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. Last Updated: 07/27/2016

State May Squeeze Sakhalin Majors

The Natural Resources Ministry is considering a recommendation to slash foreign oil majors' stakes in the Sakhalin-1 and Sakhalin-2 energy consortiums and give Russian companies majority control, a ministry spokesman said Thursday.

The news, which was met with bewilderment by another government ministry and the Sakhalin Energy Company, comes as Russia moves to restrict foreign access to its energy sector.

The Russian Academy of Natural Sciences submitted a report to the Natural Resources Ministry claiming that delays and inefficiency by foreign companies had cost Russia over $10 billion. The academy called for production-sharing agreements, or PSAs, for the two oil and gas projects to be revised to give Russian companies a 51 percent stake.

Sakhalin-1 is led by U.S. major ExxonMobil, while Sakhalin-2 is led by Royal Dutch Shell.

State-owned Rosneft has a 20 percent stake in Sakhalin-1, while Gazprom has been in negotiations to acquire a 25 percent stake in Sakhalin-2 in an asset swap with Shell.

Ministry spokesman Rinat Gitazulin said Thursday that he agreed with the academy's evaluation of foreign companies' inefficiency, which also targeted France's Total. "We believe that [Russia] is losing money as a result of this," Gitazulin said by telephone.

The ministry "will look at the question" of revising PSAs, Gitazulin said, adding that the ultimate responsibility for such decisions lay with the Industry and Energy Ministry.

An Industry and Energy Ministry spokeswoman expressed bewilderment over the report Thursday, saying neither the academy nor the Natural Resources Ministry had forwarded the report.

"We are the executive body responsible for PSAs," spokeswoman Sofia Malyanova said. "It's unclear to me why this report was not submitted to us."

Sakhalin-2 was delayed last year when the consortium doubled its initial cost estimates for the project to $20 billion, citing technical complications. The Industry and Energy Ministry postponed approval of the new budget to study the reasons for the higher costs.

The first liquefied natural gas from Sakhalin-2 had been planned to ship in 2007. The current estimate is mid-2008.

Sakhalin-2 will eventually ship up to 9.6 million tons of LNG per year to Asian and North American markets.

Sakhalin-1 began oil production in 2005 and expects to begin large-scale oil shipments by the end of the year.

A spokesman for the Sakhalin Energy Investment Company, which operates Sakhalin-2, dismissed the academy's charges. "The claim of losses to the Russian Federation is incomprehensible," spokesman Ivan Chernyakhovsky said. "How can there be losses at this point when money is still being invested by Sakhalin Energy?"

The report "is based on indirect sources. According to the latest estimates of the project's economic effectiveness, even at projected oil prices of $34 per barrel, it will bring $50 billion of profit to the Russian Federation," Chernyakhovsky said.

Spokespeople for Royal Dutch Shell and ExxonMobil did not respond to requests for comment.

The news came on the same day as a report that the Natural Resources Ministry was tightening restrictions on foreign investment in subsoil resources in a long-delayed bill.

Vedomosti cited unnamed ministry sources as saying that the bill would limit foreign investment to 50 percent in the development of hydrocarbon fields with more than 50 million to 100 million tons of oil or 500 billion cubic meters of gas.

The proposed lower limits had previously been 150 million tons for oil fields and 1 trillion cubic meters for gas fields.

The Natural Resources Ministry refused to comment on the report.

Analysts said that legal hurdles would likely prevent the forced revision of PSAs, but that the academy's report appeared to be part of a growing trend of natural resources nationalism.

"It's happening the world over," said Al Breach, head of research at UBS Warburg. "This administration sees foreign ownership in this field as a mistake of the Yeltsin era. If there is going to be any foreign involvement, everything is going to be majority-controlled by Russians."

Though the trend is understandable, Breach said, "the manner it's being done is worrying. Getting the Russian Academy of Natural Sciences to talk about something, then to say it's common sense and will increase efficiency -- it's not the right way to do this sort of thing."

Andrew Somers, head of the American Chamber of Commerce in Russia, said he saw a similar contradiction in the academy's proposal.

"If they were serious about inefficiency, they would realize that state majority ownership is likely to create great inefficiencies," he said.

Effective renationalization of major oil assets, including those of stricken oil major Yukos, has been widely blamed for stagnating oil output growth.

Deputy Economic Development and Trade Minister Kirill Androsov said Thursday that oil output might grow as little as 1.1 percent in 2006, from 470 million tons last year to 475 million tons, Interfax reported.

The stricter legal limits on foreign investment, if confirmed, "can certainly have negative consequences for oil output," said Stephen O'Sullivan, co-head of research at Deutsche UFG.

Delays in the passage of the new law have also led the government to hold up auctions for new oil and gas fields, fearing that without the law, foreign companies would win, O'Sullivan said.

"In a lot of these big energy deals, the state has been disappointed in the returns because they never fully grasped that investors start getting their money only once the projects break even," Somers said. "The payback comes later. If you're in business, you understand that. If you're in government, you don't."

A dissenting opinion came from Adam Landes, oil and gas analyst at Renaissance Capital.

"I think there is some merit in what the Russian Academy of Natural Sciences is advocating," Landes said. Sakhalin-2 has been "an embarrassment for Shell in price overshoot and delays. It's really only Exxon that has a track record of success, and it has had an extraordinary helping hand from Rosneft."

And though the current PSAs "are legally pretty watertight," Landes said, Rosneft's majority control of Sakhalin-3, Sakhalin-4 and Sakhalin-5 shows that "Russia is headed that way anyway."