Sakhalin gas: dream or nightmare? Part 1

Sakhalin gas: dream or nightmare? Part 1

The concept of oil perfectly expresses the eternal human dream of wealth achieved through a kiss of fortune, and not by sweat, anguish, hard work. In this sense, oil is a fairy tale, and like every fairy tale, a bit of a lie.

Ryszard Kapuscinski, Shah of Shahs

In the first half of 2002, Sakhalin Energy, a company owned by Shell, Mitsubishi and Mitsui is about to begin spending US$ 9 billion to build the world’s largest LNG plant at the southern tip of Sakhalin to export gas from its huge Sakhalin II field to Japan, Korea and Taiwan. A rival consortium, led by America’s Exxon and Japan’s Sodeco (Marubeni, Itochu) is strongly pressing the Japanese government to support (that is, to pay for) a 2,300 kilometer gas pipeline to from its equally huge Sakhalin I gas field to Niigata and Tokyo.

Sakhalin gas, together with its smaller cousin, oil, is going to be very important for Japan, and will go a long way to answering the Japanese government’s unending concerns about energy security for decades to come. And of course, Sakhalin gas should be very good for the balance sheets of some of the biggest companies in the world, as well as Japan.

But it is not quite so clear that these developments will so good for Sakhalin – for its people, its economy or its natural environment. Moreover, as we will see, there are real and hard-headed grounds for concern that extend well beyond Sakhalin to potentially catastrophic threats to the eco-systems of the Sea of Okhotsk and the northern part of the Sea of Japan.But let us start our story of the development of the giant oil and gas fields of Sakhalin with a little history, from the beginning of the modern period, two centuries after Russians and Japanese had begun to take the island from its Ainu, Nivikh and Orok indigenous peoples.

In 1890, the young doctor and writer Anton Chekhov crossed Russia and Siberia to explore the Czarist prison colony on the island of Sakhalin. Even though he had read widely before he left Moscow, what Chekhov found on the island was beyond his imaginings.

“I have seen Ceylon, which is paradise, and Sakhalin, which is hell.”

A decade and a half later, the government of Czar Nicholas II, reeling from the combined effects of defeat at the hands of Japan and the 1905 Revolution abandoned the brutal system of exile of convicts, men and women alike, in the half of Sakhalin that remained under Russian control. In place of the convict system, Russia encouraged free settlers, and the commercial exploitation of the island’s abundant natural resources. Of these, the most important was oil – as it still is today.

Sakhalin, Japan and hydrocarbons, Round 1

Naturally, the existence of considerable oil reserves in Russian-controlled Sakhalin was of great interest to the Japanese government, particularly the Imperial Japanese Navy. In 1919 an anti-Bolshevik White Russian government in Siberia granted rights to develop the north Sakhalin oil fields to a Japanese government-backed commercial consortium called the Hokushinkai led by Mitsubishi.

The effects of the Russian Revolution finally reached northern Sakhalin with the brief establishment of a Far Eastern Soviet administration in January 1920. The Japanese government, already committed to its 100,000 man Siberian expedition at the time, responded by invading northern Sakhalin from Karafuto, setting up a puppet White Russian “autonomous state”, and taking direct control of the oil fields. Six months later, the Cabinet provided the Navy with a special appropriation of 1,400,000 yen for oil drilling in Sakhalin. Each year between 1920 and 1925 the Hokushinkai consortium sent 100,000 tons of crude oil back to Japan.

This new source of Sakhalin oil just next door under the control of a puppet government was conveniently timed, since domestic Japanese production was declining rapidly, and consumption was reached 840,000 tons by 1925. Control of the Russian population was maintained by fierce coercion – the few Bolshevik leaders on the island were shot, or more simply thrown overboard at sea. As they had been for two centuries of Russian control, the Ainu and Nivikh indigenous people, together with the remaining local Russians, were shoved aside, and the land and forests and fish and oil simply taken.

But eventually peace of a kind returned to Sakhalin in 1925 with the signing of the Treaty of Peking between the Soviet Russian and Japanese governments. Under the agreement Japanese forces pulled back to Karafuto, but the Hokushinkai’s successor, the North Sakhalin Oil Company (Kita Karafuto Sekiyu Kaisha) headed by a retired admiral, retained rights to half of the north Sakhalin oil fields. Between 1926 and 1944, over a million tons of oil was exported from Sakhalin to Japan.

Sakhalin, Japan and hydrocarbons, Round 2

Japan’s long experience with Sakhalin oil was not forgotten, and when the oil shocks of the 1970s jolted the Japanese government into a re-newed search for secure sources of energy, Sakhalin became a target of Japanese exploration once more. A national energy security strategy emphasized nuclear power together with stable sources of hydrocarbon fuels Coal, oil and gas were to be acquired from a range of supplier countries – including Australia, Malaysia, and Canada.. Sakhalin’s oil and gas reserves were quickly shown to be very large, but mainly offshore in the shallow but often icebound and turbulent waters of the Sea of Okhotsk.

However the combination of politics, the unsolved technological problems of offshore production in an appallingly difficult climate, and the difficulty of obtaining adequate project finance stopped any foreign investment in Sakhalin oil and gas.

By the early 1990s, each of these difficulties had been at least in part ameliorated. Sakhalin was one of the most secret parts of the postwar Soviet Union. Together with the chain of air and naval bases and undersea listening posts along the chain of the Kuril Islands, Sakhalin was the site of numerous air and naval bases protecting the Sea of Okhotsk, a safe haven for the ballistic missile submarines that made up the core of the Soviet nuclear deterrent. The shooting down of KAL 007 in 1983 after it passed over the some of the most secret Soviet naval and air bases in the region was testimony to the depth of Sakhalin’s involvement in Cold War militarization. But after the collapse of the Soviet Union, most of these bases and their equipment were left without funding, without security, and often, simply left to rust.

Moreover, the combination of the enthusiastic replacement of state socialist ideology by free-for-all capitalism and the virtually complete collapse of stable sources of state revenue made the Yeltsin and Putin governments enthusiastic about foreign energy investment. Western oil and gas companies raced each other to every corner of the former Soviet Union to bring vast oil and gas reserves on stream as fast as possible.

One financial problem remained to be solved: the investment burden of developing huge natural resources projects in difficult climates and locales. Poor countries such as Russia has become in the 1990s could not possibly finance such projects themselves, and western corporations are not noted for their generosity. The solution came in two parts. Firstly, banks such as the European Bank for Reconstruction and Development (EBRD) and the World Bank were persuaded to provide loans below market rates. And secondly, a form of project financing known as production sharing agreements [PSA] was devised that ensured that the first revenues flowing from the project would go towards repaying the investment that the western companies had provided to cover exploration, development and production plant costs. Only once all these costs have been recovered from sales does a part of the revenue stream begin to flow to the host country government in the form of royalties and taxes. However, as we shall see, foreign bank financing and production sharing agreements did not always work in such a reasonable way*1.

In the 1970s and the 1980s American and European engineers solved many of the technical problems of offshore oil and gas drilling and production and transportation, especially in the severe conditions of the North Sea and Alaska and in the deep waters of the Gulf of Mexico. The way was opened for offshore oil and gas production in arctic conditions.

Sakhalin’s offshore oil and gas today

For exploration and production purposes, the waters surrounding Sakhalin have been divided by the Russian government and the local Sakhalin oblast administration into six large blocks, known as Sakhalin 1-6. Rights to explore, test and develop each were allocated to various consortiums of Russian and foreign companies during the 1990s. The make-up of each consortium frequently changed as partners fell out, discovered they lacked the required capital, lost confidence in the project, or simply changed their minds about the place of a Sakhalin project in their global strategies. Of the six blocks, Sakhalin 1 and Sakhalin 2 are the front-runners.

Sakhalin I Sakhalin II
Main fields/
  • Odoptu
  • Chayvo
  • Arkutun Dagi
  • Piltun Astokhskoye(15 km. Offshore, 30 metres of water)
  • Lunskoye(20 km. Offshore, 50 metres of water)
  • Exxon Mobil (30%, US)
  • Sodeco [Sakhalin Oil Development Company, owned by Marubeni and Itochu and XXX] (30%, Japan)
  • Indian Oil and Natural Gas (20%, India)
  • Rosneft/Sakhalinmorneftegaz(20%, Russia)
Sakhalin Energy, owned by

  • Shell (55%, Netherlands/Britain)
  • Mitsui (25%, Japan)
  • Mitsubishi (20%, Japan)
Operator Exxon Neftegas Shell Reserves of oil
Reserves of oil 2 billion barrels of crude oil 1 billion barrels crude oil
Reserves of gas 490 billion cubic metres [Bcm] 531 billion cubic metres [Bcm]
Oil production To start 2005; expected production of 8 – 12 million tones per year Phase I (present):production only during ice-free period: 15 million barrels May-December 2001 (2 million tonnes)
Gas production Possibly 2006 LNG production to start 2006, expected to reach 9.6 mtpa (million tons per annum)
Oil transportation Phase I (present): Offshore loading from Molikpaq platform onto tankers during ice-free six-month period.
Phase II (all year production and transport from 2005): Undersea and land oil pipeline to oil export terminal at Aniva Bay Gas transportation
gas transportation Plans to build a gas pipeline to Honshu Overland pipeline from gasfield to Aniva Bay (Prigorodon LNG plant, then LNG tanker export
Expected investment Stage I: $ 4 billion
Total: up to $12 billion
Total: $9 billion

Already producing oil in substantial quantities, Sakhalin II is the most advanced. Sakhalin Energy Investment, owner of the project, is in turn 55 % owned by Shell, which also operates the project, and 25% by Mitsui and 20% by Mitsubishi. For the past three years, oil has been pumped from its Piltun Astokhskoye field onto the large Molikpaq offshore production complex anchored to the seabed, where its is stored until large oil tankers arrive every six days to take the crude oil to markets in Japan and Korea. Production and loading can only take place in the ice-free months of the year (the season is less than half a year), and even then weather conditions can be severe.

In the next phase of Sakhalin I gas will be piped to shore, then down the length of the island to a liquid natural gas [LNG] production plant Aniva Bay. The world’s largest LNG plant will clean and freeze the gas, which will then be loaded in liquid form onto LNG tankers for export to markets Shell and its partners hope to find in Japan, Korea and Taiwan. Shell announced in mid-2001 to its shareholders that it hoped to announce longterm sales contracts within six months. With construction contracts for the LNG plant beginning to be announced, Shell and Mitsubishi and Mitsui shareholders and executives with $9 billion to lose will be waiting for the news.

Sakhalin I is owned by the US Exxon Mobil (30%) which also operate the project, the Sakhalin Oil Development Company [SODECO] (30%), the Indian Natural Gas Company (20%), and two Russian companies Rosneft/Sakhalinmorneftegaz (20%). While its proven oil reserves are large and its gas reserves huge, Sakhalin I is still at a developmental stage. This is mainly because Exxon and its partners intend to export gas by pipeline direct from the gas field to Niigata or further south on Honshu, a project that has given rise to wildly differing estimates of its cost. This uncertainty is in turn affecting the cost at which the gas could be offered to possible buyers, and hence, slowing down the process of making firm contracts.

The problems

Both Sakhalin I and Sakhalin II are very large and complex engineering projects planning to bring huge amounts of natural gas to industrial and consumer markets in Japan, Korea and Taiwan. No actual contracts have been signed, and competition with gas suppliers in other countries is severe. For the Japanese government, Sakhalin gas would be a welcome part of its strategy of diversifying sources and types of energy. When it is burned natural gas produces less carbon dioxide than comparable quantities of oil, and much less than coal. Accordingly, Japanese energy and greenhouse strategies both lead to plans to increase imports of natural gas.

Yet there are very serious problems with the Sakhalin I and II oil and gas projects – problems for Sakhalin, for Russia, and for Japan. In the next part of this article these problems will be examined, including:

  • the Exxon Valdez scenario of a major oil spill from a super-tanker:
  • less dramatic but frequent oil spills from rigs, and oil dumping from tankers and other ships
  • damage to the marine environment from drilling and construction
  • inadequate international ocean management regimes in the Sea of Japan and the Sea of Okhotsk
  • watering down of Russian environmental regulation in favour of no holds barred oil and gas production
  • social impact on the Sakhalin local population, including indigenous people, caused by both production and tanker and pipeline activities
  • serious doubt about the economic benefits to both Russia and Sakhalin under the production sharing agreements and employment arrangements
  • increased dependence of the Russian economy on natural resources export
  • the cost to Japanese tax payers of possible Japanese government subsidy of the planned Sakhalin I pipeline
  • a deepened commitment by Japan to an fossil-fuel and energy intensive industrial strategy.
  • Sakhalin human rights and labour conditions worsening as rapid gas project development by foreign companies with poor human rights records provokes a cycle of protest and repression under an authoritarian government with deep criminal connections.

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