Shell abandons Arctic oil quest after $7 billion bid yields ‘disappointing’ results

WASHINGTON — Royal Dutch Shell on Monday said it was abandoning a $7 billion, seven-year quest for crude under Arctic waters, after an exploratory well failed to find significant amounts of oil and gas.

Shell’s exploratory oil well in the Chukchi Sea north of Alaska encountered “indications of oil and gas” but the company said they were “not sufficient to warrant further exploration” — a significant blow for the Anglo-Dutch firm that had hoped to find a multibillion barrel crude reservoir in those remote waters.

“Shell continues to see important exploration potential in the basin, and the area is likely to ultimately be of strategic importance to Alaska and the U.S.,” said Marvin Odum, the Houston-based director of Shell Upstream Americas. “However, this is a clearly disappointing exploration outcome for this part of the basin.”

Shell said in a statement that it would cease further exploration activity off the coast of Alaska “for the foreseeable future.” “This decision reflects both the Burger J well result, the high costs associated with the project and the challenging and unpredictable federal regulatory environment in offshore Alaska,” the company said.

Shell also will take a financial charge from the decision, since the firm’s Alaska assets have a carrying value of about $3 billion and the company still has an additional $1.1 billion already committed in existing contracts for rigs, ships and other assets. Shell could pare its potential $4.1 billion write down by putting some of those contracted vessels to work elsewhere or subcontracting them to others.

The full extent of the financial damage will be described on Oct. 29, when Shell announces its third-quarter earnings. But the blow could be especially significant when cast against falling earnings. Shell’s second quarter profit was $3.8 billion, compared with $6.1 billion for the same period last year. First quarter earnings were $3.2 billion, down from $7.3 billion in the first quarter of 2014.

Shell was pursuing a major Arctic oil discovery after spending a record-setting $2.1 billion to buy 275 Chukchi Sea oil and gas leases in a 2008 government auction.

Because of the costs of extracting oil and building the infrastructure to deliver it to market, Shell CEO Ben van Beurden bluntly warned earlier this year that the economics of Shell’s Arctic project would only work “if the structures are full of oil.”

An oil discovery that would be viewed as commercially viable in other basins, such as a 1 billion barrel find in the Gulf of Mexico, wouldn’t pay off in the Arctic right now, noted Dave Pursell, head of securities at Houston-based energy investment bank Tudor, Pickering, Holt & Co.

“The challenge for this was given the remote nature and the expense it was going to have to be a massive accumulation to make it work,” Pursell said. For Shell, “this was an awfully big swing, and they didn’t even make contact.”

Shares in Shell’s A shares tumbled $1.08 in early trading Monday, down 2.28 percent on the news. Shell’s B shares dropped 2.3 percent. But analysts said the overwhelming sentiment from investors would be relief that the company pulled the plug now, rather than after spending billions more pursuing the project. Even with a significant discovery, there would be “considerable skepticism that it would be commercial in a lower-for-longer oil price scenario,” Tudor Pickering Holt & Co. said in a research note.

The company’s declaration is likely to chill oil industry investment in the region, illustrating anew that despite the tremendous promise of crude and gas locked under Arctic waters, the financial and environmental risks of getting it may be too high. Other oil companies, including Statoil and ConocoPhillips, have leases in U.S. Arctic waters but have delayed their own exploratory bids, citing regulatory uncertainty.

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Shell’s defeat also underscores the inherent risks of oil exploration, whether in icy seas north of Alaska or the temperate waters of the Gulf. In the deep-water Miocene play, where much Gulf activity is concentrated these days, just one in five recently drilled wells has been a success. Another top target, the Eastern Gulf Norphlet, has a success rate of just 17 percent.

The episode recalls the long-abandoned Mukluk well in the Beaufort Sea, just a few hundred miles from Shell’s Burger prospect. A consortium of companies spent nearly $1 billion on the well in the 1980s because they were convinced it was loaded with crude. But their only discovery, in December 1983, was salt water and traces of long-gone oil.

Analysts noted that Shell is the sole owner of the Chukchi Sea leases that make up Burger, a position that limited the company’s outside advice on the prospect. Shell did not have other partners asking potentially tough “what if” questions about the prospectivity of the site and the location of the firm’s planned wells.

“One of the reasons you have partners is to gut-check your enthusiasm, and anytime somebody does something 100 percent, the risk is they believe their own story too much,” TPH’s Pursell said.

Shell drilled into the same prospect in 1989 and 1990 and found gas, but this time, the company was aiming for oil. Executives knew that with the high cost of constructing production facilities and pipelines in this frontier region, it would not be economically viable to develop a prospect that contained merely low-priced gas, without billions of barrels of more lucrative crude.

Shell’s executive vice president for the Arctic, Ann Pickard, bluntly warned about the risks in May. “If we find more gas, it’s before its time,” she said in an interview. “It might be worthwhile some point in the future, but it’s before it’s time. We really do need to get out and prove there is some oil there.”

Pickard also cast Shell’s Burger J well as a critical test of the company’s Burger prospect. “If we get a dry hole in J, we’re done,” the Houston-based executive said at the time. “I’ll recommend we say goodbye.”

Even within Shell, some executives were skeptical of the company’s Arctic commitment. Van Beurden openly questioned the project after he became chief executive last year. But Pickard and others helped persuade him to stick by the program, even as falling crude prices forced Shell to slash other capital expenditures.

In July, van Beurden boasted that the company’s Chukchi Sea prospects could rival even “the largest prospects” in the Gulf of Mexico. Although a single well probably wouldn’t be enough to appraise the site, van Beurden said at the time that “very disappointing” results could “condemn the prospect.”

Shell started drilling its Burger J well on July 30, beginning by excavating a special “mud-line cellar” to hold emergency equipment below the reach of floating icebergs. The company was forced to briefly halt drilling in late August, amid gale-force winds and 11-foot seas.

Company officials have described the well itself as relatively straightforward — sited in shallow, 140-foot waters about 70 miles from Alaska’s northwest coastline. Using the Transocean Polar Pioneer rig, Shell drilled the well to a total depth of 6,800 feet.

A second rig, the Noble Discoverer, was barred from simultaneously boring a second well about 9 miles away because of federal walrus protections that required a 15-mile buffer zone.

Three years ago, Shell partially drilled a separate well in its Burger prospect. That 2012 effort was marred by mishaps, including a drifting drillship, air pollution permit violations and the grounding of the company’s contracted Kulluk drilling unit during a botched tow to Seattle.

The Arctic is a challenging place for oil exploration, with 20-foot seas, ice, freezing temperatures and storms that can produce hurricane-force winds. Conservationists argue that any misstep in the remote region about 1,000 miles from the nearest deep-water port could irrevocably damage the fragile Arctic ecosystem, jeopardizing walruses and whales that migrate through the area.

Environmentalists opposed to Arctic drilling also feared the activity could exacerbate climate change by unlocking significant new oil reserves.

“Drilling for oil there is inherently dangerous and will only drive the world deeper into the climate crisis,” Miyoko Sakashita, oceans program director for the Center for Biological Diversity, said in a statement. “If we’re going to leave behind a livable planet, we need to leave that oil in the ground today, tomorrow and always.”

“Polar bears, Alaska’s Arctic and our climate just caught a huge break,” Sakashita added.

Niel Lawrence, the Alaska director for the Natural Resources Defense Council, said Shell’s announcement is “a watershed moment for the climate, the company’s investors, the fragile region and its iconic wildlife, and American consumers.

“For the climate, Shell won’t be locking in fossil fuel production we don’t need and can’t afford if we want to limit global warming,” Lawrence said. “Shell’s shareholders won’t be on the hook for billions more investment that any rational climate agreement would leave stranded.”

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Analysts said Shell’s results will further discourage other companies from exploring for oil and gas in U.S. Arctic waters.

There already were signs of tepid interest. When the federal government invited the oil industry to detail what parts of the Chukchi and Beaufort seas should be available for leasing during separate 2016 and 2017 auctions, companies largely ignored the request for information. Firms objected to the Interior Department’s decision to limit available Chukchi and Beaufort Sea acreage to areas with fewer environmental risks, with tracts nominated by would-be bidders.

Although the Bureau of Ocean Energy Management has not announced plans to delay or cancel either auction, previous offshore oil sales have been postponed amid low industry appetite.

Lois Epstein, the director of The Wilderness Society’s Arctic Program, said Shell’s announcement should deter other companies.

“Hopefully, this means that we are done with oil companies gambling with the Arctic Ocean, and we can celebrate the news that the Arctic Ocean will be safe for the foreseeable future,” Epstein said.

The oil industry views the Arctic Ocean as one of the world’s last untapped frontiers, a place with tremendous reserves up for grabs. The Chukchi Sea alone is estimated to contain 15.4 billion barrels of oil that can be recovered with existing technology, according to the government’s ocean energy bureau.

Shell nodded to the area’s continued potential in its statement Monday. “For an area equivalent to half the size of the Gulf of Mexico, this basin remains substantially under-explored,” the company said.

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