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Russia adds insult to injury on Sakhalin-2

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Royal Dutch Shell and its two Japanese partners are to be made to share the burden of the huge cost overruns of Sakhalin-2, it emerged on Thursday, in news that cast a less favourable light on their deal to cede control of the project to Gazprom.

Just days after confirming that Russia would pay the companies $7.45bn to establish its controlling stake in the project, the government said it would require the three foreign owners to meet $3.6bn of the additional costs of Sakhalin-2 themselves.

Jonathan Wright of Citigroup said: "It depends on what you expect for oil and gas prices, but my figures suggest an internal rate of return for the project of 11 per cent. That's above the cost of capital, but not sufficiently above it, given the region and the risks involved, to be able to say this is an attractive project.

"This news is definitely not making a good project turn bad, but it is making a difficult project slightly worse."

He added: "This looks like payback for the negotiations last year, when Gazprom reached an agreement on taking a stake in the project, only to be told the following week that the costs had doubled."

Details of the extra costs to the three companies - Shell, Mitsui and Mitsubishi - in a confidential agreement apparently leaked by the Russians, show the three companies will have to increase risk exposure and reduce the value of this month's deal.

Earlier this month, they ceded control of Sakhalin-2 to Gazprom, Russia's state-backed gas giant, after months of sustained attack by government agencies on aspects of the project such as its rising cost and environmental record.

Shell, which owned 55 per cent of the project, Mitsui and Mitsubishi halved their stakes and offered Gazprom 50 per cent plus one share. On the day the deal was signed, the Kremlin said environmental issues would be resolved and agreed to a doubling of the cost to $20bn.

Sakhalin-2 is governed by a production sharing agreement that allowed foreign shareholders to recoup costs fully before sharing profit with the Russian state.

But it emerged on Thursday that foreign shareholders would recoup only about $15.8bn and have to put up $3.6bn themselves. Gazprom, as a new shareholder, would be exempt from this cost increase.

Andrei Dementyev, Russia's deputy minister for energy, told Vedomosti, a business daily partly owned by the Financial Times, that "foreign investors should take engineering risks upon themselves".

Shell declined to comment on the agreement. Observers say that Russia, by leaking the information to the media, was adding insult to injury.

The Russian government has now set its eyes on Kovykta, the massive gas field in Eastern Siberia controlled by TNK-BP. Alexei Miller, Gazprom chief executive, on Thursday met with Victor Vekselberg, one of TNK-BP's Russian shareholders, to discuss "co-operation" between the companies.

© The Financial Times


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