Sakhalin and Kazakhstan: an oil policy primer; What's in store for Japan and others.

A comparison of the Russian Sakhalin-2 and Kazakh North Caspian production-sharing agreements reveals the complex geopolitical realities facing oil and gas companies-whether based in Japan or elsewhere.

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THESE ARE THE LARGEST greenfield operations currently underway in the Commonwealth of Independent States (CIS--formerly Soviet Republics).

Both face pressures, notably over the involvement of national companies. But their differing experiences overall reveal much about the investment environments throughout Russia and Kazakhstan.

Agip KCO took over as operator of Kazakhstan's North Caspian production-sharing agreement (NCPSA), developing the vast Kashagan oilfield in spring 2001, as the compromise candidate in a consortium made up of BG, ENI, ExxonMobil, Shell, and Total SA, with 16.67 percent each. ConocoPhilips and Inpex were also involved, each with 8.33 percent.

The project, with 7 to 9 billion barrels in place, could see its recoverable reserves increase up to 13 billion barrels with gas injection and the development of new technologies. Eventual production is foreseen at 1.2 million barrels per day by 2015, to be exported to Western markets.

Russia's Sakhalin-2 project, led by Shell with Mitsui and Mitsubishi, is a combined oil and gas project being developed by the Sakhalin Energy Investment Company (SEIC). Phase One--oil--started in 1999, and Phase Two--liquefied natural gas (LNG)--is just beginning, with the construction of an LNG terminal and two pipelines on the island. SEIC is building two LNG production lines projected to handle 4.8 million tons per year.

For the first time in Russia's history, it is now looking east to the large markets of China, Japan and Korea to supply LNG to these fast-growing economies. The improving relationship between the US and Russia could see LNG delivered to the West Coast of the United States, where Shell is building two LNG-receiving terminals with Sempra Energy in Baja, California.

Kazakh President Nursultan Nazarbayev has, over the past few years, demanded that production begin in 2005, in time for the next presidential elections in 2006. However, the requirements of local content and technologically complicated design and construction work have meant that first oil will not appear until 2008. The fine for the delay was reportedly around $150 million.

Nazarbayev has repeatedly discussed the renegotiation of terms for the NCPSA, saying that Western companies took advantage of Kazakhstan in the early 90s--despite the Kazakh government retaining renowned Western advisors during this time, including US businessman James Giffen.

Much of the delay in Kashagan in 2003 was related to negotiations over the timing issue and the payment for the delay in early oil. There is a strong chance of another 'renegotiation' in the coming years, once Agip has built the infrastructure for the project.

SEIC, although facing some problems with the local and regional administrations, has had a less confrontational relationship with the Russian government. Intensive lobbying from the construction and steel lobbies put pressure on SEIC, but these have largely been deflected.

Overall, there does appear to be a crucial difference in official attitudes toward foreign oil firms. Former Sakhalin Governor Igor Farkhutdinov recognized the vital role of foreign firms in developing the reserves that are the key to the region's future, and tried hard to attract and retain foreign investors. In addition, the Sakhalin-2 project has received President Vladimir Putin's strong support because it will see the first LNG exports from Russia. In Kazakhstan, the tendency has been more to focus on the short-term potential of foreign oil companies as 'cash cows,' leading to constant efforts to squeeze more funding and taxes.

The Kazakh government is keen for state oil firm Kazmunaygaz to reenter the NCPSA. The 14.3 percent stake that Kazmunaygaz's predecessor, Kazakhoil, held until 1998 was sold to Inpex and Phillips for nearly $500 million to cover a budget shortfall.

With BG having expressed its intention to pull out, the government is now trying to negotiate for Kazmunaygaz to buy its stake--despite the consortium members' previously expressed intention to exercise their preemption right. The consortium will probably have to allow Kazmunaygaz in, but the Kazakh firm could have problems meeting its financial commitments to the estimated $29 billion total investment required over the project's lifetime.

Gazprom has also been keen to enter the Sakhalin-2 project, but has thus far been rebuffed. Sakhalin-2 is the only functioning PSA in Russia, and its success is widely seen as a result of the absence of domestic participation.

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Gazprom is likely to get its way eventually, thanks to Kremlin backing--although a quid pro quo may be in store, with Shell allowing Gazprom to enter the consortium in return for Shell being allowed to participate in Gazprom's projects in the Russian Arctic. Shell has publicly said that it could sell a portion of its share in SEIC.

SEIC has faced NGO criticism about its work on Sakhalin, largely relating to dangers to the Western Grey whale, which was considered extinct until exploration began off the Sakhalin coast in the early 90s. International NGOs have been very critical of the project, and have put pressure on the European Bank for Reconstruction and Development (EBRD) to withdraw funding. (Notably, the other big lender to Sakhalin-2 is the Japanese Bank for International Cooperation.)

SEIC has tried hard to deflect this criticism. It recently refocused its offshore pipeline schedule just days after the annual EBRD meeting, where NGOs intensively lobbied the EBRD Board of Directors into pressuring Sakhalin Energy to ensure the safety of the Western Grey. The move, which theoretically will not affect the timeline of first LNG exports in 2007, will be used to examine the sonar implications of deeper dredging needed to protect the offshore pipelines from ice during the winter.

For several years, SEIC has engaged with interested parties in Russia, Europe and North America.

Although the Kashagan project is equal to Sakhalin in scope, it has drawn almost no audible criticism from NGOs, despite the risk of oil spills and the sensitive biodiversity issues.

The Caspian, home to 90 percent of the world's caviar base, has seen the number of sturgeon caught substantially reduced since 1991.

The Ural River is one of the key spawning rivers for the sturgeon. Should an oil spill occur near Kashagan, some analysts have predicted long-term irreversible damage on fish stocks.

The North Caspian is also the location of several migratory flight paths, which could be affected by any release of pollutants or hydrogen sulphide, both of which are prevalent in the Kashagan field.

Lacking the experience of large projects and communication skills required of an operator, Agip has much to learn from Shell. The Kashagan project does not have an external Web site, and currently it does not engage in a systemic fashion with concerned parties.

In this respect, Agip's position as operator is easier, as the nature of Nazarbayev's regime means that dissent inside the country has largely been muffled, allowing very little information to be released.

Russia, thanks to relatively greater openness, will continue to see international NGO pressure on large international oil and gas projects, although Putin's regime would not allow domestic environmentalists to disrupt a project seen to be in Russia's interests.

The Sakhalin-2 project, if it can control its costs, looks set to be a major success in the long term, with strong Russian support.

Kazakhstan still holds much promise, but foreign investors' attitudes towards the country will change more permanently if government harassment continues. Both projects will probably have to allow national companies in.

Gordon Feller is a US citizen who has lived and worked in Asia for more than a decade. A graduate of Columbia University's undergraduate and graduate schools, Gordon began his long period of work in Asia while still a student. He is the author of more than 150 articles on Asian business, and he has served as advisor and consultant to multinational companies making investments in a variety of sectors throughout regional Asia. Gordon can be reached via email at: [e-mail]