Exxon Consortium – Rosneft dispute on the migration of oil in the Sakhalin-1 Project

One of the major recent disputes in the Russian oil & gas industry arose between a subsidiary of the U.S. oil company Exxon Mobil – Exxon Neftegas and the Russian state-controlled oil company Rosneft over the Sakhalin-1 project (the “Project”).

The dispute between these oil giants led to two parallel proceedings. In the first case, Exxon Mobil is pursuing a US$1.4 billion claim against Rosneft at the ICC International Court of Arbitration (“ICC”), after Rosneft filed a US$1.4 billion lawsuit in the Court of Sakhalin region against several Exxon subsidiaries (the “Exxon Consortium”).

In the ICC proceedings, the Exxon Consortium seeks the payment for a certain drilling and production services rendered to Rosneft, for its work in the Chayvo field. In the second case, Rosneft accuses the Exxon Consortium, the owner of the Project, of “unjust enrichment” and of reaching illicit gains. Rosneft alleges that Exxon Consortium has extracted crude oil which migrated from a neighbouring block that Rosneft has been developing alone. Therefore, Rosneft seeks 89.1 billion Russian rubles, which is $1.4 billion, in damages from Exxon Consortium for the unjust enrichment following oil cross-flow.

This post analyses the dispute between the Exxon Consortium and Rosneft regarding the allegations of the unjust enrichment and the potential legal outcomes of the proceedings before the Court of Sakhalin region unless the parties manage to reach an agreement on this matter.

Sakhalin-1 Project

Sakhalin 1 project is a consortium for the production of oil and gas on Sakhalin Island. It operates three fields in the Okhotsk sea: Chayvo, Odoptu, and Arkutun-Dagi. The Exxon Consortium is operated by Exxon Neftegaz, the Exxon Mobil subsidiary, according to the Production Sharing Agreement (the “PSA”) signed in 1996 between the Consortium partners. The partners include Exxon Neftegas which owns 30% of the Project; a  Japanese public-private venture Sakhalin Oil and Gas Development (SODECO) which owns 30%; India’s state-owned company ONGC Videsh holding owns 20%; and two Rosneft’s subsidiaries hold the remaining 20%.

The Rosneft’s subsidiaries are also named as defendants in the proceedings. The Soviet Union discovered Sakhalin-1 fields Chayvo, Arkutun-Dagi, and Odoptu in the 1980s. However, these fields had never been properly assessed and the reevaluation of their commercial viability had to be carried out.

In 2017, the Project set a world record for the drilling of the worlds longest well from Orlan platform at Chaivo field in the Sea of Okhotsk.  In 2015, Exxon Neftegas filed a $600 million claim under UNCITRAL Arbitration rules against the Russian government, alleging that it had overpaid taxes for the Sakhalin-1 project.

However, in 2017 the parties signed an amicable agreement. They did not disclose the terms of that agreement. During the last year, Exxon Mobil withdrew from a series of ventures valued at up to $500 billion concluded with Rosneft in 2011, involving exploration projects in the Russian Arctic, and shale oilfields in Siberia and the Black Sea.

Unjust enrichment of oil by Exxon and the dispute before the Russian State Courts

Before the dispute had arisen, Rosneft asked the US petroleum consultancy DeGolyer & MacNaughton to conduct an independent assessment of the volumes of oil and condensate flows between the licensed site of the Northern Tip owned by Rosneft and the parts of the field owned by Sakhalin-1. The Court of the Sakhalin region disclosed in the database of the Court’s decision details of the claim filed on 13 July by Rosneft to the Exxon Consortium. According to Rosneft, from July 2015 to 31 May 2018, the shareholders of the Project were unjustly enriched at the expense of the Russian state company.

The parties tried to settle the dispute by negotiation: in August 2017, Exxon reached a preliminary agreement with Rosneft on the oil crossflows. Following that, on 24 April 2018 Exxon Neftegas initiated arbitration at the ICC in Paris against Rosneft in order to protect the rights of the consortium. However, because the preliminary agreement lasted until 31 May 2018, Exxon suspended the proceedings until the expiration of that date. Since the parties did not reach an agreement on that matter, Rosneft filed the lawsuit in the Sakhalin Court on 13 July 2018, and following that, Exxon resumed the April’s arbitration.

Generally, the disputes between oil companies about the flow of hydrocarbons from one site to another due to the complex geology of the seams are not rare. In practice, such disputes are usually settled at the pre-trial stage, considering the refined calculations based on the geological expertise.

For instance, one of the cases of the transition of such a conflict to the courtroom includes the dispute between Turgai Petroleum (which is jointly owned by Lukoil and PetroKazakhstan) and PetroKazashtan Kumkol Resources (“PKKR”) over Kumkol oil field. Turgai exploited the half of the Kumkoil oil field whereas PKKR exploited the other half. In this respect, Turgai and PKKR concluded an agreement on the use and exploitation of the Kumkol oil field.

The conflict arose after Turgai Petroleum filed charges against PKKR in pumping oil from the field for $ 193.6 million with the use of technologies forbidden by the agreement. In 2006, the Supreme Court of Kazakhstan confirmed following the use of the prohibited technologies by PKKR the oil flow occurred from the part exploited by Turgai to that one exploited by PKKR. Thus, the Supreme Court awarded Turgai approximately $54 million. However, the Turgai-PKKR dispute is one of the few examples which became publicly available due to the submission of the case to the state courts.

Conclusion

This dispute between Exxon Consortium and Rosneft presents an important case which involves complex technical expertise and geological studies in the determination of the oil crossflows. Also, this case may affect the future partnership of the Exxon Consortium, given that two of Rosneft subsidiaries take part of the Project.