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UpstreamOnline: Changing rules on Sakhalin…

Is the Kremlin’s environmental blocking move a concealed attempt to shift the tax goalposts?

THE onslaught by Russia’s Natural Resources Ministry and technical compliance watchdog Ros-tekhnadzor that threatens to derail the second phase of the Shell-led Sakhalin 2 project may have an environmental guise — but all the signs are that it is really about hard cash and political control.

On Tuesday, the ministry cancelled its own order dated 15 July 2003 that approved the environmental endorsement of the Russian far east project’s Phase 2 expansion. The original endorsement was delivered by Russian scientists and scholars who studied construction blueprints, technical decisions and documentation prepared by the operating company, Sakhalin Energy.

Under the $20 billion Phase 2 scheme, Sakhalin Energy is set to install two new offshore platforms to add to the existing Molikpaq facility near Sakhalin Island, and build offshore and onshore oil and gas pipelines, an onshore oil and gas processing centre, a 9.6 million tonne-per-year liquefied natural gas plant and an LNG and oil export terminals on Sakhalin Island.

However, with Phase 2 work more than 75% complete and exports set to kick off in 2008, Kremlin rulers do not want to wait until 2012 or 2013 when initial investments will have been repaid to shareholders and banks and the Russian government will be able to finally have its take from hydrocarbon production.

This take is estimated to be more than $50 billion if the oil price averages around $34 per barrel for two decades after 2012.

Back in 1993, when oil prices were about $15 per barrel, the signing of the production sharing agreement for the Sakhalin 2 block between the Russian government and a consortium of US, British and Japanese companies was hailed as a major success.

At that time, Russia was fraught with risk and uncertainty, and its own just-privatised oil industry could not attract expertise and billions of dollars of financing to enable offshore development in such a remote and unexplored area as Sakhalin, so the production sharing regime seemed the only way to bring in foreign oil companies.

The PSA model guarantees the stability of taxes during the lifetime of the project. It also stipulates that, in the first few years after the start of commercial production, proceeds from the sale of almost all output must be used to repay initial investments in the project.

However, these contractual obligations are now causing irritation in the Kremlin.
For example, Sakhalin 2 oil output will initially be exempt from the $13 per-barrel oil production tax and the record high $32.50 per-barrel oil export tax that takes effect from 1 October. Russia has been increasing these taxes since their introduction in 2002. Analysts in Moscow estimate that the government now takes almost all export revenues of Russian oil companies above the threshold price of $25 per barrel.

The Sakhalin 2 PSA also does not allow Gazprom to control exports of LNG, even though President Vladimir Putin recently signed a law confirming the rights of the gas monopoly, managed by his sidekick Alexei Miller, over all gas exports from Russia.

Russia’s ambassador to Japan, Alexander Losyukov, was quoted as saying that Sakhalin 2 would move forward more quickly if it had Gazprom as a partner.

Shell itself has long shown an acknowledgement of this reality by embarking on talks to bring the gas monopoly into Sakhalin 2 by swapping part of its stake for a share of one of Gazprom’s Siberian gas fields.

Gazprom, though, seems to be in no rush, saying this week that it was halting discussions because of the environmental permit move.

Numerous reports and investigations, claiming how Sakhalin PSAs are detrimental to Russia, have been delivered by quasi-governmental agencies since Putin came to power in 2000.

It now appears that these reports were closely scrutinised in the Kremlin where officials have been waiting for an opportunity to pounce to force Sakhalin 2’s shareholders — Shell and Japan’s Mitsui and Mitsubishi — to drop the PSA and work under the existing tax regime.

Speaking this week, Russia’s Economic Development Minister German Gref said that “PSAs do not have any bright future in Russia”. He said that “compromises have to be found” on Sakhalin 2.

The moves this week signal that Russia’s government does not want to wait for cash to flow in its direction from Sakhalin 2. It remains to be seen if pressure from its trading partners who are complaining this week about contract sanctity will be enough to make Moscow rein back its ambitions or whether Shell and its Sakhalin 2 partners will finally bend to the will of the state. and its sister non-profit websites,,,,,, and are owned by John Donovan. There is also a Wikipedia feature.

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