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. Last Updated: 07/27/2016

Cloud Over Sakhalin Oil Deal

The foreign consortium that last year won the rights to explore the Sakhalin offshore oil and gas field, one of the biggest investment projects in Russia, has spent $70 million but has still not received approval from the Russian government for its development plan.

The consortium, composed of five of the world's biggest companies - McDermott International, Royal Dutch Shell, Mitsui & Co, Mitsubishi and Marathon Oil - won the rights to conduct a feasibility study of the project in March last year after a hotly contested international tender competition.

At the time, the Sakhalin project was a shining example of Russia's willingness to open up to foreign investment. But since then the political wind in Russia has veered from the free-market shock therapy of the Gaidar team to the more nationalistic and inward-looking approach championed by parliament.

Senior officials involved in the Sakhalin project, clearly worried by recent precedents awarding mining contracts to Russian firms, now say they will not spend another cent until the government makes a decision.

Over the past three months, two big projects have been awarded to Russian firms, excluding Western competitors. In November, a Western consortium that had spent three years exploring the area was disappointed when the Shtokmann shelf gas project in the Barents Sea was awarded to Russia's state gas company.

In late December, after an international competition similar to the Sakhalin tender, another contract for the Udokan copper mine in Siberia was awarded to a Russian firm amid complaints that the competition was not a fair contest.

The consortium completed its feasibility study on Dec. 31 last year according to plan, and Russian government experts have been studying it ever since. The Russian government has still not given any clear message that the project will actually proceed.

The field is located under 50 meters of icy waters, 50 kilometers west of Sakhalin Island. The sea is frozen over for half of the year and is strewn with giant icebergs so big that they scour out the bottom. Exploiting the field will require the construction of special ice-proof drilling rigs that stand on one foot. The more traditional three and four foot rigs would have their supports torn apart by expanding ice.

John Homer, Royal Dutch Shell's manager for the project, says the consortium is now concerned this project may face similar political problems to those encountered at Shtokmann shelf and Udokan.

"It's extraordinary that we have spent $70-$80 million on this project and we still have no firm indication that we will receive the mining rights", he said in an interview.

"If the government turned the project back to Russian firms, that would be a major decision that would send a signal to all Western firms".

Homer says that the earliest he expects a decision is by mid- to late-March and that until the government makes up its mind, the consortium will halt all further investment.

The project is huge and will bring about $10 billion of foreign investment into Russia - equal to a quarter of the country's total export earnings - providing thousands of jobs and transfers of valuable technology and know-how.

But despite long consultations, the consortium still has not reached agreement with the Russian government and the local Sakhalin authorities on key aspects of project.

In the meantime, the political battles around the project are threatening even greater delays to the project. Unless approval is given soon, the start of work will have to be pushed back another season.

Homer says that the feasibility study has shown that technical difficulties will make exploiting the gas and oil field one of the most difficult mining projects ever seen but that the government has not so far made concessions to ensure the project is financially viable.

'We want some exceptions from Russian tax law in the area of royalties and export taxes", he said. "We believe the program is so strategically important it deserves this, but so far we have received only a negotiating response".

Homer says another hitch is that Sakhalin authorities are putting pressure on the consortium to produce so-called "early gas", a small side-project that will supply gas for local use as soon as possible. But Homer says the project is barely viable as it is. On current plans, no gas will be pumped until 1995 or 1996 and no money is available for side projects.

He says he hopes the Russian government will overcome its indecision and understand the need for foreign investment.

"The technical problems are such that only companies like ours can get the project moving", he said.