OREANDA-NEWS. October 05, 2009. Read Ian Craig's speech to the Sakhalin Oil and Gas Conference.

Mr. Chairman, Ladies and Gentlemen!

This has been a remarkable year for Sakhalin Energy and the Sakhalin 2 project.

In April we celebrated our 15th birthday and June was the fifteenth anniversary of the signing of the PSA.

The dreams and aspirations of 1994 have now become a reality in what Russian President Dmitry Medvedev hailed as “a new energy age” at February’s LNG inauguration ceremony.

Many of you and other distinguished guests from around the world attended that historic event.

The LNG plant is the heart of the Sakhalin-2 project and its start-up was the most important milestone in the history of the Company. Whilst no other event can come close to the significance of the inauguration ceremony, the past 12 months have seen other important milestones.

So let’s look at what else we’ve achieved.

The first Piltun oil well came on stream at the end of last year. We have now drilled and completed five oil wells with an average production of over 10,000 bbls or 1,300 tonnes per day, exceeding our initial expectations. In drilling, as in anything else, we strive for continual improvement so it is pleasing to note that each well was drilled and completed faster than its predecessor. This has been achieved by the drilling team constantly challenging and seeking improvements in each step of the programme.

A further 22 oil producer and water injection wells will be drilled by 2015. We are currently completing our first Piltun water injection well. This incorporates four independently controlled down hole valves and pressure gauges, which allow us to manage injection rates into four separate zones from a single well. Such “SMART” completions help to reduce development costs and increase oil recovery.

Lunskoye drilling has also progressed well and there are now five gas wells available. These are the largest gas wells in Russia. Each well is capable of producing about 350 million scf or 10 million cubic meters of gas per day. To help put that in context each well delivers enough gas to power a 2GW gas power plant!

We will drill one more gas well to ensure sufficient gas supplies for the winter and then we plan to drill a pilot well to appraise Lunskoye’s oil rim. A further 7 gas and injection wells will be drilled in this phase of the development up to 2013.

The TransSakhalin pipeline is the backbone of the production system. It comprises 1,670 km of oil and gas pipelines, 104 block valve stations, five maintenance depots and two gas compression Booster Stations; one at the Onshore Processing Facility (OPF) and one about midway down the island.

Late last year we started to introduce hydrocarbons into our pipelines, first oil then gas. In April, following the first phase of commissioning, responsibility for maintaining and servicing the onshore lines was assigned to our contractor – Gazprom Transgaz Tomsk (GTT). Prior to the formal handover GTT also played a key role in hydrotesting and commissioning the system, allowing Sakhalin Energy to benefit directly from Gazprom’s unparalleled experience in this area.

We are now very close to the completion and start-up of the second Booster Station, near Gastello. This station, which will also be operated by GTT, will be brought on line before the winter to allow us to boost gas compression to meet increased LNG demand in the colder months. The station also boosts oil pressure allowing higher production rates to be achieved.

Onshore pipeline Right of Way reinstatement was completed during late spring and early summer this year but soil fertility and local climate will of course dictate the pace with which the indigenous flora will became fully established.

Those of us who live on Sakhalin will know that this has been an extremely wet summer. The heavy rains have impacted the river banks at some of the pipeline river crossings. This is as expected during the first year or two of bedding in. Remedial work is being carried out as part of our ongoing maintenance programme.

In December 2008 we began year-round oil operations at the Oil Export Terminal in the newly established specialized port of Prigorodnoye.

Oil from Molikpaq, Russia’s first offshore production platform, together with crude from Piltun is combined with about 20% by volume condensate (similar to a very light crude oil) from Lunskoye to create the Sakhalin Vityaz blend. Low in residues and with a low pour point (< -60C) this blend can be transported without being heated and has good cold flow properties for jet fuel and gasoil.

Looking back to Phase 1, the first offshore oil tanker was loaded in September 1999 and, until year-round operations began from Prigorodnoye, we exported 169 cargoes from the Vityaz Complex on a seasonal basis, i.e. during the ice-free period. Over the last 10 years, the Company has now exported 213 oil cargoes, mainly in Russian tankers, to energy companies and refineries in Japan, South Korea, China, Taiwan, the USA, the Philippines, Thailand and New Zealand.

In January Lunskoye came on stream with the first two gas wells flowing to Train 1 at the Onshore Processing Facility where it was compressed to drive it through the main gas pipeline to the LNG plant.

For the technically minded among you, the LNG plant removes any trace impurities and water from the gas so as to prevent freezing or damage. The gas is then cooled in a novel, dual mixed refrigerant system to around –160C at which point, as a liquid, it occupies about one six hundredth of its original volume.

The refrigeration process requires a lot of energy; the main MR compressor alone requires 80 MW of power. The lower the ambient temperature the more power is available from the compressors and the more LNG we can refrigerate. We can therefore produce more LNG in the winter months, which conveniently matches our customer demand.

In early March the first liquefied natural gas was produced at LNG Train 1. The first scheduled cargo was loaded at the end of March and delivered as a shared cargo to two of our key foundations customers, Tokyo Gas and Tokyo Electric, in early April. At the end of May we brought on stream the second trains at Lunskoye, the OPF and the LNG plant, enabling us to gradually increase LNG production capacity.

To date we have exported some 48 LNG cargoes, delivering Russian gas for the first time to Japan, South Korea, China, India, and even Kuwait!

In December 2008, in a key recognition of the Company’s environmental performance, Sakhalin Energy won an Environmental Project of the Year award which was presented by Yuri Trutnev, the Natural Resources Minister.

Here you see the Goluboy brook at Prigorodnoye. Our LNG Plant is the only plant in the world with a salmon spawning stream on its site!

The Company’s activities to protect the local Western Gray Whale population, were also recognised. The whale population remains fragile so, in response to recommendations from the independent advisory panel, the Company decided to postpone a 4D seismic survey we had planned for 2009. We believe that the data collected this year will help to allay any concerns regarding the whale population.

Construction and commissioning activity is almost complete and most contractors and staff have been demobilised. We are also demobilising many of our foreign specialists. As they leave, their positions within Sakhalin Energy are being taken by trained Russian staff. By the end of this year Russians will account for almost 80% of all employees, a figure which will rise to over 90% in a year or two.

I am pleased to report that Sakhaliners currently make up two thirds of the total workforce. In order to enhance local capabilities Sakhalin Energy has been running an Apprenticeship Programme since 2003. So far, this has trained 150 people who are now employed at the LNG plant, the OPF and offshore facilities.

In terms of the monetary value of Russian content, I am pleased to advise that the value of contracts awarded to Russian companies is now nearing the US14 billion mark.

As an example of our efforts to maximise Russian content, later today we will have a signing ceremony for a long-term charter agreement with Primorsk Shipping Corporation for its oil tanker “Zaliv Aniva”. This is the third tanker owned and operated by PRISCO that we will use.

Of course the key benefit from the project is in the revenues received by the Russian Federation and Sakhalin Oblast. Even though we are just starting full scale production, revenues to date have already exceeded US 1 billion in bonus payments, royalties and taxes. In addition, some US 600 million has been invested into Sakhalin infrastructure – roads, bridges etc., increasing the quality of life on Sakhalin.

We are steadily ramping up to full production. Once we are at full capacity we will be supplying around 5% of the world’s LNG, significantly strengthening global energy security. If we express our total oil and gas production in oil equivalent terms we are currently producing at around 390,000 boe, or 53,000 toe per day, and should exceed 450,000 boe, or 61,000 toe per day, in the winter months.

Revenues are of course increasing in line with production. Nevertheless, in line with our plans, we have recently secured an additional US 1.4bn in project finance. Details of this additional financing will be announced within the next week or two. This, I might add, is in addition to the US 5.3 billion which JBIC and an international consortium of banks have already committed to provide.

The challenges of the Sakhalin-2 construction phase are coming to an end. We are now entering a new phase and reassessing our priorities for the coming years.

Key amongst these will be our aim to maintain the highest possible safety and environmental standards. I am therefore pleased to report that we have achieved certification of all our operations and facilities to the ISO Environmental Management Systems standard 14001.

Once we have proven all the systems to their full capacity, we will explore what incremental production may be possible through re-rating or debottlenecking the facilities. This may allow us to exceed the nameplate capacity of 9.6 mt per annum at minimal cost.

In addition to exporting gas as LNG, we are in discussions with the Russian Federal Authorities and the Sakhalin Oblast regarding supplying gas to domestic consumers on Sakhalin and possibly also to mainland Russia. Assuming that agreement is reached, the substitution of coal with gas for power generation here in Yuzhno should result in a significant improvement in air quality.

Another key activity over the next couple of years is the rejuvenation and resumption of infill drilling on the Molikpaq platform in order to ensure safety, reliability and future production levels.

There are many challenges still ahead, but I’m confident that, given the experience and expertise we have gained, we will continue to deliver world-class performance.

I believe that, through the input of our shareholders and contractors, Sakhalin-2 has combined the best international and Russian practices to meet the challenges of this frontier development. Our experience hopefully provides a successful model for further sub-arctic or arctic offshore developments in Russia.

On a personal note, I regret that this is the last time I will participate in this conference as I will shortly be moving to a new, equally challenging assignment. It’s been a great privilege to work on the Sakhalin-2 project – a once-in-a-lifetime experience for all of us.

I would like to take this opportunity to express my appreciation to the Russian Federation, the Sakhalin Oblast, our shareholders, our customers, our lenders, our contractors and so many of you for your support in making this hugely challenging project a reality.

Thank you for your attention.