"We cannot support all the proposals from investors connected to rising costs. It seems to me that they haven't been thoroughly worked out -- there's still more to work on," Gref said.

Russia has strongly objected to Shell doubling its initial cost estimate of 10 billion dollars (7.9 billion euros) for developing Sakhalin-2 to 20 billion dollars.

Russia said the cost overruns would deprive the state of billions of dollars in shared revenue it expects from the project.

Shell owns 55 percent of the Sakhalin-2 consortium, while Japan's Mitsui and Mitsubishi control the rest.

On Monday, Russia's ministry of natural resources stripped environmental permits for Sakhalin-2, necessitating a halt to work on the project's second phase, which includes building the world's largest liquefied natural gas (LNG) terminal.

On Tuesday a senior official in Russian environmental monitoring agency Rosprirodnadzor rejected claims that the withdrawal of the permits had as much to do with the state's economic goals as with environmental concerns.

Analysts have said the permits issue is a front for efforts by the Gazprom energy giant to gain a stake in Sakhalin.

Shell's cost revision earlier scuttled a preliminary agreement with Gazprom to trade a 25-percent stake in Sakhalin-2 for 50 percent of a Gazprom gas field in eastern Siberia.

Speaking along side representatives of international environmental organisations, Oleg Mitvol, deputy head of Rosprirodnadzor, said the withdrawal of permits was purely motivated by environmental concerns.

"Sakhalin Energy received permission to extract oil and gas -- no one permitted it to destroy the environment," Mitvol said.

The head of the WWF environmental group in Russia, Igor Chestin, said that the project's environmental standards had always been unsound, laying the consortium open to problems.

"I don't know a single other company currently working on Russian territory, whether Russian or foreign, which is using such outdated technology and such uncontrolled construction methods," Chestin said.

Activists say the project threatens precious species such as the western grey whale.

But Stephen O'Sullivan, an energy analyst at Deutsche UFG, insisted that the environmental issue was bound up with the state's economic goals.

"The aim of the whole environmental issue is to improve the chances for Gazprom getting in (to Sakhalin-2) and the deal it gets getting in," said O'Sullivan.

Sakhalin-2 is one of three major foreign-led energy projects currently being squeezed as the Kremlin steps up its campaign to increase control over the natural resources sector.

US major ExxonMobil, which leads the neighboring Sakhalin-1 oil and gas project, and France's Total, which is developing the Arctic Kharyaga oil field, have also come under fire for alleged inefficiency and mismanagement.

All three projects are governed by strict production-sharing agreements (PSAs), which analysts say leave the Russian state little room to maneuver as it seeks to gain greater control of the projects.

Gref said that the PSA model was no longer appropriate for Russia.

"I believe that today the state of the investment climate in the country and external conditions are such that that we can do without this regime and work on normal terms," the minister said.

O'Sullivan said the inflexibility of PSAs had long rankled the state.

"It was only a matter of time before the Russian government got to the PSAs," he said.

earlier related report
EU Urges Russia To Explain Why It Cancelled Shell Energy Permit
Brussels (AFP) Sept 19 - EU Energy Commissioner Andris Piebalgs urged Russia Tuesday to explain its reasons for cancelling a permit for a Shell-led consortium to develop the huge Sakhalin-2 oil and gas fields.

"I believe that they should be clearly and unequivocally identified by the Russian authorities and Shell must be given an appropriate time to resolve them according to defined and clear criteria, set out in advance," he said.

Russia's move Monday to withdraw the essential environmental permit from British-Dutch Shell is a new example of official pressure on foreign investors as the Kremlin tightens its grip on the country's vast energy resources.

The decision will halt all work at the 20-billion-dollar (15.8-billion-euro) Sakhalin-2 project, the world's biggest privately funded energy project which is on an island in Russia's far east.

Piebalgs warned of the dangers of undermining investor confidence.

"In order to ensure that companies are willing to invest in multi-billion-euro energy projects, a secure and predictable investment climate is necessary in Russia as in the EU or indeed any country," he said.

"Without this, investment in new energy projects will be highly problematic, providing uncertainties for the world's future energy supply."

The EU was given a stark reminder of the political power of natural resources in January, when Russia switched off its gas taps to Ukraine amid a price war, hitting some supplies in western Europe.

The bloc is the world's second-largest energy market and is highly dependent on Moscow, importing more than 20 percent of its natural gas needs from Russia.

Brussels is particularly concerned about the influence of Russian energy giant Gazprom, which turned off Ukraine's supplies during a tough winter, and wants reassurances there will be no repeat of the problem.

Gazprom has been negotiating for a 25-percent stake in Shell's Sakhalin-2 project since last year, when a preliminary asset swap agreement between the two companies broke down.

"The successful EU-Russia energy partnership is based on the mutual respect of transparency, predictability and non-discrimination," Piebalgs said in his statement.

"This applies as much to the ability of EU companies to invest in Russia as to the right of Russian companies to sell gas and oil freely at both upstream and downstream levels in the EU."

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