Sakhalin Energy The New Energy Source for The Asia Pacifi c Designed by Jaz Creative/www.jazcreative.com.au

Sakhalin Island (Head Offi ce) Sakhalin Energy Investment Company Ltd 35, Dzerzhinskogo Str Yuzhno-Sakhalinsk, 693020, Russia

Moscow branch Sakhalin Energy Investment Company Ltd Novinsky boulevard, 31 Moscow, 123242, Russia

Rijswijk branch Sakhalin Energy Investment Company Visseringlaan 25, P.O. Box 60 2280 AB Rijswijk, The Netherlands www.sakhalinenergy.com

2004 ANNUAL REVIEW

Sakhalin Energy The New Energy Source for The Asia Pacifi c contents

2 Message from the CEO 16 Onshore Processing Facility (OPF) 29 Indigenous People

4 The Sakhalin II Development 19 Onshore and Offshore Pipeline 30 Social Investment - Korsakov – An Overview Projects 32 Pipeline River Crossings 8 The Sakhalin II Development 20 LNG Plant and Oil Export 35 Western Gray Whales - 2004 Progress Terminal (OET) 36 Oil Spill Response 9 Celebrating Six Years of Production 22 The Markets 39 Waste Management 10 Infrastructure Projects and Logistics 24 Meeting the challenge 40 Health, Safety, 15 Offshore Platforms: Concrete gravity 25 Russian Content Environment, Security Based Structures (CGBS) and 26 Employment Opportunities for (HSES) and Social Topsides Sakhalin Island Residents Activity in 2004

Completed CGBS at sunset.

2004 ANNUAL REVIEW 1 Message from the CEO

2004 was another remarkable year for Sakhalin Energy. It was a year in which the Sakhalin II development achieved yet more “fi rsts” for Russia thanks to Phase 1 crude sales and Liquefi ed Natural Gas (LNG) marketing. We also made good progress on our Phase 2 Project. Overall progress on this groundbreaking project – which includes design, procurement and construction – was almost 50% complete at the end of 2004. Refl ecting on some of the highlights in 2004, Sakhalin Energy commenced its sixth crude oil production season earlier than usual and produced a total of 11.7 million barrels, a 14% increase in comparison with 2003. In November 2004, we delivered the fi rst shipment of Russian Far East crude direct to Japan’s Tohoku Electric Power Company, representing the fi rst sale of Vityaz crude directly to a power company. We also expanded our existing customer base with the fi rst shipments to Thailand. In October we achieved a major breakthrough when we signed an historic agreement that will see Sakhalin Energy deliver Russian gas to the extremely competitive North American market. This landmark deal represents the fi rst sale of Russian natural gas to North America and strengthens Russia’s position as a global supplier of natural gas. Other LNG sales developments in 2004 include the signing of a binding Heads of Agreement with Toho Gas and the execution of fully termed Sales and Purchase Agreements with both Kyushu Electric and Tokyo Electric. By the end of 2004, we had sold over 50% of the capacity of our two LNG trains and with a number of commercial opportunities in Japan, Korea and China we aim to substantially complete selling the remaining capacity in 2005. In March 2005 we decided to reroute the offshore pipeline routes linking the two production platforms in the Piltun-Astokskoye fi eld off Sakhalin Island to the shore. We selected the most southern route as this alternative allows us to fi nd a balance between meeting regional energy needs, contributing to Russian’s economic development and protecting the endangered western gray whale.

Major project construction milestones were achieved in 2004. The successful completion of the main concrete works of the Lunskoye platform - the fi rst concrete gravity based structure to be built in Russia - is a magnifi cent achievement, and a tribute to the many Russian companies and workers who have played a key role in this success. We also made considerable progress on infrastructure upgrades, including extensive road and bridge works, as well as upgrades to Nogliki airport, which opened for daylight operation in October 2004.

Whilst the Company achieved some signifi cant safety milestones in 2004 and early 2005 thanks to the efforts made by both 1 Sakhalin Energy employees and our contractors, our overall safety performance still needs improvement. It is with deep regret that 2 we recorded six fatalities associated with our operations in 2004, four of which involved road traffi c accidents. Recognising that safety is one of our biggest challenges, we have launched a road safety campaign that involves both Company employees and our contractors. The three-year campaign will focus on training, education and road safety awareness in an effort to reduce road traffi c accidents. As we journey into 2005 the Company looks forward to building upon the production successes of Phase 1 and the overall progress of the Phase 2 Project in a safe, effi cient and environmentally responsible way. I hope that you will fi nd this report a useful and informative review of Sakhalin Energy’s activities during 2004. Ian Craig

1 Construction of the Sakhalin II Onshore Pipline networks.

2 Molikpaq platform.

Chief Executive Offi cer

2 Sakhalin Energy 2004 ANNUAL REVIEW 3 The Sakhalin II Development – An Overview

The Sakhalin II development is an oil and gas exploration and production project undertaken by Sakhalin Energy, a Shell-led operating company, in partnership with Mitsui and Mitsubishi, for the Sakhalin II Production Sharing Agreement (PSA). Sakhalin Energy was formed in 1994 to develop the Piltun Astokhskoye (PA) oil fi eld and the Lunskoye gas fi eld in the Sea of Okhotsk, offshore Sakhalin Island in the Russian Far East.

Sakhalin II operates under the fi rst PSA signed in Russia and when we produced our fi rst crude oil in 1999 it represented Russia’s fi rst offshore oil production.

The multi-billion dollar Sakhalin II development represents the largest single foreign direct investment project in Russia. Phase 1 of the project has been successfully producing oil from the Vityaz complex since July 1999, and during that time, over 60 million barrels of oil have been produced and exported.

Phase 1 of the development focused on oil development and went into seasonal production during the summer period in 1999 at the Vityaz Production Complex. The sea around the Vityaz Production Complex is covered with ice for approximately six months of each year and, as such, production from Phase 1 is currently limited to the ice-free 1 2 period – about 180 days.

The Phase 2 Project focuses on extending the existing Phase 1 LNG construction site. 1 development to enable export of condensate and crude 2 Completed LUN-A CGBS. oil year round from the Sakhalin II oil and gas assets. Phase 2 also includes the construction of Russia’s fi rst LNG plant, which will have an annual capacity of 9.6 million tonnes (mtpa). In addition to the construction and installation of two new offshore platforms, a system of offshore pipelines will be constructed to bring the oil and gas onshore from the platforms. The hydrocarbons will then be sent to an Onshore Processing Facility (OPF), where the gas and condensate will be separated and further processed in order for it to be transported via two 800 kilometre onshore pipelines – one each for oil and gas. These pipelines lead to an Oil Export Terminal (OET) and LNG plant at Prigorodnoye on Aniva Bay in the south of the Island, where the sea remains largely ice- free all year round.

4 Sakhalin Energy 2004 ANNUAL REVIEW 5 Piltun Astokhskoye Platform - The primary function of the OPF is the processing of gas A (PA-A)/Molikpaq and condensate received from the Lunskoye fi eld prior to The Sakhalin II Phase 1 Project involves the development transportation to the LNG plant and Oil Export Terminal and production of oil hydrocarbons on the Astokh feature (OET). The OPF will also receive oil and gas streams from of the Piltun Astokhskoye fi eld. The Molikpaq forms the the two platforms on the PA fi eld for onward transportation central feature of the Vityaz Production Complex, which by pipeline to the OET. also consists of a Single Anchor Leg Mooring (SALM) buoy The OPF will include a 100 Mega Watt power plant, and the Okha Floating Storage and Offl oading (FSO) which will generate power for the OPF itself as well as the vessel. Oil produced in the ice-free summer season from LUN-A Platform. At full capacity, the plant will be capable the Vityaz Production Complex is transported by sub-sea of processing 51 million cubic meters per day (1,800 pipeline to the SALM and FSO where it is transferred to million standard cubic feet), and about 10,000 cubic shuttle tankers for sale to customers. meters of condensate/oil per day (65,000 barrels). During the Phase 2 Project, the Molikpaq platform will be connected to the new pipeline infrastructure to enable The condensate will be integrated with oil production from year-round production. the PA fi eld, and transported by pipeline via the OPF. The combined condensate and oil will then be sent through the Piltun Astokhskoye Platform - B (PA-B) main onshore oil line to the OET using booster pumps at PA-B will be a manned integrated oil and gas platform with the OPF with a capacity to pump up to 195,000 bbl/d. drilling facilities. Its oil production capacity will be 70,000 barrels per day (11,000 cubic metres per day) and it Infrastructure Projects and Logistics (IPL) will export 2.6 million standard cubic metres (92 million Sakhalin Energy has upgraded a signifi cant amount standard cubic feet) of associated gas per day. The drilling, of Sakhalin Island’s infrastructure to support the Phase processing and production platform will extract oil and 2 Project construction activities. These are collectively associated gas from the Piltun reservoir. The platform will referred to as the Infrastructure Upgrade Project (IUP). be located approximately 12 kilometres off the northeastern In total these works will involve approximately $US coast of Sakhalin in a water depth of 32 metres. 350 million worth of improvements to Sakhalin Island’s infrastructure. At the end of 2004, the Company had Lunskoye Platform (LUN-A) already spent $US 225 million on upgrades to the island’s The LUN-A Platform will have drilling facilities, roads, railways, bridges, hospitals, waste disposal sites, accommodation and minimum processing facilities. It will Kholmsk Fishing Port and the Nogliki Airport. have the capacity to produce 51 million cubic meters of gas per day (1,800 million standard cubic feet per day), LNG Plant and Oil Export Terminal (OET) and approximately 50,000 barrels of condensate per The LNG processing plant and OET are being built day (8,000 cubic meters per day). It will be located 15 on a 490 hectare site at Prigorodnoye on Aniva Bay, kilometres off the northeastern coast of Sakhalin Island in approximately 15 kilometres east of Korsakov. The LNG a water depth of 48 metres. Separation, including gas Plant is intended for the reception, treatment, processing and treatment of LUN-A’s oil/condensate will be undertaken liquefaction of gas from the Lunskoye fi eld and associated onshore at the OPF, which will also supply power to the gas from the PA fi eld. It includes storage and loading platform via submarine cable. This platform will produce facilities and is the fi rst LNG plant to be built in Russia. the majority of the gas for the LNG Plant in Prigorodnoye. The LNG plant will consist of two gas liquefaction process trains, which will use a dual mixed refrigerant process Pipelines particularly suited to Sakhalin’s cold climate. Both trains The pipelines, one oil and one gas, will transport will have an annual capacity of 4.8 million tonnes each. hydrocarbons from the three platforms via the OPF, to the The LNG plant will also include two 100,000 cubic metre LNG Plant and OET. The offshore pipelines running from storage tanks and a jetty, with two loading arms and a PA-A to shore will each cover a distance of approximately vapour return arm, that will extend offshore some 46km while the offshore pipelines running from PA-B to 800 metres. shore will each travel a distance of approximately 72km. The OET will be located 500 metres east of the LNG plant. Once onshore, the oil and gas pipelines will be co- Crude oil will be exported via a sub-sea pipeline to a tanker mingled respectively and will each cover a distance of loading unit located approximately fi ve kilometres offshore. approximately 800 kilometres, and will share a standard The OET will support the storage and export of 170,000 43 metres width right of way (ROW). The total length of barrels per day of crude oil, along with 5,000 barrels onshore pipelines to be installed is some per day of condensate from the LNG facility. The OET will 1,670 kilometres. comprise of two fl oating roof oil storage tanks with export pumps and associated facilities. 1 Sakhalin Island and the Sakhalin II Project. Onshore Processing Facility (OPF) The LNG plant and OET will be self suffi cient having their The OPF is located in the northeast of Sakhalin Island, own integrated facilities including power, water, fi re fi ghting, inland from the landfall of the Lunskoye Platform waste water treatment services and oil spill gas pipeline. response capability.

6 Sakhalin Energy 2004 ANNUAL REVIEW 7 The Sakhalin II Development - 2004 Progress

PHASE 1 Celebrating Six Years of Production 2004 was the sixth year of production for the Complex and cumulative oil production for the season was 11.7 million barrels. In total, Phase 1 has now produced and exported more than 60 million barrels to markets in Asia and beyond. In June 2005, it is anticipated that the hundredth cargo of Sakhalin Vityaz crude oil will be loaded at the Vityaz Terminal.

Oil production levels have fallen during recent production seasons due to natural pressure reduction in the reservoir. 1 The Pressure Maintenance Project (PMP) designed to boost production, started operations in March 2004. The PMP 2 facilities are designed to treat seawater and inject it into the reservoir thus raising reservoir pressure and increasing annual oil production levels and ultimate recovery from the reservoir. Construction and commissioning work was completed on the surface facilities in the fi rst quarter of 2004. Following drilling of the fi rst water injection well, injection of water into the reservoir commenced in March 2004. Three additional water injection wells were subsequently drilled and by the end of April 2005 up to 90,000 barrels per of day were being injected into the 3 reservoir through these four wells.

4 Molikpaq Tie in Project (MTI) 1 Molikpaq platform. In early 2005, work began offshore on the Molikpaq 2 PMP module lifted onto Molipaq platform. platform and at fabrication yards onshore for the 3 Hose reel on FSO (Okha). construction of new modules for the MTI project. This 4 Molikpaq platform. project which forms part of the Phase 2 project, will enable year round oil and gas production and export from the Molikpaq by connecting it to the new pipeline infrastructure which will deliver gas and oil to the LNG plant and OET being built at Prigorodnoye in the south of the Island.

8 Sakhalin Energy 2004 ANNUAL REVIEW 9 PHASE 2 Agreements have also been executed with seven of the Island’s Municipalities (Korsakov, Kholmsk, Dolinsk, Infrastructure Projects and Logistics Makarov, Poronaysk, Nogliki and Yuzhno-Sakhalinsk) for Hospitals: road and bridge upgrades and asphalting of roads in 1 In 2005, Sakhalin Energy will begin upgrades on townships that are experiencing increased traffi c fl ow as a 2 hospitals in Nogliki and Poronaysk, as well as on the result of the Phase 2 construction period. The cost of this region’s main hospital in Yuzhno-Sakhalinsk at a total work is approximately $US 14.5 million. cost of $US 7.2 million. These upgrades will include construction works, the provision of medical equipment Kholmsk Port: (in excess of $US 3 million), training in emergency care In 2003-2004 Sakhalin Energy upgraded Kholmsk Fishing and the provision of operation and maintenance funding. Port to permit the receipt of Phase 2 construction materials, The list of the medical equipment to be provided includes including line pipe and cargo for the OPF. In 2004, the X-ray machines, blood banks, digital ultrasonic scanners, port serviced 45 vessels and unloaded more than 114 artifi cial kidney machines and more. In addition to thousand tonnes of pipe. Ancillary works at the port, this, Sakhalin Energy will also provide fully equipped including offi ce upgrades, were also undertaken. At the ambulances to six district hospitals – Nogliki, Poronaysk, end of 2004, Sakhalin Energy’s contractor, 3-S, employed Kholmsk, Korsakov, Argi-Pagi (Tymovsk) and approximately 100 local people full-time in the port. In Yuzhno-Sakhalinsk. addition, three Sakhalin freight companies were working permanently in the Port managing the onward transfer The upgrades will allow for the provision of safe, of cargo. unimpeded emergency healthcare services for local residents and communities as well as Sakhalin Energy In 2005, warehousing requirements at the port will be employees, contractors and subcontractors. reviewed to ensure they meet the longer-term onshore and offshore supply requirements of the Project. Sakhalin Roads and Bridges: Energy will also investigate the establishment of an economical development zone to encourage local service Road and bridge infrastructure upgrades commenced 3 in late 2002 when Sakhalin Energy and the Sakhalin providers to supply the Company during the operational 5 4 Oblast Administration agreed on a programme of road stage of the Project (supply of construction consumables, 1 IUP road upgrade. and infrastructure construction works. Work under this fi lters, oil and other materials) from 2007 onwards. 2 IUP bridge upgrade. programme is expected to continue until the end of 2007. Nogliki Airport: 3 IUP road repair. By the end of 2004, Sakhalin Energy had already In October 2004, following extensive upgrades, the 4 IUP bridge upgrade.

reconstructed more than 15 kilometres of roads and Nogliki Airport was opened for daylight operation. The 5 Nogliki Airport. 175 culverts. The Company has also constructed more upgrade work at the airport was completed in conjunction than 60 kilometres of gutters, 13 temporary bridges with Exxon Neftegas Limited, the Sakhalin I PSA project and 18 permanent bridges. Work to date has been operator. In 2005, work will focus on the installation completed in cooperation with Sakhalin Road Department of health monitoring systems in all aircraft and the (Sakhavtodor), and involved local Island contractors modifi cation of offshore helicopters to Vostokdorstroy, Tymovsk Road Construction Department international standards. and Sakhalin Construction and Investment Company.

10 Sakhalin Energy 2004 ANNUAL REVIEW 11 1 The start of beautifi cation work at Kholmsk boulevard.

2 Fibre optic cable ready to dispatched from St. Petersburg factory.

3 David Greer, Deputy CEO and Phase 2 Project director (right), Ivan Malakhov, Governor of the Sakhalin Region (centre), Anatoly Gusto, Mayor of the Kholmsk District (left), and Irina Stepuk, Chief Medic of the clinic, attend the opening of the Kholmsk Children’s Health Clinic. The renovation of the Clinic premises was fi nanced by the Administration of the Sakhalin Region while Sakhalin Energy purchased all the medical equipment and furniture.

4 Conduit (for fi ber optic cable) installed on Askasai river crossing.

Unexploded Ordnance: Kholmsk: Sakhalin Energy funds the work for clearance of the Following the grounding of Cristoforo Colombo off the Company’s construction sites and pipeline right of way; port of Kholmsk, Sakhalin Energy, as a responsible oil this includes the demolition or removal of unexploded and gas operator and long-term citizen is carrying out a 1 2 ordnance (UXO) (carried out by Russian military sappers), number of goodwill projects in this town. These projects demolition or removal of military chemicals and the have been agreed with the Kholmsk District Administration, 3 disinterment and reburial of war dead (Russian and and include the deployment of oil spill response equipment Japanese). All work is done in conjunction with the Military for use in the town, Primorsky Boulevard beautifi cation, Commissariat and districts administration and follows replacement of a local kindergarten roof, fi rst aid Russian Federation legislation. By the end of 2004 more equipment and furniture for children’s clinic, and provision than 3,500 live UXO had been demolished and 29,750 of an emergency medical centre at the hospital. All of litres of chemicals had been removed. The search for these initiatives are currently being implemented and are war dead discovered 41 Russian soldiers – who have scheduled for completion by the end of 2005. been reburied with full military honours - and 33 Japanese soldiers – who have been cremated according to the Please refer to page 36 for details on Sakhalin Energy’s Shinto Rites. Oil Spill Response (OSR) plan.

In addition, Sakhalin Energy is working with military support teams who are responsible for responding to civilian callouts on military UXO, materials and equipment. Sakhalin Energy’s support for these works started in 2002, during the past few years the Island’s capacity to deal with UXO and military chemicals has strengthened. These works are reducing the threat to both human and animal life, and ensuring increased safety.

Telecommunications Project: In order to complete the Phase 2 Project, a number of telecommunications works are being carried out by 4 Sakhalin Energy, including the installation of an 850 kilometre fi bre optic cable network that will connect all of the Company’s facilities for safety and operational purposes. The installation of this cable will also allow the public telecommunications operator on Sakhalin Island, Dalsvyaz, to provide modern telecommunications in towns and villages along the route of the new cable, thus providing a long-term benefi t to these communities. Installation of the 850 kilometre fi bre optic cable will commence in 2005.

12 Sakhalin Energy 2004 ANNUAL REVIEW 13 Offshore Platforms: Concrete gravity The main concrete slip forming works were also Based Structures (CGBS) and Topsides completed on the CGBS for the new PA-B platform at the Concrete gravity Based Structures (CGBS) beginning of 2005, which was followed by completion of fabrication and installation of all the required mechanical Norwegian GBS specialist Aker Kvaerner Technology AS equipment of the Lunskoye and Piltun-B substructures. and Finnish Company Quattro Gemini OY are undertaking the engineering and construction of the PA-B and LUN-A In summer of 2005 the two structures will be fl oated out CGBS. Both of the CGBS have been built in the Russian of the dock, towed to their locations on the Lunskoye and Far East at a purpose built dry dock in Vostochny Port, Piltun feature of the PA fi elds, and then carefully ballasted near Vladivostok. to place them gently on the seabed.

The two CGBS are amongst the biggest structures ever Topsides built in Russia and the varied geometry of their legs puts Simultaneously, at the Samsung Heavy Industries them amongst the most complex concrete slip forming 1 construction yard on Geoje Island in Korea, the LUN-A jobs ever undertaken. The design specifi cally takes into and PA-B platform topsides are under construction. First 2 account the winter sea-ice conditions and seismic nature cutting of steel for the LUN-A topsides was undertaken in of the area in which they will be located. They are the July 2003 and in January 2004 for PA-B topsides. fi rst structures of their type to be built in Russian and a workforce of some 2,000 were involved in By the end of 2004, progress on the 22,000 tonne their construction. Lunskoye topsides reached 65%. All living quarters had been lifted into position on the main deck and all the The construction of the two CGBS has a high percentage main deck blocks had been erected - leaving only the of Russian involvement – in total over 85% Russian drilling module, fl are boom and helideck to be installed. content - and has provided an opportunity for local Fabrication of piping was over 65% complete and tenders industry to gain extensive experience in the construction for a subcontractor for the offshore installation activities of such structures through the transfer of knowledge and was also underway. 3 technology. It has also created signifi cant business opportunities for Russian companies who are providing Fabrication on the 28,000 tonne PA-B topsides started in materials and other services to the construction site. 1 Completed CGBS in dry dock. February 2004 and is making good progress, with the lower deck now erected on site. Erection of the upper 2 Topsides construction. Construction of these substructures commenced in March deck is planned for March 2005 and overall progress at 3 LUN-A CGBS at sunset. 2004 when the fi rst concrete was poured. In November the end of 2004 was over 35%. Sakhalin Energy reached a signifi cant milestone with the completion of the main concrete works on the CGBS for Installation of the topsides onto the CGBS will be the Lunskoye platform. The Lunskoye concrete substructure undertaken offshore Sakhalin. In order to ensure a consists of a base slab and four cylindrical legs that successful installation of both topsides, a second support the topsides of the new offshore platform. It has a installation barge is now being built in a Chinese yard. total weight of 103,000 tonnes. The base is 105 metres by 88 metres and 13.5 metres high. The diameter of each leg measures more than 20 metres and they are some 56 metres high. Total height of the entire structure is 69.5 metres.

14 Sakhalin Energy 2004 ANNUAL REVIEW 15 Onshore Processing Facility (OPF) 1 OPF heat exchangers. Pipe rack in background. By the end of 2004 overall design and procurement 2 OPF heat exchangers at sunset.

progress was more than 85 % complete and the majority 3 Work continues throughout the winter months at the OPF site. of bulk purchase orders had been placed. Completion of 1 detailed design is planned for June 2005. 2 Construction work continued in 2004 with piling, casting of foundations, construction of concrete and steel buildings, piperacks and off-site prefabrication of piping spools. Piling was completed by mid 2004 when in excess of 5000 piles had been drilled and cast.

A signifi cant success for the Phase 2 Project in 2004 was the beach landing campaign at the OPF site in July and August 2004. This included the successful delivery of three barge loads of heavy and large equipment items - such 3 as gas turbines, compressors and heat exchangers, which due to their size and weight could not be transported over land.

Overall construction at the OPF was approximately 40% complete by the end of 2004, and multi-discipline construction, including electrical and instrumentation works will continue through 2005, in anticipation of phased commissioning commencing in 2006.

The OPF is planned to commence delivery of fi rst power to the LUN-A Platform in 2006, initially using diesel fuel for the gas turbines. It is expected to receive fi rst gas and fi rst year-round oil from the PA fi eld when the Molikpaq tie-in works are completed and commissioned.

16 Sakhalin Energy 2004 ANNUAL REVIEW 17 Onshore and Offshore For 2005 a full season of construction work is planned Pipeline Projects for the offshore pipelines, to largely complete the pipeline 2004 was a year of intense activity on the Sakhalin and cable systems in the Lunskoye fi eld and in Aniva Bay. Work will comprise dredging, pipeline installation and pre- 1 II Phase 2 pipelines, with the start of construction both onshore and offshore, manufacture and delivery of a large commissioning. The offshore pipeline spreads will also carry amount of line pipe and substantial progress on supporting out a variety of work in support of the CGBS installation. engineering, design and approval activities. Providing conditions are favourable, the pipeline connectors for the PA-A platform will be completed. Russian pipe and steel manufacturers are participating in the delivery of line pipe. By the end of 2004 ZAO The engineering, procurement and construction contract United Metallurgical Company had completed successful for the onshore pipeline system is being executed by delivery of 42,500 tonnes (330 kilometres) of line pipe Starstroi. In 2004 engineering substantially progressed worth a total of some $US 35 million from its Vyksa Steel and construction work commenced following a ‘fi rst weld’ Works pipe mill - with the major Russian steel manufacturer, ceremony for the onshore pipelines in January 2004. By Severstal, supplying the steel plate. This order is part of a the end of 2004, mainline welding of 312 kilometres of joint venture with the Japanese company, Mitsui & Co., Ltd. pipe had been completed, and a further 1000 kilometres Other suppliers involved are a joint venture between Russian is planned for completion in 2005. Nearly all engineering company OOO Transpromresurs and Metal 1 (whose major and construction work has been subcontracted to shareholder is Mitsubishi Corporation of Japan), and ILVA Russian companies. from Italy. OOO Transpromresurs in partnership with Onshore pipelines construction is progressing rapidly, and Metal 1 has constructed a new high technology pipe work is being carried out in the fi eld by major Russian coating plant in Vostochny for coating the majority of line pipeline construction subcontractors. In total there are pipe. This commenced fi rst production in the early 2004. approximately 5,000 staff now onsite, operating from main Work continued throughout 2004 and is expected to construction camps in Val, Nogliki Onor, Tumanovo, Sokol complete pipe coating sometime in the third quarter of and several secondary camps along the pipeline Right-Of- 2005. This coating plant, which cost approximately $US Way (ROW). In 2005 engineering activities will be largely 15 million to construct, will carry out pipe coating work completed and procurement of pipeline valves, shelters, pig 2 worth some $US 30 million for the Sakhalin II traps and a variety of supporting equipment fi nalised. Phase 2 Project. 3 In addition, winter river crossing construction has started Total investment for supply of all onshore and offshore with 39 oil pipeline and 11 gas pipeline crossings line pipe exceeds $US 400 million, and involves some completed in the 2004/2005 winter - the remaining 515,000 tonnes of steel. Cumulative coated line pipe crossings are planned to be installed in the 2005/2006 supply for onshore use reached 275,000 tonnes (1200 winter. . Detailed crossing design for some 21 seismic kilometres) at the end of 2004, of which more than faults and 30 kilometres of the pipeline route which passes 1000 kilometres is already stored on Sakhalin. Delivery through landslide areas in the Makarov mountains is of offshore line pipe (32,000 tonnes, 170 kilometres to ongoing, with completion of planned design in 2005 and date) to Kuantan, Malaysia, also began during 2004. It subsequent construction in 2006. is being transferred to the offshore pipelines engineering, procurement (excluding line pipe) and construction At particularly sensitive locations onshore, such as seismic contractor, Saipem. faults, roads and railways and in the vicinity of settlements, the thickness of the pipeline wall will be increased, and During 2004 offshore pipelines dredging and installation numerous block valves will be installed along the length of activities in the Lunskoye fi eld and in Aniva Bay were the pipeline to optimise the control of the transportation of completed as planned. This followed completion of relevant hydrocarbons. The pipeline systems will also be equipped detailed design, weld procedure qualifi cations and civil 1 Inspection of 48-inch pipe. with a highly sensitive leak detection system, and will works at Aniva Bay and Lunskoye landfalls. 2 Work continues throughout winter months. operate under a comprehensive maintenance programme. 3 Local Community Liaison Offi cer views pipeline progress.

18 Sakhalin Energy 2004 ANNUAL REVIEW 19 Liquifi ed Natural Gas (LNG) Plant and In April 2004 the Sakhalin Energy construction offi ce Oil Export Terminal (OET) on site was offi cially opened, allowing staff to be In 2004 work on the LNG/OET project shifted from permanently located at the worksite. The permanent the design and procurement centre in the offi ces of buildings, including substations and the operations and Chiyoda Corporation in Japan to the construction site at administration buildings are all progressing well, ensuring 1 2 Prigrodnoye. By the end of 2004, the main contractor, that follow-on contractors will be able to work in relative CTSD, had awarded all of the major subcontracts for comfort during the winter of 2005. construction of the permanent facilities to contractors from In October 2004, subcontractors Daewoo and Gama Russia, Japan, Korea, USA, UK, Ireland, Turkey. commenced steel erection across the entire site to bring The early works programme - site preparation, site a signifi cant change to the LNG site’s skyline. Steel bypass road and the Material Offl oading Facility (MOF) piperacks create the backbone for the entire plant, and - commenced in August 2003 and has been successfully in the second half of 2005 the pipe racks will start to be completed. Construction of a 6000-man accommodation fi lled with process piping from half inch to 72 inches camp also commenced at the same time, and is now in diametre. complete with fi nal accommodation and recreational units 2004 also marked the opening of the main pipe 3 within the camp fi nished by the end of March 2005. The fabrication facilities in which pipe will be cut and welded early works programme paved the way for the permanent to fi nal confi guration for installation in the LNG/OET engineering, procurement and construction works that took plants. More than 80 kilometres of both carbon steel and place in the spring and summer of 2004. In April 2004, stainless steel pipe will be welded here. Teams of welders the concrete batching plant which produces concrete from from a number of different countries will be engaged to locally provided raw materials was opened by HRH Prince complete the fabrication work. Andrew, The Duke of York. April 2004 also marked the start of construction of the major equipment and Numerous material deliveries have been made direct piperack foundations within the OET, utilities area and to the site and offl oaded at the MOF since the start of process train 1. 2005. Planning is in process for the single heaviest lift to be carried out on site - a 600 tonne pressure vessel to be Structural work commenced on the two 100,000 cubic- 4 lifted into place in the main process area. metre LNG storage tanks in September 2004, and the 37- 1 Construction work at the LNG site. metre high steel vapour barrier now dominates the skyline Throughout the year, work underground will continue 2 LNG train 1 under construction. LNG tank construction in background. at Prigrodnoye. In the spring of 2005, the concrete walls with piping and the 1000 kilometres of electrical and 3 Workers at the LNG construction site. of the giant outer tank will start to appear, and the roof instrument cable that will be installed throughout the plant. 4 OET tanks under construction. LNG site in background. that is currently being built inside the tank will be raised by air pressure to the top of the tank.

On another area of the site TOA Corporation has created a crushed stone ring foundation for the 100,000 cubic metre oil export tanks. Following this, Russian contractor, Koksokhimmontazh, has made excellent progress in erecting the tanks. By October 2005, it is expected that the tank shells will be complete and ready for pressure testing.

20 Sakhalin Energy 2004 ANNUAL REVIEW 21 LNG Sales Sakhalin Energy continues its preparations towards year- 2004 was an impressive year for Sakhalin Energy for round oil exports from Prigorodnoye. At peak production, our LNG and oil marketing activities. The Company Sakhalin Energy will produce around 180,000 barrels of strengthened its presence in the Asia-Pacifi c market place oil and condensate per day. Combined with the future by confi rming existing commitments and expanding the production from the Sakhalin I Project, Sakhalin will be The Markets customer base for both LNG and crude oil sales. exporting almost 420,000 barrels of oil per day, which is a substantial fi gure for Asia. Overall Sakhalin crude In May 2004 Sakhalin Energy signed a binding Heads of production will be larger than oil exports from Vietnam Agreement (HOA) with Toho Gas and executed fully termed (350,000 barrels of oil per day), Malaysia (400,000 Sales and Purchase Agreements (SPAs) with Kyushu Electric barrels of oil per day) and close to that of Indonesia and Tokyo Electric. Japan remains Sakhalin Energy’s core (500,000 barrels of oil per day). market with foundation customers continuing to expand their 1 2 offtake commitments, and negotiations are ongoing with LNG Shipping other key Japanese buyers. In 2004 Sakhalin Energy geared up its shipping capacity to facilitate the delivery of LNG supplies as called for under In October 2004 Sakhalin Energy concluded an SPA to some of the sales contracts. Following a detailed tender supply 37 million tonnes of LNG over a 20-year period, process for the long-term charter of LNG ships, Sakhalin to Shell Eastern Trading Ltd. for the North American natural Energy awarded deals for three new-build 147,200 cubic gas market. This pioneering deal represents the fi rst sales metre Moss-type LNG carriers in November 2004. Two of Russian natural gas to North America and marks the ships will be chartered from a consortium of Sovcomfl ot and beginning of Sakhalin Island as a strategic new source 3 Nippon Yusen Kabushiki Kaisha (NYK), and one ship to the of natural gas for both Mexico and the US West Coast consortium of Primorsk Shipping , Mitsui OSK lines, K Line. markets. LNG from Sakhalin Energy will be supplied to the The two ships to be chartered from by Sovcomfl ot and NYK new Energía Costa Azul LNG receiving terminal that will be will be constructed by Mitsubishi Heavy Industries. The third constructed in Baja California, Mexico carrier to be chartered from Primorsk/Mitsui/K Line will be Natural gas from the new terminal will be used to satisfy built at Mitsui Engineering & Shipbuilding. Mexico’s growing energy needs, with excess natural gas These deals represent Russia’s fi rst entry into the LNG exported from the Mexican terminal to California in the US shipping business. The Japanese-Russian partnership where, as in Mexico, there is an increasing requirement combine Japanese experience of 20 years of accident-free for new natural gas supply sources. The agreement calls LNG shipping with unique Russian skills in ice navigation for a plateau supply of 1.6 million tonnes per annum, with and experience of Russian ports. These landmark deals signifi cantly higher volumes of LNG deliveries during the fi rst demonstrates the benefi ts of the Sakhalin II Project to three years. Russia through opening up new areas of industry and the 4 introduction of new technologies. Vityaz Crude Oil Sales 6 5 Sakhalin Energy continues to see a healthy appetite for Latest Update – 2005 Gas Sales Vityaz crude within Asia-Pacifi c as buyers seek to diversify Sakhalin Energy achieved another major marketing energy sources away from the Middle East. Not only did breakthrough in February 2005 winning a tender to Sakhalin Energy achieve record premiums for its crude oil supply 1.5 million tonnes per annum (mtpa), plus a sales over the Oman oil market price – which is a similar possible option of a further 0.5 mtpa, of LNG to Korea type of oil and is used as a benchmark price for Vityaz Gas Corporation (KOGAS). The Heads of Agreement crude - the Company also expanded its customer base (HoA) with KOGAS represents the fi rst major strategic 1 Energy use in South Korea. with its fi rst ever sales to Thailand, in addition to continuing energy deal between Korea and Russia. deliveries to Japan, Korea, China, USA and the Philippines. 2 Ian Craig, Sakhalin Energy CEO (right), Ivan Malakhov, In addition in the fi rst week of June 2005 Sakhalin Energy Governor of the Sakhalin Region (left) and Ann Pickard, Executive Vice President Shell Gas and Power (centre), Moreover, Sakhalin Energy achieved another milestone with signed three more long term (20+ years) LNG supply celebrate as a pioneering LNG supply deal is signed with the fi rst sale to Tohoku Electric. This is the fi rst time Vityaz deals with Japanese utilities - a HoA with Hiroshima Gas, Shell for North American Markets. crude has been delivered direct to a power generation for 0.21 mtpa, a HoA with Tohoku Electric for 0.42 mtpa 3 Celebrations at LNG shipping ceremony. company – all previous sales have been to refi neries. and an SPA with Toho Gas for 0.5 mtpa. 4 Okha FSO (part of Vityaz complex). Overall in 2004 Japan increased its dominant position as These 2005 gas sales bring the total commitments for 5 Tokyo Electric SPA signing. the Company’s primary crude customer by purchasing 76% of total production with four new customers. LNG from the Sakhalin II Project to up to 8.0 mtpa for 6 Kyushu Electric SPA signing. period of 20 years or more.

22 Sakhalin Energy 2004 ANNUAL REVIEW 23 Meeting the challenge Russian Content Russian Content Performance in 2004 has been the Russian Content remains a key element of the benefi ts that Company’s highest to date. In order to ensure this the Sakhalin II development will bring to Russia throughout performance is continued in the coming years - particularly the life of the Project. The involvement of Russian industry into the operations phase of the Project, the Company in both the construction and operational phases will play is in the process of developing its Russian Content an important role in the overall success of the Project. Development Policy and Strategy. This will create a renewed focus within the Company of looking to the The Sakhalin II Production Sharing Agreement (PSA) future and of developing Russian Content opportunities. defi nes russian content in terms of manhours and the The Joint Committee will continue to play a pivotal role volume of materials and supplies, recognising the diffi culty in the Company’ Russian Content Development activities, Russian industry would have in providing unique processes particularly in working with the Company to review the and equipment required during the construction phase. In forthcoming 2005 –2010 Contracting and Procurement line with this approach the PSA also states that Sakhalin Activity Plan, in order to identify Russian Content Energy must use its best efforts to achieve a 70 percent Development opportunities. target for Russian Content over the life of the Project. The Company will continue to work with other oil and The Company and its partners in the Federal and Regional gas operators and engage the major oil and gas service Government are working together, through the auspices of companies on the island to collectively identify resource the Joint Committee, to promote the use of Russian industry. sharing/synergy opportunities required by the Sakhalin This committee seeks to identify Russian businesses and oil and gas industry. The development and retention of industry that can undertake contracts for the Sakhalin Russian skilled tradesmen/workforce will also be a key II Project. The committee is also advised of all contract focus area. awards and checks that the Procurement Procedures used by Sakhalin Energy have been applied in a fair, Sakhalin Energy believes that with the continued support transparent and consistent manner. of the Russian Party and the Joint Committee it is on track to meet the Russian Content requirements of the PSA and 1 The work of the committee has played a key role in possibly even exceed them. 2 3 promoting the involvement of Russian companies in the Sakhalin II Project. Since construction activities commenced – initially on Phase 1 and now on Phase 2 – between 1996 and the end of 2004 Russian contractors and subcontractors have won thousands of contracts worth up to a total of $US 4.2 billion.

The fi gures also show that not only is the PSA target of 70% already being achieved, but is being exceeded. 63 million Russian labour man-hours had been expended on the Project by the end of 2004 - 73% of total - and material and equipment supply had exceeded 3 million 1 CGBS construction site. tonnes, some 86% of the total.

2 Line pipe coating plant in Vostochny.

2 Russian Supervisor inspects pipe welding.

24 Sakhalin Energy 2004 ANNUAL REVIEW 25 1 On-site training at the OPF site.

2 On-site training at the OPF site. By January 2005 the fi rst four apprentices had successfully Employment Opportunities for 3 Apprentices – classroom training. Sakhalin Island Residents completed their English language and technical training 4 Apprentices – English language training. As part of Sakhalin Energy’s commitment to provide jobs and had commenced their competence based for the local population, the Company launched an on-the-job training. 1 apprenticeship scheme in October 2003. The scheme In 2004 a further fi ve groups were recruited – in total 2 focuses on providing training for Russian men and women more than 60 apprentices. Three of these groups started from Sakhalin Island who have a keen interest in working their English-language training programme in early 2005 as technical professionals in production operations and in preparation for the technical training to follow. maintenance for Sakhalin Energy. The apprentices will be the future operations and maintenance technicians for the Sakhalin Energy’s Recruitment scope reaches far beyond Sakhalin II onshore and offshore facilities. the apprentice programme and is following international best practice: all applicants get screened against a The scheme is a structured course combining theoretical standard competency framework, starting with initial study and on-the-job training for people with little or handling of incoming CV’s, followed by selection based no knowledge of operations and maintenance. The on structured interviews and other validated tools. To meet fi rst period of study involves English language training, the signifi cant staffi ng challenge in the coming years, the followed by technical and as well as safety training in the Human Resources recruitment function of Sakhalin Energy classroom and workshop in Russia as well as overseas. has been signifi cantly staffed up. To ensure that Sakhalin Following this, up to two years will be spent with on-the- Energy generates the large numbers of applications job-training, depending on the apprentice’s ability and his by experienced Russian nationals that are required, or her chosen discipline. the Company has extended its Attraction scope to the The training programme ensures that each apprentice Russian Far East and beyond. For details on available becomes a specialist in one of four fi elds – either opportunities, interested parties can check the Sakhalin operations, mechanical, electrical or instrumentation, whilst Energy internet site (www.sakhalinenergy.com). receiving a solid grounding in all disciplines.

Sakhalin Energy hopes to recruit and train in excess of 4 3 270 Sakhalin residents in its apprenticeship scheme between 2003 and 2018. The fi rst group of 11 apprentices was recruited in October 2003, and in November 2004 they attended a six-week training course in China. As part of the overseas training course, which was conducted entirely in English, the apprentices completed a number of tasks in a workshop setting and had the opportunity to develop their technical skills and their awareness regarding Health, Safety and Environment issues. At the end of the six weeks, the apprentices were independently assessed against internationally recognised standards and were rated as exceptionally high.

26 Sakhalin Energy 2004 ANNUAL REVIEW 27 Indigenous People In 2004 the Company started active stakeholder Sakhalin Energy has a history of engaging, supporting engagement with reindeer herders. Sakhalin Energy, in and working with local communities and the indigenous partnership with the Nogliki District Administration initiated groups of Sakhalin Island. In 1992 SEIC initiated a quarterly workshops with reindeer herders to inform them programme of consultation for indigenous people (IP). For of the Project schedule and discuss their concerns related the Phase 2 project, this programme has been expanded to the Sakhalin II Project. to meet the requirements of the Russian legislation, as At the end of 2004 and in early 2005 the Sakhalin well as the spirit and intent of the World Bank Group indigenous peoples made demands that all of the oil and Operational Directives (OD 4.20 and OD 4.30). gas operators on the Island carry out an ethnological As part of its IP programme the Company’s ongoing expertiza to determine the cumulative impacts to their monitoring and consultation activities include: traditional way of life and subsequently defi ne levels of compensation owed to them. • Communication with herders relating to construction schedules and pipeline routes; An agreement signed in January 2005 between the Sakhalin Oblast Administration, some representatives • Indigenous people socio-economic surveys; of the indigenous people and oil and gas companies proposes the development of effective coordination • Assessment and discussion of potential and perceived between the Oblast programme, “Economic and Social Project-related impacts on indigenous people Development of the Indigenous People of Sakhalin in communities, their natural resource base, livelihood 2005-2008” and other activities and social assistance activities and settlements; programmes being implemented by the companies aimed • Assessment and discussion of proposed and already at supporting the indigenous minority peoples of the north implemented mitigation measures; of Sakhalin Oblast.

• Regular consideration and consultation with In March 2005, more than 70 delegates of indigenous 1 2 stakeholders on indigenous people issues; people came to Yuzhno from all Sakhalin districts to elect an IP Council and coordinate their views on the • Determination if supplemental assistance is needed; 1 Regular SEIC workshop with reindeer herders. main priorities for the socio-economic development of indigenous population of the island. Sakhalin Energy has 2 David Greer, Deputy CEO and Phase 2 Project • Identifi cation of community needs and discussion of Director, at the IP agreement signing in January 2005. welcomed this Council’s election and has encouraged potential programmes/ projects to be supported. them to work with all oil and gas operators and the In 1994 the Company started to conduct public meetings Sakhalin Oblast Administration to address these needs. with Nivkh, Evenk, Orok and Nanai people to build The Company has also committed to the development closer relations with the different groups and organisations of an IP Development Plan during 2005 with the full representing the interests of indigenous people. participation of the indigenous peoples of Sakhalin Island.

Since then the Company has supported indigenous people through a wide range of social initiatives and projects including education programmes, the preservation of traditional culture and community development, culture and sports promotion and fi nancial support of IP conferences, congresses and other events.

28 Sakhalin Energy 2004 ANNUAL REVIEW 29 Social Investment - Korsakov The increased level of local business activity also brings an Sakhalin Energy is committed to maximise the benefi ts of increase in tax income from Project execution (contractors, the Project to communities impacted by our activities and subcontractors) to the local Korsakov budget. In co- works hard to mitigate potential negative impacts. The operation with the relevant Russian Authorities, Sakhalin town of Korsakov which lies on the northern edge of Aniva Energy and our main contractor CTSD are using their Bay in the far south of Sakhalin Island is an example of a best efforts to ensure that all LNG contractors and sub- community effected by the Sakhalin II Project. It is located contractors register locally and pay local taxes. 1 42 km south of Yuzhno-Sakhalinsk, the administrative 2 centre of Sakhalin Island, and 15 km west of the Sakhalin Infrastructure improvements II LNG site. Korsakov is the district administrative centre of Projects to improve infrastructure within Korsakov have the Korsakov District, and is the third largest community on also been and will continue to be undertaken by Sakhalin Sakhalin Island with a population of 39,300 (circa census Energy. These include a culvert upgrade over Chkalovka of October, 2002). and Ulitovka rivers, over 5km of road upgrades and repairs and the upgrade of the Korsakov landfi ll site. Also, In developing the LNG and oil export facilities there are a navigation polygons, which were not operational prior to number of negative impacts from the construction activity the new construction, were moved from the LNG site to that the Company works hard to address and minimise Aniva – improving navigation safety for Korsakov Port. their impact. Increased vehicle transport in the town and associated safety risks have been addressed through a In addition to undertaking ongoing repairs of Korsakov focused safety campaign with the authorities, citizens and roads utilised by project vehicles, Sakhalin Energy schools. Potential social impacts such as health impacts has signed an agreement with the Sakhalin Oblast from dust and noise, or the impact of an increased Administration for the concrete asphalt surfacing of the road workforce for the site construction are all monitored and between Korsakov and Kvartsitovy Konus, including the mitigated where possible. LNG bypass section. This work will be completed in 2007. However, the construction of the Sakhalin II LNG and oil export facilities has also brought various benefi ts to the Sakhalin Energy has also signed a contract with the district of Korsakov. Korsakov Administration for the re-construction of the Korsakov Park as compensation for loss of beach access Increased employment, business due to the construction of the LNG/OET facilities. opportunities and tax income 3 Sakhalin Energy is committed to open and transparent 1 Dust suppression truck on the Korsakov – Prigorodnoye Road. The construction and operation of the Sakhalin II LNG dialogue with residents and the District Administration of facilities have and will continue to create employment 2 Construction camp at the LNG site. Korsakov on any matters related to the implementation of the opportunities for Sakhalin Island residents, particularly 3 Financial support given to fi sh farm reconstruction in Ozersky. Sakhalin II project. In addition to holding regular meetings those from Korsakov. To date, in the construction phase, with the District authorities, in 2004, the company began the main LNG contractor (CTSD) has employed, directly or quarterly community engagement sessions in Korsakov. indirectly, 57 Sakhalin companies as subcontractors. By Local residents are also able to obtain information and March 2005, CTSD and its subcontractors employed over express any concerns that they may have in the community 1,000 Korsakov residents on the LNG project, making up liaison offi ce that is located in the city centre. 25% of the current LNG workforce.

During the start-up and operational phase of the facilities, it is anticipated that a number of local support services will be required, including security services, catering and administration services (camp cleaning, snow cleaning, grass cutting, etc), which will lead to the creation of new business opportunities for the community.

30 Sakhalin Energy 2004 ANNUAL REVIEW 31 Pipeline River Crossings Construction of pipeline crossings on rivers identifi ed Sakhalin Energy is constructing pipelines to carry oil as important to salmon spawning and those which may and gas from the offshore hydrocarbon fi elds northeast contain Red Book species will be carried out during the of Sakhalin Island to the south of the Island as part of winter months. This is typically from December to April the Phase II Project. The pipelines will cross more than when many of the rivers and riverbanks are frozen. This 1000 watercourses. These mostly comprise small brooks minimises silt generation and transport during construction and streams, but also include rivers with economically and after spring thaw. This winter period is also outside signifi cant salmon fi sheries and a small number of rivers the salmon spawning season when there are no salmon that possibly contain Red Book fi sh species. Sakhalin present, thereby limiting physical disturbance to the Energy recognises the importance of these watercourses to river and virtually eliminating the impact of construction the ecology and local economy of the Island - particularly activities on these fi sh. in terms of the salmon fi sheries - and is committed 1 By the end of 2004, 17 fi sh sensitive streams had to ensuring that the impact of river crossings during been crossed with one pipeline, with no measureable, 2 construction and operation of the pipelines will have only permanent negative impact to the environment. a minor short-term effect on the environment. Seven of the most sensitive larger rivers are planned to Sakhalin Energy has spent more than fi ve years be crossed with the use of Horizontal Directional Drilling undertaking surveys to collect environmental baseline data (HDD) technologies. Here pipelines will be drilled and collection along the onshore pipeline route to assess the installed underneath the river, without disturbing the river. potential impact of pipeline crossings on the environment, This method is not suitable for all rivers and geographical in particular on salmon streams. The research has been conditions because of the need for a suitable subsurface undertaken together with Sakhalin Scientifi c Research geological profi le. This method also requires the use of Institute for Fisheries Management and Oceanography special drilling muds, which is not recommended for use in (SakhNIRO), the Sakhalin State University and Russian highly permeable soils where there is potential for release environmental survey company Averina. into to the environment. The fi rst two HDDs were executed The research has enabled Sakhalin Energy to design river by a specialist contractor on the Vazi and Nabil Rivers in crossing methods, which determine how and when a river the north of the Island in early 2005. is crossed based on its sensitivity. River crossing timing Sakhalin Energy has developed an awareness programme and construction methods are approved by the relevant that focuses on compliance with construction procedures Russian Federation regulatory agencies, including local and erosion control for river crossings. River crossings with fi sh inspectorates, the regional fi shery regulatory agency, the highest sensitivity will have dedicated drawings, work Sakhrybvod, and the Federal level agency, Tsuren. execution plans, inspection and test plans. They will be During construction, trenching methods employed to cross executed only in the presence of environmental inspectors, a river can produce a short-term and localised increase who will verify compliance with environmental procedures in water turbidity, or suspended silt particles in the river. during construction. The environmental inspectors have the Although temporary in nature, this could potentially have authority to stop the work if they consider that procedures 3 an effect on fi sh and salmon spawning grounds. This or regulations are being breached, or if the environmental potential effect is minimised by avoiding salmon spawning impact is not acceptable. grounds wherever possible, reducing construction durations, adjusting the timing of the crossings to non- In addition to stringent Company, Russian and international critical periods, construction in low fl ow situations and, in standards that are being applied to river crossings, a few cases, drilling under the river. The silting effect Russian regulatory requirements also include a system of is expected to be no worse than that experienced fi sh damage assessment and monetary compensation. naturally by rivers each year during the spring thaw or This compensation is paid whether or not there is any from heavy rain. actual damage and represents some of the most stringent regulation of its type anywhere in the world. The damage 1 Winter river view.

the onshore pipelines and other Sakhalin II Project 2 Preparation for winter river crossing. facilities may potentially cause to fi sh has been calculated 3 Winter river view. according to Russian legislation. This has resulted in a sum of approximately $US 11 million in compensation. This is being paid into a government fund and used to improve the fi shing industry on the island. Part of these funds will be used to establish two new fi sh hatcheries.

32 Sakhalin Energy 2004 ANNUAL REVIEW 33 Western Gray Whales The ISRP report was published in mid-February 2005. The northeast coast of Sakhalin Island is rich with marine life Taking into account the advice contained withon the report and is a summer feeding area for the critically endangered and based on the conclusions of the CEA Sakhalin Energy announced its decision to reroute its offshore pipelines in 1 2 western gray whale (WGW). Two known feeding grounds for the WGW have been identifi ed off the northeast coast March. The pipelines - linking the PA-A and PA-B platforms of Sakhalin, a near-shore one in the Piltun Bay area, and an off Sakhalin Island to shore – will be moved 20 kilometres offshore feeding ground further south adjacent to Chayvo south of the original location, away from the key feeding Bay. The two feeding grounds have a total area of 1570 area of the WGW. Sakhalin Energy is currently seeking square kilometres. approval from Russian government agencies for this change.

In a clear demonstration of it’s commitment to ensure that its This decision is in line with the ISRP’s Report which called activities will have no adverse impact on the WGW, the for a conservative risk management approach. The selected Company halted its offshore pipeline construction activities pipeline route is the most precautionary alternative that in the PA fi eld for two seasons to allow for additional studies maximises the distance between the Company’s activities after the Company’s own research suggested that acoustic and the whales. impacts on the whales might be greater than anticipated. The ISRP Report identifi ed further measures to minimise the During 2004 Sakhalin Energy evaluated three possible impacts on the whales and Sakhalin Energy has already pipeline route options for the PA fi eld – the existing included many of these measures in revised mitigation plans identifi ed route and two alternatives. Additionally, the for its offshore activities. As a follow-up to the Panel’s report, Company carried out offshore and onshore environmental IUCN has invited members of the ISRP to review these and engineering surveys of the three route alternatives, and plans for mitigating risks to the whales associated with the completed another season of extensive WGW surveys. The development. body of information collected from past surveys combined Protection of the environment and species like the WGW with the 2004 work helped Sakhalin Energy assess the form part of Sakhalin Energy’s overall commitment to potential impacts and establish effective mitigation measures sustainable development. Sakhalin Energy is determined to ensure that the WGW is not adversely impacted by to ensure that the Phase 2 Project can be developed in the Company’s planned offshore activities in the PA fi eld. line with international environmental standards and the 3 Sakhalin Energy collated and assessed all of these results in 1 Sakhalin Energy Western Gray Whale acoustic research. Company’s commitment to mitigate potential impacts as far the “Comparative Environmental Analysis of the Piltun-Astokh 2 Western Gray Whales offshore Sakhalin Island. as is practicable - not just to the WGW, but to the Island as Field Pipeline Route Options” (CEA) report. One of the a whole. 3 Sunset near Piltun Bay. conclusions of the CEA was that with varying levels of mitigation, all three route options would be technically viable.

However, in parallel with it own study and research activities on the WGW, Sakhalin Energy took the bold step of asking IUCN – the World Conservation Union to convene an Independent Scientifi c Review Panel (ISRP) to review the effectiveness of it proposed mitigation measures to minimise the impact of its operations on the WGW and associated biodiversity in the context of the Sakhalin II Project.

34 Sakhalin Energy 2004 ANNUAL REVIEW 35 Oil Spill Response (OSR) Field surveys were undertaken in the summer of 2004 Sakhalin Energy takes the issue of oil spills seriously and and these will be continued in 2005. These are aimed at has implemented a number of measures to ensure that identifying sensitive areas, developing site-specifi c response the likelihood of spills is minimised and any potential strategies and logistical information. Ground surveys will be consequences are reduced. Our primary goal is prevention supported by aerial surveys. Data obtained will be added of oil spills. This is achieved through the robust design of to the Sakhalin Energy Geographical Information Systems- production, export and transport facilities, it is also achieved based sensitivity maps and database. These already cover by ensuring sound maintenance and operating procedures the coastal and lagoon areas adjacent to the Phase 1 – in both regards Sakhalin Energy is committed to the facilities along the northeast Sakhalin coast. 1 implementation of high international standards and In 2004 Sakhalin Energy also reviewed equipment 2 best practices. specifi cations, with particular regard to Sakhalin Energy’s Sakhalin Energy has a comprehensive Oil Spill Response light oil and to prevailing weather and sea conditions in (OSR) plan, which has been approved by the Russian Sakhalin. In addition, Sakhalin Energy will ensure that authorities, for operations under Phase 1 of the Sakhalin II equipment is suitable for third party spills that may occur development that involves the Molikpaq offshore platform on or around Sakhalin Island. In this respect, Sakhalin and tanker loading facilities. The Company maintains an Energy is committed to supporting Russian Federation and effi cient and effective OSR organisation and has access to Oblast agencies in third party spills, and will respond to its own regional resources. The OSR facilities for our existing any incident if registered under the ‘Unifi ed Command” production operations have a 24-hour response capability arrangements. from the OSR base that is maintained in Nogliki. The Sakhalin Energy will continue to promote and be involved in OSR vessel, Irbis, is maintained on standby in the Piltun- regional OSR workshops and training courses, and to foster Astokhskoye fi eld 24 hours a day throughout the ice-free production season. regional OSR cooperation.

The OSR organisation has a clear and tested chain of Cristoforo Colombo command, with clearly identifi ed roles and responsibilities. On September 8 the dredger Cristoforo Colombo was A thorough training programme, tested regularly, ensures that blown aground at Kholmsk by the strong winds and waves response teams have the right skills, and all potential team caused by the typhoon ‘Songda’ when its engines failed. At members are familiar with OSR procedures. the time of the accident the vessel, which was not owned or directly contracted to Sakhalin Energy, was at rest anchored During the last two years, less than one litre of oil has been several kilometres off Kholmsk Commercial Port awaiting spilt from the Phase 1 offshore operations – a spill record that remobilisation to the Lunskoye area. puts Sakhalin Energy amongst the top performers in the world. Sakhalin Energy has no production operations at Kholmsk. 3 The Company and its contractors use this port in the same The high standards set for Phase 1 OSR will be maintained way any other industry may use a port for normal shipping for the Phase 2 facilities. OSR plans for the Company’s activities. Any ship in the vicinity of Kholmsk, such as a ferry, Phase 2 facilities are under preparation and will be fi shing boat or merchant ship, could have suffered the same completed, agreed with the Russian authorities and put fate under such severe weather conditions. Under such in place before these facilities commence production. circumstances, there is no requirement for Sakhalin Energy to Sakhalin Energy will deploy permanent OSR equipment and have an oil spill contingency plan or equipment for the port. resources at each asset, and at strategic locations along the onshore pipeline route. Helicopter drop off points will be Sakhalin Energy however, reacted immediately and was identifi ed along the coast and the pipeline route for the air- requested to manage the ongoing response under the 1 OSR exercise – boom deployment. transportation of OSR equipment and teams to ensure that a “Unifi ed Command” system. The Company established 2 Cristoforo Colombo in Kholmsk. rapid response can be achieved in the unlikely event of its own emergency response team and mobilised its own a spill. oil spill contractor’s command group and response team 3 OSR training. within one hour. Clean up of effected areas was essentially completed by September 12, with certain areas of the Primorsky Boulevard reopened to the public that day. The entire clean up was completed in about two weeks.

36 Sakhalin Energy 2004 ANNUAL REVIEW 37 Waste Management Sakhalin Energy has developed a responsible waste management strategy. Central to this strategy is an integrated approach to the management of waste. This places emphasis on the minimisation, re-use and recycling 1 2 of waste wherever practicable, and the safe treatment and disposal of remaining materials. This approach is not only in accordance with international best practice, but also complies fully with Russian Federation regulations.

The largest volume of waste to be generated in Phase 2 will be during the construction period (2002-2008). Sakhalin Energy’s approach to waste management involves waste being disposed of as close to source as possible. This means that each project facility has full duty of care for the waste.

To support this strategy, Sakhalin Energy has developed a system that will track waste generation, classifi cation, transport, storage, treatment and disposal. As a commitment to the management of waste as close to 3 source as possible, each project facility will have a specifi c waste management plan for the construction and operational phases of the Project.

In 2004, under a cooperative agreement signed with the Sakhalin Oblast Administration, Sakhalin Energy conducted upgrades to three existing municipal waste landfi lls in Korsakov, Nogliki and Smirnykh. The landfi ll upgrade project provides for technical solutions in line with international best practice. These landfi ll facilities will be used for the disposal of the Company’s non-hazardous wastes during the construction of Phase 2, as well as for the disposal of municipal waste originating from local communities. Upgrade of the Nogliki landfi ll has been conducted in partnership with Exxon Neftegaz Limited.

In addition to the upgrades at existing waste management facilities, Sakhalin Energy is developing an oily waste bio- treatment project and comprehensive waste minimisation plan to allow for minimisation and recycling of hazardous wastes. Sakhalin Energy will also assist the Sakhalin Oblast Administration in the development of the local 1 Korsakov waste site. waste recycling industry. 2 Waste monitoring at the OPF site. In this way, Sakhalin Energy is pursuing a co-operative 3 Korsakov waste site. approach with local authorities to improve waste management on the island, which will be of signifi cant benefi t to local communities and the environment.

38 Sakhalin Energy 2004 ANNUAL REVIEW 39 Health, Safety, Environment, Security (HSES) and Social

Activity in 2004 2004 was a year in which Sakhalin Energy Investment To improve the standard of health amongst staff and Company (SEIC) put in place many of the structures, contract workers, the HSES Plan called for a number of systems, techniques and training to manage HSES and programmes to be run throughout the year. In accordance Social issues in the Sakhalin II project. It was also a year with the plan SEIC: in which the company achieved many, but not all of the • started to upgrade the emergency response 1 2 targets it set. capabilities in regional and district hospitals and Looking back over 2004, it is clear that safety, built helipads at the major construction sites to speed environmental compliance and social responsibility will medical evacuations be the main areas of focus in 2005. SEIC has expanded its HSES and social programmes to match the increased • jointly organised with the Sakhalin Oblast scale of the main construction operations, and can look Administration, a high-level workshop on ‘State, forward to signifi cant improvements in HSES and social Business and Community leaders response to STI/ performance in the coming years. HIV/AIDS and other diseases of a social character’. The workshop resulted in a joint action plan that later SEIC planned for 2004 knowing that it was going to was confi rmed by an offi cial resolution issued by the be a challenging year from the perspective of health, Vice Governor responsible for Social and 3 safety, environment and security (HSES). With the Phase Health Affairs 2 major construction projects due to reach peak working levels, and over 16,000 staff and contractors expected • conducted the fi rst health risk assessment programme to work more than 46 million man hours, the nature of of the onshore projects, bringing in expert industrial the company’s activities would expand and change hygienists to train managers and staff in each area signifi cantly during the year. • upgraded the sanitation, water supply, catering and To adapt to these changes, a detailed plan was medical clinics at contractor sites in response to a formulated to manage the HSES aspects of SEIC’s government sanitary audit, resolving 95% of the issues construction and operations activities throughout the raised within four months year. The HSES plan contained a range of targets and • ran a series of fi rst-aid training courses and health milestones designed to monitor performance and provide awareness workshops, and made a $10,000 continuous improvement to the SEIC HSES framework. donation to the Sakhalin Regional HIV/AIDS centre

1 OPF construction site. While not all of the specifi c targets in the plan were • further improved the compliance of fi tness-to-work 2 Working at heights – LNG site. reached, signifi cant structural progress was achieved, and tests for all local SEIC staff, conducted a number of SEIC is looking forward to further improvements in HSES 3 OPF construction site. health incident investigations (food poisoning and during 2005. non-accidental death cases) and conducted a series of audits of contractor staff health certifi cates Health The benchmark for health in 2004 was to achieve a target • continued to promote health awareness among of having less than 8.5 occupational illness cases per employees through a series of educational million man hours worked. There were in total 262 cases programmes on topics such as tobacco, alcohol and of occupational illness, 74 of which resulted in absences stress management. from work. This represents 5.6 cases per million man hours As a result of these initiatives, the company is confi dent worked. Occupational Illness case reporting by contractors that in 2005 the health objectives will once again has signifi cantly improved during 2004, although under be achieved. reporting in some projects areas was observed.

40 Sakhalin Energy 2004 ANNUAL REVIEW 41 Safety Other aspects of the 2004 safety programme included: Due to their scale, complexity and geographic spread, the • a comprehensive safety review by Shell Group experts Phase 2 construction projects carried a higher safety risk of all Phase 2 projects. As a result of this review, than ongoing Phase 1 operations, so safety was made 1 improvements to lifting safety and the auditing of a major area of focus in the 2004 plan. Despite this contractor methods are being implemented. 2 emphasis on safety, regrettably six fatalities related to SEIC and contractor activities occurred: four due to road traffi c • integrating each project’s emergency response accidents, one from a fall after operational procedures plan into a centralised approach and successfully were not followed and the other following a fi ght in a conducting two major emergency fi eld exercises contractor construction camp. • designing and implementing a new incident reporting The main safety issue identifi ed in the HSES Plan was and investigation system. road safety, with the target of less than 3.20 road traffi c incidents per million kilometres driven. By the end SEIC understands the critical importance of safety to the of 2004, there had been 181 motor traffi c accidents well-being of workers and the local community, and is involving company and contractor vehicles, representing confi dent that the efforts made this year to improve safety 3.56 incidents per million kilometres, and 11% over across the company will result in further measurable target. This under performance was recognised early improvements in 2005. in the year, and a signifi cant effort put in to developing road safety through the second half of the year. In August, a formal Road Safety Steering Committee was formed and charged with developing and implementing a comprehensive road safety programme.

The ‘Think, Drive, Survive’ programme was launched to over 17,000 people in December 2004, and will be conducted both within the company and among the community until at least 2008. SEIC also developed 3 a working relationship with the Global Road Safety Partnership – an initiative of the World Bank aiming to promote road safety issues worldwide. In early 2005 the “Sakhalin Road Safety Partnership” was formed on Sakhalin Island with the assistance of the Global Road Safety Partnership. 1 OPF road safety initiative.

2 Korsakov Road Safety Day.

3 SEIC staff participate in Korsakov Road Safety Day.

42 Sakhalin Energy 2004 ANNUAL REVIEW 43 1 2

Environment SEIC is committed to conducting its operations in To meet the requirements of relevant Russian Federation compliance with all applicable Russian Federation and international environmental legislation, SEIC environmental regulations, and in addition has its own enforced environmental protection measures and created stringent internal standards. SEIC and its contractors improvements using a variety of environmental controls routinely monitor their performance to ensure that their and activities. Highlights of SEIC’s environmental activities meet the requirements of the permits and licences activities included: that have been issued for their construction activities and operations. • the 8th successive year of research and monitoring carried out on the western gray whale Two environmental milestones were achieved in 2004 at the Molikpaq platform. The producing operation • the production of a comprehensive environmental underwent two surveillance audits in 2004 and analysis of three possible Piltun pipeline route options maintained the ISO14001 certifi cation of its Environmental Management System that it achieved in 2003. The • the 7th successive year of ecological monitoring platform also met SEIC’s fl aring target in 2004. Total carried out around the Molikpaq production platform hydrocarbons fl ared in 2004 were 12.7 million standard • the 2nd year of a three year monitoring and research cubic feet per day, below the internal SEIC target of 13 programme carried out on the Steller’s Sea Eagle million standard cubic feet per day.

• industrial control activities including compliance SEIC also met its targets for oil spills from Molikpaq, with monitoring to evaluate and ensure requirements of not a single spill over the HSE Plan defi ned size of 50 environmental permits and licences met litres and indeed no recordable spills during operations, despite producing more than 11 million barrels of oil. • completing the fi rst stage of development of a comprehensive company-wide integrated In September, SEIC’s emergency response team was fi rst environmental monitoring project for the on the scene for the successful cleanup of combined fuel operational phase oil and diesel near Kholmsk port when a contractor-owned 3 dredger was blown aground during a typhoon. 1 Piltun Bay. • fi nalising the solid waste management plan and

2 March in Sakhalin. upgrading three landfi lls

3 Sea birds. • ecological survey and monitoring of onshore and offshore habitats

• oil spill prevention, preparedness and response planning.

44 Sakhalin Energy 2004 ANNUAL REVIEW 45 Security Social The security priorities defi ned in the 2004 HSES Plan Sakhalin Energy strives to achieve excellence in social were to ensure staff and families had a safe and secure performance, both in the way that the Company and its environment, protect SEIC assets from theft and damage, contractors work and engage with local communities, and 1 2 review and improve security measures across the whole in the broader sense of having a positive impact operation and investigate incidents in conjunction with the on society, through Project benefi ts and social Russian authorities. investment initiatives.

Two security reviews were conducted in 2004. The fi rst Sakhalin Energy has worked hard to ensure that its social was an assessment of the security threats on Sakhalin and management processes meets international best practice in the Russian far east which was requested by the lenders. and seeks to be a leader in this area. The Company The second was a standard security review conducted is committed to a broad range of ongoing public by the security team. These reviews involved site visits to consultations and social assessments during construction the main onshore and offshore assets, and to a number of and has already devoted substantial resources to support pipeline construction sites and this effort. associated camps. In 2004, Sakhalin Energy continued to conduct social With the exception of a fatal knife attack in one of impact monitoring and extensive public consultation the contractor construction camps arising from alcohol programmes in the communities directly and indirectly related violence, these reviews found that there were affected by the Sakhalin II Project. Under these no major security issues in 2004. The very regrettable programmes, more than 50 communities were visited in fi ght incident was thoroughly analysed and several April, June, November and December 2004, to update improvement activities undertaken. However, most of the them on the Sakhalin II Project and to obtain feedback security incidents reported were, as would be expected on from them. such a project, theft of equipment from company sites and employee accommodations, verbal and physical threats to Most of this consultation work was performed by Sakhalin employees and other street related crime. Energy’s Community Liaison Offi cers (CLOs). Their key responsibilities include meetings with local stakeholders 3 A further success in the year was SEIC achieving and residents, distribution of information on Project status 1 SEIC donation of sewing machines to Nysh school. compliance with the International Ship and Port Security and addressing community concerns and grievances in 2 SEIC English language training partnership project. (ISPS) Code, which came into effect in July with Russia as line with the company’s grievance procedure. In addition, 3 SEIC school road safety presentation. one of the signatories. the CLOs provide information on job opportunities with the Sakhalin II Project. By the end of 2004 more than 1000 local residents had been provided with Project-related information and 1300 residents had been consulted on job opportunities within the Project. Assistance was also given on resumé development.

In addition to the Company’s on-going CLO activity, Sakhalin Energy is also involved in supporting the people of Sakhalin through partnerships and sponsorships. In 2004, Sakhalin Energy donated $400,000 to support projects that contribute to the environmental, economic and social development of the Island.

46 Sakhalin Energy 2004 ANNUAL REVIEW 47 48 Sakhalin Energy