Shell announces return to Arctic in 2014 despite mishaps

WASHINGTON — Shell officials on Thursday said the oil company plans to make another, dramatically scaled-back bid to find crude in Arctic waters, following a headline-grabbing 2012 season that left the firm with air pollution fines and embarrassing equipment failures.

But first, the company is preparing to scrap the floating Kulluk conical drilling unit, which ran aground near an Alaskan island on Dec. 31 after a five-day fight to tow the vessel through a fierce storm. Shell has contracted Transocean’s semi-submersible drilling unit Polar Pioneer to replace the Kulluk as soon as early 2014, while final assessments are made on whether it is cost effective to repair the damaged drilling unit in an Asian shipyard.

Simon Henry, Shell’s chief financial officer, said the company was bracing for a fourth quarter impairment of “a few hundred million dollars” if the Kulluk’s repair costs exceed the benefits of rehabilitating the 30-year-old vessel.

The disclosure, which came during a call with reporters to discuss Royal Dutch Shell’s third-quarter earnings, ends months of speculation about whether the firm would be ready to return to the Chukchi and Beaufort seas north of Alaska once ice clears next summer.

The company has devoted nearly $5 billion and eight years of work into a new generation of Arctic oil exploration, decades after floating rigs drilled the last offshore wells in the Chukchi and Beaufort seas. The project is the largest single exploration prospect in the Shell group, but Henry stressed it has multibillion-barrel potential.

“It is very important to get the drill bit into the reservoir,” Henry told reporters. “What do we have? Is there oil there?”

Shell was forced to constrain its 2012 operations to “top-hole” drilling of the initial 1,500 feet of its Arctic wells, after its unique oil spill containment system was damaged during a deployment drill and could not get to the area in time.

Scaling back

Henry said Shell would soon file a broad Chukchi Sea drilling blueprint with federal regulators at the Interior Department. The company will not seek to resume drilling in 2014 in the shallower Beaufort Sea, where the floating Kulluk had operated last year.

“We have not yet confirmed if we drill in 2014,” said Simon Henry, Shell’s chief financial officer. “Clearly, we would like to drill as soon as possible, so we are putting the building blocks in place. There remains a permitting and regulatory process through which we need to go, before we can confirm a decision to actually drill in 2014.”

Shell in February decided it would abandon work in U.S. Arctic waters in 2013, while repairs on two drilling rigs were underway. Shell’s self-described “pause” in Arctic drilling also would give the company time to stand up an emergency oil spill containment system and leave room for federal regulators to draft specific standards for oil and gas development in the region.

Major hurdles

But there are major hurdles for Shell to restart its Arctic drilling operations in 2014, even on a much more limited scale.

The company still has not fulfilled regulators’ request for a third-party audit of Shell’s management systems.

Its Chukchi Sea exploration plan will be subjected to environmental reviews and public comment, a process that can stretch for months. Drilling permits for specific wells also may be needed.

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And the company will have to stand up an armada of vessels — more than 20 were put into the region in 2012 — to support its operations.

Finally, even if the 29-year-old Polar Pioneer is ready to replace the Kulluk in 2014, it would have to win approvals to function as a backup drilling rig that is ready to bore a relief well in case of an emergency in the Chukchi Sea. Federal regulators at the Interior Department have insisted that Arctic operators have a relief drilling rig at the ready nearby, since the area is 1,000 miles from the nearest major port in Dutch Harbor, Alaska.

Environmental scrutiny

The work also will come against the backdrop of intense public scrutiny. Environmentalists had raised concerns about Arctic drilling and the risks of oil spills in the remote region long before Shell’s 2012 mishaps exposed the United States to images of a beached rig battered by crashing waves.

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In March, the Interior Department issued a report blaming Shell for not sufficiently overseeing and managing a web of contractors and said the company had prompted “serious questions regarding its ability to operate safely and responsibly in the challenging and unpredictable conditions” offshore in Alaska.

“Shell’s focus appeared to be on compliance with prescriptive safety and environmental regulations required for approvals and authorizations, rather than on a holistic approach to managing and monitoring risks identified during operational planning,” the high-level Interior Department review concluded.

Interior Department officials are drafting a formal proposal of minimum standards for oil and gas activity in U.S. Arctic waters, partly with an eye on codifying some of the voluntary steps taken by Shell, as Arctic activity accelerates.

Michael LeVine, Pacific Senior Counsel with the conservation group Oceana, said it would be irresponsible to move forward in the Arctic Ocean, after Shell’s 2012 drilling proved companies are ill prepared for the harsh conditions in the Chukchi and Beaufort seas.

“Shell appears to be throwing good money after bad,” LeVine said. “If companies refuse to learn from their mistakes and make more responsible choices, the government must step in and say ‘enough is enough.’”

“The continued pressure to drill despite all evidence showing it cannot be done safely will lead only to controversy and risk for our ocean resources,” LeVine added.

Arctic rush

An estimated jackpot of 412 billion barrels of oil equivalent lurking in the Arctic is prompting a new oil rush at the top of the globe.

Shell has taken the lead in pursuing Arctic drilling in U.S. waters, decades after the last sustained drilling in the region. ConocoPhillips and Statoil also hold drilling leases in the U.S. Arctic. Outside the United States, ExxonMobil, Cairn Energy and Gazprom are all pursuing ventures in foreign Arctic waters.

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But with a new oil and gas drilling boom onshore in North America, some energy experts and financial analysts have cast doubt on the merits of risky, expensive drilling into the U.S. Arctic frontier. Those concerns may be particularly acute for Shell, which has weathered questions from investors about its long-term investments and capital spending.

But Henry stressed the potential prize lying beneath Shell’s Arctic leases, ranking it in the same category as its Libra oil discovery in Brazil and its recent investment decisions on heavy oil projects in Canada.

“Both of those are multi-billion-barrel opportunities for Shell,” with investments and production spanning decades, Henry said. “Alaska fits into that category.”

Series of mishaps

Shell has described the mishaps during its 2012 Arctic drilling as primarily transportation and logistical challenges. They included the brief drifting of the drillship Noble Discoverer near Dutch Harbor, a fire in its rig stack and propulsion problems pulling into Seward.

The most high-profile setback came on Dec. 31, when Shell’s Kulluk rig collided with the rocky shore of Sitkalidak Island near Kodiak City, Alaska, following a five-day bid to tow the unpropelled vessel to safe harbor amid 70-mph winds and waves that climbed four-stories high. The rig was later pulled to sheltered Kiliuda Bay, sent to Dutch Harbor for further examination and then shipped to an Asian port for potential repairs.

In September, Shell agreed to pay the federal government $1.1 million in fines to settle claims it violated air pollution permits by sending excess nitrogen oxide out of its ships while drilling in the region last year.