Sept. 5 (Bloomberg) -- Russia sued to halt Royal Dutch Shell Plc's $20 billion Sakhalin oil and gas project as President Vladimir Putin's government increased pressure to gain control of the development.

The Natural Resources Ministry is citing environmental violations at Sakhalin-2, which will produce the equivalent of a third of China's gas needs. Sakhalin is key to Shell's plans to increase output and take on more projects in Russia, the world's biggest exporter of natural gas and second-largest oil supplier.

Officials in Russia, where state-run OAO Gazprom and OAO Rosneft are tightening control of production, said in May Shell, Exxon Mobil Corp. and BP Plc should allow Russian companies a bigger role in their projects. Setbacks at Sakhalin would undermine Shell's effort to persuade investors it can replace the oil it pumps, two years after the company overstated its reserves.

``It's a bit of gamesmanship,'' said Craig Pennington, global the leader of energy research at Schroders Plc in London. ``You have to ask why these attempts have emerged now. If you saw the oil price at $15 to $20 a barrel lower, you wouldn't see the same amount of confidence out of the Russian oil sector.''

Gazprom

Gazprom agreed last year to swap half a Siberian gas field for some of Shell's 55 percent stake in Sakhalin-2. The government and Gazprom are discussing whether to alter terms of that deal after Shell said in July 2005 costs at the field would more than double to exceed $20 billion. Sakhalin-2 is the biggest oil and gas development in Russia that's wholly owned by foreign companies.

``The government won't necessarily kill the project,'' said Kaha Kiknavelidze, an oil and gas analyst with UBS AG in Moscow. ``Maybe they're just trying to get acceptable terms.''

All work at Sakhalin would have to stop if a Moscow court upheld the suit, which accuses the project operator, Sakhalin Energy, of environmental violations, the Natural Resources Ministry's inspectorate said today in an e-mailed statement.

``We are surprised at the claim that the company has not complied'' with recommendations made by a state panel of experts, Sakhalin Energy said in an e-mailed statement. The company said that ``minor deviations'' shouldn't be the basis for annulling a 2003 expert review.

Earlier today, Ivan Chernyakhovsky, Sakhalin's Moscow-based spokesman, said Sakhalin Energy had stopped pipeline-laying work at a second location after a complaint from the Natural Resources Ministry. In August, the company said it had halted some pipeline construction because of environmental violations by subcontractors.

May Sell

Located off Russia's Pacific coast, the Shell venture is 55 percent owned by Shell, 25 percent by Mitsui & Co. and 20 percent by Mitsubishi Corp.

The two Japanese partners are willing to sell part of their stakes to Shell if Gazprom becomes a shareholder, Interfax reported today, citing an unidentified executive at Mitsubishi Corp. London- based Shell spokesman Andy Corrigan said he couldn't comment immediately.

``I think Shell's in a position to play hardball,'' Pennington said. Gazprom, which has no experience in liquefied natural gas projects, wouldn't be able to manage the site, he said. If it starts shipping LNG in mid-2008 as planned, Sakhalin-2 will be Russia's first export terminal of super-chilled gas.

Deliveries are expected to rise to 9.6 million tons a year, equal to about a third of China's annual gas needs. The company has sold 90 percent of the output from the LNG plant, Jon Chadwick, Shell's top gas executive in Asia, said June 22.

Gazprom and Rosneft want to tap into foreign expertise as they look for resources in increasingly hostile environments. Gazprom is selecting international partners to help it develop the vast Arctic Shtokman LNG project. Rosneft is cooperating with Exxon Mobil in Sakhalin-1 and with BP in Sakhalin-5.

Anomalous Project

Sakhalin-2, an anomaly because of its exclusive foreign ownership, is the result of a so-called production-sharing agreement, which Russia signed in the 1990s after the fall of the Soviet Union. Now flush with oil revenues and wooed by international banks, Russia can afford to challenge the agreements.

``The government considers this type of project a mistake of the past,'' Kiknavelidze said. ``I don't rule out that there are environmental issues. You have that everywhere, like in Alaska.''

The environmental inspectorate is suing to cancel a 2003 feasibility study that allowed Sakhalin-2 to go ahead.

The Sakhalin project has been a focus for environmentalists and sustainable development organizations because its operations overlap with salmon habitats and feeding grounds for the endangered Western Gray Whale.

Shell's environmental record in Sakhalin is symptomatic of failures in Nigeria and Ireland, said Christopher Hall, a Shell shareholder and spokesman for the U.K.-based Ecumenical Council for Corporate Responsibility.

``In each case, there is insufficient consultation with local stakeholders and environmental impact assessments, leading to these holdups,'' Hall said. ``If they got that sorted before the project started, they wouldn't run into these problems.''

To contact the reporter on this story: Lucian Kim in Moscow at lkim3@bloomberg.net

Last Updated: September 5, 2006 12:21 EDT