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Catastrophic news for Royal Dutch Shell Plc?: Russia calls a halt to Sakhalin II

Comments from a Shell insider on viewing the situation from the Russian perspective

EXTRACT: Gas fields and production facilities do not last forever, and by the time Shell have amortised the currently estimated development costs the Sakhalin fields will be starting to decline, and the production facilities will be reaching the end of their design life. So the Russians will have provided the gas, and received little or nothing in return, other than a depleted field, extinct whales, a damaged environment and some rusting facilities. Who can blame the Russians for being somewhat angered that a key national asset is being squandered?

THE ARTICLE

If Shell accepts a bid from a contractor to deliver a project on a specified date, at a specified cost, then the contractor accepts the financial risks of having overlooked some aspect of the project, and underestimated the costs. If, prior to completion, a contractor realises that he has underestimated costs by a factor of 2 or 3, would Shell agree to “renegotiate” the price to cover the additional costs? And what of the tenderers who bid accurately, only to lose the contract on the grounds of their cost estimates?

Shell negotiated a PSA with the Russian government, under which the Russian government agreed to pay less than $10bn for the Sakhalin development, to be paid out of gas belonging to the Russian state. Only after sufficient gas had been produced and sold by Shell to pay the agreed development costs would benefits accrue to the Russians. By doubling the costs, without approval, the date at which the Russians will start to receive income on a comparable basis has been pushed back by several years, and the “Net Present Value” (NPV) of the project for the Russians is therefore reduced to almost zero.

Gas fields and production facilities do not last forever, and by the time Shell have amortised the currently estimated development costs the Sakhalin fields will be starting to decline, and the production facilities will be reaching the end of their design life. So the Russians will have provided the gas, and received little or nothing in return, other than a depleted field, extinct whales, a damaged environment and some rusting facilities. Who can blame the Russians for being somewhat angered that a key national asset is being squandered?

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