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Financial Times: Energy groups are battered but not beaten

By Ed Crooks and Isabel Gorst
Published: January 15 2008 02:00 | Last updated: January 15 2008 02:00

Financially, the deal to resolve the dispute over the giant Kashagan oilfield could have been worse for the companies involved. The most serious damage has been done to corporate reputations.

The deal struck late on Sunday was, in its principal features, the same one that the oil companies working on the project, with the exception of ExxonMobil, signed up to in London before Christmas.

There was disagreement yesterday over the exact terms. Kazakhstan said its compensation payments for the delays and cost overruns at the project were worth $5bn, while the consortium had suggested a figure of $2.5bn to $4.5bn.

Analysts at JPMorgan estimated, on the basis of the figures from the consortium on Sunday night that the cost to the companies that are most exposed, Eni, the project operator, Exxon, Royal Dutch Shell and Total, was about $1.3bn each. That includes the cost of selling part of their stakes to KazMunaigas, Kazakhstan’s national oil company, at less than fair value, which could amount to roughly $2bn between them.

As the cost of reviving a project estimated to have a net present value of about $60bn, however, it seems a price worth paying.

The cost in terms of reputational damage will be harder to swallow.

Exxon held out against a deal last year because it was not happy with the price it was being offered for the stake in the project it was selling. Its stance seemed consistent with its typically tough line in negotiations with governments worldwide, based on a determination to honour contracts and demand that its partners do the same.

Now it has fallen into line, with Kazakhstan saying yesterday that Exxon had been offered no additional compensation to persuade it to sign. For Eni, the deal signals the end for its time at the head of the world’s most expensive engineering project.

Eni’s success in winning leadership of Kashagan in 2001 was a tremendous coup for the company, and for Italy. It had never before led such a prestigious project. But as the difficulties of the project became apparent, costs mounted and the schedule slipped.

Eni made one massively costly mistake in planning to site workers’ accommodation on artificial islands too close to the plant that will extract toxic hydrogen sulphide from the oil.

For the subsequent phases of the project, after the first “experimental” phase that will end with first oil, now expected by the end of 2011, a new joint venture company run by the four leading western partners will be in charge.

Many of the details of the new arrangement are not yet clear. The new operating company is likely to be equally shared between Eni, Exxon, Total and Shell, but it is possible that responsibility for different aspects of the project could be handled by different companies.

It is unusual for oil companies to share leadership, and unless carefully managed risks creating inefficiency and disharmony among the partners.

Kaan Nazli, an emerging markets analyst at Medley Global Advisors, warned that allowing multiple companies to operate Kashagan risked adding to the bureaucracy of managing the project.

Kazakhstan has not singled Eni out for criticism, but preferred the new joint leadership to leaving Eni in sole charge of the later phases.

Neil McMahon of Sanford Bernstein described the move as “a loss of face in the industry” for Eni.

In Italy, rumours have been circulating about the future of Paolo Scaroni, Eni’s chief executive, who is up for reappointment this year.

The Italian government, which owns about 30 per cent of Eni, must nominate him before he is put in front of shareholders for their approval, and the damage done to national pride may cost him political support.

In its vast scale and ferocious complexity, Kashagan would have taxed any single company. The new structure is a recognition that on such a challenging project, the combined capabilities of four of the world’s seven biggest international oil companies are needed.

The deal concluded at the weekend represents the final acceptance that in trying to take the lead on the Kashagan, Eni bit off more than it could chew.

Copyright The Financial Times Limited 2008

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