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THE WALL STREET JOURNAL: Shell’s Costs Soar For Russia Project

THE WALL STREET JOURNAL: Shell’s Costs Soar For Russia Project

“In a potentially big setback to its turnaround attempt, Royal Dutch/Shell Group disclosed a $10 billion cost overrun and delays at an important Russian energy project…”: “The Sakhalin delay is particularly bad news for Shell. The company last year was rocked by a scandal after it emerged that it had overstated its reserves of oil and natural gas following years of subpar performance at finding new resources”

Friday 15 July 2005

Price Tag of Sakhalin II

May Double to $20 Billion;

Half-Year Delay Expected

By BHUSHAN BAHREE and BENOÎT FAUCON

Staff Reporters of THE WALL STREET JOURNAL

July 15, 2005; Page B2

In a potentially big setback to its turnaround attempt, Royal Dutch/Shell Group disclosed a $10 billion cost overrun and delays at an important Russian energy project, becoming the latest victim of soaring development costs for the oil industry’s increasingly ambitious projects.

Shell said costs in the second phase of the massive Sakhalin II natural-gas project, which it is spearheading, may double to $20 billion, and it expects the project to be delayed by half a year.

The steep run-up in oil prices of the past two years has resulted in huge cash flows for the big oil companies, many of which have been returning funds to shareholders. The oil giants also have begun investing more in development projects, after two decades of relatively light spending. As a result, project costs are rising sharply amid a growing backlog of orders at construction and service companies and because of spiraling costs of commodities such as steel. That inflation is beginning to eat into the industry’s bonanza.

Senior officials at Shell, the world’s third-largest energy company in terms of market value, said in a conference call that some of the cost increases were specific to the Sakhalin project, arising from a clutch of issues, including environmental concerns and difficulties in laying pipelines. Other causes, they said, reflected a world-wide spiraling of commodity and project costs that has wider implications for Shell and the oil industry.

“We do not see these [cost] pressures decreasing in the near to midterm,” said Peter Voser, Shell’s chief financial officer.

Shell said that while its capital spending this year would stay at the previously announced $15 billion level, it now is reviewing all of its projects and will update investors later this year about its spending levels for 2006 and beyond.

Despite the Sakhalin cost overruns, Mr. Voser said in the conference call that the company will return $13 billion to $15 billion to shareholders this year through dividends and buybacks.

Shell declined to give any breakdown of the cost overrun at Sakhalin, which is off the coast of Sakhalin Island in the Russian Far East. Others in the industry have offered clues to the kind of cost pressures they are facing. Saudi Arabia’s oil minister, Ali Naimi, last month said costs for new projects had gone up as much as 60%.

The Sakhalin delay is particularly bad news for Shell. The company last year was rocked by a scandal after it emerged that it had overstated its reserves of oil and natural gas following years of subpar performance at finding new resources. Shell has since changed its management, scaled back its estimates of the volume of oil and gas that it owns and that it expects to produce, and embarked on a plan to revamp its key oil exploration-and-production operation.

At 4 p.m. in composite trading on the New York Stock Exchange, American depositary shares of Royal Dutch Petroleum Co., which owns a 60% interest in Shell, were down 15 cents to $64.61. Those of Shell Transport & Trading Co., which owns 40%, were down five cents to $57.60.

Yesterday, Shell said it had previously changed its management team at Sakhalin II, which this week advised the company’s leaders that earlier cost estimates — leading to approval of the project in 2003 — vastly understated the spending needed to complete the project.

Still, Malcolm Brinded, Shell’s exploration and production chief, said the project remains “worthwhile” even after the cost overruns. Shell expects to recover about 17.3 trillion cubic feet of gas and one billion barrels of oil at an estimated development cost now of $5 to $6 a barrel of oil equivalent, including the liquefied-natural-gas plant. Mr. Brinded declined to specify the break-even point of the project.

Shell is the operator of the Sakhalin II project with a 55% stake, with Mitsui & Co. and Mitsubishi Corp., both of Japan, holding 25% and 20% stakes, respectively. Last week, Shell agreed to an asset swap with Russia’s OAO Gazprom that would result in the Russian energy titan acquiring a 25% interest in the Sakhalin II project from Shell’s stake. Shell, with the remaining 30%, would continue to be the operator.

It isn’t clear how the cost overrun may affect the Gazprom deal. Costs for such projects typically are shared by partners in line with their stakes. Shell and Gazprom have yet to finalize the monetary adjustment for the swap. Shell officials said the cost-overrun information for Sakhalin was barely a day old and they had called Gazprom yesterday morning to advise the company of the changed situation.

Shell said deliveries of liquefied natural gas from the project now were set to start in the summer of 2008, instead of November 2007, as originally planned.

Write to Bhushan Bahree at [email protected]

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

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