[A-List] Russia: blow to US oil groups

["Michael Keaney" <michael.keaney@xxxxxx>]

Russia stirs up Sakhalin projects
By Sergei Blagov
Asia Times, February 4 2004

MOSCOW - The Russian government has annulled the results of an international
tender for a major oil and gas project, leaving observers wondering whether
an investment climate change is taking place. The original Sakhalin-3 tender
was won by a consortium led by the world's largest oil company, ExxonMobil,
back in 1993, when Sakhalin island, north of Japan, was seen as a new
hydrocarbon bonanza in the northern Asia-Pacific region.

Yet according to the decision announced by Russian Deputy Prime Minister
Viktor Khristenko, the 1993 tender won by Exxon and Texaco allowed the
companies to explore offshore fields, but involved no firm legal guarantees
for the eventual development of Sakhalin-3.

The developers of Sakhalin-3 would be picked through another auction,
Khristenko said, adding that offshore blocks would be offered at an open
tender, even though Exxon had said it was no longer seeking a
production-sharing deal and was ready to tap it on a regular tax regime.

In 2002, Russia came close to abandoning the production-sharing system,
which guarantees investors stable taxes over the life span of a project.
Only three advanced production-sharing agreements (PSA) projects survived,
including Sakhalin-1 and Sakhalin-2, led by Exxon and Royal Dutch Shell and
another in Siberia. A number of other less advanced PSA plans have been
skipped, including Sakhalin-3. Six Sakhalin offshore blocks have been seen
as potentially among the largest 21st-century energy projects. Sakhalin
crude and natural gas are aimed at nearby Japan, which is understood to
count on Sakhalin to cut its dependence on oil supplies from the Middle
East.

ExxonMobil, which is already operating a US$12 billion project at
Sakhalin-1, with a 30 percent stake in the project, has so far refrained
from overtly critical remarks over the annulment of its Sakhalin-3 tender.
However, some of the company's executives reportedly talked about rights
violations and wrong signals being sent to foreign investors. Sakhalin-1's
potential recoverable resources are 2.3 billion barrels of oil and 17.3
trillion cubic feet of gas. ExxonMobil reportedly spent $60 million on
Sakhalin-3.

Russian observers and media expressed little sympathy toward ExxonMobil.
Yuri Boldyrev, an expert with Russia's Audit Chamber, claimed that
ExxonMobil overstated its Sakhalin-3 expenses. Russian daily Kommersant
commented: "Khristenko booted out the Americans." It is rumored that
Sakhalin-3 might eventually end up in hands of Russia's natural-gas monopoly
Gazprom.

Sakhalin-3 consists of three blocks, Ayashsky, Kirinsky and Odoptinsky, on
the shelf of Sakhalin, with combined estimated reserves 4.6 billion barrels
(620 million tons) of oil and 770 billion cubic meters of gas.

ExxonMobil, ChevronTexaco and Rosneft each have equal stakes in the Kirinsky
block. ExxonMobil controls two-thirds of the Ayashsky and the East
Odoptinsky blocks, while the rest is held by state-owned Rosneft, which acts
as the government's agent in foreign oil projects in Russia.

Rosneft basically shrugged off the Sakhalin-3 news. Rosneft is ready for any
government decision, spokesman Dmitry Panteleyev told Asia Times Online.
However, he conceded that in the wake of the abandoning of the PSA system,
Rosneft is recalculating some of its Sakhalin projects. Rosneft is involved
in five out of the six Sakhalin blocks, potentially among the largest
21st-century energy projects.

Incidentally, Russia received $6.5 billion in foreign direct investment
(FDI) in 2003, with nearly half of that total invested in Sakhalin. Moscow
expects the country will receive $8.2 billion in FDI this year, of which at
least one-third is expected to go into Sakhalin.

However, some Sakhalin oil and gas projects now face a reality check. Last
December, Rosneft announced it would halt work at two oil-exploration
blocks. A joint venture with oil major British Petroleum (BP) reportedly had
poor exploration results on Sakhalin-4, known as the Astrakhan block. The
$2.5 billion project was previously believed to hold up to 100 billion cubic
meters of gas.

Last month, Rosneft also announced withdrawal from the Sakhalin-6 block.
Rosneft was disappointed by the results of exploration on this block, which
was initially believed to contain reserves of up to 2.2 billion barrels of
oil. Sakhalin's most successful project to date is Sakhalin-2, led by Royal
Dutch/Shell, which has been producing oil since 1999 and is planning to
build the world's largest liquefied-natural-gas plant by 2006.

On January 23, the Sakhalin council approved the spending of $2.5 billion
this year to expedite the construction of the main oil and gas pipelines
from the north to the south of the island. The construction of two
800-kilometer pipelines is due to take two years and $1.2 billion to
complete.

The project is grandiose in scale. It involves the construction of the main
pipelines through which oil and gas will be pumped to the south of the
island for refining and exporting to buyers in the Asia-Pacific region and
beyond, Sakhalin energy chief executive officer Steve McVeigh is reported as
saying.

Another project, Sakhalin-1, led by US ExxonMobil, plans to produce its
first oil in 2005. The two projects, Sakhalin-1 and Sakhalin-2, are
estimated to require a combined $22 billion in investment.

However, some investors have recently complained about the high costs of
Sakhalin projects. India's ONGC Videsh Ltd has started an examination of the
reasons behind an $800 million cost overrun in Sakhalin-1. ONGC has so far
invested $920 million in the Sakhalin-1 project in the hope that it would
get about 2 million tons of crude oil each year for 15 years. These concerns
should be addressed by ExxonMobil as the project's operator, Rosneft's
spokesman Panteleyev indicated. While he recognized the ongoing cost
escalation in the Sakhalin-1 project, Panteleyev argued that the overrun was
"predictable".

Moreover, Rosneft was reportedly set to ask BP for an extra $5 billion over
the next decade to tap their Sakhalin-5 venture. In 1998, Rosneft formed an
alliance with BP to complete the Sakhalin-5 project. The deal gave BP 49
percent in an exploration venture for Sakhalin-5, while operator Rosneft had
51 percent. The agreement expires this year. BP reportedly favors a more
even split of development costs, while Rosneft, which holds the drilling
rights, would prefer not to raise its investment in the projects.

Sakhalin-5 is potentially one of the largest, with oil and gas condensate
output forecast at a maximum exceeding 700,000 barrels per day - close to
the output of Organization of Petroleum Exporting Countries member Qatar.
The hypothetical recoverable reserves of oil amount to 433 million tons. The
estimated total cost of the project is $30 billion, while gross income
estimates exceed $100 billion. Rosneft has said it expects Sakhalin-5 to
begin oil output in 2010.

Rosneft declined to confirm that it had asked BP to finance the entire
development of Sakhalin-5, but says negotiations on how the block should be
financed continue. Meanwhile, Rosneft's reluctance to raise its own stake in
Sakhalin-5 could be somewhat indicative of the changing investment mood.