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Exxon scores technical victory

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On the beach of Sakhalin Island, some of the roughest, remotest terrain in the world, Exxon Mobil Corp. scored a major technical victory last month: It finished drilling a 7-mile-long hole, the longest between an onshore oil rig and an undersea oil field. Done in record time, the well marked a triumph in Exxon's bid to unlock one of the planet's juiciest remaining oil troves.

But the technological difficulty of Exxon's multibillion-dollar Russian odyssey pales beside a slew of political challenges. The world's largest publicly traded oil company has clashed repeatedly with Russian authorities over various details of the project - details crucial, in Exxon's mind, to maximizing the project's profitability. The fights boil down to a basic difference in approach between the oil company and the oil-rich country. For Exxon, the motive is money. For Russia, it's a complex stew of politics and profit.

The slog by Exxon and its chief executive, Rex Tillerson, to maintain its famous efficiency in infamously inefficient Russia shows how Big Oil is adapting to a power shift in the energy world. With most of the big fossil-fuel stores in the West already tapped, oil companies have been moving to the less politically predictable countries where the most alluring fields remain. Initially, those oil-rich governments, from Russia to South America to West Africa, largely deferred to Western companies they hired to harvest their hydrocarbons. Now, emboldened by rising energy demand, those governments are increasingly calling the shots.

Known historically for its brash confidence, Exxon is now trying to keep a low profile and focus on the operational details it still can control. It's betting that if it can produce the Sakhalin oil on schedule and within budget, it will be able to avoid the regulatory crackdown at Sakhalin that ensnared another oil giant, Royal Dutch Shell PLC. Exxon says a series of decisions have kept costs at the project within 10 percent of target on a per-barrel basis, despite surging prices for key supplies like pipe.

Exxon's Russian project, called Sakhalin-1, is the 10th-largest project in Exxon's portfolio, based on the value of the oil and gas it holds, according to Deutsche Bank. Exxon has spent more than a decade and about $2 billion so far on the project. Sakhalin is important beyond the numbers. Because of its technical difficulty, the project is used as Exhibit A by Exxon when the company is pitching its services to other oil-rich governments.

''I hope the Russian government . . . says, 'Yeah, these guys did what they said they'd do,' " says Tillerson, who assumed Exxon's top job in 2006 in large part because of the reputation he built through years of work putting together the Sakhalin project. So when other governments are looking to hire an oil company, ''hopefully we'll be looked on positively.''

Exxon almost certainly will make more money from Sakhalin than it envisioned when it entered the project, thanks to higher energy prices. But the increasing assertiveness of the Russian government means Exxon probably won't capture the full benefit. Oil was trading at about $25 per barrel in 2000; it closed Friday at about $62.

Vladimir Milov, a former deputy energy minister and now a frequent critic of the Kremlin, warns that Exxon could find itself in authorities' sights once other, bigger foreign projects have been brought under tighter state control.

So far, Russian officials are playing their cards close to the vest. ''There are problems that Exxon is running into and which must be solved in the near future,'' Energy Minister Viktor Khristenko says, referring to a dispute over where to sell the gas from the project. Though Exxon so far has fared far better in Russia than Shell has, Khristenko says that's no guarantee for the future: ''I can't say that Exxon is doing fine while Shell is doing badly.''

Sakhalin Island sits in the Sea of Okhotsk, just north of Japan. Exxon's project there dates back to the 1970s, when a group of Japanese companies lent the Soviet Union money to explore for oil in the region. Cold War tensions put that deal in a deep freeze until the early 1990s, when Exxon got involved.

At that time, Exxon and other foreign oil giants insisted on special contracts, known as ''production-sharing agreements.'' Common in many developing countries, the deals exempt foreign oil companies from paying most local taxes. Instead, they require that the foreign companies, after selling enough oil to recover their capital investment, share the rest of the oil from the project with the government. Desperate for investment amid low world oil prices, Russia agreed to the terms.

The project really got going after President Vladimir Putin took office in 2000, looking to jump-start Russia's battered economy. While tensions soon appeared, Exxon was initially successful in insisting on doing things its way.

Exxon also was mindful of Russian politics. When Exxon signed on to the project, the Russian state-controlled company, OAO Rosneft, was widely regarded within the oil industry as a bureaucratic morass. But Exxon decided it wanted to have a state-owned company sharing its financial interest, in part anticipating disputes with Russia over the contract. So Exxon elected to keep Rosneft as a partner. Though Exxon manages the Sakhalin project, it doesn't have a controlling stake.

''We felt it was important to keep the Russians involved,'' Tillerson says, in part so that if economic disputes arose, the company and the Russian government would be ''on the same side of the table.'' The decision was prescient. Today, the Kremlin requires all major energy projects to have a Russian shareholder, preferably with a controlling stake.

In recent years, Putin has moved to tighten his control over large swaths of the Russian economy, none more than the energy sector, now the country's largest single revenue source. Still, as recently as 2003, Exxon saw Russia as far more welcoming than other oil-rich countries to foreign investment. Exxon pursued a multibillion-dollar deal to acquire a large stake in OAO Yukos, then Russia's largest private oil company. That deal fell apart after the Kremlin jailed Yukos' chief executive and main shareholder in a case widely viewed as politically motivated. Most of Yukos' assets have since been taken over by Russia's state-controlled energy companies.

© The Wall Street Journal

2 Responses to “Exxon scores technical victory”

  1. Andrea Says:

    Quite a few online retaliers won’t deliver to Russia but one way round this is to fill in your correct Russian address but put the country as UK/Canada/wherever. The parcel will be sent to that country where the posties will see that the country’s wrong and forward it on to Russia. Sounds odd but it does work most of the time.

  2. dutch Says:

    Times are changing for the better if I can get this online!

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