Shell shakedown

How the world’s second-largest oil company lost control of its $22 billion project on Russia’s Sakhalin Island.

(Fortune Magazine) — Word that control of the world’s largest integrated oil and gas project had been wrested from Royal Dutch Shell trickled down to the company’s staff on Russia’s Sakhalin Island in December the same way it reached everyone else: via the newswires.

Outside Shell’s six-story steel-and-glass compound in Yuzhno-Sakhalinsk, a town of 175,000, snow swirled in subzero wind past drab rows of communist-era cinderblock apartments. Inside, Jim Niven, the company’s gregarious head of external affairs, was halfway through an upbeat presentation on the vast potential held in this claw-shaped island dangling from the Siberian Arctic – an estimated 45 billion barrels of oil and gas – when he was interrupted by a nervous colleague, paper in hand.


The news was stunning, even if rumors had been flying: Shell was halving its ownership in the $22 billion project, cutting its stake from 55% to 27.5%, and Gazprom, the Russian gas giant, was stepping in, buying Shell’s share plus half the stakes owned by Japanese partners Mitsui and Mitsubishi, for just $7.5 billion – the equivalent, says a Shell spokesman, of “paying to enter on the ground floor, as if they were a shareholder at the beginning.” The foreign companies also agreed to absorb $3.6 billion of the project’s mounting cost overruns.

Shell’s top executives, who were in Moscow at the time, weren’t negotiating from a position of strength. Not in Vladimir Putin’s Russia, where strong-arm tactics have been used to reassert government control of the country’s vast natural resources. Last summer the Russian Ministry of Natural Resources suddenly backed Sakhalin Island environmentalists, revoking permits and delaying work on twin 400-mile pipelines that connect to a monstrous LNG terminal and an oil-export facility. The threat of a $50 billion lawsuit meant Shell stood to lose everything.

Fortune