7. Economic impact management

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

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

  • Since Sakhalin Energy started its operations, the Russian Federation’s proceeds from the Sakhalin-2 project have totalled over US$ 20.8 bln, including US$ 8 bln received by the Sakhalin Oblast.
  • Russian companies have gained access to new technologies and business development opportunities.
  • Over US$ 24 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 (over US$ 600 mln was invested by the company).
  • 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 have been awarded to Sakhalin companies that took part in the Sakhalin-2 project. Their capacity and competitiveness has been enhanced dramatically.
  • The company has carried out extensive social and public initiatives on Sakhalin Island.

In 2016, according to the International Accounting Standard (IAS), revenues of Sakhalin Energy amounted to US$ 4,554 mln, and its total net income was US$ 869 mln.

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.

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).

Production sharing between the company and the state is triggered when the 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.

In total, for the reporting period, Sakhalin Energy paid almost US$ 2.02 bln (in kind and in cash) to the Russian Federation.

Royalties (in kind payment) amounted to US$ 289 mln.

The Russian party’s production profit share was US$ 330 mln. In addition, the 2015 fiscal year profit tax totalled US$ 1.36 bln paid by the company in 2016.

Based on the performance results for 2016, a profit tax in the amount of approximately US$ 0.9 bln will be paid to the budget in 2016.

Over the entire period of project implementation (1995–2016), the Russian party has received US$ 20.8 bln from the Sakhalin-2 project, taking into account the 2016 amounts.

Total amount of payments to the Russian party from the project in 1995–2016, US$ mln

Taxes and other mandatory payments made to the Sakhalin Oblast budget and to local budgets from the Sakhalin-2 project in 1995–2016, US$ mln

Taxes and other mandatory payments made to the Sakhalin Oblast budget and to local budgets totalled US$ 1.3 bln in 2016. Revenues from the Sakhalin-2 project were a significant part of the total fiscal revenues of the Sakhalin Oblast in 2016 and represented over 60% of the regional budget.

Russian Content

The Russian Content means the utilisation of Russian labour, equipment, and services.

In accordance with the PSA requirements, the 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 2016, the company reached a Russian Content level of 86% of labour and 94% of materials and equipment used.

Sakhalin Energy has identified its key activities and mechanisms for maximising 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, providing targeted assistance to Russian companies in order to increase their competitive potential, and developing the workforce and suppliers.

The total value of contracts awarded to Russian companies since the project was launched through the end of 2016 has reached approximately US$ 24.2 bln. In 2016, the value of new contracts and amendments to existing contracts with Russian companies totalled approximately US$ 947.7 mln, or 59% of the total value of the contracts.

Examples of contracts awarded to Russian companies in 2016:

  • SCF SHELF for seagoing vessel charter services;
  • ZAPOLYARPROMGRAZHDANSTROY for performing early work (site preparation) for the OPF Compression Project;
  • GIPROGASCENTER for development of the Train 3 Project FEED (Front-end engineering and design) documentation and design documentation for the Gas Transportation System (GTS) upgrade;
  • SM TRADING for providing fully managed bus services;
  • SOGAZ for providing offshore operational insurance, including risks of physical loss and physical damage, equipment damage and Operator’s extra expense related to Drilling activity;
  • INTRA SERVICE COMPANY for providing CUI (corrosion under insulation) services for OPF;
  • UHSEP for providing compliance services.

Russian companies involved in the project have unique access to international best practices, global business opportunities, and management skills.

In addition to new jobs as well as personnel and capacity development, Russian companies also benefit from the following:

  • improving the quality of services and materials, as well as occupational safety standards;
  • introducing technologies that are new to the Russian Federation and acquiring unique experience;
  • doing business with international partners and setting up joint ventures;
  • increasing their competitiveness as bidders in other project tenders, both in the Sakhalin Oblast and worldwide.

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 employees and contractors, but primarily to company personnel that are directly engaged in supply chain management. The Policy applies to all activities that involve spending the company’s funds on equipment, materials, resources, services, and labour.

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

Sakhalin Energy adheres to the following SCM principles:

  • 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 contract award and management process uses the following process.

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

Conducting tenders for the 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;
  • submitting 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 the 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 and conducts training in order to ensure compliance with its requirements (including those related to HSE and social performance, anti-corruption and bribery, 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:

Health, Safety and Environmental (HSE) Requirements

Contractors must:

  • include compliance with HSE principles in the performance assessment;
  • perform checks and investigate any breaches of the HSE rules to ensure the company’s HSE policy is properly followed;
  • independently evaluate the HSE management system for compliance with generally recognised standards;
  • verify that they are in compliance with similar HSE standards and provide the necessary advice on these issues, etc.

Requirements for the Quality of Materials, Equipment and Services Supplied

Contractors must:

  • develop and comply with the company’s 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 Russian Content requirements have arisen from the Production Sharing Agreement concluded with the Russian party. The parameters used to measure the Russian Content are weights of material and equipment, man-hours and their cost equivalents.

Requirements for a Tender Proposal

A tender proposal shall clearly demonstrate and confirm the following:

  • a company is financially stable and solvent;
  • a company has the relevant experience;
  • services provided, work performed, and materials supplied are high quality and reliable;
  • HSE management systems and procedures are in place;
  • a quality assurance system and procedure are in place;
  • resources are available to meet the work/supply schedule.

Vendor Development Programme

Sakhalin Energy has released a new brochure on the development of Russian Content in the Sakhalin-2 project

The publication contains general information about the project, the most vivid examples of cooperation with the leading enterprises of Russian industry and services, as well as information about the Russian vendor development programme. Particular attention is paid to development projects, opening up new opportunities for domestic enterprises. An electronic version of the brochure can be found on the company’s website www.sakhalinenergy.com.

For several years, Sakhalin Energy has been actively implementing the Russian Vendor Development Programme, the main purpose of which is to offer greater opportunities to Russian businesses and to increase the Russian Content in the Sakhalin-2 project.

An important component of the Vendor Development Programme is its educational module that provides regular workshops on the following important subjects:

  • HSES;
  • Quality Management System;
  • Skills in participating in Sakhalin Energy’s tenders.

As part of the Vendor Development Programme, in 2016, the company held a number of workshops for potential contractors of Sakhalin Energy, including one distance workshop via videoconferencing. The workshops were attended by more than 42 specialists from 27 Russian companies, including 16 Sakhalin companies.

In addition to offering the training module, the Vendor Development Programme targets particular Russian companies to ensure that they receive the technical qualifications necessary to be added to the approved vendor list of Sakhalin Energy.

Programme for audits of Russian companies for the LNG plant Train 3 construction project

In addition to the Vendor Development Programme, in early 2016 the company launched an audit program for the Russian industrial companies in order to compile a list of technically acceptable Russian manufacturers for construction of the LNG plant Train 3. During the year, the audit covered about one hundred Russian companies which are the leading manufacturers and suppliers of oil and gas equipment and materials, more than 80 companies of which were reported as conforming to qualification requirements.

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