Global Insight Perspective | |
Significance | A review of the 2006 costs of the Sakhalin-1 and Sakhalin-2 projects undertaken by Russian auditors has recommended that Russia reduce its reimbursable expenses to the operators of those projects, ExxonMobil and Shell, respectively. |
Implications | Since Russia only gets royalties from the production-sharing agreement (PSA) projects after reimbursing the capital expenditures of the operators, a decision by the government to lower payments for expenses incurred is effectively a negation of the projects' 2006 operating budgets, as well a strong signal to keep a lid on costs going forward. |
Outlook | In a related story, Sakhalin-2, which is now led by Gazprom after it acquired a majority stake in the project in December, said it would no longer use PricewaterhouseCoopers (PwC) as its auditor but instead use a Russian firm, indicating that the government intends to keep a close watch on the project's budget. |
Higher Costs, Lower Payments
In another attempt by the Russian government to exercise greater control over the Sakhalin-1 and Sakhalin-2 projects in the Far East of the country, the Industry and Energy Ministry said on Friday (13 April) that independent audits of the two projects recommended that the government reduce its payments to the operators of Sakhalin-1 and 2 for their reimbursable expenses. Both projects are being developed under the umbrella legal and regulatory protection of a production-sharing agreement (PSA), which means that Russia only gets royalties from the projects after reimbursing operators' capital investments.
The Ministry said that the independent audit of the Sakhalin-1 project, which was conducted by Russia's BKR Interkom-Audit, recommended that the government cut reimbursable expenses to project operator ExxonMobil by 10.4%, or US$370 million, for 2004 and 2005 together. Reuters also reported that the independent audit of Sakhalin-2, conducted by Russia's Top-Audit, recommended that reimbursable expenses to project operator Shell be reduced by 7.2%, or US$362.5 million, for 2004. Shell was operator of the project at the time, but the Dutch/U.K. supermajor, together with its Japanese partners in Sakhalin-2, sold a majority stake to Russian gas giant Gazprom in December of last year (see "Related Articles").
The Ministry has not said yet whether it will heed the recommendations of the independent audits, although officials said that they would soon meet with the auditors and the operators of the projects before making a decision. ExxonMobil has already disagreed with the findings, but with the government already upset over the rising costs of developing both projects, the U.S. supermajor may consider this a potential battle not worth fighting. The report said that Russia has already approved Sakhalin-1's 2007 proposed budget of US$1.2 billion, and this after the project's total budget (out to 2014) was revised upwards last year from US$12.8 billion to US$17.8 billion, after calculations were switched from 2002 prices to 2005 prices. Considering the environmental probe that is currently under way at Sakhalin-1, and taking into account what happened to Shell at Sakhalin-2, ExxonMobil may decide to just forfeit the costs and not seek to be reimbursed for those expenditures cited by the audit.
Outlook and Implications
This presumes, of course, that Russian authorities choose to abide by the recommendations in the independent auditors' report. However, all signals at this point suggest that the Ministry of Industry and Energy will use this report to cut payments to Shell and ExxonMobil. While grudgingly accepting the higher budgets for the PSAs (albeit essentially forcing Shell to concede control of Sakhalin-2 after the company's announcement of a doubling of projected costs at the US$22-billion project), the government has the ability to withhold payment for reimbursable expenses, using the independent audit as the pretext. Although this money is but a fraction of the total cost of the project, it sends a signal to the two supermajors that the government is not willing to accept all of the higher costs in the development of the projects.
In a related note, the Sakhalin-2 consortium, which has a project budget approved at US$1.2 billion for 2007, said on Friday that it has dropped PricewaterhouseCoopers (PwC) as its auditor after 10 years of service. Gazprom, newly installed as operator of the project, had said last week that it was keeping PwC as its auditor, despite the fact that the U.S. firm has come under fire from Russian authorities about alleged improprieties in its previous audits of Yukos, the bankrupt oil firm currently in the process of being liquidated. The receiver for Yukos said, also on Friday, that the creditors' committee for the firm had decided to form a single lot to sell off Yukos's oilfield service companies—which failed to attract any buyers at an auction earlier this month—together with its construction, maintenance, information and technology companies.
With regard to PwC, the Energy Ministry said in a statement that the U.S. auditor's work with Sakhalin-2 was "viewed by Russia as unsatisfactory because of its constant comments relating to completion of the audit accounts and the amount of reimbursable expenditure". PwC is already facing a separate US$11-million back-tax claim, and its offices in the Russian capital, Moscow, were raided last month in a probe related to that claim. The firm is awaiting a decision on its licence to continue working in Russia. Industry and Energy Minister Viktor Khristenko denied any link between the Yukos audit investigation and the government's decision to stop using PwC as the auditor of Sakhalin-2. However, with Russian firm Finekspertiza slated to take over auditing duties, and Gazprom now in the driver's seat of the project after the earlier doubling of its expected costs, it is clear that the government intends to keep a closer eye on costs at Sakhalin-2 going forward.
Related Articles
Russia: 9 April 2007: Yukos Death Knell Set for May as Creditors Decide Timetable for Remaining Asset Auctions
Russia: 2 April 2007: Will ExxonMobil Get the "Shell Treatment" at Sakhalin-1 in Russia's Far East?
Russia: 29 March 2007: Environmental Watchdog Launches Probe into Russia’s Sakhalin-1 Project
Russia: 27 February 2007: Momentum Builds in Russia’s Far East for Unified LNG Marketing from Sakhalin
Russia: 21 March 2007: Tax Authorities in Russia Win Lawsuit Against PwC over Yukos Audits
Russia: 12 March 2007: PwC Offices Searched in Yukos-Related Tax Evasion Investigation in Russia
Russia: 6 February 2007: Prosecutors Hit Ex-Yukos CEO with New Charges
Russia: 22 December 2006: Gazprom Secures Controlling Stake in Sakhalin-2 Project in US$7.45-bil. Deal