A new dawn for gas

By Ben Thompson, Senior Editor

Given its former status as a gulag for exiled Tsarist dissidents, Sakhalin Island has long had a reputation as one of the gloomiest places in Russia. But thanks to its abundant reserves of oil and gas, the island could yet prove an unlikely source of hope for the economy.

“When the Sakhalin II project is fully on stream, it will supply around five percent of the world’s LNG and make a significant contribution to strengthening global energy security”
-Ian Craig, CEO, Sakhalin Energy

As operating environments go, the oil and gas fields of Sakhalin in Russia’s Far East are up there with some of the harshest on the planet. Offshore temperatures in the North of the island regularly plunge as low as -40˚C, and storms whip the waves up to 10 metres in height. For at least six months of the year, the Sea of Okhotosk is covered in thick ice, complicating navigation and oil production. The frequent typhoons can produce up to 220mm of rain during a single 24-hour period. Winds often reach hurricane strength. And to complicate matters further, the island sits atop one of the most active seismic areas on Earth. There are more than 40 active volcanoes on the island, while some 2000 people died in the 1995 earthquake in Neftegorsk in the north of the island. With the risk of seaquakes just as great, any structures – onshore or off – must be designed to withstand the worst. Dramatist Anton Chekhov, visiting in 1890 when the island still housed the largest prison camp in the world, described it as “hellish” – and in such an elemental environment, it’s easy to see what he meant.

Still, for those willing to brave the extreme climate, the rewards are rich indeed; the 600-mile-long island is also home to some of the world’s most lucrative hydrocarbon reserves. An estimated 45 billion barrels of oil equivalent lie beneath the icy seas off its shores – recoverable oil reserves of almost seven billion barrels, and natural gas reserves reckoned to be in the region of approximately 80 trillion cubic feet. As such, Sakhalin has proved a magnet for international companies looking to gain a foothold in Russia’s significant oil and gas plays. And even though developing those resources is proving lengthy, difficult and expensive, there are signs that progress is finally being made.

International experience
When the Russians first discovered oil at Sakhalin in the mid-19th century, the find was so inaccessible that it was all but ignored. Even as recently as the 1980s, when geologists began to understand the vast scope of the offshore resources, it was unclear how the remote oil and gas could ever be brought to market. It was only when the Russian government invited tenders from international companies with the offshore experience required to develop such fields that Sakhalin’s long-held promise began to be realised, through the creation of a number of multinational consortiums.

The Sakhalin II project is one such example. A joint-venture between Russian majority shareholder Gazprom, Anglo-Dutch company Shell and Japanese firms Mitsui and Mitsubishi, the project is operated under the Sakhalin Energy Investment Company and represents the world’s largest integrated oil and gas project. It comprises six large-scale subprojects being advanced in parallel to develop the island’s Piltun-Astokhskoye and Lunskoye fields, and includes three large offshore platforms located off the north coast of the island, an onshore hydrocarbon processing plant, a gas liquefaction plant in the south, an oil export terminal and many hundreds of kilometres of connecting oil and gas pipelines.

“Sakhalin Energy has been at the forefront of developing this new province,” explains the company’s CEO Ian Craig proudly. “We installed Russia’s first offshore platform in our initial phase of development. Now, we have just finished Russia’s first LNG plant as well as the TransSakhalin Pipeline system, two new platforms and an onshore processing facility. To be able to contribute to the development of such a frontier is very satisfying.”

It’s been a significant undertaking for Craig and his team. The project employed some 25,000 people from more than 30 different nations at the height of the construction phase in 2007, during which Sakhalin Energy transported goods and people a distance of six million kilometres monthly – the equivalent of seven trips to the moon and back each month. The onshore pipeline system entails a total of 1600km of pipe, equal to the distance between Moscow and Berlin, and crosses more than 19 seismic faults and 1000 watercourses. Offshore pipelines have been rerouted to address environmental concerns over the endangered Western Gray Whale. And the Lunskoye-A offshore gas platform, Russia’s first, incorporates a series of trail-blazing (not to mention record-breaking) engineering and technology innovations. Total costs are estimated in the region of $20 billion, with around $500 million spent on much-needed infrastructure upgrades to the island alone.

Global energy challenges
Despite initial concerns over the size of the budget, a growing body of evidence suggests such investment is critical to Russia, its neighbours and the world’s energy markets in general. Global demand for energy is expected to more than double by 2050 as economies and populations grow, and supplies of easy-to-access oil and gas will have difficulty keeping up with surging demand. At the same time, environmental stresses are increasing, with rising carbon emissions a major concern. As such, natural gas – the cleanest-burning fossil fuel – has a key role to play in meeting future energy needs, with Sakhalin’s vast reserves a major part of Russia’s future export plans.

Moscow is betting that liquefied natural gas (LNG) will provide the means to bring clean, abundant, affordable natural gas from the fields where it is produced – often in remote areas far away from customers – to local markets where it is needed. LNG can be transported and stored more easily than natural gas because it occupies up to 600 times less space; it also reduces dependence on costly pipeline systems for transportation, a significant handicap to the profitability of the natural gas sector to date. Transforming the gas into a liquid makes transportation more efficient and brings geographically remote gas fields such as Sakhalin into play as serious energy sources.

It’s a view shared by energy analysts. “A widening separation of supply from the demand centres favours the economics of LNG over pipeline gas,” explains Daniel Yergin, Chairman of Cambridge Energy Research Associates. “LNG also brings something else that is very compelling: flexibility. This becomes increasingly important as the global gas market develops. The next two years will see a giant step-up in LNG supply. Global capacity will rise by almost one-third by the end of 2010, and Sakhalin II is an important contribution to that growth.”

The centrepiece of the Sakhalin II project is its LNG production plant and offshore export terminal, located near Prigorodnoye on the south coast in Aniva Bay. Two identical processing units (or trains) process gas to produce 9.6 million tonnes of LNG annually. The complex also includes storage tanks for LNG and oil, a 480-megawatt power supply, an undersea pipeline to the tanker loading unit and a seaport. The new plant – officially inaugurated by President Dmitry Medvedev on February 18 – lays the foundation for Russia to become a leading energy exporter to the highly competitive energy markets of the Asia-Pacific region.

“When the Sakhalin II project is fully on stream, it will supply around five percent of the world’s LNG and make a significant contribution to strengthening global energy security,” explains Craig. “About 98 percent of our gas is contracted on a long-term basis over 20 years, with two-thirds going to Japan and about 15 percent to Korea. Japan is the largest LNG market in the world, while Korea is the second largest. And they’re both on our doorstep. Sakhalin has now firmly established its position on the global energy map.” That position was further solidified when Japan received its first imported liquefied natural gas shipment from Sakhalin earlier this month.

An important milestone
It’s a big step both for the company and for Russia as a whole. During the unveiling of the Sakhalin plant, President Medvedev conceded that its completion was an important milestone for the Russian government. “The project is of strategic significance, both to our country and to our foreign partners,” he said with barely concealed excitement. “It will promote our capabilities on gas supplies and Russia’s position as a global supplier of natural resources in the world.” Estimates indicate that LNG’s share of the international gas trade will grow significantly over the next two decades, with demand volumes forecast to increase 180 percent by 2020 and 250 percent by 2030.

Craig believes that Sakhalin Energy is now well placed to capitalise on that upward trend, and can even improve on its current nameplate capacity. “Once the system is fully operational, we’re looking at de-bottlenecking and other operational improvements in order to try and get an additional 10 percent out of it, so we’ll have a little bit of flexibility with those volumes,” he says. “If you look at most LNG developments, they rarely stop with the first two trains. We have decided not to progress a third train right now – we want the company to focus on getting the first two trains up and running, and then the shareholders will take a look at future expansion – but I think there are sufficient reserves within the Sakhalin II PSA area to underpin that expansion.”

Further exploration, in areas outside the boundaries determined by the Sakhalin II project agreement, is purely hypothetical at the moment as the company is only currently able to develop the reserves within the license area. However, in the long-term, he concedes that third-party gas could be looked at, as well as additional fields. “There is gas in Sakhalin I that hasn’t found a home yet. And there will be further exploration and development in Sakhalin III. So there’s loads of gas on the island, and we’ve invested in substantial infrastructure for its development.”

For now, Craig insists the company remains firmly focused on the task at hand. “It’s entirely possible for us to get involved in other areas of exploration, but that would require further negotiation between the shareholders and the Russian government. Within our license, however, we have additional prospects to drill and appraise. For example, at Lunskoye we have prospects below the level of the current reservoir that we want to assess. We also have an oil rim that we want to take a look at, as well as various other structures that we’d like to assess south of our existing fields. But the key priority in the next couple of years is to get the current facilities up to full capacity. So any further exploration activity will be secondary to that objective.”

Getting up to speed
Now that Phase 2 of the project is complete, attention has turned to the ramp-up stage – part of which involves the technology transfer from foreign specialists to local operations teams. “In the construction and startup phase there was a very heavy dependence on foreign specialists, primarily from Shell, but as time goes by those numbers will reduce,” says Craig. “Our technology transfer program involves training up Russian staff to take over those roles. In five years’ time, 90 percent of the company will be Russian, with 10 percent being outside specialists – nominated on a rotation basis from amongst our shareholder companies – to keep ideas fresh. We currently have a split of about 70/30 in favour of Russian employees.”

Besides the obvious benefits of having a Russian workforce, the move is also a reflection of the recent ownership change that saw Gazprom assume a majority stake (of 50 percent plus one share) in the company. Until Sakhalin II, Gazprom had no LNG expertise, despite being the world’s largest gas producer and reserve holder. Being the largest shareholder of Sakhalin II, however, gives the Russian giant a very big window into this increasingly important industry.

As far as Craig is concerned, however, the behind-the-scenes changes have had little impact on the project. Gazprom has few technical experts involved in the project at present, preferring to cede technical responsibility to Shell – although a Gazprom subsidiary will soon operate the onshore pipelines.

“In terms of the day-to-day operations, there isn’t a huge change, to be honest,” he says with a smile. “We tend to drink vodka with dinner as well as wine, but there isn’t much difference in the day-to-day running of the company. It’s an international company with over 40 different nationalities, and Russian has always been the predominant nationality – even when Shell had a 55 percent ownership, there were many more Russians in the company than other nationalities. My own view is it will remain a very international company because it’s customer-focused, and because of where it is. And I’ve seen no inclination by Gazprom to change that. I think they see the business imperative of keeping that international aspect.”

Indeed, he feels that Sakhalin II could serve as a model for other Russian megaprojects, such as the one that will be needed to develop the resources of the Yamal Peninsula, and that as a result Gazprom will want to make the project a success. “If you look at some of the developments that Gazprom has going forward, then the mix we have here at Sakhalin – where you’re blending Russian expertise, foreign expertise and both domestic and foreign capital – is a good basis for success.”

Opening new frontiers
Experience demonstrates again and again that the development of large gas reserves in remote locations – particularly when using LNG – brings significant and sometimes daunting challenges – technical, financial and operational. “The very size of LNG investments, with many billions of dollars in upfront capital, has often encouraged a joint-venture approach to share out the burden and risks,” confirms CERA’s Yergin. “Often the combination of the skill sets of national oil companies and international oil companies is what is required to bring about successful execution.”

Viktor Martynov, Rector of the Gubkin Russian State Oil and Gas University, agrees. “The oil and gas business and its technologies are essentially international,” he says. “The era of easy fields is over; projects are becoming more complicated, and technological and financial challenges are often insurmountable for a single company. Tackling projects through international consortiums leads to lower costs, better budget planning and more qualified workers.”

The alignment of interests between many different stakeholders can be challenging, but is critical if such developments are to be successfully executed. And it is this quality that Craig believes provides the defining success story of Sakhalin. “You may have a department or a company that produces oil or gas, a department that sells, and perhaps a department or company that makes LNG. In Sakhalin Energy we have all of that together – from the reservoir to the customer,” he states. “My vision of Sakhalin in 10 years time is that the island will have developed its capabilities much further. It will have homegrown contractors that can service the international oil industry, not just the Russian sector. They will be competing internationally, going out in the world and doing equally challenging work, perhaps in the Arctic. I’ve seen this model develop in other parts of the world. So in the future, when I bump into a Sakhaliner in some remote corner of the world I will know that we did a good job here.”

And for Russia itself, the future is equally bright. “The start of export to Japan, Korea and the United States is, for our country, an opportunity to assume a new function as a reliable supplier of liquefied gas,” concludes Gubkin’s Martynov. “Hopefully Russia will not stop at this, but will develop new projects – for example, in the Arctic.” As those projects start to come on stream, Russia may yet come to view Sakhalin as one of the most important developments in its recent history.

The local leader
Alexander Khoroshavin, Governor of the Sakhalin Region
Life in Sakhalin started to change as energy companies began coming to the island and offshore projects developed. The roads became busier, field developments commenced and towns and villages began to emerge. New jobs were created and people cheered up; they saw hope for a better future.

Of the population on Sakhalin, 300,000 are employed. Our unemployment rate is fairly low – 0.8 percent, which equals to some 2500 people. For this number of unemployed people we have some 6000 vacancies, which are mostly highly paid jobs. The average salary on Sakhalin is around 32,000 roubles.

Sakhalin’s budget amounts to over 42 billion roubles, with 60 percent of the funds from revenues generated by the island’s offshore developments. In terms of budget per capita, Sakhalin can be compared to Russia’s most developed regions.

Now we are able to invest much more cash in social projects and infrastructure developments. Just this year we have invested four billion roubles in the construction of 30 kilometres of roadway for the Trans-Sakhalin highway, the island’s main artery. We are also building hospitals, schools, sports arenas and health facilities.

The majority shareholder
Alexander Medvedev, Deputy Chairman of Gazprom’s Management Committee
I believe that Gazprom and Shell have overcome any fundamental difficulties and are now professionally tackling the main challenges in implementing such a large-scale infrastructure project as Sakhalin II.

I am sure that Sakhalin II will be a platform for the expansion of our co-operation with Shell. Gazprom is hoping that Shell will remain one of our key partners, that we will be able to find common points and develop high-potential projects, including LNG, with due regard to corporate goals and complying with the business principles of each side.

LNG has become an integral part of global gas trading and one of the key factors in the energy market. Indeed, a large share of the annual increase in gas consumption today is provided by LNG.

Since 2004, Gazprom has been pursuing a phased strategy to boost our presence in the LNG market. As a part of the first phase of this strategy that implies one-off deals and LNG/pipeline gas swaps, liquefied gas was supplied to the United States, United Kingdom, South Korea, Japan and also to Mexico and India.

The implementation of Sakhalin II will ensure stable energy supplies to Japan, South Korea and the United States. This will, in turn, enable Gazprom to become established in the global LNG market. Gazprom and Shell hold regular meetings at the top and working levels, discussing Sakhalin II issues and the potential for wider cooperation.

A pioneering project
Sakhalin II represented many Russian ‘firsts’, including:
• The first production sharing agreement (PSA), signed in 1994
• The first offshore oil and gas development
• The first LNG plant
• The first opportunity for Asia-Pacific customers to access Russian gas

Timeline:
Sakhalin II project: key milestones

1984 Lunskoye field is discovered in the northeastern part offshore Sakhalin
1986 Piltun-Astokhskoye field is discovered in the northeastern part offshore Sakhalin
1991 The USSR announces an international tender to conduct a feasibility study for the development of the Piltun-Astokhskoye and Lunskoye licence blocks
1994 The Sakhalin II PSA is signed by the Russian Federation, the Sakhalin Oblast Administration and Sakhalin Energy
1999 Commercial oil production begins from the Molikpaq platform at the Piltun-Astokhskoye field, Russia’s first offshore oil production
2003 Construction starts on the TranSakhalin pipeline system, one of the largest systems in the world
2004 Sakhalin Energy delivers first cargo of Russian Far East crude oil to Tohoku Electric Power Company in Japan
2006 The LUN-A platform is installed, Russia’s first ice-class gas production platform
2007 Sakhalin Energy successfully installs the PA-B platform
2008 Year-round oil export begins through the Oil Export Terminal in Prigorodnoye
2009 Sakhalin Energy delivers its first LNG shipment to Japan

Prigorodnoye production complex
The liquefied natural gas plant at Prigorodnoye is designed to receive, treat, process and liquefy natural gas. Annual gas import to the plant will total about 13.8 billion cubic metres, primarily from the Lunskoye field. Gas treatment, processing and liquefaction will be performed on two parallel processing trains. Each processing train is fitted with an acid gas (CO2 and H2S) removal unit; a gas dehydration unit with molecular sieves; mercury removal using activated carbon; fractionation for refrigerant and stable condensate production; and a gas liquefaction unit.

To liquefy natural gas (clean methane CH4) it must be cooled to -162˚C through compression. The gas undergoes a 600-fold volume reduction and becomes liquid at ambient pressure. It can then be shipped by large tankers t a receiving terminal where the LNG will be re-gassified and delivered to power generator customers and gas consumers through local gas distribution systems.

Shell, the global leader in LNG technology, developed the proprietary double mixed refrigerant process especially for the Sakhalin II plant. This leading-edge technology is optimised in such a way that it offers maximum efficiency in the cold Sakhalin winters whilst keeping the compressors running at their best performance.

Liquefied gas is directed to two isometric storage tanks with a capacity of 100,000 cubic metres each. The tanks are designed as two-wall structures 37 metres high and 67 metres in diameter. The LNG is kept in the tanks until being loaded to LNG tankers.

As the tanker approaches, LNG loading through the specially constructed jetty is started. The LNG jetty is 805 metres long and fitted with four arms – two loading arms, one dual purpose arm and one vapour return arm. Water depth at the tail of the jetty is about 13 metres, and the jetty can accept liquefied natural gas tankers with capacities from 18,000 to 145,000 cubic metres.

According to preliminary estimates, loading operations will take from six to 16 hours, depending on vessel capacity. The jetty will be able to load around 160 LNG tankers per year.