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Contents

• Introduction
• 1. Russian - Japanese LNG Projects Since 1990s
• 1.1 Sakhalin-2
• 1.2 Sakhalin-1
• 1.3 Pechora LNG
• 1.4 Baltic LNG
• 1.5 Yamal LNG
• 1.6 Vladivostok LNG
• 1.7 Choice of the Project for Analysis
• 2. Economic Profitability of Liquefied Natural Gas Project
• 2.1 Revenue Flows for Production Sharing Agreements and Joint Ventures
• 2.2 Methodology for Evaluating Profitability of the Projects
• 2.3 Risk-Adjusted Returns for LNG Investments
• 3. The Profitability Analysis of the Sakhalin 2 Project
• 3.1 Net Present Value Analysis of the Project Sakhalin 2
• 3.2 Project Profitability Analysis and Explanation of Results
• 3.3 Risks at the Current Stage of the Project Sakhalin 2
• Conclusion
• References
• Appendix

Introduction

In recent years, The Russian-Japanese economic ties have developed with a great speed. According to statistics of Russian Customs, the amount of bilateral trade between Russia and Japan in the period since January till March for this year was 7815.3 million US dollars that sustained 4 per cent of all trade amount of Russia for this period. In compare to the same period in 2012, the trade volume has increased on 10.1 percent.

Figure 1: Japan's LNG Imports by Source, 2013 (%).

Source: BP Statistical Review of World Energy.

Despite of traditional Japanese investments in energy field some contracts in automobile industry were signed. Among such initiatives are constructions of Toyota and Nissan plants near St. Petersburg. Such cooperation became a reality due to the development of Russian economy - the annual GDP growth for the last three years fluctuated around 4 per cent. The Japanese economy has also overcome the period of depression and reached in 2012 the GDP growth at the level of 2 per cent in 2012.

The amount of Russian export of liquefied natural gas in 2013 has increased on 17, 6 percent. For Russia, the breakthrough to the LNG market is one of the strategic points of economic development program while for Japan Russian LNG market is a chance to diversify its imports and be not so dependent from Middle East.

Figure 2: Russia Gross Export Sales in 2013 (% and billion US$)

Source: EIA, gks.ru

The nuclear accident made Japan focus more precisely on energy security challenges although the problems existed long before this catastrophe. However, the return to the power in 2012, December of the Liberal Democratic Party moved the main course of energy policy towards restarting nuclear projects. Nevertheless, the so called «resources diplomacy» (shigen gaiko) that was an initiative of Yoshihiko Noda has not been abandoned by Sinzo Abe. The importance of cooperation with Russia was also stressed during the prime-minister «energy tour» in spring of 2013, when the first destination was Moscow.

In this chapter there will be investigated six main LNG projects with the stake (or potential stake) of Japanese companies. They are Sakhalin-1, Sakhalin-2, Pechora LNG, Yamal LNG, Vladivostok LNG, and Baltic LNG.

1.1 Sakhalin-2

The Sakhalin-2 project took its roots in early 1990s, when three companies - Marathon Oil (independent upstream company with international operations in exploration and production, oil sands mining and integrated gas, which headquarters is based in USA, Texas), McDermott (leading engineering, procurement, construction and installation company focused on executing complex offshore oil and gas projects worldwide) and Mitsui (one of the largest keiretsu in Japan) created the three M consortium and signed an agreement to develop the Lunskoye and Piltun-Astokhskoye deposits. In 1993, the project went through all bureaucratic boundaries and finally was approved by authorities from Russian side. For the purpose of project development in 1994, a special company Sakhalin Energy Investment Company Limited was created.

In order to start its activities the newly established company signed a Production Sharing Agreement (PSA), which main purpose was to create commercial relations between the investors and the state on a legal base. By ratifying such agreement, the state grants an investor an exclusive right to develop a mineral deposits, oil and gas field with investors' own resources and risk. The Production Sharing Agreement was the first PSA in Russia and RF government and Sakhalin Oblast Administration represented the Russian side. The main goal of the Sakhalin-2 PSA was to determine terms and conditions for all processes - exploration, development, production, processing and transportation by replacing existing tax and regimes of licensing with contractual arrangements, which would remain effective for the whole life cycle of the project. According to the PSA, the Russian authorities retain the right of ownership of the oil and gas deposits while the Sakhalin Energy invests the capital required for exploration and development. Among basic principles of the Sakhalin-2 PSA are financial transparency, mutual responsibility, approval of work budgets and auditing the expenses by Russian Federation.

The PSA was formalized in 1996, when corresponding federal laws had passed and established a specific tax regime for the Project. Substitution of most of the taxes and duties by product sharing means instead of a value-added tax, a property tax, a mineral resources tax, etc. Sakhalin Energy pays 6 percent royalties since first extracting of hydrocarbons. Sakhalin Energy is also paying profit tax at the level of 32 percent and transfer entitlement gas to Russian side. The extraction of first hydrocarbons started in 2012 and the amount of money, which Russian party gets from the Project, now reach more than 5 billion US dollars.

In 2000, the Marathon Oil share was bought by Shell and it led to restructure of shareholder portfolio: Shell Sakhalin Holdings BV (55 %), Diamond Gas Sakhalin, company owned by Mitsubishi (20%) and Mitsui Sakhalin Holdings B.V. (25%).

The Project, including production, gas transport and liquefaction plant, had experienced significant delays and overran all expected costs almost twice. Maybe, one of the potential reasons was increase in equipment prices on the global market and partly these delays happened due to the difficulties with going through administrative barriers. Moreover, it faced the complaints of environmental organizations. In order to continue its functioning, Shell decided to sell significant part of its share to Gazprom (50 %). As a result the structure of investors' portfolio has changed one more time: Shell (27, 5 %), Gazprom (50 %), Mitsui (12, 5 %), and Mitsubishi (10 %).

Gazprom's entry eased the situation to certain extent due to the governmental support. The work was completed and the export of LNG to the Pacific market began. The plant was launched in 2009 and in 2012, the LNG production reached 10, 8 million tons. It is important that almost all prospective volumes of production were divided among future consumers in advance. 65 percent of Sakhalin-2 LNG was intended to Japan (with the highest share), South Korea and North America.

Although this project was considered the most expensive in Asia-Pacific region, part of the investments are returning sooner that it was expected because of the changing global climate (the need for more clear and environmentally friendly fuel), Fukushima nuclear disaster (partial refusal of using nuclear energy and suspension of the development of new projects) that resulted in growing demand for LNG and new energy pricing in the region.

In 2012 Gazprom as a main shareholder decided to expand the Project for two reasons: favorable conditions on the market of Asia-Pacific and pressure from the Russian authorities, which were strongly intended to start new LNG projects. The Sakhalin-2 was an ideal platform to continue development in this sphere.

The third line of Sakhalin-2 LNG project should come online in 2017. Sakhalin Energy will remain the operator of the project. The potential costs may fluctuate from five to 7 billion US dollars. At the same time, Gazprom is planning to give priority for participation to current partners- Shell, Mitsui and Mitsubishi.

In 2013, the structure of LNG exports was as follows: Japan remains the key consumer with the share 81, 63 percent of total exports, South Korea - 17, 77 percent and Taiwan 0, 6 percent. Consumer's ships performed the transportation of LNG and tankers produced specially for such purposes by two Russian-Japanese consortiums and rented by Sakhalin Energy on the long-run basis. The company also gives part of the extracted LNG to the Gazprom pipelines as a royalty in a natural form to the Russian side. Since the beginning of extracting first hydrocarbons, Russian Party has almost 1 439 billions of cubic meters of gas.

One of the cornerstones of Gazprom's plans is that expanding the Sakhalin plant may require the third line of LNG in order to receive gas from other suppliers. Gazprom informed about eagerness to buy gas from Sakhalin-1 and tried to organize negotiation process between Sakhalin Energy and ExxonMobil with the government as a mediator. However, for Sakhalin-1 consortium is more preferable to develop their LNG production. In such situation in order to satisfy needs of all stakeholders (Russian consumers in Far East, importers, Vladivostok LNG plants) the only way for Gazprom is to develop new reserves through the Sakhalin-3 project.

1.2 Sakhalin-1

Sakhalin-1 was another PSA project launched in the early 1990s. Potential deposits of gas and oil was found in 1977 at the field Odoptu, than in 1979 in Chayvo and finally in 1989 in Arkutun-Dagi. After enforcement of the Production Sharing Agreement in 1996, there was a period of exploratory works continued until 2000. During this time, seven appraisal wells were drilled and about 1200 square kilometers were explored. In 2001, the consortium Sakhalin-1 had announced the profitability of the project and got the approval of authorities to start extraction for commercial purposes.

The members of the consortium Sakhalin-1 are Exxon Neftegas Limited (a subsidiary of ExxonMobil) with the share of 30 percent, RN- Astra (8, 5 percent) and Sakhalinmorneftegas- Shelf (11,5 percent) (both companies are subsidiaries of Rosneft), Japanese consortium Sodeco with the share of 30 percent and Indian state owned oil company ONGC Videsh Ltd. (20 percent). The operator of the project is Exxon Neftegas Limited.

The project is divided into four main parts. The first step is a development of the Chayvo deposit with usage of land and sea facilities. The extracted resources are moved to the Chayvo Onshore Processing Facility where the export oil is stabilized and then goes to the consumers. The next step is the development the Odoptu deposit where drilling had started in 2009 in May and then in September, 2010 oil and gas production started. In February 2011 the first stage of drilling processended successfully. The third part is connected with Arkutun-Dagi field. The beginning of extraction is planned in this year. Fourth part of the project is aimed on development of natural gas deposits at Chayvo field.

One of the problems at the beginning of the project is lack of understanding between its stakeholders. Members of the consortium wanted to export the gas produced at Sakhalin-1 to China but the Russian government stopped all initiatives at the very beginning. For some period the key production of the deposits was oil while the gas was kept as a reserve or for technical purposes.

The situation started to change when in 2012 Rosneft moved towards gas market. At first, companies' activity did not come into conflict with Gazprom monopoly on gas exports. Both companies even performed joint actions in order to prevent invasion of private investors in the offshore sites. But in February, 2013 Rosneft began to support the liberalization of LNG exports together with Novatek. The real competition started when the company applied for the same licenses as Gazprom. Now Rosneft is planning to build an LNG plant on Sakhalin-1 in cooperation with ExxonMobil. This decision was announced in 2013 and in 2014 according to the strategic plan the design of the plant on the Sakhalin Island should be completed. The capacity of this plant is 5 million tons of LNG with ability to expand to 15 million tons. The required capital investment is 15 billion of US dollars and the possibility of Sodeco and ONGC Videsh Ltd. joining the investors' team is rather high. So, at the moment Rosneft statures the process of finding a partner to design and engineering works and according to the schedule the plant would be built till 2018-2019.

The plant will get raw materials from the second part of the project Sakhalin-1- Odoptu deposit and from other Rosneft's offshore deposits on the Far East. For the company it is a beginning of its expansion on the LNG market. Rosneft has a resource base, technology potential in order to be successful in implementing their strategies. First important agreements for LNG supplies that proved the company seriousness towards LNG market were signed in 2013 at the International Economic Forum in St. Petersburg. The contractors were two Japanese companies Marubeni and Sodeco and amount of supplies were 1, 25 million tons and 1 million tons annually and company Vitol (2, 75 million tons per year). The contracts were signed and the only important thing that should be done in order to start initial supply is liberalization of LNG exports.

In 2013 Rosneft was forced by government to build this plant with other companies and made the Ministry of Energy be engaged in the process. The main appeal of Vladimir Putin was as to act «so that everyone works under a single plan and understands what will happen and how it this will impact Asia-Pacific markets». This means Gazprom could transfer that project, started successfully by Rosneft, for use. In such situation where both companies are state-owned and liberalization of LNG market in Russia is still an urgent point of discussion everything depends on the decision of the country's leaders.

The project is rather prospective and could make high returns on investments a reality. The main reasons for it are already developed infrastructure in the region, the benefits of geographical position and low cost of production in comparison with other LNG projects have launched since 2010.

1.3 Pechora LNG

In 2009, December the privately owned Russian company Alltech searching for the new investments opportunities suggested to build an LNG plant in Nenets Autonomous District. The company had a diversified business where gas and oil assets represented an important role and was searching for ways or reserving its gas assets. The project suggested by the company involved the development of two deposits - Korovinskoye and Kumshinskoye, the design and construction of transportation infrastructure and an LNG plant with capacity of 4 million tons annually. The amount of capital investment in the project is planned to be around 5, 5-6, 5 billion US dollars (about 2, 7 is going to the plant construction).

LNG plant will be on area of 220 hectares in a non-freezing part of the Barents Sea shore, in 230 kilometers off administrative center of the district - Narayan-Mar town. The production capacities are planned to be 4 billion cubic metros of dry gas and 2, 6 million tons of LNG. The expansion of gas processing could be improved in future (8 billion cubic meters). The main commodity market for product is Asian-Pacific region. LNG transportation will be performed by special sea terminal built near the plant. Also for Project, services will be built several Arctic LNG carriers of Arc4 with capacity 180 thousand cubic meters. The agreement has been already signed with the JSC Far East center of shipbuilding and ship repair, a member of OSK.

The company cannot make a decision now because it has not a permission to export LNG. The project is very attractive due to the competitive advantages such as existence of reserves for production and transportation, more comfortable weather conditions that allows providing year-round supply of LNG. Nevertheless, the main problem is that Alltech is a private company while in case of Russia only major players can compete on this market. Only if one of these players - Novatek, Rosneft or Gazprom provides a political support for this company it can be successfully implemented.

In 2013, April in Moscow a meeting was held between Alltech representatives, CEO of Pechora LNG (company, specially created for this project) and Alexey Miller on issue of execution of the Project. On this meeting a platform for further cooperation process was established between local authorities, Gazprom and Alltech Group.

1.4 Baltic LNG

The idea to build an LNG facility in the Leningrad region was under consideration almost for a decade. First time it was proposed by Gazprom in 1997 as a small project to construct a plant with capacity of 2 million tons per year. But investment was not encouraged because of the high costs of entering LNG market, lack of investors and low gas prices on the markets of prospective consumers - USA and Europe.

But the need to build such facility existed. At that time, Russia has difficulties with choosing the partners for development of Shtokman and Yamal deposits and actively searching for any ways to gain a ground as a key supplier of LNG on the world market. So the Ust-Luga was announced as a construction site and Canadian company Petrocanada became the first international partner in this project. This cooperation turned out to be effective as Petrocanada offered Gazprom to be a partner in construction of Gros-Cacouna terminal in Quebec and gave independent access to the North American LNG market.

In 2005, a joint venture company in order to operate the project was created. Its shareholders are Gazprom Export and Sovcomflot. The gas was to be supplied from the portfolio of Gazprom and would not be tied to any certain deposit. The Primorsk port was selected as a site for construction and the LNG plant should start its work in the end of 2012. The planned capacities were from 7, 5 to 11 billion cubic meters supplied from UGSS trough the Volkhov-Vyborg-Primorsk corridor of the planned North Stream pipeline.

The amount of planned capital investments fluctuated from 3, 5 to 6 million US dollars. This project was the first in the Atlantic that involved Russian resource base. The main factor of the Gazprom's strategy is independency in terms of distribution and marketing on the LNG market. In such situation, foreign investors could not expect to get a significant share of LNG for independent sale. It could be said that the strategy later was repeated in case of Shtokmain field development. Gazprom Export would buy LNG on a «free on board» basis (it means that buyer pays for transportation of the goods) and transport it to import markets. Gazprom wanted to gain control on each stage of value chain using two options. First option is to use the principle of «deliver ex ship» that means that the passing of risk does not occur until the ship has arrived at the named port of destination and the goods are available for unloading to the buyer. In addition, the second is connected with buying or leasing regasification terminals and gas transmission capacities in order to have contractions with end-users.

The stage of studying and completing design of the project has ended in the end of 2007. Experts agreed on that fact that the supplying gas through the Baltic was a worst alternative due to the high transportation costs and the gas transmission system should be expanded. Also for Gazprom domestic risk-free supplies were more attractive than an export-oriented LNG project. Moreover, in 2007 there was signed an agreement between Total and Gazprom to develop Stockman first phase. All forces of the company were moved to the Stockman deposit and the project was cancelled in 2008, February.

In 2009 the question of re-launching the Project was raised again but the Board of Directors of Gazprom resumed not doing that. In 2013, the Baltic LNG Project got the chance of rebirth. Gazprom announced again the idea to build a plant on the Gulf of Finland with planned capacity 10 million tons annually. At the stage of development, the prospective markets were Latin America and Europe. Also one of the options was gas supplement of bunkering and small-shipping in Baltic - a new sector that gain the ground with high speed due to the new more strict regulations of emissions which will start acting from 2015. Also, Gazprom has a plan to build a 3 billion cubic metros regasification terminal in Kaliningrad for supplies from Baltic LNG. The plant will be launched in late 2018. The required capital investments are 5-7 billion US dollars. Gazprom also wants to attract investors with a view to remain the 49 per cent in the project. Among prospective investors, there can be industrial enterprises, institutional investors or potential buyers of the LNG. In 2006, Gazprom invited seventeen companies to participate in the Project. In 2007, April Gazprom chose four companies - the perspective partners. They are Petrocanada, BP, Eni and Mitsubishi.

1.5 Yamal LNG

The Yamal project has been discussed since 2006. The marketability of it was questionable but the situation has changed when it was transferred to Novatek. The project includes the construction of LNG plant with production capacity 16, 5 million tons of LNG annually, seaport and airport near the construction site. The main resource base for this plant was South Tambey on the Yamal Peninsula. The total planned capital investments are 30 billion US dollars and the date of the launching the plant and infrastructure objects is 2017.

The structure of investors' portfolio has been changing since 2006 and is still the topic under discussion. In 2011 Novatek, who owned 51 per cent of the project announced the proposal to co-invest. The 191919 was as follows - to remain 51 per cent to Russian side while the rest 49 per cent could be divided among several investors. Among prospective investors were Shell, ExxonMobil, ONGC, Qatar Petroleum, Mitsui, Mitsubishi, ConocoPhillips, and Total. Finally, Novatek found two partners - Total (French Oil Company) with the share 20 per cent in 2011 and CNPC (Chinese Oil Company) with the same share in 2013. The partnership agreements with China includes not only the investment issues but also supply contracts for a 15-year period (the proposed amount of supplies - 3 million metric tons per year). Novatek decided to leave the control share for its own and the last 10 per cent minus one share the company plan to sell to one or two investors. Now several companies are competing for this - Indian ONGC and Japanese consortiums Mitsui and Mitsubishi.

Although the final structure of investors' stakes is still discussed, the work on project has already begun. The government and the company cooperate to start a building of the port. The port has a strategic significance because it can provide a year-round navigation along the Northern Sea Route. According to federal budget, the government plan to invest in port construction, canal and ice barrier leading into the port around 1, 5 billion US dollars in the four-year period (2012-2016). The capital investments provided by Novatek are 0, 8 billion US dollars. The prospective shipments through a new port are expected to reach 5 million tons annually by 2016 and 15 million tons by 2018.

The main challenge of the Project - severe climate conditions that causes difficulties in navigation process - has been overcome with the planning of period of supplies according to the season. From July to November Novatek plans to supply LNG from Yamal to Asia-Pacific countries through the Northern Sea Route. From December to June, shipments will go through the western route (over the Atlantic). The thing is that convoying the tankers with the nuclear icebreakers is rather expensive and increases the costs of shipment of LNG. Moreover, it is very risky.

The company completed several test deliveries via the Northern Sea Route. However, difficulties in determining costs still exist. The regular supply through this route instead of deliveries via Suez Canal could save 3 million US dollars on transportation. But the costs of ice breaking should be taken into account. Russian experts now are trying to determine these costs.

But the route is not only one challenge of the Project. In 2012 Gazprom and Novatek signed a Memorandum of cooperation in order to establish a joint venture. The Gazprom, according to this memorandum, should increase the capacity of the Yamal LNG facility by leveraging the resource base of its Tambey deposits. At the same time, Gazprom will be able to process gas from Tambeyskoye fields. But the cooperation process slowed down in 2013 as both sides did not signed an agreement.

Economically the attractiveness of the project is made from several puzzles. Firstly, it is a simple process chain (in comparison to Shtokman). Secondly, it is a solution to diversify supplies using Asia-Pacific region. Thirdly, the resources of hydrocarbons are cheap onshore conventional gas reserves. Finally, it is a deal with the state authorities: the company promised to provide the lowest cost for the project in exchange for the building of infrastructure and designing a taker fleet by the government.

1.6 Vladivostok LNG

The first idea of construction an LNG facility near Vladivostok- the significant Russian port with an access to Asian markets - appeared in 2002. The Project was considered an alternative to Sakhalin-2 which was launched without Gazprom participation. The idea was good enough but due to the lack of investors and resource base, it was left aside for several years. In 2009 Gazprom announced reconsideration of this Project based on gas supplies from Eastern Siberia. The construction of the Eastern Siberia-Pacific Ocean oil pipeline might be the reason as it represented the prospects of transportation gas to the ports of Pacific. Although Gazprom has a very positive outlook towards this project Vladivostok LNG facility has much in common with the developing of Baltic LNG plant which was started a year before.

In 2009-2010 Gazprom in cooperation with two Japanese companies, Japex and Itochu and the Japanese Agency for Natural Resources and Energy made an analysis of effectiveness of creating such a plant. According to the study conducted by Gazprom and Japanese Agency and signed agreements it was decided to construct a plant with a capacity 15 million tons and capital investments should be around 12,4 billion US dollars. The main suppliers of gas for processing will be East Siberia region and transportation will be via pipelines. The target markets for this Project will be Japan and South Korea, China, Pakistan, Taiwan and Vietnam but now there are no any signed and discussed agreements.

After the tragedy of March, 2011 in Japan, the consequences of the earthquake and accident at the Fukushima nuclear power plant, the Russian Party announced the increasing of LNG supplies to Japan. But not all existing reserves and volumes of extracted gas were enough. As a result, the increasing supplies of gas for Japan led to the decrease of exports to third countries. That is why Gazprom became more active towards building new facilities and investing money in expanding existed deposits or developing new ones.

In 2013 under the government pressure to speed up the breakthrough to the Asian LNG market, the stage of design started. First line is planned to be launched in 2018, the second - in 2020, respectively. In addition, it was announced that the joint companies in the project are Itochu and JGC and in future, other Japanese companies can be a partners of Gazprom.

The main challenge of the project as it was said earlier is lack of resources. The competition for gas produced on Sakhalin projects is rather high and there existed a claim of Russia side on part of reserves. A Sakhalin Island divided to three projects - Sakhalin-1 and Sakhalin-2, developed in cooperation with foreign investors with the help of Product Sharing Agreements, and Sakhalin-3, developed by Gazprom. In this region, there is a big demand on extracted raw gas resources. Among consumers are Sakhalin-2 LNG plant, Sakhalin-1 LNG plant, developed by Rosneft, domestic consumers in Far East. The project Sakhalin-3 concentrates the main resources for Gazprom LNG plants. The production is supposed to come from Kirinskoe offshore field in Okhotsk Sea (the start of production -2013, October), and Yuzhno-Kirinskoe field nearby (the start of production is planned in 2018). Therefore, the Vladivostok LNG plant will be built earlier and will have many capacities that will be unused until 2018. As a result, main resource base for Vladivostok LNG plant will remain Chayandinskoye deposit (Yakutia). Here the first production of gas is expected in 2017. Transcontinental trunk line «Power of Siberia» is planned to be constructed at the same time.

The competitiveness of LNG from Vladivostok reduces as the construction of Chayandinskoe field is rather high and consisted almost 13 billion US dollars; the gas pipeline will cost 23 billion US dollars while the construction of first two stages of the plant will cost 13, 5 billion US dollars. As a result, the whole costs for a Project will be almost 50 billion US dollars. To compare the numbers, the Gazprom budget in 2012 was 1, 5 times less. The uniqueness of the project (that will be the first project in the world where gas will be transported by pipeline over a distance of three thousand kilometers for liquefaction) attracts investors but even now, there is no clarity towards Chayanda gas field. It is still critical for Vladivostok LNG how much Sakhalin gas Gazprom can get.

In 2013, February Gazprom announced final investment decision and in March the strategy for project implementation was approved. Five years remains and in order to implement all its ambitious plans Gazprom should hurry.

In conclusion, despite of the difficulties at the first stages of their launches all these projects are very attractive for investing. The timing and costs for delivering projects are important but not critical as the period of return on investments for these projects can be delayed for several decades. Five of these projects have a Japanese investors share and one - Pechora LNG - can be the next subject of interest for Japanese Party. Two of these projects are developed under Production Sharing Agreement while others are represented at the current stages as Joint Ventures. In the next chapter there will be explained the method of counting the profitability of these projects.

1.7 Choice of the Project for Analysis

For my analysis, I have investigated several projects with possible stake of Japanese side. Among them are two projects developed as PSAs and three projects that will be developing with high possibility as JVs. In the Table below, there is a comparison of main performance indices of these projects.

Table 1: LNG Projects developed on the Russian territory with stake/potential stake of Japanese investors.

Source: author analysis.

For the purpose of my study I have chosen the Sakhalin 2 project due to following reasons: availability of gaining more indices in comparison to other projects, a huge amount of literature and research papers devoted to this project, the relatively clear time framework of the project (the existence of geological exploration results about proven reserves let us assume the maximum lifetime of the project at the level of 49 years - see Table). Among other criteria of choosing the Sakhalin 2 are the existence of first results and sells of extracted and processed hydrocarbons and settled list of investors. Sakhalin 2 agreement was signed in 1994 and the project operations were launched in 2006, while shareholders of the Sakhalin Energy Investment Company, Ltd. are Shell (27, 5 %), Gazprom (50 %), Mitsui (12, 5 %), and Mitsubishi (10 %).

Table 2: Sakhalin 2 Oil and Gas Reserves

Source: OAO Rosneft-Sakhalin Morneftegas, Development of the far eastern fuel and energy complex, Sakhalin I and Sakhalin II projects implementation, May 1997 p.3. Original figures given in million tons of oil/condensate and billion cubic metres of gas converted into million barrels (1 tonne oil = 7,33 barrels; 1 tonne condensate = 10 barrels), and 1 billion cubic feet (1 cubic metre = 35,315 cubic feet).

In the next chapter, I explain how I built my analysis of this particular project and explain the results of my research.

2. Economic Profitability of Liquefied Natural Gas Project

The Joint Operating Agreement is the main vehicle widely used by joint ventures in exploring and producing oil and gas resources. It serves two main functions - firstly, it defines the proportions of interest of the parties and then it allocates the rights. The first function provides the legal basis for the sharing of rights and liabilities under the production license. The declaration of personal interest is one of the essential provisions in a JOA.

Figure 3. Joint Operation Agreements Revenue Flow

Source: author analysis and A.J. Alawode and Olusegun A. Omisakin model.

Figure 4. Product Sharing Agreements Revenue Flow

Source: author analysis and A.J. Alawode and Olusegun A. Omisakin model.

All rights and liabilities arising in connection with the production license will be shared between the licensees in proportion to their percentage interest. Regarding the second function of a JOA, the allocation of rights, the JOA creates contractual duties of performance between the co-ventures and it provides a set of rules for the conduct of operations under the production license. There are two classes of party to a JOA: the operator and the non-operators. The operator is the party who implements the collective will of the joint venture and is responsible for the day-to-day management of the operations. The other members are known as non-operators. Operation involves designating one of the licensees as operator who is responsible for conducting the day-to-day operations, subject to the supervision of a Joint Operating Committee, which is representative of all licensees.

In Russian legislation practice JVs are regulated by Federal Law from 09.07.1999 N 160-FZ (edited in 05.05.2014) «Foreign Investments in Russian Federation». Here the Joint Ventures are named «organizations with foreign investors» and their tax bases and Tax Code of Russian Federation determines tax rates with the conditions that are not less favorable as for the rest of same organizations in Russia. However, there are some restrictions. For example, in case the foreign investor possesses less than 10 percent of shares in the authorized (share) capital of this organization are not under the legal protection, guarantees and privileges established by the present Federal Law.

The taxes paid under JVs are the next: VAT, corporate income tax, severance tax, payment for negative effects on the environment, water tax, government duties, tax on land, excise duty (except excise duty on excisable mineral raw materials), local taxes and duties (trading fees, vehicle duties, tax on property of the organization), customs duties.

According to the Russian Tax Code, the tax base of severance tax for oil and gas condensate from oil deposits defined as the amount of extracted minerals in physical terms and the tax rate for it is 340 rubles per ton. Furthermore, tax rate is used with the coefficient that is calculated as follows:

Tax rate coefficient = (C - 8) x Р / 252,

Where C - average price level of crude oil grade "Urals" in US dollars per barrel for the fiscal period; P - average value of the US dollar to the Russian ruble, established by the Central Bank of the Russian Federation for the tax period. The VAT tax rate is 10 percent (in case the production is moved abroad). The corporate income tax is established at the level of 20 percent. Water tax is paid in accordance to the territory and water resource placement and is adjusted each year with the coefficient 1,1. Since 2014 year, the natural gas is one of the excised goods in the Russian Tax Code and excise duty rate for it is determined as 30 percent. Government duties is paid individually while registration of organization or signing agreement. Tax on land is calculated by tax authorities and paid accordance to their estimations.

Vehicle duties are defined individually according to the type and capacity of the vehicle (all transport vehicles except offshore fixed and floating platforms, mobile offshore drilling rigs and drilling ships).

You can observe the revenue flow for JOA on the Figure 3.

A production sharing agreement is an internationally binding contract in commercial purposes between an investor and a government.

A standard PSA defines the conditions for the development and exploration of natural resources from a certain field over a determined period. According to the terms of any oil and gas PSA, ownership is retained by the state and the investor held responsibility for extracting the resource. Typically the majority of early revenue from the project was got by investors, as some kind of compensation for the cost of exploration and development (on the Figure 2 it is presented as compensated production). Once the project reaches the cost recovery stage (on the Figure 1 it is presented as a profit oil), subsequent revenue starts to be shared between the investors and the state according to a pre-negotiated terms.

Nowadays PSAs are generally used to protect foreign investing companies from the political risks associated with upstream capital investment in unstable and developing countries. By establishing the conditions and defining terms of exploration and development for the life of the project, PSAs are created to protect foreign companies from risks such as unpredictable regulation, arbitrary tax legislation and rent seeking by government authorities. PSAs exist throughout the world, but in recent years, they have achieved special popularity in Russia.

In Russia PSA is operated under the federal law from 30.12.1995 N 225-FZ (edited in 19.07.2011). The law establishes the legal basis for relations, arising in the implementation of Russian and foreign investments in exploration and production of mineral resources in the Russian Federation, as well as the continental shelf and (or) within the exclusive economic zone of the Russian Federation on the sharing agreements products. According to the law Production Sharing Agreement is a contract in accordance with which the Russian Federation provides an investor a fixed term exclusive rights for exploration, extraction of mineral resources in the subsoil, indicated in the agreement and to conduct related works, and the investor from their behalf undertakes to conduct these works at their own expense and risk. The agreement defines all the necessary conditions related to subsoil use, including conditions and procedure of production sharing agreement between the parties. The agreement duration is determined by the parties. Among main requirements of the PSA are involvement of the citizens of the Russian Federation as employees (not less than 80 percent of all employees involved), acquiring necessary for exploration and production, transportation and processing equipment, facilities and materials of Russian origin (not less than 70 percent of the total cost) in each calendar year. The 8 chapter of the law regulates the production sharing process. According to it, products are divided between the state and the investor in accordance with the agreement, which must include the total volume and value of production, a portion of output that is passed into the ownership of an investor to reimburse its expenses for the execution of works under the agreement (compensatory production with maximum level 75 percent of the total volume produced), the division of production between the state and investor minus value of the tax payment on mineral extraction, compensation production for the reporting (tax) period. The taxes paid under PSA are the next: VAT, corporate income tax, severance tax, payment for negative effects on the environment, water tax, government duties, tax on land, excise duty (except excise duty on excisable mineral raw materials). At the same time taxpayer is free from paying state and local taxes, property tax in respect of fixed assets, intangible assets, inventories and costs that are on the balance of the taxpayer and used exclusively for the implementation of activities under the PSA; customs duties; vehicle tax. The procedure of determining these taxes bases and rates is the same as it was described higher in case with Joint Ventures.

You can see the revenue flow from PSA on the Figure 4.

To sum up, PSA seems to be more preferable as it take into account the interests of both sides - the investor and the government. It allows decreasing risks connected with internal political stability and attracting potential partners. Furthermore, the each PSA project in case of Russia is rather unique and depends on range of factors among which is operational, political, consortium, regional, technological, geopolitical and legal factors.