OREANDA-NEWS. October 03, 2008.
Mr. Chairman, Ladies and Gentlemen.

It is a great privilege and pleasure to be here to provide an update on the Sakhalin II project.

2008 is a very special year for Sakhalin Energy as we move from construction through commissioning and then into operation of the Phase 2 facilities and I am pleased to be able to share some of this journey with you.

First of all let me address the increasing contribution from our major shareholder, Gazprom.

The entry of the world’s largest gas company brings access to a wealth of expertise and knowledge that has been accumulated over decades of successful operations both in Russia and as Europe’s major energy partner.

As you know, Gazprom operate the most extensive gas pipeline network in the world. We leveraged this knowledge by asking Gazprom to provide us with an expert team which is currently playing a key role in the commissioning of the onshore pipeline system.

Later today we will sign a five year contract with a Gazprom affiliate, Gazprom Transgaz Tomsk, for servicing and maintaining the TransSakhalin pipeline system: 1670 kms of oil and gas pipelines, 104 block valve stations and a booster station. This partnership between Sakhalin Energy and Gazprom Transgaz Tomsk gives Sakhalin Energy the benefit of their extensive expertise and provides Gazprom with an operational footing on Sakhalin.

Beyond their undoubted pipeline expertise, Gazprom has provided invaluable additional support in a number of areas, most notably in the development of our Environmental Action Plan, which I will come back to later.

As you are aware, the global finance crisis is making headlines every day. In the midst of the turmoil created over the past year by the credit crisis, it is therefore very gratifying that we achieved a major milestone when we secured Project Finance in June.

The Japan Bank for International Cooperation (JBIC) and an international consortium of banks have committed to provide US5.3 billion to contribute to the financing of the project. This is the culmination of several years of effort by the Company and intense scrutiny by the prospective lenders. It is one of the largest project finance deals in the industry and, by a substantial margin, is the largest ever project finance deal in Russia.

New benchmarks were set in terms of standards and transparency so the deal has significance beyond Sakhalin to other future potential large scale energy projects in Russia and elsewhere.

Let’s now look at what has been achieved in the project itself.

We start with Molikpaq which has been in production since 1999 and has since delivered over 100 million barrels of oil in seasonal production. Until the TransSakhalin pipeline system is completed later this year, we are dependent upon the Single Anchor Leg Mooring system for oil export.

You may recall that this was damaged in a storm at the end of 2007. I am pleased to report that the unit was repaired and successfully reinstalled in July, allowing production to resume.

In addition to providing the foundation for our oil exports, Molikpaq gas, which up till now has been injected back into the reservoir, is now being used for initial commissioning of its sister platform Piltun-Astokhskoye-B as well as the Onshore Processing Facility in the north of the island. In due course the gas will contribute to the LNG feed stream.

The Piltun-Astokhskoye-B platform, which was installed about a year ago and was declared fit for habitation around the time of last year’s conference, has now been hooked up and the drilling systems commissioned. The first batch of conductors has been driven and the first well, a cuttings reinjection well, has been completed.

Good progress is now being made on the first oil well. Gas from the Molikpaq is already being used to switch the platform’s power generation from diesel to gas in advance of Piltun’s own gas being available. We are on track to deliver first oil from Piltun by the end of the year. As we progress with the drilling and completion of the oil wells, Piltun production will progressively supplement that from Molikpaq, whereas the gas will become another LNG contributor.

Both Molikpaq and Piltun-Astokhskoye-B are close to the Western Grey Whales’ feeding grounds. Although the major construction is complete, we continue in our whale monitoring and protection efforts, sharing our programme plans and results with the WGWAP, the panel of independent whale experts.

On LUN-A the cuttings reinjection well has also been drilled and the first two gas wells, which are all we need for starting up the first LNG train, are substantially complete. Final testing and commissioning of the production systems are in progress utilising a flotel to accommodate the additional workers. The first two wells will be perforated, beamed up and cleaned up as soon as the platform and onshore systems are ready to accept the gas, which is currently scheduled for November.

Two more wells will be drilled in the next few months which will then provide sufficient gas for starting up the second LNG train in early 2009.

The Onshore Processing Facility processes (by that I mean separates, cleans and dehydrates the gas and oil) then compresses and pumps the gas and oil through the trunk lines to the south. It also performs a key role as the upstream operations coordination centre.

It should be noted that the OPF removes the condensate from the gas which is then commingled with the oil from Molikpaq and Piltun-Astokhskoye-B. The gas condensate will eventually become a significant proportion of our liquids production.

Construction and initial commissioning of the first OPF process train was completed a few weeks ago allowing the introduction of gas for the second phase of the commissioning process, that of testing the power generation and compression equipment on gas. The second process train will be ready in the next few weeks.

The TransSakhalin pipeline system forms the backbone of the development.

A year ago the key remaining construction challenge was the completion of 19 seismic crossings. Where the pipeline crosses potentially active seismic fault zones it is reoriented and provided with elbows to minimise the stresses, strengthened and surrounded by light, crushable material in specially designed trenches to facilitate movement. Each of these had to be tailored to accommodate the maximum possible fault displacements and local site conditions.

I am pleased to report that all crossings are now complete and the remaining pipeline system commissioning is well under way.

The pipeline system may be considered in three sections: from landfall at Chaivo to the OPF, from OPF to Booster Station 2 (BS2) and from BS2 to the LNG/OET site. The first, northern, section is already completed and is indeed already conveying gas, as I described earlier. Oil from Molikpaq will be introduced in the northern section later this month. At this point the offshore export of oil will cease.

The central section will see the introduction of hydrocarbons in November, closely followed by the southern section.

Construction of BS2, located near Gastello, is well under way but it is not required to be on stream till the second half of 2009 when increased gas production will necessitate additional compression.

Apart from completing construction and commissioning of the pipeline system, good progress has also been made in technical and biological reinstatement of the 800 km Right of Way (RoW) in accordance with our Environmental Action Plan, which was supported by the Ministry of Natural Resources last year. Minister Trutnev made a visit to the island last week to evaluate the work in person. I am delighted to report that he was very pleased with the progress that had been made, describing the project as exemplary in this regard.

The reinstatement work will be substantially complete before the onset of winter but we do expect some follow up work in 2009 and beyond as it takes some time for such measures to become fully established.

Moving further south, the LNG plant, like the OPF, also has two process trains. The first of these was completed and handed over to operations in May. The second train will be completed in the next few weeks. Commissioning of both trains and associated equipment has been accelerated by the importation of two cargoes of LNG in 2007 and a third in 2008. The final commissioning phase for the first train is of course dependent upon the high volume gas from the first two gas wells, which I described earlier.

We currently expect to move into the final phase of LNG commissioning towards year end, leading to first LNG export early in 2009.

The LNG jetty has of course been fully commissioned during the LNG import operations. Oil will however be exported from a separate Tanker Loading Unit (TLU) some 4.5 km from the shore.

Initial mooring trials with the 108 thousand tonne tanker “Governor Farkhutdinov” took place in July and a further trial is scheduled for the end of this month. It will take some weeks for the oil from Molikpaq to fill the oil pipeline and then the tanks at the Oil Export Terminal (OET). Oil export using the “Governor Farkhutdinov” and her sister ship the “Sakhalin Island” is expected by the end of the year.

These export activities will take place in the newly established Prigorodnoye specialised port. A Russian Federation decree in May established the port area and opened the port for foreign vessels. A border checkpoint however remains to be established. This requires another government decree and we are working closely with the relevant agencies to have this in place by the end of November.

The port will, at peak, serve approximately 160 LNG carriers and 100 Aframax oil tankers each year, which is approaching one ship per day. These activities will be managed through a joint venture between Sakhalin Energy and Sovcomflot, Russia’s largest shipping company.

Sovcomflot also plays a key role in our LNG carrier operations. They, together with NYK, formed a Russian- Japanese consortium that owns and operates two of our three dedicated LNG carriers, the Grand Aniva and the Grand Elena. A second consortium of Primorsk Shipping Corporation, Mitsui OSK and “K” Line owns and operates the third vessel, the Grand Mereya. All three vessels have been launched and named and crews fully trained in other LNG operations in readiness for the start of our operations.

If you are wondering about the names; Aniva obviously refers to the bay whereas Mereya is a small but prolific salmon river situated just beside the LNG plant. By contrast, Elena commemorates the late Elena Zolotareva whose contribution to the Sakhalin II PSA and the project was immense.

Construction and commissioning activity is gradually reducing and demobilisation of contractors is underway. We currently estimate that we have some 15,000 people employed on the project, down from the peak of about 27,000. Numbers will reduce substantially as we approach year end but some post start-up construction work will continue into 2009.

Recruitment and training for long term positions has continued at a steady pace. This year, as in 2007, we will have recruited close to 300 Russians who will be developed to progressively take over the roles of foreign specialists. Here too Gazprom’s entry has had a beneficial impact as we have been able to expand cross training arrangements and make use of some of their training programmes. We are already over 60% Russian and there will be a sharp increase as we move into 2009 and project teams demobilise.

In summary good progress has been made in completing the construction phase and preparing for start up. Several challenges remain and we need the support of several agencies to help us overcome them. We are however on track to achieve year round production by the end of this year and 1st LNG export early in 2009.

I would like to take this opportunity to express my appreciation to the Oblast, the various RF authorities, our shareholders, our contractors and of course our staff for their huge efforts in helping to deliver this hugely challenging project.

Together we are delivering a world class project that we can all be proud of and providing a much needed boost to energy supplies in the Asia Pacific region.

Thank you for your attention.