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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

SHELL's $20 billion problem with Sakhalin 2

Companies / Oil Companies Sep 20, 2006 - 09:00 PM GMT

By: Shahla_Walayat

Companies

After the Russian's shut down Yukos Oil, not it seems that it is Shells turn and the giant $20 billion Sakhalin Island oil project as the Russian government look to increase the states stake in Russia's energy projects.

State run Gazprom wants a 25 percent stake in Sakhalin-2. Talks have been suspended after development costs had doubled from $10 billion to $20 billion. Shell owns 55% of the project. The Natural Resources Ministry intensified probes of the venture's environmental safety standards and signed an order this week to cancel part of Shells licence on environmental grounds.


Both the UK and Dutch governments are seeking an explanation for Russia's tough line on a project.

The way the deal is structured via the PSA, is that Russia only sees a revenue once costs are recovered therefore a doubling in projected costs impact on revenue projections. PSA's are now looked upon with disfavor by the Russian government and are seen as relics of a past age when Russia was deemed hugely risky by western oil companies and PSA's were the only way to encourage them to invest," analysts at Deutsche UFG said in written research

In the final analysis Russia would likely not go as far as to take the Sakhalin-2 licence away from Shell, but Shell might have to swallow some of the large cost overrun to keep the Russian government happy and offer Gazprom better swap terms.

In oil reserves terms, Shell has booked reserves of 12 billion, with about 2.5 billion barrels from the Sakhalin, any resolution to the issues would lead to a rally in the share price, as it is expected the negotiated deal would still prove highly lucrative to Shell.

On the risk side is the possibilities that even costs of $20 billion are an under estimation of the eventual cost ! As its not unconceivable that costs could run as high as $30 billion !

For the oil giants as a whole, now that the easy, safe oil fields such as the North Sea and the Gulf of Mexico have been exhausted, that leaves only risky places such as Russia and Nigeria for development of new fields and reserves.

(c) MarketOracle.co.uk 2005-2006

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