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Shell’s Sakhalin-2 gas project hit by eight-month delay and $10bn cost rise

Financial Times: Shell’s Sakhalin-2 gas project hit by eight-month delay and $10bn cost rise

Friday 15 July 2005

By Thomas Catan in London

Published: July 15 2005

Royal Dutch/Shell, the Anglo-Dutch energy giant, yesterday said its flagship Russian gas project would be delayed by at least eight months and cost $20bn (£11.4bn) – twice the original estimate.

The giant Sakhalin-2 liquefied natural gas project off the east coast of Russia has been beset by a range of problems, the company said, including the rising cost of raw materials, a shortage of contractors, Russian inflation and currency exchange rate fluctuations.

The project had already been delayed by environmental concerns, which forced the company to re-route a pipeline to avoid whale feeding grounds.

“Unfortunately, it is now clear that the Sakhalin project budget and schedule were significantly underestimated when it was approved in 2003, especially given the project’s scale, its complexity and the frontier nature of execution,” said Malcolm Brinded, executive director for Shell’s exploration and production unit.

The massive cost overrun will hurt the profitability of one of Shell’s most important new projects and could hit its overall production of oil and gas in 2008.

It also raises questions about whether the company was too optimistic in other large projects that were approved by the previous management, ousted last year after the reserves downgrade scandal.

In spite of the delay, Shell stocks rose after the group assured shareholders it still planned to pay back $13bn-$15bn this year through buybacks and dividends.

Shell has changed much of the management at Sakhalin Energy, the joint venture company carrying out the project, and is setting up a special academy to improve management of other large projects in the future.

It will also conduct a review of all big projects to see if earlier cost estimates were correct. In the light of rising costs, Shell will reconsider its capital expenditure budget for 2006 and beyond.

Sakhalin-2 is one of the great hopes for Shell as it tries to boost its flagging production of oil and gas. The company said it now expected its first delivery of LNG – supercooled natural gas that can be shipped on tankers – in summer 2008 instead of November 2007.

The delay could also hurt Asian countries that depend heavily on LNG for energy.

“Any delay to LNG start-up will worsen what we were already predicting to be an extremely tight Pacific basin market in 2008,” said Frank Harris, vice-president of global LNG at Wood Mackenzie, the oil consultants. “It’s bad news for Asian buyers that already know they will be short of volumes in 2008, particularly Korea.”

Shell owns 55 per cent of the Sakhalin-2 project, with the remainder split between Mitsui and Mitsubishi of Japan.

However, Shell announced an asset swap last week that would see Gazprom, the state-controlled Russian gas monopoly, take a 25 per cent stake in the project.

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