TB0469

Kannan Ramaswamy

ExxonMobil and Royal Dutch Shell:

The Tale of Two Projects in Sakhalin
The present reality is that we do some projects very well, and this large Sakhalin II project and some
others we don’t do that very well. I fully realize it has an impact on our reputation—certainly for this
project and then, of course, I’m concerned it will carry over to other things we do.
Jeroen van der Veer. “Shell Chief Keeps Faith in ‘Elephant’
Projects,” Financial Times, July 10, 2005.

Rick Davis set down his coffee as he skimmed the Wall Street Journal article on the emerging debacle at Kashagan
in Kazahakstan. Titled “How a Giant Kazakh Project Went Awry,”1 it described the perilous journey of the
ambitious megaproject controlled by energy giants Eni, ExxonMobil, Royal Dutch Shell, Kaz Munai Gas, and
CNPC. The project had exceeded cost estimates by $30 billion and blown past its projected schedule by eight years.
This struck close to home for Davis since he was just getting ready to share some of the lessons he had learned
from Shell’s experience in Sakhalin where he had first signed up as a young project engineer. His presentation
before a team of his peers was scheduled for later that week, and it was expected that some of the senior leaders
of Shell would also be dropping by.

Rick sensed that although some competitors such as ExxonMobil did a better job than Shell on some projects
such as Sakhalin I, no company seemed to have an unblemished record. Even ExxonMobil had a substantial
cost overrun in Sakhalin. Rick also recalled that some of his downstream colleagues seemed to think that these
mishaps happened only in upstream projects, while, in reality, he knew it was equally prevalent all across the
board. ExxonMobil, for example, had a significant cost overrun in the Singapore Parallel Train (SPT) project
that was delivered after a year’s delay. Georges Grosliere, ExxonMobil executive for the project, had mentioned
that the delay was “because of the scale and complexity of the investment. Some 22,000 construction workers
from 30 different countries, with at least eight different spoken languages, were involved at the construction
peak, and it took time to train them.”2 Shell’s own Pearl GTL project that had escalated in cost by a factor of
3-4X was yet another downstream venture that had significant challenges. Although each project was unique
with its own challenges, there were some common problem areas around project clarity, front-end shaping of
alignment, managing multiple stakeholders, and influencing without direct authority that Rick identified as key
anchors for his presentation. These were among the key leadership skills that he believed Shell ought to foster.

A Promising Phoenix Rises from the Ashes of the USSR

Sakhalin, a remote island located off the eastern coast of Russia, just north of the Japanese island of Hokkaido,
was a penal colony in Tsarist times. Populated by reindeer herders and fishermen, the island was quite rural
with antiquated Soviet infrastructure, decrepit roads and communication systems, and almost no expertise in
the technical trades that developing oil and gas fields required. Rosneft, the Russian state-owned oil company,
had been producing small amounts of oil on the island but had not ventured offshore, where much of the oil
and gas reserves seemed to be located. In 1991, the USSR had invited a consortium of companies (Marathon,
McDermott, Mitsui) to undertake seismic mapping off the island. The consortium presented its findings, suggesting
that there were 45 billion BOEs (barrels of equivalent energy) that were recoverable in the area, an estimate that
was far greater than the British, Norwegian, and Dutch sectors of the North Sea combined.3 Soon thereafter,
the collapse of the USSR unleashed a wave of chaos in the country that resulted in enormous opportunities for
foreign investors who were willing to take really large risks. Against this backdrop, the government invited oil
and gas companies to invest in Russia and help monetize its huge gas reserves. Sakhalin was clearly a crown jewel.
Given its proximity to the rapidly growing Asia-Pacific markets, development of these reserves was deemed a

Copyright © 2016 Thunderbird School of Global Management, a unit of the Arizona State University Knowledge Enterprise. This
case was written by Professor Kannan Ramaswamy for the sole purpose of providing material for class discussion. It is not intended
to illustrate either effective or ineffective handling of a managerial situation. Any reproduction, in any form, of the material in
this case is prohibited unless permission is obtained from the copyright holder.
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 national priority. The Russian economy was in the doldrums in the early 1990s with significant unemployment,
declining GDP growth, and a precipitous drop in the value of the Russian ruble. Moving quickly to revive the
economy, the government threw open its doors to foreign investment and was willing to negotiate Production
Sharing Agreements (PSAs) with oil and gas companies willing to invest in Russia. Many of the global players saw
this as a key opportunity to secure a beachhead in a country that contained the third largest gas reserves globally.

Although Shell was not an original partner in the Sakhalin prospecting consortium, it was the company’s
priority to buy its way into the partnership. This was accomplished by 1993 when Shell became a partner in
SEIC (Sakhalin Energy Investment Company) after acquiring a 20% interest. The next year, Russia signed a
PSA with SEIC. (See Exhibit 1 for PSA terms.) PSAs were considered vital among companies who were willing
to invest in regions where the institutional infrastructure (e.g., legal, economic, physical, political) was either
non-existent or weak. Russia was a good example of such an environment because its traditional systems, built
around communist principles of a centrally planned economy, had come undone during the breakup of the
USSR. Its legal infrastructure was rife with conflicts between federal powers and state powers. Questions regarding
enforceability of contracts, and even the constitutionality of the government’s authority to sign PSAs, would
soon surface. There was uncertainty writ large, but oil and gas companies were no strangers to these challenges.

The government presented PSAs as an alternative legal framework that insulated the project investors from
the typical downside business risks associated with political environments in flux. The race to sign the first PSA
was considered vital because “the first PSA always has the best conditions for the foreign investor.”4 Expediency
was accentuated by three other key considerations. First, it was believed that the company that could deliver gas
the fastest would be able to line up the most lucrative long-term deals with Asia Pacific-based buyers. Second,
the building season both onshore and offshore in Sakhalin was quite short due to the brutally harsh winters
(temperatures in winter averaged -24° C/-11° F) that locked the island in ice for a large part of the year. Finally,
competitive intensity was bound to increase with ExxonMobil and its partners also negotiating leases in Sakhalin
at the same time as Shell. The race to the riches was on.

In a rush to sign the first PSA, Shell had accepted a restrictive local content clause. Internal projections
had suggested that the project would return $45 billion to the Russian government over the life of the project,
a figure strongly contested in the press. Critics reported that Shell had used “money-of-day” analysis to derive
its benefits estimate, while a traditional net present value approach indicated that the benefits were about $ 1.8
billion over a 25-year period, of which Shell was supposed to get a $1.2 billion share of profits.5

The Challenge of Execution

The project was undertaken in two distinct phases. The first phase entailed an investment of $1.6 billion (originally
estimated to cost between $660 million and $780 million6) and focused primarily on producing oil. The second
phase, originally estimated to cost $10 billion, targeted gas offshore to be piped from the north of the island to
LNG (Liquefied Natural Gas) processing facilities in the south over a distance of 500 miles to Aniva Bay. The
island was subject to frequent earthquakes, as well as typhoons, making construction arduous and demanding.
Hoping to solidify its position as the operator, Shell had worked hard to obtain a majority equity position in the
project, a goal that was realized in 2000. It had persuaded Marathon to sell off its holdings and consequently
increased its own position to 55%, with Mitsui owning 25% and Mitsubishi controlling 20%. (See Exhibit 2
for a comparison of the ownership structures of all Sakhalin projects.) According to David Greer, Shell’s project
director, “SEIC was a Shell-affiliated company. Period. Shell standards apply.”7 Although a majority equity stake
gave Shell the lion’s share of the reserves, it also increased project execution risks.

Phase I commenced construction immediately after the PSA was signed. It had been designed to come
online in 1999 providing cash flows that would be plowed into Phase II. It was also seen as a “proof of concept”
for all parties that a PSA regime would work smoothly, and that Shell could undertake the formidable challenges
of the much bigger Phase II.

David Greer, who had worked in many challenging and remote environments, was at the helm of Shell’s
execution effort. He showed remarkable stakeholder management skills, and put in place a very methodical
engagement strategy. He frequently pointed out to his team that, “You must always be conscious of the fact that

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 we, as project managers, are only temporary guests in this great country. When we leave and the project execution
is complete, some sources of employment will disappear also. So what we must do is ensure that nobody is left
worse off than before we started the project, and that new skills and opportunities for further development
are left behind.”8 Toward that end, Shell undertook a massive community engagement exercise under which
several of its employees fanned out across the local communities on the island trying to assess their needs so that
mutually beneficial infrastructure needs could be fruitfully addressed. The focus was clearly on the local provincial
(Oblast) government. The governor at that time, Igor Farkhutdinov, became a staunch supporter of the project
and intervened with the federal government in Moscow when his help was needed to speed up approvals.

Shell had assigned 45 employees solely dedicated to oversee discussions and approvals of permits needed
for both the project phases. It had realized very quickly that although ministers were responsible for signing key
documents, the civil service bureaucrats were enormously influential in drafting various pieces of legislation and
approvals that were presented to the ministers. Therefore, instead of focusing exclusively on the top echelons
of government, Shell had prepared a grassroots strategy. Every individual official who had a hand in the TEOC
(technical and economic substantiation for construction) process was carefully studied. What were the central
drivers that are key to the official in charge? What could Shell do to make him/her feel comfortable in signing
off on, or drafting, the necessary approvals? What were the principal peer networks that the official belonged
to? What pressure groups (e.g., NGOs) were seeking to influence the official? These were some of the questions
that drove the active stakeholder engagement strategy. Once the officials had been categorized based on their
disposition toward the project (positive, neutral, or negative), Shell went about methodically putting in place
influencing approaches seeking to convert some of the negatively disposed officials to at least a neutral position,
and others from a neutral position to a more favorable position.

By 1999, the offshore oil project phase had been commissioned and was producing oil for six months of
the year when the platform was free of sea ice. Attention then turned to the second phase.

From Oil to Gas

The project focus shifted from oil to gas when SEIC decided to commit funds to Phase II in 2003. This period
had been extremely difficult for Shell and its partners. A major transition of government had occurred at the
federal level. Putin had been elected as the new president of Russia. This change heralded a radical redefinition of
state v. federal powers. Under Yeltsin, local provincial governments were allowed a fairly high level of autonomy;
however, this power was recentralized at the federal level under Putin. This meant that many of the approvals that
SEIC had to obtain for Phase II were now being directed from Moscow. Combined with rising oil prices, Russia
was beginning to exert its resurgent strength across the industry landscape. A new priority for the government
had been renationalizing some of the crown jewels that had been privatized. During this period, local lobbying
groups had started to raise public sentiment against foreign investors, especially in the core oil and gas sector. Local
players such as Yukos, that had been created as a result of the massive privatization early in the Yeltsin presidency,
felt that foreign investors were getting much better tax rates and fiscal incentives compared to domestic players,
and this had created a strong anti-foreigner climate.

SEIC partners had agreed that they would approve the Phase II investment provided three conditions were
met. First, they wanted to ensure that the conflicts in the law, especially between federal and provincial levels, were
eliminated (legal stabilization) and the validity of PSAs reaffirmed by the Russian Duma. Second, they wanted
to have all the technical and economic clearances (TEOC) in hand before moving ahead. Last, they wanted to
have firm contracts with buyers in Japan and Korea willing to buy the gas that the project would bring online.
Unfortunately, as of May 2003, the SEIC-imposed deadline for approving Phase II, none of the three conditions
had been met. The Russian Duma was unwilling to take up any legislation that would be seen as favoring foreign
investors and, hence, legal stabilization was off its agenda. The TEOC clearances involved 15 agencies spread
across both federal and provincial levels. Underlining the complexity of the process, David Greer had remarked,
“We’ve got permits coming out our ears. There is a huge machine that you have to work with.”9 Although Shell
had negotiated a memorandum of understanding with some buyers, they were far from the type of firm contracts
that were expected. Nevertheless, Shell decided to proceed with Phase II despite the apparent lack of progress on
its own internal benchmarks. It did so on the basis of a comfort letter,10 a document signed by then-Prime Minister
Kasyanov, saying that Russia would honor the terms of the PSA that had been signed with Shell. At that time,

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 Shell’s Chairman of Exploration and Production Services (Russia), Rein Tamboezer, had observed, “It is a good
letter. While of course not as conclusive as clear legislation, the letter shows the government’s clear understanding
that the Sakhalin II PSA is grandfathered and sets out the legal justification for this view.”11

By mid-2003, Shell had commenced construction of Phase II. It was a very complex endeavor. Its blocks
were about 15 miles offshore and, hence, the offshore platforms had to be linked to land-based processing facilities
entailing a complex system of pipes that had to be laid in the path of migratory whales, a key environmental
concern. Once the pipelines reached the island, they had to be routed from the north to the south to Aniva Bay,
where the processing center and export terminal were located. (See Exhibit 3 for a map of the island and offshore
facilities.) The pipelines had to traverse a distance of 500 miles, roughly the distance from Paris to Berlin, cross
over 1,000 rivers and streams, and 19 geological faults prone to earthquakes. Shell had set about engaging local
contractors to undertake a substantial portion of the construction, a choice that was directly connected to the
PSA terms that called for 70% local content. This proved to be quite a challenge since Russia did not have the
qualified labor pool with the expertise required for such a massive undertaking. In due course, Shell had outsourced
several critical pieces of the project to outside contractors and took a hands-off approach to execution. Although
Shell had always prided itself on its execution and project management capabilities, those competencies were not
evident as Phase II moved into high gear. Having lost a substantial part of its in-house technical talent during
the lean years of the 1990s, it had to depend on contractors for much of the execution.

By 2005, Shell found itself mired in a legal wrangle with state regulators who had accused SEIC of several
environmental violations involving the construction of the pipelines. Oleg Mitvol, deputy director of the Russian
Natural Resources Ministry, had called Shell “a pure banana republic—colonizers in cork helmets.”12 Although
operations within its perimeter enclosing the LNG plant in Aniva Bay were consistent with world standards,
outside the perimeter the story had been quite different. Contractors had dredged the bay without requisite
clearances, and about two million cubic meters of sand had been dumped in an area that threatened fish breeding
grounds. Excavations for the pipelines had resulted in pollution of river crossings, damage to nature preserves,
and degradation of local fish hatcheries. To make matters worse, the government had also leveled charges that
SEIC had not met local employment covenants embodied in its PSA and had threatened action. By 2006, SEIC
had announced that it was likely to incur a project cost overrun of 100%, an increase of $10 billion. Linda Cook,
Shell’s head of gas and power, had said, “We set very aggressive targets in terms of cost and schedule, and it’s proven
out over the two or three years since we made the decision to move forward, it was much more aggressive than
it should have been, given the realities of the project that we now understand.”13 Attributing the cost overruns
to a variety of causes ranging from faulty geological modeling, rerouting of pipelines to address environmental
concerns, and a general increase in the cost of labor and materials, van der Veer, Shell’s CEO observed, “Scope
changes are basically because we didn’t do enough homework in advance. If you have a marginal project, you
would like to do a hell of a lot of homework, because otherwise you lose your shirt.”14 The Russian government
was hardly pleased.

Same Place, Same Conditions But Different Results: ExxonMobil and Sakhalin I
ExxonMobil had made a lot of progress by 2006 and had started shipping oil from its blocks, a mere two months
past the original projected date of completion. The company was known for its risk management prowess and
had made sure that it had ironed out crucial details regarding the measurement of local content, selection of local
contractors, and the myriad other nuances that usually lead major projects astray. Its original partnership structure
included Rosneft, the Russian state-owned oil major, and SODECO, a partnership of Japanese companies. Later,
at the behest of the Russian government, ExxonMobil allowed ONGC (Oil and Natural Gas Corporation of
India), India’s NOC, to take a 20% position.

Starting in 1996, ExxonMobil and its partners had undertaken a five-year exploration program that
included seven appraisal wells along with extensive seismic data collection over a 1,200 Km2 area. Richard
Powell, ExxonMobil geosciences manager, had reported, “We now had found what could be a billion barrel oil
development that was previously unknown…in the end, it really was more than just new technology. It truly
came down to the team’s creativity, innovation, and determination to find and deliver that first step for Sakhalin
I.”15 The consortium had received the requisite approvals, including the TEOC, shortly after the exploration
phase and project construction commenced in late 2004. ExxonMobil had undertaken an exhaustive process

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 of contractor evaluation in parallel as it awaited TEOC clearance. It had been able to entice a qualified set of
local contractors, complemented by a stable of global suppliers with whom it had enjoyed productive working
relationships at its other project sites. Many of the local employees in technical functions were sent to professional
training programs in Russia, Canada, and the U.S. Estimated at roughly $5 billion, more than two-thirds of the
third-party contracts awarded went to Russian firms. This strategy had paid off since it ensured the creation of
a local pool of talented resources that could be harnessed. The project thus benefitted from the local knowledge
that these contractors brought to the venture and, in return, their own skills and capabilities were considerably
enhanced by working with ExxonMobil on some of the leading technologies. Neil Duffin, president of ExxonMobil
Development Company had observed, “For Russia, a key is to create jobs and maximize local content—that
is, Russian goods and services—in the project. One of our goals is to maximize the involvement of Russian
companies in our operations where possible, and recruit Russians to commence building the operations group.
We also have employees from our Russian consortium partners helping to manage the project.”16 (See Exhibit 2
for key contractors for Sakhalin I and Sakhalin II projects.)

Sakhalin I called for many new technologies and technical feats that had not been attempted under Arctic
conditions before. Extended reach wells were drilled from a land-based rig, Yastreb, the largest of its kind ever
assembled. Originally constructed in Louisiana by Parker Drilling, the rig had to be shipped nearly 7,000 miles
in three cargo vessels, timed just right to beat the arctic winter. Richard Rush, Sakhalin drilling manager, had
observed, “The weather-related delays and logistic hurdles stemming from the absence of a dock at the Chayvo
worksite forced us to continue working into late fall and winter. In all, we shipped 1,500-18,000 loads by rail
and trucks and still managed to get the rig assembled and ready on schedule by June 2003.”17 With accumulated
experience from drilling the initial wells, the drilling team was able to cut down drilling time by more than
50%. Remarkably, the lost-time incident rate (LTI) at Sakhalin was nine times better than the global average
for projects of a similar nature.

The onshore processing facilities had also been constructed using a modular approach by Fluor in Ulsan,
Korea, instead of a conventional on-site stick-build approach. The choice was largely driven by the relatively
short construction window on the island. The onshore processing facility was linked with the export terminal
located in the west of the island, a distance of roughly 150 miles. This challenging task also required underwater
pipelines from the offshore platforms to the east of the island, as well as across the Tatar Strait west to the
shipping terminal. This plan had the added advantage of being able to supply some gas to the domestic market in
Khabrovsk province, a major boost to the Russian government’s effort to bring more of the country under its gas
infrastructure. Laying underwater pipelines was a delicate affair complicated by environmental challenges. NGOs
had initiated a very intensive campaign accusing both SEIC and ExxonMobil of violations. They had claimed that
the pipelines threatened migratory gray whales and the habitat of sea eagles. ExxonMobil took these challenges
very seriously and employed an extensive crew of marine biologists, ornithologists, and environmentalists to
ensure that its construction plans did not pose serious threat to local flora and fauna. Despite these challenges,
the project was delivered just two months behind schedule. The cost overruns, however, were significant. The
project cost had increased from an estimated $12.8 billion to $ 17.8 billion, mostly due to spiraling input costs,
weakening of the U.S. dollar, and inflationary pressures.18

The successful commissioning of the project in 2006 was indeed a significant contrast with the experience
of SEIC which at that time was mired in controversy over environmental violations and local content disputes
with the government. Stephen Terni, president of ExxonMobil Neftagas in Sakhalin, had captured the contrast
succinctly in observing, “Technology was fundamental to the project’s [Sakhalin I] 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 ExxonMobil’s global functional organization to deliver 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 Khabrovsk communities to successfully
execute the project on schedule despite one of the world’s toughest environments.”19 Echoing similar sentiments,
Anna Kuniasky, VP-corporate affairs for ExxonMobil at Sakhalin, had remarked, “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 success of the Sakhalin I project.”20 Delivering as promised did indeed
have its advantages. Analysts had frequently noted that Sakhalin I had hardly received the amount of unfavorable

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 scrutiny and governmental intrusion that its competitor SEIC seemed to have attracted. One expert observed,
“The strength, competence, and composition of the Sakhalin I consortium in part explains why the Russian
government has refrained from aggressively intervening in the project.”21

SEIC: The Endgame Unfolds

SEIC had found itself in an unenviable position in 2006 after its construction permits and licenses had been
suspended. In withdrawing the requisite licenses for the project, Oleg Mitvol, deputy director of the environmental
ministry, had remarked, “Times have changed in Russia. We want international investment, but we don’t want to
be made into a banana republic.”22 The Russians had been incensed by the spiraling project costs, environmental
damage associated with the construction, and a delay in their ability to generate tax revenues and extract profits
from the project. Resurgent energy prices had emboldened Russia, and Shell, it appeared, had provided an opening
for renegotiating the deal. In short order, the Russian government signaled a desire to join the consortium as an
equity partner with a majority interest. Negotiations with Gazprom, the Russian gas monopoly, had been kicked
into high gear. When the deal was signed, Gazprom had muscled its way into the project with 50% plus one
share for a sum of $ 7.45 billion. Shell and its partners had to proportionately give up their equity positions and
also agree to delay recovering the cost overruns until Russia got a share of the profits. A substantial portion of
the cost escalation had to be borne by the foreign partners. The price paid by Gazprom was well under market
price, but Shell CEO van der Veer had said, “I think the great news is that there is stability so we can all work
together, all the shareholders, to get the project up and running as soon as possible.”23 The transfer of control
had cost Shell 402 mBOE (million barrels of equivalent energy). Phase II had been commissioned in mid-2009
at a final cost of over $20 billion, reflecting a cost overrun of 100%+ and a delay of nearly two years.

What Lessons Can Be Learned from the Two Projects?

Rick Davis had sketched out some notes for the presentation he was going to make to his group. He had chanced
upon a presentation that Edward Merrow, the president and CEO of Independent Project Analysis, had made
recently. IPA had been commissioned to perform an exhaustive analysis of 13 different Shell projects and had
issued a scathing report on Shell’s project management capabilities. The very first slide suggested that megaprojects
had a failure rate of 65%, and any project over $750 million rapidly declined in performance. (See Exhibit 4
for some of the slides that were presented by IPA.) Those odds were formidable, but given that the industry
was moving toward more megaprojects, it was an inescapable reality that all the leading companies would have
to contend with. Davis had distilled his questions into three key categories; namely, (1) project strategy and
economics, (2) ownership and governance, and (3) people capabilities. (See Exhibit 5 for some of Davis’ notes.)
He wanted to focus less on external factors that usually lie outside the control of the individual leaders who lead
various parts of a megaproject. Instead, he wanted to focus mostly on the role of individual leaders and what
they might consider as they build skills and capabilities that could help Shell manage large projects in the future.

Endnotes
1
Williams, S., Amiel, G., and Scheck, J. 2014. “How a Giant Kazakh Project Went Awry,” Wall Street Journal, March 31.
2
http://www.sgprocessindustries.com/SingleNews.aspx?DirID=160&rec_code=820322&title=Delay+in++ExxonMobil%
26%2339%3Bs+second+complex.
3
Catan, T. 2006. “Shell’s Sakhalin Shows an Industry Its Daunting Future,” Financial Times, January 6.
4
Engel van Spronsen, Sakhalin Technical Director. Cited in “Journey to Sakhalin: Royal Dutch/Shell in Russia (A).” Rawi
Abdelal. Harvard Business School Case 704-040.
5
Rutledge, I. 2004. “The Sakhalin II PSA—A Production ‘Non-Sharing’ Agreement.” Sheffield Energy Resources Information
Services. UK.
6
The Audit Commission of the Russian Federation reported an expected cost $660 million, while the EBRD reported
$780 million.
7
David Greer, Sakhalin Project Director. Cited in “Journey to Sakhalin: Royal Dutch/Shell in Russia (A).” Rawi Abdelal.
Harvard Business School Case 704-040.
8
Ibid.
9
Catan, “Shell’s Sakhalin Shows an Industry Its Daunting Future.”
10
A comfort letter is typically not a legal document that can be enforced in a court of law. It is only a statement of intent,
which is widely seen as non-binding in any way.
11
Rein Tamboezer. Cited in “Journey to Sakhalin: Royal Dutch/Shell in Russia (A).” Rawi Abdelal. Harvard Business School
Case 704-040.
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 12
Lustgarten, A. 2007. “Shell Shakedown,” Fortune, February 2, pp. 92-100.
13
Maitland, A. 2005. “Shell’s Sakhalin Targets Too Aggressive,” Financial Times, November 23.
14
Catan, “Shell’s Sakhalin Shows an Industry Its Daunting Future.”
15 “The Quest Begins.” www.exxonmobil.com/corporate/files/…/sakhalinEnglish4.pdf.
16
Zwicker, D. A. 2002. “Multinational Project to Represent Record Foreign Investment in Russia.” http://www.sakhalin1.com.
17
“World-Class by Any Measure.” www.exxonmobil.com/Corporate/Files/…/SakhalinEnglish1.pdf.
18
Bierman, Stephen. “Russia Approved Increased Sakhalin I Budget,” International Oil Daily, 16 April 2007.
19
“World-Class by Any Measure.”
20
Ibid.
21
Krysiek, T. F. 2007. “Agreements from Another Era: Production Sharing Agreements in Putin’s Russia, 2000-2007.”
Working Paper WP 34. Oxford Institute for Energy Studies.
22
Kramer, A. 2006. “Russia Criticized for Withdrawing Sakhalin Oil Permit,” New York Times, September 20.
23
Ibid.

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 Exhibit 1. Terms of the Sakhalin II PSA
The following abstract summarizes the key terms and conditions set forth in the Production Sharing Agreement (PSA)
signed by SEIC and the Russian Federation in June 1994.

• Duration of the PSA: The terms of the PSA were set at 25 years with the proviso that should SEIC find it economically
viable to continue to exploit energy resources in its leases, it could renew its license for a further period of five years
each time, thus giving SEIC the right of first refusal. This seemingly indeterminate period of the PSA was quite atypical
of PSAs in general.1
• Royalty Rate: The royalty rate was set at 6% under the PSA. This was quite favorable to SEIC because prevailing royalty
rates under PSA regimes at that time were between 10% to 20%.2
• Cost Recovery: SEIC could recover 100% of all costs incurred in the project plus a return on its investment before
the Russian Federation began to receive a profit share. Although cost recovery terms were comparable to other PSAs,
the inclusion of a return rate (estimated at 17.5%) and the lack of a spending cap were unusual features. The Russian
Federation would receive only 10% of revenues for the first two years and 50% thereafter until SEIC had achieved a
24% rate of return.3
• Local Content Requirements: SEIC agreed to undertake “best efforts” to ensure 70% local content (materials and
labor) during the life of the project. The local content would be measured in terms of volume of local materials used
and man-hours attributable to local labor. Industry analysts believed that the proportion of local content was quite
high and poorly structured since the terms of translating dollar cost investments into materials and labor hours were
not readily codified at the time of signing.
• Fiscal Incentives: SEIC would be allowed a range of fiscal benefits including favorable customs duty treatment, excise
tax exemptions, as well as a fixed profit tax rate of 32%. The income tax rate was lower than the rates that prevailed in
the country (35%) at the time of signing the agreement.
• Signature Bonus: SEIC would pay a total of $50 million for the project (Phase I and II) spread over installments.
• Exploration Costs: The Russian Federation would receive $80 million as compensation for exploration costs that had
been already incurred prior to singing the PSA. These costs would be paid in installments until SEIC exceed a rate of
return of 17.5%, beyond which another $80 million will be disbursed in similar installments.
• Local Oblast Government Payments: SEIC would pay $100 million toward the Sakhalin Development Fund over a
period of five years.

1
Rutledge, I. 2004. “The Sakhalin II PSA—A Production ‘Non-Sharing’ Agreement.” Sheffield Energy Resources Information Services.
UK.
2
Ibid.
3
Ibid.

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 Exhibit 2. A Comparison of Sakhalin Projects
Project Owners Operational Details Status
Sakhalin I ExxonMobil (30%), Project was commissioned Operational as of 2006. Gas
SODECO (30%), almost on schedule in 2006 but reserves had yet to be monetized
Rosneft (20%), costs exceeded budget by roughly for exports as of 2016.
ONGC-Videsh India $5 billion. Key contractors were
(20%) Parker Drilling, Fluor, J. Ray
McDermott, ECC-Vecco.
Sakhalin II Shell (27.5%), Phase I (oil) commisioned Discussions were underway with
Gazprom (50%), in 1999. Phase II (LNG) Gazprom on project expansion
Mitsui (12.5%), comissioned in 2009. Phase II to construct additional LNG
Mitsubishi (10%) was delayed by two years and processing capacity as of
came in over budget by roughly 2016. Shell was nominated as
$14 billion. Key contractors were Gazprom’s strategic partner for
CTSD (LNG Plant), Stastroy global projects.
(Pipelines), and AMEC (Marine
facilities).
Sakhalin III Rosneft (49.8%), Originally, ExxonMobil and Rosneft and Gazprom were very
Sinopec (25.1%), Chevron were investors having active in development phase in
Sakhalinskaya Neftyanaya won the license. Project was their respective blocks.
Kompaniya (25.1%) retendered under normal tax
regime subsequently. Russia
invited Shell to join the project
in 2009.
Sakhalin IV BP (49%), Rosneft (51%) Not known.
Sakhalin V Elvary Neftegaz-BP (49%), Not known.
Rosneft (51%)
Sakhalin VI Urals Energy, Alfa Eco Not known.

Source: www.eoearth.org; www.sakhalin-1.com; www.gazprom.com; www.rosneft.com.

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 Exhibit 3. Map of Major Sakhalin Projects and Blocks

Source: urbansustainability.snre.umich.edu/wp-content/uploads/.../RFE.11.pdf.

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 Exhibit 4. Selected Slides from Presentation by Edward Morrow

Source: Based on presentation by Edward Morrow, President & CEO of Independent Project Analysis. “Why Large Projects Fail
More Often.” Joint meeting of the AACEI and ASME, April 20, 2011.

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 Exhibit 5. Rick Davis’s Presentation Preparation Notes

Project Strategy and Economics Ownership and Governance

• How well did we understand the strategic objectives of the other partner groups?
What about external stakeholders such as the government?
• Did we have a clear understanding of the value the project would create for all
parties? Was our PSA a win-win proposition, or were we concerned only about
our own risks?
• Should we have focused on first-mover advantage, or would we have been better
off following ExxonMobil? What is the price we paid for the chance to get in
first?
• Our front-end project shaping seemed to have gone astray. Why did that happen?
Did we focus too much on gaining control of the project?
• How sensitive were we to the dynamic changes in the political arena and their
impact on project economics and execution? Energy prices? Nationalization
agenda of Putin government?
• Why did we believe that we should have majority equity in a venture that had so
much risk? Wouldn’t it be better to do what ExxonMobil did and take a smaller
share? Was operatorship really at stake?
• What benefits might ExxonMobil have been able to access with two NOCs on
the project—Rosneft and ONGC? Weren’t they booking fewer reserves this
way?
• We need to look at ways in which we can gain project operating control without
depending on our equity position. Why should we treat those as equivalent?
ExxonMobil has only 30%!!
• We seem to have forged good relationships at the local as well as federal levels
when we first started. How did this come about and why did that goodwill not
carry forward in later years?

People Capabilities Shell v. ExxonMobil

• Influencing without authority? How good were we in this? Can we get better
systematically? What tangible steps can we take?
• Diplomacy skills? This could come in handy even in the early shaping phase and
surely during execution. Do we recruit for these skills? Can these be built? How?
• ExxonMobil did not seem to have such a hard time with the government like we
did. What were their people doing differently? Were our people too eager to
please?
• Execution leadership? Do we hone all those fundamental leadership skills such
as vision clarity, clear communication, what v. why?
• ExxonMobil also went through the trying times in the late 1990s, but their
project execution capabilities seem intact. What should we do better in
transferring experience from more senior staff to the new entrants? Are we
taking fewer risks with our people?
• We moved much faster than XOM in securing
an ownership position and signing the PSA
• We had a more ambitious plan, especially
the transport of gas across the island and
building LNG capability—a first for Russia
• We managed some of the delicate relationships
at the federal and local levels quite well (at
least initially)
• Our oil project came online in a very short time
without major hitches
• Great relationship with Gazprom
• XOM sacrificed first mover advantage in favor
of more analysis. Is there something to this?
• Their people seem to have better ability to
work with contractors. How did that emerge?
Can RDS copy?
• XOM also suffered a cost overrun of (~40%)
but it was much lesser than ours (their project
was smaller, too)
• Their senior leaders seem to have a better
relationship with the government. How do they
do that?

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