The Observer: Shell banks on Russian energy revolution

The vast gas reserves controlled by Vladimir Putin give his nation enormous global influence. But he needs the Anglo-Dutch oil giant's help to fully exploit his position, reports Nick Mathiason
Sunday February 26, 2006
In July Russia's President, Vladimir Putin, will welcome the leaders of the world's seven richest nations to Moscow. At the top of Russia's G8 agenda will be energy security. To many, this has the makings of a joke waiting for a punchline. After all it was the Russian leader who just last month ordered the state energy giant Gazprom to turn off the gas supply to neighbouring Ukraine, forcing an icy shiver down the spine of the Western world.
Here was petropower writ large. The Russian bear showed its teeth at a time when world oil supplies have rarely been less secure. Royal Dutch Shell's top man in Russia, Chris Finlayson, 49, momentarily saw the funny side too. In London this week, he allowed himself a brief spluttering guffaw when asked whether he believes President Putin's primary concern was global energy security.
But for Finlayson, himself a roly-poly bear of a man, diplomacy is a prerequisite because for Royal Dutch Shell, Russia is vital. The Anglo-Dutch giant has two massive projects there. It is the single largest foreign direct investor in Russia and is desperate to win the right to extract more Russian oil and gas if it is to stave off nervous investors who are only now recovering from the company's mis-stating of its oil reserves by 40 per cent.
Composing himself on the 22nd floor of Shell's South Bank London headquarters, Finlayson says: 'I think frankly it's a good thing that they're bringing [energy security] up as an issue they want to discuss, rather than it being put to them as a concern and a challenge.'
Some might call that getting your retaliation in first. But not Finlayson. Careful with words, he says the renationalisation of vast swathes of industry, and in particular energy firms previously controlled by oligarchs, is a 'rebalance of the portfolio from one where it was a case of very little control for government.' The row with Ukraine, meanwhile, is 'robust negotiation style on display'.
Finlayson is not expecting a repeat performance of a Ukrainian-style Russian show of strength. 'Their own importance as an energy supplier means people are hanging on every nuance of every action…. So I would be surprised to see anything done in the same way in the future but that's my speculation.'
Does Putin, by having more gas reserves than any other country on the planet, want to effectively control the world? 'I think there can be no question that given the scale of the resources, Russia sees that this gives them a place of real influence and a place at the top table so they want to make sure that importance is recognised by the world.'
But this is something they can only do with Shell's help. Shell is the world leader in the liquified natural gas sector. This is the technique of freezing natural gas into liquid form which can then be transported around the world in ships. Far easier than using cumbersome, geopolitically sensitive pipelines.
At a stroke this changes the distribution of energy, broadening Russia's global horizons, yielding new markets and international relationships.
And it is why Shell was given the right to lead a consortium on what's known as Sakhalin-2 off the east coast of Russia. There is 4.9 billion barrels'-worth of oil and gas here. At a conservative estimate revenues to Russia will be in excess of $50bn and several billion to Shell.
But for the Anglo-Dutch oil giant, these are nervous days. Sakhalin-2 has gone an astonishing $10bn over its initial $10bn budget and Putin isn't happy. Russia is concerned that its share of the Sakhalin revenue will be delayed as a result of cost overruns. Finlayson has said that the ballooning budget will be borne by the consortium members alone.
Some in the City say that it is only because the price of oil has shot up and that Shell has merged its British and Dutch divisions that have allowed it to escape investors' flak.
Finlayson attributes overruns to a budget drawn up when oil was $10 a barrel. It is now six times that and the resulting construction inflation combined with rouble inflation and 'not having the information to fully appreciate all the challenges there from the start' have led to the $10bn overspend.
But questions are being asked. Is the company capable of handling such pivotal and difficult projects? Sakhalin is inhospitable. Winter temperatures average minus 24C, the area is prone to typhoons and is littered with unexploded ordnance – a legacy of Russian- Japanese hostilities.
Sakhalin Energy Company, 55 per cent owned by Shell, has to build platforms to withstand massive ice flows and dig trenches for pipes in frozen sea floors while trying not to disturb endangered grey whales who feed in the area. There's also the risk of poisoning of fishing stocks vital to islanders' livelihoods.
But Finlayson is convincing when he defends the handling of the scheme. 'It is estimated that up to 50 per cent of the total pipeline subcontractors in the Russian federation are working in Sakhalin at the moment. Those companies are learning about the challenges of working to full Western standards with external, independent monitoring and when they do other projects one hopes that learning will stay with them.'
He adds that Shell's responsibility is proved by its moving the route of a pipeline, at a cost of $300m, so that it will not affect the endangered whales.
And some do praise the firm for this. Jason Kenney, an energy industry analyst at ING says: 'The environmental aspects in Sakhalin that Shell has achieved have been groundbreaking for the industry. Not just the whales or the salmon industry or how they're dealing with the river crossings, but their efforts in trying to ensure the islanders benefit.'
But environmentalists pour scorn on this, pointing to vivid examples of Shell's failure. They argue that Shell only moved because it was pushed and until now they have had a field day at Shell's expense. The firm privately admits it has been on the back foot in dealing with campaigners, and Finlayson is eager to put Shell's side of the argument before Tuesday. Then, environmentalists will be lobbying the European Bank for Reconstruction and Development at a public meeting in London. They will be urging the bank to refuse to forward money to the Sakhalin consortium. The issue is portrayed as a test of the bank's environmental credentials.
Without the EBRD's backing, getting loans from other banks will be much harder. In two months, Shell will finally learn whose side the EBRD is on.
But, however Sakhalin is financed, it will happen. And it is just the start. There are many shelves beyond the island that will yield huge resources. But how secure is Shell in Russia? Once Russian companies have the ability to harness LNG, will they not just seize Shell's assets? 'No,' says Finlayson. 'I think we will jointly grow the space and I think we have a track record of showing we can work with national partners who then develop their own businesses. At the same time our business is not constrained by that.'
Shell is keen to win concessions in western Siberia. But it has to get Sakhalin right. If not then Putin's joke will be on the world's third biggest energy firm