Exxon's Sakhalin-1 Comes Under Fire

The government on Thursday switched the focus of its attack on huge foreign-led ventures to ExxonMobil's Sakhalin-1 oil project, saying it would forbid a $4.2 billion increase in spending that would cut the state's profits.

The government has already taken aim at Royal Dutch Shell's Sakhalin-2, which it has ordered to be partly halted for environmental infringements, prompting tough criticism of its actions from Japan and the European Union.

The moves against Shell and Exxon are widely seen as part of a broader Kremlin campaign to tighten its grip on the energy sector, a drive which is expected to speed up before President Vladimir Putin's tenure is scheduled to end in March 2008.

Analysts have said the country is trying to force foreign oil majors to give up part or all of their advantageous production sharing agreements, negotiated at a time of much lower global oil prices.

"If costs continue to rise without control, Russia will be left with only 6 percent of royalties, while all profit will go to repaying costs," Sergei Fyodorov, head of geological and subsoil use policies at the Natural Resources Ministry, said of Exxon and Shell projects on Sakhalin Island, in the Pacific Ocean.

Another state official said Thursday that Exxon would not be allowed to start regular shipments of oil to Asian refiners before Nov. 15, as the company wanted, because its terminal needed more checks. And a third official said the resources ministry had in July put up for auction a small oil deposit despite claims by Exxon that it was part of Sakhalin-1.

Fyodorov said his ministry had been informed on a preliminary basis that Exxon's costs could rise to $17 billion from an initial $12.8 billion, but it had seen no final documents.

This follows a doubling of costs to $20 billion at Shell's Sakhalin-2 project, which the government has strongly opposed. The Natural Resources Ministry this week revoked an ecological permit from Shell, which the firm said would severely damage the project.

"The consequences of this revocation could be suspension of the operation that would lead to significant delay of the project, extra costs and irreparable damage to the reputation of this venture ... and the Russian Federation as a whole for failure to deliver gas to buyers," Sakhalin Energy, the project operator, said Thursday.

Fyodorov said costs, as well as slow drilling operations and underperformance on other aspects of the project, might serve as a basis for the withdrawal of operating licenses: "Our lawyers believe it is possible and does not contradict the agreements."

The production sharing agreement, signed in 1993, does not allow Russia to unilaterally terminate the project. But record oil prices mean the government is losing out on potential revenue.

Deutsche UFG said the government disliked PSAs, which were relics of a time when the country was deemed risky by Western oil firms and which gave the government very little control.

"The outcome will not be the loss of the project's license, that would be too extreme and probably lead to international arbitration," the bank said.