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The Moscow Times: Shell Makes Sakhalin Offer

sakhalin II

(Lucian Kim / Bloomberg
A Sakhalin Energy employee taking in the view at the LNG plant at Shell’s Sakhalin-2 facilities on Sakhalin Island

Tuesday, December 12, 2006. Issue 3559. Page 1.
By Miriam Elder
Staff Writer  

Shell succumbed to months of creeping state pressure on Monday, offering Gazprom new terms of entry into its key Sakhalin-2 project.

Shell CEO Joroen van der Veer held talks in Moscow on Friday with Gazprom CEO Alexei Miller and Industry and Energy Minister Viktor Khristenko, spokespeople at Shell and Gazprom said.

Both sides refused to comment on a Reuters report citing industry insiders that said Shell had offered to cede its controlling stake in Sakhalin-2 to the state-run gas giant.

“The discussions are confidential, but they have been constructive and positive,” a Shell spokesman said. “A lot more discussions will be held to bring this to a conclusion.”

Officials at Shell were keen to stress that no deal had yet been reached. Reuters reported that Shell and Gazprom had agreed in principle to a deal that would see the state-run gas giant take a controlling stake.

Shell would reduce its 55 percent holding to a blocking stake of at least 25 percent, Reuters cited the source as saying, adding that Japanese minority shareholders Mitsui and Mitsubishi would reduce their stakes — 25 and 20 percent, respectively — by 10 percent each.

Gazprom would need a stake of 50 percent plus one share to gain control.
One of the foreign companies would have to give up a bit more for Gazprom to gain control.

“During the meeting [on Friday], Mr. Van der Veer presented Gazprom with a series of proposals regarding the Sakhalin-2 project,” Gazprom spokesman Sergei Kupriyanov said in a statement.

“These proposals are currently being analyzed. A decision about them will be made taking into account the problems surrounding Sakhalin-2, including ecological ones,” he said.

Gazprom spokespeople could not be reached for further comment.

The Natural Resources Ministry’s environmental campaign against project operator Sakhalin Energy has widely been seen as a means for the state to pressure Shell into sweetening the terms of Gazprom’s entry into the project.

Oleg Mitvol, deputy head of the ministry’s environmental watchdog, said nothing would change when Gazprom entered the project. He said he was meeting Tuesday with a team of New York- and London-based lawyers on bringing a $15 billion lawsuit against Sakhalin Energy for purportedly covering up environmental violations.

“I have complaints against Sakhalin Energy, and those complaints have no bearing on who is a stakeholder in the company,” he said.

The original terms of the deal, preliminarily agreed to in July 2005, foresaw Gazprom taking a 25 percent stake in Sakhalin-2 in exchange for giving Shell a 50 percent stake in Zapolyarnoye, a smaller field in western Siberia.

Gazprom walked out of the talks when Shell increased cost estimates for Sakhalin-2 from $10 billion to $22 billion just one week later, arguing that the cost overrun decreased the value of the world’s largest liquefied natural gas project.

Shell officials have insisted that the timing of the announcement was simply bad luck. The negotiating team and the group carrying out the revised cost estimate were never in communication, they say.

Gazprom and the state — which holds a production sharing agreement, or PSA, for the project — were infuriated. A campaign that has seen water-use licenses for the project’s main contractor revoked and wild threats of $15 billion lawsuits have apparently succeeded in pushing Shell to ensure that Gazprom takes on a controlling stake, analysts said.

If Shell has indeed offered to give Gazprom a controlling stake in the project, “that is the most sensible outcome for both sides,” said Roland Nash, chief strategist at Renaissance Capital.

“Fighting the Russian government on its home turf is a very bad idea,” he said. “The current administration has made it very clear that within the hydrocarbon sector you look first and foremost to the Kremlin for leadership.”

The Kremlin has been trying to push through the State Duma a bill on subsoil use that would ensure that the state had a 50 percent plus one share in all hydrocarbon development projects.

The goal of the state’s recent campaign against Sakhalin-2 “was to bring the PSA into line with the structure of how energy deals are done today, with a Russian company holding over 50 percent,” said Chris Weafer, chief strategist at Alfa Bank.

The two sides have been in talks for months, but recent activity indicates that both sides are keen to wrap up the deal by the end of the year, he said.

Analysts were loath to comment on the potential deal, saying more details were needed to see how far Shell had capitulated. The British-Dutch oil and gas major has been struck by a series of setbacks in recent years, and has yet to fully recover from a 2004 scandal, when it was found to have over-reported its proven hydrocarbon reserves.

“The key is, is this a cash deal or an asset swap?” said Stephen O’Sullivan of Deutsche UFG. “Shell would be more interested in getting an asset inside Russia.”

Alex Brooks, an oil and gas analyst at UBS Warburg, agreed. “What would be very surprising is if there was not some sort of asset being offered to Shell by Gazprom.”

Analysts agreed that the PSA, which will see the state take in revenue only after the project stakeholders have recouped all their costs, would stick. But Shell may have offered to add amendments ensuring the state would reap more of a profit now that oil prices are up to five times higher than when the agreement was signed in 1994.

“This won’t bring a big change to the foreign investment climate,” said Denis Maslov, an analyst with Eurasia Group, a Washington-based risk consultancy. “We already knew there would be no more PSAs, that the existing PSAs would be examined under pressure, and that the new subsoil law will be instated.”

“This decision, if true and not a bargaining position, reinforces the general market understanding of what the rules of the game are now,” he said. and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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