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Russia to take back Sakhalin-2

Russian President Putin has issued a decree to take charge of the Sakhalin-2 project, a massive oil and gas project in which Shell has just over a 27% stake.

The takeover could force Shell and Japan's Mitsui and Mitsubishi to abandon their investments as the fallout from the Ukraine war spreads. Multinational oil and gas company Shell stated that they: "are aware of the decree and are assessing its implications."

The decree said a new company would completely take over Sakhalin Energy Investment. In February, Shell announced that it would dispose of its Russian investments due to the war in Ukraine, including the flagship in Sakhalin Island, taking a £3.8bn hit by departing Russia.

Sakhalin-2 supplies around 5% of the world's current liquefied natural gas (LNG) market and is 50% owned by Gazprom. According to the Russian decree, Gazprom will retain its holdings, but other shareholders must ask the Russian government to be included in the new company within thirty days. Moscow will then decide whether to allow them to have a stake.

According to reports, Shell had been talking with potential buyers for its share of the project, including some from China and India.

Shell’s chief executive, Ben van Beurden, said that Shell was "making good progress" in its plan to extricate itself from the project. "I cannot tell you exactly where we are because it's a commercial process, so I have to respect confidentiality, but I can tell you when I got updated last week, I was pleased with where we are," he said.

This appears to be a profoundly political decision with most of the impact falling on Japan, which has played a leading role in sanctions against Russia. Two other non-Russian companies hold major stakes in Sakhalin-2 apart from Shell, namely Mitsui, and Mitsubishi.

With Shell having already written off the value of its Russian assets and saying it would leave the country, Japan, remains heavily reliant on Russian LNG.

Competition for supply globally is intense - and the Sakhalin project alone provides for almost 9% of its needs. So, the prospect of Russia potentially seizing control of Japanese interests in the project is sure to generate an uneasy response in Tokyo - although ministers insist it will not make importing gas "immediately impossible."

If Russian liquid natural gas supplies to Japan are stopped, Japan will have to find sources elsewhere – further increasing competition for available supplies. That could raise prices globally as growing energy costs are already driving inflation.

Japan had said previously that it would not give up its stake in the Sakhalin-2 project, which is vital for its energy security, even if Russia asked it to leave. Shares in Mitsui and Mitsubishi fell 5% in trading on Friday on concerns about losses, with the broader Nikkei index dropping 1.8%.

A spokesperson for Mitsubishi said they were discussing how to react to Putin's decree with its partners in Sakhalin Energy and in Tokyo. Mitsui has a 12% stake in the project and Mitsubishi 10%, while Shell holds 27%. Russian gas giant Gazprom owns 50%, plus one share, giving it a controlling interest and making it the majority stakeholder.

According to Shell, Japan, South Korea and China are the main buyers of oil and liquid natural gas exports.

Chief cabinet secretary Seiji Kihara said Japan was studying the decree's contents and evaluating Moscow's intent. "Generally, our country's interests in resources should not be harmed," he told a news conference, without mentioning if his government was in communication with the Russians about the matter.

Japanese industry minister Hagiuda said his government did not consider the decree a requisition. "The decree does not necessarily mean that Japan's liquid natural gas imports will become unfeasible, but it is necessary to take all possible measures in preparation for all possible circumstances," he said.

Many believe that Russian liquid natural gas production from projects like Sakhalin-2 is likely to suffer as time passes because of overseas expertise and parts becoming unavailable, which will tighten the LNG market materially. In addition, any increase in Russian government involvement will make procurement from these projects more challenging for many buyers.