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. Last Updated: 07/27/2016

Pioneer Sakhalin JV Hopes to Weather Storm

SAKHALIN ISLAND, Far East -- As construction manager of a brand new $70 million oil refinery on Sakhalin Island, Dennis Mosher has much to be proud of. But his smile beams brightest when talking of the dock he built last fall on the Sea of Okhotsk.

Using local materials and Russian labor, Mosher put up the dock in just five weeks, in time for the landing last October of a barge with 4,500 tons of construction material for the Petrosakh oil refinery on the east coast of Sakhalin.

"There had never been such a landing on this island," recalled Mosher in a recent interview. "The Russians didn't think I could do it."

Mosher and Petrosakh have made a habit of pushing things to the limit in Russia. At its site 650 kilometers northeast of Sakhalin's capital Yuzhno-Sakhalinsk, Petrosakh brought to production capacity five wells that the Soviets had abandoned as unprofitable in the 1970s.

In May, just seven months after the barge landing, Petrosakh, a joint venture between Nimir Petroleum of Dallas and two Russian partners, entered the history books, becoming the first foreign-built oil refinery to operate on Russian soil.

"We are the ones who showed it could be done," says Richard Powell, Petrosakh's refinery manager and one of a handful of Texas oil men who run the remote Petrosakh operation.

Getting the job done was a logistical and manpower feat. Petrosakh shipped in 18,000 tons of construction materials and equipment on barges, built a self-contained housing unit with a kitchen transported from the north shore of Alaska, drilled its own water wells and hooked into CNN. Meals are catered out of Seattle, Washington, by Ogden Universal Inc.

For the 287 employees at the remote refinery site, including 20 Americans, food is ordered six months ahead in 18-ton shipments.

Employees work 15-day shifts and are brought to the refinery via a 10-hour train ride from Yuzhno-Sakhalinsk and a four-hour drive over winding dirt roads that climb high into the mountains of eastern Sakhalin Island. Last winter, snowdrifts up to nine meters high cut off the refinery from outside contact for two months.

To work at the refinery, Petrosakh is retraining lawyers, nurses and teachers, some of whom have come from as far away as St. Petersburg to work for the joint venture.

"We have good living conditions and good salaries," says Sergei Nesterov, an English teacher turned warehouse manager.

Modern working conditions have produced a loyal workforce, Petrosakh executives say. The biggest problem to date has been petty theft, which is now being controlled with security guards. Several employees were fired earlier in the year.

"They were taking cups, salt and pepper shakers, steak knives and tools," says field operations manager Jake Jernigan.

While on the whole pleasantly surprised by the work orce, Petrosakh has been disappointed in Russian equipment. The company expected to use a good deal of local apparatus, but performance has been abyssmal. Russian-made tractors have broken down after just a few days on the job, and American well heads have to be imported because there aren't any spare parts for Russian ones.

Yet, in spite of its accomplishments on the ground, to observers on Sakhalin, Petrosakh looks more puerile than pioneering. At a time when other foreign oil projects in Russia were battling exorbitant export taxes or waiting for investment-friendly legislation to pass in the Russian parliament, Nimir Petroleum forged stubbornly, some would say blindly, ahead.

Plans to recoup costs by exporting oil products to Asia backfired when a January presidential decree wiped out the company's three-year tax exemption. A $5 per barrel export tax has forced Petrosakh to cut drilling by half. The refinery is working at half capacity, refining about 2,000 barrels a day.

"Petrosakh hasn't broken any new ground from an economic standpoint," says an executive with the Sakhalin Energy Corporation. It is in its sixth year of waiting for investment guarantees and tax benefits to be codified into Russian law before it begins a massive oil development project off the coast of the island.

"They took a risk, went ahead and have been taxed into an unprofitable situation."

Government officials on Sakhalin are philosophical about Petrosakh's situation.

"We have a saying in Russian," says a Sakhalin Administration official who works on foreign oil projects. "The first pancake has lumps." Arbitrary presidential decrees have been the Achilles' heel of Western oil executives operating in Russia. To date, there has been little defense against retroactive legislative decisions, like the one that rescinded Petrosakh's tax-exempt status.

Petrosakh's managers are taking the long-term approach.

"With the help of the Russian government, we'll get the tax issue resolved," says Petrosakh's Jernigan.

In the meantime, Petrosakh is selling gasoline and fuel oil locally to generate some cash flow.

There are plans to construct three more oil refineries as well as a project to build an offshore oil-exporting terminal, which would free Petrosakh from dependence on bad roads as well as eliminate the need to build a pipeline. The offshore terminal could be financed in conjunction with the Sakhalin Energy's offshore project, which will also be sending oil products to Asian markets, according to Petrosakh executives.

When operating at full capacity, the Petrosakh refinery will be able to meet a third of Sakhalin's fuel needs, say company representatives. But even with the refinery operating at half-capacity, there is joy in southern Sakhalin.

"We've never had a refinery before," says Natalia Zapekina, deputy head of the foreign investment department of the Sakhalin Regional Administration. "Before, it went to the mainland, from where we received the finished product."

Petrosakh executives have their fingers crossed that exports will begin to flow again this fall with restoration of tax exemptions.

"Given the right tax structure and transportation facilities, we are in a darn good position," Petrosakh president Donald Joiner says.