Sakhalin oil sparks hopes and fears

'A giant gas pump on the Pacific Rim'

by Russell Working

YUZHNO-SAKHALINSK, Russia — Sakhalin Island is a remote former penal colony where the sea freezes for up to six months a year and villagers have been known to sleep in tents pitched in their bedrooms when the central heating fails.

Off the coast of Sakhalin Island, in the Sea of Okhotsk, north of Japan, the Molikpaq oil rig produces thousands of barrels a day.

In recent years, power outages have periodically blacked out much of the island, and motorists grouse about skyrocketing prices at gas stations.

It is not a place one would expect to emerge as an energy source for East Asia. But with offshore oil and natural-gas reserves thought to rival those of Europe’s North Sea, an island still suffering from the Russian Far East’s perpetual energy crisis is poised to muscle into the market as a major petroleum supplier to Japan, China and South Korea.

Sakhalin’s offshore crude reserves, estimated at 28 billion barrels, make it one of the most promising fields in the world, foreign petroleum officials say. The natural gas from Sakhalin’s Lunskoye field alone would be sufficient to generate electricity for six modern cities of 1 million people each for 20 years.

Given the island’s proximity to Asia’s developed economies, one foreign oil executive in Sakhalin said, energy companies hope someday to build natural gas pipelines to Japan, China and South Korea, and they already export oil by tanker to the same countries.

Workers on the Molikpaq oil rig.

“It’s got potential no other oil fields have got,” he said. “It’s like a giant gas pump on the Pacific Rim.”

Oil and natural gas could transform the island’s economy by providing billions of dollars in foreign investment in a place where destitute villagers poach salmon from the streams to get by. Yet the pumping of offshore oil and natural gas has sparked a nascent environmental movement, which worries about the risks to the rich fisheries in the Sea of Okhotsk, where the drilling occurs.

Furthermore, federal officials’ handling of the project has drawn scathing criticism from independent government auditors, who last year claimed that officials have stolen millions of dollars in oil receipts meant for the national budget.

Even an oil rig can look beautiful in certain lights, but environmentalists worry about its impact on the Sea of Okhotsk.

The 930-km-long Sakhalin Island lies along the Sea of Okhotsk near an area known as “the ice kitchen,” and oil companies face formidable hurdles in their bid to extract petroleum. For six months a year, ice floes buckle and compress with a force that can crush steel. The drilling season is only five months long, and seismic conditions are similar to California’s. In 1995, an earthquake flattened the northern Sakhalin town of Neftegorsk, killing 2,000 people.

Nevertheless, foreign interest in Sakhalin is intense, and the stakes are enormous. American and Japanese investors plan to spend $36 billion over the life of the first three major projects, Sakhalin 1, 2 and 3.

For nations dependent on oil imports, Sakhalin offers the promise of diversifying sources, so that political disruptions in one region, such as the Persian Gulf, do not cut off the supply entirely. Indeed, Japanese interest in Sakhalin oil first started in 1975 for that reason.

“After the so-called oil crisis, the Japanese government decided to have other sources of oil and gas,” said Sugiura Toshishiro, manager of the local office of the Japanese-owned Sakhalin Oil and Gas Development Co. Ltd.

The company is one of the investors in the Sakhalin 1 project, which is set to start pumping oil in 2005.

Several Japanese firms have joined in the consortium Sakhalin Energy Investment Co. Ltd., which is already pumping oil off northern Sakhalin. Mitsui controls 25 percent of the shares, while Mitsubishi owns another 12.5 percent (the largest portion of the shares are controlled by Shell Oil Co.).

“We’re very active in marketing to the countries of the Pacific Rim,” said P.G. Bristow, Sakhalin Energy’s corporate affairs general manager. “Japan is a prime target, but we’re also looking at Korea and China. . . . Our source is nearby, and we can add to the diversity of their supply.”

The company — aided by early production-sharing agreements passed by a Russian Parliament that has since grown more hostile to foreign oil production in Russia — began pumping oil in mid-1999. This year, it projects that it will pump 13 million barrels of oil, with prices hovering around $30 a barrel.

Other companies have yet to start drilling, and they have complained that the Lower House of the Russian Parliament, the Duma, has stalled legislation that would allow drilling. In the case of Sakhalin 1, the production-sharing agreement has been approved, “but it is not working effectively,” Sugiura said.

Even for Sakhalin Energy, which is pumping oil, the tangle of contradictory regulations breeds frustrations. By law, oil companies are required to work together when possible, and they hope to build a pipeline from northern Sakhalin, where the oil is pumped, to an oil-export facility and natural-gas-liquefying plant in the southern port of Korsakov (when liquefied, the volume of gas is reduced 600-fold, allowing for export by tankers). Yet customs regulations would not allow the oil companies to cooperatively import the pipe for the pipeline.

Oil officials hope this will change. When Russian President Vladimir Putin visited the island this year on his way to Japan, it became clear that selling Sakhalin oil and gas was a priority for the Kremlin.

“We had the feeling that after his visit to Sakhalin, our project is going along at a good pace,” Sugiura said.

For all the hope that some place in oil, it also brings environmental risks in a nation that has been described as in a state of “ecocide” due to 70 decades of unchecked industrial expansion followed by economic collapse. Some fear that a country that recently abolished its Environmental Ministry does not have the regulatory capacity to keep an eye on a risky business such as offshore drilling. The Sea of Okhotsk is one of the world’s most biologically productive bodies of water, according to “Sakhalin’s Oil: Doing It Right,” a report commissioned by Sakhalin Environment Watch and the U.S. Pacific Environment & Resources Center. Fishermen from Russian, Japan and other nations harvest crab, shrimp, pollock and other seafood there, and the seas are spawning grounds for wild Pacific salmon.

“Yet new offshore oil developments along the northeastern shore of Sakhalin Island have greatly increased risks to the Sea of Okhotsk and its shorelines through an increased risk of oil spills,” the report states.

Natalia Barannikova, deputy director of the Sakhalin Environment Watch, said she has two major concerns. First, oil-based drilling mud should be either injected into the wells or disposed of by land (as is done in Alaska and Norway), rather than dumped at sea. The group also fears the possibility of spills by tankers. She and other environmentalists say offshore drilling may have been responsible for a huge “die-off” of Pacific herring that washed ashore in Sakhalin’s Piltun Bay in June last year.

“Tankers go to Korea and Japan every week, and nobody controls them,” Barannikova said. “In June, there were five tankers that belong to different companies. . . . In case of a huge oil spill, there is enough equipment to block only one bay. And the sea is so cold, the process of self-cleaning is zero.”

The group has urged Russian emergency officials to modernize their sparse equipment and work together with their Japanese counterparts to prepare for an oil spill. (The environmental group’s report adds, incidentally, that aging onshore fields pose a far greater immediate pollution risk than the new offshore drilling.)

Sakhalin Energy, however, responds that despite inherent risks in drilling, it is a good corporate citizen with a concern for the environment. In the case of an oil spill, materials and equipment are available locally and internationally to respond. “Emergency equipment stores and response teams have been established by Sakhalin Energy, and its personnel have been given regular training to ensure that equipment and material can be used quickly and effectively,” the company states in a report for the public.

Bristow added that 12 spills reported to the media have been tiny. The largest was eight liters, while the smallest was “literally a teacup full.”

“We have an environmental observer on the platform at all times,” he said. “There is sensitivity here, and understandably. This is a fishing area.”

There is no doubt that oil has the potential to bring billions into Russia’s coffers. But even as early as last year, concern was growing about how Russia’s oil revenue was being used. A report by the State Auditing Chamber, an independent federal body, states that bureaucrats from Russia’s Fuel and Energy and Finance ministries illegally transferred the receipts from oil revenues into private accounts of the Sakhalin regional administration and the energy ministry.

These, the report says, “are illegal withdrawals of federal-budget money that must be returned. The damage to the federal budget is estimated as at least $19.7 million.”

Ilya Kasyan, a spokesman for the Sakhalin administration, dismissed the report as “rubbish.”

“They are obviously incompetent people,” he said. “We have had so many auditing commissions here that the report could not be misused in any way.”

If the profits actually reach the people, oil’s benefits for islanders themselves could be enormous. Since its inception, Sakhalin Energy has invested $1.4 billion into the project, $550 million of which has gone to Russian ventures, the company estimates. A shipyard in Komsomolsk-na-Amure on the Russian mainland, for example, built a support structure for the Molikpaq offshore oil rig.

Throughout the capital city of Yuzhno-Sakhalinsk, a trickle-down of oil money is evident as foreign oilmen spend money, hotels fill up and oil companies hire local experts. Store owners have painted and plastered the fronts of their businesses, and new prefabricated shops and kiosks have sprung up throughout town. Even a report by foreign experts commissioned by Sakhalin Environment Watch acknowledges “the potential economic and social benefits to the local people from environmentally responsible development of Sakhalin’s offshore oil and gas deposits.”

The ripples in the economy can be seen beyond the capital, in the island’s destitute villages. Kasyan, the administration spokesman, said the flow of government oil revenue has reached remote towns.

“Hospitals and schools are being built,” he said. “The airport in Okha has been remodeled. In Nogliki, we built a gas power turbine [to supply the city with electricity]. We have added money to the pensions for retired people. We deepened the port in Kholmsk, and built a highway across the mountain pass.

“Over the past two years we’ve had enormous changes for the better.”