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RIA Novosti: Russia has outgrown PSA (*Shell accused of inflating Sakhalin II costs?)

MOSCOW. (Igor Tomberg for RIA Novosti) – A Russian environment official has said recently that inspections of the large Sakhalin 2 energy project are to continue.

“We have not checked the stream flows and outside sea areas yet,” said Oleg Mitvol, deputy head of the Federal Service for the Oversight of Natural Resources. “Based on preliminary information, these checks can prove that the suspension of the project had been justified. We have the results of a study done by the Russian Academy of Sciences and reports of public organizations and environmentalists.”

In recent weeks, ExxonMobil and Royal Dutch/Shell, which are involved in multibillion energy projects in Russia, have been complaining about pressure from Russian regulators. The General Prosecutor’s Office has backed the service’s complaint against the state environmental expert examination of the Sakhalin 2 project, operated by Sakhalin Energy. Prosecutors said that the Natural Resources Ministry’s resolution endorsing the results of the expert examination had to be abolished. On September 18, the ministry annulled the examination results of the second stage of the project. This means that work in the licensed offshore areas has to be suspended at least until new examination results are announced. This will lead to the project’s failure to meet the deadlines and to lawsuits from buyers of contracted gas.

ExxonMobil also has numerous problems with the Russian authorities related to its Sakhalin 1 project. On September 18, the Far Eastern Service for Ecological, Technological and Nuclear Supervision ordered Exxon Neftegas to suspend loading oil in the pipeline, which goes to an export terminal at the De-Kastri port across the Khabarovsk Territory, due to its failure to carry out all the necessary environmental precautions.

Earlier, the Russian authorities turned down Exxon’s request to increase its development license. The U.S. company wanted to expand the borders of the Chaivo field, having discovered additional oil reserves estimated at 75 million tons. But under the law on natural resources, a field of this scale is viewed as a strategic one.

Regulators have become more active, as the Russian government seems to be dissatisfied with the terms of product-sharing agreements under which energy projects are being developed. One of the main reasons is said to be the misbalance in the PSA costs and profits. According to the Industry and Energy Ministry, aggregate costs of the three PSA in Russia (Sakhalin 1, Sakhalin 2 and the Kharyaginsk field development, operated by France’s Total) have reached $18.182 billion, of which only $407.7 million has gone to the budget.

That a PSA is not very profitable for the hosting party has repeatedly been said from the very beginning, when the relevant law was adopted in 1995. At that time, there was powerful opposition against using this mechanism in investment cooperation with foreign companies. Unlike the national tax regime, a PSA offers investors significant benefits. It relieves companies that develop a field from almost all taxes, except for the unified social tax, the profit tax and payments for subsurface use at a discounted rate. It is a kind of risk bonus for investing in a country with an unfavorable investment climate. The basic idea of a PSA is that a country – i.e. Russia – starts receiving its share of the profit from national natural resources only after investors have recovered their costs. This means inevitable losses for the budget.

The problem is not only that there are great opportunities for abuse and corruption. The temptation to inflate the project’s spending on any pretext is very strong. This is what is happening at Sakhalin 2, whose operator Sakhalin Energy now wants the government to endorse an increase in the costs from $12 billion to $20 billion. The Russian party is not inclined to agree, because it means higher state spending on the project and a delay in revenues.

The Russian authorities have recently said they are not content with foreign companies’ activities under a PSA. Earlier this month, the Russian presidential aide Igor Shuvalov said it would be better if the projects’ participants switched over to the national tax regime. Kirill Androsov, deputy economic development minister, said that Russia did not intent to cancel the existing PSAs, but it would not sign new ones. Economic Development Minister German Gref made a similar promise. “We should certainly honor the current agreements,” he said, adding, however, “I believe that the current investment climate in the country and the situation on the foreign market allow us to do without this regime and work on standard terms.”

Remarkably, Western mass media, in their numerous comments about the pressure the Russian government puts on foreign oil companies, often – and relevantly – use the word “humiliating.” On September 19, the Guardian quoted Adam Landes, an oil and gas analyst with Renaissance Capital, as saying, “It seems to be a brutal way of renegotiating previous deals that were quite humiliating for Russia.”

Indeed, it does not befit a country that aspires to be an energy superpower to preserve the PSAs. It seems the era of this mechanism in Russia is drawing to a close. Western oil companies are in for tough talks in a desperate attempt to at least preserve the status quo. Expansion of borders or budgets is most probably out of the question. It will already be a good result if they manage to fight off the environmental criticism. Suggestions that Gazprom can join the Sakhalin 2 project also seem grounded. The pressure will weaken as the Russian gas giant’s influence in the project will grow. Exxon’s plans of an export pipeline to China are unfeasible given Gazprom’s pipeline monopoly.

As to the negative investment climate, foreign mass media are exaggerating the situation. Although Russia’s investment climate has traditionally received low assessments from international organizations, this has not stopped private investors. In the first six months of 2006, foreign direct investment in the Russian economy surged by 43.6%, according to the official statistics. A survey of foreign investors conducted by the Foreign Investment Advisory Council for the Economic Development Ministry produced a similar picture. Last year, as many as 71% of respondents were willing to invest in Russia. Now, however, their optimism has spread to 91%.

All negative factors related to state interference are outbalanced by the huge potential of the Russian market combined with the country’s economic growth and high oil prices. Returns on investment in Russia are only slightly lower than in China and are many times higher than in developed countries or even in Eastern Europe, company executives say. This is why many firms that are not active here yet have announced their intention to enter the Russian market very soon.

Dr. Igor Tomberg is a senior research fellow at the Center for Energy Studies, the Institute of World Economy and International Relations, Russian Academy of Sciences.

The opinions expressed in this article are those of the author and may not necessarily represent those of RIA Novosti.

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