THE BUSINESS: Lopsided rig exposes oil’s soft underbelly

THE BUSINESS: Lopsided rig exposes oil’s soft underbelly

“Royal Dutch/Shell… revealed on Thursday that costs had doubled at its Sakhalin II gas project to $20bn “…Citigroup argues the cost increase halves the returns from the project from 22% to a lacklustre 11%. But more serious is its effect on Shell’s reputation…”:

Sunday 17 July 2005

By: Richard Orange

July 17, 2005

THE world’s international oil giants must be hoping accidents don’t come in threes: At the start of the week BP’s $1bn (£560m, E820m) Thunderhorse oil platform in the Gulf of Mexico was spotted at a terrifying 20% tilt and feared to be sinking. Royal Dutch/Shell then revealed on Thursday that costs had doubled at its Sakhalin II gas project to $20bn.

Both are flagship projects of such scale that such mishaps would seriously hurt even BP and Shell’s bulging balance sheets. Since the 1990s, oil companies have tended to concentrate their spending on fewer and bigger projects. This is partly in search for sheer economies of scale, and partly the result of pushing into Arctic and deep water territory where only giant projects make sense.

Their skill in managing massive projects is also the main advantage international oil firms have left to offer the national oil and gas companies of Russia or the Middle East.

Last week’s scares underline the risk of the approach. If BP lost Thunderhorse, its growth in oil output for next year would be slashed from 8.9% to 5.4%. If Shell’s Sakhalin project’s profitability took a major dive, it could drag on company’s financial performance for over a decade.

Thankfully, BP’s alarm was turning to relief in the run up to the weekend. Oil platforms do sink – Norwegian firm Statoil’s Sleipner platform sunk like a stone at its launching ceremony, and Brazilian oil firm Petrobras’s platforms seem to keel over with alarming frequency. But Thunderhorse now looks unlikely to be one of them.

The platform not been damaged by the Hurricane Denis, as feared. Valves in the ballast system seemed the most likely culprit, and Hurricane Emily looked set to miss it this week. If the analysis reveals design flaws, BP could still see delays, but the platform, the world’s largest, appears safe.

Shell’s problems are more serious. Citigroup argues the cost increase halves the returns from the project from 22% to a lacklustre 11%. But more serious is its effect on Shell’s reputation, just as it was recovering from 2004’s reserves downgrade. The overrun is arguably another part of the fallout from the legacy of former chairman Phil Watts.

If employees under Watts came under pressure to produce figures that meant oil and gas reserves could be booked, who’s to say they didn’t also do so to make projects fly? The rising fees demanded by construction and service companies and the soaring costs of materials are clearly part of the problem, but these pressures hang over the entire oil industry, and few others have announced 100% cost hikes.

With an extra $1bn in costs already loaded on to its much delayed Bonga oil platform, similar overruns at its Canadian oil sands projects, and Pearl GTL scheme, Shell’s reputation for executing big projects is looking shaky. And it depends of reputation to win further deals with Gazprom and Middle East countries.

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