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Shell faces obstacles even in scaled-back Arctic drilling bid

Jennifer A. Dlouhy

WASHINGTON -- Shell plans to make a dramatically scaled-back bid to find crude oil in Arctic waters next year, following a headline-grabbing 2012 season that left the firm with a beached drilling rig, air pollution fines and embarrassing equipment failures.

But even though the company is prepared to scrap its damaged Kulluk drilling unit and focus solely on wells in the potentially more lucrative Chukchi Sea off Alaska's northwest coast, major hurdles remain before the firm can return to the Arctic frontier.

Shell Oil -- the Houston-based U.S. arm of Royal Dutch Shell -- already has devoted nearly $5 billion and eight years of work toward a new generation of Arctic oil exploration, its largest single prospect.

In a conference call Thursday to discuss Royal Dutch Shell's third-quarter earnings, Chief Financial Officer Simon Henry said the company's Arctic territory has "multibillion-barrel" potential.

"We would like to drill as soon as possible, so we are putting the building blocks in place. There remains a permitting and regulatory process through which we need to go, before we can confirm a decision to actually drill in 2014," Henry said. "It is very important to get the drill bit into the reservoir. What do we have? Is there oil there?"

The company tried to find those answers in 2012. But it had to confine drilling to the first 1,500 feet of its wells in the Chukchi and Beaufort seas, after a unique oil spill containment system could not get to the area in time.

This time, Shell is focusing its 2014 aspirations on the Chukchi Sea, with plans to use its contracted drillship Noble Discover for the work, after it returns from repairs in an Asian shipyard.

But Shell is likely to scrap its floating Kulluk conical drilling unit, which worked in the Beaufort Sea last year. The vessel ran aground on an island off Kodiak on Dec. 31, after a five-day fight to tow it through a fierce storm.

Henry said Shell is bracing for a fourth quarter impairment of several hundred million dollars if it determines that repair costs exceed the benefits of rehabilitating Kulluck, and the company gets rid of its three-decade-old vessel.

Meanwhile, Shell has contracted Transocean's semi-submersible drilling unit Polar Pioneer to replace the Kulluk, at least as a backup rig ready to bore a relief well in case of an emergency in the Chukchi Sea.

Federal regulators at the Interior Department have insisted that Arctic operators have a relief drilling rig at the ready nearby, since the area is 1,000 miles from the nearest major port in Dutch Harbor, Alaska.

But Shell faces major impediments to restarting its Arctic drilling operations next year, even on a much more limited scale.

It has not fulfilled regulators' request for a third-party audit of its management systems.

Its Chukchi Sea exploration plan, to be filed soon, will undergo environmental reviews and public comment, a process that can stretch for months. And even if Shell gets overall approval, it would need drilling permits for specific wells.

And the company will have to stand up an armada of vessels to support its operations. More than 20 sailed into the region during the 2012 foray.

Even if the 29-year-old Polar Pioneer is ready to replace the Kulluk in 2014, it would have to win approvals from the Coast Guard and Interior Department.

The company likely would have an easier time securing air pollution permits for the Arctic exploration - a major hurdle in previous years. Although the Environmental Protection Agency previously oversaw Clean Air permitting in the Arctic, Congress has shifted that oversight to the Interior Department.

The work will come against the backdrop of intense public scrutiny. Environmentalists had raised concerns about Arctic drilling and the risks of oil spills in the remote region long before Shell's 2012 mishaps produced public images of a beached rig battered by crashing waves.

In March, the Interior Department issued a report blaming Shell for not sufficiently managing a web of contractors offshore in Alaska, and said the company had prompted "serious questions regarding its ability to operate safely and responsibly in the challenging and unpredictable conditions."

Interior Department officials are drafting a formal proposal of minimum standards for oil and gas activity in U.S. Arctic waters, partly with an eye on codifying some of the voluntary steps Shell took in 2012.

Michael LeVine, Pacific Senior Counsel with the conservation group Oceana, said Shell's 2012 drilling proved companies are ill-prepared for the harsh conditions in the Chukchi and Beaufort seas.

"Shell appears to be throwing good money after bad," LeVine said. "If companies refuse to learn from their mistakes and make more responsible choices, the government must step in and say 'enough is enough.'"

Greenpeace International's Arctic oil campaign leader Ben Ayliffe said Shell's "Arctic bravado is a desperate attempt to reassure its investors."

"Brushing off the loss of hundreds of millions of dollars and casually scrapping a drilling program are not the actions of a company in control of its operations," he said.

An estimated jackpot of 412 billion barrels of oil equivalent lurking in the Arctic is prompting a new oil rush at the top of the globe.

Shell has taken the lead in pursuing Arctic drilling in U.S. waters, decades after the last sustained drilling in the region. Houston-based ConocoPhillips and Norway's Statoil also hold drilling leases in the U.S. Arctic. Outside the United States, Exxon Mobil, Cairn Energy and Russia's Gazprom are all pursuing ventures in Arctic waters.

But with a new oil and gas drilling boom onshore in North America, some energy experts and financial analysts have cast doubt on the merits of risky, expensive drilling into the U.S. Arctic frontier.

Those concerns may be particularly acute for Shell, which has weathered questions from investors about its long-term investments and capital spending.

Henry emphasized the potential prize lying beneath Shell's Arctic leases, which would rank it in the same category as Shell's Libra oil discovery in Brazil and its recent investment decisions on heavy oil projects in Canada.

"Both of those are multibillion-barrel opportunities for Shell," with investments and production spanning decades, Henry said. "Alaska fits into that category."

Shell has described the troubles during its 2012 Arctic drilling as primarily transportation and logistical challenges.

They included the brief drifting of the drillship Noble Discoverer near Dutch Harbor, a fire in its rig stack and propulsion problems pulling into Seward. In September, Shell agreed to pay the federal government $1.1 million in fines to settle claims it violated air pollution permits by releasing excess nitrogen oxide from its ships.


By Jennifer A. Dlouhy
Houston Chronicle