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Journey to Sakhalin- Royal Dutch-Shell in Russia (A) Case Solution

Solution Id Length Case Author Case Publisher
808 865 Words (3 Pages) Rawi Abdelal Harvard Business School : 704040
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International oil market is greater in size than the international gas market. Main producers of oil include Saudi Arabia, Iran, Russia and United States. Global oil market has an intergovernmental organization which consists of twelve main countries which produce oil. Every country requires oil because of its extensive use in every industry. Mainly, countries import or export oil through sea routes such as with the help of oil tankers.

On the other hand, volume produced in international gas market is smaller in terms of volume produced in the oil market globally. Main players of the gas market consist of Russia, United States, Canada and European Union. However, despite the major producers, global gas market has no official cartel at an international level such as OPEC. Gas is not the demand of every country; hence import levels of gas are not usually high. Contrary to the oil, gas is supplied throughout the world using pipelines and land routes.

Following questions are answered in this case study solution:

  1. What are the most important differences between international oil and gas markets?

  2. How is Russia situated in these markets?

  3. How much protection do Production Sharing Agreements (PSA’s) provide for foreign investors?

  4. Why are PSA’s so controversial in Russia?

  5. Should Shell’s managers proceed with Sakhalin II, and invest another $10 billion in Russia, despite the fact that the project’s legal issues have not yet been resolved?

  6. How can Shell’s managers mitigate the risks associated with this project?

Journey to Sakhalin Royal Dutch Shell in Russia A Case Analysis

How is Russia situated in these markets?

Being one of the major producers of gas and oil, Russia has an extremely strategic and vital role to play in both, oil and gas, markets. Russia with its tactical geographic situation has access to both land and sea routes. Russia contributes to the 30% of world gas reserves whereas it is the 8th most concentrated country in terms of oil reserves. Russia is the world leader in terms of exports of gas and second largest producer of gas globally. Moreover, Russia is also the biggest oil producer and exporter in the international market.

How much protection do Production Sharing Agreements (PSA’s) provide for foreign investors?

Production Sharing Agreement is a pact between a foreign investor and host government. The purpose of the contract is to cover the commercial aspects which substitute the country’s tax and license regulations for the life of the project. PSA provide protection to investors by:

  • Making an exception from value added tax (VAT) and customs and property taxes.

  • And guaranteeing 100% cost recovery for its investors.

Why are PSA’s so controversial in Russia?

Even though, PSA was a source of protection for the investors, PSAs were controversial in Russia due to following main reasons:

  • There is no considerable development regarding legislation which protects and identifies the allotment of production.

  • There was no proper infrastructure provided for the civil service to device the terms of PSA, due to which SEIC had to face everyday inquiries about custom-free import raw materials for the project.

  • Politicization of PSA was another main pretext to give way on the skepticism of PSA. This rose up the issue of specifically calculating the man hours and volume of materials used in the project. For that matter, SEIC had to hire specialized content manager to deal with the complexities and complications of the PSA.

Should Shell’s managers proceed with Sakhalin II, and invest another $10 billion in Russia, despite the fact that the project’s legal issues have not yet been resolved?

Shell has already invested millions of dollar as sunk cost, despite all the uncertainties and social and legal issues faced by the Shell’s managers in taking the final decision of investing another $10 billion in Russia, or not, Shell managers need to consider many implications of the environment and surroundings of the project in which they are going to invest. The amount of gas and oil produced by this project alone will generate enormous revenues for Shell. With this Shell can take the risk of moving forward with this project even if the legal issues are resolved. Until the decision of these issues, Shell needs to take calculated measure to start with drilling and other initial operations.

How can Shell’s managers mitigate the risks associated with this project?

Before Shell’s managers can device any plan to reduce the risks associated with Sakhalin II, they need to identify the potential risks that can hinder the future progress of the project. Following are the risks that can possibly curtail the advancement of this project:

  • Imperiling the population of gray whales.

  • Failure to provide adequate data and methodology to carry on.

  • Hazard to salmon species on Sakhalin Island.

  • Legal challenges that can be faced if Russian rules are violated.

  • Improper techniques applied to manage oil spills.

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