The Kashagan oil field is the largest oil discovery in 40 years, and oil companies are all fighting to get their hands on it. However, Kashagan is not an easy field to work on, and the project is so large that it's taking a consortium of oil majors to develop it, including ExxonMobil (XOM 4.00%), Royal Dutch Shell (NYSE: RDS-B), Italy's Eni (E 4.58%), and France's Total (TOT +0.00%).
Size and complexity
Kashagan is not just one of the world's largest oil fields, it has also turned into one of the most complex oil projects ever undertaken. Indeed, the size and development costs of the whole project are mind-boggling.
When originally planned, the Kashagan development was supposed to cost $57 billion for the life of the project, including design, construction, and operation. However, now the project is expected to cost a staggering $136 billion during its lifetime, although this figure could be about to increase.
Of course, with a price tag that big, it goes without saying that Kashagan is no simple find-drill-and-produce well. The Kashagan field is located within Kazakhstan's zone of the Caspian Sea, meaning that to avoid damage from pack ice in a shallow sea, which freezes for five months of the year, much of the project's infrastructure had to be built on artificial islands. As a result, the project required the construction of a landmass to ensure its long-term survival.
Stop-start
Things were progressing to plan -- albeit slightly behind schedule and over-budget -- as of last September, when the project finally started up, but then a gas leak from one of the project's pipelines forced production to stop. Tests were made on the pipeline and surrounding environment and results are expected during the next month or so, which should give engineers the data they require to fix the problem and allow them to recommence production within the year; or that's what was thought anyway.
According to a fresh release from the consortium operating the Kashagan project, "The current assessment, based on the results of an investigation, is that both the oil and the gas pipelines might have to be fully replaced." This is a disaster for Kashagan; the oil field is 4,200 meters below the seabed where pressures are very high, and the gas reaching the surface through the pipelines is mixed with high concentrations of hydrogen sulphide in some of the highest concentrations ever encountered.
According to companies operating the project, these high levels of sulphide are eating away at the pipelines, and have caused stress cracks, which is the root cause of the problem. Claudio Descalzi, head of exploration and development at Italy's Eni, a partner in the project was quoted saying, "The problem is worse than we considered." And Eni believes that only two pipelines will need to be replaced, in contrast to other estimates.
However, a tendering process for the replacement has already begun, and it's expected that by June the consortium will know how much the replacement will cost, and will be able to put a time scale on the whole project. It's likely that the new pipes will cost 10 to 15 times more.
Now, it is unlikely that Kashagan will produce oil this year, which is worrying for the majority of consortium participants, as they were relying on Kashagan output to meet production forecasts for this year.
Who's to blame?
Nevertheless one very important question arises from this debacle, who is to blame for the poor quality pipes?
Well, it would appear that those operating on the project do not want to comment about which company is doing what. However, according to Reuters, Sumitomo Metal Industries Ltd, which merged with Nippon Steel Corp in 2012 to become Nippon Steel & Sumitomo Metal Corp, supplied pipelines to the project seven years ago, and it's possible that the consortium of majors developing the project kept the same supplier.
One unnamed official has been quoted as saying some of the pipes that leaked were among those supplied by Sumitomo. That being said, nothing can be said for certain.
Foolish summary
It would appear that more delays are going to slow the start-up of the world's largest oil project. For oil majors coming under pressure to increase cash flows and decrease spending, this is a disaster, as it's likely that Kashagan's final bill will be much higher than current expectations. Only time will tell if the project will pay off.
