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The Daily Reckoning: Oil: Exploration desperation

Wed 26 Jul, 2006

…Sakhalin’s booming…In 2005, the island beat Moscow as the largest recipient of foreign direct investment in Russia. It owes much to 1996 when two oil and gas production consortium deals were signed. Sakhalin-I and Sakhalin-II. An estimated total spend of $21bn for a huge prize of 14bn barrels of oil and 96tn cubic feet of gas…
 
Jim Rogers expects $100 oil…possibly this year.

But that’s old news to Goldman Sachs who’s “super spike” reported back in March 2005 a possible $105 oil. Plenty of traders agree with them. Oil is up over $75 today. Others disagree…

Unless we get disruption says one. “You’d probably need to lose Iran” says Merrill Lynch’s head of commodity research, Francisco Blanch.  Another at Citibank cites the over-the-top bullish sentiment as a clear sign of a price top.

As the forecasters argue the toss, one oil major gives a glimpse of the extreme efforts being made today to increase production.

Oil exploration desperation: Sakhalin Island

Sakhalin Island is a long slim strip of land lying off the east coast of mother Russia. Two thirds is mountainous, the north a swampy plain. The freezing Sea of Okhotsk to the east keeps it cold and blanketed in cloud most of the year. Temperatures can drop to -45 0c in winter.

It’s a place few people would choose to live. Most didn’t. Many of the ancestor’s of today’s inhabitants didn’t have a choice. They were dragged there: Stalin sent 32,000 Russians, two-thirds of those to the gulags. Koreans, the second largest ethnic minority, were shipped in by the Japanese in World War II as forced labour for the coal mines.

Into this tough and inhospitable part of the world what do they find?

Oil.

And Sakhalin’s booming…

In 2005, the island beat Moscow as the largest recipient of foreign direct investment in Russia. It owes much to 1996 when two oil and gas production consortium deals were signed. Sakhalin-I and Sakhalin-II. An estimated total spend of $21bn for a huge prize of 14bn barrels of oil and 96tn cubic feet of gas.

Oil exploration desperation: Oil to the Russian mainland

Sakhalin-I is led by Exxonmobil together with Russian, Japanese and Indian partners. It exploits three fields off the north-east coast of the island. It then pipes it west via a 136- mile pipeline across the Tatar strait to the Russian mainland.

Sakhalin-II is led by Shell with minority Japanese interests to exploit two fields off the east coast. Russia’s Gazprom has recently acquired a stake in the project too. The prize may be large but the obstacles are formidable and costs at $20bn have almost hit the original estimate for both projects combined.

Amongst the challenges in Shell’s quest for black gold to prop up their dwindling reserves…

Offshore oil platforms need special construction standards equivalent to California skyscrapers to withstand an earthquake.

Environmental issues. The route of its offshore pipeline has had to be changes to avoid disturbing a feeding ground for western gray whales. Concerns have also been raised at the threat to salmon spawning grounds. Fishing accounts for about a third of Sakhalin’s native economy. Furthermore, failure to meet environmental concerns could threaten $200m funding from the European Bank of Reconstruction and Development is studying and have a negative influence on other banks.
Oil exploration desperation: Profit-sharing deal

Then, as the oil price soars, the Russian government wants more of the pie. The original profit-sharing deal was signed in 1994 when the oil price was low.

“There is an element of nationalization in this industry…If the reward to the company gets too high, the government comes along, changes the rules, and takes     some of it away.” Roger Nightingale, a strtegist at Millenium Global Partners tells Bloomberg.

Part of the deal requires a 497-mile pipeline to be built from the north-east to a terminal in the south where it can be exported. Shifting pack ice for half the year around the platforms themselves make local conditions too hazardous and restrictive for ships.

One engineer on the project tells Bloomberg:

“We’ve got rivers, railways, mountains, swamps, seismic faults, everything…The hardest time is the end and beginning of winter because of the rain and the mud.”
   
Steel and labour costs have gone up and so has the ruble. Plus most contractors are Russian and unfamiliar with laying pipelines in the conditions or to the standards required.

Current Shell chairman Jeroen van der Veer expects the “unconventional” projects in Sakhalin II, Nigeria, the Gulf of Mexico and Canadian tar sands to provide a quarter of current output in the next decade.

So take your pick. Some godforsaken Russian backwater on a fault-line, a rebel-torn African republic or a hurricane target waiting to happen.

Room for disruption..?

Regards,

Rob Mackrill
for The Daily Reckoning 

http://www.dailyreckoning.co.uk/article/260720062.html

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