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Alaska Journal of Commerce: BP takes on the challenge of Russia’s Far East

Web posted Sunday, October 22, 2006

By Tim Bradner
Alaska Journal of Commerce 
 
YUZHNO, Russia – The multibillion-dollar Shell and Exxon Mobil oil and gas projects off Sakhalin Island, in Russia’s Far East, could be just the start of major oil discoveries in the region.

Oil discoveries are being made by BP and its Russian partner, Rosneft, in deeper waters is the Sea of Okhotsk, north of Sakhalin, although it isn’t yet known if the discoveries can be developed commercially. Rosneft is also in the early stages of exploration in another area further north, just offshore the Kamchatka Peninsula.

In terms of oil production, the region could easily become another North Sea or Gulf of Mexico, the companies say. Two exploration wells drilled in 2004 and 2005 by Rosneft and BP through their joint-venture company, Elvary, have scored discoveries, according to Doug Suttles, president of BP Sakhalin. Two more wells were drilled in the 2006 season, and the results of those are now being evaluated, he said.

One of the Rosneft-BP test wells flowed at 20,000 barrels per day in production tests, according to one industry source.      
 
All four wells are in the Kaigansky-Vasuykansky area, one of the prospects in the Sakhalin 4 and 5 license areas north of the Sakhalin.

Suttles said it is significant that the joint-venture was able to complete two exploration wells in the 2006 summer drilling season. Multiple wells in one season signals increasing efficiency with the offshore drilling program, which is complex and difficult, Suttles said.

Seasonal mobilization costs for the exploration program typically run $50 million to $70 million, and, in 2006, the partners will have spent $250 million to $275 million. With costs like these, it is important to drill as many wells as possible in a single season. Suttles expects the learning curve to continue, so that three wells in a season will be achieved.

All the current wells are drilled in a prospective area 20 miles wide, but Suttles said Rosneft and BP should be able to test most prospective areas in the license block in the next two years. The area covered by the licenses is huge, approximately 100 miles by 150 miles, he said.

It is also too early to determine if commercial production can be established. Discoveries of 500 million to 1 billion barrels of recoverable oil will probably be needed to justify development, Suttles said. A decade or more of exploration and development work may be needed to get production underway, based on BP’s experience in other frontier offshore areas. This would put the first production somewhere between 2015 or 2020, Suttles said.

BP and Rosneft are bullish enough, however, that Elvary has initiated some pre-development studies, including ice and sea-state, seabed conditions and coastal areas, Suttles said.

The Sakhalin 4 and 5 license blocks are north of the island and are more exposed to heavy winter ice and storms coming out of the Sea of Okhost, in contrast to Shell and Exxon Mobil’s areas, which are in shallow waters nearer to shore.

Elvary’s current exploration drilling is about 25 miles offshore in water depths of 100 meters, but depths go to 200 meters in parts of the license area.

Suttles said the region is on the same latitude as London, but the climate conditions and logistics issues are similar to Arctic drilling in the Alaskan Beaufort Sea, where BP has experience.

The drilling season is from July to October. Sea conditions are often favorable during those months, but fog is often a problem, he said.

Winter is another story, however. The sea is ice-bound in winter, and ice thickness can reach 1 meter. There are strong storm waves and currents, as well.

Logistics support is complex, Suttles said. The primary support comes from Singapore, 4,000 miles away. On the local level, the project is being supported by sea from Moscalvo, a small port on the north of Sakhalin, and by air from Oha, another small community where there is an airport.

Elvary is beginning to consider development scenarios, Suttles said, and what seems more feasible at this point is an offshore tanker loading facility similar to those used in the North Sea and offshore Angola. But this will have to be built to withstand severe winter ice conditions in the region, he said.

A tough, but attractive, project

Despite its challenges, Suttles said this is the kind of project to which BP is attracted. “We tend to be in big projects with a big share. These are the kind of ventures where we can best use our skills,” he said. “We feel we have to do this with a Russian partner, though.”

The BP and Rosneft venture is structured differently than that of the Shell and Exxon Mobil deals, Suttles said. Not only does Rosneft own 51 percent of Elvary Neftegaz, the partners’ joint-venture company, but Rosneft and BP have elected to do their deal under Russia’s general royalty and tax laws, rather than seek a production sharing agreements.

PSAs negotiated by the Shell and Exxon Mobil groups have become controversial for the Sakhalin projects led by the other companies.

It is a model that has worked elsewhere in Russia for BP, Suttles said. The company’s partnership with TNK, for example, now produces about 1.5 million barrels per day.

The company hopes its partnership with Rosneft will shield it from the political troubles now being experienced by two large Sakhalin oil and gas projects being developed by consortiums led by Shell and Exxon Mobil, which do not have major Russian participation.

On an operational basis, however, Suttles said BP and Rosneft both bring a lot of experience and track-record to the partnership. “We are merging our offshore know-how with Rosneft’s Russian operating experience,” Suttles said. BP has extensive offshore experience in the North Sea, the U.S. Gulf of Mexico and offshore Angola. Rosneft brings decades of experience with production in Sakhalin’s onshore producing fields as well as experience in doing business in Russia, Suttles said.

The companies are also participating with Shell and Exxon Mobil in studies of threatened wildlife species, such as western gray whales. Gray whales in the area have become a major concern for international wildlife groups, which are lobbying international banking groups involved in financing Shell’s Sakhalin project.

With the whales, BP hopes to build on its experience in the Alaskan Beaufort Sea, where the company has developed successful mitigation strategies to offset the effects of its Northstar offshore field on migrating bowhead whales, according to Ray Jakubczak, general director of BP’s Sakhalin operations.

Jakubczak, who was transferred to Sakhalin from Alaska, was in charge of BP’s whale research programs in the state, along with other duties.

Suttles said it is also important for the companies to get the right relationships established with Russian local governments and communities, and with influential non-governmental organizations, before major investments are made.

Exploration is the first stage, followed by preparations for development, including the gathering of environmental and technical information. “It’s important to get these things right at the front-end, because if you get too far into projects without having established the right alignments, you can get trapped.”

BP and Rosneft also have to make sure their joint-venture company works as expected. Elvary was formed by 2003, but it is still a start-up organization that has people from BP and Rosneft working together, Suttles said.

Despite the challenges, Rosneft and BP are extremely bullish on the Sakhalin region. “If it’s big, and it’s good, it will happen,” Suttles said.

Tim Bradner can be reached at [email protected].

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