Call it a Russian miracle. Despite political, environmental and economic pressures, Russia’s Sakhalin oil and gas projects continue to advance.
The Sakhalin-1 project began exporting light, sweet Sokol crude oil to Japan in September.
Sakhalin-1 is expected to generate about 250,000 barrels of oil per day by mid-2007.
New oil sources and engineering improvements, combined with OPEC limits on Saudi output, have made Russia the world’s largest oil producer.
The Sakhalin-2 project will add a major LNG export capacity for the country.
A loading platform and jetty were recently completed for Sakhalin-2, scheduled to begin LNG plant operations in 2008.
ExxonMobil holds a 30 percent interest in the Sakhalin-1 project consortium, and Shell currently has a 55 percent interest in Sakhalin-2.
But how much non-Russian companies will be allowed to benefit from Sakhalin development remains to be seen.
Russia’s grip-tightening on its domestic oil and gas industry could alter the future for foreign participants.
AAPG member Gregory Ulmishek served for years as the U.S. Geological Survey’s expert on Russian resources. When he retired and joined Direct Petroleum in Denver, he began looking at small plays in Russia.
His contacts and background give him a uniquely clear view of today’s situation in the Russian oil and gas industry.
“It’s my general feeling,” he said, “that nobody knows, for certain, what happens now.”
Defining the Play
Sakhalin Island, narrow and elongated, stretches roughly north-south off Russia’s southeastern coast. It sits at the south end of the sea of Okhotsk, just north of Hokkaido, the northernmost of Japan’s main islands.
As many as nine major exploration and development projects are proposed for the Sakhalin area.
Negotiations for Sakhalin-1 and Sakhalin-2 development began in the 1990s. Russia signed its first Production Sharing Agreement (PSA) for Sakhalin-2.
Sakhalin-1 includes the Chayvo, Odoptu and Arkutun-Dagi fields, with estimated recoverable reserves of 2.3 billion barrels of oil and 17.1 trillion cubic feet of gas. Production at Chayvo began Oct. 1, 2005.
Partners in the Sakhalin-1 consortium are operator Exxon Neftegas Ltd., 30 percent; Japanese company Sakhalin Oil and Gas Development, 30 percent; India’s ONGC Videsh Ltd., 20 percent; and two affiliates of Russia’s state-owned Rosneft – Sakhalinmorneftegas-Shelf, 11.5 percent, and RN-Astra, 8.5 percent.
The consortium recently commissioned a 24-inch, 140-mile pipeline that will move Sakhalin oil west to the new, year-round DeKastri loading terminal in the Russian Far East.
Sakhalin-2 now draws most of the international industry’s interest, for two reasons:
♦ First, work there has progressed fairly rapidly toward the beginning of commercial export two years from now.
♦ Second, some observers believe Russia is creating obstacles for the project in hopes of gaining more control for domestic companies.
China Petroleum and Chemical Corp. (Sinopec) has begun exploration drilling in the Sea of Okhotsk for the Sakhalin-3 project, under a Sinopec-Rosneft joint venture.
Sakhalin-4 and Sakhalin-5 offer exploration opportunities over several large structures, primarily in the island’s northern waters.
Sakhalin-6 includes a tract offshore the island’s east coast, with large, seismically defined anticlines. Seismic also has shown evidence of structural stratigraphic traps in the Sakhalin-7 project area, southeast of the island.
Sakhalin-8 and Sakhalin-9, west and south of Sakhalin Island, remain largely undefined but may contain promising sand reservoirs.
‘Projects … Progressing Well’
Work at Sakhalin-2 now focuses on building out the project’s LNG and processing facilities and developing the 18.2 Tcf Lunskoye gas field, which will produce most of the gas for the LNG operation.
Ivan Chernyakhovskiy is principal spokesman for Sakhalin-2 developer Sakhalin Energy Investment Co.
“Our Phase 2 development is 75 percent complete, consuming some 60 million man-hours per year, with approximately 17,000 people in Sakhalin employed on the project,” Chernyakhovskiy said.
“All these projects are progressing well, even though such scope of work in a severe frontier environment is unprecedented for the world oil and gas industry,” he noted.
Chernyakhovskiy said Sakhalin-2 development requires “simultaneous execution of several major multi-million dollar, complex-engineering mega projects,” including:
- A second production platform on the Piltun-Astokhskoye Field, in addition to tying in the existing Molikpaq platform for year-round production.
- A platform on Lunskoye, capable of producing up to 17 Bcm/year of nonassociated gas.
- An onshore processing facility for the gas and condensate from both fields.
- 300 kilometers of offshore pipelines.
- 1,600 kilometers of oil and gas pipelines to the south of the island, capable of delivering 18 bcm/year.
- An oil export facility.
- The first LNG plant and associated export facilities in Russia, including two trains (liquefaction units) with a total capacity of 9.6 million metric tons per year.
“And, of course, island infrastructure upgrades and construction required for implementing all the above in a frontier environment and severe conditions,” he added.
Although the LNG plant is still under construction, most of its future capacity is already sold under long-term contracts, according to Chernyakhovskiy.
“The company anticipates signing binding Heads of Agreements for the remaining gas in the near future,” he said. “First LNG shipments are planned for the summer of 2008.”
Shareholders in Sakhalin Energy are Shell Sakhalin Holdings BV, 55 percent; Mitsui Sakhalin Holdings BV, 25 percent; and Mitsubishi Corp. subsidiary Diamond Gas Sakhalin BV, 20 percent.
Bright Future
Russian environmental agencies have mandated several changes to Sakhalin-2 plans, including significant rerouting of pipelines, and have even called for suspension of development.
That may – or may not – represent Russian pressure for a larger domestic share of the project.
“I’m sorry to say the situation looks to me in recent years more nationalistic,” Ulmishek commented. “Not nationalistic in the full sense, but to try to keep outsiders out of the petroleum play in the country.
“They have put a lot of effort to make a state company, Rosneft, a principal player,” he said. “It seems that Rosneft becomes stronger and stronger in that market. And rules, actually, in that market.”
Russian giant gas company Gazprom reached an agreement with Shell to take a 25 percent interest in Sakhalin-2 in exchange for an interest in selected Siberian properties, but that agreement faltered when Shell doubled its cost estimate for Sakhalin-2.
“In 2005, we announced a revised cost estimate for Phase 2 of the order of $20 billion for the full project to 2014. This cost revisions was, and still remains, our best estimate,” Chernyakhovskiy said.
According to Chernyakhovskiy, overall development costs for Sakhalin-2 are approximately $5-6 per barrel, including capital expenditures for infrastructure upgrades, the LNG plant and export terminal.
“Assuming a forward oil price of $34 per barrel, the project will generate some $50 billion of benefits to Russia over its lifetime,” he said.
“And since the current price of oil is much higher, there is potential to increase revenues even further,” he added.
Boom Times?
Barry Ickes serves as a professor of economics at Pennsylvania State University and finance director at the New Economic School in Moscow.
Helped by high prices for its petroleum exports, Russia has gone through an economic resurgence.
“Russia has a huge current account surplus and it’s paying off its debts. The economy is doing quite well,” Ickes noted.
However, oil production isn’t booming like it should, he observed.
(Yukos was once one of the world’s largest oil companies, producing 20 percent of Russia’s output. Its assets were acquired in controversial circumstances by the Russian government and was declared bankrupt in August.)
“It slowed down after 2003-2004, with the problems of Yukos,” Ickes said. “The big problem with Russia is that all its new oil is in hard-to-get-to places.”
Also, Russia still hasn’t developed the technical and engineering expertise required for its extensive production operations and new projects.
“They need the technology – they should be more into petroleum engineering than they are,” he said.
“There’s sort of a conflict between the need for the technology and assertion of control.”
Ickes recently co-authored a paper describing how economic benefits, or
“rents,” flow into the Russian economy from its domestic oil and gas industry.
“The big point is that these rents are widely distributed,” he said. “These companies pad a lot of their costs, so the rents are spread out.”
Balancing Act
Russia’s petroleum industry supports or helps support many other domestic industries, like the machine-tool industry, Ickes noted. And Russia makes sure local economies and businesses benefit from major development work.
“In the Sakhalin-2 PSA, Sakhalin Energy undertook a commitment to achieve a level of 70 percent Russian content, including labor, materials, equipment and contract services, over the life of the entire project, Chernyakhovskiy said.
The consortium has easily surpassed that target, he stated.
“Since 1996, over 100 million Russian man-hours of services have been expended, representing some 72 percent of the total. Material and equipment supply exceeded 6.2 million metric tons, some 89 percent of the total by the end of 2005,” he said.
“We also recognize the importance of maximizing Russian content performance in terms of value. Since construction activities commenced in 1996 on Phase 1, Russian contractors and subcontractors have won thousands of contracts worth up to a total of $7.2 billion,” he added.
Foreign participation in Russia’s oil and gas sector has been a puzzle, problem and perplexing dilemma for Russian President Vladimir Putin and his energy advisers.
The petroleum industry reportedly accounts for more than half the government’s revenues.
Russia wants to maintain some control over its domestic industry without discouraging outside investment. It wants access to Western technology and expertise without opening the oil sector to foreign influence.
Those desires have led to policies and actions that often appear conflicted, and reflect a growing nationalistic stance.
“In this time of uncertainty, there is no equilibrium. It’s all unstable now,” Ulmishek said. “I think maybe in a year or two an equilibrium will be reached.”
Meanwhile, against all odds, Russia’s Sakhalin mega-projects go right on moving forward.