Case 4 Sakhalin 1 Project

8/10/2019 Case 4 Sakhalin 1 Project

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Sakhalin-1 Project:

Delivering Excellence in Project Execution

This case is about the Sakhalin-1 Project considered to be the largest and the most

ambitious world-class oil and gas development projects in the world. Located on the

northeast shelf of Sakhalin Island in Russia, the project is developed by a consortium

of Russian, Indian, Japanese, and US oil and gas companies.

Operated by Exxon Neftegas Ltd (ENL), the Sakhalin 1 Project includes three offshore

oil fields, the Chayvo, Odoptu, and Arkutun Dagi. The project is being developed in

four phases using both onshore and offshore drilling fields. The total recoverablereserves were estimated at 307 million tons of oil and 485 billion cubic meters of

natural gas.

The case describes the development and execution of the project. Advanced

technologies and construction methods were adopted in the execution of the project

which reduced the overall cost of development and minimized environmental impact.The case highlights how the project overcame the technical and environmentaldifficulties to achieve its goals. It discusses how the project team successfully

managed the challenges associated with the project such as limited infrastructure,

complex regulatory rules, limited skilled labor, and difficult logistics. Analysts opined

that with careful planning and efficient use of technologies, the project successfully

completed its first phase of development.

The project, one of the largest single foreign direct investments in Russia, aimed tofulfill the growing energy demand worldwide. It provided energy supplies for

domestic use and for export to Northeast Asia and consolidated Russia's strategic

position as an energy supplier to world markets. The case also discusses the benefits

the project brought to Russia, particularly to people of the island of Sakhalin.

The case concludes by discussing the future phases of the Sakhalin-1 Project.


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Sakhalin-1 Project:

Delivering Excellence in Project ExecutionThe key to maximizing resource value lies in the ability of a global organization to

apply leading-edge technology and deliver excellence in project execution. Nowhere

is this truer than in the challenging Russian Arctic, where ExxonMobil is proud to be

associated with Sakhalin-1 one of the most ambitious projects industry has ever

undertaken.1

- JB McNeil, vice-president, ExxonMobil Development Company in 2008.

Introduction

In December 2008, the American oil and gas company ExxonMobil Corporation s2

(ExxonMobil) oil and gas development project in Russia

3

, the Sakhalin-1 projectreceived the Excellence in Project Integration Award from the committees and

sponsoring societies of the International Petroleum Technology Conference4 (IPTC).

The award was given to the company for effectively implementing the first phase of

the Sakhalin-1 Project through the application of modern production engineering

techniques, geoscience knowledge, construction and facilities engineering practices,

health, safety, and environmental processes, human resources policies, community

development, and collective teamwork. Commenting on the achievement, Mark

Albers, senior vice president of ExxonMobil, said, We are extremely proud of the

Sakhalin-1 project achievements. The Sakhalin-1 project is one of the largest energy

investments in Russia and is a testament to international cooperation to successfully

execute this project in one of the most challenging Arctic environments in the world

in a safe and environmentally responsible manner.5

The Sakhalin-1 Project is one of the largest oil and gas development projects in theworld. Located on the northeast shelf of Sakhalin Island, the project comprises threeoffshore oil fields, the Chayvo, Odoptu, and Arkutun Dagi. The total oil and gas

1 Sakhalin 1- ANew Frontier,http://www.exxonmobil.com/Corporate/Files/Corporate/SakhalinEnglish_Intro.pdf.

2 Based in Irving, Texas, ExxonMobil Corporation is one of the worlds largest oil & gascompanies. It is involved in the exploration, production, transportation, and sale of crude oiland natural gas. The company markets fuels and lubricants under three brands Esso,Exxon and Mobil. For the year ended 2008, the companys revenues were US$ 477.35billion.

3 Prior to 1991, Russia was the largest republic in the Soviet Union (USSR). The troubledeconomic conditions together with political turmoil led to the dissolution of the Soviet Unionin 1991 into fifteen separate countries. As a result, Russia together with the Ukraine andBelarus formed the Commonwealth of Independent States which was later joined by otherSoviet republics.

4 The IPTC Excellence in Project Integration Award recognizes companies whichsuccessfully execute multi billion oil and gas industry projects. The International PetroleumTechnology Conference (IPTC) is an international oil & gas conference and exhibition. IPTCaddresses key challenges and issues plaguing industry specialists in the gas sector worldover. The third edition of the IPTC was held from 3-5 December 2008 at the Kuala LumpurConvention Center and was hosted by PETRONAS, the national petroleum corporation ofMalaysia. About 7,568 participants from 57 countries attended the event.

5 Sakhalin-1 Project Receives Award for Excellence from International PetroleumTechnology Conference, www.sakhalin1.com, December 3, 2008.


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Sakhalin-1 Project: Delivering Excellence in Project Execution

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reserves of the fields are estimated to be about 307 million tons (2.3 billion barrels) ofoil and 485 billion cubic meters (17.1 trillion cubic feet) of natural gas. The project isoperated by Exxon Neftegas Limited6(ENL), a subsidiary of ExxonMobil, on behalf

of an international consortium comprising Russian, Indian, Japanese, and US oil andgas companies. The project was declared commercial in October 2001, and thedevelopment of oil and gas from the fields began in 2005.

In the first phase of development of the project, oil was produced from the Chayvofield using both onshore and offshore facilities. These facilities included theconstruction of one of the worlds largest land-based drilling rigs, an offshore drilling

platform, an onshore oil and gas processing facility, a crude oil pipeline, and an oilexport terminal. Initially, the project produced up to 50,000 barrels of oil and 60million cubic feet of natural gas per day. The oil was exported to the Asian marketswhereas the natural gas was supplied to domestic customers in the Khabarovsk Krai 7region. The subsequent phases were to involve development of oil and natural gasfrom the Odoptu and Arkutun-Dagi fields. In 2008, the development of the Sakhalin-1

Project was put on hold for about two months as it awaited budget approval from theRussian government for the years 2008 and 2009. After the budget was approved bythe Russian Energy Ministry in April 2009, the project resumed with the developmentof the second phase of the project.

According to experts, the multi-billion dollar Sakhalin-1 Project was one of the largestforeign investment projects in Russia. The investment was expected to reach US$ 12

billion over the life period of the project. In addition to oil and gas development, theproject was expected to bring in significant economic as well as social benefits to theRussian community. Economic benefits included improved transportation and medicalfacilities and other infrastructure developments. Besides generating revenues to thegovernment, the contracts awarded to Russian companies as part of the developmentof the project were estimated to be more than US$ 3.2 billion. More than 13,000 jobswere created for Russian nationals during the initial development of the project.

Experts opined that though the project brought in significant benefits, it was repletewith challenges. The project had to deal with multiple problems including a harsh sub-Arctic climate, a remote location with minimum infrastructure, logistic problems,limited availability of skilled labor, and a complex regulatory system. Despite thesechallenges, it was successful in completing the initial development phase and wasreportedly prepared to address the future challenges too. Experts were of the view thatwith global energy demand expected to increase by almost 50% by 2030, theSakhalin-1 Project would become a vital link in the global energy supply and inmeeting the worldwide energy demand. Talking about the benefits of the project,Steve Terni (Terni), president of ENL, said, Working together, Russians, Americans,and our international partners have overcome great challenges to accomplish whatmany previously doubted was even possible. Forty years from now, Sakhalin-1 isexpected to still be reaping benefits for Russia, the Asia-Pacific, and an energy hungry

world. Equally important, it has created opportunities for people to enjoy a betterquality of life. With support from the Russian local, regional, and federalgovernments, the Sakhalin-1 consortium will continue to work to make this peopleachievement even greater.8

6 Exxon Neftegas Limited (ENL) is a subsidiary of ExxonMobil Corporation. It is the operatorof the Sakhalin-1 Project and holds an interest of 30% in the project.

7 Khabarovsk Krai is a Russian federation located in the Russian Far East along the coastlineof the Sea of Okhotsk.

The administrative center of the Krai is the city of Khabarovsk.8 Sakhalin 1- A New Frontier,

http://www.exxonmobil.com/Corporate/Files/Corporate/SakhalinEnglish_Intro.pdf.


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Background Note

Sakhalin, one of largest islands in Russia, is located off the east coast of Russia in the

Sea of Okhotsk. Colonized by Russia and Japan in the 18th

and 19th

centuries, theisland came under Russian control in 1875. The Sakhalin region is popular for its vastnatural and hydrocarbon resources. Oil reserves in the area are estimated to be around14 billion barrels while the natural gas reserves are approximately 96 trillion cubicfeet.

9Commercial oil reserves were discovered in the region in 1910 in the Okha field.

But because of political unrest, difficult climatic conditions, and lack of adequatefinance, the oil fields could not be developed.

In the early 1970s, a subsidiary of Rosneft,10

Sakhalinmorneftegas Ltd.11

(Sakhalinmorneftegas) pursued the development of offshore oil resources in theSakhalin continental shelf. During that time, the Russian oil and gas industry lackedadequate infrastructure to carry out oil explorations in the region. Moreover, theindustry did not have the technical know-how and had very limited experience ofoffshore oil and gas development in sub-arctic regions such as Sakhalin Island.Therefore, Sakhalinmorneftegas, with support from the Russian government, decidedto seek foreign assistance. Japan was considered as a potential investor as it had somemajor oil and gas companies which could provide the needed infrastructure.Geographically too, it was close to the Sakhalin Island. In 1975, Russia signed acooperation agreement with the government of Japan for oil and gas exploration anddevelopment in the region. As per the agreement, Sakhalinmorneftegas had to workwith Japanese consortium Sakhalin Oil and Gas Development Co., Ltd. 12(SODECO)to carry out oil and gas development in the region.

Between 1977 and 1989, Sakhalinmorneftegas and SODECO were involved inexploring the oil fields in the region. The oil exploration process involved seismicsurveys

13and exploratory drilling. The extensive efforts led to the discovery of three

oil fields in the region the Odoptu field in 1977, the Chayvo field in 1979, and the

Arkutun Dagi field in 1989. With the discovery of the oil fields, the Russiangovernment planned to develop Sakhalin Islands offshore oil reserves and exportenergy to Northeast Asian markets, mainly Japan.

In 1991, after the dissolution of the Soviet Union, Russia became a separate state andthe country opened its doors to foreign investments. The Russian government waslooking for more international investors who could explore and develop the oil fieldsin the island. The government then decided to auction off sections of the Sakhalinshelf for developing oil and gas. It began to offer tenders for blocks of acreage on

9 http://www.eoearth.org/article/Energy_profile_of_Sakhalin_Island,_Russia.10 Rosneft is the largest oil producing company in Russia. It is involved in the exploration and

production of hydrocarbons, petroleum products, and petrochemicals. For the year ended

2008, the companys average daily crude oil production was about 2.12 million barrels. TheRussian government holds a 75.16% stake in the company.

11In 2008, Sakhalinmorneftegaz Ltd produced 1.76 million tons (12.9 million barrels) of crudeoil and 0.63 billion cm of gas.

12 Sakhalin Oil and Gas Development Co., Ltd. (SODECO) is a consortium of several majorJapanese companies, including the Japanese National Oil Company. The other principalshareholders in the company are Japanese investment companies such as JAPEX, Itochu andMarubeni.

13 The seismic survey is a type of geophysical survey which measures the properties of theearths sub surface by generating, recording, and analyzing sound waves (also called asseismic waves) that travel through the Earth. The surveys generate seismic images whichhelp geologists in locating underground structures that may contain oil or gas reserves. Thesesurveys are primarily used for oil and gas exploration.


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Sakhalin Island. The government along with the local Sakhalin Oblastadministration

14 divided the Sakhalin continental shelf into six blocks and named

them Sakhalin 1-6 (Refer to Exhibit I for a snapshot of the Sakhalin blocks). The

contracts for developing the oil reserves in each of these blocks were allocated tovarious consortiums comprising foreign as well as Russian multinational oilcompanies. Besides the six blocks, the government planned to develop three more

blocks on the Sakhalin continental shelf. The new blocks which were yet to beawarded would be called Sakhalin 79. As of 2008, all the six Sakhalin projects werein different stages of development. Of the six blocks, Sakhalin-1 and Sakhalin-2 werethe front-runners as the oil and gas produced from these regions was expected to meeta significant percentage of energy demands in the Asian continent.

The Sakhalin-1 Project area comprised the Chayvo, Odoptu, and Arkutun Dagi fields.These fields were estimated to contain 2.3 billion barrels of oil (307 million tons) and17 trillion cubic feet of gas (485 billion cubic meters). Initially the contract to developthe Sakhalin-1 oil fields was awarded to a consortium comprising US, Russian, andJapanese oil and gas companies. ENL and SODECO held a 30% interest each in the

project. The other investors were Russian oil companies Sakhakinmorteneftegas(23%), and RosneftSakahalin (17%). In 2001, the ownership pattern changed asIndian oil and gas company ONGC Videsh Limited15 joined the Sakhalin-1consortium with a stake of 20% while the subsidiaries of Russian oil companyRosneft, Sakhalinmorneftegas-Shelf, and RN-Astra had an 11.5% and 8.5% stake inthe project respectively. The responsibility of the consortium was to manage theconstruction of the projects oil and gas extraction and transportation facilities. Capitalinvestment over the life of the project was estimated to reach US$ 12 billion, makingit one of the largest foreign direct investments in Russia.

Exploration and Project Documentation

In late 1993, the five-member consortium signed a Memorandum of Understandingwith the Russian government to formulate the Sakhalin-1 production-sharing

agreement16

(PSA).The PSA, considered as the governing document for the Sakhalin-1 Project, required about two years to negotiate. Finally in October 1996, the PSAwas approved and executed. It established a clear set of guidelines related to theoperational, financial, and administrative aspects of the project. Under the PSA, theRussian government was to retain ownership of the oil and gas resources in the statewhile the consortium would invest the capital required to develop the fields.

14 The Sakhalin Oblast is a federal region of Russia comprising the island of Sakhalin and KurilIslands.

15 The ONGC Videsh Limited (OVL) is a wholly-owned subsidiary of the national oil companyof India, the Oil and Natural Gas Corporation Limited (ONGC). It is involved in thedevelopment of oil and gas acreages including acquisition of oil and gas fields, exploration,development, production, transportation, and export of oil and gas. The companysinternational oil and gas operations produced about 8.802 million metric tons of oil and gasin 2007-08.

16 Production sharing agreements (PSAs) is a commercial contract between an investor and thestate government which allows the investor to undertake large scale and long terminvestments in the state. The PSA defines the terms and conditions for the exploration anddevelopment of resources through a contract based arrangement that exists over the life ofthe project.


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Exhibit I

The Sakhalin Blocks (May 2008)

Sakhalin I Sakhalin II Sakhalin III Sakhalin IV Sakhalin V Sakhalin VI

Primary Field/Block

Names

Odoptu

Chayvo

Arkutun-Dagi

Piltun-Astokskoye,Lunskoye

Kirinskii,

Veninskaya,

Vostochno-Odoptu,Aiyashkii

PogranichnyBlock, WestSchmidt,Okruzhnoyefield

Kaigansko-Vasyukansk (K-V), E. Schmidt

Pogranichny

Oil Reserve

Estimate

975 millionbbl*

1.0-1.2 billionbbl

4-5 billion bbl 880 millionbbl.

E. Schmidt -2.98bill. bbls). K-V -8.5 billion bbls

600 million bbl

Natural Gas

Reserve Estimate11 Tcf** 17.3 Tcf 27-38 Tcf 19 Tcf. 15.2-17.7 Tcf n/a

Net Total

Investment

Phase 1: $5billion

Phase 1: $4.5billion, Phase 2:$20 billion

$13.5 billionexpected(ExxonMobil-$80m ingeologicalstudies)

$2.6 billionexpected

$3-5 billionexpected

n/a


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Current & Expected

Production Level

Max oilproduction

from Chayvofield achievedin Feb. 2007 at250 kb/d.Commercialgas productionexpected in2008

Current: 80,000bbl/d for 6

monthsPhase II:180,000 bbl/d,

year-round oilproductionexpected by2009, LNGproductionexpected by2009

n/a n/a n/a n/a

Primary ProjectDevelopers

ExxonNeftegaz(30%),SODECO(30%), ONGCVidesh (20%),Sakhalinmorneftegaz

(Rosneft-SakhalinmorneftegazSubsidiary,11.5%), andRN Astra(Rosneft

Gazprom(50%+),Sakhalin EnergyInvestmentCompany: Shell

(27.5%), Mitsui(25%),Mitsubishi(20%)

Rosneft isprimarydeveloper.VeninskyBlock: Rosneft(49,8%),Chinese

Sinopec(25.1%) andSakhalinskayaNeftyanayaKompaniya(25.1%)

BP (49%),Rosneft (51%)

Elvary Neftegaz:BP (49%), Rosneft

(51%)

Urals Energy(via Petrosakh),

Alfa Eco


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Subsidiary,8.5%)

Status

Mode of gas

export still up

for

negotiation.

Exxon

preferred

pipeline

exports to

China. Other

shareholders,

Gazprom

preferred

piping to LNG

terminal at

Sakhalin II.

Oil production

began in 1999;

Processing

terminal under

construction with

capacity of

66,000 bbl/d of

oil, 1.8 bcf/d of

gas

License

possibly

suspended.

Lukoil in

association

with Gazprom

would

probably take

part in new

tenders for

Kirinskii and

Vostochno

blocks.

There is

speculation

that

unreleased dril

ling results

during 2007

were not

positive. No

drilling

planned in

2008, although

seismic

activities

continued.

Activities in 2008

included seismic

processing,

interpretation and

acquisition on the

existing license

blocks

3 blocks in

Sakhalin VI

have not been

awarded, but

Gazprom seems

to be interested.

* bbl stands for barrels

**tcf stands for trillions of cubic feet

Source: www.eoearth.org/article/Energy_profile_of_Sakhalin_Island,_Russia


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The Russian government was to receive a proportion of revenues from production asthe project progressed. As per the PSA, the oil derived from the Sakhalin shelf would

be shipped to Asia and other markets while the natural gas would be sold exclusively

in the domestic market. The PSA stipulated that all the members of theconsortium would proportionally share income from the sale of oil and natural gasgenerated from the project.

Upon the execution of the PSA in 1996, a five-year exploration period began. Acommercial development plan for the Sakhalin-1 Project was also formulated duringthis period. The exploration period involved delineation of the three oil fields,assessment of hydrocarbon volumes in the region, and identification of the bestresource location from where oil could be developed. As part of the exploration

process, seven appraisal wells17were drilled and three-dimensional seismic data wascollected covering more than 1,200 square kilometers area. ENL used advanced 3Dseismic technology

18 to map the Sakhalin-1 fields. With continuous 3D surveys and

evaluation drilling, the consortium discovered crude oil on the western flank of the

Chayvo field. This was a major discovery for the project to proceed further.Finally, in September 2000, the exploration period ended with the demarcation of theChayvo 6 well which confirmed the presence of a 150-meter oil column in the Chayvoreservoir. Talking about the discovery of oil reservoirs in the Chayvo field, RichardPowell (Powell), ExxonMobils Geoscience project manager for the Caspian, Russia,and the Middle-East, said, We now had found what could be a 150 million-metric ton(1 billion barrel) oil development that was previously unknown. This became thecenterpiece to the dining room table we had been searching for. But in the end, itreally was about more than just new technology. It truly came down to the teamscreativity, innovation, and determination to find and deliver that first step for Sakhalin1.

19

After successfully completing the exploration period, the Sakhalin-1 consortium

declared the project commercial on October 29, 2001. It was approved by the Russian

Federation on December 3, 2001. The declaration formally ended the exploratory

phase and marked the commencement of the 20-year development period of the

project. The project was subjected to over one hundred agency inspections and audits

to ensure that it complied with Russian regulatory and project documentation

procedures. In July 2002, the project was given the green signal by the State

Ecological Expert Review20

(SEER) for use of Extended Reach Drilling21

(ERD)

technology to drill wells in the region. In October 2002, the technical expertise bureau

17 Appraisal wells are drilled to assess characteristics of a hydrocarbon source accumulated ina reservoir

18 3D seismic technology constructs models of underground rock formations based on three-dimensional models. Earlier, 2D models were used but they were difficult to read. 3D

techniques significantly reduced the number of dry holes drilled, thereby increasing thenumber of productive wells.

19 The Quest Begins, www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish4.pdf.20 The State Environmental Expert Review (SEER) is an independent body which assessed

Sakhalin-1 Projects design, waste management, and water protection measures, disastermanagement, economic and social impact as well as the measures taken by the project toprotect marine and land biological resources.

21 Extended Reach Drilling (ERD) is an evolved form of simple directional drilling andemploys both directional and horizontal drilling techniques. It is defined as a type ofdirectional drilling in which the horizontal well departure is at least twice that of its totalvertical depth-to-deviation (TVD). ERD is cost effective as it does not require installation ofadditional offshore facilities or pipelines. Production from ERD wells which run throughlong distance reserves is much greater than output from conventional wells.


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of Russia approved the Justification of Investment22

(JOI) for the Sakhalin-1 Project.

Approval of the JOI was a key milestone for the Sakhalin-1 Project as it allowed the

project to proceed to the Technical and Economic Substantiation of Construction

(TEOC) stage required for the construction of the oil export pipeline route acrossSakhalin Island to an export terminal. As part of the project documentation stage, the

consortium received over 1,000 additional approvals, licenses, and permits from

federal, regional, and local district authorities in the Sakhalin region.

In April 2003, the Authorized State Body23

(ASB) approved the Development

Program and Budget24

(DP&B) for the Sakhalin-1 Project. Total capital expenditure

for the project was set at US$12.8 billion. In April 2004, the Russian government

approved the TEOC stage which allowed the consortium to start full-scale

construction of facilities at the project site. According to project operator ENL, once

the Sakhalin-1 Project had passed the exploratory stage, project costs increased

significantly. To carry out operations related to the development and construction of

oil fields in the region, tenders were awarded to Russian contracting companies. In2002, Russian businesses acquired large contracts, and the total value of the contracts

awarded to Russian suppliers and contractors as part of the Sakhalin-1 Project

exceeded US$ 1 billion (Refer to Exhibit II for the list of contacts awarded).

According to Galina N. Pavlova, Director of the Oil and Gas Industry Department of

the Sakhalin Oblast Administration, The successful implementation of the Sakhalin-1

Project became possible thanks to mutually-beneficial cooperation between Federal

and regional Russian authorities, and the members of an international consortium

including operator ExxonMobil, a global leader in the oil and gas industry. This

consortium brings together the talents of major companies: ExxonMobil, SODECO of

Japan, ONGC of India, and the Russian state oil company Rosneft.25

Development

The Sakhalin-1 Project was executed in phases. According to analysts, a phased

development approach was followed so that the procedures built in the first phase

could be used in the future phases, thereby making the project cost-effective. The first

phase of the Sakhalin-1 Project involved the development of oil and gas in the

Chayvo oil field. The subsequent phases included oil and gas development in the

Odoptu and Arkutun Dagi fields, Chayvo field gas development, and late-life gas

development. It was reported that these future phase developments would push the

Sakhalin-1 Project through 2050.

22 Justification of Investment (JOI) is a document that addresses the feasibility of a proposed

project. It analyzes the returns from an Investment by demonstrating the proposed projectsgoals and capabilities.

23 Authorized State Body (ASB) is a constituent of the Russian Industry and Energy Ministry.It is the governing authority of the Sakhalin 1 Project and oversees the implementation of thePSA on behalf of the Russian Federation. It includes representatives of the FederalMinistries of Economic Development and Trade, Taxes and Levies and Energy, and theSakhalin Oblast Administration.

24 The Development Program and Budget (DP&B) is a strategic plan which provides costestimates of activities related to the oil and gas development production in the Sakhalinregion. It also lists the benefits the project would bring to Russia and provides details ofenvironmental protection measures undertaken as part of the project.

25 Exxonmobil Announces Production Start-Up from Sakhalin-1 Project in Russia,www.sakhalin1.com, October 2, 2005.


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Exhibit II

List of Contracts Awarded for Sakhalin-1 Project

Contract Project

Area

Scope of Work Contractor

DeKastri Material Supply, Transportationand General Services at DeKastri

ACCESS - AmurServices Co., LLC.

Orlan, Chayvo,DeKastri, Yuzhno

General Maintenance andMechanical Services forProduction Facilities

ECC-VECO, LLC.

Orlan, Chayvo,DeKastri, Nogliki,Odoptu, Yuzhno

General Instrument, Control &Automation, Electrical,Telecommunication Maintenance

and Construction Services

OOO KentechSakhalin TechnicalServices


General Engineering andProcurement Services forSakhalin-1 Facilities

OOO SakhalinTechnical Services

Network

Chayvo Fleet Management, Fuel Depotand General Services at Chayvo

Pacific RimConstructors

Orlan, Chayvo,DeKastri, Nogliki,Yuzhno

Camp Management and CateringServices at various Sakhalin-1sites

Remote ProjectServices GroupGlobal, LLC.


Misc. Personal ProtectiveEquipment

ZAO Vostok-ServiceSakhalin

Kholmsk, Korsakov Shorebase Services (facility,manpower, equipment)

Sakhalin ShelfServices

*Data as of 2007

Source: www.sakhalin1.com/en/contracting/opportunities.asp

Phase I - Development of Chayvo Field

The first phase of the Sakhalin 1 Project focused on oil and limited natural gasproduction from the Chayvo field. The development costs of this phase were expected

to be about US$ 4 billion. The initial phase was expected to produce 50,000 barrels(6,300 metric tons) of oil per day by the end of 2005. By 2006, the production wasexpected to reach 250,000 barrels (33,000 metric tons) of oil per day. Thedevelopment of oil from the initial phase of the Sakhalin-1 Project began on October2, 2005. The time period of Phase I of the Project was about five years.

The harsh Arctic weather and the remote location of Sakhalin Island presentedsignificant challenges for the execution of the initial phase. Experts opined that thedevelopment of infrastructure amidst such climatic conditions was a herculean task.However ENL, which had developed some of the major oil fields in the world, wasable to overcome these barriers. Despite the adverse climatic conditions, phase I of the


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Sakhalin-1 Project started on schedule. The Russian Amur Services Company (ASC)26

provided a complete range of construction support services for the Sakhalin-1 Projectwhile ECC-VECO LLC

27provided civil construction, maintenance, and other services

for the project. ExxonMobil is pleased with the timely start-up of Phase 1 of theSakhalin-1 project. This project employs leading-edge technology including the use ofArctic development technologies and extended reach drill wells that are among thelongest in the world. Application of this technology for the Sakhalin-1 project is asignificant breakthrough in our ability to develop the resources in the most cost-effective, efficient, and environmentally sound way possible,

28said Rex W Tillerson,

Chairman and CEO of ExxonMobil.

The first phase of development involved the construction of offshore and onshoredrilling facilities, an onshore oil and gas processing facility, a crude oil pipeline, and amarine export terminal with year-round storage and tanker loading facilities (Refer toExhibit III for a route map of the first phase of the Sakhalin 1 Project). The first stepin the Phase I of the Sakhalin-1 Project was to access the oil and gas reserves in theChayvo field using onshore and offshore drilling procedures.

Exhibit III

Route Map of Sakhalin-1 Project

Source: www.eoearth.org/article/Energy_profile_of_Sakhalin_Island,_Russia

26 Founded in 2002, Amur Services Company (ASC) provides infrastructure and supportservices for construction projects including transportation, cargo hauling, logistics, wastemanagement, etc.

27 ECC-VECO LLC is a Russia-based construction company formed specifically to carry outconstruction activities at Sakhalin shelf projects.

28 ExxonMobil Announces Production Start-Up from Sakhalin-1 Project in Russia,www.sakhalin1.com, October 2, 2005.


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Onshore Drilling

The Chayvo field was developed using onshore as well as offshore drilling facilities.

To drill the north western flanks of the Chayvo fields which were about 8-11kilometers offshore, a suitable option was ERD as it not only reduced the amount of

drilling but also saved on time and costs per well. For this purpose, ENL planned to

construct an onshore land rig29

with numerous extended-reach wells from the

shoreline to the Chayvo field. Talking about the application of ERD, Powell said, We

were aware that 11 kilometer (seven-mile) extended-reach wells had been drilled in

the United Kingdom and South America. What about at least partially developing

Chayvo with extended-reach drilling (ERD) from the Sakhalin shore-line? It not only

would offer the potential for lower cost and faster drilling start-up but would reduce

environmental impact as well.30

The construction of the 22-storied land rig and its support equipment began in October

2001 in Louisiana, USA. The rig was designed and built by Parker Drilling

Company31

in less than two years. The rig was disassembled and shipped to SakhalinIsland, which was about 11,000 kilometers from the construction site, aboard three

cargo vessels. Despite the adverse weather conditions on the Island, the rig reached on

time, was reassembled at the Chayvo field, and was ready for drilling by June 2003.

According to Richard Rush, Sakhalin drilling group manager, The weather-related

delays and logistic hurdles stemming from the absence of a dock at Chayvo worksite

forced us to continue working into late fall and winter. In all, we shipped 1,500 to

1,800 loads by rail and truck, and still managed to get the rig assembled and ready to

drill on schedule by June 2003.32

Named Yastreb (meaning hawk in Russian), the land-based drilling rig was 230 feet

tall (70 meters) and was custom designed to drill extra long extended reach wells from

land-based locations to offshore fields. The rig could withstand temperatures of -400

Celsius and high intensity earthquakes. Its power was 13,000 hp33almost doublethat of conventional land rigs. The Yastreb rig could drill extended reach wells

downward and then horizontally under the sea to a total distance of up to 6.8 miles till

the Chayvo field, making it one of the most powerful land rigs in the world. We

called it the Yastreb, which is the Russian word for hawk. And like a hawk, the

Yastreb has soared to great accomplishments with the extended-reach wells it has

drilled,34

said Sam Vera, drilling engineering supervisor of Sakhalin-1 project.

The rig became functional in November 2003. The rig drilled the first Sakhalin-1 well,the Z6, to a total measured depth of 9,375 meters (30,938 feet). To improve thedrilling rate and to ensure safety, ENL used modern drilling procedures. Baker

29

A land rig is a drilling machine that drills only on land. It consists of pumps, a derrick ormast, a substructure, drill pipe, mud tanks, a rotary table, and engines to power theequipment.

30 The Hawk and the Sea Eagle,www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish5.pdf.

31 Parker Drilling Company is a US-based global energy company which provides offshore andonshore contract drilling services, project management, and rental tools to the energyindustry worldwide.

32 World-Class by Any Measure,www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish1.pdf.

33 Horsepower (hp) is a non-metric unit of power. It is equal to 746 watts.34The Hawk and the Sea Eagle,

www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish5.pdf


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Hughes INTEQs35

AutoTrak Rotary Closed Loop System (RCLS)36

was used toenhance well-site efficiency and improve the quality of bore holes. With continuedimprovements in well design and drilling procedures, the daily drilling rates doubled.

In April 2007, ENL completed drilling of the 17th

ERD well, the Z-11,37

at the Chayvofield. It was drilled in 61 days, about fifteen days ahead of the schedule, with belowexpected costs.

By 2007, about 17 ERD wells were drilled from the Yastreb rig as part of Phase I ofthe Sakhalin-1 Project. Experts pointed out that since the drilling of the Z6 well in2003, the time required to drill these wells had come down by more than 50%. The

presence of repair centers close to the Chayvo well installed by the Russian contractcompanies ensured smooth drilling without any delays. Repair and maintenance ofkey drilling equipment was carried out at these service centers. Otherwise, theequipment would have had to be repaired at regional centers as far as Singapore.Experts also pointed out that by using ERD, ENL had curtailed operational costs asextended reach wells did away with the need for building and installation of additional

offshore structures. Moreover, ERD followed safe drilling practices and addressedenvironmental issues by minimizing the impact on marine environment, they said.

Offshore Drilling

To develop the south western flank of the Chayvo field, a gravity-based offshoreplatform was used. Called Orlan

38, it was one of the largest offshore drilling platforms

constructed in the world. The earthquake and high wave resistant Orlan platformfeatured a drilling rig with more than 13,000 hp, a 10 mega-watt power plant, andliving quarters for 120 workers. The Orlan platform was actually a concrete islanddrilling system

39 (CIDS), which was withdrawn from use and kept in reserve in

Alaska. ENL decided to use the CIDS for offshore drilling at Chayvo. Talking aboutthe procurement of the Orlan platform, John Plugge (Plugge) offshore subproject

manager of ExxonMobil, said, We were pleased to find it in quite good condition.But before we reached a decision, we invited a team of about 25 Russian specialists tocome look it over the following summer. Nobody knows ice and the Arctic like theRussians. After a very thorough inspection, they concurred that it was quite suitablefor Chayvo and could be used for many years to come. This was great news for the

project since we originally estimated the use of CIDS would save a minimum of $100million. And with the better understanding of costs we have today, we know that thesavings is considerably more.

40

The CIDS platform was shifted to the Amursky Shipbuilding yard located in Far EastRussia for removing the CIDS topside facilities and a large wave deflector wasconstructed around the platform base to make it earthquake resistant. In 2001, the

35

Based in Houston, Baker Hughes INTEQ is one of the eight divisions of Baker Hughes Inc.,an Oil field service company. It is one of the worlds leading oilfield drilling and evaluationservice companies.

36 Rotary Closed Loop System (RCLS) is an advanced drilling technique used to drill deepbore holes in extended-reach wells.

37 The Z-11 was the longest ERD well in the world. It achieved a total measured depth of37,016 feet (11,282 meters) or over seven miles.

38 The Orlan platform was named after a white-shouldered sea eagle unique to the Sakhalinisland.

39 The CIDS is gravity-based offshore drilling platform. Built in 1983, the CIDS was designedfor year round drilling in Arctic waters.

40 The Hawk and the Sea Eagle,www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish5.pdf.


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CIDS platform was towed to Russia using three super-class tugs. The renovation ofthe platform was completed in 2004 after which it was taken to Ulsan, South Korea,where top side modules weighing nearly 12,000 metric tons and a fully automated

drilling rig were installed. After installation of the support equipment, the platformwas tugged to Russia and was ready for offshore drilling. Talking about the advantageof the platform, Plugge said, A major advantage of the gravity-based platform is thatits self contained. Crews can live onboard and get the platform ready for drillingwhile its still in the shipyard. Then, when you are ready, you essentially just deballastand go offshore.

41The Orlan drilled its first extended reach well in December 2005.

A total of 18 extended wells were drilled using the Orlan offshore drilling platform.

Onshore Processing Facility

In order to separate the oil and gas produced from the drilling operations, an onshoreprocessing facility (OPF) was installed at the Chayvo field. The OPF was designed toprocess up to 34,000 metric tons (250,000 barrels) of oil and 23 million cubic meters

(800 million cubic feet) of gas per day from the Chayvo field.42 An off-site modularconstruction approach was followed to build the OPF instead of a stick buildapproach. Talking about the importance of the facility, the project manager ofSakhalin-1, Jim Flood (Flood), said, Its truly the heartbeat of this project. All of the

pieces of the project were ancillary to some extent to the successful completion of theOPF. Any delays in the OPF construction and start-up would greatly impact theoverall economics of the project. Yet with a scheduled construction cycle of only 36months and the major limitations on the productivity due to the highly remote sub-Arctic location, we were not confident that a conventional stick-build approach wouldget the job done in time.

43

The construction of the OPF began in 2003 and the contract to design the facility wasawarded to Fluor Corporation

44. The modules of the OPF were fabricated at the

Hyundai Heavy Industry yards in Ulsan, South Korea. The platform contained 36modules weighing 40,000 tons. The heavy modules were unloaded at Sakhalinthrough two sea lifts and moved to the OPF site through the Chayvo Bay Bridge

45.

The offsite construction of the OPF helped the project in saving 18 months of timeand more than US$300 million in cost. Our execution strategy for the OPF includedusing 36 pre-assembled and pre-commissioned modules for a majority of the plantfacilities. This helped offset the productivity impacts of working in a remote Arcticenvironment with a short construction window,46said Flood.

Until the OPF became fully operational, the project team decided to install an interimprocessing facility (IPF) in order to process the crude oil obtained as a result ofdrilling at Yastreb and Orlan. In 2004, an IPF comprising 60 modules was built in the

41

The Hawk and the Sea Eagle,www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish5.pdf.

42 From Design to Loading Tankers in 34 Months,www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish6.pdf.

43 From Design to Loading Tankers in 24 Months,ww.exxonmobil.com/Corporate/Files/.../SakhalinEnglish6.pdf.

44 Fluor Corporation is a US-based engineering, construction, and maintenance servicescompany.

45 The Chayvo Bay bridge, completed in 2003, links the Chayvo well site with the OPF. Builtby Dalmostostroi, a Khabarovsk Krai construction company, the bridge is 830 meters (2,700feet) long.

46 ExxonMobil-40 Years of Arctic,www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish3.pdf.


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US and Canada and then sea lifted to Sakhalin and assembled. The IPF was installedby the Expro International Group Plc, a UK-based oilfield services company. InAugust 2005, the IPF with the capacity to process 6,300 metric tons (50,000 barrels)

of oil and 4.2 million cubic meters (150 million cubic feet) of gas per day becameoperational. In 2006, when the OPF became functional, the IPF was closed down. TheOPF produced stabilized crude oil called Sokhol crude oil which was piped to the DeKastri oil export terminal. The dry gas obtained was re-injected into the Chayvo fieldfor conservation.

Oil Export System

The oil export system of the Sakhalin-1 Project included a pipeline which was of 24inch diameter and about 225 kilometers long, valve stations, an oil export terminal, asingle point mooring (SPM) facility, and oil tankers.

From the OPF, the pipeline transported oil across the western Sakhalin Island and theTatar Strait

47 to an oil export terminal located at De Kastri in the Khabarovsk Krai

region. The construction of the pipeline began in 2004. The design and location ofeach pipeline was approved in advance by the Russian environmental protectionagencies and the construction was carried out during winters when the streams werefrozen to reduce possible impacts on the marine life. Adequate measures were taken toensure the safety of endangered species during construction of the pipeline. Forinstance, on discovering a nest of an Orlan sea eagle during construction, the projectteam rerouted the pipeline. The project operators installed eight remotely operatedvalve stations to shut down the pipeline in case of a leak or any emergency. Tofacilitate communications across the entire pipeline route, the team installed a fiberoptic cable along the length of the pipeline and a microwave tower on each side of theTatar Strait. The pipeline could transport approximately 250 thousand barrels of oil

per day (12 million tons of oil a year).

The construction of the oil export terminal at De Kastri began in December 2003. A

Russian construction company JST Trust Koksokhimmontazh (KXM) designed,manufactured, and built two 100,000 cubic meter (650,000 barrel) storage tanks forthe De Kastri oil terminal. By June 2006, the oil terminal became operational. The DeKastri oil export terminal had oil storage facilities and a single point mooring (SPM)tanker loading facility to load crude oil onto tankers for export to world markets. TheSPM facility located 5.7 kilometers offshore was fully automated with a conical base

built to withstand heavy loads. It weighed 3,200 tons and was 210 feet above sealevel. The facility was installed by J. Ray McDermott, a US-based supplier of offshorefield development products. The oil was transferred from the oil terminal through asubsea loading line to the SPM facility. The SPM, considered as the worlds largestfixed tower, allowed emergency shutdown and released tankers during unfavorableweather conditions. It was considered as the safest, most environmentally sound, andcost-effective method of tanker loading in an Arctic environment as it eliminated theneed for a jetty48for tankers.

The Delivery

In August 2006, the Sakhalin-1 Projects oil export system was commissioned. Withthe commissioning of the system, the Sokhol crude oil developed by the project wassupplied to international markets. The startup of Sakhalin-1 exports will provide

47 The Tatar Strait is a channel between Sakhalin Island and the Asian mainland, in theNorthwest Pacific Ocean, connecting the Sea of Japan and the Sea of Okhotsk.

48 A jetty is a structure which extends into the sea and generally protects a harbor or coastlinefrom the effects of currents and tides.


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additional needed energy supplies to the expanding economies of Asia and to otherglobal customers. This project is another example of a long-lead time, technologyintensive development brought to fruition this past year to help address the

world's ever-growing energy demand,49

said Stuart McGill, senior vicepresident of ExxonMobil.

On August 29, 2006, SPM received the Sokhol crude oil from the De Kastri terminalfor loading onto tankers. On September 30, 2006, the first tanker loading of the crudeoil started. Aframax class tankers

50were supplied to the project by Russias Primorsk

Shipping Corporation (PRISCO)51. Each tanker carried up to 720,000 barrels (100,000tons) of crude. According to Les Carter, sub-project manager at DeKastri terminal,Our pumps at the terminal are designed to move 6,100 metric tons (45,000 barrels) ofoil an hour into the subsea loading line, through the SPM, and onto the tankers. Withthe loading operations gradually ramped up to full project capacity, tankers begandeparting De-Kastri on average every three to four days in early 2007.

52

In the first quarter of 2007, the Sakhalin-1 Project achieved its production goal as it

reached production rate of 34,000 metric tons (250,000 barrels) of oil per day. The oilwas supplied to refineries throughout the Asia-Pacific region while the natural gaswas supplied to domestic consumers in the Khabarovsk Krai region. In December2007, the Sakhalin-1 Project achieved a production milestone of 100 million barrels ofcrude oil from the Chayvo field. Commenting on the achievement, Stuart McGill,Senior Vice President of ExxonMobil, said, ExxonMobil, through the operatorship ofExxon Neftegas Limited, is pleased that the Sakhalin-1 Consortium achieved its

production goal for peak crude oil operations in a timely manner. Achieving thisproduction milestone is a significant example of how the energy industry andexporting nations can work together to provide needed energy supplies to globalmarkets.

53

The domestic sales of natural gas began in 2005 and totaled 575 million cubic meters

(20.3 billion cubic feet) in 2006. Experts opined that the supply of natural gas fromthe Sakhalin-1 Project to customers in the Khabarovsk Krai was a significant step inthe Russian Far East Gasification Program54. By February 2007, the natural gas supplyto the Khabarovsk Krai region had reached 35 billion cubic feet (one billion cubicmeters). In 2007, the average gas supplies to Khabarovsk Krai were 115 million cubicfeet (3.27 million cubic meters) per day.

In January 2008, local natural gas sales were above 200 million cubic feet/day (5.85million cubic meters) per day.

55As of August 2008, domestic gas sales totaled 105

billion cubic feet (3 billion cubic meters). According to experts, the gas supply fromthe Sakhalin- 1 Project was expected to fulfill the demand in the Khabarovsk Krairegion until 2025. According to governor of Khaborovsk Krai Viktor Ishaev, Thisgas has helped bring fuel stability to our region and represents a major step in support

49 ExxonMobil Announces Start of Sakhalin-1 Exports; Newest Milestone inCompany's Effort to..., www.allbusiness.com,September 7, 2006.

50 Aframax tankers are small oil tankers which carry oil through narrow harbors and canals.51 Primorsk Shipping Corporation (PRISCO) is a Russian shipping company involved in the

transportation of various oil and liquid cargos.52 From Design to Loading Tankers in 24 Months,

ww.exxonmobil.com/Corporate/Files/.../SakhalinEnglish6.pdf.53 Sakhalin-1 Project Production Goal Achieved, www.sakhalin1.com, February 14, 2007.54 The gasification of Russian regions was started in 2001 by state-owned oil company,

Gazprom. As part of the program, Gazprom finances construction of gas pipelines andensures gas supply for regional consumers.

55 http://www.sakhalin1.com/en/project/marketing.asp.


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of Russias Far East Gasification Program. With increased supplies becomingavailable from Sakhalin 1, we look forward to being able to move more of ourcommunities away from dependence on coal to greater use of natural gas.56

Project Benefits

According to experts, the Sakhalin-1 Project was one of the biggest projects

developed by the international oil and gas industry. It represented one of the largest

single FDIs in Russia managed by a multinational consortium. According to analysts,

the Sakhalin-1 Project had helped Russia in strengthening its position as an energy

supplier to world markets by providing oil and gas supplies for export to domestic and

commercial markets. It also served as a medium for developing friendship between

Russians and other foreign nationals, they said. According to Anna Kuniasky, Vice

President Corporate Affairs, ENL, The joint work on the project, including the many

years of negotiations, is a vehicle for developing friendships between Russians and

foreigners and appreciation for each other's capabilities. This experience has increased

the trust between the Russians and foreigners and thus has contributed to the successof the Sakhalin-1 project. I also believe that our positive experience will open future

opportunities for foreign investment.57

The Sakhalin Project was one of the first oil and gas projects in Russia to employ

PSAs. The PSA approach attracted a huge amount of foreign investment as it offered

suitable tax procedures and guaranteed stability of the project over its lifetime. This,

in turn, allowed the development of the project in harsh environmental conditions.

Experts opined that the Sakhalin-1 Project was successful in developing the oil

resources present in the Sakhalin Island in an efficient and cost-effective manner.

Some of the achievements of the Sakhalin-1 Project included the on-schedule

commencement of the first phase of the project, drilling of record breaking ERD

wells, commissioning of the OPF before schedule, timely completion of the exportpipeline and terminal, start-up of the oil export operations, and attaining the targeted

levels of 250,000 barrels of oil per day. Commenting on the key elements which

ensured the success of the Phase I development of the Sakhalin-1 Project, Terni said,

Todays world-scale projects require proven capability to develop, extend, and apply

leading edge technology to all aspects of a project. Technology was fundamental to

the projects focus on developing the Chayvo resource at maximum value. However,

leading-edge technology alone was not enough. Also key to maximizing value was the

ability of ExxonMobils global functional organization to deliver excellence in project

execution from concept selection to start-up and a strong commitment to excellence in

all aspects of project development. Equally important, these capabilities were brought

to bear in partnership with co-ventures, the Russian government, and local contractors

as well as the Sakhalin and Khaborovsk communities to successfully execute theproject on schedule despite one of the worlds toughest environments.58

Besides developing oil and gas, the project offered economic as well as social benefits

to Russia and to the Sakhalin region in particular. Benefits to Russia from the

Sakhalin-1 Project included direct revenues to the Russian state, major infrastructure

developments, technology transfer, the employment of Russian citizens, and the use of

56 To Full Production and Beyond,www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish7.pdf.

57 http://www.sakhalin1.com/en/news/project/pnw_03152002_lamp.asp.58 www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish3.pdf.


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Russian suppliers for contracts and procurement. It was reported that over the life of

the project, the Russian state would receive more than RUB591.250 trillion (US$50

billion) as taxes, royalties, and the states share of hydrocarbons from the Sakhalin-1

Project. As of August 2008, the Russian government had received approximately US$1.1 billion (RUB 28 billion) in royalties and the states share of oil production.Since

the inception of the project, the Sakhalin Oblast administration received RUB 5.3

billion (US$ 211 million) in revenues.

The Sakhalin-1 Project also brought significant benefits to the people of Russia,particularly to those in the Sakhalin region. In 2005, the project employedapproximately 8,000 workers, including direct employees and contractors. Nearly 500Russians worked directly for ENL. To enhance their skills, many of them received

professional training in Russia, the US, and Canada. The value of these trainingprograms was estimated to be about US$ 12 million. For instance, a workshop at theSakhalin-Alaska College helped 60 Sakhalin welders to improve their professionalskills and obtain international certificates. According to ENL, More than 13,000 direct

and indirect jobs would be created for Russian nationals as part of the initialdevelopment of the project. It was expected that the number of Russian nationalsworking on the project would reach 90% within 10 years. (Refer to Exhibit IV forsome of the achievements of the Sakhalin-1 Project).

Exhibit IV

Accomplishments of Sakhalin-1 project

The project applied cutting-edge technologies engineered specially for Arcticoperations to develop the Sakhalin Island energy resources with careful regardfor the environment, efficiency, and costs.

The three-dimensional seismology used by ExxonMobil increased exploration

success and reduced exploration costs.

The project undertook successful operations in seas with six feet thick icewhich were carried out using state-of-the-art computer models and five yearsof ice data.

The project invested over 17.5 billion RUB (US$700 million) in environmentalprojects to help protect wildlife and habitats in the areas of operation.

The design of the project facilities was protective of the Western Gray Whale,the Orlan eagle, and other wildlife native to Sakhalin Island.

Employees worked over 80 million hours with industry-leading safetyperformance. The project's Lost Time Injury Rate (or LTIR) of 0.02/200,000work-hours was several times better than the international oil and gas

construction industry average.

The project followed a phased development strategy along with detailed andintegrated front-end execution planning. It implemented a plug-and-playapproach which allowed it to capture efficiencies and minimize risk.

The project set 17 world records for extended-reach drilling and also fordrilling speed. The worlds most powerful land-based rig was drilled in theChayvo field as part of the Sakhalin-1 project.

59 Ruble (RUB) is the currency of Russia. As on November 2009, 1 US$ was approximatelyequal to 28.70 RUB.


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The project awarded contracts worth over US$5 billion to Russian companiesor joint ventures.

The project funded over US$120 million to improve infrastructure in theSakhalin region including hospitals, clinics, roads, bridges, harbors, airports,and power and water facilities.

The project donated over US$3.5 million in charitable contributions to localcommunity organizations, including health, youth, arts, and civic projects.

Compiled from various sources

One of the key objectives of the consortium was to promote Russian content. It hired

as many local contractors as possible for the project. ENL, along with the Sakhalin

Oblast Administration and the Ministry of Economic Development and Trade of the

Russian Federation, established a Joint Committee to promote local content. The main

objective of the Joint Committee was to maximize the involvement of Russian

subcontractors and Russian suppliers of goods and services in the project. Accordingto Neil Duffin, president of ENL, For Russia, a key is to create jobs and maximize

local contentthat is, Russian goods and servicesin the project. One of our goals

is to maximize involvement of Russian companies in our operations where possible

and recruit Russians to commence building the operations group in 2002. We also

have employees from both of our Russian consortium partners helping to manage the

project.60

As of 2008, the value of contracts awarded to Russian companies as part of the

Sakhalin-1 Project was about 125 billion RUB (over US $5 billion), more than two-

thirds of the total contracts awarded to third-party vendors. The consortium also

launched a project website to communicate information related to the Sakhalin-1

Project to Russian contractors and suppliers. Seminars related to the project were heldin Moscow, Khabarovsk, and Yuzhno-Sakhalinsk.

The strategy to promote Russian content was mutually beneficial to the Russian

contractors as well as to the project operators. The project operated smoothly due to

the experience of the regional contractors who understood the local operating

environment better. On the other hand, ENLs latest construction, drilling, and

production procedures helped the local contractors gain sufficient knowledge about

the latest technologies and improve their productivity.

Community Development

Besides creating jobs and awarding contracts to Russian suppliers, the Sakhalin-1

consortium contributed to the well-being of the community as it tried to improve the

standard of life of the communities in which it operated. ENL implemented variouscharitable small-grant programs to support communities in the Sakhalin Oblast and

Khabarovsk Krai region. These programs primarily focused on areas of education and

healthcare and support for local people. ENL contributed over RUB 85 million

(US$3.5 million) to support education, healthcare, and cultural projects in the

Sakhalin region such as instituting Teacher of the Yearawards, setting up hospitals

for children, organizing summer camps, as well as supporting earthquake victims

(Refer to Exhibit V for community development initiatives of Sakhalin-1 Project).

60 Denise Allen Zwicker, Multi-national Project to Represent Record Foreign Investment inRussia, http://www.sakhalin1.com, 2002.


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Exhibit V

Sakhalin-1 Project: Community Development Initiatives

Education

The Sakhalin-1 project supported educational organizations and elementary andsecondary schools in order to improve teaching and learning and achieve

professional development. It provided educational materials and equipment andsponsored student programs and extracurricular activities to enhance the quality oflearning.

The Sakhalin-1 project offered grants toward educational development to thefollowing:

Sakhalin State University, for purchase of equipment for the media laboratoryof the Journalism Faculty.

Junior Achievement Sakhalin Foundation, which helped students from K-12 to

learn the basics of business and economics. In 2005, over 7,500 studentsparticipated in the JA events compared to 1,980 students in 2000.

Sakhalin Oblast Department of Education, where ENL was the GeneralSponsor for the annual Teacher of the Year Competition.

Logos Club, which organized intellectual competitions (trivia contests) forhigh-school and college-age students in Yuzhno-Sakhalinsk. During the yearsof ENLs sponsorship, more than two thousand students participated in theLogos Club competitions.

Volunteer Involvement Program. ENL offered small grants to supportemployees volunteer activities in schools and kindergartens that their childrenattended. The program made possible field trips to natural history sites,classroom improvements, book purchases, and many other contributions.

Val Settlement (Nogliki District) Secondary School, for purchase of personalcomputers to improve computer training resources.

Sakhalin Oblast Traffic Inspectorate and the Sakhalin Oblast Committee ofsports and physical culture. ENL sponsored the Safety Wheel children's trafficsafety festival, in which teams from all over Sakhalin competed to show theirknowledge of the rules of the road.

Yuzhno-Sakhalinsk Education Department, to sponsor academic Olympiads inwhich over 1,500 high school students took part each year.

Special Correction Comprehensive School for Mentally Challenged Children,for purchase of athletic equipment and educational materials.

Health

ENL supported programs targeted at health issues and made contributions tohealth-related organizations which addressed public health issues and localcommunity needs.

Examples of organizations and programs that received contributions included:

Paramedics-Midwife Stations in remote areas (Val, Nekrasovka): purchaseof medical equipment.

Nogliki Secondary School for purchase of medical equipment.

Support of the International Conference Publicly AccessibleDefibrillation and Preventive Measures for Sudden Cardio Death.


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Civic and Community Service

ENL supported civic and community service organizations which fulfilled socialneeds and enhanced social and economic conditions. It also supported culturalorganizations, which provided access to art.

Examples of organizations and programs that received contributions included:

Sakhalin Culture Fund rewards which gifted youth and professionals fortheir contribution in culture and arts.

Publication of the Sakhalin Oblast Commemorative Book dedicated to thehistory of Sakhalin from 1930 to 1950.

Centennial Celebrations of the Yuzhno-Sakhalinsk City Park.

Okha Central Library for purchase of office equipment, software, andbooks.

Okha Childrens Library for purchase of personal computers and officeequipment.

Sakhalin Regional Library for purchase of equipment

Yuzhno-Sakhalinsk Chamber Orchestra for purchase of musicalinstruments and sponsorship of concerts.

Indigenous Minority People of the North (IMPN) was an important recipient ofENL contributions.ENL financed the following organizations and programs in association withIMPN:

Summer camp for IMPN children from Ulchi District;

Support of the Giva IMPN Folk Ensemble (Bulava Settlement)

Tourist equipment for IMPN children of the De-Kastri Settlement

Equipment for restoration of documents in the Bogorodskoye PublicMuseum

Sponsorship of the Ulchi District Nivkh delegation participation in the 1stNivkh Congress

Support of the Bulava social center

Contribution of furniture, athletic, and other equipment for Sofijsk andTyr Boarding Schools

Equipment for the sewing lab of Khabarovsk Technical College BulavaBranch

Source: www.sakhalin1.com

The Sakhalin-1 Project invested over RUB 3 billion (US$120 million) ininfrastructure improvements in the Sakhalin region such as upgrading hospitals, roads,

bridges, ports, and airports. The project also contributed to the development of thelocal communities. For instance, the project donated US$ 300,000 for the purchase ofnew surgical and diagnostic equipment at the Central District Hospital in KhabarovskKrai. In 2007, ENL made significant investments in the modernization of the Yuzhno-Sakhalinsk Womens Clinic.


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Another noteworthy initiative launched by the Sakhalin-1 Project was a regional smallbusiness development program launched in 2004 in the northern Sakhalin districts ofNogliki and Okha in association with USAID.61 The program launched with an

investment of US$ 500,000, created about 180 small businesses and more than 500local jobs in the region. It provided financial support to small business units whichwere unable to obtain commercial bank loans. The project also contributed about US$100 million to the Sakhalin Development Fund over a five-year period (2003-2008)and offered production bonuses of about US$ 60 million.

Safety and Environment

Besides offering multiple benefits to Russia, the project paid attention to operational,environmental, and safety performance. The Sakhalin-1 project ensured the safety of

people, the environment, and the local community through effective application of thesafety system and tools. With support from the consortium and the Russiangovernment, the project applied best safety and environmental practices in a phaseddevelopment approach. The lost-time incident

62(LTI) rate reported by the project was

significantly better than the average for the worldwide oil and gas constructionindustry. From the first quarter of 2005 to January 2006, the project operated for 26million work hours without an LTI. By the end of 2006, the projects LTI rate wasnine times better than the worldwide oil and gas construction industry average. Thetotal recordable injury index of the Sakhalin-1 Project was 0.21, three times betterthan the index of 0.59 for all projects operated globally by ExxonMobil. When youtake into account a multinational workforce operating in a harsh sub-Arcticenvironment and amassing more than 75 million work hours since the start-up ofdrilling and construction activity in 2003, this was an incredible accomplishment.Making these safety records even more impressive was the fact that the workersachieved them while keeping the project moving ahead on schedule,

63said Tim

Murphy, lead safety advisor of Sakhalin 1 Project.

One of the primary reasons for the safety success of the project was an ExxonMobil

business plan called the Operations Integrity Management Systems (OIMS). The

Sakhalin-1 Project fully adopted and implemented the OIMS. Jim Reisz, the OIMS

safety manager, described the OIMS as defining everything we do and how we do it.

It takes the randomness out of your approach to business, safety, and the environment

and makes it predictable. Just as you develop a business plan, you also develop a

safety plan and an environmental plan. And, most importantly, every employee is

accountable.64

According to experts, besides achieving excellence in safety, the Sakhalin-1 Project

also ensured environmental protection. For instance, the oil export pipeline was

designed to run east-west rather than north-south to reduce the number of stream

crossings and lessen environmental impact. While carrying out drilling and

construction activities, care was taken to protect fish and endangered wildlife. To

protect endangered marine species, the construction of jetties along the shoreline northof Chayvo was eliminated from the development plan as that construction might

61 The United States Agency for International Development (USAID) is the US federalgovernment organization providing economic and humanitarian assistance to countriesworldwide.

62Lost-time incident (LTI) is any work related injury which prevents personnel from doing anykind of work after the accident.

63 Champions for the Safety and Environment,www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish8.pdf.



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disturb the marine life. The Orlan platform was successfully towed from the iceconditions of the Bering Sea to the Sakhalin Island. In Russian, Orlan symbolizes

strength, boldness, and speed, and Orlans 3000-mile journey from Alaska to the

Russian port of SovGavan without incidents underlines our commitment to safety andthe environment in all aspects of our business,

65said Tom Hall, manager of Sakhalin-

1 Project.

Western gray whales, which were considered as an endangered species by the World

Conservation Union,66

inhabited the shallow waters off Sakhalins northeast coast.

Since 1997, the Sakhalin-1 consortium spent about US$15 million on studies related

to these whales and adopted measures to protect them. During the 2001 seismic

survey in the Odoptu field, the project implemented the most extensive whale

protection program ever undertaken by the oil and gas industry. We developed a

monitoring program in which we had trained observers, usually marine biologists,

stationed on the seismic vessel and support boats. When a gray whale was sighted

within a protection zone of four to five kilometers between the vessel and the

mammal, operations were shut down until it had cleared the area, 67said Dan Egging,Sakhalin-1 Houston regulatory manager.

To protect endangered birds such as Stellers Sea Eagle (Orlans), the Sakhalin-1 team

carried out field studies in association with environmental experts. For example, with

help from Vladimir Masterov, a leading ornithologist from Moscow State University,

the project conducted a number of baseline studies to identify sea eagle habitat along

the coasts of Sakhalin including the mapping of nests and hunting areas. They

constructed artificial nests and perches to attract the birds to new coastal sites away

from project facilities. The project also gave precedence to protecting native islands

and the livelihoods of reindeer herders, who inhabited the northern Sakhalin Island

and the Khabarovsk Krai. As of June 2008, the project had spent over US$ 700

million in environmental projects to help protect wildlife and safeguard environment

in the areas of operation. Out of this, over US$ 40 million were spent on variousarchaeological, ornithological, bathymetric, meteorological, seismic, topsoils,

fisheries, stream crossing, waste management, bioremediation, oil spill response, and

other studies, and another US$ 17 million on initiatives aimed at preserving the

western gray whale population.

Challenges

Experts considered the Sakhalin-I Project to be a multifaceted engineering project as itposed some of the most difficult challenges that the oil and gas industry had facedanywhere in the world. The project faced both environmental as well as manmade

problems. These challenges included operating in a harsh physical environment, aremote location with limited infrastructure, environmental limitations, government

regulations, and lack of skilled labor. Analysts opined that the project team had tounderstand the physical, cultural, and political environment of the area to make the

project successful.

65Denise Allen Zwicker, Multi-National Project to Represent Record Foreign Investment inRussia, http://www.sakhalin1.com, 2002.

66 The name World Conservation Union was used in conjunction with the InternationalUnion for Conservation of Nature (IUCN), an international organization dedicated to theconservation of natural resources.



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Sakhalin Island, situated between Russia and Japan in the North Pacific, is amountainous region with a harsh Arctic environment. The region is covered by a packof ice three to five feet thick about six to seven months in a year. As a result, the

project could operate only during the months of summer. The region is seismicallyactive and earthquakes occur frequently. Moreover, the geology of the region iscomplex, leading to exploration problems. The remote location of the site made traveldifficult. An extensive network of helicopters, trains, and vehicles was required toreach the work site.

Besides climate-related problems, another important challenge confronting the projectwas environmental protection. The region was characterized by abundant flora andfauna. Developing oil and gas in an ecologically sensitive area would lead to protestsfrom environmentalists. Environmentalists pointed out that that increasing seismicsurveys, constant drilling, and oil spills from rigs and tankers and movement ofvessels and helicopters at the production site affected the marine environment presentin the Sea of Okhotsk. To protect the marine life, the Russian Ministry of Natural

Resources restricted seismic testing and drilling in some areas of the island. Due toenvironment restrictions, drilling of some of the wells was carried out from onshoreinstead of offshore. This resulted in a delay in the project and increased costs. Due tothe delay, the payback period of the project could get extended, analysts said.

In October 2008, a group of NGOs filed a lawsuit, appealing against the verdict of theState environmental appraisal for the Sakahlin-1 Project. According to them, the

projects appraisal required a thorough investigation as some significant changes hadbeen recorded in the distribution and number of Western Pacific grey whales in thePiltun spit. They attributed the changes in the number of grey whales to the activitiesrelated to the Sakhalin-1 Project in the region. According to them, the pipeline

between the Odoptu drilling platform on the Piltun spit and the Sakhalin Island wasdangerous for the whales. They demanded that the pipeline construction across Piltun

bay be stopped. According to Alexey Knizhnikov, head of the The World Wildlife

Fund (WWF) - Russia68Program on environmental policies of the oil and gas sector,Sakhalin 1 project must immediately halt its pipeline construction across PiltunBay, before the formal Court consideration. It is also important to identify the exactreasons for the changes in the whales distribution observed in the summer 2008 . 69A court ruling was awaited in the lawsuit.

In addition to physical and environmental challenges, the Sakhalin-1 Project also

faced workforce related problems. There was no skilled labor in the region. ENL had

to invest significantly in training the workers but they were not very adept with the

latest construction and drilling procedures. To minimize training expenses, the project

operators imported manpower from other regions. The Sakhalin regional

administration alleged that most of the workers participating in the project were

foreigners. According to them, the project should maximize Russian content by hiring

contractors and workers from the region as stipulated in the PSA.Analysts were of the view that though the project faced some harsh challenges, ENL

through the application of leading-edge technologies such as 3D seismic and ERD,

visualization analysis, simulations, and field studies had managed to successfully

complete the first phase of the Sakhalin-1 Project. Commenting on the challenges of

the project, Terni said, People ask me if ExxonMobil with its 100-plus years of

global exploration and development has ever been involved in a project that offered so

68The World Wildlife Fund (WWF)Russia Program works for the conservation of wild life inRussia.

69 Environmentalists Appeal to Halt Sakhalin 1 Project Before any Formal Court Ruling,www.wwf.ru, January 12, 2009.


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many challenges. I tell them that the company has had experience with all of these

challenges-operating in sub-Arctic environments with short work seasons, researching

and applying ice-breaking technology so we get could get the oil to the market,

working in remote areas thousands of miles from manufacturing and supply centerswhich required extensive logistics planning, developing drilling plans for extreme

horizontal drilling, working under complex regulatory regimes, and many others.

However, while we might have faced two or three of these challenges on a project

before, just about every single one of them came together on this project.70

Outlook

After completing its first phase, the project moved on to the next phase which was to

develop oil and gas from the Odoptu field. According to the project consortium,

experience gained during the first phase including ERD, logistics, winter work

productivity, contracting strategies and Russian contractor expertise, regulatory

processes and design criteria would be used to carry out the subsequent phase of the

project. Future phases of the Sakhalin-1 Project would include developing theArkutun-Dagi fields, expanding the Chayvo OPF, and further developing the Chayvo

gas field (Refer to Exhibit VI for a brief on the future phases of Sakhalin 1 Project).

Experts felt that the three fields in the Sakhalin oil field area could provide a long-

term supply of gas for export and domestic use in Russia. It was estimated that the

Chayvo field alone had enough gas to produce 1 billion cubic feet per day (10 billion

cubic meters per year) for more than 25 years. Similarly, the Odoptu and Arkutun-

Dagi oil fields could sustain oil development for more than 40 years at a production

rate of 1 billion cubic feet per day (10 billion cubic meters per year).

In February 2009, ENL suspended work on the Odoptu and Arkutun Dagi fields at

Sakhalin as the Russian government did not approve its development plans and

budgets for 2008 and 2009. However, production from the Chayvo field was not

halted. Due to suspension of work, a 23% fall in oil production was noticed. As inFebruary 2009, output decreased to about 193,000 barrels of crude oil per day from a

peak of 250,000 barrels per day in February 2007. It was speculated that production

might further drop by 11% in 200971

.

According to some analysts, the reason for the suspension of work at the two fieldswas a dispute between ENL and the Russian government over the sale of natural gasdeveloped from the region. The Russian government wanted the operators ofSakhalin-1 to sell the natural gas to Gazprom

72to cover domestic needs, while Exxon

planned to export the gas to China. ENL wanted to build a natural gas pipe line toChina and supply 8 billion cubic meters of gas annually to China. But the Russiangovernment did not approve the pipeline to transport the gas as it wanted ENL to sellthe projects gas to Gazprom at a lower price. Some observers felt that the Russian

government was creating obstacles for the project as it felt that it was losing controlover the domestic oil and gas companies and wanted to confine the Sakhalin-1consortium just to developing the Chayvo field and to develop the remaining twofields on its own.

70 World-Class by Any Measure,www.exxonmobil.com/Corporate/Files/.../SakhalinEnglish1.pdf.

71 OVL's Sakhalin-1 project faces roadblocks, www.financialexpress.com, February 25,2009.

72 Gazprom is a global energy company involved in the exploration, production, transportation,storage, processing, and marketing of gas and other hydrocarbons as well as electric powerand heat energy production and distribution. The Russian Ministry of Oil and Gas holdsa 50 per cent controlling stake in Gazprom.


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Exhibit VI

Future Phases of the Sakhalin-1 Project

Odoptu Development

The second phase of the Sakhalin-1 project included the development of theOdoptu field. The field is located off the northeast coast of Sakhalin Island about35 miles (55 km) north of the Chayvo operations. The first stage of development inthe Odoptu field would include modification of the existing Chayvo facilities.Development plans included the construction of roads to the Odoptu site and theestablishment of on-site housing and work facilities. The Yastreb drilling rig, whichwas used for onshore drilling at the Chayvo field, was relocated to the Odoptu sitewhere it would be used to drill onshore extended reach wells. A 49 mile (79 km)16-inch flowline would be laid to transport the oil and gas to the existing ChayvoOnshore Processing Facility, from where the pipeline to the De-Kastri Terminalwould further transport the oil to international markets. As of April 2009, theOdoptu field development was going through regulatory and government reviews

and the Yastreb rig was relocated to the Odoptu site. The project was to undertakeadditional construction activities after obtaining the required regulatory approvals.

Arkutun-Dagi Development

The third phase of development of the Sakhalin-1 project involved the developmentof oil and gas from the Arkutun-Dagi field. The field is located approximately 25kilometers off the northeast coast of Sakhalin Island, east of the Chayvo field. As

part of the Arkutun-Dagi development, a new offshore drilling and productionplatform with a gravity base substructure and topsides facilities was to beconstructed. A new flowline would transport the oil and gas from the Argatun-Dagi field to the existing Chayvo Onshore Processing Facility, where existing

pipelines would transport the oil and gas for export. Over 30 Russian designinstitutes and contractors were involved in the development of the Arkutun-Dagifield. As of 2009, the development of the Arkutun-Dagi field was passing throughregulatory and government reviews.

Chayvo Field Phase 2 Commercial Gas Development

The Sakhalin-1 project was supplying natural gas to domestic customers in theRussian Far East as part of the first phase of the Chayvo field development. The

phase succeeding the Arkutun-Dagi field development would be Chayvo Phase 2gas development. This phase would expand natural gas production by developingand producing non-associated gas. The development of this phase required a multi-

billion dollar investment and significant expansion of existing onshore and offshorefacilities at the Chayvo field site including additional drilling, processing, power,and other infrastructure developments. The gas produced from this phase was to besupplied to both domestic and export markets. In order to deliver the gas to exportmarkets such as China and Japan in a cost-effective way, th

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Case 4 Sakhalin 1 Project