TIME EUROPE
November 6, 2000, Vol. 156 No. 19
Arctic Riches
Oil-drilling opportunities in Sakhalin are attracting the largest foreign investment projects in Russia
By ANDREW MEIER Yuzhno-Sakhalinsk
The American oilman's toast, at an intimate gathering of his Russian and foreign partners, was jubilant. "I've been on Sakhalin Island for five years now, and although Anton Chekhov made it famous for its prison colony, I'm living proof you can survive here. Sure, we've hit some rough spots, but the boom's going to come to this island and we're gonna make it happen. I believe in Sakhalin and in its oil."
Since the Soviet collapse, Sakhalin Island, off Russia's far eastern edge, has seen more than its share of ebullient executives from Western oil giants. But not many have remained so hopeful for long. Many have endured tedious, frustrating years waiting for their deals to be signed, as bureaucracy, xenophobia and corruption combined to thwart their dreams of black gold. Some have even left in frustration. But in recent weeks, Sakhalin's oilmen have turned almost giddy — buoyed in equal measure by the continued high price of crude and a new public pledge by President Vladimir Putin to build a legal foundation for their multibillion-dollar bet on Russia.
Russia is awash in petroleum. With proven reserves of nearly 49 billion barrels and production hitting 6.3 million barrels per day, the country is the Saudi Arabia of the north. The problem is getting it out of the ground and then on to market. Years of Soviet mismanagement and underinvestment have taken their toll. Most of the country's fields — some of which were discovered a century ago — are in dire need of rehabilitation; Siberia is littered with rusting derricks ringed by porous labyrinths of well-worn pipelines.
Before Russia's 1998 economic crisis, local oil moguls were certain of their ability to lure Western companies into developing long-neglected oil fields. Many foreign companies have tried, few have succeeded. "Everyone here knows it makes the most sense to invest in new fields, rather than dumping millions more into existing sinkholes," says Glenn Waller, director of the Petroleum Advisory Forum, an association of the Western energy majors invested in Russia.
Since the 1998 crisis, and in the ensuing years of political instability, the Russian oil and gas market saw its foreign capital pools drain as prospectors turned to more welcoming political and economic climates elsewhere. Waller reports that oil production in Russia has fallen from 11.8 million barrels per day in 1987 to a projected total for this year of 6.3 million barrels per day, of which 2.2 million barrels (35%) are exported. "Russia has learned its lesson," says Waller. "It can't rely on old fields, it needs to develop new ones. And to do that it needs capital and expertise."
Sakhalin is set to show the way to the market. Once a notorious Czarist penal colony, then little more than a Soviet airbase the size of Ireland, Sakhalin is now home to the largest foreign investment projects in Russia. These deals, totaling some $26 billion, are long-term oil and gas Production Sharing Agreements — PSAs, in the argot of the oilmen.
The leading PSA, known as Sakhalin 2, is run by Sakhalin Energy, a consortium led by Europe's largest oil company,
Royal Dutch/Shell, with a 37.5% stake. At a reported investment of $10 billion, it is Russia's largest single foreign investment project. It is also the market's first and only success story to date, Russia's first PSA and the first to draw oil. "After years and more than 1,000 permits signed, we did it," boasts Sakhalin Energy's Scottish president, Alan Grant. The Molikpaq, the rig Sakhalin Energy dragged from the Canadian Arctic to Sakhalin's northeast coast, is pumping more than 80,000 barrels a day.
The success of Sakhalin's psas has not been lost on the new men now running Russia's finances. After all, taxes on oil and natural gas provide more than half of the government's revenue. In early September, Putin made a stopover in Sakhalin on his way to Japan. In a star appearance at a conference on the future of psas in Russia — with Bill Richardson, the U.S. Secretary of Energy, in attendance — Putin celebrated the island's oil projects and vowed to smooth the way for the dozens more psas still in limbo. He even instructed his Economics and Trade Minister, German Gref, to take charge of the state's role in developing and administering psas.
Later that month Russian Prime Minister Mikhail Kasyanov followed up on Putin's promise, taking the State's PSA sales pitch to London in hopes of luring more Western energy companies into the market. After all, Russia's hopes for survival rest not only on the high price of crude, but on developing a generation of such partnerships. Economic growth is predicted to run as high as 7% this year, but the state will continue to depend heavily on oil revenues. In the Duma, the lower house of parliament, elected representatives still complain that the West only wants to pillage the country's riches. But Putin and his economic aides seem genuinely interested in finally answering the one question that has stymied overseas investors: When will Russia find a legal, dependable and profitable way for foreign companies to help Russia extract and export its petrochemicals?
But lest anyone think that happy days are just around the corner, there is an all too familiar Russian twist to the Sakhalin oil tale. Aside from the environmental impact, few on Sakhalin, where blackouts remain frequent and hot water scarce, have felt any trickle-down effect. It turns out, as one Alaskan rigger put it, that "there's tons of oil and gas on this island, just none for the folks who live here." The only existing pipelines take oil and gas straight off Sakhalin to mainland Russia — bypassing the local population of hunter-gatherers, who are forced to pay the highest prices for gasoline in Russia.
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