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Bloomberg: Shell Cedes Sakhalin-2 Stake, Giving Putin Control (Update1)

By Lucian Kim and Torrey Clark

Dec. 21 (Bloomberg) — OAO Gazprom agreed to buy 50 percent plus one share in Royal Dutch Shell Plc’s Sakhalin-2 oil and gas project for $7.45 billion, cementing President Vladimir Putin’s control over Russia’s energy industry.

Shell, Mitsui Co. and Mitsubishi Corp. will each sell half of their stakes in the project to Gazprom, Shell said in a statement today. The partners have invested about $12 billion in the venture. Shell’s stake will fall to 27.5 percent, with Mitsubishi retaining a 12.5 percent holding and Mitsui holding 10 percent.

“Our first priority is to get Sakhalin-2 up and running,” Shell Chief Executive Officer Jeroen van der Veer said in the statement. “This agreement is an important step forward, and positions Sakhalin-2 for further growth opportunities.”

Shell’s deal with Moscow-based Gazprom ends a yearlong campaign in which the government threatened to block Sakhalin-2’s investment plans and cancel building permits on environmental grounds. European and Japanese leaders have raised concerns that Putin’s campaign to restore the state’s dominance of the economy will undermine Russia’s reliability as an energy supplier.

Gazprom suspended a preliminary agreement on an asset swap to join the venture after project operator Sakhalin Energy doubled its cost estimates in July 2005. The government complained the overruns would yield less revenue under a so-called production sharing agreement and threatened to suspend Sakhalin-2 licenses because of environmental violations.

“There’s a new reality in Russia, majority foreign-owned investment doesn’t work anymore,” said Michael Bradshaw, a geographer at Britain’s University of Leicester who has focused on Sakhalin energy projects.

Shell’s Need for Reserves

The venture, which is developing fields off Sakhalin Island, north of Japan, is key to Shell’s plans to revive output and boost reserves. The Hague-based Shell is still recovering from the 2004 accounting review that forced it to reduce proven reserves by 5.63 billion barrels, or 29 percent.

Shell last year replaced only 67 percent of the proven reserves it pumped from the ground after exploration lagged behind its competitors. BP Plc replaced 95 percent of reserves under U.S. accounting rules.

The agreement with Shell also allows Gazprom to maintain its control over Russian gas exports. While the company’s export monopoly is enshrined in law, Sakhalin-2 is exempt under its production sharing agreement. Sakhalin-2 has one of three such agreements signed in Russia in the 1990s when foreign capital was needed to revive flagging oil output.

Environmental Attacks

The government’s attacks on Shell, led by environmental inspector Oleg Mitvol, were similar to the tactics used in Putin’s dismantlement of OAO Yukos Oil Co., which was hit $30 billion in back tax claims.

Putin is building Gazprom and state oil company OAO Rosneft into challengers to Shell and Exxon Mobil Corp. using assets from Yukos, once Russia’s largest oil producer.

Mitvol, the deputy head of the Natural Resources Ministry’s environmental agency, toured Shell’s Sakhalin project in September and said the company may have caused as much as $50 billion in damages, an estimate even environmentalists said was too high.

“Shell received permission to extract oil and gas, not to kill the environment,” Mitvol said Sept. 19 in Moscow, after returning from an inspection of Sakhalin-2.

Exxon, Total Pressured

Other oil companies operating in Russia are facing government pressure. The country’s Natural Resources Ministry in May urged Irving, Texas-based Exxon Mobil, Total SA in Paris and London- based BP to give Russian companies a bigger role in their ventures.

The government has said it’s unhappy with the original production sharing agreements, signed in the 1990s, that cover Sakhalin-2, Exxon Mobil’s neighboring Sakhalin-1 project and Total’s Kharyaga field in northern Russia. Under the agreements, negotiated when crude was a third of today’s price, most of Russia’s revenue would be deferred until the companies earned returns on their investments.

The Natural Resources Ministry has said it will continue to push its environmental claims against Sakhalin-2 even if Gazprom gains a stake in the project.

Russia plans to file suit against Shell by March for at least $10 billion environmental damages, Mitvol said on Dec. 12.

To contact the reporter on this story: Lucian Kim in Moscow at [email protected] Torrey Clark in Moscow at [email protected] .

Last Updated: December 21, 2006 11:40 EST and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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