Shell has conceded defeat in the long-running battle with the Kremlin for control of a huge oil and gas project off the Siberian coastline.

After talks held at chief executive level last week between Shell and the Russian state-controlled Gazprom, it is likely that the Anglo-Dutch energy group will cede the majority stake.

Shell's holding is expected to fall from 55 per cent to a 25 per cent plus one share - still enough to be a blocking minority shareholder. The two current Japanese investors Mitsui and Mitsubishi will also see their holdings fall from 45 per cent to 25 per cent, in order to make space for Gazprom to take a 50 per cent plus one share control.

Gazprom had already been forecast to take a smaller interest in the development, which will now cost nearly €17 billioto complete as it brings one of the largest reserves of oil and gas onshore and across the 800km Sakhalin island to both a new port and a liquid gas plant.

It is not yet clear if Shell will receive a minority stake in other Gazprom developments. Over the past few months, a variety of different Russian agencies, notably environmental inspectorates, have complained of construction problems on the island, as the pipelines pass over 1,100 rivers. Shell denied the scale of the complaints and countered that the rules were being applied selectively towards it compared with similar Russian-controlled projects.

The Kremlin was incensed when Shell announced late last year that costs would double, with the Russian government not due to receive full royalties until this enlarged debt had been paid off. The Kremlin also believes the original production sharing agreements, signed in the 1990s, were a bad deal for the country and wants them revised. "It was definitely inevitable that some sort of compromise had to be reached. These agreements are now seen as being inappropriate to Russia; they're really for bankrupt third world countries. They don't give governments control and this is one government that wants control," explained Stephen O'Sullivan, the head of equities research at Deutsche UFG in Moscow, last night.

Although the Kremlin perceives oil, gas, media and metals as strategic industries, he doesn't believe other sectors are subject to the same state scrutiny. "But the question in business minds will be: 'What happens if the rules of the games change again?' Although the place is booming, you should never say no to investment and this is reminding people the rules of the game have changed," he said.

Shell has repeatedly hailed the Sakhalin-2 project as the largest and most complex energy project in the world. Overall, it hopes to extract a billion barrels of crude oil and 500 billion cubic metres of natural gas. Some elements of the scheme are already operational, with the new liquid gas plant due for completion by mid-2008.

There are four other oil and gas schemes linked to Sakhalin island, which lies off the Siberian coastline and just 80km north of Japan, but none of these are affected directly by the current negotiations.

Separately, president Vladimir Putin has hinted that foreign partners may be allowed take a stake in the upcoming Shtokman development in the Arctic - another of Russia's vast energy reserves the Kremlin wishes to tap.

This appears to be a reversal of the surprise decision by Gazprom last month that it would shun foreign partners and extract gas offshore from the Arctic ocean alone - a plan that was greeted with scepticism by the five major energy companies which had bid to be named as partners in the scheme.