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 numerous benefits from the Sakhalin-2 project.

  • since Sakhalin Energy started its operations, the Russian Federation’s proceeds from the Sakhalin Energy activity under Sakhalin-2 project have totalled over US$ 22.6 bln, including US$ 9 bln received by the Sakhalin Oblast.
  • US$ 25 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.
  • with the company’s support, extensive social and public initiatives have been carried out on Sakhalin Island.

In 2017, according to the International Accounting Standards (IAS), revenues of Sakhalin Energy amounted to US$ 5.401 mln, and its total net income was US$ 1.503 mln.

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 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.

Over the entire period of project implementation (1995–2017), the Russian party has received US$ 22.6 bln from Sakhalin Energy under the Sakhalin-2 project, taking into account the 2017 amounts.

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$ 1.8 bln (in kind and in cash) to the Russian Federation.

Royalties (in kind and in cash payment) amounted to US$ 377 mln.

The Russian party’s production profit share was US$ 474 mln. In addition, the 2016 fiscal year profit tax totalled US$ 860 mln paid by the company in 2017.

Based on the performance results for 2017, a profit tax in the amount of approximately US$ 1.2 bln will be paid to the budget in 2018.

Total amount of payments to the Russian party from Sakhalin Energy under the project in 1995–2017, US$ mln

1995–2014 2015 2016 2017
13 623 5 188 2 022 1 768

Taxes and other mandatory payments made to the Sakhalin Oblast budget and to local budgets from Sakhalin Energy under the Sakhalin-2 project in 1995–2017, US$ mln

1995–2014 2015 2016 2017
4 300 2 411 1 281 918
7.3. 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 2017, the company reached a Russian content level of 87% of labour and 98% of materials and equipment used.

A Winner of the National Import Substitution Award

Sakhalin Energy became a winner of the Priority-2017 Award for achievements in import substitution in the Oil and Gas Industry nomination.

The Priority Award is an annual competition designed to support and recognise Russian manufacturers involved in competitive substitution of imported goods and services. The PRIORITY Award is sponsored by pertinent Federal ministries (Ministry of Industry and Trade, Ministry of Agriculture, Ministry of Energy and Ministry of Telecommunications), as well as by non-profit organisations (e.g. Russian Council of Entrepreneurs and Industrialists, Russian Chamber of Commerce and Industry, Delovaya Rossiya) and Federal Antimonopoly Service (FAS) Russia. The Priority was the first and still remains the only prestigious award that is presented to Russia’s best companies demonstrating high achievements in the import substitution. Since its inception three years ago, about 1,000 companies have participated in the Priority Award competition, of which 443 and 137 have become nominees and winners, respectively.

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 2017 has reached US$ 25 bln. In 2017, the value of new contracts and amendments to existing contracts with Russian companies totalled approximately US$ 830.9 mln, or 67% of the total value of the contracts.

Examples of contracts awarded to Russian companies in 2017:

  • Sakhalin Shelf Service for the supply of base oil;
  • TMK for the supply of premium oil-country tubular goods;
  • SOGAZ for the provision of voluntary medical insurance for RN personnel;
  • Aurora Airlines for the provision of fixed wing aviation services;
  • Borchimmash for the supply of air cooled heat exchangers.

While participating in the project Russian companies have a unique opportunity to upgrade their assets, introduce cutting-edge technologies and adopt global 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. For now, it is planned to include a number of Sakhalin companies into the 2018 Prequalification Audit Programme.

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 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 March 2017, Sakhalin Energy attended the oil and gas procurement services conference, NeftegazSnab-2017, where it hosted a round-table discussion Extension of Engagement with Russian Vendors in the Oil and Gas Sector. Speaking at the conference, Sakhalin Energy provided details of the company’s procurement, delivery/acceptance and payment processes, as well as the tendering and contract award procedures. Special attention was given to the engagement with Russian vendors of materials and equipment. The import substitution programme and Russian vendors’ involvement in Sakhalin-2 were also discussed.

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 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.

7.5. Vendor Development Programme

For over 10 years, Sakhalin Energy has been actively implementing the 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 training module that provides regular workshops on the following important subjects:

  • HSES;
  • Quality Management System;
  • skills in participating in Sakhalin Energy’s tenders;
  • business ethics principles.

As part of the Vendor Development Programme, in 2017, the company held four workshops for potential contractors of Sakhalin Energy. The workshops were attended by 117 representatives of 80 Russian companies, including 35 Sakhalin ones.

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

In addition to offering the training module, the company holds activities targeted particular Russian companies to ensure that they receive the technical qualifications necessary to be added to the approved vendor list of Sakhalin Energy.

The First-Ever Joint Workshop

Sakhalin Energy held its first joint workshop with Gazprom transgaz Tomsk (GTT), a contractor working for Sakhalin-2, in March 2017. This cooperation opened up new opportunities for sharing expertise between the companies and demonstrated Sakhalin Energy's adherence to the continuity principle.

The training workshop was attended by the Sakhalin Government and twenty construction companies based on Sakhalin.

The GTT delegation shared their experience in providing services to Sakhalin-2, as well as information about GTT's tender procedure and the local contractors’ opportunities for succeeding in the materials, supply and services tenders.

Qualification Audit Programme for Russian Vendors under the LNG Train 3 project

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 capacity to produce and supply equipment and materials for the LNG Train 3 project. 41 Russian companies were audited during the year, with the total number of lead Russian vendors and manufacturers in the oil and gas sector covered by the audit reaching 137 within the programme duration period (2016-2017).

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

Application for participation in audit programme can be sent to seic-vendor-development-program@sakhalinenergy.ru.

Extended Workshop to Develop Potential Vendors for Sakhalin-1 and Sakhalin-2 projects

Another workshop for potential vendors was held in Moscow by Sakhalin Energy and Exxon Neftegaz Limited, the operator of Sakhalin-1, in September 2017.

The workshop’s focus was traditionally on briefing Russian vendors on the Sakhalin-1 and Sakhalin-2 activities and on the HSE / quality control / tender requirements for the contractors. The workshop agenda also included awareness sessions on individual scopes for the upcoming tenders (e.g. diving operations; structural steel supply; industrial/calibration/high-purity gas supply; haulage; NDT and CUI services).

The workshop was attended by over sixty participants representing 11 Russian companies.

Attendance by the Federal Ministries of Energy and Industry and Trade, as well as by the Sakhalin Ministry of Natural Resources and Environmental Protection contributed to a higher profile of the workshop.

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