Bloomberg: Shell Cedes Sakhalin-2 Stake, Giving Putin Control (Update3)

By Lucian Kim and Torrey Clark

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

Shell, Mitsui Co. and Mitsubishi Corp. will each sell half of their stakes in the project to Moscow-based Gazprom, Shell and Gazprom said in a joint statement today. Shell, based in the Hague, and its partners have invested $12 billion in the venture, Russia’s first project to produce liquefied natural gas.

“Our first priority is to get Sakhalin-2 up and running,” Shell Chief Executive Officer Jeroen van der Veer said in the statement.

The deal 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 raised concerns that Putin’s campaign to restore the state’s dominance of the economy will undermine Russia’s reliability as an energy supplier.

“We’ll do everything in our power to make sure this project is realized,” Putin told the heads of Shell, Mitsui, Mitsubishi and Gazprom at a meeting in the Kremlin today, in remarks broadcast on state-owned Perviy television.

Shell’s stake will fall to 27.5 percent, with Mitsubishi retaining 12.5 percent and Mitsui 10 percent.

Gazprom and the Sakhalin-2 shareholders will enter an “arrangement” on developing oil and gas reserves off Sakhalin Island, which lies north of Japan, and turning the area into an “oil and LNG hub,” the companies said.

`New Reality’

“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 shares were little changed, down 1 pence to 1,790 pence, after dropping as much as 1.1 percent to 1,771 pence before the news.

Gazprom suspended a preliminary agreement to join the venture after Shell in July 2005 doubled its cost estimates for the current phase to $20 billion. The government complained the overruns would yield less revenue under a so-called production sharing agreement and threatened to suspend Sakhalin-2 permits because of environmental violations.

Russia’s Energy Ministry and the shareholders agreed on an amended budget for the Sakhalin-2 project today, which will be sent to a government supervisory board for approval, Shell said in a separate statement. It didn’t give details.

`Harder for Gazprom’

“They’re losing more on the reputational damage that a compulsory transaction implies than they made on a cheap price,” said Ian Hague, who manages $2.8 billion in assets for Firebird Management LLC in New York. Hague isn’t selling his Gazprom shares. “It’s already made it harder for Gazprom on a diplomatic level to buy into European assets, although they are reaching agreements.”

Gazprom, the world’s fourth-largest company by market value, is seeking to buy gas-marketing assets in Europe to improve profit margins.

The venture is key to Shell’s plans to revive output and boost reserves. The sale will probably hit Shell’s reserves replacement, Fitch Ratings Ltd. said Dec. 19. Shell is still recovering from the 2004 accounting review that forced it to reduce proven reserves by 5.63 billion barrels, or 29 percent.

Gazprom’s acquisition of a controlling stake will allow it to maintain its control over Russian gas exports. While Gazprom’s export monopoly is enshrined in law, Sakhalin-2 was exempt under its production-sharing agreement.

The venture has committed to sell almost all of its planned 9.6 million tons a year of LNG, which is gas cooled to liquid for transport by tanker, to utilities in Japan, Korea and North America. All the contracts will be honored, the companies said.

Environmental Attacks

The attacks on Shell, led by environmental inspector Oleg Mitvol, were similar to the tactics used in the dismantlement of OAO Yukos Oil Co., which was hit with $30 billion in 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, deputy head of the Natural Resources Ministry’s environmental agency, toured Shell’s Sakhalin project in September and said the company will have to fix damage it has caused to rivers, fishing grounds and forests.

“Nothing has changed,” Mitvol told reporters today. “An international court is the last resort, if they don’t remedy all the claims we made in September.”

The shareholders will have “more precise discussions” with the Russian authorities about environmental and budgetary issues, Van der Veer told reporters today before meeting with Natural Resources Minister Yuri Trutnev.

Exxon, Total Pressured

Other foreign oil companies in Russia face government pressure. The 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.

Total’s license to extract oil at Kharyaga, its biggest Russian project, will be reviewed tomorrow by the country’s subsoil resources agency.

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.

Credit default swaps based on Shell’s bonds, a measure of investor perceptions about the company’s ability to meet its debt obligations, were unchanged.

Shell’s 5.25 percent pound-denominated bond maturing in 2010 declined, with the yield widening 2 basis points, or 0.02 percentage point, to 5.51 percent, according to RBC London prices.

Gazprom shares advanced 0.1 percent to $11.56 in Moscow before the announcement of the Sakhalin accord.

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 14:24 EST

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