Finance & MarketsJapan and Shell can lose stake in Sakhalin-2 as Putin takes over...

Japan and Shell can lose stake in Sakhalin-2 as Putin takes over Sakhalin Energy

At the end of May, the Minister of Economy, Trade and Industry, Koichi Hagiuda, said that Sakhalin-2 is an asset "our predecessors worked hard to acquire". He said that Russia might own the land, but the leasehold and the liquefaction and transportation equipment belong to the Japanese government and Japanese companies. "We do not intend to leave [the project], even if we are told," he said. 

Russia is now putting foreign investors in the Sakhalin-2 project – Shell, Mitsui and Mitsubishi, in a test of loyalty to Russian jurisdiction. According to President Vladimir Putin’s latest decree, all the Sakhalin Energy project property will be transferred to the ownership of the Russian government. The new operator of the project will be a Russian LLC, and if they wish, Gazprom and foreign participants in Sakhalin-2 can remain as a shareholder. If they refuse to stay in the project under the new conditions, their share will be sold, and the proceeds from the sale will be frozen in the Russian Federation on type “C” accounts. Moreover, this amount can be reduced by the “damage” that the foreign participant may have caused during its previous activities in Russia.

A C-type account is a part of the Russian countermeasure against western sanctions. The C-type account is a bank account opened for non-resident legal entities, including those that do not have a branch or representative office in Russia, and non-resident individuals, including those who are not individual entrepreneurs. Only rubles can be credited to this account which only a few banks are authorised to open. It can be used to pay for foreign currency acquired by a non-resident under transactions, the conclusion and execution of which are carried out by the Bank of Russia. They can also be used to pay taxes and fees. There are other conditions, but these are the most relevant in this case.

The Sakhalin-2 project has been implemented on a production sharing agreement (PSA). Other than Gazprom, Shell (27.5%), as well as the Japanese Mitsui (12.5%) and Mitsubishi (10%), own shares in the project. Shell has already said that it is looking for a way to exit the project due to the military operation in Ukraine and the subsequent Western sanctions against Russia.

Under the PSA, the Russian state paid in full for the construction of key production and transport infrastructure, as well as a gas liquefaction plant, and under the terms of the agreement, these facilities should become the property of the state.

The Russian government will create a Russian LLC, which will take over all the employees, rights and obligations of the current operator of the Sakhalin-2 project, Sakhalin Energy. In this LLC, the existing shareholders of Sakhalin Energy will receive the appropriate shares, for which foreign participants need to submit a notification to the Russian government within a month.

In simple words, the Russian authorities are forcing foreign companies to agree to the proposed conditions for maintaining their participation in Sakhalin-2; otherwise, foreign shareholders risk losing their stake.

Japan doesn’t want to leave Sakhalin-2 

In June, the Japanese government said it intends to keep the participation of national companies in the Sakhalin-1 and Sakhalin-2 oil and gas projects. It was stated in the White Paper on Energy approved by the Cabinet of Ministers for the fiscal year 2021.

The document noted that the situation with high prices for energy resources might drag on for a long time. In this regard, Japan needs access to a stable supply of liquefied natural gas (LNG) from Sakhalin-2. The Japanese government estimates that these supplies provide about three per cent of the country’s electricity generation. And the supply of LNG based on long-term contracts makes it possible to reduce the negative effect of the global rise in energy prices. 

At the end of May, the Minister of Economy, Trade and Industry, Koichi Hagiuda, said that Sakhalin-2 is an asset “our predecessors worked hard to acquire”. He said that Russia might own the land, but the leasehold and the liquefaction and transportation equipment belong to the Japanese government and Japanese companies. “We do not intend to leave [the project], even if we are told,” he said. 

According to the International LNG Exporters Group (GIIGNL), by the end of 2021, 9.2 million tons (12.7 billion cubic meters) of liquefied natural gas (LNG) were contracted for the project. About 5 million tons (6.9 billion cubic meters, or about 60%) were contracted by Japanese companies. The largest buyers are the Korean Kogas and the Japanese Jera, which purchase 1.5 million tons (2.1 billion cubic meters) of LNG from the PSA project each year.

In March, the Japanese newspaper Nikkei reported that by the end of 2021, Japan imported LNG worth $35.9 billion, of which Sakhalin-2 received about $2.5 billion. According to the publication, the price under the long-term contract under the project for Japan was about $10 per MMBtu (1 million British thermal units), i.e. $357 per 1000 cubic meters.

Japan finds LNG from Sakhalin-2 times cheaper than buying it on the spot market. Maintaining Sakhalin gas supplies is the only way to deal with rising gas and thermal coal prices.

Shanklin-2 LNG project 

The Sakhalin-2 LNG project is being implemented on the shelf of the Sakhalin Peninsula under a Production Sharing Agreement (PSA). It provides for developing two fields – Piltun-Astokhskoye (mainly oil) and Lunskoye (primarily gas). It is the oldest PSA in Russia, concluded in 1994, and the first LNG project in the country. Gazprom owns a controlling stake in Sakhalin Energy (50% plus one share).

Shell may not get its money for a long time

Shell has not yet withdrawn from the project. To do this, it will need permission from the Russian authorities. The Russian Prime Minister Mikhail Mishustin had announced the preparation of a corresponding decree on March 1. Shell has been discussing the stake sale with companies in India and China. But, now Shell’s stake will be credited to the C Type account in rubles and frozen. Even if Russia releases the money, Shell may find it difficult to convert currency due to the Western sanction on currency conversion and SWIFT trade.

Shell is unable to purchase Russian LNG because of the sanctions by the British government. The company said it estimates losses of $ 5 billion due to its withdrawal from Russia

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