Project Delays Will Cost These Oil Majors Billions

The Kashagan project is delayed and over-budget. The delays are now projected to cost Royal Dutch Shell, Eni, and Total billions.

Rupert Hargreaves
Rupert Hargreaves
Jul 28, 2014 at 11:17AM
Energy, Materials, and Utilities

The Kashagan oil project is a mammoth engineering project. Not only is the project the world's largest oil development, but it is also the world's most expensive and complex. In fact, the project is so expansive and expensive, that is it taking a consortium of the world's largest oil companies to develop it.

At present, the project is being overseen by Italy's Eni, although ExxonMobil is shortly set to take over. France's Total is also involved, and so is Anglo-Dutch company Royal Dutch Shell.

Plenty of problems
The Kashagan project has been plagued with problems ever since its inception. Because of the location of the field, offshore Kazakhstan, the project had to be built on artificial islands, as ice floats would have damaged a traditional oil rig structure.

In total, Kashagan is now expect to cost a total of $136 billion, more than 140% above initial estimates. Production has been consistently delayed; the most recent delay, which occurred at the end of last year, concerns the project's pipelines.

As it turns out, because of the nature of the gas being produced from the field, the pipelines need to be constructed of a special alloy. Unfortunately, engineers only found this out after they had laid the pipelines. Now they all need to be replaced. Production is not expected to restart until next year.

However, as of yet, the costs of this redevelopment and the delays it will cause have not been fully broadcast, which has left investors in the dark.

But now, thanks to analysts at Morgan Stanley, we have some idea of what's going on. 

Putting together a forecast
Morgan Stanley has, during the past few days, put out a forecast that gives us some idea of how much impact these delays will have on the oil majors involved in the project.

Shell, Eni, and Total all have a 16.8% stake in the project, and Morgan Stanley's analysts believe that as a result of the delays, these three companies will have their 2016 net income estimates reduced by $500 million each. That is a large figure, even for these oil giants.

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In percentage terms, that is a 6% fall in 2016 net income for Eni, a 3% fall for Total, and a 2% decline for Shell. These reductions come at a really bad time for these oil majors.

Specifically, all these oil majors are under a lot of pressure from investors to boost returns and lower spending; the Kashagan delays send the opposite signal.

Lacking cash
It had been previously assumed that the start-up of Kashagan would add $800 million to 2016 cash flow for Shell, Eni, and Total -- a hefty payout after years of delays and returns that are much needed.

Indeed, last year, all three majors failed to cover their capital spending and dividends with free cash flow. As a result, some concerns had been raised that the three European majors would be forced to slash their dividend payouts.

Still, Exxon, which is set to become the project's operator, is not under pressure to cut spending as much as its European peers. As a result, the company has more flexibility to spend and drive returns from its share in Kashagan.

The bottom line
All in all, the Kashagan project is delayed and costly. As a result of delays, Shell, Eni, and Total will see their 2016 net income figures come in at least $500 million lower than expected.

These delays and added costs come at a bad time for these majors. Nevertheless, as Kashagan starts up hefty payouts should follow, although some majors might to be forced to sell their share to cut costs before the project hits its full capacity.