Sakhalin-1 passed into new hands: why the Russian company became the new project manager

The prerequisite for the issued decree was that Exxon Neftegaz Limited unilaterally declared force majeure on all contractual obligations under Sakhalin-1. In fact, this means a complete refusal to perform the functions of an operator, and, therefore, blocking the work of the project. As a result, not only the shipment of oil was stopped, but also the supply of gas to the inhabitants of Primorye. On the one hand, it is impossible to ensure a reliable power supply for the inhabitants of the Khabarovsk Territory and the north of Sakhalin Island under such conditions. On the other hand, the downtime of the project’s production capacities and the direct financial losses caused by this situation, obviously, cannot suit either Russia or the project partners from India and Japan.

The decision of the President will allow resuming the full-fledged work of the project as soon as possible.

“The transfer of the functions of the operator of the Sakhalin-1 project to Sakhalinmorneftegaz-Shelf is a completely logical and justified decision. This will allow to resume uninterrupted production of hydrocarbon raw materials within the framework of the project, as well as to provide gas resources to the residents of the Khabarovsk Territory and the north of Sakhalin Island. The former operator of the project, ExxonMobil, de facto withdrew from participation in it, stopped oil production (since May 15 of this year), and then gas (since September 16), thereby completely paralyzing the activities of Sakhalin-1. It cannot be called otherwise than sabotage,” commented an associate professor at the Financial University under the Government of the Russian Federation, an expert at the InfoTEK analytical center

Valery Andrianov.

To date, Sakhalin-1 has remained the only project implemented on the basis of a production sharing agreement, or PSA, in which the issue of participation of foreign shareholders has not been resolved. Previously, the operatorship for two other PSA projects – Sakhalin-2 and the Kharyaginskoye field – was transferred to Russian companies. However, such a decision is long overdue: the PSA mechanism, which has been operating in Russia for several decades, has proved its colonial orientation and parasitic nature, the budget of our country annually loses tens of billions of dollars.

President Vladimir Putin spoke about this a few years ago: “This is a colonial treaty that has absolutely nothing to do with the interests of the Russian Federation. I can only regret that in the early 1990s, Russian officials allowed themselves such antics, for which they should have been imprisoned. The fulfillment of this agreement led to the fact that Russia allowed its natural resources to be exploited for a long period of time and received nothing in return. It’s just practically zero.”

Over the entire period of the agreements, the proceeds from the sale of hydrocarbons produced under the PSA amounted to about $160 billion, the Accounts Chamber reported following an audit of the implementation of agreements for 2018. At the same time, budgets of all levels received only $47 billion of this amount, i.e. less than a third.

“If the deposits were developed under standard conditions, the state would receive 1.5 times more. Between 2005, when Sakhalin-1 was launched, and 2018, the average level of tax burden on oil companies was about 50% (Rosneft – 55.2%, Lukoil – 48.2%, Gazprom Neft) – 49.3%), with an indicator of 29.4% for PSA projects. This testifies to the low budget efficiency of production sharing agreements,” says Sergey Suverov, investment strategist at Arikacapital.

As the expert explained, under the terms of the agreements, Russia’s share in the PSA projects amounted to 15% (Sakhalin-1), 10% (Sakhalin-2) and 47.7% (Kharyaginskoye field). It was assumed that as foreign investment pays off and the profitability of projects grows to the planned levels, the share of the Russian state in profitable products will also grow. In practice, it turned out that over the decades of the PSA operation, only the Kharyaga project was able to achieve the established rate of return, as a result of which the state’s share in it was increased to 63.4%. As for the Sakhalin PSAs, this figure did not even reach the minimum level (17.5%).

But the expectations of foreign investors were more than justified. For example, for ExxonMobil, Sakhalin-1 has become a real Klondike: according to the calculations of the investment bank Goldman Sachs, the internal rate of return (IRR) of the Sakhalin-1 project exceeds 20%, which is significantly higher than the average for the company’s 20 largest projects (the average for them is 17%, calculated by Goldman Sachs). The return on Sakhalin-1 for ExxonMobil is 3.2 times higher than the return on investment in its largest Kazakh project, Kashagan, and 4.4 times higher than that for Australia’s largest LNG project, Gorgon.

“The total volume of production since the start of the project has amounted to 147 million tons of oil and 33 billion cubic meters. m of gas, respectively, the revenue is about $84 billion, of which about $25 billion comes from ExxonMobil. The return on the project for an American company was approximately 2.5 times higher than the costs of the project: with a total investment of $36 billion, ExxonMobil invested about $10 billion,” Suverov said.

“It should be noted that this precedent clearly demonstrates the absurdity and unprofitability for Russia of projects on the terms of the PSA. The level of taxation of PSA projects was significantly lower (less than 30% of revenue) than the level of taxes for Russian oil and gas companies operating “on a general basis” (about 50% of revenue). As a result, Sakhalin-1 turned out to be extremely profitable. And now here is such a “gratitude” – a deliberate blocking of a strategically important project! However, it can be said that ExxonMobil has achieved its goal – it has remained in the project, retains its right to receive a share of the profits, and at the same time can do nothing, but only continue to demonstrate its “ardent desire” to leave Russia – as demanded of it by curators from State Department,” explains Andrianov.

Under the terms of the PSA, the investor is exempt from most taxes, but bears all the risks and costs associated with the implementation of the project. At the same time, expenses are compensated at the expense of the products received, the volume of which is deducted from the state’s share. It turns out that the more you spend, the less you have to give. In conditions of weak financial control within the PSA, the managers of foreign operating companies often did not save on anything, but rather on the contrary: instead of purchasing Russian materials, equipment, products, the cost of which, including freight, is significantly lower than imported ones, everything was brought from the USA.

Note that the impudence of PSA operators was noticed at the highest level. The Accounts Chamber also presented its claims in squandering to them. According to the agency, the companies annually included in the reimbursable costs the costs not related to the implementation of the project. For example, for holding cooperatives, celebrating Christmas and Halloween, buying gifts and souvenirs. Among the non-targeted expenses is also the rent of elite housing for foreign top managers in Moscow. The total cost of rent and compensation for housing under the Sakhalin-1 and Sakhalin-2 projects in 2014 alone amounted to $11.8 million, according to the report of the Accounts Chamber. In general, the auditors estimated the unjustified expenses for the two projects in the same year at $36.5 million. amounted to $113.4 million.

“It is clear that ExxonMobil is an American corporation and it is forced to be in the forefront of the anti-Russian sanctions campaign. Of course, the logical step on her part would be to immediately and completely withdraw from Russia. Yes, the company reported on some negotiations with an unnamed “third party” to transfer its stake in Sakhalin-1, but this did not result in anything concrete. Not enough time or desire? Let me remind you that nothing prevented other Western oil and gas companies from leaving Russia. For example, the French TotalEnergies said goodbye to the Kharyaga PSA, and Shell withdrew from Gydan Energy and Shell Oil. The Norwegian Equinor also bowed out.

As a result, ExxonMobil “lasted” the decree of the President of the Russian Federation, which temporarily prohibits shareholders from unfriendly countries from selling their stakes in strategic assets, including Sakhalin-1. That is, just as BP said goodbye for a long time, but never left the capital of Rosneft, so ExxonMobil pretended to be offended for a long time, but in the end, de facto, remained in the Sakhalin-1 project. But at the same time, she continued to sabotage its implementation,” Andrianov concluded.

But these are crumbs compared to the cost of the equipment, which, under the terms of the PSA, must be transferred to the ownership of the state. In 2018, the Accounts Chamber valued this property at $24.3 billion. In September, the State Duma instructed Vice Speaker Irina Yarovaya, together with relevant committees, to analyze the effectiveness of the implementation of production sharing agreements (PSA), and primarily for Sakhalin-1. We look forward to the results of this work with great interest.