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RUSSIA - Profile - Ivan Pavlovich Malakhov.

The Governor of the far eastern island of Sakhalin, Malakhov is a very active figure who has succeeded the long-serving Igor P. Farkhutdinov. The latter died in a helicopter crash along with 17 other passengers on Aug. 20, 2003. The Mi-8 helicopter was flying from the Kamchatka peninsula to the Kurile Islands. Farkhutdinov's death prompted fears among foreign investors that the Kremlin would get Gazprom and RosNeft to increase their influence in the Sakhalin region.

Farkhutdinov had played a key role in the development of the ExxonMobil-led Sakhalin-I and of the Shell-led Sakhalin-II PSA ventures. He had in mid-2002 secured Moscow's approval of Sakhalin-II's $8.6 bn project to develop its gas field for a two-train, 9.6m t/y LNG export plant to be on stream by 2006. Since then, the project's cost has risen to $10 bn and the LNG plant's completion schedule has been extended to 2007. The LNG plant is being built in southern Sakhalin, whereas the gas field is in the north. Field development work, originally due to begin in early 2003, was delayed.

However, Malakhov has proved to be equally as positive towards the Shell-led venture, now trying to persuade Moscow to accept Sakhalin-II's cost overruns. Negotiations with Moscow, which will take place by November at the latest, will be tense because under the PSA, higher costs will mean less profit for Russia. The project is the largest integrated energy investment in the industry's history. It was concluded as a PSA in 1994 when Moscow was desperate for foreign investment. But Russia now considers such agreements faulty and insists that new energy investments be covered by a normal tax and royalty regime.

Ian Craig, CEO of Sakhalin Energy Investment Co. (SEIC) or Sakhalin II, the consortium in which Shell holds 55%, was on Sept. 8 quoted by the Financial Times as saying: "There is a sector that believes the government of the day shouldn't have entered into the agreement [and that] Russia didn't get a good deal". Craig dismissed suggestions that Moscow might use the expected cost overruns as a pretext for renegotiating the deal. He said: "This really is a litmus test for foreign investment in Russia. If they wanted to renegotiate the biggest investment in the country, it would raise questions about any future investment".

The Moscow government has already threatened ExxonMobil, the world's largest energy group, with a re-auction of its exploration rights in another project, Sakhalin III. That disagreement, in which Moscow accuses Exxon and its partners of failing to invest enough, led to recent negotiations between Spencer Abraham, US energy secretary, and President Putin.

Some politicians in Sakhalin, including the island's hardline Deputy Governor Vladimir Shapoval, are urging Moscow to renegotiate. But Malakhov, who is also vice-chairman of the supervisory board that will review SEIC's proposed budget, said: "Renegotiating the terms of an agreement that was signed several years ago is not the right thing to do".

Craig said: "Throughout the world there are issues that everybody knows are pushing up project costs, like steel prices" which have risen considerably since 2002. Weakness of the US currency was also having a big impact, Craig said, adding: "A lot of your [SEIC] services are in yen, or euros or roubles and you're getting a lot less services for the dollar".

Shell as a group recently raised its estimate for this year's capital spending from $13 bn to between $14.5-15 bn, largely because of budget overruns in Sakhalin and a Nigerian project.

There has been speculation that Moscow may use rising costs as an excuse to negotiate a stake in the consortium for Gazprom. Craig denied any link between the two issues but said Gazprom might make a good equity partner. He said equity participation "could change, as in any company like this, if existing shareholders saw some strategic benefit by someone else coming in". He said potential signatories to long-term LNG contracts, including Sinopec of China, had expressed interest in buying a stake in Sakhalin-II. Sinopec would also buy LNG from the venture. Craig, a Shell heavyweight, said: "China is typically looking at those kind of things. That's something we would definitely consider".

Of the 9.6m t/y of LNG the project intends to sell, SEIC has secured long-term contracts with Japanese companies for 3.4m t/y. It is close to concluding a deal with California for the supply of 1.6m t/y, the first such contract between Russia and the US (see Gas Market Trends Nos. 9 & 10). The consortium calculates that the project will bring the Russian government at least $45 bn over the project's lifetime.

The gas from the field will be pumped to the LNG plant by pipeline almost 1,000 km across the island to the port of Prigorodnoye, some 60 km from the capital Yuzhno-Sakhalinsk. This will provide gas to almost 30 towns and industrial centres which are currently using coal and fuel oil. It will also allow the island, which has to battle every year with Moscow over fuel deliveries, to become less reliant on the federal budget.

The Sakhalin-II partners are Shell (55%), Mitsui (25%) and Mitsubishi (20%). Shell is the operator and responsible for marketing the gas on the island and the LNG in the Far Eastern countries. Sakhalin-II's oil output will rise to 180,000 b/d when an onshore processing plant being built will allow year-round production. Now oil is only produced from June to November because of heavy snowfall in winter.
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Publication:APS Review Gas Market Trends
Date:Sep 13, 2004
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