What Do the Kashagan Delays Mean for the Oil Industry?

The Kashagan project is likely to be delayed again. Here are 3 implications of the delays.

Apr 15, 2014 at 11:20AM

With 13 billion barrels of economically recoverable oil and an estimated peak production of 1.5 million barrels of oil a day, the $50 billion Kashagan project is one of the largest oil projects of its generation.

With a total expenditure that is $30 billion over budget and a project timeline that is many years delayed, Kashagan also represents all that can go wrong with a megaproject. 

Kashagan is a symbol that the easy oil is truly gone.  If there were better investment opportunities elsewhere, ExxonMobil (NYSE:XOM), Eni (NYSE:E), Royal Dutch Shell (NYSE:RDS-B), and Total (NYSE:TOT) would be elsewhere. Yet the oil companies are still in Kashagan because the other opportunities are just as tough as Kashagan, if not tougher. 

If the easy oil is gone and the future is filled with more Kashagan-like projects, what are the implications?

Canadian oil sands are a better bet
The first implication is that projects that are technically easy but operationally expensive will look more attractive. 

The Canadian oil sands, for example, are not as technically challenging as Kashagan because 20% of their reserves are on the surface. The oil sands are operationally expensive, however, because of the costly infrastructure needed to convert oil sands to synthetic crude oil. Many new oil sands projects require a minimum of $80 per barrel to break even. 

If the easy oil is gone and triple-digit crude prices are here to stay, the Canadian oil sands will look more like sure things and see more investment.

Greater Chinese participation
The second implication is that Chinese companies will play a greater role in future megaprojects.

Not too long ago, when oil was relatively cheap to extract, the oil industry viewed Chinese oil companies as competitors. The U.S. government, for example, rejected CNOOC's offer to acquire Unocal in 2005, citing national security concerns. The oil industry simply didn't need any additional capital at the time.

But with future projects being more capital intensive, the oil industry needs additional capital. To the oil industry, allowing Chinese companies to participate in future projects is a great way to raise that additional capital because Chinese companies are often willing to pay a premium for their stake. If the Chinese pay a premium, other companies in a given project reduce their overall risk. The Chinese companies are willing to pay a premium because the Chinese government wants to diversify its holdings away from the U.S. dollar and prevent high oil prices.

Oil service companies look more attractive
The third implication is that oil service companies will see more business going forward. 

According to Schlumberger, over the past decade, total oil industry exploration and production capital expenditures grew by 400% while global oil production only grew by 15%.

The principle reason for the discrepancy between capex growth and production growth is that the easy oil is gone. Oil companies need to spend more to produce the same amount of oil.

If the future is filled with even tougher projects than the projects in the past 10 years, industry capital expenditures will likely increase further and oil service companies, by being on the receiving end of capital expenditures, will realize greater revenues.

The bottom line
Despite Kashagan's many troubles, it's not all bad news -- the project will be completed at some point.

If the Kashagan gets any worse, the participants can always sell their stake. Former participant ConocoPhilips did just that, by selling its 8.4% stake to Kazakhstan's state oil company for $5 billion in 2013.  . 

Kashagan will not be the figurative iceberg that sinks any super-majors, but it does symbolize a future with higher costs, greater difficulty, and different players.

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Jay Yao has no position in any stocks mentioned. The Motley Fool recommends Total SA. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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