07MOSCOW508, RUSSIAN ENERGY: SHELL TALKS ABOUT SAKHALIN-2

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Reference ID Created Released Classification Origin
07MOSCOW508 2007-02-06 11:12 2011-08-30 01:44 CONFIDENTIAL Embassy Moscow

VZCZCXRO9131
OO RUEHDBU RUEHFL RUEHKW RUEHLA RUEHROV RUEHSR
DE RUEHMO #0508/01 0371112
ZNY CCCCC ZZH
O 061112Z FEB 07
FM AMEMBASSY MOSCOW
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
RHEHNSC/NSC WASHDC PRIORITY
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). 
 
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 
---------------- 
. &
#x000A;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

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