Crippled Kashagan oil project a bureaucratic 'nightmare'

Reuters

By Andrew Callus and Stephen Jewkes

LONDON/MILAN (Reuters) - Giant Kazakh oilfield Kashagan, which was brought to a halt by leaks shortly after start-up last year, is grappling with a bureaucratic "nightmare" on top of its engineering troubles as it strives for commercial production in 2014.

The scale and complexity of the world's most expensive standalone oil project led its seven partners away from the traditional single operator command-and-control model, where one of the larger companies takes charge while the others provide support and share the risks, costs and rewards.

The consortium, which includes ExxonMobil (NYS:XOM), Royal Dutch Shell (LSE:RDSA), Total (PAR:FP) and Kazakh state oil firm KazMunaiGas(KMG) (RDGZ.KZ), first put one of the smaller partners - Italy's Eni (MIL:ENI) - in charge of construction and delivery in 2001/02. They retreated from that decision in 2008/09 after years of delays and cost escalation, opting instead for collective responsibility.

This has created problems along the way, and is an extra headache for engineers and managers as they battle to find out why a pipeline started to leak last year, just weeks after oil flowed for the first time, and to fix the problem so that oil can flow out and revenue in.

"It's a bit of a nightmare to be honest," said one industry source with knowledge of the project. "The consortium is the operator until first commercial production, so it's all a bit 'by committee' until then."

The Caspian Sea project aims to exploit the biggest oil discovery in decades, producing a peak of 1.66 million barrels a day - as much oil as OPEC member Angola, from a reserve almost as big as Brazil's. Much of it is built on artificial islands to avoid damage from pack ice in a shallow sea that freezes for five months a year in temperatures that drop below minus 30 degrees Celsius (-22F).

The field extends over 3,375 square kilometres (1,303 sq miles), and the whole onshore and offshore site is bigger still. The oil is 4,200 metres (4,590 yards) below the seabed, at very high pressure, and the associated gas reaching the surface is mixed with some of the highest concentrations of toxic, metal-eating hydrogen sulphide (H2S) ever encountered.

Kashagan has cost an estimated $50 billion so far, five times early projections, and its 13-year life is a tale mostly of delay.

In September and October 2013, pipeline leaks that investigators think were caused by H2S-linked stress cracks led to shutdown.

Commercial production could be many months away as a result, and the engineering difficulties have exposed the shortcomings of the unwieldy administrative structure, which will stay in place until the oil is flowing properly.

Agip, Eni's engineering arm, was initially the operator and is still nominally in charge of the construction and delivery phase, much of it conducted by Eni unit Saipem (MIL:SPM).

But the operatorship changed in 2009 when a new entity, representing all the partners and called the North Caspian Operating Company (NCOC), took over.

"It gives you a headache just thinking about it," said a second source.

"There used to be a normal operatorship set-up. Now it's just one committee after another. Each company has its own internal auditing, permitting procedures, personnel management, communication, etc. Every single step has to be seen by everyone else. It's as if there was no CEO but the board met every day."

It won't get any simpler when the oil starts flowing.

Shell will then take over management of production operations along with KMG, the NCOC website says.

Shell will also take on planning, development and construction of phase 2 of the project's offshore facilities, which is designed to bring it up to full production, but Agip will do the onshore work, and ExxonMobil will do the phase 2 development drilling.

Meanwhile, Total, the fourth international oil company (IOC) in the consortium, is conducting the leaks investigation, including use of a "pigging" pipeline investigation robot.

The companies involved in the project have also changed over the years. BP (BP.L), BG Group (BG.L) and ConocoPhillips (COP.N) have all sold out.

Sources among the bolters say picking Eni as operator - much less experienced in giant projects than some of its partners - was the result of unwillingness among the bigger players to see one of their near rivals operate such a prestigious scheme.

They say that lack of experience might have contributed to Kashagan's problems and to the change of approach in 2009. Eni declined to comment on that suggestion, but a spokesman said the company "was awarded operatorship of the project as the outcome of a selection process within the venture group".

PIPE QUALITY

For now, all eyes are on the investigation.

According to a statement by NCOC in December, tests carried out on parts of the pipe by TWI Laboratories in Cambridge, England, found the cracks were caused by a reaction between water and H2S, which is known in the industry as sour gas.

Why this reaction caused the pipe to crack remains unclear, and one expert said the search for the reason - and a solution - was like "finding a needle in a haystack".

The leaks, in the onshore section of a 95-km pipeline taking gas ashore for processing, have caused some to question the quality specification of the pipes, given the high H2S content.

Reuters has been unable to ascertain the exact type of pipe used, but experts say it was most likely a carbon steel pipe, given the high cost of using alloy for such a length.

A spokesman for NCOC said the pipeline was "aligned with the X60 specification" - a reference to a grade of pipe that tends to be carbon steel but can also be alloy.

The spokesman said the X60 grade pipes were dealing with associated gas containing approximately 15 percent of H2S and were designed to withstand concentrations of 12 to 15 percent.

"The pipeline design basis has very recently been confirmed by experts, and it would have been designed in exactly the same way if it had been built today," the spokesman said.

A source with secondary knowledge of the investigation said the consortium was looking at whether the pipes were up to the job and whether costlier grades should have been fitted.

The NCOC spokesman declined to answer further questions about the pipes.

Sumitomo Metal Industries Ltd, which merged with Nippon Steel Corp in 2012 to become Nippon Steel & Sumitomo Metal Corp (NSSM) , supplied pipe to Kashagan seven years ago, according to a company official who did not want to be named.

The official said some of the pipes that leaked were among those supplied by Sumitomo. He said the company had been asked to look into the past manufacturing record of the pipes supplied to Kashagan and found they met all requirements.

NSSM also declined further comment on the pipes used.

Another area of investigation is the welding. The consortium said in December that the Cambridge lab was looking at the pipeline joints. The NCOC expects to have the results from the robot "pigging" search in early 2014.

The IOCs - Exxon, Shell, Total and Eni - and KMG each has a 16.81 percent stake in Kashagan. Japan's Inpex has 7.56 percent, and China National Petroleum Corp (CNPC) (CNPET.UL) acquired 8.33 percent in 2013 as ConocoPhillips exited.

(Additional writing and reporting by Stephen Eisenhammer and Silvia Antonioli in London, Yuka Obayashi in Tokyo and Dmitry Solovyov in Almaty; Editing by Will Waterman)

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