"Economic Development and the Environment"
on the Sakhalin Offshore Oil and Gas Fields II

Copyright (C) 1999 by Slavic Research Center , Hokkaido University.
All rights reserved

Introduction ^*1

The dissolution of the Soviet Union and the demise of the Communist dictatorship quickly raised hopes for the development of a democracy in new Russia. However, the ensuing chaos in the country has raised doubts about the prospects for a society based on the Western notions of law and justice. Lawlessness is said to be as much an enduring characteristic of Russian society as obedience and submission to authority. The Russian people are said to exhibit the contradictory tendencies toward deference to authority and resistance to authority. According to Vasilii Kliuchevskii, "arbitrariness of thought corresponds to arbitrariness of authority." ^*2  "The thinking man who confronts a problem which does not fit his customary outlook employs Russian common sense and says, 'I am above logic' and refuses to recognize the problem or resolve the conflict." ^*3

It is universally held that a democracy requires the presence of civil society in which citizens recognize and exercise their rights and discharge their responsibilities as members of a community. It is increasingly maintained that civic consciousness today includes recognition of the impact that citizens' activities have on their environment and on that of others. There is evidence that Russian citizens' environmental conscious has been growing since the beginning of perestroika. Unfortunately, however, there is also evidence that commitment to the solution of ecological problems has waned since the early 1990s, both at the political level and at the grassroots level, as the nation has plunged into a prolonged economic crisis and most Russians are more preoccupied with their everyday concerns than with ecological issues. ^*4  One would suspect this image of ecologically passage people also applies to Sakhalin, where economic difficulties are just as serious, if not more serious, as in the rest of the country.

Do citizens of Sakhalin exhibit the traditional characteristics noted above? Do they see the ongoing development of oil and gas resources off their island as a development largely beyond their control, as a product of some arbitrary decisions by their authorities, and as a project that brings to them more harm than good? Alternatively, will the development projects promote the formation of values and institutions that meet the standards of contemporary civil society? Above all, what role do the citizens of Sakhalin see themselves playing in this process? The present study is our first step toward answering these questions.

Will the energy development now underway in Sakhalin bring about the material prosperity the region's citizens have been promised since the beginning of the radical economic reforms in 1992? Will it further exacerbate the problems of environmental deterioration and social dislocation that they are currently experiencing? Will the economic benefits be shared fairly and equitably among the citizens, or will most of the profits go to small circles of politicians, bureaucrats, and businessmen? Will Sakhalin become merely a supplier of raw materials for the more advanced capitalist neighbors? Will the oil and gas development projects promote or weaken citizens' confidence in their leaders' ability to navigate the island's future in the ocean of globalizing capitalist economy in the twenty-first century? However we measure the success of energy development, there is no question that the ongoing oil and gas projects in Sakhalin will have a profound impact on the lives of the Sakhalin citizens, economically, environmentally, socially, and perhaps even politically.

Our ultimate goal is to contribute to the formulation of recommendations for enhancing the positive impact of the development projects on the lives of Sakhalin citizens. We need to examine closely the results of our study and to offer explanations for our findings. Even though our immediate concern relates to ongoing developments in Sakhalin, our responsibility as social scientists goes beyond describing such developments and their immediate impact. We need to bring a fuller understanding of Russian society into the discourse on the contemporary economic life of Sakhalin citizens. We will do so on the basis of our understanding both of the contemporary context in which Sakhalin citizens find themselves and of the historically rooted cultural norms and orientations that shape the value orientations and behavioral patterns of contemporary Russians. We believe it is essential that we go back in Russian history and identify certain patterns of behavior and attitude among the Russians. This need arises from the fact that so much change has taken place in the political, social, economic, and cultural spheres of life in Russia generally and in the Russian Far East particularly. We need to separate sources of change from sources of continuity in the contemporary Russian society.

In the following pages, we will first provide a brief background to the Sakhalin oil and gas projects. Secondly, we will introduce the preliminary results of our survey conducted in September-December 1998 to identify the perceptions and attitudes of Sakhalin citizens toward those projects. We will then provide a summary of findings and conclude with some explanations for the most important of the findings and some additional thoughts.

It should be stressed that we are in early stages of our study and the findings we report in this paper are preliminary. We are sharing our findings at this point to stimulate discussion about this neglected issue and to receive feedback from our colleagues. We also believe that some of our findings are potentially quite important and that they require further study.

The Sakhalin Oil and Gas Projects

Energy and fuel production served as the backbone of the Soviet economy and its importance has increased during the years of Russia's transition to a market economy. In 1997, for example, the industry provided 68 percent of all federal budget revenues. In Russia today, oil and gas account for about 45 percent of tax revenues, 25 percent of the GDP, and 10 percent of employment. ^*5

The economy of Sakhalin Island, as elsewhere in post-Soviet Russia, has suffered steady declines since 1991. Population fell by 12 percent from a high of 719,000 in 1991 to 634,000 in 1998. ^*6  Most of the loss in population is due to economic hardships in Sakhalin and it is expected that many more people will leave the island if they find employment opportunities elsewhere. Under these circumstances, the revitalization of traditional resource industries, including energy production, has become a very important goal of the regional government. Energy development occupies an important place in the economy of this Far Eastern island, with coal, oil, and gas together representing 24.9 percent of industrial output. ^*7

It is against this background that both the Russian government and the Sakhalin Oblast administration are promoting the development of oil and gas reserves in Sakhalin. As a U.S. analyst of the Far Eastern economic scene observes, while Western investment is fleeing from Russia, the energy sector of Sakhalin has managed to attract major international investment. ^*8

In 1995 the Russian Ministry of Foreign Affairs and the Japanese joint stock company SODECO (Sakhalin Oil Development Corporation) concluded an agreement to develop oil and gas on the continental shelf off Sakhalin Island in the project known as Sakhalin-1. The origin of the project goes back to 1972, when the Soviet Union proposed to Japan that they jointly explore for oil and gas on the continental shelf off this remote island. The exploration began in 1975 and led to the confirmation in 1978 of the resources of the two fields, Chaivo and Odoptu, but the declining world oil prices suspended the project until it was resumed in 1991. That year SODECO teamed up with Exxon Neftegas and won the international tender for Sakhalin-1 but lost the rights to develop Lunskoe and Piltun-Astokhskoe oil and gas fields, the project known as Sakhalin-2. The two companies agreed that each side would cover 30 percent of the estimated cost of the project. The project expanded with the addition of the Arkutun-Dagi oil and gas field in 1993. In 1995 two Russian companies Rosneft-Sakhalinmorneftegas (SMNG) and SMNG-shelf joined the consortium, agreeing to assume 17 percent and 23 percent of the total cost, respectively.

The exploration for oil and gas in Sakhalin-2 began in 1984. In 1986, Mitsui and McDermott formed a consortium, each side assuming 25 percent of the project cost. In 1991, Marathon Oil joined the consortium with a 37.5 percent share of the cost. In 1992, when the group acquired the rights to develop the fields, two more companies joined the project: Mitsubishi with a 12.5 percent share of the cost and Royal Dutch Shell at 25 percent. In April 1994, Sakhalin Energy Investment Company was formed to operate the project and to enter into a production sharing agreement with the Russian government. ^*9  Officially, the project's implementation commenced in April 1996. By that time McDermott had left the consortium. In 1998 a giant sea rig was installed in the Piltun-Astokhskoe field and the first oil is expected in 1999.

In June 1994 the Russian side - the federal government and administration of Sakhalin Oblast - and the operating company signed a production sharing agreement for Sakhalin-2. A production sharing agreement was signed for Sakhalin-1 a year later. In January 1996 the Russian Federation enacted law on production-sharing to attract investment and advanced technology for oil and gas development. The Sakhalin production-sharing agreements stipulate that Russia must delegate the right to develop the offshore resources to the investors that will undertake both the financial and technical implementation of the projects. Profits will be used first to recover the cost of the investment and royalty payments (6-8 percent of the cost of the product), and only after that initial stage will a "profit sharing" mechanism kick in.

Under the agreement on Sakhalin-1, the Russian side will receive 15 percent of the profits if the internal rate of return is lower than 16.5 percent, but if it is higher the Russian share will increase to 54 percent, with the remaining 46 percent going to the investors. If this is the case, the total share of the Russian side in profits can be as high as 72 percent, including the share of the two Russian companies participating in the consortium. In the production sharing agreement for Sakhalin-2, the Russian share will be 70 percent if the internal rate of return is higher than 24 percent. If it is within the 17.5-24.0 percent range, the profits will be split evenly, but with a level of return lower than 17.5 percent, the share of the foreign investors in the profits will be 90 percent. ^*10

The Sakhalin-2 and Sakhalin-2 contracts (as well as the contract for Sakhalin-3; see below) also provide for bonus payments for the Federation government upon initial signing and the start of production. Each consortium contributes to the Sakhalin Development Fund after a commercial discovery is announced and annually for five years after that. The Federation Treaty and Federation Law on Sub-Soil Resources specify a division of the royalties for extraction of hydrocarbons, which gives the Federation government 40 percent, Sakhalin Oblast 30 percent, and local government 30 percent. There is contradicting information that suggests the Sakhalin Oblast administration will receive only a modest share in the bonus payments, royalty oil, profit taxes, and "profit oil" (the production share designated after recovery of certain costs). From Sakhalin-2, the regional administration expects to receive an average of only $20 million per year from 2000 to 2010. ^*11

The Sakhalin-1 and Sakhalin-2 projects represent a very important effort by Russia to cooperate with the international community in developing energy for domestic use and for export. With its own investment capital dwindling and technology increasingly outdated, Russia desperately needs international participation in these projects.

The total investment in Sakhalin-1 and Sakhalin-2 is estimated to reach $15 billion and $10 billion, respectively, by 1999. ^*12  The two projects will produce an estimated 279 million tons of oil, 1,230 billion cubic meters of natural gas, and 82 million tons of condensed gas. ^*13  The first oil is expected in 1999 from Sakhalin-2, and in late 2000 from Sakhalin-1, with commercial gas extraction to follow in 2002. A Sakhalin-3 project has also been proposed. The participants will include Exxon, Mobil, ^*14  Texaco, and Rosneft-SMNG. The project consists of four main fields including the East Odoptu, Aiashskoe, Veninskoe, and Kirinskoe fields. ^*15  Total reserves of oil and gas condensate are estimated at about 133 million tons and natural gas reserves over 500 billion cubic meters. The agreement on Sakhalin-3 allows six years for exploration and 19 years for exploitation. The implementation of the project will begin in 2000, pending the Russian Duma's approval of a list of individual production sharing agreements. The project is very large, with geological exploration alone requiring an estimated $500 million. There are other pending projects: Sakhalin-4 and Sakhalin-5, which will involve Arco, British Petroleum, and Rosneft-SMNG.

These projects represent a major environmental risk. The sea area of Sakhalin-1 and Sakhalin-2 is frozen six months out of the year and there is drifting ice for another three months. The transportation of oil and gas also entails environmental risks. Two pipelines will be used to transport oil and gas to the south of Sakhalin Island, where the first Russian LNG plant is slated for construction. Exxon and SODECO have proposed to transport the recovered oil through 625 kilometer-long pipeline to an oil terminal to be built on the eastern coast of Sakhalin Island. The Sakhalin Oblast administration wants the oil to be transported to the south of Sakhalin through a pipeline that it assumes can be used for both Sakhalin-1 and Sakhalin-2. The great differences in temperature from north to south may cause clogging. The southern half of the island is quite narrow and pipelines may disrupt the north-south migration pattern of reindeer. ^*16  There are also feasibility studies underway for an under-water pipeline to Japan and a gas pipeline to the Russian mainland and North and South Korea. ^*17  These alternatives, too, raise serious environmental concerns.

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