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Financial Times: Shell/Sakhalin

Published: December 23 2006 02:00 | Last updated: December 23 2006 02:00

For Brits, grainy footage of Neville Chamberlain clutching a piece of paper and talking about “peace in our time” captures an era when civilised chaps were flummoxed by foreign bullies. Jeroen van der Veer, chief executive of Royal Dutch Shell, returns from Moscow with a few bits of paper of his own after concluding negotiations with Gazprom over the Sakhalin-2 gas project.

Gazprom will pay $4.1bn in cash for half of Shell’s 55 per cent stake. It will also buy on the same terms the stakes of Shell’s minority partners, Mitsui and Mitsubishi, thereby taking control. At least Moscow has promised to call off the dogs and let the project proceed. In that respect, Mr van der Veer has extracted peace with a semblance of honour.

The payment is a little higher than expected but underlines Sakhalin-2’s poor economics. The implied value of the entire project is $14.9bn. Citigroup estimates that this equates to an internal rate of return of 11 per cent on the $12bn of investment already made and the $8bn due up to 2014, of which Shell will fund 27.5 per cent.

Shell has become a junior partner in a project now run by a company that raises its capital expenditure in line with sales forecasts and recently saw fit to purchase Russia’s biggest circulation newspaper. With low gearing and few attractive investment projects, cash is the last thing any of the oil majors need, but Gazprom took off the table the more attractive option of an asset swap.

Shell’s problems partly stem from capex overruns, which, under Sakhalin-2’s original contract terms, left Moscow out of pocket. Still it forms part of the bigger picture of Russian resource nationalism and other majors will be watching to see where the government strikes next. Sakhalin-2 is pretty marginal for Shell in terms of its value and reserves. BP, however, relies on Russia for perhaps a third of its non-proven oil and gas reserves – the basis for its long-term growth. Peace in Sakhalin, on these terms, will provide some comfort, but reducing its dependence on Russia remains a priority for BP.

Copyright The Financial Times Limited 2006

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