Milestones : Russia – Gazprom Wins Sakhalin-2 Skirmish



Sakhalin-2: Project is

weighed down with a

host of problems

After a drawn-out scuffle, the story of Royal Dutch Shell and Russian state-owned oil company Gazprom is finally reaching a close, with Gazprom getting rights to a minimum 50% stake in the Sakhalin-2 energy project in Russia. The transaction has been in the works since July 2005, when Shell first offered the stake of no less than 50%with 25% coming from Shell subsidiary Sakhalin Energy and 25% coming from its co-owners Mitsui and Mitsubishiin exchange for interest in Gazproms Zapolyarnoye gas field.

However, since those first discussions, Sakhalin-2 has experienced a host of problems. Difficulties with the projectparticularly the Russian governments refusal and delay of drilling permits and visas, and legal wrangling over environmental violationshave led to soaring costs and project delays, which are having a knock-on effect not just in discussions with Gazprom but also on global clients. Russian government meddling in market affairs has long been an issue for foreign companies operating in Russia. The problems experienced by Sakhalin Energy in developing Sakhalin-2 suggest that this practice is far from over.

Project timetables are no longer on schedulefor example, drilling is late at Lunskoye, the large offshore gas fieldwhich will likely mean delivery delays to clients in Japan and South Korea. And costs for the project have skyrocketed: Capital expenditure has ballooned from $12 billion to an estimated $25 billion.

In addition, Russian environmental officials have estimated the project will cause $10 billion worth of ecological damage. In the original agreement with Gazprom, environmental implications had to be concluded before the deal went forward. Some reports have suggested that legal threats over the environmental impact and permit delays were simply a ploy by the Russian government to improve the state-owned oil companys bargaining position.

The details of the final offer have not yet been released, but it is believed that the deal, whether based on shares or an all-cash offer, will be worth much less than Shell had hopedwhich is particularly galling as analysts say Sakhalin-2 is on the cusp of creating significant value for its shareholders, despite rising capital costs.

Denise Bedell