For Big Oil, a Cautionary Kazakh Tale

Exxon, Shell, Total, and others are over budget on a megaproject

After 11 years and $39 billion of investment, ExxonMobil, Royal Dutch Shell, Total, and their partners have yet to sell a drop of oil from what was once hyped as the biggest discovery in four decades. Centered on a man-made island in the northern Caspian Sea 70 kilometers (44 miles) from Kazakhstan’s coast, the Kashagan project is still 12 months from pumping its “first oil”—$15 billion over budget and eight years behind schedule.

The Kazakh government, a partner in the field, now wants the group to commit to an even bigger second phase, a project the companies are undecided on. (Big oil and gas projects are generally done in stages, since it takes decades to fully develop a large field.) “The biggest worry is whether the project can ever be profitable, given the huge cost escalation and delays,” says Julian Lee, a senior analyst for the Centre for Global Energy Studies in London. Julia Nanay, a senior director at PFC Energy, says the first phase should generate profits if current oil prices hold.

Kashagan, which may hold enough oil to supply the world for six months, is a warning to oil companies, which expect to spend $20 trillion through 2035 finding crude in ever more inaccessible places. The partners in the project, which include ConocoPhillips and ENI, underestimated the complexity of drilling in this part of the Caspian.

The 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, which manages the project. The toxic gas must be separated from the oil, adding a layer of difficulty. Gas sensors dot the island, scanning for 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 working on the biggest of the five artificial islands.

The managers of Kashagan have had to wrap the islands and the equipment in impermeable membranes to block all contamination of the Caspian, home to seals and caviar-bearing sturgeon. Barriers surround the islands to fend off ice. The water is only three to six meters deep in the area, and with its low salinity and winter temperatures below -30C (-22F), the northern Caspian is frozen for almost five months of the year. Kashagan’s problems already have forced one reorganization. In 2008, ENI handed over the job of managing the project to the newly formed NCOC, which agreed to pay higher royalties to Kazakhstan.

It will be a while before the Kazakhs see those royalties. Exxon and its partners get to keep all the revenue from Kashagan until they recover their expenses. Only later do they split the proceeds with the government of President Nursultan Nazarbayev. The country relies on oil for 18 percent of gross domestic product, and the government needs extra revenue to rebuild after a devastating bank crisis from 2007 to 2009.

The prize for the five main partners is as much as 252,000 barrels a day each, once the second phase is running. Such production is hard to find as existing fields age and governments reserve control for state companies. Yet the Western partners in NCOC hardly sound eager to jump into a second phase. “We will finish Phase One, and then we will look at Phase Two,” says Peter Voser, Shell’s chief executive officer. “It’s not immediate.” Christophe de Margerie, CEO of France’s Total, when asked about a second phase, says, “Let’s start Kashagan One.” The partners aim to agree on an expansion plan by yearend that can be sent to the government for approval, according to NCOC. “We don’t have clarity, either about the time frame and cost or the production volumes at the second stage,” says Kazakh Oil and Gas Minister Sauat Mynbayev.

Some partners may want to cut their losses. ConocoPhillips Chief Financial Officer Jeff Sheets said on an Oct. 26 conference call with analysts that Kashagan is in the “general category of looking around our portfolio in places where we have maybe not long-term strategic good opportunities.” India’s Oil & Natural Gas Corp. and GAIL India, the nation’s biggest natural gas distributor, have made a nonbinding offer for ExxonMobil’s 16.8 percent stake in Kashagan, two people with direct knowledge of the matter said in June. D.K. Sarraf, managing director of ONGC Videsh, ONGC’s overseas unit, declined to comment. Reports of a Kashagan exit are “speculation,” Charles Engelmann, an Exxon spokesman, said in a statement.

“Phase Two won’t move ahead simply. It will be later than people anticipate,” says Stuart Joyner, an oil analyst at Investec Securities in London. “Kashagan will be a

— With assistance by Brian Swint, and Tara Patel


    The bottom line: After spending $39 billion developing the Kazakh field, Western oil giants are wary about signing on for a new phase.

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