International Herald Tribune: Russia revokes approval for Royal Dutch Shell-run Sakhalin project

By Andrew E. Kramer Bloomberg News, Reuters
Published: September 18, 2006
 
MOSCOW: A Russian government agency on Monday withdrew environmental approval for the world’s largest combined oil and natural gas development, a project led by Royal Dutch Shell on Sakhalin Island in the Pacific Ocean that will eventually supply Japan, Korea and the United States.
 
The project with offshore platforms, a liquefied natural gas plant on shore, and hundreds of miles of pipeline snaking toward an ice-free port in the south, has had its share of critics among conservationists.
 
But the decision came amid a tense business dispute between Shell and Russia’s state-owned natural gas monopoly Gazprom, which is trying to buy or swap assets to join the consortium.
 
Energy analysts in Moscow, where the government has tightened its grip on the oil industry in recent years, interpreted the environmental ruling as a form of pressure on Shell to sell to Gazprom. If so, it would serve as a blunt display of the close intertwining of power and business in Russian energy politics.
 
The ruling by Rosprirodnadzor, the environmental agency, revoked a 2003 environmental approval for the Sakhalin-2 project, according to a posting on the agency’s Web site; before it takes effect, the decision must be cleared by a second Russian government agency, according to the statement.
 
Russian authorities cited damage to salmon-bearing rivers and excessive logging along a pipeline route.
 
“Dozens of hectares of forest were destroyed and a large number of fish died because of improper river crossings,” Oleg Mitvol, deputy director of Rosprirodnadzor, said by telephone.
 
“Nobody will lose their license,” he said. “The talk now is about the environmental problems that have occurred.”
 
Mitvol said he understood approval had been revoked only for the pipeline construction, not the project, though a Shell spokesman said that it appeared the statement referred to approvals for the entire onshore and offshore development. Shell denied it had violated any Russian environmental laws.
 
Shell, an English-Dutch company, was nearing completion of the second phase of Sakhalin-2. That phase is estimated to cost $20 billion. The liquefied natural gas that will come online in the summer of 2008 has already been sold in futures contracts to companies serving Japan, Korea and the U.S. West Coast.
 
This summer, Shell and its partners employed roughly 17,000 people in construction; it was unclear whether they would be idled by the revocation.
 
The project was an anomaly in Russia as a wholly foreign-owned venture at a time of rising resource nationalism. It operated under a production sharing deal that the Russian government was believed to be unhappy with, but that was written into Russian law from the 1990s, approved by Parliament.
 
Also Monday, Sergei Fyodorov, an official at Russia’s Natural Resources Ministry that oversees the three production sharing agreements in force, said all had violated “technical” provisions in the contracts and their licenses could be revoked, the Interfax news agency reported.
 
Exxon Mobil of the United States and Total of France operate the other two production sharing fields.
 
Shell’s Sakhalin-2 development is anomalous in Russia also because Shell was marketing the natural gas, a commodity Gazprom has a monopoly on elsewhere in the Russian economy. The Sakhalin concessions were incorporated as an exception to a law formalizing Gazprom’s natural gas monopoly passed this year.
 
To allow Gazprom into the project, Shell in July 2005 agreed to swap a 25 percent stake in Sakhalin-2 for a share of an Arctic gas field owned by the Russian company. Days later, however, Shell announced the cost of development at Sakhalin-2 had doubled, to an estimated $20 billion from $10 billion.
 
Gazprom has formally announced it was displeased it had not been informed of the higher cost estimate before signing the deal; the companies have been negotiating over the terms of the swap since.
 
Also, the higher cost estimate lowers the initial profits for the Russian government; under the terms of the deal, the operator, Shell, recuperates costs before sharing income with the government. Until the costs are recovered, Russia will receive roughly $300 million a year; afterward, the government share rises to $2 billion annually.
 
Shell executives say soaring steel prices, the appreciation of the Russian ruble and a tight market for oil rig equipment drove up costs.
 
“We assume there is a connection,” between the environmental ruling and Gazprom’s business dispute, said Aleksei Kormshchikov, an oil and gas analysts at UralSib brokerage in Moscow. “There is no direct connection, of course, but all of a sudden they deny ecological approval on the back of these negotiations.”
 
“Everyone understands why this is going on,” he said. “Nobody is surprised to see the state pursue a hard line to get better leverage for Gazprom.”
 
The Russian Trading System stock market shrugged off the announcement because investors in Russia anticipate such actions by the government, Kormshchkiov said. The market closed up.
 
In another sign of the Russian state tightening its grip on oil, Gazprom is in talks to buy into BP’s joint venture in Russia, TNK-PB, a leading oil company in the country, the Vedomosti newspaper reported Monday. TNK-BP is now owned 50-50 by BP and a trio of Russian oligarchs. Gazprom is in talks to buy out the private Russian partners, the paper reported.