Reuters: Russian pressure on Shell alarms UK

Tue Sep 19, 2006 4:20 PM BST
By Dmitry Zhdannikov and Elif Kaban

MOSCOW (Reuters) – Russia stepped up the pressure on Royal Dutch Shell (RDSa.L: Quote, Profile, Research) and its Japanese partners on Tuesday over a $20-billion (10.6 billion pounds) oil and gas development in the Far East, sparking protests from Tokyo, Brussels and London.

In the latest blow to Sakhalin-2, one of the world’s biggest energy projects, Russian gas monopoly Gazprom (GAZP.MM: Quote, Profile, Research) revealed that asset swap talks with operator Shell (RDSa.L: Quote, Profile, Research) had stalled for months due to Shell’s cost overrun at Sakhalin.

This followed a Russian decision on Monday to revoke environmental approval for the project because of allegations that Shell had violated their terms. Shell denies this.

The European Commission said it was taking Russia’s withdrawal of the permits “very seriously” and called on Moscow to guarantee a secure and predictable investment climate.

Japan’s prime minister-in-waiting Shinzo Abe said a major delay to Sakhalin could hurt diplomatic relations and the British government said it was “deeply concerned”.

The head of the International Energy Agency, Claude Mandil, said Russia’s investment climate could suffer.

Japan’s Mitsui & Co Ltd (8031.T: Quote, NEWS, Research) and Mitsubishi Corp (8058.T: Quote, NEWS, Research) own a combined stake of 45 percent in Sakhalin-2. Import-dependent Japan will be a major customer.

Royal Dutch Shell shares fell 1.7 percent on the news.

KREMLIN PRESSURE

Analysts suspect the Kremlin will ratchet up the pressure to the point where Shell would be forced to surrender long-established production deals to give Russia a bigger slice.

“The Russians want in, full stop,” said UBS’s chief Moscow economist Al Breach. “Russia does not want these big fields run by foreign companies. They are putting pressure on Shell to come to a deal. It’s all about money.”

Steven Beharrell, a senior counsel at law firm LeBoeuf, Lamb, Greene & MacRae, said this may prove to be a watershed, with assets coming under much closer Kremlin control.

“I think this is an indication and a warning to anyone wishing to invest in Russian infrastructure that you will do it on national terms and not on any others,” he told a London conference.

Sakhalin-2 involves the construction of the world’s biggest liquefied natural gas (LNG) plant with capacity of 9.6 million tonnes a year that would supply customers in Japan, the United States and Asian countries.

Shell has spent upwards of $10 billion on Sakhalin-2, on the remote, mountainous Pacific island of Sakhalin which is freezing cold in winter. The project is due to go on stream in 2008 and much of the initial production has already found customers.

Until August, the company said it had worked in step with Russian regulators to fulfil all the necessary regulations, winning around 3,500 separate approvals and permits.

Diplomats in Moscow mounted a big lobbying drive to salvage the Sakhalin-2 deal, Russia’s largest foreign investment.

We are deeply concerned,” Britain’s ambassador to Russia Tony Brenton told Reuters. A British foreign office spokesman said the government had expressed its concerns to the Russian government “at a number of levels”.

GAZPROM INTEREST?

Analysts said Russia is trying to force foreign oil majors to give up part or all of their advantageous production sharing agreements (PSAs), which were negotiated at a time of much lower global oil prices.

The PSA which Shell signed back in 1993 does not allow Russia to unilaterally terminate the project. But record oil prices mean Russia is losing out on potential revenue.
“The Russians are putting a straw in our drink, and it’s all very bare-knuckle,” said a senior Western diplomat.

“When you have gas, oil, pipe in the same sentence, you have a constellation of very high interests inside the Kremlin.”

Analysts said Russia also wanted to help its national gas champion Gazprom to get better terms for a stake in the project.

“The revocation of environmental approval … could reflect the state’s desire to provide Gazprom with a larger stake in the project than initially agreed,” said UralSib bank analysts.

Gazprom had planned to swap 50 percent in lower deposits of its giant Siberian Zapolyarnoye field against a 25 percent stake in Sakhalin-2.

But the plan ran into trouble after Sakhalin-2 said project costs would double to $20 billion, while the first LNG delivery would be postponed by six months to summer 2008.

“As far as our assets swap talks are concerned they haven’t progressed for more than a year after Sakhalin-2 declared changes to the initial economic parameters of the project, which have yet to be approved by the Russian Federation,” Gazprom spokesman Sergei Kupriyanov told Reuters.

“In this situation, we cannot continue talks,” he said. Kupriyanov denied that the revocation of ecological approval on Monday had influenced Gazprom’s talks with Shell as he said they had already reached an impasse.

Shell’s shares fell 1.7 percent after the Gazprom announcement. At 1435 GMT the stock was trading down 0.7 percent at 1728 pence, compared to a 0.66 percent rise in the DJ Stoxx European oil and gas sector index < .SXEP>.

Diplomats said the end game was difficult to predict with Russian power-broking fragmented into competing fiefdoms from energy giant Gazprom to ministries with varying interests.

“The picture is very muddied at the moment,” said one. “We’re all trying to figure out what comes next.”

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