Royal Dutch Shell Plc  .com Rotating Header Image

Shell Ties Woes Of Russia Project To Lack of Data

The Wall Street Journal: Shell Ties Woes Of Russia Project To Lack of Data

“Executives at the Royal Dutch Shell PLC-led Sakhalin II project, a Russian oil and natural-gas project that Shell said in July could cost $20 billion, or roughly €16 billion, twice as much as expected, partly attribute the overruns and delays to going ahead with insufficient information.”

Monday 12 September 2005

Sakhalin II Exemplifies
Challenges and the Costs
Facing Major Oil Firms

September 12, 2005

YUZHNO-SAKHALINSK – Executives at the Royal Dutch Shell PLC-led Sakhalin II project, a Russian oil and natural-gas project that Shell said in July could cost $20 billion, or roughly €16 billion, twice as much as expected, partly attribute the overruns and delays to going ahead with insufficient information.

In interviews, managers at the Shell-led joint venture said this meant the company didn’t properly model the geology of the area and was unprepared for the effect of ice on the pipeline and environmental concerns. Shell already said in July that overly optimistic assumptions by its managers led to the revised costs and schedule. The company also said then that industrywide cost inflation and unforeseen technical and environmental challenges had a role.

The problems exemplify the difficulty and costs that oil majors face as they try to both keep pace with the growing demand for oil and maintain their reserves. Shell promised investors in July it would review its entire capital-spending plan for 2006 and later years and has already disclosed that costs at other projects such as Nigeria’s Bonga deepwater platform have soared. Shell’s full evaluation is expected later this year.

Shell manages the Sakhalin II project, located off the coast of Sakhalin Island in the Russian Far East.

Shell has a 55% stake and operates Sakhalin Energy Investment Co. Ltd., the company that was awarded the Sakhalin II project. Mitsui & Co. and Mitsubishi Corp. both of Japan, respectively hold 25% and 20% stakes.

However, Russia’s OAO Gazprom has signed a preliminary deal to buy up to 25% of Sakhalin Energy.

The first part of the current project will produce hydrocarbons from new offshore platforms and the second is to transport oil and gas under sea and over land in two large pipelines to a liquefied natural gas, or LNG, plant and oil terminal.

Undue optimism for the startup of offshore production “was the predominant factor causing us to reset the schedule,” said Sakhalin Energy Chief Executive Ian Craig.

The executives, however, said the insufficient information on which the initial cost assessment was based in 2003 could be justified by the need to go ahead quickly with a final investment decision.

“It’s always a question [of] how far you go” in evaluations before a company gives the green light to a project, said Jaap Guyt, Sakhalin Energy’s pipelines manager.

Mr. Craig succeeded former Chief Executive Steve McVeigh in the second quarter of 2004, after the departure of Shell Chairman Philip Watt — the executive who had spearheaded the Sakhalin project. Mr. Watt’s lawyer didn’t reply to requests for comment, while Mr. McVeigh couldn’t be reached.

The joint venture had to delay the start of new-oil extraction from Piltun-Astokhskoye, one of the project’s two offshore fields, when in late 2004 it discovered flaws in its reservoir model, which describes the sort of geological structure an oil producer expects to find when it starts extracting hydrocarbons in a field.

Until late 2004, the venture used a model from U.S. independent oil company and former project operator Marathon Oil Corp., from which Shell bought a 37.5% stake in 2000, Mr. Craig said.

Sakhalin Energy “knew [it] had to incorporate the latest data. It hadn’t been done,” Mr. Craig said of the situation he found last year. Though the company knew the model would have to be reviewed, it was “not expecting the revision would be so significant,” he added.

Mr. Craig said his company also underestimated ice-related working limitations during the operational setup of the platforms.

“Speed is greatly reduced [by sea freeze in winter] … and time is cost,” he said, without detailing the overruns.

Insufficient data also led to a high-profile decision to reroute a subsea pipeline, leading to more overruns, said Mr. Guyt, Sakhalin Energy’s pipelines manager. Mr. Guyt arrived in the second quarter of 2002.

Following a late-2003 survey, Sakhalin Energy announced in April 2004 that ice was a factor deeper into the sea bed than previously expected and that, as a result, the pipeline would have to be buried more profoundly.

Mr. Guyt said Sakhalin Energy had relied on old data that underestimated the depth. The deeper burial implied the use of more powerful equipment that generated more noise, potentially a major nuisance to the rare gray whales that feed in the area, he said.

As a result, the company decided to stop work to assess the potential damage and then “decided to have three offshore seasons, instead of two” to reach a 2006 deadline, Mr. Guyt said.

Following advice by a panel selected by the Independent Union for the Conservation of Nature and Natural Resources, Sakhalin Energy also decided this March to reroute the line farther to the south to avoid the whales’ feeding ground. The pipeline is still expected to be completed on schedule, but costs have significantly increased because it mobilized vessels for one additional season to lay the pipeline, Mr. Guyt said.

By contrast, Mr. Guyt said any effects of soaring metal prices — by 20% to 50% in two years — “haven’t been a critical issue” for the pipeline because the cost of most pipes had been negotiated as early as 2003. He said the only exceptions were pipes ordered at a later stage, and only those with new specifications.

Increased concerns about environmental issues also significantly contributed to an expected delay in gas production.

Mr. Craig said “a significant factor” in the cost revison was the company’s assumption that it could start drilling for gas before doing anything else. The initial plan was to deposit wastes generated by hydrocarbons extraction at the bottom of the platform, Mr. Craig said.

But from its experiences with the Russian authorities over the past few years, Sakhalin Energy “is now uncertain whether that will be approved by the authorities,” Mr. Craig said.

As a result, the venture is considering drilling wells that will only be used for storing the pieces of rock brought to the surface during future gas extraction. Only then will it move forward with gas-producing wells.

Drilling first for nonproducing wells instead of natural gas would account for one-and-a-half to two months out of the expected half-year delay to the LNG delivery schedule. Sakhalin Energy had initially expected to load its first LNG in November 2007, but it now expects the first tankers may leave as late as summer 2008.

Write to Benoit Faucon at [email protected]

This website and sisters,,,, and, are owned by John Donovan. There is also a Wikipedia segment.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.