Journey to Sakhalin
Sakhalin Island’s resources include oil, gas and coal, as well as forestry and fishing. Before the collapse of the USSR, oil and gas were being extracted from the ground. Several geological studies show that the vast reserves of Sakhalin’s oil and gas were mainly under the Sea of Okhotsk. After the disintegration of the USSR, Russia was eager to rebuild its economy and oil and gas were resources that it could leverage for foreign assistance. Before Sakhalin II, Russia would contract with foreign investors or companies to exploit their natural resources with agreements in line with Russian laws and tax codes. The Sakhalin project was the first Russian production-sharing agreement (PSA) with foreign corporations. A PSA is a commercial contract between investor(s) who are willing to make a large, long term and high risk investments with the host country that has the natural recourses (usually oil and/or gas) to exploit. The terms behind PSAs are usually different than regular commercial contracts, as they usually bypass some of the regulations that the host country imposes on foreign investments. The agreements also last for the lifetime of the project. Under the terms of the PSA, the investing company gets the larger share of revenues at the beginning of the contract to recoup the cost of investment. As time goes by, the net revenues (revenues after the cost of operations) are shared between the investment companies and the host country, usually a 20/80 split. PSAs are controversial in Russia because they bypass some of the taxes and licenses that a foreign company would have to pay. Previous foreign companies had worked in Russia under the regular tax system, therefore it was argued that PSAs don’t treat all businesses equally and create a sense of unfairness. Furthermore, PSAs apply only to greenfields.. Greenfields are unexploited, undeveloped large pieces of lands with exploitable resources, and some circles felt that Russia should not cheaply bargain away these coveted lands. PSAs are agreements between the foreign direct investors (FDI) and the federal Russian government; thereby limiting the power of the mid-level establishment, traditionally and politically a powerful group in Russian politcs. At the time of the agreement, the local Sakhalin Government, led by Governor Igor Farkhutdinov, was a key player in the decision, mainly because Farkhutdinov was politically influential and in favor of the project. After the fall of the communist regime, Russian GDP fell by 50% and up to half of the population was living below the poverty line. Oil and gas constituted the main export earnings of Russia, whose borders encompassed the largest supply of gas in the world (30%). Attempts by Russia to privatize state-owned energy firms had mixed results. The oil industry produced a number of vertically integrated firms such as Sidanko and Sibneft, which formed the basics of a competitive environment. Conversely, privatization of the gas industry produced a single, dominant company: Gazprom. At times, it appeared that the Russian Government acted on behalf of Gazprom due to the significantly higher impact this industry had on the Russian economy, and because it was a 38% stakeholder in the company. As Gazprom controlled 20% of the worlds gas production, there were significant political interests associated with the development of this industry in Russia. Thus far, Russia’s exports were mainly to Europe, as Russia had been unable to build pipelines to East Asia and Japan. The energy sector constituted 20% of GDP, and Gazprom alone was responsible for 8%. The growing economies of the Far East, combined with Russia’s need to exploit its oil and gas reserves (both for economic reasons, as well as for political influence) helped push Russia to seek Foreign Direct Investment (FDI). Russia also required foreign expertise, as transportation of gas to Asia would require a Liquefied Natural Gas (LNG) facility;...
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