Russia Threatens to Shut Down Sakhalin-II Oil Production

Sakhalin II Location
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MOSCOW Sep 1, 2006 (Dow Jones Newswires)

Russian authorities may order the Sakhalin Energy Ltd. international energy consortium to stop pumping oil if the company does not correct environmental violations registered over the past year, officials said Friday.

Analysts called the announcement an attempt to increase pressure on Royal Dutch Shell PLC (RDSB.LN), which owns 55% of Sakhalin Energy, at a time when Shell and Russian state-owned natural gas concern OAO Gazprom (GSPBEX.RS) are at loggerheads over an asset swap involving Sakhalin Energy.

Russian officials, however, also said they are still several bureaucratic steps away from actually halting production at the international venture, which is developing an offshore oil and gas site known as Sakhalin-II on Russia's Pacific coast.

Sakhalin Energy currently pumps about 80,000 barrels a day of crude oil, and plans to start shipping liquefied natural gas, or LNG, to East Asian and North American markets starting in 2008. The Sakhalin Energy consortium is majority owned by Shell, while a subsidiary of Japan's Mitsui & Co. Ltd. (MITSY) holds a 25% stake and Diamond Gas Sakhalin, a subsidiary of Japan's Mitsubishi Corp. (8058.TO), holds 20%.

Last year Shell announced a preliminary swap deal with Gazprom that would give the Russian gas giant up to 25% in Sakhalin Energy in exchange for a 50% interest in Gazprom's massive Zapolyarnoye gas field in northern Russia.

But only days later, Shell said it expected costs to double at the Sakhalin Energy project to $20 billion, prompting Gazprom to say it would reassess the planned exchange.

Russia's Ministry of Natural Resources said in a release on Thursday that Sakhalin Energy had pumped more coolant water from its offshore production platform back into the sea than allowed under its operating licenses, hadn't turned over information to the Russian authorities by deadline and had registered higher-than-acceptable levels of pollution in the surrounding waters.

If environmental problems continue, the Ministry said Friday, officials will order the company to stop pumping oil by revoking its water-use license.

Analysts said the move appeared to be part of a gradual increase in pressure on Shell in an attempt to strong-arm the company into allowing Gazprom into the project on better terms.

"The message is fairly clear," said Chris Weafer, chief strategist at Moscow's Alfa Bank. "The state wants to restructure Sakhalin-II. They've tried the carrot, and now they are trying the stick."

Gazprom on Friday said it had nothing to do with the decision-making process of the Ministry of Natural Resources.

"The decisions of the Ministry of Natural Resources have no relationship to Gazprom's entry into Sakhalin-II," the company's press service said in a statement.

Russian environmental watchdog Rosprirodnadzor also announced this week that it had ordered the company to stop building oil and gas pipelines, saying a subcontractor had apparently broken the law by felling trees and causing erosion.

Officials said another round of inspections would take place this fall. If violations are found to continue, a spokesman for the Ministry of Natural Resources said, the company will be given a further warning before the water-use license is pulled.

"The bottom line, this is yet another manifestation of the state showing who's boss," said Adam Landes, oil and gas analyst at Renaissance Capital.

A Sakhalin Energy spokesman said that while wastewater discharge from its Molikpaq offshore platform was indeed 9% over water-use license limits in 2005, total water discharge levels from the production complex were 12.6% below the limit.

The spokesman, Ivan Chernyakhovsky, said the oil products level in the water discharge had been 0.01 milligram per liter above official limits on two occasions, and that "the most likely reason for this may have been a measurement error."

The company itself informed the authorities about the deviation, he said.

Shell said it is still in talks on the Sakhalin Energy-Zapolyarnoye exchange. "We remain committed to finding the right formula with Gazprom for the swap, and continue discussions," a spokesman said.

Russian President Vladimir Putin has increased the state's influence over its natural resource sector, while state-owned energy companies like Gazprom and oil producer OAO Rosneft (ROSN.RS) have become more confident about asserting their interests.

Copyright (c) 2006 Dow Jones & Company, Inc.

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