TOP INTERVIEWS Interview with Mr. David L. Simerka, Outgoing Vice President & Venture Manager, Exxon Neftegas Limited, Sakhalin Current Vice President & General Manager, Exxon Ventures (CIS) Inc. Moscow Yuzhno-Sakhalinsk, July 11th 2002 Could you begin by outlining the main characteristics and recent investment figures of the Sakhalin 1 project? This is an exciting, world class project. In terms of reserves, Sakhalin 1 holds approximately 2.3 billion barrels of recoverable oil and 17 trillion cubic feet of gas. These are world class reserves by all standards in the oil and gas industry. After approval of the PSA [Product Sharing Agreement] in 1996, then shooting seismic and drilling approximately 7 appraisal wells, in October of 2001 we declared commerciality of the project, and we are now moving forward in a big way. This project has numerous benefits to all stakeholders. It will bring major benefits to the state, the Russian people and especially the Sakhalin residents. We plan to invest $4.5 billion in phase 1 alone and to achieve first oil in 2005. Then, once the gas market develops and buyers are ready to purchase gas, our total investment will be up to about $12 billion. This translates into approximately $35 to $40 billion for the state in terms of revenue from taxes, royalties and profit sharing. On the island we will be creating thousands of jobs, and we will initiate payments to the Sakhalin Social Development Fund to the tune of $20 million a year for the next five years. so it is an exciting project for the state, for Sakhalin and for investors. Having said this, it is also a technically challenging project. This is an offshore project which must deal with ice conditions during 7 months of the year, along with seismic activity. Therefore, our top priority is safety, for our employees, for the community and for the environment. One of the challenges has been going through the PSA approval process. Has time and speed of approval been a major issue and a problem to expedite first production? It has certainly been a challenge. We were awarded the Sakhalin 1 license in 1993 and it has taken from 1993 to 1996 to finalise a PSA, then we declared commerciality in 2001 - which translates into 8 years, and we have anticipated that it would take another four years for first oil production. So it has taken a long period of time. Of course, there were numerous challenges which were partly due to the changes in Russia, and investors needed a stable fiscal and legal environment. Yet we decided to maintain our investment targets while the reform process was taking place in Russia. So we were taking quite a great deal of risk, and today we have spent close to $800 million. Yet I am very confident that the progress that has been made in Russia is positive. Just a few weeks ago the first reading of the PSA chapter of the tax code was passed, and the second / third reading should take place in the fall of 2002. We need this in order to ensure that tax provisions agreed in our PSA, will be grandfathered and those agreements are maintained. Is there competition between the Exxon consortium and the Sakhalin Energy consortium, especially now that Sakhalin 2 has started to market their oil? Every oil company is in competition with each other. Having two major oil companies on Sakhalin island, I would agree that we are in competition. We are in competition for the on island resources and for undivided attention from the regional and state governments. In my view, companies have more flexibility in seeking out oil markets, however, gas marketing is a different story. Sakhalin 2 is taking the LNG (Liquid Natural Gas) route while Sakhalin 1 is focusing on the export pipeline option. Both projects would like to capture a gas market in the Far East sphere. How are you preparing to design the route for the gas pipeline to Japan, and what are you doing to develop your gas marketing strategy in Japan? A Feasibility Study Consortium was formed in April 1999 and members include Japex, Itochu Marubeni and Exxon Japan Pipeline Led. The scope of the work was to evaluate the technical and economic feasibility including route selection of a gas export pipeline to Japan. The majority of the study has been completed and this year a report will be completed to demonstrate the commercial and technical viability. There are several advantages for a Sakhalin 1 natural gas pipeline to Japan. Sakhalin 1 is a world class resource of clean fuel in close proximity to Japan and therefore we can supply diversity, in terms of both source of supply and transportation system. Our marketing efforts today are focusing on convincing Japan that Sakhalin 1 pipeline gas can provide energy diversity and can be delivered economically. Would say that your shareholders and partners are satisfied with the deadlines and the efforts you are making to maximize profitability & reduce costs? You are always working to reduce costs. You always try to plan and budget capital investments based on what it takes to economically develop the field, and get your product to the market at the lowest possible cost. As you go through the construction there tends to be cost escalation pressures. So it is always a challenge to keep costs down. There are always upward cost pressures, but this is something which we can manage and we are sure to keep costs down to maintain economic profitability of the project. Is Russian content hampering or benefiting the project, or both? It is difficult to achieve Russian content at 70% of total manpower and investments, which is the required percentage. We are slightly above 50% right now, but over the life of the project we believe that we will exceed 70%, which includes operations phase. As our operations take shape and evolve, more and more Russian companies will be acquiring expertise and managing some aspects of the project. So this is not a problem within the duration of the project. The challenge today is adopting Russian content at the front end of the project, during the construction implementation phase where it is difficult to source local products that meet international specifications. Having said this, we are going out of our way to visit the fabrication plants and pipe mills to find and identify the Russian factories and plants with which we can work with and support to meet our specifications. It is difficult, but we are working at it because it is important for Russia. Nevertheless, I believe that everybody realises that there is a percentage of investments which cannot be sourced in Russia - I do not know any project in the world where you can source 100% in the country you work in. What are future expectations for Sakhalin 3? Sakhalin 3 is still moving ahead in the background, since it has not finalised a formal PSA agreement. Former Russian President Boris Yeltsin signed the list law in June 1999 to allow Sakhalin 3 to be developed under the terms of a negotiated PSA. However, two years have passed and not much progress has been achieved. Now, negotiations are starting up again and I am hoping that by 2003 a PSA will be concluded and we will be in a position to start the exploration drilling. Sakhalin has always been oriented towards Moscow, but do you feel that this is the time and the opportunity for Sakhalin to look towards Asia-Pacific instead? Yes, if Sakhalin has the desire to play that role. It is seven time zones from Moscow and approximately 10,000 kilometres away, and I believe that Sakhalin can play an important role for Russia in Asia. Sakhalin Island now has the opportunity to develop its offshore resources and use the financial benefits to improve the social infrastructure such as roads, electrical power generation, heating and overall living conditions. The multiplier effect of foreign investments will push Sakhalin ahead of other areas in the Russian Far East. You have been here for 5 years, and the PSA was approved in 1996. In light of the time you have spent working on this project, will it be hard to leave now that you are being transferred to Moscow? Although I am going to Moscow, I am certainly not leaving the project. Even in Moscow, the #1 project that we are focused on is Sakhalin 1, and I will be returning to the island regularly for regular business meetings. When I first got here, I was working on Sakhalin 3 for Mobil Russia Ventures Inc. and during the first three years of my tenure here, and I really wanted to see a well drilled before leaving the island. We still do not know if there is oil or gas (or both) in the Kirinski block. After the merger of Exxon and Mobil, it was exciting to get involved in the drilling operations of Sakhalin 1, which has moved ahead with a strong momentum. Today we employ 137 people and by next year we expect to grow to 200 employees. I look forward to being here when first oil is produced in 2005, and I am anxious to see what Sakhalin 3 holds for us as well. What are the best memories that you will bring back with you about Sakhalin - will it be the work, the people, the harsh winters. All of it - it has been a fulfilling project in every respect. On a professional level, it has been interesting to see the progress of Sakhalin shelf development. On a personal level we have developed strong Russian friendships. I am originally from Southern Texas, and I love the snow here, even when it is 6 to 8 feet high. In Moscow I will unfortunately not be able to enjoy the great outdoors of Sakhalin. After 5 years here I can truly say that I have developed a strong bond with Sakhalin and its people. Note: WINNE cannot be held responsible for the content of unedited transcriptions.