TheBusinessOnline: Shell facing a rough ride over its Sakhalin Island gas project

By Richard Orange
20 August 2006
 
IN any competition for the oil industry’s most angst-filled executives, Royal Dutch Shell’s Russia negotiators would merit a mention, given the mounting pressure on Shell’s $20bn (E15.5bn, £10.6bn) gas project on Sakhalin Island.

Russia’s Resources Ministry is next week slated to finish its audit of the liquefied natural gas (LNG) project on Russia’s Far East coast.

Shell had to double the project’s planned costs last year and will get a rough ride when the ministry releases its findings. On top of that, the ministry’s environmental monitoring arm earlier this month threatened to take Shell to court, possibly next month, to stop construction on one of the project’s key pipelines, which it claims is at risk of mudslides.

And the Russian Academy of Natural Sciences concluded at the end of May that Shell, Total, and Exxon should pass over majority ownership of the three Production Sharing Agreements (PSAs) Russia signed in the early 1990s, which include Sakhalin, to Russian oil and gas companies. Some of this is no doubt related to Shell’s negotiations with Russian gas monopoly Gazprom. Before Shell announced its cost increase, the two signed a preliminary deal to swap a 25% plus one share stake in Sakhalin for a 50% stake in its giant Arctic Zapolyarnoye field.

Shell now says negotiations on the swap could continue into next year.

The growing nationalism of bureaucrats in the Russian Natural Resources Ministry also plays its part. The ministry argues that the PSAs are too generous to the oil companies. They are exempt from normal Russian law on natural resources and, crucially, they allow the companies to recover the costs of their developments by keeping most of the initial oil and gas produced.

France’s Total has fought a long battle over government claims that it pumped up costs at its Kharyaga PSA. Exxon, which already has Rosneft as a partner on its Sakhalin-1 project, is also experiencing problems. Gazprom recently let slip that it opposed Exxon’s plans to pipe the project’s gas to the Chinese mainland.

Those in the Russian government who want the PSAs ripped up or rewritten probably won’t get their way. The damage that would be done to the business climate is too great. 

But the western oil companies operating under PSAs are likely to come under regulatory pressure unless Russian companies gain larger stakes.

At Total’s Kharyaga PSA, private oil firm Lukoil, which has an option to take 20% in the PSA, is the most likely buyer. Gazprom and state-dominated oil company Rosneft would relish majority stakes in the Sakhalin projects.

But Rosneft is in a weak position, given that it sold part of its share in Exxon’s Sakhalin project to India’s ONGC a few years back. Exxon has bent over backwards to meet Russian demands over Sakhalin.

Shell only has 55% of Sakhalin-2, meaning it is in no position to grant Gazprom a majority stake. But negotiating with Gazprom is testing at the best of times and the cost increase puts it firmly on the back foot. Sakhalin executives should be nervous for a while yet.

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