ENERGY COMPASS: Sakhalin costs overshadow Shell's new start: “Gazprom has already said the new budget will affect the asset swap that it is negotiating with Shell, and analysts estimate it could cost Shell $1 billion in these discussions alone But it has broader implications for Shell, which… is developing an accident-prone reputation…”: “Costs have spiraled on the Athabasca oil sands project in Canada, on Bonga in Nigeria, and most recently on the Pearl GTL project in Qatar — priced at $5 billion at its launch last year, but now already creeping up to around $6 billion.”: “Questions have also been raised about Shell's management of investor expectations.”: Posted Monday 1 August 2005

Published by www.energyintel.com 22 July 2005

Royal Dutch Shell bosses should have been popping champagne corks this week. Instead, they're likely to have been drowning their sorrows. The company moved to a single UK stock listing on Jul. 20, ending nearly a century of corporate history and making good on promises to simplify governance structures in the wake of last year's reserves accounting scandals.

But the historic move has been overshadowed by a new upstream crisis, this time over spiraling costs at the Sakhalin-2 LNG development in Russia. Shell has said it now expects the project to cost $20 billion, up an eye-watering $10 billion from the original 2003 estimate.

Gazprom has already said the new budget will affect the asset swap that it is negotiating with Shell, and analysts estimate it could cost Shell $1 billion in these discussions alone (EC Jul.l5,p9). But it has broader implications for Shell, which despite its global leadership in LNG is developing an accident-prone reputation when it comes to project execution. Sakhalin is the latest in a series of flagship projects where it has failed to stay within budget. Costs have spiraled on the Athabasca oil sands project in Canada, on Bonga in Nigeria, and most recently on the Pearl GTL project in Qatar — priced at $5 billion at its launch last year, but now already creeping up to around $6 billion.

"This type of high-profile project disappointment can do little to help Shell's case when competing for new opportunities with host governments," investment bank Citigroup says. "Following 30% cost overruns on Bonga and a 20% increase in cost estimates for Pearl GTL, resource holding governments must be paying attention."

Questions have also been raised about Shell's management of investor expectations. It put a new team into Sakhalin last year, but until last week had offered no fresh guidance to shareholders on how costs were escalating. "It seems just absurd to me," one pension fund analyst tells Energy Compass. "The process and controls and reporting lines obviously aren't working."

Shell has acknowledged that good project management is key to winning new business, but has defended its track record. "We've executed eight LNG projects in five years on time and on budget," upstream chief Malcolm Brinded says. "That is what gets you the reputations, the access, the new business development."

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