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The Wall Street Journal: Russia Softens Tone Regarding Sakhalin Project

September 27, 2006

MOSCOW — Taking a more conciliatory tone with one of the world’s largest energy projects, Russian regulators gave Royal Dutch Shell PLC a month to come up with plans to rectify what they called major environmental violations before a possible shutdown of the $20 billion operation.

“We fully understand the investment significance of this project,” Minister of Natural Resources Yuri Trutnev said yesterday. “We want to do everything possible within our power to avoid stopping the project, but whether we’re able to do that depends on the company.”

Threats from Russian regulators in recent weeks to revoke a crucial permit for the project, known as Sakhalin-2, provoked criticism from foreign governments amid worries the Kremlin was seeking to change the terms of the country’s largest foreign-investment deal and a major source of natural gas for the Asian market. In the past few years, the Kremlin has tightened its control over the strategic energy sector, narrowing opportunities for foreign companies. Sakhalin-2 is one of several foreign-led projects dating to the 1990s that have faced increasing criticism from Russian officials as overly favorable to the foreign companies.

For Shell, the regulatory pressure comes as the company is negotiating with the government about a near-doubling in the cost of Sakhalin-2. Under the terms of the contract, higher costs reduce revenue from the project for Russia, where officials have criticized Shell for mismanagement. At the same time, Russian state natural-gas giant OAO Gazprom has been negotiating with Shell to take a stake in the Sakhalin project, leading some analysts to suggest the Kremlin is using the environmental claims as a pretext to drive down the price.

In a radio interview yesterday, Igor Ignatiev, a representative for Sakhalin Energy, the Shell-controlled operator of the project, said a shutdown would cause economic losses of up to $10 billion. Winning new environmental approvals could take more than a year, he said.

Though Shell officials weren’t available to respond to Mr. Trutnev’s comments, Shell has repeatedly insisted it is meeting all environmental standards. Production of liquefied natural gas is slated to start in 2008 and the bulk of production has already been sold to customers in Japan and the U.S.

Mr. Trutnev said his agency’s motivation was to ensure the safety of a massive project in a pristine and fragile environment. Showing pictures of damaged areas, he said Russian and international environmental groups have criticized Shell’s performance.

A team of Russian regulators is on its way out to Sakhalin now to conduct a detailed audit of the project. Mr. Trutnev said a decision on whether to annul the permit will be made at the end of that monthlong audit. Regulators have invited journalists and environmentalists to come along on some of the inspections, a rarity in Russia.

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