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Shell's Vast Sakhalin Gas Project To Double To $20B

View of Sakhalin 2 site.

Washington (UPI) July 19, 2005
When Royal Dutch/Shell acknowledged last Thursday that costs of the Sakhalin Energy liquefied natural gas project in Eastern Siberia will double to $20 billion and that it expects a six-month construction delay, Gazprom immediately demanded a renegotiation of the terms of its swap deal with Shell.

Shell said increased project costs and the time delay at Sakhalin-2 is due to the need to cover the rising price of raw materials, especially metals, higher contractor prices and the ruble's strengthening against the dollar.

Russian oil giant Gazprom learned of the project challenges when it signed off on the swap deal, which was announced July 7.

Under the deal, Gazprom acquired a 25 percent stake in the Sakhalin-2 gas field on Russia's Pacific coast; Shell meanwhile acquired a 50 percent stake in the Zapolyarnoye field in Siberia, the world's fifth-largest gas deposit.

"In pursuit of its strategy, Gazprom becomes a player in the LNG sector and enters new markets," said Alexey Miller after the signing ceremony.

"The document signed ... opens the way for Gazprom to become in the nearest future a large shareholder of a fast growing project for hydrocarbons development, LNG production and sale to strategic markets in North America and Asia-Pacific Region."

But Gazprom is now asking Shell to renegotiate the terms of the swap deal in light of cost overruns and a delay in the first shipments of gas, which lower the value of the project, the Sunday Telegraph reported.

Shell Chief Executive Officer Jeroen van der Veer said while in London he only learned of the extent of the cost overruns when a six-month review of the project was completed last week.

"Gazprom was aware last week that there were cost challenges," he said Thursday. "However, we were not aware, so we could not make Gazprom aware, that there were such significant further cost overruns."

He said he immediately informed Gazprom on the cost overruns.

The news came when Shell said it would still return up to $15 billion to shareholders by the end of this year and the company made assurances its other projects will not be affected.

"We will return $13 billion to $15 billion to shareholders in 2005 through dividends and buy-backs," Shell's Chief Financial Officer Peter Voser told journalists.

"We are taking immediate action to address these issues - and consulting and discussing with appropriate stakeholders to enable this critical and challenging frontier project to come to an acceptable completion," said Malcolm Brinded, executive director for Shell's Exploration and Production, in a news release.

"The Exploration and Production executive team, and the Sakhalin Energy Investment Co. management, always recognized the massive challenges of this project. We are committed to deliver the project - and to deliver value to shareholders and to Russia."

The setback is a another blow to Shell's reputation as a project manager following the controversy surrounding the management of its oil reserves and the reshuffle of its executives, which has led to embarrassment with partners such as Gazprom, Japanese investors Mitsui and Mitsubishi, and the Russian government. Environmental issues still surround the project and remain a serious concern.

The recoverable resource base in Sakhalin-2 is 17.3 trillion cubic feet of gas and 1 billion barrels of oil, which at the revised estimates means a project development cost of some $5 to $6 per barrel of oil equivalent. The project is the largest of its kind.

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