7. Economic
Impact Management

7.1. Importance of the Sakhalin-2 Project for the Russian Federation and the Sakhalin Oblast

The Russian Federation and the Sakhalin Oblast have gained significant benefits from the Sakhalin-2 project.

  • Since Sakhalin Energy started its operations, the Russian Federation’s proceeds from Sakhalin Energy`s activity under the Sakhalin-2 project have totalled over US$ 25.1 bln, including over US$ 9.5 bln received by the Sakhalin Oblast.
  • US$ 25.7 bln worth of contracts have been awarded to Russian companies and organisations.
  • The Russian Federation has gained valuable experience in managing complex high-tech projects in remote locations and in subarctic conditions.
  • The infrastructure on Sakhalin Island has undergone large-scale upgrades.
  • Local employment levels and local workforce quality have increased (both direct and indirect effect).
  • Incomes and living standards for the local population have risen.
  • Many contracts and subcontracts under the Sakhalin-2 project are being awarded to Sakhalin companies.
  • With the company’s support, extensive social and public initiatives are being carried out on Sakhalin Island.

In 2018, financial statements prepared in accordance with the International Financial Reporting Standards (IFRS), revenues of Sakhalin Energy amounted to US$ 6,273 mln, and its total net income was US$ 2,041 mln.

Standards Harmonization Project

The company’s key production assets were originally designed using mainly international standards, foreign materials and equipment.

Over the years, the company has made a significant progress in production localisation and certification of Russian industrial companies according to international standards. Nonetheless, a certain share of equipment and services is still supplied from abroad. Therefore, to further develop Russian content, an initiative to align and harmonise the company’s and Russian standards commenced in 2014.

This project is aimed at the identification and comparative analysis of gaps and alignment between international and Russian standards applied in the industry. Successful implementation of this project will allow the company to expand the potential vendor database, ensure a high level of competition and increase Russian content share in the project through larger volumes of Russian-sourced materials and equipment.

The main goal of the project is to establish opportunities for increased involvement of Russian vendors into onshore procurement processes without compromising on HSE, reliability, and integrity performance.

Taking into account the significant interest from key foreign industry players in the Russian market, the results of this comparative analysis might be used for developing unified requirements on combined use of Russian and international standards and potentially have an impact on a broader scale. The application of harmonised standards in Russian industry will sufficiently enhance the overall quality of products and services, and increase the readiness of Russian companies to participate in international projects.

Sakhalin Industrial Park

In December 2018, solemn ceremony of capsule placement in the foundation of Sakhalin Industrial Park was held in Yuzhno-Sakhalinsk. The ceremony was attended by Roman Dashkov, CEO of Sakhalin Energy, Valery Limarenko, Acting Governor of the Sakhalin Oblast, Sergey Nadsadin, Mayor of Yuzhno-Sakhalinsk, and Alexander Parkhomenko, Director of Sakhalin Business Development Section of Gazprombank affiliate branch.

The idea of establishing a dedicated service park for Sakhalin oil and gas industry had originated in 2013. In the beginning of 2016, the project entered the feasibility study phase. A memorandum of cooperation between Sakhalin Energy, Sakhalin Oblast Government and Gazprombank was signed at the Eastern Economic Forum in September 2018.

The first stage of the first phase of the project includes creation of the following services: repair and maintenance of drilling equipment, valves, instrumentation and control automation equipment, testing and lab testing complex, repair of electric motors and equipment that was previously maintained outside of Sakhalin.

Availability of such a park will enhance reliability and efficiency of operations under the Sakhalin-2 project. Considering international cooperation in the project, the park will become an arena for transfer of technologies and best industrial practices.

Similar projects, especially those deployed in conditions of geographical remoteness from the existing production assets, are very important for the island. They form local engineering and technological centres and carry out city-forming function: one job in oil and gas industry creates five or six jobs in related sectors.

7.2. Financial Benefits to the Russian Federation and the Sakhalin Oblast

In 1994, Sakhalin Energy signed the Agreement on the Development of the Piltun-Astokhskoye and Lunskoye Oil and Gas Fields on the Basis of Production Sharing (PSA) with the Russian Federation, represented by the Government of the Russian Federation and the Sakhalin Oblast Administration. A PSA is a commercial contract between an investor and a state, allowing the investor to make large-scale, long-term, and high-risk investments under a stable tax regime.

Production sharing between a company and a state is triggered when an investor recovers all of its costs (the specific shares of each party are not fixed, but depend on the profitability of the project). The PSA also stipulates that the company should pay a profit tax, and the profit tax for the company is currently payable at a rate higher than the profit tax rate for non-PSA taxpayers.

According to the PSA, the state retains the ownership rights to the field and grants the investor an exclusive right to develop the mineral resources. The investor develops the resources by its own means and at its own risk and invests funds required for the exploration and development of the fields.

Under the PSA, some types of taxes, levies, and duties are replaced with production sharing. This effectively means that instead of some taxes (including the mineral extraction tax, property tax, etc.) and levies, Sakhalin Energy uses hydrocarbons as a form of royalty payment, and after product sharing starts, it will use them as the profit share. Financial benefits to the Russian party include the profit tax paid by the company and a number of mandatory payments, contributions, and levies. In addition, the Russian party receives income on R-share dividends (a special preference share providing the right to receive dividends).

In total, for the reporting period, Sakhalin Energy allocated US$ 2.5 bln (in kind and in cash) to the Russian Federation.

Royalties (in kind and in cash payment) amounted to US$ 495 mln. The dividends paid by the company to the R-share amounted to US$ 177 mln.

The Russian party’s production profit share was US$ 606 mln. In addition, the 2017 fiscal year profit tax totalled US$ 1.2 bln, which was paid by the company in 2018. Further payments of profit tax to the budget of Russian Federation in the amount of US$ 141.8 thousand were made.

Based on 2018 financial performance profit tax in the amount of approximately US$ 1.7 bln will be paid to the budget in 2019.

Over the entire period of project implementation (1995–2018), the Russian party has received US$ 25.1 bln from Sakhalin Energy under the Sakhalin-2 project, including amounts paid in 2018.

Total amount of payments to the Russian party from Sakhalin Energy under the Sakhalin-2 project in 1995–2018, US$ mln

1995–2014

2015

2016

2017

2018

13,623

5,188

2,022

1,768

2,528

Taxes and other mandatory payments made to the Sakhalin Oblast budget and to local budgets from Sakhalin Energy under the Sakhalin-2 project in 1995–2018, US$ mln

1995–2014

2015

2016

2017

2018

4,300

2,411

1,281

918

639

 

7.3. Russian Content

The Russian content means the utilisation of Russian labour, equipment, and services in the Sakhalin-2 project. In accordance with the PSA requirements, Russian content is measured in labour input (in man-hours), as well as materials and equipment (in weight units) delivered by Russian contractors (both legal entities and individuals). Sakhalin Energy will make its best efforts to achieve a Russian content level of 70% over the life of the entire Sakhalin-2 project. In 2018, the company reached a Russian content level of 88% of labour and 84% of materials and equipment used.

Sakhalin Energy Opens the Largest Data Centre in the Russian Far East

The new Data Centre is an integrated multi-component system designed to support uninterrupted automated operation of all Sakhalin Energy's business processes.

The Data Centre was designed according to the latest standards for construction in seismic areas. The project uses unique engineering solutions, including energy and back-up power supply, HVAC and fire safety systems.

Sakhalin companies will provide servicing and data processing for the Data Centre, which is another illustration of the Sakhalin-2 project maintaining focus on the Russian content development.

Sakhalin Energy has identified its key activities and mechanisms for increasing Russian content, which are featured in the Russian Content Policy and the Russian Content Development Strategy. The company’s efforts are primarily focused on long-term planning for Supply Chain Management requirements, identifying opportunities for Russian content development at an early stage, providing targeted assistance to Russian companies, in order to increase their competitive potential.

The total value of awarded contracts and variation under existing contracts with Russian companies since the project was launched through the end of 2018 has reached approximately US$ 25.7 bln. In 2018, the value of new contracts and amendments to existing contracts with Russian companies totalled approximately US$ 681.3 mln.

In 2018, the company reached a 58% level of Russian costs (actual expenditures).

Examples of contracts awarded to Russian companies in 2018:

  • Ioka Support Services (registered in the Sakhalin Oblast) for operation and maintenance of the company’s infrastructure projects in Yuzhno-Sakhalinsk;
  • SKF Geo (registered in St. Petersburg) for the provision of 3D/4D seismic acquisition services;
  • Remote Project Services Group Global LLC (registered in the Sakhalin Oblast) for the provision of catering and janitorial services for remote onshore assets;
  • Ioka Support Services (registered in the Sakhalin Oblast) for the provision of catering and janitorial services for offshore assets;
  • Sakhalin centre Ecospas (registered in Moscow) for the provision of OSR operations and management services;
  • RBT Sakhalin (registered in the Sakhalin Oblast) for the provision of travel agency services;
  • SMNM-VECO, ECC LLC (registered in the Sakhalin Oblast) for the provision of services on modification of hazardous industrial facility OPF Compression Site: Tie-ins and Hookup of Utility Lines;
  • Nabil Timber Industries (registered in the Sakhalin Oblast) for the provision of services on maintenance and repair of 0–50 km section of the Southern Access Road.

Further, in 2018, the company achieved a significant milestone in utilising TMK piping in the first offshore well, following successful international certification of TMK piping.

5,779 contracts and orders were awarded by the company in 2018. This includes 3,926 contracts and orders awarded to Russian companies with 2,580 (66%) of them awarded to the companies registered in the Sakhalin Oblast. The main contracts awarded to the companies registered in the Sakhalin Oblast are listed above.

While participating in the international project, Russian companies obtain a unique experience, opportunity to learn and develop the personnel’s competence, introduce high quality and HSE standards, therefore enhancing their competitiveness in the Russian and international market.

Sakhalin Energy is currently exploring opportunities for engaging more Sakhalin companies. To achieve that, we are closely interacting and exchanging information with the Sakhalin Oblast Government. It is planned to include a number of Sakhalin companies to Prequalification Audit Programme.

In September 2018, Sakhalin Energy and AKROS Signed a Letter of Intent at the Eastern Economic Forum

This document provides for cooperation in the area of cutting re-injection services provision.

Sakhalin Energy re-injects cuttings and wastewater from the platform, which is a safer, more environmentally friendly and cost-efficient method when compared to conventional methods of waste disposal.

For the first time ever in the Sakhalin-2 history, a Russian company will be providing these services at the project’s offshore platforms.

7.4. Supply Chain Management

The company pays close attention to the effectiveness of Supply Chain Management (SCM).

Our fundamental Supply Chain Management document is the Sakhalin Energy Supply Chain Management Policy (hereinafter referred to as the Policy). This Policy applies to all company’s employees and contractors, but primarily to the company’s personnel that are directly engaged in supply chain management. The Policy is applicable to all activities that involve spending the company’s funds on equipment, materials, resources, services, and works.

The Supply Chain Manager is responsible for ensuring that our model contracts contain the appropriate terms and conditions, for effective implementation of these terms and conditions in the procurement processes and for ensuring that control and assurance measures that are specified in the Policy and other Policy-based documents.

Sakhalin Energy adheres to the following principles in Supply Chain Management:

  • safety—causing no harm to people, the environment, or to our property; ensuring that contractors comply with the company’s safety standards;
  • additional value in SCM—value maximisation, cost effectiveness, and long-term commercial profit;
  • zero tolerance for personal profit, bribery, or corruption—in all SCM operations in accordance with the supply transparency principle;
  • competition—development of open competition in markets;
  • Russian content—maximisation of the Russian content and development of Russian suppliers and contractors;
  • human rights—ensuring respect for, observance, and promotion of human rights by contractors;
  • sustainable development—ensuring sustainable development in the process of selecting a contractor and in making supply chain management decisions.

The Policy lists rules and measures that ensure compliance with these principles.

In accordance with the principles listed above, our sourcing and award and contract management processes are set up as follows.

Creating a list of qualified vendors (for certain scopes of resources/services or for specific tender scopes):

Conducting tenders for purchase of materials/equipment or provision of services:

  • competitive bidding is preferred when sufficient market capacity exists;
  • distributing Invitations to Tender (ITTs) and Clarification Bulletins;
  • receiving bids (proposals);
  • conducting technical bid evaluation (including HSE, etc.);
  • conducting commercial bid evaluation.

Contract award:

  • upon completion of all stages of the bidding process, the company awards the contract under the terms and conditions specified in the ITT.

Contract management:

  • during performance of the contract, the company monitors contractor activities by tracking the mutually agreed Key Performance Indicators (KPIs) and by organising meetings to review contractor performance;
  • the company raises awareness of, and conducts trainings for contractors in order to ensure compliance with its requirements (including those related to HSE and social performance, anti-corruption and bribery principles, human rights, etc.);
  • the company conducts contract performance audits.

Sakhalin Energy’s Requirements for Contractors and Suppliers

Sakhalin Energy attaches great importance to the fulfilment of the company’s requirements by contractors and suppliers. These requirements include the following.

Health, Safety and Environmental and Social Performance (HSE&SP) Requirements

Contractors must:

  • include compliance with HSE&SP principles to the performance assessment;
  • perform checks and investigate any breaches of the HSE&SP rules to ensure the company’s HSE policy is properly followed;
  • independently certify the HSE&SP management system for compliance with generally recognised standards;
  • verify that they comply with HSE&SP standards.

Requirements for the Quality of Materials, Equipment and Services Supplied

Contractors must:

  • develop and comply with quality assurance policy;
  • specify (develop) and comply with the quality control process and its procedures;
  • specify (develop) and comply with quality assurance procedures.

Russian Content Requirements

Sakhalin Energy`s Russian content requirements have arisen from the Production Sharing Agreement concluded with the Russian party. The parameters used to measure the Russian content are weight of material and equipment, number of man-hours and their cost equivalent.

Requirements for a Tender Proposal

A tender proposal shall clearly demonstrate and confirm the following:

  • a tenderer is a financially stable and solvent company/organisation;
  • a tenderer has the relevant experience in the subject scope;
  • high quality and reliability of the provided services/performed works/supplied materials;
  • HSE&SP management systems and procedures are in place;
  • a quality assurance system and procedure are in place;
  • availability of resources to meet the work/supply schedule.

7.5. Vendor Development Programme

Development of Russian vendors is one of the key activities of Sakhalin Energy, the main purpose of which is to contribute in developing their competences and increasing Russian content in the Sakhalin-2 project.

For over 10 years, Sakhalin Energy has been actively implementing the Vendor Development Programme. An important component of the Vendor Development Programme is its training module that provides regular workshops on the following important subjects:

  • HSES;
  • quality assessment and quality control;
  • skills in participating in Sakhalin Energy’s tenders;
  • business ethics principles.

As part of the Vendor Development Programme, in 2018, the company held four workshops for potential contractors of Sakhalin Energy, including one workshop in Moscow. The workshops were attended by 71 Russian companies, including 33 Sakhalin ones.

In addition, the company provides individual information sessions (round tables) which purpose is early informing about terms and conditions of forthcoming tenders for potential Russian vendors. During such sessions, Russian vendors get information of scope of supply and general requirements for equipment and service provider.

Information about Vendor Development Programme is available on the company’s website, including description of the programme’s components, requirements for participants (including the process for application), preliminary schedule with topics indicated, and contact details.

Workshop for Potential Russian Suppliers for Molikpaq Major Rig Refurbishment and Upgrade Project

In July 2018, the company held a workshop for potential Russian suppliers of bulk materials for implementation of the Molikpaq Major Rig Refurbishment and Upgrade Project. The main purpose of the event was to inform potential Russian suppliers about the scope of supply of the forthcoming tenders and get feedback about the current Russian suppliers’ capabilities to ensure the manufacture and supply of products according to the requirements of Sakhalin Energy.

The workshop included general presentation of the project, planned scope and terms of procurement, main requirements for participants of tenders as well as holding technical discussions in format of "round tables" concerning pre-qualification procedures and imposed technical requirements for the following categories:

  • piping, fittings and valves;
  • electrical materials;
  • instrumentation & automation;
  • structural steel and fasteners.

The workshop was attended by more than 60 representatives from 42 Russian companies, most of them the leading manufacturers and suppliers of equipment and materials in the Russian market.

Participation of technical specialists both from Sakhalin Energy and Russian suppliers gave a special importance and information value to this event that provided an open, "live" and interesting discussion and allowed to develop constructive proposals for further successful cooperation with Russian companies.

 

Qualification Audit Programme for Russian Vendors

In addition to the Vendor Development Programme, the company continued with the programme of pre-qualification audits for drawing up a list of Russian manufacturers possessing technical capabilities to produce and supply equipment and materials for the LNG Train 3 project. 46 Russian companies were audited during the year, with the total number of leading Russian vendors and manufacturers in the oil and gas sector covered by the audit reaching 183 within the programme duration period (2016–2018).

The companies recognised during the analysis as technically qualified for inclusion in the project will also be considered as suppliers within the company’s operating activity that will allow to significantly increase the number of domestic suppliers under the Sakhalin-2 project.