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Bloomberg: Shell Faces Sakhalin Grab as Putin Seeks Greater Energy Control

By Lucian Kim and Garfield Reynolds

Sept. 22 (Bloomberg) — First Russian President Vladimir Putin attacked OAO Yukos Oil Co. Now it’s Royal Dutch Shell Plc.

This week’s threat to shut down Shell’s $20 billion development on Sakhalin Island, the country’s biggest foreign investment, is another maneuver to force companies operating in Russia to share more profits with the government, analysts said. It’s a reminder of the tactics used in Putin’s dismantlement of Yukos, whose assets were transferred to state-run OAO Gazprom and OAO Rosneft after the government filed $30 billion in tax claims against the company.

“Putin seems to be ready to accept short-term reputational damage for the sake of reaching his strategic objectives,” said Christopher Granville, managing director of Trusted Sources, a London-based company that analyzes political risk and economics in emerging markets. “It’s a massive project so it’s easy to find something to hold it up. It’s a classic game of bluff.”

Gazprom wants a 25 percent stake in Sakhalin-2, the country’s first liquefied natural gas venture. The company, 50 percent owned by the state, suspended talks to join the group after Shell, based in The Hague, said in July 2005 that development costs had doubled from $10 billion, Gazprom spokesman Sergei Kupriyanov said Sept. 19. The Russian company wants a piece of the project to maintain its gas export monopoly, which generates about 75 percent of its 1.3 trillion rubles ($48.7 billion) of annual gas revenue.

Government Pressure

Other oil companies operating in Russia are facing government pressure. The country’s Natural Resources Ministry in May urged Irving, Texas-based Exxon Mobil Corp., Total SA in Paris and London-based BP Plc to give Russian companies a bigger role in their ventures.

The government has said it’s unhappy with the original production sharing agreements, signed in the 1990s, that cover Sakhalin-2, Exxon Mobil’s neighboring Sakhalin-1 project and Total’s Kharyaga field in northern Russia. Under the agreements, negotiated when crude was a third of today’s price, most of Russia’s revenue would be deferred until the companies earned returns on their investments.

Sakhalin Energy, the operator of Sakhalin-2, agreed to pay royalties of 6 percent of the oil and gas produced to Russia throughout the lifetime of the project. Russia gets a share of the rest of the revenue only after the venture breaks even on its investment.

“Russia wants to renegotiate the Sakhalin production-sharing agreement, especially the 100 percent cost recovery, which is very unfavorable to Russia,” Granville said. “You wouldn’t get that sort of deal today.”

Cancel License

To influence Shell, which owns 55 percent of Sakhalin-2, the Natural Resources Ministry intensified probes of the venture’s environmental safety standards, which have been criticized by groups including Greenpeace and the World Wildlife Fund. The agency also backed the Russian Academy of Natural Sciences, which called for local companies to gain more control over the projects.

Natural Resources Minister Yuri Trutnev this week signed an order to cancel part of Shell’s Sakhalin-2 license on environmental grounds. That order was sent to Rostekhnadzor, the federal service for industrial safety, for its approval.

If Rostekhnadzor agrees, it would force Shell to stop building pipelines needed to ship gas extracted from Sakhalin-2, delaying production of liquefied natural gas. Shell has already signed contracts to sell most of the project’s expected annual production of 9.6 million tons, equal to about a third of China’s yearly gas needs.

Sakhalin Energy has said it fulfilled the requirements of the Sakhalin-2 PSA and Russian laws.

Damaging Annulment

“Annulment could be damaging for the project and for Russia and lead to delays in project development,” Sakhalin Energy said Sept. 18 in a statement. “The lifetime economic benefits to Russia from this project will total over $50 billion, assuming oil prices in the mid-$30s.”

Letting Gazprom into the project on favorable terms might resolve the conflict “faster and more amicably,” said Vladimir Matias, a managing partner at Asset Capital Partners, a Moscow- based adviser on mergers and acquisitions.

BP’s Russian unit in March said it offered Gazprom a stake in its $18 billion Kovykta gas project to safeguard the venture. In May, the Natural Resources Ministry said BP must strike an accord to keep its license to the Siberian venture.

Suspending Shell’s license to develop Sakhalin continues a campaign begun in 2003, when Yukos Chief Executive Officer Mikhail Khodorkovsky was arrested on tax and fraud charges. Yukos was declared bankrupt in August.

Gazprom and Rosneft gained Yukos assets, almost tripling government control over Russian oil production to 29 percent.

Cold War

Consideration of the current Sakhalin projects began in the mid 1970s, when the Japanese government approached the Soviet Union for energy. Japan founded Sodeco — Sakhalin Oil and Gas Co. — in 1975. The project was put on hold amid worsening Cold War tensions.

International companies returned to Russia after the Soviet Union’s collapse in 1991. In 1994, the Sakhalin-2 agreement was signed. The project is 45 percent-owned by Mitsubishi Corp. and Mitsui & Co., Japan’s two biggest trading companies.

To contact the reporters on this story: Lucian Kim in Moscow at [email protected] ; Garfield Reynolds in Moscow at [email protected]

Last Updated: September 21, 2006 16:56 EDT and its sister non-profit websites,,,,,, and are owned by John Donovan. There is also a Wikipedia feature.

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