The Wall Street Journal: Shell May Cede Control of Project To Russia’s Gazprom

By GUY CHAZAN in Moscow and CHIP CUMMINS in London
December 12, 2006; Page A3

The Russian government may be close to a victory in a long-running dispute with Royal Dutch Shell PLC over a $20 billion energy project, a development that would bolster Kremlin control of the nation’s vast oil and natural-gas reserves in a time of concern over world supplies.

Shell has proposed ceding a controlling stake in the Sakhalin-2 project in Russia’s far east to state-run OAO Gazprom, an official close to the situation said. Another person close to the talks stressed they are continuing and an agreement hasn’t been reached. Such a move would underscore the Kremlin’s opposition to foreign control of large energy projects in Russia at a time when an increasingly confident Russian state, buoyed by high oil prices, is determined to restore its domination of the country’s oil and natural-gas industry.
 
Shell owns a 55% stake in Sakhalin-2, which has an expected total cost of $20 billion to develop. Russian regulators threatened to impose sanctions on the project following Shell’s announcement in 2005 of big cost overruns. That cast a pall over what is one of the biggest liquefied-natural-gas projects in the world and the single-biggest foreign investment in Russia.

Shell and Gazprom declined to comment on Shell Chief Executive Jeroen van der Veer’s talks Friday with Gazprom Chief Executive Alexei Miller and Russia’s energy minister, Viktor Khristenko, saying only they had discussed Sakhalin-2. Gazprom said Mr. van der Veer made the company a number of proposals and it is analyzing them. A spokesman for Shell said the discussions were “positive and constructive,” but the contents remained confidential.

An official close to the situation said one of the proposals under consideration was for Shell to offer Gazprom a controlling equity stake in the project. Reuters reported the offer early yesterday. It is unclear whether the offer will be acceptable to Gazprom and lead to an agreement, or how Gazprom would pay for the stake, whether in cash or assets.

It also is unclear how Sakhalin’s final ownership structure would look under such a deal and what rights and guarantees Shell would have, though a person close to Gazprom said the gas monopoly wants Shell to stay on as operator because the Russian company has little experience extracting gas offshore or producing liquefied natural gas. Such a role would guarantee Shell would continue to lead the project, though it would enjoy less of the financial benefits with a minority stake.

The person close to Gazprom also said gaining a controlling stake in Sakhalin-2 would set a precedent for Gazprom to press for control of other big Russian gas projects, such as the Kovykta field in Siberia, currently owned by the Anglo-Russian venture TNK-BP Ltd.

Although any dilution of Shell’s stake could dismay the Anglo-Dutch oil company’s investors, a new ownership structure involving Gazprom could improve Shell’s standing in Russia. In London, Shell’s Class B shares fell 1.1% to close at £18.24 ($35.63).

If Shell were to cede substantial equity in Sakhalin-2, the Anglo-Dutch company would likely experience a decline in the reserves it planned to book from Sakhalin. Most major oil companies have struggled to add reserves amid dwindling prospects and tighter control by state oil companies. Shell drastically reduced its inventory of so-called proved reserves in 2004 after years of overstating them. It is unclear how much reserves Shell had hoped to add with Sakhalin.

On the other hand, by reaching an agreement with Gazprom, and resolving its Russian regulatory problems, Shell would be able to meet a crucial deadline for beginning shipments of liquefied natural gas. Shell was due to start deliveries in the summer of 2008, but fears of a delay grew as pressure from the authorities intensified. Analysts and industry executives were expecting Gazprom to wind up with a big stake one way or another.

It is unclear how the most recent negotiations between Shell and Gazprom will affect Sakhalin’s minority partners, Japan’s Mitsui & Co. and Mitsubishi Corp., which own 25% and 20% of Sakhalin Energy respectively. “About this stake issue, Shell and Gazprom are in talks now [and] Mitsui & Co. will consider what to do after they reach an agreement,” said a Mitsui spokesman. A Mitsubishi spokesman wasn’t available for comment.

–Gregory L. White in Moscow and Mari Iwata in Tokyo contributed to this article.

Write to Guy Chazan at [email protected] and Chip Cummins at [email protected]

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