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Sun 1 Oct 2006 12:00 AM

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Moscow Vs majors

The Kremlin is giving Shell and Exxon Mobil a hard time over their Sakhalin projects

The Shell-led Sakhalin 2 project in the Russian far east continues to have a hard time of it from the Kremlin, while the Exxon Mobil-led Sakhalin 1 project is also running into problems.

In August, the natural resources ministry in Moscow suspended construction of part of Sakhalin 2’s oil and gas pipelines due to an alleged high risk of mudslides.

Officials say they are possible along the route of the pipelines and might cause water pollution or loss of life.

Then in September, the environmental regulator said it had asked a court to revoke approval for the US $20 billion project on the once-pristine northern Pacific island.

The federal service for the supervision of natural resources gave several warnings ahead of the move.

The watchdog said the suit was filed due to a lengthy catalogue of unfulfilled recommendations.

Many observers believe that all the official attention toward Sakhalin 2 is aimed at pressuring Shell to offer state-controlled gas monopoly Gazprom better terms, as it negotiates the final shape of its proposed 25%-plus-one-share shareholding in the Sakhalin consortium.

Some Russian officials admit they want far more, and in the Kremlin, senior figures say Russia ’s political clans are using environmental issues for their own ends.

Gazprom will gain a huge slice of an almost complete LNG project.

In return, it is offering Shell a development play—50% of the large gas deposits in the deeper levels of the huge Zapolyarnoye field in west Siberia at the other end of the country.

For decades Gazprom’s fortunes rested on vast volumes of cheap gas easily produced from the shallower levels, but now it needs help to tackle the deeper and trickier deposits.

Meanwhile, Exxon faces opposition from Gazprom to its plan to supply China with oil and piped gas from Sakhalin.

Exxon says the Sakhalin 1 consortium is in talks with China National Petroleum Corp (CNPC) to build a pipeline.

Some of the project’s partners, including Russian state-controlled Rosneft, have stood behind Exxon.

Along with Gazprom, however, consortium partner Oil and Natural Gas Corp (ONGC) of India has pushed for LNG exports, making export destinations more flexible and opening up the possibility of supplying India, possibly via LNG swaps with Japan.

The pattern in all this is that Gazprom is attempting to take control, especially of the export and sales operations, of the only Russian gas projects it does not already own.

There are very few production sharing agreements (PSAs) that allow majors like Shell and Exxon to operate and market independently of Gazprom.

The omens are that there soon won’t be any or that they will be diluted.

After years of grumbling, Gazprom and its allies in the government are taking action.

The fact that they are acting on environmental grounds is no less serious for being laughable—in the light of Gazprom’s less than green record.

Sakhalin Energy has been subjected to more than 200 audits by the authorities in the first half of this year alone.

Until now, there has been routine criticism of the three big PSAs — Sakhalin 1 and 2 and Total’s Kharyaga project.

The agreements were signed in the 1990s when oil prices were at rock-bottom, and on unfavourable terms to host governments. But now Shell has admitted faults in some of its pipelines and the authorities appear ready to strike a serious blow.

The onshore Sakhalin 2 pipelines comprise two parallel oil and gas lines both 800km long, built by a Russian subcontractor, Starstroi.

Shell says that suspension of work on a short section will not cause delays.

The pipelines run from the deposits off the north of the island to a port in the south, which is usable all year round by ice-class tankers.

Here Shell has just completed a 9.6 million tonnes per year LNG plant, and Exxon has its oil export terminal.

In early September, Exxon shipped its first cargo and plans exports of 250,000 barrels of oil a day by early 2007.

So far, the oil continues to flow despite the pipeline wrangle.

The Shell-led operator, Sakhalin Energy, says an internal audit had already revealed the pipeline problem and that it asked the Russian contractor to suspend work.

Rather weakly, but probably correctly, Shell claims that it has limited powers to control its dozens of subcontractors—and that disputes are commonplace.

Shell may be unable to finish construction by March 2007 if it is forced to reroute large pipeline sections.

The group took almost a year to design a new offshore route from the Piltun-Astokhskoye field, after the planned route was criticised for running through grey whale feeding grounds.

Sakhalin Energy admits that the latest claims may significantly increase the project’s budget, but denies that it will be unable to supply its 2008 gas sales contracts.

In a related development, President Vladimir Putin has signed a law that confirms Gazprom’s monopoly over gas exports.

The law consolidates its hold over gas exports, including piped natural gas, liquefied natural gas and liquefied petroleum gas—butane and propane.

The only exceptions are three existing PSAs.

Yuri Trutnev, minister of natural resources, said recently that new restrictions will limit foreign companies to a maximum of a 49% share of any development deemed to be strategic.

The effect of the law, and widening the definition of strategic, will be to reinforce the dominance of Gazprom and oil company Rosneft—the Kremlin’s favourites in the sector.

However, even with the proposed limits, Russia’s investment regime would be much more permissive than those of Saudi Arabia, Iran and other big producers, where foreign investment often is more limited.

The areas being developed by Shell and its partners—Japanese firms Mitsui and Mitsubishi—have reserves of about one billion barrels of oil and 500 billion cubic metres of gas.

Shell sees Sakhalin 2—the centrepiece of which is the construction of new liquefied natural gas production and storage facilities—as vital to building its business in Japan, China and Korea.

No doubt it is right, but it looks increasingly likely that the business will be shared with its new Russian partner—Gazprom.

David Hill is a European and Asian LNG spot market analyst, who worked for Dow Jones in the Americas.

He can be contacted by e-mail at davidgoliathhill@yahoo.com

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