Shell shakedown (cont.)

By Abrahm Lustgarten, Fortune

Much of the ammunition for Russia's political war against Sakhalin Energy comes from the cramped Yuzhno office of an independent environmental group called Sakhalin Environment Watch. At its helm is Dmitry Lisitsyn, a sharp-witted 39-year-old who has been hounding oil companies on the island for more than a decade. "We understand that our issues are being used as leverage," Lisitsyn says, "but at the same time, real problems exist."

If the government's inspections were politically fueled, though, Lisitsyn's motivations are not. He has the respect of his foes, and as Sakhalin Energy's Hilary Mercer, who heads the LNG project, puts it, "wants what is best for this place." Lisitsyn says Sakhalin II is a "lighthouse," a template for how future projects will deal with environmental and social standards. Chief among his concerns is the impact of the LNG plant, Russia's first, and the pipeline that leads to it.

The LNG plant and export terminal lie on a 1,210-acre patch of land about eight miles from Korsakov, abutting the steel-gray Aniva Bay. To the north a wide right-of-way cut in the forest marks the gas and oil pipelines' path up over the hills to the offshore platforms. To the south a jetty sticks out into the bay like a needle, ready to inject the 156 LNG tankers expected to dock there annually with liquefied gas, before sending them off to markets in the U.S., Japan, and Korea. The plant, mostly completed, won't come online until 2008, but already its output for the next 20 years is sold out.

Inside the perimeter fencing, where roughly 10,000 of Sakhalin Energy's 18,000 employees work, is - for now - the world's largest LNG facility. What happens inside the fence is by most accounts an orderly, world-class operation and a feat of engineering in Sakhalin's near-arctic conditions. It's what happens outside the fence that has drawn the scrutiny of Sakhalin Environment Watch and fomented ill will.

In order to bring LNG tankers into Aniva Bay, Sakhalin Energy had to dredge the bottom near shore, then dump the mud - two million cubic meters of it, Lisitsyn says - farther out in the bay. The island's second-largest industry after oil is fishing, and Aniva Bay is home to a diverse ecosystem that could be threatened by the dredging.

Lisitsyn wanted the company to use a longer pier, requiring less dredging, and dump the material farther out at sea. Instead Sakhalin Energy pursued the cheaper near-shore option. Now Lisitsyn is taking Sakhalin Energy to court, seeking a full accounting of environmental damages in the bay. Among other things, he alleges some of the dredging was conducted during the summer, in violation of laws protecting salmon spawning.

In that case and in disputes over the pipeline route, Lisitsyn has been highly critical of Sakhalin Energy's oil-spill preparedness and construction techniques. He says the company spends more time talking than taking action. "Sakhalin Energy loves the dialogue - it is one of their gods," he says. "But we don't want just talk, we want solutions."

That approach has led to delays and cost increases. In 2005, Sakhalin Energy made routing adjustments to its pipeline design to minimize risk from a possible earthquake. The company says it followed proper channels, but Oleg Mitvol, deputy director for environmental inspections at the Natural Resources Ministry, told the press that the pipeline cut into a protected nature reserve, prompting him to describe Sakhalin Energy as "a pure banana republic - colonizers in cork helmets."

The following year a controversy erupted over large piles of earth left along the pipeline, which Sakhalin Environment Watch says were never permitted and which led to the temporary revocation of construction licenses last September.

"Look, this is a huge, complex, frontier type of project," says Sakhalin Energy's Niven, explaining the slew of confrontations. "We were the first company ever to put an offshore production platform in here. These are new to Russia, so the Russians themselves have had to learn how to manage and approve them."

To be sure, Shell isn't the only culprit. Russia's own oil and timber companies have been pillaging the island for resources for more than a century, and Lisitsyn says, "There is a common perception that Gazprom will be much worse." Furthermore, it was the Kremlin, not Shell, that recently cut the island's take of oil taxes from 60% to just 5%. And Sakhalin Energy deserves credit for keeping the project afloat and providing employment through a period of unprecedented economic and political change in Russia.

But to a large extent the mood on Sakhalin Island comes down to perception, not fact. Says Oleg Yugai, deputy for economic policy and budget for the regional government: "This is all about the psychology of the people."