Russia: Energy Analyst Looks At Sakhalin-2 Takeover

Part of the Sakhalin-2 project (file photo) (ITAR-TASS) December 22, 2006 (RFE/RL) -- Anglo-Dutch giant Shell and two Japanese companies have announced they will cede their majority stake in the Sakhalin-2 energy project to Russia's state-controlled natural gas monopoly, Gazprom, for $7.45 billion. Sakhalin-2 is the largest combined oil and natural-gas development in the world. Its passage into state hands has been seen as another successful Kremlin effort to reestablish control over Russia's energy production.

RFE/RL correspondent Jeremy Bransten spoke with Jonathan Stern, director of the gas program at Britain's Oxford Institute For Energy Studies, about the impact the news will have on foreign investment in Russia.

RFE/RL: The Shell-led consortium was under pressure from Russia's environmental-protection authorities, who threatened it with billions of dollars in potential fines for causing ecological damage. Was there any truth, in your opinion, to the charges -- or were they just a pretext to force the consortium to sell its stake to Gazprom, especially after Shell announced huge cost overruns?

Jonathan Stern: We've been hearing about environmental problems from the NGOs for many years. So those of us who followed the project knew about the environmental problems. [Until recently] the Russians did not appear to have taken them on board. What clearly became evident, when the full extent of the cost overrun was understood, was that the position from the Russian side was untenable, which was that they were not going to get any money from this project for a very long time. And that was really the main problem for the Sakhalin-2 partners -- what to do about that situation.

RFE/RL: Can you explain why the cost overrun, from $10 billion to $22 billion, was untenable for Moscow? Was it because it meant the Kremlin realized it wouldn't be making money from Sakhalin-2 for much longer than it had anticipated?

Stern: It appears that the PSA [production-sharing agreement] was of a very old variety, whereby the government got absolutely nothing until all the costs had been recovered. That's an early version of PSAs that mostly is not used anymore. In other words, PSAs still allow for cost overruns, basically saying that if there's a cost overrun, the costs of that will be shared between the partners and the state. This PSA basically appears to say that whatever the costs of the projects are, the state gets nothing until those costs are recovered. And I think that's unacceptable.

RFE/RL: So, in your opinion, Moscow had a case for breaking the deal with the Shell consortium. But do you agree it's part of a pattern in which the Kremlin has tried to reestablish control over the energy sector?

Stern: Having said that, it's absolutely true that the Russian government is determined to gain control over major energy projects on its territory. And the question that we will never know is if there had not been this cost overrun, would the Sakhalin-2 project have suffered a similar fate? We'll never know the answer to that.

RFE/RL: What is the impact going to be on other foreign investors, especially in the energy sector? Will this scare them off?

Stern: I think it sends a warning. But I think if you said to any foreign company: you've got a cost overrun of twice the capital costs of the project, do you think you're going to get problems? The answer would be: well, yes. So for me, Russia holds all the cards in the sense that there is nowhere to go in the world, as far as I'm concerned, which offers the kind of resource opportunities that Russia offers. On the other hand, I think what investors know and knew even before this, is that you're not going to get a majority stake in a project. In fact, you're probably not going to get much more than 30 or 40 percent, if you're lucky and you need a strong Russian partner. And the Russian state, in the end, will call all the shots.

RFE/RL: What about other energy-rich markets around the world? Don't they offer a better deal to investors?

Stern: Once you move outside the North Sea and North America, wherever you want to go: Latin America, the Middle East, CIS countries -- if you can get in -- those are the conditions you're going to face.

RFE/RL: How reliant is Russia going to be on foreign technology to extract oil and natural gas in the future? Some reports say that despite its huge reserves, Russia could run short of natural gas soon, because domestic demand will outstrip supply -- and that it needs Western savvy to tap currently inaccessible reserves.

Stern: I think that's the wrong way to look at the problem. The problem that Gazprom is facing is that it's got excess demand at home, because prices are far too cheap. And like any commodity, if you underprice the commodity, you're going to get excess demand. What they've done, in the last few weeks is to foreshadow a significant increase in domestic prices, which in my view within a couple of years will choke off demand. There's nothing that Western technology can do within a couple of years to dramatically change this situation.