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Reuters: Shell gets cash, promises in Sakhalin-2 deal: source

Tue Dec 19, 2006 7:29 AM ET
By Tom Miles and Dmitry Zhdannikov

MOSCOW (Reuters) – Royal Dutch Shell and its partners in the $22 billion Sakhalin-2 project have accepted cash and a promise of future cooperation with Gazprom in a deal to let the Russian firm into the venture, a source close to talks between the companies said on Tuesday.

Shell and Gazprom have both signaled that their negotiations may yield a deal later this week, with Shell CEO Jeroen van der Veer expected to make a third visit to Moscow in as many weeks on Thursday or Friday.

“I hope it will be this week… there are no differences remaining, work is under way on the final documents,” Gazprom’s deputy chief executive Alexander Medvedev told reporters. He said the deal would be on market terms but did not give details.

Gazprom had originally offered Shell a share of its Zapolyarnoye field as a swap for 25 percent of Sakhalin-2, the world’s biggest liquefied natural gas (LNG) project which is based on Russia’s Pacific energy hub, Sakhalin Island.

But last year Shell announced the project’s costs had doubled, prompting Gazprom to reopen negotiations with Shell and its Japanese partners Mitsui <8031.T> and Mitsubishi <8058.T>.

Gazprom’s chairman has said it wants around 50 percent in Sakhalin-2 and sources have told Reuters that Shell is likely to give up a 30 percent stake out of its 55 percent, although the Shell-backed project operator Sakhalin Energy would remain.

The cost hike also angered the Kremlin, since under the project’s production sharing agreement, the operator can recoup costs before sharing any profit with the state. Higher costs mean Russia waiting longer for less profit.

Russian officials have put Shell under pressure with a campaign of rhetoric and threats of license withdrawals and administrative sanctions. Sakhalin Energy has said their interference is putting the timetable of LNG deliveries to Japan, South Korea and the United States at risk.

SHELL WARNED ON RESERVES

Analysts have said the deal is more important for Shell than for Gazprom, which has grown into a $270 billion giant in the last two years.

Its entry into Sakhalin-2 will help cement the Kremlin’s grip on Russia’s energy sector, since the venture — the biggest single foreign investment in Russia — is the only big project without any Russian involvement.

Shell needs to add to its energy reserves, since it has one of the worst records in its peer group at finding new resources.

Ratings agency Fitch warned on Tuesday that its plan to give Gazprom 30 percent of Sakhalin-2 could have an adverse impact on its reserve replacement strategy.

“Any significant loss of future production volumes and reserves could be detrimental to Shell’s efforts to catch up with its peers in respect of reserve replacement and reserve life, an important parameter to evaluate an oil major’s long-term growth prospects,” Fitch said in a statement.

Gazprom’s financial health is unlikely to suffer from a deal to get into Sakhalin-2, although analysts have estimated it might have to pay anything from $4 billion to $10 billion.

“The general expectation is that they’re not likely to pay much,” said Okan Akin, a credit analyst at Bear Stearns. “They have the capacity to borrow and it won’t have much impact (unless) they finance everything through new issues.”

Gazprom’s offer of cooperation could solidify its plans to work with Shell on a gas-to-liquids plant or use Shell and the Japanese firms to further its ambitions to become a world leader in LNG, the mainstay of Sakhalin-2.

Gazprom has no experience in LNG, a supercooled fuel which can be shipped around the world, breaking the dependence on gas pipelines to get to market.

But it wants to tap the huge Shtokman field in the Barents Sea for LNG sales to the U.S. market, a project that both Shell and Mitsubishi previously tried and failed to get into.

Gazprom also said in June that it might invite Mitsui and Mitsubishi to join an LNG project on the Baltic Sea. Sources have told Reuters that each may give Gazprom 10 percent of Sakhalin-2 out of their respective stakes of 25 and 20 percent.

Shell spokesmen in London and Moscow declined to comment.

(Additional reporting by Tom Bergin)

© Reuters 2006. All rights reserved.

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