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Exxon’s Sakhalin Troubles: A Redux of Shell’s Sakhalin II?

Seeking Alpha

January 25, 2010

By Craig Pirrong

ExxonMobil is (XOM) at loggerheads with the Russian government over the Sakhalin I project. The issue is the one that eventually spelled Shell’s (RDS.A) doom in Sakhalin II: Development costs under the production sharing agreement (PSA):

The government rejected a proposal by ExxonMobil, the world’s largest company by market value, to invest $3.5 billion this year in the Sakhalin offshore fields, putting the oil producer’s plans at risk again, Sakhalin Governor Alexander Khoroshavin said Thursday.

Higher expenses in production sharing agreements — such as Sakhalin-1, which is operated by an Exxon-led consortium — would delay the government in receiving its share of revenues until the companies that develop fields recoup their investment.

“We believe it is an inflated amount,” Khoroshavin told reporters after a Cabinet session Thursday that discussed unrelated issues. “The consortium can’t substantiate it for us, this $3.5 billion.”

Exxon said it had to suspend work on a Sakhalin field for several weeks at the start of last year as it argued with the government about the 2009 investment budget for the project that it co-owns with Rosneft (RNGZY.PK), Japan’s Sodeco and India’s ONGK Videsh. The consortium has been producing oil at a field off Sakhalin for a few years and is investing in another field.

An ExxonMobil spokesman said the company was working to respond to the government’s concerns and hoped to return to discussions on the matter in the spring.

Khoroshavin said Exxon would submit a revised spending plan to the government in March.

This negotiation takes place, of course, in the shadow of Gazprom, which needs the Sakhalin gas to meet its own commitments, and to achieve its ambitions to control the supply of gas to China:

The spending dispute has been recurring as Gazprom (OGZPY.PK) seeks to buy all future gas from Sakhalin-1 to prevent it from flowing to China, which would create competition for Gazprom’s own plans to sell gas on that market. Exxon has said the project would sell gas to the highest bidder.

Gazprom also needs the Sakhalin-1 gas to fill a pipeline that it is constructing from the island to Vladivostok to supply clean fuel in time for the Asia-Pacific Economic Cooperation forum in the port city in 2012.

“Much will depend on Sakhalin-1, that is, whether Gazprom can buy their gas for the pipeline,” Khoroshavin said, referring to the prospect of fully loading the pipeline by 2012.

ExxonMobil currently has the right to market the gas itself, an exception from Gazprom’s gas export monopoly that grates on the Russian behemoth. Given these circumstances, there is good reason to be suspicious of these standoffs. They are quite likely pretexts to holdup XOM, and wrest control of Sakhalin I gas.

Given the experience of Shell, it is hard to imagine that a canny company like XOM would inflate costs, knowing that this would give Putin the perfect excuse to crank up the “these unfair PSAs were negotiated when Russia was on its knees and now we’re standing tall and will take back what’s ours” rhetoric. That may be coming regardless, but Exxon has every incentive not to provide Putin any ammunition.

This isn’t over. It’s almost certain that the pressure will intensify, especially as the 2012 APEC date approaches, and Gazprom becomes more desperate for gas to cover its own falling production.

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