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. Last Updated: 07/27/2016

EU, Japan Issue Warning on Sakhalin

bloombergA platform in South Korea before being moved to Sakhalin-2 this summer.
The Natural Resources Ministry's decision to revoke approval of Shell's Sakhalin-2 project provoked sharp criticism Tuesday from the European Union and Japan, amid signs that the move was part of a broader attempt to put a state stamp on foreign-run energy projects.

EU Energy Commissioner Andris Piebalgs warned against the creation of an unstable investment environment that could halt future energy projects and disrupt global oil supplies. He took "this announcement very seriously indeed," Piebalgs said in a statement, adding that he would soon discuss the issue with Industry and Energy Minister Viktor Khristenko.

Shinzo Abe, Japan's government spokesman and the man tipped to succeed Prime Minister Junichiro Koizumi later this month, said the decision, which effectively suspends all work on the multibillion-dollar project, could harm diplomatic relations between the two countries, Reuters reported.

The Natural Resources Ministry canceled its approval of the Sakhalin-2 project on Monday, citing environmental violations during the construction of an oil and gas pipeline on Sakhalin Island. Shell, with a 55 percent stake in the Sakhalin Energy holding, is the project's operator on behalf of minority shareholders Mitsui and Mitsubishi of Japan.

Japan, heavily dependent on energy imports, is to be the top customer for Sakhalin-2, which will be the world's largest liquefied natural gas, or LNG, project once it comes on stream.

The head of the Paris-based International Energy Agency, Claude Mandil, also warned that the move against Shell could deter investment, Reuters reported.

The revoking of environmental approval was the culmination of months of steadily increasing state pressure on project operator Sakhalin Energy, which announced last year that the estimated cost of the project had doubled to $20 billion. Under its production sharing agreement, or PSA, with Sakhalin Energy, the government must wait until investors recoup their costs before taking in revenue from the project.

The move against Shell comes as PSAs increasingly come under fire as the state seeks to maximize revenue from high oil prices.

Economic Development and Trade Minister German Gref said Tuesday that PSAs were outdated investment mechanisms, and while the state would continue to honor its three existing PSAs, none would be signed in the future, Reuters reported.

"We can support far from all proposals regarding greater costs. In our opinion, some of them are not very well considered. There is room for improvement," Gref said, Itar-Tass reported. "As far as the existing agreements are concerned, we shall be obliged to ensure their observance."

ExxonMobil has also been under fire for its involvement in Sakhalin-1. The head of Russia's environmental watchdog in the Far East Federal District, Alexander Poleshchyuk, said the terminal should undergo more checks before being given the green light, Reuters reported. Total is the operator of the country's other PSA, the Kharyaga oil project in the Nenets autonomous district.





























Russia's PSA Projects
 
SAKHALIN-2:
Shell 55% (operator), Mitsui 25%, Mitsubishi 20%.
 
SAKHALIN-1:
Exxon 30% (operator), Japan's Sakhalin Oil and Gas Development 30%, India's ONGC 20%, Sakhalinmorneftegaz-Shelf 11.5%, RN-Astra 8.5 %.
 
KHARYAGA:
Total 50 % (operator), Norsk Hydro 40%, Nenets Oil Company 10 %.
 
-- MT


The Sakhalin Energy PSA was signed in 1993, when the country was in the throes of political and social upheaval and eager to provide a sense of stability to wary foreign investors. The stability of recent years, underpinned by high oil prices, has changed that.

PSAs are most often used to cover high-risk ventures, stipulating their own tax and license regimes and thus protecting investors from changes in volatile national tax law.

"The brutality suggests this is more than just Gazprom entering the project," said Adam Landes, oil and gas analyst with Renaissance Capital investment bank. "It is necessary to say at this juncture that Russia wants to change the economic terms of PSAs.

"These deals were struck a decade ago, when Russia was in a very different position. Russia would not be offering now the terms it offered back then," he said, adding that "this has happened the world over" since oil climbed to more than $60 per barrel.

Russia is the latest country to move toward regaining control of its energy industry, as governments scramble to fill state coffers with the huge windfalls that high oil prices provide.

In the most extreme recent case, Bolivia deployed its army this summer to wrest control of foreign-run natural gas fields after announcing it would nationalize its oil and gas industry.

In Chad, President Idriss Deby said last month that his government should hold a 60 percent share in oil production and levied hundreds of millions of dollars in back taxes against Chevron and Malaysia's Petronas, which each hold a large share in the country's oil industry.

"There certainly has been a notable trend around the world toward energy nationalization," said Chris Weafer, chief strategist at Alfa Bank. "Yet this is something that has been a feature of energy-dependent countries over the decades."

Russia is likely to avoid the inefficiency and underinvestment that have plagued so many countries' nationalized industries by keeping foreign companies around as partners, Weafer said.

While the Kremlin is not seeking outright nationalization of the energy sector, it is trying to ensure that state-run companies have a much bigger say in the industry.

Analysts said the state was unlikely to revoke Shell's license to develop Sakhalin-2, but would rather ensure that state-run gas giant Gazprom ended up with a significant stake in the project.

"The government will get direct control over the project in this way," said Andrei Gromadin, an oil and gas analyst at MDM Bank. "This is a more effective and more direct tool than renegotiation of the PSA."

Gazprom spokesman Sergei Kupriyanov said that Monday's decision had halted its negotiations with Shell. Gazprom has sought a 25 percent stake in the venture in exchange for half of the Zapolyarnoye field in western Siberia.

The state will likely revisit its PSAs with ExxonMobil in Sakhalin-1 and with Total in the Kharyaga oil project to maintain a controlling stake, Weaver said. "With the other two PSAs, the state will wait for some opportunity to barter something in exchange for an equity stake," he said.

And, as the government looks toward future projects, "Gazprom and Rosneft will have controlling stakes in projects, with foreign companies playing a supporting role," Weafer said.

Oleg Mitvol, deputy head of the Natural Resources Ministry's environmental watchdog, insisted state actions against Sakhalin-2 were driven by environmental concerns.

The Sakhalin-2 project has committed gross violations of the law, Mitvol told a news conference on Tuesday, backing up his point with photographs that he said showed pipelines on Sakhalin Island that crossed rivers and caused land erosion and the destruction of salmon spawning grounds.

"We are just doing what any country in the world would do," Mitvol said.

"If [someone had done this] in the United States, he'd be in jail. Here, he's sitting in a Mercedes."

Staff Writer William Mauldin contributed to this report.