Russia to Get Dividend in Sakhalin-2 Deal

MOSCOW Apr 27, 2007 (From the Wall Street Journal via Dow Jones Newswires)

In addition to ceding a controlling stake in their flagship Sakhalin-2 project to the Russian state gas company last week, Royal Dutch Shell PLC and its partners also agreed to pay a substantial annual dividend to the Russian government as part of a deal to salvage the $20 billion venture, according to people familiar with the situation.

The previously undisclosed agreement was part of a settlement that ended months of pressure from Russian regulators who had threatened to shut down Sakhalin-2, a huge oil and natural-gas project in Russia's remote Far East. The pact essentially changes the terms of the Sakhalin-2 agreement, while avoiding the legal complexities that would be involved in formally revising the contract.

A so-called priority dividend will be paid to the Russian government from 2010 onward and will be linked to the price of oil, said a person familiar with the matter. The exact amount wasn't clear and will vary. "It's going to be something under a billion dollars every year," this person said. Another person familiar with the terms said the payments "won't have a material impact on the economics of the project," adding that the effect on Shell would be smaller, because the Anglo-Dutch company's stake in the venture had been reduced.

Spokesmen for Russian gas company OAO Gazprom and Sakhalin Energy Investment Co. -- the consortium representing partners Shell, Mitsui & Co. and Mitsubishi Corp. -- declined to comment on the dividend.

The concession shows just how far major Western oil companies are willing to go to stay in the good graces of oil-producing countries such as Russia that are tightening state control over their natural resources. Russia has some of the world's largest untapped reserves in a time of worry over global supplies.

Under the deal granting Gazprom a majority stake in Sakhalin-2, the shareholders agreed to issue a single nonvoting share -- known as a class-R share -- to the Russian government, entitling it to a percentage of profits from sales of oil and gas, said one of the people familiar with the matter.

In effect, the R share is a major change to the terms of the 1994 production-sharing agreement, or PSA, that regulates Sakhalin-2. People familiar with the negotiations said the pact doesn't amount to a formal rewriting of the contract and is intended to stabilize the PSA.

Russia's Energy Ministry said in a press release last week that the agreement between the Sakhalin consortium and Gazprom included a mechanism aimed at "protecting the state's economic interests," but officials declined to comment further.

Gazprom will also increase managerial control over Sakhalin-2. It recently said it will nominate Sakhalin Energy's chief executive when the contract of the current CEO, former Shell executive Ian Craig, expires in 2008. Sakhalin-2 ran into trouble when Shell admitted in July 2005 that the project's cost had doubled to $20 billion, and that the first cargoes of liquefied natural gas produced at the field wouldn't be loaded until the summer of 2008, much later than planned.

That infuriated the Russian government, since it meant it would start earning revenue much later than it had expected. Under Sakhalin's PSA, the Russian state receives revenue from the project once the investors have recouped their costs and begun earning profits.

Talks dragged on until last summer, when Shell and its partners began to come under pressure from Russian regulators, who accused it of illegal logging and damage to streams, and threatened to revoke a key environmental permit for the project.

After months of regulatory pressure brought the project to the brink of shutdown, Shell and its partners agreed last December to sell a majority stake in the project to Gazprom for $7.45 billion. At the signing ceremony, President Vladimir Putin said Sakhalin-2's environmental problems had been resolved.

Copyright (c) 2007 Dow Jones & Company, Inc.