CONTRACT SIGNED FOR DEVELOPMENT OFF SAKHALIN

Foreign companies have signed a production sharing contract with the Russian government for the Sakhalin II Project, the biggest single U.S. investment in Russia.

Sakhalin Energy Investment Co. plans to spend $10 billion to appraise, develop, produce, and transport oil and gas from Piltun-Astokhskoye and Lunskoye fields off Sakhalin Island.

Sakhalin Energy partners are Marathon Oil Co. 30%, McDermott International Inc., Mitsui & Co. Ltd., and Royal Dutch/Shell 20% each, and Mitsubishi Corp. 10%.

The foreign combine signed its pact June 22 in Washington during a meeting of the U.S.-Russian joint Commission on Economic and Technological Cooperation chaired by Vice Pres. Al Gore and Prime Minister Victor Chernomyrdin.

The commission hopes to encourage other direct investments in the Russian production and refining sectors. It expects "an early completion" of negotiations under way on a number of other major investment projects, in particular oil and gas development in the Timan Pechora region of western Siberia.

Gore said "Our work in the last 6 months has not been easy. Uncertainly about the future of economic and political reform in Russia drove some to question whether our work together would be successful."

Chernomyrdin said negotiations for Sakhalin II took more than 2 years "and on the Russian side we had to overcome enormous difficulties-difficulties that could not be dealt with in a legal way because they concerned something that is not yet on the legal books.

"I would call this project a real breakthrough, and this will be followed by other breakthroughs in Siberia, the Urals, and other areas which Russian and American experts are able to cope with."

WHAT'S NEXT

Before appraisal work begins, Russia's parliament must approve terms of the production sharing contract and formulate legislation to ensure stability of legal and taxation terms.

Sakhalin Energy hopes approval will be received in time to begin offshore work next spring. A Royal Dutch/Shell official said initial activity will include further seismic surveying, drilling, and an estimate of land use needs.

Combined estimated reserves for the fields are I billion bbl of oil and condensate and 13 tcf of gas. Development will be hampered by freezing of the Sea of Okhotsk, which allows a relatively short weather window.

Royal Dutch/Shell said a full appraisal will be made after Russian legislation is passed. Determination of dates for start of oil and LNG production will be based on this appraisal.

The group hopes to begin full scale development work in 3-4 years.

Besides a $15 million bonus paid on signing of the project feasibility study agreement, the group also will pay $15 million on commencement of the project, $15 million at the start of Piltun Astokhskoye development, and $20 million at the start of Lunskoye field development.

INCENTIVE PACKAGE

After returning to Russia, Chernomyrdin announced his government will send the Russian parliament a package of tax breaks and legal incentives designed to encourage western investments.

The provisions will give foreign owned firms a 5 year tax holiday and guarantee that tax laws will remain stable.

Foreign firms are to be allowed to own land and be given fewer restrictions on money transfers.

In addition, Russian and foreign joint ventures are to be able to import production equipment and materials duty free and retain all hard currency earnings from their exports.

COMMERCE REPORT

The Gore-Chernomyrdin meeting also received a report on fiscal and regulatory measures needed to encourage domestic and foreign investment in Russia's petroleum sector.

The U.S. Commerce Department said the report was the first such document jointly prepared by the Russian and U.S. governments.

"The recommendations are consistent with Russia's objective to become a full fledged trading partner abiding by international standards of trade and investment," Commerce said.

The report noted several disincentives to investing in Russia, including revenue and export taxes, confused tax implementation and compliance, and lack of a legalized production sharing contract system.

Russian President Boris Yeltsin issued six decrees in May and the prime minister issued two resolutions that together are designed to improve Russia's tax policy and encourage oil and gas investments.

The Commerce report recommended that Russia go further and create a clear and predictable tax system based on a profits levy. It said Russia should lower and eventually eliminate export taxes.

It also called for a Russian legislative guarantee to production sharing contracts. And it said Russia should provide equal access to pipelines.

The report said if Russia did those things, it would "open the door much wider to investment of billions of U.S. private capital in Russia's oil and gas sector."

OTHER PACTS

Also as part of the Gore-Chernomyrdin meeting, U.S. Energy Sec. Hazel O'Leary signed a pact with Russian Fuel and Energy Minister Yuri Shafranik to open a Russian-American Oil and Gas Technology Center this fall in Tyumen City, western Siberia.

They said it will serve as a place for U.S. and Russian oilmen "to exchange information on technologies, equipment and operating procedures, and to discuss common problems and situations."

Also, Interior Sec. Bruce Babbitt signed an agreement with the Committee of the Russian Federation on Geology and the Use of Underground Resources that will foster cooperation in regulating exploration and development of Russian offshore resources.