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The Yomiuri Shimbun: *Sakhalin II partners surrender in face of Russian onslaught?

Actual headline: Russians get cut slack on Sakhalin / Companies to review oil, gas project to reduce burden on Moscow

Saturday 28 October 2006

Royal Dutch Shell PLC, Mitsui & Co. and Mitsubishi Corp., which are leading oil and gas development off Sakhalin, Russia, have decided to drastically review the project plan to give favorable conditions to the Russian side, sources close to the companies said Friday.

The three companies now plan to cut the nominal amount of the total cost of the Sakhalin-2 project by billions of dollars from the current estimate of 20 billion dollars (about 2.38 trillion yen) to reduce the burden on the Russian side. They also will move forward the time when the Russian side receives profit from the project to develop oil and natural gas fields.

Though the three companies will have to shoulder the gap between the nominal and actual costs, they judged the concession for Russia is essential to prevent any delay of the development, the sources said.

By presenting the concession, the three companies aim to reach a new agreement with the Russian side by the end of the year, but the sources said the talks may be tangled.

About the Sakhalin-2 project, Russian Natural Resources Minister Yury Trutnev pointed out Wednesday that violations of environment protection laws eligible for criminal penalties had been found in at least five places.

Sakhalin Energy Investment Co., the operator of the development project capitalized by the three companies and other partners, said it would accept the minister’s allegation.

However, Russia is shifting the focus of dispute from environmental damage to the total cost of the Sakhalin-2 project, which has doubled from the initial estimate.

Initially, Royal Dutch Shell told the Russian government that the total cost would be 10 billion dollars.

But the international oil firm announced a doubling of the figure due to a rise in price of materials in July 2005, just after the three companies reached a basic agreement with Gazprom, Russia’s state-run natural gas firm, for its joining the project.

The development cost of the project is shared by the partners in proportion to their capital contributions in Sakhalin Energy, and profit from produced oil and gas is primarily spent to recover the cost.

Gazprom plans to acquire a 25 percent stake in Sakhalin Energy by buying shares from the three companies. Thus, increase of the cost means more financial burden for Russia and a delay in the provision of profit for the Russian government.

The sources said that the Russian government seems to have put pressure on the project out of dissatisfaction with the current business conditions of the project.

Thus the three companies began reviewing the plan because “even if the environmental problems can be solved, pressure from Russia will continue unless the cost problem is settled,” the sources said.

Royal Dutch Shell has told its Japanese partners that the Russian government probably will not accept the total cost figure of 20 billion dollars.

Though the actual total cost will be 20 billion dollars, the three companies will shoulder the difference with the nominal figure to be presented to Russia.

Depending on Russian reaction, the three companies are considering such options as:

— Handing over Russia’s share of profit, which would be given only after the cost is recovered, in advance.

— Not asking Russia to shoulder any additional burden even if the total cost cannot be cut.

— Increasing Gazprom’s stake in the project to more than 25 percent.

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