Not Deterred By Huge Risks, Shell Opts For Megaprojects

July 2015, Vol.242, No. 7

Nick Cunningham,

U.S. shale has offered the oil industry a business model that is different from conventional drilling of the past.

High initial decline rates, especially compared to conventional wells, requires companies to continuously drill to keep up production. But with lower upfront costs and shorter ramp up times, shale drilling is arguably less risky than a multibillion-dollar megaproject that the oil majors had become accustomed to over the past decade.

And in a period in which prices are relatively weak, shale could allow exploration companies to increase drilling or throttle back depending on market conditions, providing a degree of flexibility over conventional drilling that often has longer lead times.

Many of the world’s largest oil projects have suffered from delays and inflated costs. These megaprojects have also increased the financial burden on companies just as prices have swung to their lowest levels in years. In a July 3 article, for example, the New York Times described the massively expensive Gorgon LNG export facility in Australia run by Chevron. The $37 billion project has seen costs swell to over $54 billion as delays and extraordinarily complex logistics lay waste to budget forecasts.

“This is probably the last of the megaprojects for the oil companies for a while,” an analyst with Edward Jones told the NYT.

It is curious then that Royal Dutch Shell is not ready to give up on the huge complex oil project. It is only a few weeks away from starting to drill in the Chukchi Sea, a campaign that has cost the company somewhere in the neighborhood of $7 billion so far, with very little results to show for its troubles. Shell is committing another $1 billion this year, and it appears that it will only be able to drill one well.

Arctic Alaska may hold a lot of oil and gas – estimated to be around 30 Bbbls of oil and 221 Tcf of natural gas – but it presents challenges and risks. The closest deepwater port is a 1,000 miles away in Southern Alaska. The Arctic has sea ice, harsh weather, and a dearth of onshore infrastructure. There is a reason that nearly every other company has spurned the Arctic, concluding that the risks are not worth the potential rewards.

But Shell is not stopping there. The Anglo-Dutch company just approved the construction of its eighth offshore drilling platform in the Gulf of Mexico, which will also be the largest to date. Shell is targeting 650 MMbbls of oil in the Gulf, located about 80 miles from the Louisiana shore. The platform will eventually produce 175,000 barrels per day from the Appomattox and Vicksburg fields.

The project will be complex. It will consist of a four-column-platform and a subsea production system – equipment on the seafloor to pump oil. It will have 15 producing wells and five water injection wells to keep up pressure.

Shell has quite a bit of experience in the Gulf. It is already producing around 225,000 bbls of oil equivalent from the Gulf of Mexico. Shell says it has found costs savings in the Appomattox, reducing the total project cost by about 20%. It estimates the project will break even if oil prices stay above $55 per barrel.

Offshore fields tend to have stable production for years. With oil infrastructure onshore in Louisiana and Texas, and without sea ice to contend with, the Gulf may not actually be as risky as it might seem.

But risks abound. Oil prices are fickle. Any delays or cost overruns will alter that forecast. Drilling at such extraordinary depths are technically challenging to say the least. With so much on the line, any mishap can present significant threats to the company – just ask BP. Even more troubling for the company that hopes to produce for the next four decades from the Appomattox is the possibility that the United States and the world slap on carbon restrictions to fight climate change. That would leave Shell with yet another massive stranded asset on its hands.

Many of the largest oil companies are retrenching after an era of overspending and failing to deliver. With fewer risks, shale was thought to offer the way forward. But Shell is sticking with its strategy to going big, despite the enormous risk.

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