The Australian: Sakhalin's potential is costing Shell dearly: “The project, of which Shell owns 55 per cent, has at times appeared to be slipping out of its control.”: “The events may have hurt Shell's ambitions in Russia. Since the announcement of the jump in costs, Gazprom, Russia's state-controlled gas monopoly, has denied Shell a stake in its giant Shtokman gas field in the Barents Sea…”: “To make matters worse, Gazprom was due to take a 25 per cent stake in Sakhalin-2 under an asset swap with Shell, announced only a fortnight before the size of the cost overrun became apparent. Gazprom is now driving a much harder bargain.”: Sunday January 16, 2006
The big oil company has to contend with much more than just savage arctic conditions, writes Thomas Catan
ON a remote island off the eastern coast of Russia, encased in ice for nearly half of the year, the future of the world's oil and gas industry is beginning to take shape. And judging by the scale of the project that is coming into being around the bleak shores of Sakhalin, that future will be expensive, complex and, above all, big.
Off Sakhalin's north coast, two of the largest concrete structures ever built in Russia have been installed in the sea. As large as football fields and as tall as 15-storey buildings, the offshore platform bases have been towed in from 1850km away. About 6000 construction workers labour in temperatures that can reach minus 40C laying 800km of pipeline down the length of the island.
On the south side, Russia's first liquefied natural gas plant is being built in Aniva Bay. There, the natural gas will be super-cooled into liquid form and shipped to Japan, South Korea and the US -- markets that have never before had access to Russia's massive gas reserves.
After decades of false starts, the big push is under way to transform Sakhalin into the world's latest oil and gas province. A consortium led by ExxonMobil started producing oil in October from its Sakhalin-1 project.
Sakhalin-2, led by Royal Dutch Shell, has also been pumping oil in the summer months since 1999. But the second phase of Shell's project, now under construction, is of a wholly different scale. It is by far the largest direct foreign investment in Russia and one of the largest integrated oil and gas developments in the world.
"This is the biggest single project certainly that Shell has and, by most measures, that anybody has," says Shell's Russia country manager, Chris Finlayson.
The project is burning through $US100 ($130) a second and occupying 60 million person-hours a year. When complete, it will deliver up to 150,000 barrels of oil a day and 9.6 million tonnes of LNG a year to Asia's energy-hungry economies. Future expansion could see a doubling of that capacity. But it is the scale of the technical task that has led Shell managers to call it "the Mother of all Projects".
For Shell, the development is central to its plan to recover from a difficult couple of years. The world's third-largest energy company by market value has long lagged behind peers in the crucial business of finding and exploiting new reserves of oil and gas. That turned into a crisis in 2004, when the company was forced to admit that it had exaggerated the extent of its "proved" reserves by around 40 per cent.
The admission triggered more than $US150 million in fines by financial regulators and the departure from the company of chief executive Sir Philip Watts. The company has always argued that the reserves are still there -- that it merely overstated how close they were to being brought to market. Big projects such as Sakhalin are therefore crucial if Shell is to develop more of the resources it has in the ground.
However, Sakhalin-2 has been anything but easy, testing Shell's management abilities to the limit. The project, of which Shell owns 55 per cent, has at times appeared to be slipping out of its control. (The other shareholders in Sakhalin Energy, the company that operates the project, are Mitsui & Co and Mitsubishi Corporation of Japan.) When Shell first approved the development, the budget through to 2014 was $US10 billion. Last July, the group admitted the cost had ballooned to $US20 billion. Although the industry as a whole is suffering from cost inflation, the scale of the increase suggested that Shell had greatly underestimated the difficulties of carrying out the project in such a tough environment.
The admission hurt Shell's hard-won reputation for being able to manage large and complex projects and stalled the turnaround plan of Jeroen van der Veer, who took over from Sir Philip. It also complicated Shell's relationship with the Government in Russia -- a country it believes is key to rebuilding its energy reserves.
Shell's chief executive believes the company's future lies in multi-billion-dollar projects such as Sakhalin-2 -- which he terms "elephant projects". At the moment, Shell has three elephant projects under way. Within a decade, Mr van der Veer wants Shell to have 10 such projects on the go concurrently.
For the moment, he has had to occupy himself with limiting the fallout from the rising cost of Sakhalin-2. The Shell-led consortium is in talks with the Russian Government over the revised budget, but those are not proving easy. The higher price tag will delay the day when Moscow will start to see revenues from the project.
The events may have hurt Shell's ambitions in Russia. Since the announcement of the jump in costs, Gazprom, Russia's state-controlled gas monopoly, has denied Shell a stake in its giant Shtokman gas field in the Barents Sea, north of Europe. Russian officials have hinted that Shell's problems at Sakhalin were partly to blame.
To make matters worse, Gazprom was due to take a 25 per cent stake in Sakhalin-2 under an asset swap with Shell, announced only a fortnight before the size of the cost overrun became apparent. Gazprom is now driving a much harder bargain.
The list of obstacles faced by Shell and its partners is daunting. Sakhalin's arctic climate and remote location make it an inhospitable place to live, let alone build such an ambitious project. Winter temperatures average minus 24C and the island is located in the middle of a typhoon area.
The platforms have had to be specially designed to withstand the massive ice floes that can crumple into their sides at speeds of more than 2m a second, as well as earthquakes that frequently shake the island. Ten years ago, a quake measuring 7.5 on the Richter scale killed 2000 people in the town of Neftegorsk.
It is not the only danger. Sakhalin was long fought over by Russia and Japan and is littered with unexploded ordnance. Shell has already cleared around 900 rusting bombs from construction areas.
Sakhalin's pristine environment has meanwhile made Shell the target of campaigners around the world. An endangered population of only 100 western grey whales feed on Sakhalin's northeastern shore during the summer months. The Shell development threatens their existence, environmental groups contend.
To allay concerns, Shell re-routed the undersea pipeline from one of its platforms to avoid the feeding ground, at a cost of more than $US300 million. Shell also devised a way to install the offshore platforms more silently to avoid scaring off the whales during the feeding season, again at greater cost.
Environmental groups also fear that the construction of the twin pipelines, which cross 1000 rivers and streams, will interfere with salmon spawning and harm the island's fishing industry.
"Salmon can't spawn in a dirty river," the chairman of Sakhalin Environment Watch, Dmitry Lisitsyn, says. "We have found many, many violations (of company procedures)."
The company is drilling under rivers that are held to be particularly sensitive and has sought to allay fears about its impact on the island's fishing industry. After some inhabitants objected that a new jetty would block the progress of salmon along Aniva Bay, the company installed three tunnels at a cost of $US2 million. Subsequent monitoring has found that the salmon merely swim around the jetty.
"From an environmental point of view, it's useless," concedes Harald Hansen, the site's environmental engineer. But he says that if such measures increase the confidence of the local population, they will have been worthwhile. So far, the fish appear to have been unaffected by the construction work -- 2005 was a bumper year for salmon there.
A bigger concern is that the company does not have a plan for what to do in the event of an oil spill under ice. It says it is working hard to come up with one.
As if all of this was not difficult enough, foreign companies must contend with the difficulties of doing business in a country that retains much of its Soviet-era bureaucracy. The company has 45 people dedicated to securing permits and paperwork from up to 15 government entities. Many more people are involved in the process at any one time.
"We've got permits coming out our ears," David Greer, project manager for Sakhalin-2, says. "There is a huge machine that you have to work with."
Shell makes clear it is not complaining, however. Given the dearth of opportunities for oil companies, the group knows it must make a success of projects such as Sakhalin if it is to turn itself around.
"This is what the big oil companies have to get right, because these are the opportunities of the future," says Ian Craig, Sakhalin Energy's chief executive. "That's the competitive niche that the Shells, the Exxons and BPs have to work at. A lot of the key opportunities going forward are going to be in these sorts of environments."
Click here to return to ShellNews.net HOME PAGE