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The Moscow Times: Sakhalin Squabble Threatening Profits

The Moscow Times Sakhalin II

(Workers constructing Sakhalin Energy’s LNG plant near Korsakov on the southern tip of Sakhalin Island on Friday.)

Monday, October 2, 2006. Issue 3509. Page 1.
By Miriam Elder
Staff Writer  
Marina Lystseva / Itar-Tass
KORSAKOV, Yuzhno-Sakhalinsk — The concrete tanks and metal cranes of Sakhalin-2 rise incongruously from the forested shores of Sakhalin Island. Workers scurry around the sprawling plant putting the finishing touches to a project that will seek to harness the vast hydrocarbon riches that lie beneath the island’s northern waters.

If the oil and gas starts flowing as planned in 2008, in a few years the state and the foreign oil majors running the $20 billion project stand to make billions of dollars annually. Yet a threatened halt to the project by environmental officials could send costs soaring even higher, and jeopardize both sides’ profits.

Behind the dispute, many believe, is a disagreement over how large the state’s share in the project should be.

Sakhalin-2, the only major energy project in the country without a Russian partner, is poised to become a key supplier to energy-hungry markets in Asia and the United States. With oil prices hovering around $60 per barrel, Russia stands to lose out on billions of dollars per year if it does not have a direct stake in the project.

Shell has said it is willing to give state-run Gazprom a part in the project, and in July of 2005 Gazprom agreed to take a 25 percent share, in exchange for giving Shell a 50 percent stake in its Zapolyarnoye oil field in western Siberia.
Talks hit a roadblock one week after a deal was struck, however, when Shell announced that it had doubled cost estimates for Sakhalin-2 to $20 billion.

Neither Gazprom nor the government, which holds a production sharing agreement, or PSA, with Shell-led Sakhalin Energy, was pleased.

The steps taken by the Natural Resource Ministry to review the project’s environmental approval are widely seen as a means of putting public pressure on Shell to renegotiate the terms of the asset swap in Gazprom’s favor.

“The state wants to have 50 percent plus one share” in Sakhalin-2, said Al Breach, chief economist at UBS. “There is something here about power and control.”

Sakhalin Energy, which operates Sakhalin-2 on behalf of 55 percent shareholder Shell and Japan’s Mitsui and Mitsubishi, who together hold 45 percent, maintains it has observed environmental standards at the plant. The company points to the 20-kilometer rerouting of an offshore pipeline as evidence that it has tried to preserve the feeding area of the endangered western gray whale.

“We’ve always been cooperative” with the Natural Resources Ministry, Alexei Okhotnikov, Sakhalin Energy’s head of government relations, said at the plant Friday. “We are the most transparent company in Russia.”

That claim was once made by Yukos, before the Kremlin tore the firm apart amid speculation that CEO Mikhail Khodorkovsky was close to signing a deal to sell a major stake to a U.S. major.

Yukos’ biggest production unit, the 1 million barrels-per-day Yuganskneftegaz, went to state-run Rosneft for a bargain price in a December 2004 auction. Now Rosneft and Gazprom, which recently surpassed Shell to become the world’s largest energy company by market capitalization after Exxon, are racing to acquire Yukos’ remaining assets.

The state increased its share of oil production further last fall, when Gazprom bought Roman Abramovich’s Sibneft for $13 billion. Now Gazprom and Rosneft are eyeing the Russian half of No. 3 oil firm TNK-BP. That control has added to President Vladimir Putin’s strategic energy arsenal. He wielded the energy weapon last winter, shutting off gas to Ukraine to push the country into accepting a higher gas price.

The January crisis and the current standoff with Shell have prompted warnings from diplomats and analysts that Russia’s reputation as a reliable energy supplier could be permanently dented. Yet the country’s oil and gas spoils remain too attractive for Western companies simply to pull out.

Statoil and Norsk Hydro, the two Norwegian companies competing with France’s Total and U.S. Chevron and ConocoPhillips for a stake in Gazprom’s huge Shtokman gas field, said they had no intention of withdrawing their bids.

“Statoil is committed to Russia for the long-term and we look forward to future opportunities,” company spokesman Havor Engebretsen said.

Norsk Hydro spokeswoman Kama Holte Strand said: “We haven’t changed our opinion of what we’re doing. We’re still waiting for the results, for Gazprom to decide.”

And Russia needs Western technology and expertise to develop projects like Shtokman, said Julia Nanay, senior director of PFC Energy, a Washington-based energy consultancy.

“Gazprom could not do Shtokman on its own,” she said. “It’s going to be a cutting-edge project, even for the foreign companies involved.”

Shtokman lies in the Arctic waters of the Barents Sea, in extremely difficult conditions. Gazprom has said it will probably take on two or three partners in the project, which is expected to cost over $20 billion. Shtokman holds 3.7 trillion cubic meters in gas reserves.

Sakhalin-2, the country’s largest foreign investment project, is due to start producing oil by the end of 2007, paving the way for exports that are due to reach 160,000 barrels per day. By late 2008, gas is due to flow through the 800-kilometer pipeline that runs from the shelf off the north of Sakhalin Island to the liquefied natural gas, or LNG, plant on the island’s southern tip. The plant will transform that gas into 9.6 million tons of LNG per year, which can then be shipped by tanker to LNG regasification plants anywhere around the world.

“The future of Russian production is offshore and in East Siberia. To prepare for that, investments have to be made soon,” Nanay said. While current investors are unlikely to pull out, attracting new ones may pose a problem, she said.

“Where Russia may run into a problem is when oil prices fall — to below $50, or even at $50,” she said. Rising oil production by non-OPEC countries will likely drive down prices by 2010 or 2011, she said. “Russia should be preparing to try to create an environment so that companies come in and commit to these massive investments, knowing there is some uncertainty with the oil price.”

Whether Sakhalin-2 goes forward or is frozen could be known within a month, when a team from the Natural Resources Ministry is due to complete an audit into allegations of ecological damage. Under the terms of the PSA, revoking the environmental license — and the delays and startup costs involved — could bring huge losses to both Sakhalin Energy and the government.

The PSA also means that the $10 billion estimated cost increase that Shell announced last year also had a direct effect on eventual government revenue from the project. Sakhalin Energy’s Okhotnikov said those costs came from higher manufacturing prices for steel and other materials, environmental challenges and poor infrastructure. and its sister non-profit websites,,,,,, and are owned by John Donovan. There is also a Wikipedia feature.

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