Shell’s greed punished in Sakhalin

Article 8 Jan 2007 admin

This analysis report was first published in Platform’s Carbon Web Newsletter, Issue 6.

After months of haggling over the Sakhalin II gas project, differences between Shell and the Russian government have been resolved through a change in project ownership. The Russian state gas company Gazprom will become the majority shareholder, while Shell, Mitsubishi and Mitsui will halve their stakes.

In August, the Russian state environmental watchdog attempted to revoke licences and put project construction on hold. Shell’s environmental violations included damaging salmon fisheries and threatening the critically endangered Western Gray Whale. These environmental failures are widely accepted as real. However, most analysts agreed that Russian state interest was focused more on the project’s economics.

Much of the media coverage expressed sympathy for Shell and its partners, portrayed as victims of an unfair and forceful Kremlin. However, the true cause was not President Putin’s greed, but the oil companies’ – expressed in a deeply unfair contract signed when the Russian state was new and weak in the early 1990s.

In 2004, PLATFORM commissioned an analysis of the deal by energy economist Ian Rutledge of SERIS. The report revealed that the project’s production sharing agreement permitted the Russian state to receive revenues only after the companies had not only recouped their costs but also made healthy profits. It is this which has dismayed the Russian government most.

The real turning point came in 2005, when Shell admitted cost overruns would double the project budget to $20 billion. Higher costs would mean lower and later Russian revenues. By late 2006, some analysts predicted a lifetime project return so low that ‘production sharing’ could never set in, and Russia would not get a penny, other than the mere 6% royalty. While the PSA has not been changed, the new project arrangements mean that at least the Russian state will take a share of profits through Gazprom.

The European Bank for Reconstruction & Development is now unlikely to finance Sakhalin II, due to the high level of state involvement. However, both Gazprom and Shell need financial support from private banks and export credit agencies. With reduced political risks resulting from Gazprom’s involvement, banks including RBS and ABN AMRO may still seek to arrange a project finance deal. Although Russia may have clawed back at least some of the revenues from Shell’s ripoff contract, the environmental damage remains. PLATFORM and BankTrack have warned private banks that if they finance the project, they will be in breach of their own lending standards, Russian and international environmental law.


Focus Areas Places Players