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The Wall Street Journal: Russia Delays Sanctions On Shell’s Energy Project

By GREGORY L. WHITE in Moscow and GREG WALTERS in Yuzhno-Sakhalinsk, Russia
October 26, 2006; Page A13

Russian regulators put off imposing sanctions on Royal Dutch Shell PLC’s $20 billion Sakhalin-2 project for what they say are widespread environmental violations, keeping the pressure on as the Kremlin steps up complaints about massive cost overruns at the venture.

After an inspection tour of the project on the far eastern island of Sakhalin, Russian Natural Resources Minister Yuri Trutnev cited “multiple violations” of Russian environmental laws at a meeting with Shell officials.

Mr. Trutnev gave regulators another month to complete inspections of the project before making any decision on withdrawing a permit or imposing fines. Officials also said they could seek criminal charges for some of the alleged violations over the next two weeks.

Shell has said that it has addressed most of the concerns regulators have raised so far, and officials pledged yesterday to work closely with the government to seek clarification of and resolve remaining ones. Shell officials say the project remains on schedule to deliver its first liquefied natural gas to the Asian market in the summer of 2008. Limited oil production began in 1999.

The environmental crackdown comes as Shell is seeking Russian government approval for a near-doubling of the cost of the project, which had previously been budgeted at $12 billion. Russian officials, including President Vladimir Putin, have blasted the overruns, which they say mean that Russia will have to wait as many as 10 years longer to see its share of the oil and gas produced.

The Sakhalin-2 deal is one of only three so-called production-sharing agreements in force in Russia, offering special terms that allowed the foreign oil companies to keep most or all production until they recovered their costs and began to turn a profit. Though they insist they will continue to abide by them, Kremlin officials have denounced the deals — reached in the 1990s when oil prices were low and Russia was desperate for investment — as overly generous to the foreign companies.

People close to the situation say the Kremlin appears to want Shell to absorb more of the cost overrun. Last week Mr. Putin said the issue should be resolved through negotiations and criticized some of Shell’s increased expenses as unjustified.

Shell so far hasn’t publicly indicated any willingness to agree to financial concessions, insisting the cost overrun is the result of increased complexity and surging costs for important materials like steel. But yesterday, the head of the Shell-controlled operating company for the project admitted that it will face “challenges” in getting it approved. A spokesman for Shell in London said the company wouldn’t comment on whether it was negotiating about any of the commercial terms of its agreement with the Russian government.

The other major foreign-led Sakhalin project, Exxon Mobil Corp.’s Sakhalin-1, also is dealing with higher costs, but so far hasn’t faced the regulatory pressure Shell has. Unlike the Shell project, Sakhalin-1 includes a Russian partner, national oil company OAO Rosneft, which has a 20% stake.

The Kremlin has steadily tightened its grip on the strategic energy sector in the past several years, squeezing foreign investors and private companies in favor of state-controlled giants Rosneft and OAO Gazprom, the natural-gas monopoly.

Shell is in talks that would give Gazprom a 25% stake in the Sakhalin-2 project, but those talks have made little progress amid the conflict over the cost overruns, according to Gazprom officials.

Write to Gregory L. White at [email protected] and Greg Walters at [email protected]

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