By James Brooke Oct. 19 (Bloomberg) -- A 700,000-barrel oil tanker slipped away from the end of Russia's first export pipeline to the Pacific on Monday near Sakhalin Island, culminating a $17 billion project led by Exxon Mobil Corp. and local partner OAO Rosneft. About 350 miles to the south, at the tip of the island, engineers for a $22 billion venture led by Royal Dutch Shell Plc work under the shadow of a campaign by Russia's environmental agency to revoke a key pipeline construction permit. The Shell project has no Russian partners. The attack on Shell is more about OAO Gazprom's attempt to get a piece of the project than protecting wildlife, analysts say. The move has angered Asian nations banking on Sakhalin to help meet their growing energy needs. Sakhalin, just 25 miles north of Japan, contains the equivalent of 45 billion barrels of oil, equal to the North Sea's reserves, Shell estimates. ``If the project gets suspended for some time, a long time, it will be very, very damaging in the minds of potential investors in Russia, not just in the energy sector, but in other sectors,'' says Yasuo Saito, Japan's ambassador to Russia. Mitsubishi Corp., Japan's largest trading company, owns 20 percent of Shell's Sakhalin-2 venture, and No. 2 Mitsui & Co. holds 25 percent. Japanese utilities have agreed to buy almost two-thirds of the liquefied natural gas to be produced by the project, which includes Russia's first LNG plant. About 30 percent of Russia's energy exports will flow to Asia by 2020, up from 3 percent today, President Vladimir Putin said Sept. 9 in Novo Ogaryovo, outside Moscow. Asian Growth Energy consumption in mainland Asia will rise faster than in any other part of the world through 2030, estimates Stephen Terni, president of Exxon's unit in the Russian Far East. Oil and gas use in the region will more than double to 113 million barrels a day, almost equal to the combined consumption of Europe and North America, Terni said Oct. 5 at the opening of a gas pipeline from Exxon's Sakhalin-1 project to Khabarovsk, Russia. Sakhalin will be an ``energy bridge between Russia's Far East and the Asian-Pacific region,'' Sergei Bogdanchikov, chief executive officer of Moscow-based Rosneft, said Oct. 3 during a press conference in Yuzhno-Sakhalinsk, Sakhalin's biggest city. For now, Russia's review of the Shell-led project is slowing development of the resources. On Sept. 5, the Natural Resources Ministry sued to halt Sakhalin-2, saying the venture had caused landslides and illegally cut down trees. A month later, the ministry said The Hague-based Shell, Europe's second-biggest oil company, had to reapply for permits to build twin 500-mile oil and gas pipelines. $10 Billion Delay Sakhalin Energy Investment Co., Shell's Sakhalin venture, on Oct. 16 filed a complaint with the prosecutor's office on the island alleging that the ministry's environmental inspectorate had committed ``excesses'' in its review of the project. The venture has complied with all environmental rules and is willing to correct any violations, says Sakhalin Energy CEO Ian Craig. A one-year delay in the project would cost investors about $10 billion, Craig says. The estimate is based on expenses for mothballing then restarting the project, lost gas sales and penalties for failing to fulfill gas delivery contracts. ``But the greatest damage of all would be the damage to Russia's reputation as a reliable source of supply,'' Craig said in September at an oil and gas conference on the island. ``So I don't think it is in anyone's interest to let that happen.'' Economy Minister German Gref sought to ease tensions Oct. 11 in an essay published in Handelsblatt, a German business newspaper. ``All problems can be settled,'' Gref wrote, referring to Sakhalin-2. ``It just takes the will for that, and we have it.'' Gazprom Stake The goal of the attack is to help Gazprom buy into Shell's project, says Michael Bradshaw, a professor of human geography at the University of Leicester in Britain, who studies energy investment in Russia. Gazprom seeks a monopoly over Russian gas exports to Asia to strengthen its pricing power, he says. In July 2005, Shell and Gazprom signed a memorandum of understanding allowing Gazprom to swap half of a Siberian gas field for part of Shell's 55 percent stake in Sakhalin-2. Two weeks later, the Shell venture almost doubled the total cost of the project to $22 billion. Gazprom put the talks on hold. ``The sooner that Gazprom is involved in the Sakhalin-2 project, the better,'' Bradshaw says. John Aronson, president of AATA International, a Denver- based environmental consulting firm, says the crackdown on Shell has little to do with the project's record. Aronson has worked on Sakhalin projects since 1990. ``Technically, everything has been done according to Hoyle,'' he says, referring to the rule book for cards and other games. ``Why isn't Sakhalin-1 getting hit? They went across streams, they went across the Tatar Strait. Well, they have a Russian partner.'' `Only Rumors' Denis Ignatyev, a spokesman for Moscow-based Gazprom, says suggestions that bureaucrats are softening up Shell to make way for the Russian company are ``only rumors.'' ``We are hoping that they will get their problems solved so that we can go ahead with the asset swap,'' he says. Shell says it wants Gazprom as a partner. ``At this moment, all the partners are foreign partners, so we think it is quite sensible to have Gazprom as a partner in the project,'' Shell CEO Jeroen van der Veer said Oct. 5 during an interview in Irving, Texas. ``We have been very consistent. We really welcome Gazprom as a partner in the Sakhalin project. We think that is the logical way.'' Exxon Outlook Sakhalin-1, the project led by Irving, Texas-based Exxon, has fared better than Shell's development. On Oct. 5, the Exxon venture made the first gas deliveries through its pipeline to Khabarovsk, across the Amur River from China. At the same time, the tanker Viktor Titov was loading oil at a bright yellow pumping station that rises 150 feet above the Tatar Strait near the town of DeKastri on the Russian mainland. The tanker loading, normally a 12-hour process, took two weeks, as Russian environmental inspectors threatened, and then postponed, checks. The loading time was the result of standard startup precautions, not excessive government inspections, says Michael Allen, Exxon's spokesman on Sakhalin. Exxon has a powerful ally in state-controlled Rosneft, which owns 20 percent of Sakhalin-1. Rosneft's chairman, Igor Sechin, is Putin's deputy chief of staff. By 2010, Sakhalin will export enough gas to meet 22 percent of Asia's expected demand, says Ate Visser, commercial director for Sakhalin Energy. Japanese companies have agreed to buy 63 percent of the Shell-led project's annual LNG output of 9.6 million tons, which would generate one-10th of Japan's electricity needs in 2010. South Korea will receive 16 percent of the gas, and 19 percent will go to the U.S. and Mexico. Foreign Policy Together, the Exxon and Shell projects will export 400,000 barrels of oil a day, or 7 percent of the oil produced in Asia for international trade, Visser estimates. ``Ten years from now, Russia will be playing a considerable role in addressing the energy needs of Asia,'' Bradshaw says. ``In turn, this will increase Russia's influence in Asia, a key foreign policy goal of the Kremlin.'' The Shell and Exxon ventures are pumping from just two of the nine offshore regions that the government has mapped for development around Sakhalin, a 589-mile long island that once housed Soviet labor camps. The two projects operate under production agreements that split revenue between the partners and the Russian government, after costs have been recovered. Sakhalin's energy resources are on a par with those of the North Sea and Alaska during the 1970s and '80s and the Gulf of Mexico in the late 1990s, Craig said at the conference. `Further Development' ``After decades of development, there are about 800 installations in the North Sea and about 4,000 in the Gulf of Mexico,'' he said. ``By contrast, the Russian Federation, with the largest oil and gas shelf in the world, has got two installations in operation, with another three under development. The scope for further development is clear.'' As investors bet on an oil and gas boom on Sakhalin, money is also flowing into non-energy projects. Hermitage Hospitality, a Moscow-based hotel development company, plans to open in November the Ramada Plaza Sakhalin, a 149-room hotel in Yuzhno-Sakhalinsk. Next to the Ramada, the first foreign-brand hotel in the Russian Far East, rises the 10- story steel frame for what will be the island's largest office building, scheduled to open next summer. The structure is part of a $300 million development that will include a 350-room, five-star hotel, a 1,000-car underground garage, and 800,000 square feet of shops and offices. The complex will be linked by a half-mile underground shopping arcade. Terry Sloane, director of development for Hermitage, says he has lined up financing and permits for the project, which will break ground next spring. American Express Sakhalin, once closed to foreigners, is welcoming a growing number of Americans. Last year, New York-based American Express Co. opened a travel office in Yuzhno-Sakhalinsk, the company's third in Russia after Moscow and St. Petersburg. In August, William Burns, U.S. Ambassador to Russia, opened a Consular Agent Office on the island. In June, OAO Aeroflot started direct flights between Moscow and Sakhalin. Sloane says he hopes Aeroflot will extend this nine-hour flight to the U.S. West Coast, restoring a service that was dropped after Russia's 1998 ruble crisis. Sloane, who has a decade of experience on Sakhalin, says that, years hence, 2006 won't be remembered for the bureaucratic battles around the Shell and Exxon projects, but for the opening of Russia's first oil export pipeline on the Pacific. ``Once Sakhalin Energy has a Russian partner, the problems will go away,'' he says. ``They are not going to let the oil sit in the ground while money could be coming out.'' To contact the reporter on this story: James Brooke in Moscow at jbrooke2@bloomberg.net
