we saw an increasing interest from our Chinese clients in investing in Russia,’ says Patterson. ‘I think it’s turned out to be a good move. I spend about 50% of my time on Russia-related transactions. We’re trying to add another Russia-speaking lawyer to our team here in Beijing specifically.’
For Vinson & Elkins, the impetus has largely been from Chinese companies seeking opportunities in Russia, rather than the other way round. Meanwhile, the headlines that Putin has generated are more down to the fact that Russia is waking up to Asia.
‘When you look at the Japanese trading houses they have been in Russia for a very long time,’ says Norton Rose’s Moscow-based corporate partner Nick Dingemans. ‘Mitsubishi and Mitsui have been partners in Sakhalin Energy with Shell from the beginning. They and the other Japanese trading houses have been in Russia for a very long time. There is quite a big Asian expat community in Moscow, representing Japanese, Korean, Indian, Indonesian and Malaysian as well as Chinese businesses. Asian investment into Russia happened a lot sooner than the Russian investment into Asia. Now though, Russia has turned a corner and is really thinking about investment into Asia in a positive sense. The APEC forum in Vladivostok was a very public demonstration of that.’
For most firms, however, it is still very much a waiting game, where enthusiasm and talk hasn’t translated into major instructions.
‘There is a lot of PR about the Russia-Asia opportunity,’ says Pranav Trivedi, a corporate finance partner at Skadden, Arps, Slate, Meagher & Flom. ‘There is a lot of noise
coming from the Russian government about the fact that they are really looking East for their development now. There are obviously issues with Europe and the US. So far though, in terms of what has translated into work, it is more talk than reality. There have certainly been one-off examples of significant Chinese investment, but to my mind it hasn’t translated into a significant flood of work. We are hopeful the work will come, and we believe we are well positioned for when it does.’
As such, most firms haven’t made major commitments in terms of getting their Russian-speaking lawyers into Asian offices. Most of the energy has been put into marketing activities.
‘Renewed interest could result in further opportunities. It may make sense to have a Russian team in our Tokyo office (we had this before the crisis but Japanese investment in the Russian Far East didn’t develop as we hoped it would),’ says London and Moscow-based White & Case projects partner Marc Polonsky.
‘We met a lot of Chinese clients looking into Russia,’ adds Eric Michailov, a Moscow-based partner at White & Case. ‘They’ve all got a Russian strategy. Some of the clients we met had Russian business cards. They had Russian-speaking staff on their projects and business development side. They haven’t got anything on the ground but they’ve got their infrastructure ready to go. A lot of them are resources companies, and manufacturing companies and Chinese banks.’
‘There have certainly been one-off examples of significant Chinese investment, but to my mind it
hasn’t translated into a significant flood of work.’
Aside from infrastructure projects and joint ventures, the work has so far been fairly limited. The potential for capital markets work seemed promising after Cleary Gottlieb Steen & Hamilton represented Rusal on its $2.2bn Hong Kong listing in 2010. Since then, however, little has materialised. IRC, an iron ore mining unit of the London-listed gold miner Petropavlovsk, also listed in 2010, although investor interest was so weak that it had to cut the share price and reduce the shares on offer by 20%. The debt side saw some movement in 2011, when Cleary advised Russia’s second largest bank, VTB Bank, on a landmark Renminbi bond issue in Hong Kong – the first of its kind for an emerging markets issuer outside China. Despite the pioneering nature of the deal, however, it has yet to translate into a significant flow of work.
Barriers to entry
Most of the barriers that Chinese and other Asian clients face aren’t new – in fact they are reflective of the issues that most investors encounter when dealing with Russia. Among these is the risk factor, whether it stems from corruption or political interference.
‘None of the Chinese companies here underestimate the potential difficulties and risks of doing business in Russia,’ says Patterson. ‘We work with one Chinese resources company that has been looking at investments, but has told me that Russia is in their second tier of investments around the world. Australia and Africa are in the tier above them, because they are just a bit more nervous about Russia.’
‘Although Russia’s image suffers a bit, it is still supposed to be a reliable investment country and is probably too big to be skipped.’
This problem isn’t unique to Russia, but also arises among other CIS countries keen to attract Asian investors. In the case of Ukraine, the nervousness is even greater.
‘We have had interest from Chinese companies,’ says Julian Ries, managing partner of Beiten Burkhardt’s Ukraine office. ‘They are very active in the construction sphere. Although, when I talk to my Russian colleagues, the pace of investment is much quicker there. Ukraine suffers from its bad political reputation. The Timoshenko case was a disaster for Ukraine. Investors say they are waiting another two years, and many have been discouraged. Although Russia’s image suffers a bit, it is still supposed to be a reliable investment country and is probably too big to be skipped.’
The fact that Chinese companies do see Russia as a strategic avenue of investment can often count against them. Despite their recent proclamations, Russian politicians still eye the long border with China somewhat nervously. As a result, Chinese companies aren’t always greeted with open arms, in fact it can be quite the reverse.
‘I’ve been involved in auctions of mineral rights and it has been clear that, on occasion, steps have been taken to exclude Chinese bidders,’ says Glen Ireland, a partner and mining expert at Latham & Watkins. ‘The Chinese are interested in Russia, but they know they need to play their cards carefully. The situation might be starting to change a bit, as we are seeing some large resource/infrastructure projects where Chinese investment is being welcomed.’
This experience certainly isn’t unique to Latham lawyers: ‘Almost every single deal that we have been in involving a Chinese party has been rejected by the Russian government,’ adds one partner at a major international firm. ‘On the one hand Russia sees the potential of the Asia market, but they’re also scared to death of it and they won’t really let the Chinese into something that is strategic. The government has made it clear to us that it would so much prefer a US company coming in to develop its strategic reserves to having China come in. The political situation is interesting, Russia is concerned about the US, but really what it is afraid of is China. It is really the biggest elephant in the room.’
Power politics
This level of political interference, especially when it comes to strategic assets, isn’t unique to Chinese companies. It is something experienced by the industry as a whole, regardless of where the investors come from. By all accounts it is something that is on the increase, and not just in the energy and natural resources sectors.
‘Everything is a lot more scrutinised than it used to be,’ says Michailov at White & Case. ‘Anything big or strategic, such as resources or telecoms, seems to need to get the nod from the right government departments. In the past foreign investors could come in and anti-monopoly consent was rarely refused, but now it is a bit more touch and go.’
‘Some of these oil and gas projects have quite strong state support,’ adds Alexey Konevsky, a partner and head of real estate and construction at the Russian law firm Pepeliaev Group. ‘Most of these are not pure business projects and when they are quite expensive the state will usually get involved to facilitate the development of that part of the country.’
Given the strategic importance and scale of most of these businesses and projects, it is perhaps unsurprising that politicians will demand greater input, whatever the issue might be. Whereas low commodity prices might force the closure of a plant in the UK or elsewhere, in Russia there are extraneous factors to be taken into consideration.
‘A lot of the mining and metals projects in Russia are in remote parts of the country and they typically have local communities that are totally reliant on them financially,’ says Ireland. ‘It’s not easy for Rusal, for example, to shut down one of its smelters.
The Kremlin is highly sensitive to the social issues caused by such events, and President Putin has a track record of becoming personally involved.’
These realities are something that most large investors, and indeed their legal advisers, are prepared to take on the chin. The potential returns, particularly when it comes to the oil industry, are so large that any political downside is something they are happy to bear.
‘We need to remember that this is the oil and gas business,’ says Logofet at Herbert Smith. ‘It is very political. It is high stakes and high returns. I don’t think there is a more interesting jurisdiction for foreign majors than Russia. Russia is offering huge acreages and that is a wildcatter’s dream. That is why I think the actual business model of the majors is built on developing such acreages. It’s what they do. I think there is no fear or worry. In legal terms we have to tell the client that there are 100 ways that the Russian government can screw the investor, and we do. But I don’t think it’s like 20, or even ten, years ago. Investors see Russia as a more mature market and the state as a more mature state.’
The road to nowhere
While the investment climate in Russia has improved by leaps and bounds, one ongoing issue that certainly needs to be addressed is the parlous state of the country’s infrastructure. The problem is particularly acute in the east of Russia, where much of the connection with Asia is likely to be developed.
‘In order to have any possibility of developing in this direction one of the important issues is to develop the infrastructure here,’ says Pavel Karpunin, a partner at the St Petersburg office of Capital Legal Services. ‘We have a very big country and very few connecting lines between east and west. That is why the development of infrastructure is of huge importance.’
It is something that Putin acknowledged at APEC, although transforming words into deeds will be a massive undertaking. It is a hugely expensive hurdle that has to be considered for every project.
‘We’re advising on one petrochemical project in the far east of Russia,’ says a partner at a major City firm. ‘One of the concerns there is how do you get as much oil as is needed to the project because of the challenges around the infrastructure. You’ve got a number of investments going on but it is fair to say that for infrastructure in the energy sector, and for transport infrastructure in general, there is a huge investment to be made.’
The question in this respect is where the money will come from. There are relatively few major projects that have been done on a project finance basis, with Sakhalin and RusVinyl – the E750m financing of Russia’s largest integrated PVC production plant – being among the few high-profile ones to reach completion. Yamal LNG is also expected to use project finance, but compared to other jurisdictions, it remains a relatively untried financing model in Russia.
‘Pure project financing is pretty rare in the Russian context,’ says Ireland. ‘As a practical matter it is a challenging structure in Russia. There are a lot of uncertainties in terms of access to infrastructure, so project lenders are loath to go on risk to the assets concerned. They want to keep the project sponsors on the hook for any problems that might occur. It all does lead to more pressure on the public purse to get things done.’
For transport infrastructure, the impetus is very much on the government to either fund projects directly or do them on a public private partnership (PPP) basis. When it comes to direct government procurement contracts, many of these are done with minimal need for outside legal counsel. Meanwhile, PPP is a sector that has suffered considerably as a result of the liquidity crisis in the eurozone. For the most part, financing is the domain of domestic Russian banks such as VTB, Sberbank and Gazprombank, so the options for international law firms are fairly limited.
‘This year the market isn’t as optimistic as the oil and gas sector because of the European crisis,’ says Olga Revzina, who heads Herbert Smith Freehills’ infrastructure group. ‘All of these projects are so huge and huge project financing is needed to implement them. There are few banks that can afford to do that right now. The Russian Federation can only rely on itself, so there are few players on this market.’
‘It is obvious that there needs to be investment in infrastructure otherwise growth will be strangled,’ adds Hammond at CMS Russia. ‘But it isn’t clear at all how that is going to happen. It is definitely a problem across the board.’
Aside from the eurozone crisis, foreign investors are still reluctant to take part for numerous reasons, including foreign exchange risk, and the fact that there is no common consensus as to how PPP should be tackled. Without federal government support, many of the projects are done at a local and regional level, which makes it harder to find a consistent approach.
‘The regions procuring PPP projects aren’t willing to guarantee the fluctuation in exchange rates.’
‘Regions understand they have to finance infrastructure that they are responsible for, and they definitely lack support from the federal government,’ says Ilya Skripnikov,
an infrastructure specialist at Salans. ‘From our experience we will see that for the next three to five years it [PPP projects] will be largely occupied by domestic banks. The regions procuring PPP projects aren’t willing to guarantee the fluctuation in exchange rates. The major question for construction companies and investors is who is willing to take the foreign exchange risk. Foreign lenders are ready to invest in Russia but they definitely don’t see a step forward from the local governments in dealing with the Forex risk.’
Beyond the foreign exchange issues, there is also the simple lack of efficiency in bringing these projects to a close. The most high-profile PPPs so far have been the Moscow-St Petersburg Tollroad, St Petersburg’s Western High-Speed Diameter, and the Moscow-Minsk M1 Tollroad, although getting them to closure wasn’t easy.
‘Several large infrastructure projects have been successfully completed but not without significant delays or other complications,’ says Polonsky at White & Case. ‘Infrastructure investors are concerned about the uncertainties and may be reluctant to get involved.’
‘There is a bit of history in Russia on the difficulty of PPP infrastructure projects, like the Moscow-St Petersburg toll-road that has been on and off so much,’ adds Julia Czarniak, a New York-based project finance partner at Skadden Arps. ‘There is interest because capital is available, that being said, the opportunities are few and far between and the borrowers expect competitive pricing.’
These are all issues that have been encountered in western Russia, so the assumption is that it will be far more difficult to manage in the east, where the environment and distances involved will make the projects much harder and costlier.
Outward bound
Whether or not the growth in Asia-related work does occur, most Russia-based energy lawyers can at least take comfort from the fact that their sector is busy. The domestic oil and gas market has in its own right become a self-sustaining behemoth with enough activity to keep many law firms active, even without the high-profile Arctic block projects or increased investment from Asia.
‘There are the high-profile joint ventures that get a lot of exposure in the West,’ says Alexey Kondratchik, a partner in Akin Gump Strauss Hauer & Feld’s Moscow office. ‘But the most interesting ones are the domestic joint ventures, such as Lukoil and Bashneft. These companies come together because some have the licences and some have the infrastructure. That is just the maturity of the domestic market.’
On top of this domestic activity, there is also a greater degree of investment between CIS member states.
‘There are the high-profile joint ventures that get a lot of exposure in the West’
‘CIS investment into Russia is a great market,’ says Logofet at Herbert Smith. ‘It brings a great smile to my face when we get instructed by Ukrainian companies to buy Russian assets under English law. This has happened only in the past three or four years. It shows that people are prepared to work together on Western terms.’
This maturity and increased Westernisation is reflected in the significant shift in the way that the large domestic energy companies operate internally, particularly state-owned ones such as Gazprom and Rosneft.
‘In the last few years you have seen an interesting phenomenon where younger people who have worked for law firms, investment banks and accounting firms have taken up positions in state-owned companies,’ says Murat Akuyev, a corporate finance partner in Cleary’s Moscow office. ‘The staff have become younger and we speak the same language.’
The increasingly outbound nature of some of their investments has helped those companies develop internally as well. This is something that has certainly been noticed within the legal recruitment industry. ‘Energy is beginning to come back in the market, both domestically but also with Russian-based energy companies making substantial investments overseas,’ says Guy Adams, a director at the recruiter Laurence Simons. ‘As is always the case in Russia, certain companies are bucking the general industry trends, but overall there seems to be a great deal more positivity in the market than there has been for the last couple of years.’
‘In terms of workload here, I think it’s been a bright spot,’ says Kyle Davis, a partner at Goltsblat BLP, who recently joined from Akin Gump. ‘Initially you saw Lukoil as leading the international charge. Now you see Rosneft and Gazprom Neft moving quickly to become oil majors. They now have seasoned international teams there. In the beginning there was a period where their teams and international counsel had to get acclimated to each other, but by now they’ve become quite savvy in instructing
law firms on transactions. When you look at the size and link ups of the deals they have been doing, it’s no surprise that their teams have developed very quickly. They’re determined to go shoulder to shoulder any place in the world with the big international oil companies.’
He adds: ‘This intense exposure to big-time international oil business is good for Russia, it’s good for Russian companies and it’s exciting being on the vanguard of something that is really important.’
For most energy practices, it is this sort of work that has helped sustain strong levels of activity despite the slowdown that has impacted other practice areas. Often this has been achieved without help from blockbuster deals such as the Arctic Block licences. The fact that these licences are translating into projects, and will almost certainly feed more activity into the wider market, is simply a bonus. Add the potential growth of the Asian market into the mix and the outlook has never looked more promising. Now it is down to Putin to follow through on his pledges.
anthony.notaras@legalease.co.uk
Field of dreams
Cyprus has long been the favoured destination for businessmen seeking to structure their investments outside of Russia. Its ability to facilitate tax-efficient deals has been a boon to the country’s legal community and, up until the eurozone crisis, Cypriot banks were flush with Russian cash. Certain dynamics have changed in the past two years, some for the better, some for the worse.
The loss that creditors had to take on Greece’s sovereign bonds was particularly painful for Cyprus’s financial institutions, which were heavily exposed to Greek debt. The country is still reeling from this, although with immaculate timing, major offshore gas discoveries have recently been made in Cypriot territory. The US company Noble Energy has already announced finds of 35 trillion cubic feet of gas, of which a fifth are in Cypriot waters. Overall, there is estimated to be 122 trillion cubic feet of gas in the Levant Basin, which is shared between Cyprus, Israel and Lebanon. This is enough to meet the world’s needs for a year, and if Cyprus does successfully exploit its reserves it could produce enough to earn up to $3bn a year at current prices.
What’s more, the geopolitical importance of the region, particularly for Russia, has meant that Russian companies such as Novatek, Russia’s second largest natural gas producer, have already expressed an interest in bidding for licences to explore off the Cypriot coast.
‘Cyprus suddenly has the potential of becoming a major energy hub, which would require major infrastructure investment,’ says George Pamboridis, name partner at Cypriot law firm Pamboridis. ‘Number one in the region for this is Russia, and it wants to be involved. It’s interesting to suddenly become a part of the puzzle and not just to be a place of business. You are now affected directly by the structures you set up. It’s nice to see that.’
The Russian gas giant Gazprom is expected to play a major role in the exploitation of Israel’s gas fields, and a high-profile summer visit from President Vladimir Putin to Israel has increased the likelihood of this co-operation.
‘Russians think that by having a big foot in what is happening in Cyprus it will give a boost to their global energy plans.’
‘Obviously Russia is very interested in this part of the world, since it is crucial to the various energy routes that go all the way to Europe,’ says Elias Neocleous, head of corporate at Cyprus-based Andreas Neocleous & Co. ‘The Russians want to make sure they can maintain these routes. They want to play a role, there is no doubt about that. They feel quite concerned with what is going on in Syria – that their power in the region is diminishing. Of course they think that by having a big foot in what is happening in Cyprus it will give a boost to their global energy plans.’
In the case of Israel, any infrastructure such as pipelines needed to transport the gas abroad will almost certainly go through Cyprus – its only friend in an otherwise volatile region. Cyprus’s membership of the EU will also ensure immediate access to a major market.
Cypriot law firms are anticipating a large influx of work from abroad. The investment required to exploit the resources will be at such a level that Cyprus will certainly need outside assistance. A liquified natural gases (LNG) plant with two trains costs in the region of $10bn, which is almost half of Cyprus’ GDP, which stood at $24.7bn in 2011. ‘This is a huge number for Cyprus,’ says George Pamboridis. ‘It is beyond our means and we cannot afford to do this on our own. Once you have a discovery, banks and investors queue up for you to consider them.’
As with the infrastructure deals, the law firms are also looking to establish ties with foreign law firms. Pamboridis has already established a co-operation agreement with DLA Piper, and has liaised closely with the firm’s energy and infrastructure expert Charles Morrison.
‘We created a joint team which aims to serve global clients,’ says George Pamboridis. ‘There is a lot of politics behind who gets what public contracts, so you need to have the local insight, which we are providing. We have been very happy with the co-operation we have had with DLA. It’s a close co-operation with mutual benefits.’
As with all areas of the gas industry, political considerations have to be taken into account and so far it hasn’t all gone Russia’s way.
‘We are going to see a lot of Asian and Russian interest,’ says Emily Yiolitis, managing partner of Harneys’ Cyprus office. ‘There are political considerations as well, which is why the first deal was given to an American energy company, Noble.’
While most law firms are excited about the opportunities, and many, like Pamboridis, are laying the foundations for future work, most remain fairly grounded when it comes to the short-term opportunities. ‘The interest from clients for getting involved in the local industry is growing, but it is still at its initial stages,’ says Irene Christodoulou, head of corporate at the Cypriot law firm Kinanis. ‘It is important to point out that the national gas company was just incorporated in the first week of October and thus the whole field is in its development phase.’
Christodoulou continues: ‘Reaping the benefits for the economy, is a serious and difficult challenge, in view of Cyprus’ location, political situation, as well as due to the global economic crisis.’
Indeed, for most the question now remains whether Cyprus can responsibly handle this scale of investment and potential wealth.
‘We live in a Mediterranean country, we don’t live in Norway,’ says Neocleous. ‘We need to promote growth without falling into the temptation of not doing things correctly. When the wealth is so huge it is always open to abuse and corruption.’
‘We have not yet passed the critical point where we can say that Cyprus has been able to capitalise on this,’ adds George Pamboridis. ‘The big bet is whether you can capitalise on this development by creating local content. If you look at countries like Norway, it is benefiting tremendously from its natural gas reserves. Not because of the direct income. The biggest benefit for Norway is the local content. They are now exporting that expertise. Our opportunity here is not primarily to grab the money and run. The opportunities here are indirect and it depends on us whether we manage to create value out of the resources. This remains to be seen.’
The big sell off
While lawyers working within Russia’s energy and natural resources sector are hoping for a time of plenty, corporate finance activity in other areas has been slow to say the least. Capital markets and M&A has been especially hit, and the slowdown in M&A has been much harder in Russia than it has in other global jurisdictions, with a drop of 28% between 2010 and 2011, as compared to a global drop of 6% in the same period.
One ray of hope has been the next stage of the government’s oft-delayed privatisation of state assets. The latest instalment of this was the $5bn UK offering of a 7.6% stake in Sberbank, in which Cleary Gottlieb Steen & Hamilton represented Sberbank and its selling shareholder the Central Bank of Russia, while Linklaters advised the underwriters. As has been the case with other assets on the block, such as Rosneft, Russian Railways and the Russian company Sovcomflot, the Sberbank listing has been beset by delays.
‘It’s obviously been in the works for quite a while,’ says David Gottlieb, one of the Cleary partners advising on the Sberbank deal. ‘Equity capital markets transactions these days are taking longer. There are lots of stops and starts. The parties need to be continuously ready because the windows of opportunity are very narrow. Sberbank was fortunate in being ready to launch in a relatively strong market. There have been periods of no or very little equity capital markets activity in Russia over the past 18 months. The same has generally been true in western Europe, the US and other developed markets.’
‘The good news for those of us in the market is that it seems to be getting better,’ says Pranav Trivedi, a corporate finance partner at Skadden, Arps, Slate, Meagher & Flom. ‘We are seeing privatisation matters that had been put on hold restart. The Sberbank deal was a very good sign. It was well received and it is a good indication that investors are prepared to come back into the market.’
The shape and form of these privatisations remains to be seen; whether they will be through the capital markets or through strategic sales, either to sovereign wealth funds or domestic investors. The government has already confirmed it is going to sell a 25% stake in Sovcomflot, the state-owned shipping company, and there are indications that it could go directly to a strategic investor, possibly from Singapore. Shares in smaller assets, such as the power generator TGK-5 and the Eastern Seaport of Vanino, are also up for sale, and they could also go directly to domestic investors.
The question then is which firms will get the work. If they are done on the capital markets, which looks likely for the bigger deals, then Cleary will be one of the favourites to work for the public sector, since it is already on the panel to do all of the government’s sovereign bond listings. This stems from strong links with the government going back to the early 1990s, which included advice on the post-Soviet debt restructurings and subsequent eurobond issues. Linklaters is also likely to get involved for the banks. Indeed, Cleary and Linklaters have worked opposite one another on many of Russia’s largest listings, including Sberbank, Rusal and Rosneft’s original 2006 IPO.
New procurement rules, however, have made the whole process a lot more arduous. Despite its track record and government connections, Cleary has to retender with
the Ministry of Finance for the government bond work each year. When it comes to the privatisation process, future listings of state-owned entities will require separate pitches to each of the individual issuers, all of which have their own different hierarchies, factions and procedures. As such, nobody is taking anything for granted.
‘There is definitely a realisation that the market for legal services is very competitive so we have to always be on our toes,’ says Murat Akuyev, a corporate finance partner at Cleary. ‘It does take a lot of effort in terms of pitching for meetings and this is a very hefty task.’
‘It was very painful from a documentation perspective,’ says one partner recounting their experience tendering for the state. ‘Months and months of filling out data forms, so I’m happy that we did win. On the one hand there is a prestige factor involved in having on your CV that you represented the state-owned entities, then on the other hand there is the real world. Fees are always an issue when you’re on the state side.’
Aside from the time involved in pitching for the work, there is also the fact that after several lean years, many of the corporate and capital markets groups within Russia have been pared to the bone. If the privatisations do go ahead as planned, and most are expected to be completed by 2016, then some firms might struggle to keep up.
‘If they do pick up the pace then the legal market will be stretched,’ warns Laura Brank, Dechert’s Moscow head. ‘Over the last few years there has been attrition in the market and if the deal flow increases more than marginally then the law firms in town will be stretched quite markedly. It has really contracted and that means that the whole new cadre of deal lawyers hasn’t really received as much experience as they should have. Just a moderate increase in deal flow will cause a real tightening in the market and there will be a real need for firms to hire again.’
Joining the club
Finally it has happened. After almost 20 years of negotiations, going back to the pre-World Trade Organization (WTO) days of The General Agreement on Tariffs and Trade, Russia has joined the WTO. That it took so long for Russia perhaps doesn’t come as a surprise.
‘If you joined after the WTO was established in 1995 you had to go through an extensive accession process whereby you had to accept additional, country-specific commitments in addition to all the general rules,’ says White & Case trade partner Brendan McGivern, who works out of the firm’s Geneva office. ‘Existing WTO Members insisted that Russia accept a wide range of unique – and in some cases, fairly intrusive – WTO commitments.’
For the most part, Russian lawyers feel that viewed as a whole the final deal is in Russia’s favour, despite claims that certain sectors such as pharmaceuticals and the automotive industry might suffer. The protective benefits that the WTO provides give them a far stronger position than they were in previously.
‘For Russian companies it is clearly a double-edged sword,’ says McGivern. ‘On the one hand, they are subject to increased competition but equally they have new opportunities to access foreign markets. Russian companies no longer have to accept gratuitous discrimination in foreign markets – they have recourse to multilaterally agreed rules to enforce their rights. It really is a whole new world.’
‘The outcome I think was quite positive for Russia,’ adds Leonid Zubarev, a partner at CMS Russia. ‘Lots of issues were defended. There were no concessions, for example, in the banking sector. There were lots of changes in terms of the agricultural sector and the automotive sector. Key industries saw terms become more favourable. For example Russian agricultural producers will be in a more advantageous position. They are entitled to certain compensations that they wouldn’t receive now.’
International law firms with significant trade practices, particularly those with offices in Geneva, where the WTO is headquartered, Brussels or Washington DC, could find themselves in a strong position. Russian domestic producers seeking access to international markets, something that will be on the increase following accession, have already started making enquiries. Many of these had previously instructed domestic law firms, but now their international rivals could get a foot in the door. It is certainly something that is on the radar with domestic lawyers.
‘There is a fear that the foreign legal companies will be able to make some good business,’ concedes Pavel Karpunin, a partner at the Russian firm Capital Legal Services.
‘I already see more interest from Russian companies and international companies,’ adds Edward Borovikov, managing partner in Salans’ Brussels office, who provided legal support to the European Commission during the accession negotiations. ‘It looks like everyone has been waiting for this to happen, but nobody believed it would. Then they suddenly woke up and everyone said, “Oh my God, Russia is in the WTO”. If there is a Russian law firm that wants to do WTO it would be quite difficult without support from Brussels and Washington DC.’
The complicated nature of the rules means that it is more or less a closed shop, limited to those trade lawyers with years of experience.
‘For law firms that do not have a WTO practice and haven’t kept up it is tough to step into the Russian WTO law market now.’
‘If you look at these rules it is pretty tortuous stuff,’ says McGivern. ‘For the agreements themselves there is also case law that goes back to 1947. For a lot of companies and law firms it is a pretty impenetrable system if you don’t understand the rules of the game. For law firms that do not have a WTO practice and haven’t kept up it is tough to step into the Russian WTO law market now. There is too much baggage. The firms that will do well in this market are those that have a well-established WTO practice already.’
For those with well-established trade practices, and offices in Moscow, the potential to access a previously closed-off Russian client base has now increased significantly.
Ukrainian shale storm
The last few years have provided a vivid example of the inextricable links between politics and gas in Ukraine. The prohibitive gas prices that Ukraine agreed in a long-term deal with Russia in 2009 were used as justification for the arrest of the country’s former Prime Minister Yulia Tymoshenko in 2011. This was on the basis that she exceeded her authority when it came to brokering the deal. While the reasoning behind her arrest and current incarceration is murky, the strategic importance of the gas supply couldn’t be clearer. Recent discoveries with regard to Ukraine’s shale gas reserves, could seriously affect this dynamic.
‘Ukraine’s vulnerability in terms of importation of energy, first and foremost Russian oil and gas, has long become a serious economic and political factor threatening Ukraine’s independence,’ says Armen Khachaturyan, senior partner at the Ukrainian firm Asters. ‘Consequently, conventional and unconventional resources, including shale gas reserves, may become a good alternative to expensive importation of natural gas from Russia.’
Ukraine is estimated to have Europe’s third-largest shale gas reserves, and it has been quick off the mark in trying to exploit them. The government has already agreed deals with Shell and Chevron to explore and develop two possible shale gas fields, and it is looking to tender at least one more.
‘The government is seriously interested in diversifying its gas supply and decreasing its dependence on Russia,’ says Nazar Chernyavsky, a partner at the Ukrainian firm Sayenko Kharenko. ‘Renewable sources are one way but everyone realises it isn’t efficient in replacing the usual supplies, which is where shale gas is important.’
‘The government is seriously interested in diversifying its gas supply and decreasing its dependence on Russia’
‘This contract between Naftogaz [Ukraine’s national oil and gas company] and Gazprom is very unfavourable for Ukraine,’ adds Mikhail Ilyashev of the Ukrainian firm Ilyashev & Partners. ‘There is a provision that obliges Ukraine to buy a certain amount of gas. The contract will come to an end around 2018 and Ukraine should prepare itself for this moment so that it can have a good negotiating position with Russia.’
If exploiting the shale gas reserves does turn out to be feasible – and that is a big if, given the uncertainty and cost of developing shale gas, not to mention the environmental concerns — then Ukraine would certainly reduce its reliance on Russia, which provides two thirds of its gas.
‘Development of shale gas will definitely have an impact on relations with Russia,’ says Oleh Malskyy, a partner at Astapov Lawyers. ‘Ukraine is heavily dependent on Russian gas, and Russia exploits this opportunity by establishing high gas prices. As a consequence it undermines the Ukrainian chemical industry. If the fields are developed correctly, this may be a substantial alternative to Russian gas.’
‘For gas companies in Ukraine and those interested in exploring for shale gas, the risks are high, the politics uncertain, but the rewards could be immense’
For international investors and their legal advisers, it could also provide significant opportunities.
‘For gas companies in Ukraine and those interested in exploring for shale gas, the risks are high, the politics uncertain, but the rewards could be immense, and only time will tell if shale gas is a short-term or long-term game changer for Ukraine,’ says Maksym Cherkasenko, a partner at Arzinger. ‘During this period law firms will have a lot of opportunities, which are not limited just by legal support and provision of legal services as to enforcement of the current legislation regulating extraction of minerals in Ukraine. It also means active participation in drafting regulations directed at improvement of the legal framework in the area of shale gas production.’
‘Since the announcement of the shale gas initiatives by the government, a number of law firms, including Asters, have been involved in drafting amendments to the applicable laws and regulations,’ says Khachaturyan. ‘Primarily in the area of product sharing agreements, which are to be used as legal basis for all anticipated shale gas activities.’
While the existing supply contract with Russia will still be in force for a few years, the foundations are clearly being set to make the most of shale. Few countries could have a bigger incentive to do so than Ukraine. LB