Mark Lewis, Kepler Cheuvreux, e-newsflash reproduced with permission (no url): “It has been reported by Quartz overnight that the super-giant Kashagan oilfield in the northern Caspian sea “will be out of production for at least two years”. The shutdown has been necessitated by leaks of toxic gas from a pipeline, with Quartz reporting that two new pipelines will now be required to replace the two existing oil and gas pipelines.”
“As reported in the FT last month, the Kashagan field had already been beset by problems over many years, with production only beginning on 11 September last year, nearly a decade behind schedule. So far it has only produced at a rate of about 75,000 barrels a day for only one month, as it was shut in again in October shortly after beginning to produce when the problem of toxic-gas leaks first became apparent. The FT’s report had already stated that it was uncertain when the field would restart, and the WSJ indicated last week that it might be out over the whole of this summer, but the Quartz report is the first time it has been stated that the field could be out “through at least 2016 and possibly 2017”.
Kashagan is symptomatic of rising capex for diminishing returns: The Kashagan field is estimated to contain 13bn barrels of recoverable oil — for context, annual global oil demand is c.30bn barrels of oil — and as such is one of the largest discoveries in the last 30 years. But so far it has cost the consortium behind it $50bn just to develop the first phase of the project, and the Quartz report states that the new pipelines could cost 10-15 times what ordinary pipelines cost owing to the need to use a specialized nickel-based alloy that can resist the poisonous and corrosive hydrogen-sulfide gas (H2S) that is the cause of the leaks. According to the FT report, the Kashagan field had meant to be producing 370,000 barrels a day by the start of 2015, before rising to 1mbd by the end of the decade. That it will not now produce any oil at all before 2016 (and possibly 2017) will therefore be a shock to the market’s supply expectations over the next couple of years, and a further blow to the financial expectations of the western majors involved in this project (Eni, Shell, ExxonMobil, and Total).
… and hence of asset-stranding risk: Even before this latest setback report by Quartz, an article in Forbes last week rasied the question as to whether or not the companies in the Kashagan consortium would be willing to make the further capital outlays necessary to boost production to the 1.5 million barrels a day ultimately envisaged by the end of phase three of the project: “The $50 billion spent on Kashagan so far is only for the first 400,000 bpd phase. At that rate (and at a price of $100 per barrel) it would take more than 5 years for the partners just to pay for construction, let alone generate royalties for Kazakhstan or a return on investment. Will the partners have the stomach to boost output to 1.5 million bpd?”. The answer to that question almost certainly depends on how oil prices develop in the next couple of years, as the recent announcements by the majors to cut back on capex indicate that current prices are not high enough for them to earn sufficient returns even across their entire portfolios, never mind on specific projects that are highly capital intensive and have been subject to significant and recurring delays.
Capex cutbacks signal insufficient returns at current record-high oil prices: Over the last two months, most of the world’s major international oil companies have announced cutbacks to their capex plans as costs have begun to outstrip prices. This is despite the fact that oil prices have been stable at record-high real levels for the last three years. This indicates to us that the upstream oil industry is struggling to make the returns that shareholders require for the kind of upstream risks that are now being taken – of which Kashagan is a very good example – and that the risk of under-performing and/or stranded assets is not limited to an environment of falling oil demand and falling oil prices. We will have more to say on this point in a forthcoming report.”
Future Today
