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The Wall Street Journal: Shell/Sakhalin

COMMENT FROM breakingviews 
December 27, 2006

The Russian airbrush is back. In Soviet times, it was normally used to remove a “nonperson” from a photograph and so create a more politically convenient version of reality. Now it’s being used to airbrush someone in. That, in essence, is the deal that Gazprom has just struck with Royal Dutch Shell and its Japanese partners to take control of Sakhalin II, the world’s largest single integrated oil-and-gas project. Gazprom has taken a 50%-plus-one-share stake, and in return is paying the proportionate share of its investment costs — as if it had been there from the start.

The deal math is relatively simple, despite months of negotiations. Shell, Mitsui & Co. and Mitsubishi Corp. have invested $12 billion in a project that is 80% complete. That implies its full cost will be $15 billion. Gazprom is paying $7.5 billion for half of the same, so the sums match. Looked at another way, Gazprom is paying just under $4 per barrel of Sakhalin’s reserves. By comparison, when Rosneft floated this summer, it was valued at $4.70 per barrel. Part of that premium is because much of Rosneft’s oil and gas was already on stream.

True, by paying only cost, Gazprom saves on any risk premium that Shell and its Japanese partners faced getting the project off the ground. On the other hand, those risks were never that great. Although Sakhalin is a technically challenging project, there was never any exploration risk; Sakhalin’s fields were already mapped and the oil and gas was in place.

That might not make this a great deal for Shell, but it’s not a bad one, either. The company will have to unbook some of its reserves, because its stake in Sakhalin has fallen below half, but at least with Gazprom as its partner it can now develop the reserves it has there. As President Vladimir Putin encouragingly said during the signing ceremony, the project’s “fundamental problems can now be considered resolved.” The Russian playing field may not be level for foreign oil companies operating there, be they Shell or BP. But then Russia enjoys a natural home advantage; it owns the stadium — and the house photographer.

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