By Nariman Gizitdinov – Nov 16, 2011 8:01 PM GMT
After 11 years and $39 billion of investment, Exxon Mobil Corp., Royal Dutch Shell Plc (RDSA) and their partners have yet to sell a drop of oil from what was touted as the worlds biggest discovery in four decades.
Centered on a man-made island 70 kilometers (44 miles) from Kazakhstans coast, the Kashagan project is just months away from completion, $15 billion over budget and 8 years behind schedule. As the milestone of first oil nears, the Kazakh government is pressuring the group for a commitment on an even- bigger second phase, a project the oil companies are undecided on and one analyst says may not make money.
The biggest worry is whether the project can ever be profitable given the huge cost escalation and start-up delays, said Julian Lee, a senior analyst for the Centre for Global Energy Studies in London. It may be impossible for investors to earn a return on any investment in a second phase before their contract for the field expires in 2041.
Kashagan, which may hold enough oil to supply the world for six months, has become a cautionary tale for oil companies worldwide as they spend an estimated $20 trillion through 2035 finding supplies in ever more difficult places. Expenses mounted as engineers underestimated the complexity of drilling under a region of the Caspian Sea thats frozen almost half the year. The government accused the partners, which are allowed to recoup spending before sharing the oil, of inflating costs.
Colossal Work
Nursultan Nazarbayev, Kazakhstans leader-for-life, toured Kashagan in September and declared it a colossal work defining his 20-year rule since the Soviet Unions collapse, which included building a new capital city in the middle of the countrys steppe. When the oil project starts production it will be a milestone for the Central Asian republic of 16.5 million thats four times the size of Texas.
The project is vital to Nazarbayev because the country relies on oil for 18 percent of gross domestic product and is rebuilding the economy after a devastating banking crisis. Kazakhstans national oil company believes expansion can be achieved by 2017. The partners in the project arent so ready to rush in.
We will finish phase one and then we will look at phase two afterwards, Peter Voser, chief executive officer of The Hague-based Shell, said in an interview at the Group of 20 Summit in Cannes, France. Its not immediate.
Christophe de Margerie, CEO of Frances Total SA (FP), echoed his sentiments, saying lets start Kashagan one when asked about prospects for the second phase.
Lethal Concentration
Kashagan has proved potentially lethal as well as complicated. The crude oil, locked 4,200 meters (2.6 miles) below the seabed in a highly pressurized reservoir, has a high concentration of poisonous sour gas, according to North Caspian Operating Co., or NCOC, the venture formed to manage the project.
Gas sensors dot the island, scanning for any leaks of the vapor, which has a 15 percent concentration of flammable hydrogen sulfide. Weekly emergency drills are carried out with the 5,500 people living and working on the biggest of five islands.
The projects structures are wrapped in impermeable membranes to keep contamination from the Caspian, home to seals and caviar-bearing sturgeon, and surrounded by barriers to fend off ice. The water at the site is only 3 to 6 meters deep and with low salinity and winter temperatures below minus 30 degrees Celsius (minus 22 Fahrenheit), the northern Caspian Sea freezes for almost five months of the year.
The geology, islands and ice and have inflated costs for the first phase to $39 billion from $24 billion estimated by the government in 2008.
Main Partners
The prize for the five main partners is as much as 252,000 barrels of crude a day each from peak output once the second phase is running. That kind of production is growing harder to find worldwide as existing fields age and governments in the Middle East, Russia and Latin America reserve control for state companies.
Exxon, Shell, Total, Rome-based Eni SpA (ENI) and KazMunaiGaz National Co., the state oil company, hold 16.8 percent of NCOC each. Houston-based ConocoPhillips has 8.4 percent and Japans Inpex Corp. (1605) 7.6 percent. The partners aim to find a preferred expansion plan by the end of this year that can be sent to the government for approval, according to NCOC.
We dont have clarity either about the time-frame and cost or about the planned production volumes at the second stage, Kazakh Oil and Gas Minister Sauat Mynbayev said last month.
One option is building more islands, similar to the existing 1.9 square-kilometer (0.7 square mile) manned collection hub and four surrounding structures, NCOC said. The cluster was built from 7 million metric tons of rock carried 300 kilometers from an ice-free port to the south.
Makes Sense
Expanding Kashagan makes more sense economically than halting at the first phase, KazMunaiGazs former Chief Executive Officer Kairgeldy Kabyldin said on Oct. 4, before he stepped down from the post. Still, there are signs that some partners may be willing to cut their losses.
ConocoPhillips (COP) Chief Financial Officer Jeff Sheets said on an Oct. 26 conference call that Kashagan is in the general category of looking around our portfolio in places where we have maybe not long-term strategic good opportunities.
Oil & Natural Gas Corp., Indias largest energy explorer, and GAIL India Ltd., the nations biggest natural-gas distributor, have made a non-binding offer for Exxon Mobils 16.8 percent stake in Kashagan, two people with direct knowledge of the matter said in June.
The stake may cost $6 billion, the Financial Chronicle said Oct. 17, citing an unidentified official involved in talks. D.K. Sarraf, managing director of ONGC Videsh Ltd., ONGCs overseas unit, declined to comment on Kashagan.
Exxon Speculation
Exxon plans to remain a major investor in Kazakhstan and reports of a Kashagan exit are speculation, Charlie Engelmann, a Houston-based spokesman for the Irving, Texas-based company said in a statement.
There are no talks about any partners leaving the project, Andrey Sukhov, Shells regional head of taxation in Russia and the Caspian region, said Oct. 21.
Kashagans delays already forced one reorganization of the project. In 2008, Rome-based Eni gave up operatorship of the project to the newly formed NCOC, which agreed to pay higher royalties to Kazakhstan.
After many difficulties and setbacks, and in the face of ballooning costs and much acrimony and debate, the companies had to start over and reallocate roles, oil industry historian Daniel Yergin said in his book The Quest, published in September. All of this has infuriated the Kazakh government, which is having to wait years longer that anticipated for Kashagan revenues to flow.
Double Production
Kashagan may initially produce 370,000 barrels a day, which will rise to 450,000 barrels a day by 2016, Kazakhstans Mynbayev said Oct. 4. The expansion would more than triple that to 1.5 million barrels a day, according to President Nazarbayev. Thats almost double Kazakhstans current production of about 1.6 million barrels a day, about the same as Libya produced before the revolt against Muammar Qaddafi.
Completing the expansion as early as 2017 is only possible if the partners choose a plan by early next year, KazMunaiGaz National CEO Bolat Akchulakov said in an interview in Astana, the capital, on Oct. 25.
Phase two wont move ahead simply, it will be later than people anticipate, said Stuart Joyner, an oil industry analyst at Investec Securities Ltd. in London. Kashagan will be a million-barrel-a-day field, but from a value perspective its been disappointing.
To contact the reporter on this story: Nariman Gizitdinov in Almaty at [email protected]
To contact the editor responsible for this story: Will Kennedy at [email protected]
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