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The Wall Street Journal: Exxon’s Sakhalin Project Could Fall Short of Output Targets

October 9, 2006

YUZHNO-SAKHALINSK, Russia — Exxon Mobil Corp.’s $12.8 billion Sakhalin-1 project in Russia’s Far East could fall short of planned output targets because of a recent government decision refusing to expand the project’s permit to develop a key oilfield, an executive at OAO Rosneft, the Russian state oil company that is a 20% partner in the project, said Monday.

The news comes amid growing pressure from the government on high-profile foreign-led energy projects on Sakhalin, alarming investors in what is widely viewed as part of an effort to win more favorable terms in the deals for Russia.

Exxon, the operator of the Sakhalin-1 project, had appealed to the government for an automatic expansion of the license area northward to include what Exxon argued was a part of the same geologic structure of its Chaivo offshore field. But regulators refused, saying they would put the acreage up for auction.

The Sakhalin-1 project had been counting on the oil in that extra area to meet its production target of 12.15 million tons next year, Lev Brodsky, head of Rosneft’s Sakhalin Projects unit, told reporters.

As a result, Mr. Brodsky said Exxon and its partners will have to look for other reserves within the existing license area to make up the lost production. The extra acreage contains about 10 million-12 million tons of crude, he said, and the government’s decision not to expand the license would cost the project 1.2 million-1.4 million tons a year of output.

“We will try to make it up, we don’t know yet if we can,” he said. The project’s current forecast is for production of around 12 million tons a year until about 2010, after which output will drop to around 9 million, before recovering toward 12 million around 2015 as new fields are brought on line.

Rosneft officials noted that the contested license area on the north edge of the Chaivo field is different from the smaller Lebedinsky block nearby, which was recently won at a government auction by Rosneft.

They also said that regulatory approvals for the new De Kastri terminal that will handle the Sakhalin-1 project’s crude exports are proceeding on schedule and should be in place by the end of the year. The first tanker is expected to be loaded by around Oct. 15.

Mr. Brodsky said project officials are now working on detailed figures for cost estimates for the next phase of the project, which are likely to be presented to regulators early next year. He declined to provide figures. Royal Dutch Shell PLC, operator of the nearby Sakhalin-2 project, has faced fierce opposition from the government to its effort to raise cost estimates from $12 billion to $20 billion.

Exxon has said the cost of the Sakhalin-1 project, estimated at $12.8 billion in 2002, would be about $17 billion in current dollars, adjusting for inflation and other factors. The project consortium plans to have spent $7.2 billion by the end of this year.

A key question for the future of the project is what to do with the natural gas it produces. The project consortium is looking at alternatives for pipeline exports to China or Japan or possibly using liquefied natural gas, Mr. Brodsky said. Talks will begin soon with OAO Gazprom, Russia’s gas monopoly, although Mr. Brodsky said that the Sakhalin-1 consortium believes its contract exempts it from Gazprom’s monopoly over exports. He said he hoped a decision on export strategy could be reached by the end of the year.

At present, the consortium sells modest volumes of gas within Russia for prices “substantially” below those on the world market, he said.

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