Identifier
Created
Classification
Origin
07MOSCOW508
2007-02-06 11:12:00
CONFIDENTIAL
Embassy Moscow
Cable title:  

RUSSIAN ENERGY: SHELL TALKS ABOUT SAKHALIN-2

Tags:  EPET ENRG ECON PREL RS 
pdf how-to read a cable
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TO RUEHC/SECSTATE WASHDC IMMEDIATE 7212
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUEHXD/MOSCOW POLITICAL COLLECTIVE PRIORITY
RUEHBJ/AMEMBASSY BEIJING PRIORITY 4165
RUEHUL/AMEMBASSY SEOUL PRIORITY 2639
RUEHKO/AMEMBASSY TOKYO PRIORITY 4082
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RHEBAAA/DEPT OF ENERGY WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 000508 

SIPDIS

SIPDIS

DEPT FOR EUR/RUS WARLICK, HOLMAN, AND GUHA
DEPT FOR EB/ESC/IEC GALLOGLY AND GARVERICK
DOE FOR HARBERT/EKIMOFF
DOC FOR 4231/IEP/EUR/JBROUGHER
NSC FOR GRAHAM AND MCKIBBEN

E.O. 12958: DECL: 02/01/2017
TAGS: EPET ENRG ECON PREL RS
SUBJECT: RUSSIAN ENERGY: SHELL TALKS ABOUT SAKHALIN-2

REF: 06 MOSCOW 12930

Classified By: Econ M/C Pamela Quanrud. Reasons 1.4 (b/d).

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 000508

SIPDIS

SIPDIS

DEPT FOR EUR/RUS WARLICK, HOLMAN, AND GUHA
DEPT FOR EB/ESC/IEC GALLOGLY AND GARVERICK
DOE FOR HARBERT/EKIMOFF
DOC FOR 4231/IEP/EUR/JBROUGHER
NSC FOR GRAHAM AND MCKIBBEN

E.O. 12958: DECL: 02/01/2017
TAGS: EPET ENRG ECON PREL RS
SUBJECT: RUSSIAN ENERGY: SHELL TALKS ABOUT SAKHALIN-2

REF: 06 MOSCOW 12930

Classified By: Econ M/C Pamela Quanrud. Reasons 1.4 (b/d).


1. (C) Summary: On January 25, we met with Alf D'Souza,
Shell's External Affairs VP, and Bibi Bautleuova, a Shell
government affairs rep, to talk about the Sakhalin-2 deal
that Shell and its partners (Japan's Mitsubishi and Mitsui)
reached last month with Gazprom. D'Souza said that they got
the best deal they could have hoped for under the
circumstances. Three agreements were signed regarding the
project: two with Gazprom -- one on the sale of the stake and
another in which the companies agreed to work jointly on the
future development of Sakhalin-2 (and possibly other
projects). The third agreement was with the GOR to set up a
joint commission to approve Sakhalin-2's budget. The GOR's
environmental concerns with the project were fading fast and
should be wrapped up shortly, and Shell is still interested
in the EXIM/EBRD/JBIC/ECGD loan package. Putin was "very
upset" about the cost overruns and that, as a result of their
performances, Ministers Khristenko and Trutnev as well as
Gazprom's Aleksandr Medvedev likely improved their standing
within the GOR energy policymaking community. Shell will
continue to play a significant role in the project, partially
dispelling worries that Gazprom's entry would be a disruptive
influence. End Summary.
.
The Deal
--------------
.

2. (C) D'Souza said Shell views the outcome as essentially
the best deal they could possibly have hoped for under the
circumstances, and not a bad deal even on its own merits.
The $7.5 billion price tag values the company at $15 billion
-- not far from the $13 billion already spent for a project
that's about 80-85 percent completed. For its $7.5 billion,
Gazprom will get 50% plus one share. The deal is in a purely
mechanical stage now and should close by March. In addition,
Sakhalin Energy Investment Company (SEIC),the developer of

the project, will still have seven directors, with Gazprom
appointing four and Shell three. Gazprom's new stake will
come from the other partners in proportion to their previous
holdings (Note: Shell previously owned 55 percent, Mitsui 25
percent, and Mitsubishi 20 percent).


3. (C) D'Souza assured us that, by virtue of SEIC's
governance structure, the western investors will maintain
control over important decisions, such as contracting out for
services. Further, he said Gazprom will not be "carried" --
they will pay their share of future expenses -- and Shell
will remain "technical advisor" to SEIC. Shell believes
Gazprom is very happy with this situation, and acknowledges
that, at least for now, it does not have any LNG expertise.
.
Approving the Budget and Moving Forward
--------------
.

4. (C) Shell also reached agreement with the GOR on setting
up a mechanism to work on the current budget -- and the cost
overruns -- and approve the consortium's next budget.
D'Souza said that the budget will be vetted by an interagency
commission of interested GOR entities, including the
Ministries of Natural Resources, Industry and Energy, and
Economic Development and Trade. Through this commission,
SEIC has been told in no uncertain terms that about $3.6
billion of its previous "cost overruns" are not allowable.
However, the way the payback is structured the net present
value of the cost to SEIC will be only about $200-$300
million.


5. (C) SEIC and Gazprom also signed an agreement on Areas of
Mutual Interest, on which they will work together in the
future regarding Sakhalin-2. D'Souza speculated that this,
for example, could mean bringing other sources of gas into
the Sakhalin-2 export chain or step-out drilling within the
license block. This deal could be "a relationship that could
lead to other things, but that they (Shell) weren't getting
carried away."
.

MOSCOW 00000508 002 OF 002


Environmental Problems Fade
--------------
.

6. (C) D'Souza expects the GOR's environmental concerns to
disappear soon. He believes Shell's liabilities for all the
alleged violations that have filled the news in recent months
will be low. This is a convenient face-saving way for the
GOR to close down the drama of recent events. Already the
pressure is abating -- the Lunskoye drilling permit was
recently issued, visa issues for their workers are being
resolved, and water permits are back in force.
.
MDB Loan Package
--------------
.

7. (C) D'Souza indicated that SEIC is still very interested
in the Exim/EBRD/JBIC/ECGD loan package. Unlike the news
coverage suggesting that EBRD has canceled consideration of
the loan, SEIC considers it merely in limbo and expects that
it will be dusted off and revisited after the dust from the
deal with Gazprom settles.
.
Politics in the Rear-View Mirror
--------------
.

8. (C) On the political front, D'Souza admitted that Putin
became upset at the cost over-runs and personally became
involved in authorizing the GOR to go after SEIC. (Note:
This is the first time we have heard this from a Shell
executive here, although we have heard it from others in the
know for some time. End Note) A major problem, however, was
that Putin's sources of information were so narrow (basically
just Gazprom) that he could never make an accurate judgment
about the over-runs. D'Souza said that the Ministry of
Economic Development and Trade, for example, was shocked when
shown Shell's economic model because it was so significantly
different than their own (developed, we think, by Gazprom)
and showed such different conclusions.


9. (C) Our Shell counterparts pointed out who they felt were
the GOR's winners in the aftermath of this crisis. Energy
Minister Viktor Khristenko comes out looking pretty good for
having come in at the end to close the deal, and Natural
Resources Minister Yuriy Trutnev's standing has increased for
having "looked out for the interests of the state." In
addition, Aleksandr Medvedev, Deputy CEO of Gazprom and head
of Gazexport, proved that he is a real player in the energy
world here, having done much of the negotiating for the
Russian side.
.
Comment
--------------
.

10. (C) Gazprom's recent assurances that contracted LNG
shipments will go forward, apparent acquiescence to Shell's
continued role as operator, admittal of its technological
shortcomings, and willingness to pay a relatively fair price
for its stake suggest that the state's advent into the
project may not herald either significant delay or complicate
Russia's entry into the global LNG market. While the
strong-arm tactics used to secure its spot in Sakhalin-2
showed Gazprom's clout, Shell admits it is probably a good
thing to have Gazprom as a partner and indeed had been
courting Gazprom for such a role for several years. With
this deal, Putin and his closest advisors are one step closer
to putting in order those inheritances from the 1990s that
they perceive as unjust or (in the case of the cost
over-runs) abusive.
BURNS