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Sakhalin Oil Treasure is Finally Set to Flow After 3 Decades, 250,000 Barrels a Day

Posted on: Thursday, 29 September 2005, 12:00 CDT

By James Brooke

Jad Mouawad in New York contributed reporting for this article.

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Just north of Japan and across the Pacific from California, Sakhalin island at last is about to pump oil from its vast reserves.

On Saturday, three decades after vast pools of oil and gas were discovered off lonely shores of this former prison colony, a consortium led by Exxon Mobil is to start pumping as much as 250,000 barrels of oil a day, its first oil and gas from seven wells drilled deep in the Sea of Okhotsk.

That will be the start of major production from Sakhalin's offshore reserves, a rich energy province that some geologists call, with a bit of swagger, this decade's Alaska North Slope. Noting the string of ministers flying here from Moscow in September to inspect the newest riches in oil, Galina Pavlova, Sakhalin's top energy official, boasted, "They believe Sakhalin is the second Kuwait."

Mapped since the 1970s, the recoverable offshore reserves of Russia's easternmost major island now total 14 billion barrels of oil or just over 1 percent of global reserves and 96 trillion cubic feet, or 2.7 trillion cubic meters, of gas, 28 times the amount that the United States imported last year.

After decades of debate, this long, spindly island eight time zones from Moscow is getting the largest inflow of foreign investment in Russian history. Analysts hope the Sakhalin projects will help increase Russia's output and bring badly needed oil and gas supplies to world markets in the coming decades.

The recent slowdown in Russian output and the Kremlin's tighter grip on its energy sector have raised concerns over the investment climate in Russia. But with much of the Middle East shut off to foreign oil companies, Russia still offers some of the best prospects for growth in oil supplies.

The Exxon-led consortium is paying out $12.8 billion and a second group, led by Royal Dutch Shell, is spending $20 billion to produce oil and gas and to build Russia's first liquefied natural gas plant. BP is exploring a third section. Nine additional offshore sections remain virtually untouched.

Sakhalin promises to be a cash producer that will loom large in calculations of Russian economic might. By 2050, the companies project that it will have brought Moscow $85 billion in oil revenue, royalties and taxes $45 billion from the Shell project and $40 billion from the Exxon project.

Twelve days by tanker from California, Sakhalin may also prompt Americans to start looking to Russia for oil and gas. Until now, Russia, with 6 percent of the world's known oil and 27 percent of its known gas, largely produced in western Russia to sell to Western Europe.

Much of Sakhalin's energy will power China, Japan and South Korea. But recently, work started on a terminal in northern Mexico that is to receive liquefied natural gas shipments from Sakhalin in the summer of 2008. This gas will then head by pipeline to California. By that time, Shell and Exxon should also be pumping a total of 550,000 barrels of oil a day into tankers, placing 10 percent of Russia's overall oil production onto Pacific waters and the international spot market.

"This is the largest integrated gas project in the world," said Ate Visser, commercial director for Sakhalin Energy Investment, the Shell-led group that has an army of 17,000 workers on Sakhalin.

Starting with two huge offshore drilling platforms now in place up north, the project is building two 640-kilometer, or 400-mile, pipelines, one for oil and one for gas. These will end at Aniva, where 7,250 workers, one-third of them foreigners, are building a $2.5 billion liquefied gas plant and deepwater loading terminals on a bay 145 kilometers northeast of Japan.

To Shell's chagrin, its gas-field-to-carrier project has become the largest in the world, partly because the overall 10-year project cost estimate doubled in July, to $20 billion. The overruns seem to stem from the difficulties of doing business in Russia and from rosy calculations made in 2003 to win final project approval by the Russian government, the ultimate owner of most oil and gas produced after construction bills have been paid.

Shell, which owns 55 percent of the project, says the cost overrun resulted from the dollar's fall against the euro, the rising cost of Russian labor in the boomtown atmosphere here, rising costs of pipeline steel and oil and expenses incurred to minimize disturbances to an endangered population of 100 western gray whales that feed every summer in Shell's production area.

"We will insist on a very meticulous audit of this," Pavlova, director of oil and gas for Sakhalin's regional government, said of the increased costs. "We will be meeting with Shell through the winter."

Shell disclosed the $10 billion cost overrun in July, one week after Shell and Gazprom, Russia's state oil monopoly, had announced an asset swap. The swap was intended to bring a powerful Russian partner into an all-foreign project here. But now, the two companies are embroiled in what are to be yearlong talks to calculate a price difference that Shell needs to pay Gazprom to even the deal.

"It has been a hard swallow for our shareholders," Visser said of Japan's minority shareholders, Mitsui, with 25 percent, and Mitsubishi Corp., with 20 percent. "But it also has been a hard swallow for Shell. But people only see one side of the story, that costs have doubled, but not that the price of oil has also doubled."

Increasingly nationalistic, Russia restricts foreign investment to the most technically difficult energy developments, largely those offshore or in the Arctic. Russian state companies have pumped oil from onshore wells here since the 1930s. But after production dwindled, Russia sought foreign expertise for offshore work.

"Originally, Russia needed foreign companies for technology and for the money," said William Dinty Miller, senior vice president of BP Sakhalin. Alluding to Russia's soaring currency reserves in the era of nearly $70-a-barrel oil, he added, "Now the money argument has gone by the wayside."

Despite the controversy, work is on track at the liquefied gas plant here. From a window of a commercial plane one recent morning, a trench for two pipelines, one for gas and the other for oil, could be seen coursing south from this island capital.

At present, two gas-processing "trains" are under construction, giving the plant an annual capacity of 9.6 million tons. Around the world, the plant here is rivaled in size only by Qatargas-2, a plant in Qatar that is to produce 15.6 million tons of liquefied gas by the end of 2007. On Sakhalin, room has been left to expand the project by one-third.

One future supply source would be the fields that Exxon is to start tapping this weekend. Exxon's oil and gas, from fields with recoverable reserves estimated at 2.3 billion barrels of oil and 484 billion cubic meters of gas, will flow into an existing Russian- owned pipeline network, drawn from seven wells drilled by the Yastreb rig of Exxon.

The land-based rig allows for wells to be drilled to points 11 kilometers offshore to minimize the environmental impact and the number of offshore platforms in a region known for Arctic cold fronts blowing down from Siberia.

Stephen Terni, the president of Exxon-Neftegas, summed it up for Russian and American executives here on Sept. 12: "The shore-based rig, the Yastreb, is the largest and the most powerful land rig ever built."

Source: International Herald Tribune

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