Forbes: New Problem At Sakhalin

Chris Noon, 09.27.06, 4:20 PM ET

Russia on Wednesday threw a new roadblock in the way of the foreign companies trying to develop the Sakhalin-2 energy site in the eastern part of the country, charging Royal Dutch/Shell, Mitsui and Mitsubishi with violating worker safety rules.

A week ago, a suddenly ecologically minded Kremlin revoked environmental authorization for the $20 billion project.

“There have been quite a lot of violations of industrial safety rules … this worries our inspectors,” said Konstantin Pulikvosky, head of the environmental, engineering and nuclear monitoring agency Rostekhnadzor. The decision has, unsurprisingly, caused international protest. Yasuo Saito, Japan’s ambassador to Moscow, called the Russian government action “one-sided”, and lacking in “procedural transparency”.

There’s method behind the Kremlin’s madness. Last year, Shell (nyse: RDS.A – news – people) announced a preliminary swap deal with Russia’s state-owned gas giant Gazprom that would give the Russian concern up to 25% of the Sakhalin Energy project in exchange for a 50% interest in Gazprom’s humongous Zapolyarnoye gas field in northern Russia. Thus, Moscow’s fault-finding may be designed to strengthen Gazprom’s bargaining position.

Russian Foreign Minister Sergey Lavrov has tried to soft-pedal concerns over the country’s energy pacts. He said Wednesday that environmental and regulatory inspections of foreign-owned energy projects in Russia aren’t aimed at the eventual cancellation of their production licenses. He added that agreements with foreign oil firms would not be scrapped but that the companies should “fulfill their obligations”.

It’s unlikely that the Sakhalin-2 project, which employs 17,000 people, will be shuttered. There’s too much at stake for Gazprom. However, the dispute is burning Russia’s diplomatic bridges. Shinzo Abe, Japan’s incoming prime minister, has already called Sakhalin a symbol of cooperation between Japan and Russia, and warned that a long delay in implementing the project could hurt the relationship between Tokyo and Moscow.

Shell owns a 55% stake in Sakhalin Energy while Mitsui (nasdaq: MITSY – news – people ) and Mitsubishi (other-otc: MSBHY.PK – news – people ) hold 25% and 20%, respectively.

Sakhalin-2 is typical of other massive energy projects being developed by foreign oil companies under production sharing agreements signed during the 1990s, a time when oil prices were low and Russia was thirsty for foreign investment to develop its energy reserves. The oil companies get tax breaks while the Russian government gets a share of the oil and gas once the project’s production costs have been covered.

Sakhalin-2 is scheduled to start liquefied natural gas production in mid-2008, and is expected to produce 9.6 million tons a year when fully operational.

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