By Andrew E. Kramer
Published: September 18, 2006
MOSCOW Citing damage to salmon- bearing rivers on Sakhalin Island, the Russian government on Monday withdrew environmental approval for the largest private energy investment here, the Royal Dutch Shell-operated Sakhalin-II liquefied natural gas project.
The complex development straddles the coastline on the northern rim of the island, with offshore platforms, a liquefied natural gas plant and hundreds of miles of pipeline snaking toward an ice- free port in the south, and it has had its share of critics among conservationists.
Still, the decision Monday came amid a tense business dispute between Shell, the English-Dutch oil major, and Russia’s state-owned natural gas monopoly, Gazprom, which is trying to join the consortium that Shell now controls.
Oil analysts said the ruling looked like a ploy by the Russian government to renegotiate terms or force Shell to concede to Gazprom’s demands in the $20 billion production sharing deal rather than close it down on environmental grounds.
Sakhalin Island, a ribbon of sub-Arctic land off Russia’s east coast, and the
surrounding seas, hold more oil than the remaining deposits in the North Sea. Nearly untapped now, the island’s resources could help shape energy markets in Japan, Korea and China in the decades to come. Sakhalin-II is also the world’s largest combined oil and natural gas development.
Liquefied natural gas, a fuel that is gaining in popularity, has already been sold into markets as far away as California in futures contracts beginning in 2008, according to Shell, which vowed in a statement to fight the Russian government’s decision.
The ruling by Rosprirodnadzor, the environmental watchdog, revoked a 2003 environmental approval for the Sakhalin-II project, according to a posting on the agency’s Web site; before it takes effect, the decision must be cleared by a second Russian government agency, according to the statement.
The Russian authorities cited damage to salmon-bearing rivers and excessive logging along a pipeline route.
“Dozens of hectares of forest were destroyed and a large number of fish died because of improper river crossings,” Oleg Mitvol, deputy director of Rosprirodnadzor, said by telephone.
“Nobody will lose their license,” he said. “The talk now is about the environmental problems that have occurred.” Mitvol said that he understood approval had been revoked only for the pipeline construction, not the project, though a Shell spokesman said it appeared the agency statement referred to approvals for the entire onshore and offshore development.
Shell denied that it had violated any Russian environmental laws.
“Although there have been various environmental challenges on this project, these have been tackled and largely overcome,” Shell said in a statement released in Moscow. “All concerns are being addressed expeditiously in cooperation with the relevant authorities and do not constitute any legal grounds for nullification.”
An annulment of the approval “could be damaging for the project and for Russia,” the statement said. “We have no doubts that the government of the Russian Federation will honor its obligations”
Shell was nearing completion of the second phase of Sakhalin-II. It owns 55 percent of Sakhalin-II; Mitsui of Japan holds 25 percent and Mitsubishi of Japan has 20 percent. This summer, Shell and its partners employed roughly 17,000 people in construction.
The project was an anomaly in Russia as a wholly foreign-owned venture at a time of rising resource nationalism. It operated under a production sharing deal that a Russian government minister said last week he was unhappy with, but that was written into Russian law in the 1990s, approved by Parliament.
Also Monday, Sergei Fyodorov, an official at Russia’s Natural Resources Ministry that oversees the three production sharing agreements in force, said all had violated “technical” provisions in the contracts and that their licenses could be revoked, the Interfax news agency reported.
Exxon Mobil of the United States and Total of France operate the other two production-sharing fields.
Shell’s Sakhalin-II development is unique in Russia also because Shell was marketing the natural gas, a commodity Gazprom has a monopoly on elsewhere in the Russian economy. The Sakhalin concessions were incorporated as an exception to a law formalizing Gazprom’s natural gas monopoly passed this year.
To allow Gazprom into the project, Shell agreed in July 2005 to swap a 25 percent stake in Sakhalin-II for a share of an Arctic gas field owned by the Russian company. Days later, however, Shell announced the cost of development at Sakhalin-II had doubled, to an estimated $20 billion from $10 billion.
Gazprom subsequently announced that it was displeased that it had not been informed of the higher cost estimate before signing the deal; the companies have been negotiating over the terms of the swap since.
Also, the higher cost estimate lowers the initial profit for the Russian government; under the terms of the deal, the operator, Shell, recuperates costs before sharing income with the government. Until the costs are recovered, Russia will receive roughly $300 million a year; afterward, the government share rises to $2 billion annually.
Shell executives say soaring steel prices, the appreciation of the Russian ruble and a tight market for oil rig equipment drove up costs.
“This is a negotiating technique, like a kick in the shin is a negotiating technique” said Caius Rapanu, an oil and gas analyst at the UralSib brokerage firm in Moscow.
The production-sharing agreements “were signed a long time ago,” he said. “In the meantime, the Russian government has woken up, and they say, ‘why can’t we get more, which we deserve. Why does Shell get the oil? What has Shell ever done for me?'”
It remained unclear, he said, whether the decision was a limited attempt to force Gazprom into the Sakhalin-II project, or whether it signaled the beginning of a more sweeping revision of the production-sharing deals.
The Russian Trading System stock market shrugged off the announcement because investors in Russia now expect such actions by the government. The market closed up 1.1 percent on Monday.
It was unclear what effect such tactics would have, if any, on efforts by Chevron and ConocoPhillips of the United States and Statoil of Norway and Total to join a separate international consortium with Gazprom in the Barents Sea.
In another sign of the Russian state tightening its grip on oil, Gazprom is in talks to buy into BP’s joint venture in Russia, TNK-BP, the Vedomosti newspaper reported Monday. TNK-BP is now owned by BP and a trio of Russian oligarchs. Gazprom is in talks to buy out the private Russian partners, the paper reported.