The Observer: Shell’s costs on Sakhalin spiralling: $28 bn

Leaked Russian document claims final bill for troubled joint gas project could be $28bn

Nick Mathiason and Heather Connon
Sunday October 22, 2006

Costs on Sakhalin-2, one of Royal Dutch Shell’s most treasured yet politically fraught gas projects, are rocketing, says an internal report by the Russian government leaked to The Observer.

The news will anger the Kremlin because it could in theory mean it receives less revenue under the production-sharing agreement it signed with Shell a decade ago.

The report, by the mineral services division of the Russian Ministry of Natural Resources, drawing on Shell’s own figures, states that operational costs will rise from a predicted $15bn in 2003 to $28bn, according to its latest estimate. The liquefied natural gas plant off the east coast of Russia has doubled its construction budget of $20bn (£10.6bn) and there is a strong possibility that construction costs could rise further.

The project is at the heart of a bitter struggle for control between the Anglo-Dutch oil giant and Russian state energy firm Gazprom.

The report comes as Russian sources indicate that a deal could come shortly to give Gazprom a stake of around 25 per cent in the LNG plant that will provide gas to eastern Asia and America. This will mean Shell’s majority control evaporates. Its share of what would be a four-member consortium project would only be 5 per cent higher than its three other partners.

Shell would not comment on the document, which it said it cannot verify.

The power play by Russia has gathered momentum in recent weeks. This month it excluded foreign capital from development of Russia’s giant Shtokman gas field in the Barents sea, upsetting Western companies. But President Putin, speaking after a summit with EU leaders in Finland on Friday night, insisted this did not signal any policy shift away from welcoming foreign investments.

However, Russian watchers say there is growing pressure to snub foreign oil majors who signed extraction deals when oil prices were low and Russia’s economy was on its knees.

The coming week is crucial for Shell because Russian Natural Resources Minister Yury Trutnev will on Tuesday head a delegation to Sakhalin island to inspect what it says are serious environmental violations caused by Shell that prompted the ministry to suspend the company’s licence to construct the scheme.

Shell was forced to change the route of a pipeline off Sakhalin as it would have disturbed whales’ feeding grounds. But it has subsequently been accused of shoddy construction techniques that have damaged rivers where salmon spawn.

This week, along with BP, Shell signals the end of three years of record earnings as both announce a fall in underlying profits for the three months to September.

Even without the Sakhalin problems the oil majors have been hit by the recent sharp drop in oil prices. Brent crude has fallen from more than $70 a barrel to under $60 in the last three months. An increase in oil supply is also encouraging Opec (the Organisation of Petroleum Exporting Countries) to cut production.

BP’s third-quarter figures will also reflect the production difficulties which have dogged it following a series of accidents in Alaska and Texas. .

However, Tony Shepard, oil analyst with broker Charles Stanley, says the companies: ‘will still generate large cash flows and will therefore continue with share buybacks.’

The consensus among analysts is that BP will make $4.7bn (£2.5bn). That would be 12 per cent below the same period in 2005. At Shell third-quarter profit is expected to reach $5.7bn, excluding one-off items, down from $5.8bn in the same period last year.

http://business.guardian.co.uk/story/0,,1928280,00.html

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