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The Moscow Times: Gazprom Takes Control of Sakhalin-2: ‘The deal marks a big blow to Shell…’

Friday, December 22, 2006. Issue 3567. Page 1.
By Miriam Elder
Staff Writer

Shell and its Japanese partners agreed on Thursday to sell a controlling stake in Sakhalin-2 to Gazprom for $7.45 billion, ending an era in which foreign energy companies were able to pursue huge projects without Russian partners.

The deal marks a big blow to Shell and is a powerful reaffirmation of the way business now takes place in Russia. According to the rules of the game, all major natural resource deals must now include a domestic firm with close ties to the Kremlin.

Highlighting the deal’s political significance, the agreement was blessed by President Vladimir Putin at a Kremlin ceremony that included Gazprom CEO Alexei Miller, Shell CEO Joroen van der Veer and the heads of Mitsui and Mitsubishi and Industry and Energy Minister Viktor Khristenko.

The terms of the deal stipulate that current shareholders Shell, Mitsui and Mitsubishi will each give up half of their holdings to give Gazprom a 50 percent plus one share in the oil and liquefied natural gas, or LNG, project on Sakhalin Island.

Shell now has a 55 percent stake; that will drop to 27.5 percent. Similarly, Mitsui, with its 25 percent share, will drop to 12.5 percent; and Mitsubishi will go down from 20 percent to 10.

The cash-only deal further excludes any asset swaps and promises no major future cooperation between Gazprom and the foreign shareholders.
 
This provision is a heavy blow to Shell, which had been seeking to solidify its presence in Russia’s oil and gas sector.

“The Russian government, as an investor, is interested in the realization of this project,” Putin said in televised comments. “I want to urge again that you do everything to see that this project is realized.”

Sakhalin-2, run under a so-called production sharing agreement with the Russian government, foresees Moscow reaping some of the profits once the project’s investors have recouped all their costs.

The agreement came after months of pressure by state regulators, who had threatened to revoke a key environmental permit for the project amid tense negotiations with state-run gas giant Gazprom.

“We welcome Gazprom’s entry into [project operator Sakhalin Energy] as a leading shareholder,” Van der Veer said in a statement. “Our first priority is to get Sakhalin-2 up and running.”

The project, which includes two 800-kilometer pipelines feeding oil and gas into a massive plant at the south of Sakhalin Island, is about 80 percent complete. Sakhalin Energy, the company owned by the three foreign investors to run the Sakhalin-2 project, warned earlier this month that its timetable to ship oil and gas to customers in Asia and North America by 2008 could be disrupted by environmental inspections.

“We will solve all ecological problems together,” said Stanislav Tsygankov, head of Gazprom’s foreign affairs department, speaking before a meeting between the Sakhalin-2 shareholders and Natural Resources Minister Yury Trutnev. Van der Veer, of Shell, said after meeting Trutnev that the formal agreement would be signed next year.

In July 2005, Shell pursued a deal that foresaw Gazprom taking a 25 percent stake in Sakhalin-2 in exchange for giving Shell a 50 percent stake in Zapolyarnoye, a smaller western Siberia field.

But Gazprom walked out of the talks when Shell upped the cost estimate for Sakhalin-2 to $22 billion just one week after the preliminary deal was reached.

Besides keeping its share, Shell remains an adviser to Sakhalin Energy under the new agreement. Gazprom has no experience producing LNG. Shell also will get exclusive rights to remaining deals on Sakhalin.

Analysts said the $7.45 billion price tag appeared fair. British energy consultancy Wood MacKenzie recently estimated the value of the whole project at $17.5 billion, meaning a 50 percent stake would have cost $8.75 billion.

Sakhalin-2 will produce 9.6 million tons of LNG per year once it is up and running. Gazprom produces around 550 billion cubic meters of gas per year.

Staff Writer Maria Levitov contributed to this report.

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