Shell's Misadventures in Alaska

Though Royal Dutch Shell (NYSE: RDS-A  ) has made major strides over the past decade in overcoming the negativity surrounding the 2004 reserve overstatement scandal, which led to the ouster of its CEO and other top executives, the company continues to be plagued by operational blunders that are straining its relationships with shareholders.

At the company's annual meeting last Tuesday, top executives were overwhelmed by a barrage of questions from anxious shareholders about the company's beleaguered oil campaign off the northern coast of Alaska, which, despite nearly $5 billion of investment, has yet to produce a single drop of oil. Many even urged the company to overhaul its operations and strategy in the region altogether. Let's take a closer look.

Trying times for Shell in Alaska
Shell's Alaskan oil campaign has been beset by various challenges, including regulatory and legal hurdles, as well as equipment failures. Last summer, the company was planning to drill five exploratory wells but was forced to push back its plans after the containment dome – a crucial piece of safety equipment intended to prevent oil spilling into the Arctic sea – was damaged during the test phase.

Then, on New Year's Eve, one of its two Alaskan drillships, the Kulluk, ran aground near Kodiak Island in the Gulf of Alaska. Shortly thereafter, a company official told a U.S. Coast Guard panel that, just days before the accident, it was clear to him that towing issues posed a serious threat to the safety of the vessel. As if that wasn't enough bad publicity for the Hague-based company, more incriminating evidence has emerged this past week.

On Saturday, Sean Churchfield, Shell's Alaskan operations manager, testified during a hearing that the Kulluk was ordered to leave its port mainly due to financial considerations. Had the drillship remained stationed at Alaska's Dutch Harbor, Shell would have had to pay millions of dollars in taxes, he revealed. His testimony flies in the face of statements he made immediately after the accident, in which he argued that tax considerations did not play a role in the drillship's departure from its port.  

Additional reviews and investigations
Even before this information emerged, the U.S. Department of the Interior initiated a review of Shell's practices, which determined that it was "not fully prepared" when it entered last year's drilling season and that its management of contractors illustrated "serious deficiencies" in its operations. The departmental review concluded with a harsh warning, asking the company to completely overhaul its plans before being permitted to resume drilling in the Alaskan Arctic.

In addition to the Department of Interior investigation, Shell faces other serious probes that could result in civil or criminal convictions. The U.S. Department of Justice, for instance, is considering imposing sanctions on the company for violations that allegedly occurred on both of its Arctic drillships.  

In the wake of these incidents and elevated regulatory scrutiny, other companies looking to drill in the region are also rethinking their operations. ConocoPhillips (NYSE: COP  ) , for instance, has cancelled its plans to drill in the Chukchi Sea due to federal regulatory uncertainty, while Statoil (NYSE: STO  ) , which also holds leases in Chukchi, said last year that it would delay drilling in the American Arctic until 2015.  

Implications for integrated oil companies
As Shell's experience highlights, the world's largest integrated oil companies are taking on tremendous risk by venturing into remote parts of the world in search of oil. In doing so, they are offered no guarantee of success, while taking on challenges ranging from political and regulatory uncertainty to harsh climates and equipment failures.

All told, Shell still has a way to go before it can spend more freely. While cash flow has doubled over the past three years, its capital budget has also grown by leaps and bounds. This year, the company plans on spending $34 billion, about $8 billion more than it thought it would spend in 2011.  

Minimizing operational blunders, such as those in Alaska and Nigeria – where oil spills, theft, and vandalism have cost the company 60,000 barrels of oil a day in lost production – and capital efficiency will be crucial for the company to keep shareholders happy and sustain its generous 4.7% dividend.

Though Shell and the rest of the oil majors are having difficulty boosting production, companies focused exclusively on exploration and production are having better luck. Chesapeake Energy, for instance, has reported nearly 40% year-over-year growth in liquids production. As the company transitions away from natural gas, will it manage to meet its oil production target and boost cash flow? Or will it languish under the weight of its heavy debt load? To answer that question and to learn more about Chesapeake and its enormous potential, you're invited to check out The Motley Fool's brand-new premium report on the company. Simply click here now to access your copy, and as an added bonus, you'll receive a full year of key updates and expert guidance as news continues to develop.


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