Sakhalin Energy Launches Russia's First LNG Plant in Far East; Exports to Asia Set to Begin

The US$22-bil. Mega-Project in Action

In a landmark ceremony earlier today on Sakhalin Island in Russia's Far East, Russia's President Dmitry Medvedev and Japan's Prime Minister Taro Aso presided over the formal launch of the Prigorodnoye liquefaction plant, which will soon begin exporting its first cargo of LNG under long-term contracts to Japanese customers. The launch of the 9.6-million-t/y-capacity Prigorodnoye LNG plant, built by the Sakhalin Energy consortium to export gas production from the Sakhalin-2 project, marks the culmination of the US$22-billion mega-project, which has been beset by delays, cost overruns, environmental concerns, and a high-profile shake-up in the consortium itself (see "Related Articles").

The first LNG cargo from the Prigorodnoye plant is not expected to be loaded until the end of March, but the significance of that shipment and today's formal ceremonial launch should not be underestimated. Plans are for the first tanker, the 145,000-cm Grand Aniva, which was built by Japan's Mitsubishi (a 10% stakeholder in Sakhalin Energy), to deliver its load to Tokyo Gas Co. and Tokyo Electric Power Co. (TEPCO) which, Reuters reports, will split the first cargo. Some 65% of the LNG plant's total output—almost all of which has already been contracted—is slated to go to Japanese customers, with the rest roughly split between South Korean customers (which should get their first cargo in April) and the North American market. LNG exports to North America will be received at a Mexican terminal, regasified, and then sent to the LNG-hungry U.S. West Coast market.

Sakhalin Energy's CEO Ian Craig said that about 50 cargoes of LNG will be shipped from the Prigorodnoye plant this year, while the consortium also anticipates sending about 50 cargoes, of 700,000 barrels each, of oil Sakhalin Energy, which is comprised of Gazprom, Shell, Mitsui, and Mitsubishi (see table), expected to produce about 3.2 million tonnes of LNG this year, only about half the earlier government estimates of 6 million tonnes, but Craig said that the Prigorodnoye plant should reach full capacity next year, with the amount of 145,000-cm cargoes expected to rise to 160.

A Bridge to End a War?

With the vast majority of Sakhalin Energy's LNG exports slated to be delivered to Japan, the Sakhalin-2 project is potentially an important vehicle by which Russia and Japan can bridge their long-held political differences. The focal point of these has been the territorial dispute over the Southern Kuril Islands in the Pacific Ocean. Aso's visit to Sakhalin Island, which is only 150 km away from Japan's northernmost island of Hokkaido, was the first visit by a Japanese prime minister since the days when Japan held the southern part of the island before the end of the Second World War. Thousands of Japanese were evacuated from the island near the end of the war, and Russia's seizure of the Southern Kuril Islands, which Japan calls the Northern Territories, near the end of the war, has proven a thorn in the side of bilateral relations since then, as the dispute over the islands has prevented the two governments from signing a formal peace treaty to end the Second World War.

Whether the increased economic ties from the start of Russian LNG exports to Japan can help end their territorial dispute remains to be seen, but Aso at least expressed optimism that this could help foster a resolution. He emphasised the blossoming "partnership" between Russia and Japan in energy co-operation, saying that, "By making progress in the negotiations over the biggest issue that lies between the two nations—the final resolution of the territorial issues—I strongly hope for building of Japan-Russia relations that are befitting of true partners in this region".

For Japan and South Korea, the Prigorodnoye liquefaction plant is a large and proximate supply source that can reduce reliance on more distant or unreliable LNG producers such as Qatar or Indonesia. Indeed, LNG cargoes from Sakhalin can be shipped to South Korea within three days, compared to a week from South-East Asia and fifteen days from the Middle East. The proximity of the terminal will push down transit costs for Asian consumers, which are likely to make shipments more competitive in relation to other suppliers. Following start-up, LNG imports from Russia will account for around 7% of Japan's supplies, (the world's largest consumer of the fuel), which will help Japanese utilities offset the 75% reduction of LNG supplies from Indonesia's Bontang terminal, as the Indonesian government seeks to redirect supplies towards the domestic market (see Indonesia – Japan: 13 February 2009: Japanese Utilities Agree to Huge Reductions in LNG Supplies from Indonesia).

Outlook and Implications

The launch of the Prigorodnoye plant and the imminent start of LNG exports from the Sakhalin-2 project represents a milestone for the Russian government and state-run gas giant Gazprom. Having dabbled in LNG trading and some one-off LNG shipments in one-off spot cargo deals bought from other sources, this now marks the first foray by Russia into the widening global LNG market using its own, domestically extracted and liquefied natural gas resources. What is more, the start of LNG exports to Japan and South Korea (and eventually to North America) allows Gazprom to diversify its export markets, reducing its dependence on the European market.

The strategic importance of the Sakhalin-2 project—both to the Russian government and Gazprom—helps explain the heavy-handed approach taken by Russian authorities back in 2006 in pressuring Shell and its Japanese partners in Sakhalin Energy to concede a role in the consortium for Gazprom. Shell, along with Mitsui and Mitsubishi, duly obliged, allowing Gazprom to acquire a 50%-plus-one stake. More than two years later, after several delays from the previously scheduled launch date, the Prigorodnoye LNG plant is now operational, with exports set to begin soon. President Medvedev, formerly the chairman of the board of Gazprom, could hardly conceal his happiness with the launch, saying, "This strengthens our position, Russia's position, as an important player on the global energy market and I will not hide that we are very pleased by this."

The launch of the terminal could also pave the way for further progress on a preliminary agreement signed between Gazprom and Korea Gas Corp. (KOGAS) for a natural gas pipeline that would be supplied by gas fields on Sakhalin. South Korea hopes the proposed pipeline will supply between 15% and 20% of its gas demand needs by 2015, thus significantly augmenting its supply security. However, problems over the pipeline route and doubts over Russia's immediate commitment to the project, given its own hope of using Sakhalin gas to boost supplies to domestic consumers in the Russian Far East, raise significant problems for the project. South Korea will have to continue relying on liquefied, as opposed to piped, gas supplies until these issues are resolved, although the launch of the terminal is likely to provide some momentum for further discussions on the project.

Related Articles

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Russia: 21 October 2008: Sakhalin-2 Partners Reaffirm LNG Exports to Commence Early 2009

Russia: 24 April 2008: Gazprom Targets Growth in U.S. Gas Market; Sakhalin-2 LNG Exports Delayed Until 2009

Russia: 12 August 2008: Gazprom to Cover Delayed Sakhalin LNG Deliveries with Short-Term Contract

Russia: 17 June 2008: Sakhalin-2 Consortium Clinches Financing Deal with Japanese Banks

Russia: 18 December 2007: Sakhalin-2 Says First LNG Exports Pushed Back to Q4 2008

Russia: 22 December 2006: Gazprom Secures Controlling Stake in Sakhalin-2 Project in US$7.45-bil. Deal

Russia: 19 September 2006: Shell-Led Russian Project In Jeopardy Following Cancellation of Environmental Permit

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