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THE TIMES: Shell forced to admit Russian costs have doubled

THE TIMES: Shell forced to admit Russian costs have doubled

“The doubling of costs and an anticipated half-year delay to the construction schedule is a blow to Shell’s reputation as a project manager and it will lead to further embarrassment with Shell’s partners, including Gazprom, the Japanese investors Mitsui and Mitsubishi, and the Russian Government.”

Friday 15 July 2005

By Carl Mortished, International Business Editor

SHELL has been forced to admit that the cost of Sakhalin Energy, a vast liquefied natural gas project in Eastern Siberia and a pillar of the company’s future expansion, has ballooned from $10 billion to $20 billion (£11.4 billion).

The doubling of costs and an anticipated half-year delay to the construction schedule is a blow to Shell’s reputation as a project manager and it will lead to further embarrassment with Shell’s partners, including Gazprom, the Japanese investors Mitsui and Mitsubishi, and the Russian Government.

Gazprom was unaware of the full extent of the cost escalation as recently as last week when the giant Russian utility agreed to swap half of Zapolyarnoye, one of its largest gasfields, for a 25 per cent interest in Sakhalin Energy.

Hailed as Russia’s biggest foreign investment when it was launched in May 2003, Sakhalin Energy will produce gas offshore of a remote island on Russia’s Pacific coast and chill it into liquid form for export. Shell’s customers, notably Tokyo Electric and Korea Gas, may now suffer delays as the first cargoes, targeted for delivery in November 2007, are now expected in the summer of 2008.

Jeroen van der Veer, Shell’s chief executive, said yesterday that he became aware of the extent of the cost overruns only this week when a six-month review of the project was completed. A week previously the Shell chief signed a memorandum of understanding with Gazprom over the asset swap and in the presence of Alexei Miller, Gazprom’s chairman, hailed the “$10 billion Sakhalin project”.

Yesterday the Shell chief said: “Gazprom was aware last week that there were cost challenges. However, we were not aware, so we could not make Gazprom aware, that there were such significant further cost overruns. We only became aware of that yesterday.” Mr van der Veer said that he telephoned Gazprom “this morning” to inform them of the new level of costs.

Soaring commodity prices, difficulties in operating in a sub- Arctic climate and dollar weakness were blamed for the cost overruns yesterday by Malcolm Brinded, Shell’s head of exploration. He suggested that there had been a failure to recognise the full size and “scope” of the project.

He said that Sakhalin’s budget was “significantly underestimated” in May 2003 when it was sanctioned by the Shell board, then led by Sir Philip Watts, who subsequently lost his job in the reserves scandal.

Budget problems at the Sakhalin project were first disclosed when The Times reported in April last year that costs had run $2 billion over the $10 billion budget. Shell then sent internal audit teams to investigate and after tense meetings with the Japanese partners removed the project director. Last year the chairman and finance director of Sakhalin Energy were replaced and in December the company launched a root-and-branch review.

Shell is sticking to its budget of $15 billion for capital expenditure this year but Peter Voser, Shell’s finance director, said that expenditure next year was under review.

( Posted here by John Donovan of http://royaldutchshellplc.com/ )

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