Shell’s Arctic Drilling Gets Frozen … Again

by Aaron Levitt | January 4, 2013 10:39 am

It seems that my favorite integrated major can’t seem to catch a break in the Arctic[1].

Royal Dutch Shell (NYSE:RDS.A[2], RDS.B[3]) has suffered setback after setback — thanks to the trio of regulatory issues, environmental scrutiny and fast-approaching sea ice — in its quest to reach an estimated 20 billion barrels in fields off of the northernmost U.S. city: Barrow, Ala.

Now, it may have to wait even longer to tap into the region, which includes the Chukchi and Beaufort Seas. Stormy weather has kicked off the new year … and put a damper on Shell’s $4.5 billion project.

For investors, the series of obstructions doesn’t bode well for Shell’s ambitions in the region — nor its share price.

70 MPH Winds

Shell’s latest Arctic woes stem from the fact that its 28,000 ton conical drill ship — the Kulluk — broke free of its tow[4] lines in stormy seas and grounded itself of the coast of Kodiak Island. Originally, Shell purchased the old rig (which was destined for the scrap pile) and spent about $292 million upgrading the vessel to use for its Arctic project. Rig contractor Noble (NYSE:NE[5]) provides the crew and manages the Kulluk’s drilling operations.

The integrated major had previously used the Kulluk back in September and October to drill prospect wells in the Beaufort Sea. It was being taken to Seattle for the off-season. That’s when a mechanical failure caused the drill ship to break free of its towing vessel.

According to the tug boat[6] doing the towing, the emergency back-up plan to control the drilling rig also failed and the ship had to be grounded in order to avoid further complications. The Coast Guard helped evacuate the 18 employees on-board.

An initial flyover by a Coast Guard showed no signs of damage to the rig and detected no visible oil sheen. However, seas remain rough — with 40-foot swells — and the Kulluk contains roughly 139,000 gallons of ultra-low-sulfur diesel fuel as well as about 12,000 gallons of combined lube oil and hydraulic fluid. Environmentalists predict that if there is a spill that damage to the region could be “catastrophic.”

While the rig appears to be safe, the grounding of Kulluk is the latest is a series of unfavorable events affecting Shell’s ambitious goals of tapping the Arctic’s petroleum riches.

A Pile of Problems

Aside from the various lawsuits from environmental groups such as Greenpeace, Shell has had to continuously deal equipment failures[7] and problems. The other Arctic drilling vessel[8] used by Shell — the Noble Discoverer — has been a point of contention on the project. The rig was held by the Coast Guard back in November after it lost propulsion and inspectors found safety discrepancies.

Before that it couldn’t meet Environmental Protection Agency emission standards for nitrous oxide and ammonia and slipped its anchor back over the summer and drifted perilously close to the shore. Additionally, the Coast Guard raised questions about the durability of one of Shell’s underwater oil-spill containment vessels — the Arctic Challenger — in severe weather over the summer.

Is Shell Up To The Task?

This latest issue is certainly more egg on the face of the integrated giant. While the grounded Kulluk wasn’t prospecting for fuel when it ran aground, the difficulties in just transporting equipment in the area highlights just how difficult tapping the Arctic region[9] will be.

Given that this now the eighth year that Shell has trying to tap the Chukchi and Beaufort Seas since winning the leases, you have to wonder if they are really up to the task. I mean, Norway’s Statoil (NYSE:STO[10]) — who basically wrote the book on frozen deepwater drilling — is holding off entering Alaska until at least 2015.

As an investor, the continued Arctic setbacks are really hard to deal with. Seeing how much of my enthusiasm for Shell stock stems from the company’s willingness to think long-term and devote itself to these unconventional projects, screw-ups especially hurt. Exercises and setbacks like this are expensive, and so far Shell has had nothing to show for its spending.

While most of its major rivals like Conoco (NYSE:COP[11]) have been diving into North America’s shale — a great opportunity in of itself[12] — Shell’s “cool” factor was that it was willing to gamble on projects like the Arctic or floating LNG production.

That “coolness” seems to be fading as the Arctic is proving to be a cruel mistress.

While I’m not giving up just yet on shares — Shell still mints a ton of cash, pays a strong dividend, owns plenty of producing assets and refines a ton of products — it’s getting harder to swallow the Arctic issues. I would to hate to see them abandon the project before it really bears fruit.

As of this writing, Aaron Levitt was long RDS-A and RDS-B.

  1. in the Arctic:
  2. RDS.A:
  3. RDS.B:
  4. broke free of its tow:
  5. NE:
  6. tug boat:
  7. equipment failures:
  8. drilling vessel:
  9. Arctic region:
  10. STO:
  11. COP:
  12. opportunity in of itself:

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