Exxon, Shell Pressed to Revisit Russian Oil Pacts

MOSCOW Sep 15, 2006 (Dow Jones Newswires from the Wall Street Journal)

A pair of multibillion-dollar energy projects in Russia led by Exxon Mobil Corp. and Royal Dutch Shell PLC have encountered unprecedented regulatory pressure in recent weeks, amid rising complaints by officials here that the deals are unfavorable to Russia.

The projects, off Sakhalin Island in Russia's far east, are the biggest foreign investments in this country's energy sector and some of the largest new oil-and-gas developments in the world. They are expected to provide important additional supplies to the global energy market starting in the next few years.

The basic terms of the deals were set in the 1990s, when oil prices were low and Russia was eager for foreign capital to develop its vast energy reserves. As prices have surged in recent years, Russia, like many other oil-producing countries, has shifted its approach to give precedence to local companies -- primarily state-controlled giants OAO Gazprom and OAO Rosneft -- relegating foreign companies to junior-partner roles.

So far, Russian officials insist they won't change the terms of the contracts governing the Sakhalin projects. These special deals approved by Parliament are called production-sharing agreements under which, in lieu of taxes, Russia takes part of the oil and gas produced once the investors' costs are covered.

But one ministry earlier this year called for giving Russian state companies control of the projects, while a top Kremlin official last week said he thinks the foreign companies should voluntarily give up the projects' special status and subject themselves to regular tax laws.

That is a nonstarter with Shell and Exxon, however. Exxon last week said that failing to honor the deal would "have a significant negative impact on the Russian investment climate." A Western diplomat in Moscow was more blunt: Reopening the deals, which took years to negotiate, "would be a nuclear explosion."

The companies hope to resolve the issues, but the pressure is rising.

The Shell-led project, known as Sakhalin-2, is facing a lawsuit filed by Russian environmental regulators that could shut it down. Shell officials have rejected the regulators' allegations of environmental violations, insisting that the project meets all relevant standards and that the issues raised in the suit are minor.

This week a top Russian official said the scrutiny is part of Russia's efforts "to defend its interests" after Shell announced the cost of the project would nearly double to $20 billion, meaning Russia would have to wait almost twice as long before seeing its share of the profit. Under terms of the agreement, the government must sign off on any changes in cost estimates.

The cost overrun also has complicated Shell's negotiations to swap a 25% stake in Sakhalin-2 with Gazprom in return for a share in a huge natural-gas field in the Russian Arctic. Analysts say Shell's regulatory troubles are likely to strengthen Gazprom's hand in those talks, although officials deny any connection between the two.

Sakhalin-2 is now the only major international oil project in Russia in which a local company doesn't have a stake, and Shell and its partners have welcomed Gazprom's interest.

Exxon, meanwhile, has run into an unexpected refusal by Russian authorities to expand the scope of its production license after Exxon found the field it is exploring extends beyond the permit boundaries. Exxon says the extension should be automatic, but Russian regulators want to auction off the additional zone.

The conflict at the project, called Sakhalin-1, comes as Exxon has discussed the possibility of building a pipeline to carry gas from Sakhalin to China, where sales would be much more lucrative than the current sales inside Russia at low regulated rates.

But that pipeline proposal puts Exxon in potential conflict with Gazprom, which jealously guards its monopoly on Russian gas exports. People close to the Sakhalin-1 project say the licensing problem could be linked to Gazprom's opposition to the pipeline, although Gazprom and the Russian government deny that.

"This may be the ugly way that Gazprom is getting itself into that deal," the Western diplomat said.

Gazprom's chief executive, who signed a cooperation agreement with Sakhalin's governor yesterday, said all of Sakhalin's gas projects should be linked through a single pipeline network. The government already has designated Gazprom to control that effort.

"In the past, you could talk about a role for foreign investors," one Western energy-industry executive said. "Now it seems the national champions are ascendant, and foreign investors are welcome only to the extent that they can help them realize their ambitions."

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


Our Privacy Pledge

Most Popular Articles

Brent Crude Oil : $51.78/BBL 0.77%
Light Crude Oil : $50.85/BBL 0.83%
Natural Gas : $2.99/MMBtu 4.77%
Updated in last 24 hours