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Royal Dutch/Shell Group has been hit again by the “Watts effect”

THE WALL STREET JOURNAL: Shell: Royal Dutch/Shell Group has been hit again by the “Watts effect”

Monday 18 July 2005

Edited by Hugo Dixon

July 18, 2005

Royal Dutch/Shell Group has been hit again by the “Watts effect.” The oil giant certainly looked on the bright side under its former chief executive, Sir Philip Watts. It didn’t just over-egg reserves; it also under-egged the costs of developing the giant Sakhalin gas project in Russia. Shell reckons it will now cost $20 billion, or about €16.5 billion, to develop the field. That is twice the amount when the project was approved two years ago. Citigroup estimates that the rate of return on the field will now drop to 11% — below Shell’s hurdle rate. (See related article – Read the article)

This does little to improve Shell’s image with investors. Oil-development costs are rising everywhere, but not by this much. It will also annoy the Russian government — and President Vladimir Putin has taken a pretty severe view lately of oil men who don’t get their sums right. The less profitable the field is, the less money Russia will get under Sakhalin’s production-sharing contract. Worse, state-controlled Gazprom has also just agreed to take a 25% stake in the field, shortly after the state upped its stake in the gas giant to 51%.

So has Shell managed to stiff the Russian state? It might look that way, but no. In return for the stake in Sakhalin, Shell is taking a stake in a Gazprom field, with any valuation difference covered by a balancing payment. Shell will pay in the end.

—- Jonathan Ford, Christopher Hughes and John Paul Rathbone

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