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"Russian rage over Sakhalin project" by Emerging Markets, April 19, 2004

Russian rage over Sakhalin project
Shell's cost estimates attacked by Russian minister

April 19, 2004
By Simon Pirani /Emerging Markets

Russian Deputy Economy Minister Yuri Isaev yesterday expressed "serious concern" about cost overruns on the Sakhalin II project in Russia's far east and gave beleaguered Royal Dutch Shell yet another headache.

The array of objectors to the project in its present form also includes environmental NGOs, who will meet with EBRD President Jean Lemierre on Tuesday to air their concerns, as well as local Sakhalin politicians and Russian companies who say too many Sakhalin contracts are going to foreign competitors.

The project, to produce natural gas, liquefy it and export it to Asia-Pacific markets, is being developed under a production sharing agreement with the Russian government. It was always going to be tough to fund and, at an estimated $10 billion, was set to be the world's largest-ever project financing. Then two weeks ago it was widely reported that Shell's overall estimate of costs had risen from $12 billion to $13 billion, provoking anger among Russian state officials.

"We have issues about the constantly rising costs," Isaev said in an interview with Emerging Markets. "Obviously the cost profile will impact on our profit.

"We will not approve any budget without being absolutely clear on all the implications. Maybe five years ago Russian ministries may have rubber-stamped deals without looking closely enough at them. Now the situation has changed. We need much more information."

These issues are expected to come up at a regular meeting, scheduled for the end of this month, between Russian federal and Sakhalin regional officials with Sakhalin Energy, the 55% Shell-owned project company. A Shell spokesman would not comment on specific cost figures but said that "in a project of this size and complexity there are always unexpected events. The Stage II budget covers an enormous level of activity even beyond the first five years of large-scale construction." Isaev said the Russian government would also push our partners [at Sakhalin Energy] very hard" on the issue of the level of Russian content of construction and other contracts.

The purchasing and sales agreement stipulates 80%, but Russian parliamentarians and construction companies have alleged it is far lower. Fifteen Russian companies sent a letter to President Vladimir Putin last week claiming it was just 6%.

The political risks surrounding the project now make it crucial that the EBRD and other multilateral institutions, who were the principal financiers of its first stage, are brought in to the much larger second stage.

But the EBRD has ruled that environmental impact assessments are "unfit for purpose" and has postponed any decision on the financing until Sakhalin Energy revises them.

Environmental campaigners see this as a window of opportunity to press their concerns. Dmitry Lisitsyn, chairman of Sakhalin Environment Watch, told Emerging Markets: "The project is smelling more and more odious. Shell is producing massive amounts of documentation, but on the ground nothing is changing. Sakhalin Energy continues to violate a string of international standards. We believe that under these circumstances the EBRD, with its environmental mandate, should not join the financing."

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