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Shell ‘hanging in there’ on Sakhalin as Russia ups pressure

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Royal Dutch Shell is "hanging in there", company sources say, as Russia squeezes its $22 billion Sakhalin-2 oil and gas project over cost overruns, environmental violations and to secure a stake for state firm Gazprom.

Sakhalin-2 on the Pacific island of Sakhalin, north of Japan, is one of the world's biggest and most ambitious energy projects and the largest foreign direct investment in Russia, according to operator Sakhalin Energy.

The deal, one of three similar projects Russia signed in the 1990s, was supposed to mark a new era of cooperation.

But the project, led by Shell and involving Japan's Mitsui and Mitsubishi, has recently soured along with other foreign investments in Russia.

"We're hanging on in there," said a Shell source who declined to be named.

"There's no issue with the schedule or with the total cost at the moment. The longer it goes on, the more difficult it gets of course."

A doubling of costs has infuriated Russia because under the terms of its production sharing agreement with the companies Russia will not see any profit until the costs are recouped. Near-record oil prices have only added to Russia's frustration.

Russia's environment agency RosPrirodNadzor, has accused Shell of inflicting ecological damage to Sakhalin, a feeding ground for gray whales, and threatened legal action.

It says contractors have illegally cleared forests, dumped soil in rivers and laid pipelines in areas prone to mudslides.

Shell says it is working with Russia to find a solution. Chief Executive Jeroen van der Veer has said he hopes to "resolve issues and misunderstandings through discussions."

In private, Shell sources say it is increasingly difficult to know who in Russia is calling the shots.

"Now it's got $20 billion costings, different ministries and RosPrirodNadzor are saying: 'There are environmental violations and we could shut you down for not painting around the doorhandles'," said a source familiar with the Sakhalin project.

"And who's in control. Is it the Ministry of Natural Resources, the Ministry of Economic Development or is it Gazprom?"

Another Shell source said Russian self-confidence had grown in tandem with surging oil prices. The world's second biggest oil exporter and holder of the biggest gas reserves is keenly aware how important its energy supplies are to Europe and Asia.

Foreign operators Shell, Exxon Mobil and BP are finding the negotiating climate increasingly tough.

"The Russian negotiating leverage is in a different place than it was. They are more self confident than they once were and they feel that anybody's fair game," the Shell source said.

Shell is depending on Sakhalin to help boost reserves and revive falling output. It is scheduled to begin liquefied natural gas (LNG) exports to Asia in summer 2008, later than earlier planned. Shell spokesman Andy Corrigan said Sakhalin-2 was on track to start LNG exports in 2008.

The project involves drilling for oil and gas in the Pacific Ocean, pumping it through 800 km-long pipelines along the island, which lies in an earthquake zone, and turning the gas into liquid at a giant LNG plant.


Russian gas export monopoly Gazprom plans to take a 25 percent stake in Sakhalin-2 through an asset swap with Shell but the doubling of the budget has created disarray.

Gazprom may now demand a greater stake, taking some equity from Shell's partners Mitsui and Mitsubishi. Shell currently has 55 percent, Mitsui has 25 percent and Mitsubishi 20 percent.

Sources close to Shell said that was a possible outcome.

"There is a lot of discussion taking place. We don't know where it will end up, they don't know where it will end up, but I think both sides have a vested interest in it being a fair outcome," said the Shell source.

Corrigan said talks with Gazprom were continuing, but declined further comment.

Russian state auditor Sergei Abramov said on Monday he expects the Sakhalin-2 partners to accept a change in the terms of the production sharing agreement (PSA) that governs the project to improve Russia's share.

While Abramov said Russia would not unilaterally revise the PSA, it would never agree to a budget of $22 billion.

"Shell will have to come to terms with the fact that it has disappointed the Russians," another Shell source said.

© Reuters

One Response to “Shell ‘hanging in there’ on Sakhalin as Russia ups pressure”

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