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Aggressive bidding after reserves scandal put Shell on path to Arctic disappointment

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$7 billion bust in the Arctic Ocean

Screen Shot 2015-10-05 at 14.03.31By Jennifer A. Dlouhy: 5 Oct 2015

WASHINGTON — Shell’s dreams of an Arctic oil bonanza were dashed with disappointing results from a critical exploratory well this summer, but they were in full force seven years ago, when the company aggressively outbid competitors to nab drilling rights in the Chukchi Sea.

Reeling from a scandal involving overstated reserves and desperate to replenish its portfolio, Royal Dutch Shell spent $2.1 billion buying up those Chukchi Sea leases, vastly outspending the competitors who plunked down just $800 million combined in the same government auction.

Shell’s outsize bidding posture put the company on a trajectory that ended with its $7 billion bust in the Arctic Ocean.

Related: Arctic oil well comes up dry

“Having spent billions when other companies spent millions, Shell seemed determined to proceed whatever the cost or obstacle,” said Michael LeVine, Pacific senior counsel for the conservation group Oceana.

Royal Dutch Shell said it would abandon Arctic drilling “for the foreseeable future” this week after disappointing results at a critical test well in the Chukchi Sea. It was the only well Shell was able to finish drilling during a seven-year pursuit that cost the company some $7 billion. Instead, legal challenges, regulatory obstacles and damage to a Shell-contracted drilling rig thwarted the company’s bid to sink more wells in the Chukchi and Beaufort seas.

In 2012, the effort was marred when a drillship briefly drifted out of control in Dutch Harbor, Alaska, and when the Kulluk drilling unit careened into an Alaska island during a botched tow to Seattle.

All oil companies are under relentless pressure to replace reserves at  affordable costs. But the pressure may have been more intense for Shell as the company headed into the 2008 Chukchi Sea auction.

At the time, Royal Dutch Shell was still trying to recover from an embarrassing admission that it had vastly exaggerated the size of its reserves. Shell first acknowledged it had overstated global proven reserves in 2004, but it made several additional cuts to the reserve number over the next year. Ultimately, In March 2005, Shell did a final revision to its 2002 proven oil and gas reserves, saying they were just 13.72 billion barrels — some 5.6 billion barrels less than what the company had originally claimed.

The overstatement prompted investor lawsuits, fines and the departure of three top executives. It also left the company scrambling to find new oil and gas assets around the country.

Enter the U.S. Arctic. Although Shell did not participate in a government sale of Beaufort Sea drilling rights in 2003 — before the reserve scandal — it was a big bidder when Beaufort leases were auctioned again in 2005.

Related: Shell’s Arctic miss is just the oil industry’s latest dry hole

Shell spent $44 million acquiring 180,000 acres in the Beaufort Sea that year, eclipsing the next highest bidder, ConocoPhillips, which spent just over $1 million acquiring 26,000 acres.

“Though no public statement linking the events is apparent, the timing makes it appear that this heavy investment was at least in part a response to Shell’s reserves scandal,” said Oceana in a 36-page report that examines some of the financial costs and risks of the company’s long Arctic pursuit.

Shell officials have said there was no link between the reserves scandal and the company’s Arctic position.

But one thing is certain: Shell made a much bigger push for Arctic acreage than its oil industry competitors.

That was illustrated in Shell’s 2008 bidding on the Chukchi Sea leases. While Shell offered one sealed $34 million bid for a single lease block. its only competitor, ConocoPhillips, offered $60,000 for the same tract.

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