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#12 - JRL 7180
New York Times
May 13, 2003
Russia's Latest Oil and Gas Oasis
By James Brooke

On this desolate shore of Sakhalin Island, where sea ice blurs into treeless tundra, stands a bright blue drilling rig, 22 stories high and fresh from Louisiana.

The rig, here since early 2003, is now the tallest structure on the island, once a Czarist penal colony, and it is the lance point of a $12 billion oil and gas development project. It is scheduled to begin drilling the first of 10 wells deep below the Sea of Okhotsk on June 11 for a consortium led by Exxon Mobil.

A few minutes away by helicopter, pipeline routes are being cleared to serve Russia's first offshore oil production platform, part of another oil and gas development, a $9 billion project led by Shell. Later this year, construction is expected to start on Russia's first plant for liquefying natural gas for export, which will ship gas from the project to light up the neon of the Ginza district in Tokyo.

A few miles away, BP is prospecting for more oil and gas as the leader of a third consortium, spending three years and $150 million to prepare the way for what it hopes will be a multibillion-dollar project like those of Royal Dutch/Shell and Exxon Mobil.

Aggressive investments by the world's three largest oil producers illustrate how this isolated island north of Japan has become a world hot spot for energy development. Sakhalin, roughly equal in area to Maine but with fewer than half as many residents as Maine's 1.2 million people, is on a track to surpass Moscow this year as the top destination for foreign investment in Russia.

"We expect the volume of foreign investments to double this year and to reach $1.3 billion," Igor P. Farkhutdinov, Sakhalin's governor, said in an interview.

Much of the oil giants' work here is concentrated on modernizing the infrastructure of a poor and backward corner of the country, building bridges and piers, paving roads and airport runways, and repairing the narrow-gauge railway that runs north and south on Sakhalin's spine, to make it easier to support the oil field development to follow.

"If you are in oil and gas, this is the place to be," said Jeffrey Valkar, director of the American Business Center of Yuzhno-Sakhalinsk, a United States-financed investment assistance office in the island's capital. "This is the biggest oil and gas development happening around the world today."

Russia has already made great strides in revamping its oil industry in recent years, stepping up production by 25 percent and becoming the world's No. 2 oil exporter after Saudi Arabia. But that production revival has taken place in the already extensively developed fields of central and western Russia. For the future, Russia's big growth area may be its Far East, especially in the waters around Sakhalin.

It is a hard place to work. "Take Alaska and the North Sea, combine the worst of both and you have Sakhalin -- drifting ice, snow, fog, earthquakes, tsunamis, you name it," said William Dinty Miller, executive vice president of BP Sakhalin. But the rewards are on the same heroic scale as the obstacles, Mr. Miller said, with offshore reserves estimated at 200 trillion cubic feet of gas and 60.5 billion barrels of oil. "The north slope of North Alaska -- that is the Sakhalin shelf," he said.

Russia formally took possession of the island in 1855 and has produced oil onshore since the 1920's, but Moscow has tended to see Sakhalin as far, far away. From the perspective of resource-poor economies like those of Japan and South Korea, though, Sakhalin's energy wealth is conveniently close -- just three days away by tanker, much closer than the Middle East or even Southeast Asia.

But tapping it requires the latest technology and plenty of capital, and to get it done, Russia has turned to foreign companies in a way that it has not elsewhere, and made special legal provisions to attract them.

On May 15, the Russian Parliament is scheduled to give final approval to a law intended to assure that the Sakhalin operations of the consortiums led by Shell and Exxon Mobil will have stable and consistent tax and royalty treatment. The law is expected to open the way for a cascade of gas purchase agreements by companies in Japan, the world's largest importer and consumer of liquefied natural gas.

"We will supply 15 percent of gas going into Tokyo," said Andy C. Calitz, commercial director of Sakhalin Energy Investment, as the Shell-led consortium is called. "Half of what we produce will flow into Japan."

The consortium said on Monday that it had reached its first major supply agreement, selling up to 1.1 million tons of liquefied natural gas a year to Tokyo Gas for a period of 24 years, starting in 2007.

Competing gas projects are expected to come online in the next few years in Australia, Malaysia, Indonesia and East Timor. But Northeast Asia increasingly views the Russian Far East as its filling station of the future.

"It is quite obvious that the countries of the Pacific Rim want to diversify their energy sources," Galina N. Pavlova, the Sakhalin regional government's oil and gas director, said in her office, littered with trinkets from visiting energy company delegations. "The political instability of the Middle East and Indonesia has worked for us in selling gas."

In Japan, officials have taken note of the country's growing reliance on oil from the Persian Gulf -- up to 86 percent of imports in 2003 from about 70 percent in the 1991 Persian Gulf war. In April, Japan mounted a lobbying campaign to persuade Russia to build a 2,500-mile pipeline to carry a million barrels of oil a day from eastern Siberia to Nakhodka, a Russian port facing Japan. Tokyo offered to finance the entire $5 billion pipeline, which could meet nearly one-quarter of Japan's oil needs.

The Russian government decided to back a shorter and cheaper rival pipeline proposal instead, to supply northeastern China. The decision effectively gave China first crack at the oil, but it left open the possibility of building a branch later to serve Japan. With oil consumption in China expected to double in this decade, the country will soon overtake Japan as the world's No. 2 consumer after the United States, and could easily swallow all of Russia's East Siberian oil exports, leaving little need to extend the pipeline.

"We lose," Kotaru Tamura, a member of Japan's upper house of Parliament, said in Tokyo about Russia's pipeline decision. Mr. Tamura favors a gas pipeline from Sakhalin to Japan instead, which would be far from any risk of diversion to China.

Japan needs the gas. Rolling power shortages are expected in Tokyo this summer because 16 of Tokyo Electric Power's 17 nuclear power plants have been shut for safety checks and repairs since mid-April.

"If the nuclear plant situation continues, you will see growth in gas," said Larry G. Smith, vice president of Exxon Neftegas, the Sakhalin subsidiary.

Japanese investors are also helping finance development. In the case of Sakhalin Energy, Shell's partners are the Mitsui Corporation with 25 percent and the Mitsubishi Corporation with 20 percent; Shell has the remaining 55 percent.

The consortium's project, known as Sakhalin-2, calls for twin 500-mile oil and gas pipelines from near here to Prigorodnye, a bay near the island's southern tip where ships can call year-round. The gas processing plant to be built there would be able to liquefy up to 9.6 million tons a year, equal to about one-sixth of Japan's total needs.

Some of the gas may go to South Korea or Taiwan as well as Japan; together, the three countries account for 70 percent of the world trade in liquefied natural gas. China buys little now, though analysts expect its needs to rise to 10 million to 15 million tons by the end of the decade.

The Exxon Mobil consortium, which is spending $1.2 billion in Sakhalin this year, hopes to start oil production from Chayvo in 18 months, followed by gas production for export to Japan in 2008. Exxon Mobil has 30 percent of the consortium, which also includes a Japanese group of 13 companies; two Russian partners, RN-Astra and SMNG-Shelf; and ONGC Videsh Ltd. of India.

Unlike Shell, Exxon Mobil hopes to skip the sea transportation and build a 1,450-mile, $900 million gas pipeline all the way to Tokyo.

Such a pipeline could yield benefits beyond reliable energy. Japan and Russia have never signed a peace treaty formally ending World War II because of a lingering dispute over four small islands near Sakhalin. Building a gas pipeline could bring about the kind of interdependency between Russia and Japan that a gas line to Western Europe fostered between the Soviet Union and West Germany in the 1980's.

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