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* Kilometres of Kashagan pipelines defective-sources
* Could be cheaper to replace onshore section
* Project costing around $45 mln a day in lost revenues
* Kazakhstan raises pressure with $737 mln fine
By Oleg Vukmanovic and Stephen Jewkes
MILAN, April 2 (Reuters) - Western oil majors struggling to restart production at one of the world's biggest offshore oilfields in Kazakhstan have found that whole kilometres of pipeline are defective, two people recently returned from the $50 billion project say.
Replacing the damaged section altogether may be a better bet than trying to repair it.
Oil company investigators have yet to announce conclusions about what went wrong at Kashagan in October, when onshore pipes carrying corrosive gases sprang leaks and brought offshore production in the Caspian Sea to a halt a month after start-up.
Yet early accounts of findings collected from engineering, banking and industry sources, some of whom have just returned from the site, reveal that the scope of technical faults may delay oil flows longer than expected.
The project has presented huge engineering challenges throughout the 13 years since work began. Much of it is built on artificial islands to avoid damage from pack ice in a shallow sea that freezes for five months a year.
The oil is 4,200 metres (4,590 yards) below the seabed at very high pressure, and the associated gas reaching the surface is mixed with some of the highest concentrations of toxic, metal-eating hydrogen sulphide (H2S) ever encountered.
It has now emerged that sulphur-laden sour gas burped out from the oil field during production last year may have weakened long stretches of processing pipelines, two sources said.
"The problem goes on for kilometre after kilometre, it's a systemic problem," an industry source briefed by Kashagan engineers told Reuters.
That defective stretch of pipeline runs mainly through hard-to-reach swampy terrain, making intervention costly and difficult.
A banker briefed by management of one of the companies involved in engineering work said he was told the best course of action could instead be to lay a new line alongside the old one.
"It is cheaper to build a new parallel line than to pull up and repair the old one," the banker said.
A Kashagan consortium spokesman declined to comment beyond saying that no decision has yet been taken on the pipeline rehabilitation plan. At the same time it delayed the release of its final results into the pipeline investigation to the second-quarter.
Problems with an inspection robot designed to help detect what is wrong were not helping, another source, who makes frequent trips to Kashagan, said, and compressors designed to keep the oil flowing were causing extra headaches.
Two compressors are known among the thousands of workers on Kashagan as "the widow maker" and "the rotating bomb", nicknames, a consortium spokesman pointed out, which refer not to unsafe working conditions but to the complexity of the kit.
Output remains stuck at zero despite initial projections of 180,000 barrels per day in the early phase of production build-up on a field that aims to produce 1.66 million barrels a day at peak - as much as OPEC member Angola.
According to Reuters calculations, by mid-year, lost revenue is likely to amount to between $4 billion and $12 billion.
A second engineer associated with the project said the consortium's decision to keep the pipelines outside in harsh conditions may have stripped away their corrosion-resistant coating, rendering them more vulnerable to leaks.
"The storage was the problem, the pipes were left in the desert for too many months and this altered the coating of the pipes," the source, a specialist in inner-tube coatings on Kashagan said.
The consortium over-estimated the acidity of the sour gas when they built and treated the pipelines, the source added, "so it can't have been a problem of estimating the content of acid".
Another source with one of the Kashagan stakeholders also said that the span of pipeline under scrutiny is kilometres long, with coatings at the heart of the problem.
The consortium said only that toxic gas lay behind the problem. "Sulphur stress cracking was identified as the root cause of the pipeline issues," the spokesman said. "This process occurs if steel of high hardness is exposed to high concentrations of H2S (hydrogen sulphide) under high pressure in the presence of water," the spokesman said.
"This mechanism is not at all related to normal corrosion (formation of rust) but solely to the hardness of the steel".
Last month, infuriated Kazakh officials slapped a $737 million ecological damage fine on the consortium, which includes Eni, Exxon Mobil, Royal Dutch Shell, Total, and Kazakh state-run KazMunaiGas.
The penalty is the strongest signal to date from Kazakhstan that it is running out of patience, while the consortium's decision to fight the fine could raise tensions with a government grown more assertive with foreign investors.
The consortium, which was meant to start its first output 10 years ago, has already seen KazMunaiGas taking a large stake in the project last decade following previous delays that angered the government.
A repeat of that scenario together with the state's possible refusal to pay a chunk of development costs are the main threats to the group just as the restart date remains deeply uncertain.
"The project stopped production as a result of pipeline issues with the hydrocarbons coming onshore," Shell's chief financial officer Simon Henry said last month.
"All the partners have contributed their technical expertise to look at how this challenge of running the pipelines can be addressed. There is no decision yet about how best to do this or when production can be restarted," he added.
Kazakh officials have said they have no plans to nationalise the project so far and say they hope it could restart in the second half of 2014 and produce 22 million barrels of crude by the end of the year.
Up to now, Kashagan has missed out on around $2.7 billion in oil revenue, a fact likely to cast a shadow over state decision-making.
The contractual terms stipulate the government may refuse to reimburse the costs, potentially the entire $50 billion bill, if the consortium misses the final deadline. That was set by the state as October 2013.
The Kashagan spokesman said that output had in fact briefly reached commercial levels, as written in the contract, of 75,000 bpd before its shutdown, but not for long enough to count.
A nine-month delay from September 2013 to July 2014 will cost the consortium at least $12 billion of lost oil revenues based on full scale output of 450,000 barrels per day.
Even if minimal output levels of 150,000 bpd are taken into account, lost revenues would still be a hefty $4 billion, according to Reuters calculations. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For a graphic on Kashagan - link.reuters.com/pen92v ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
"It's dragging on. Everyone's losing money, big money, and so they all want to get on with it. But there are technical problems," said a source just back from Kashagan.
For its part, the central Asian state urgently needs production revenues to hit its fiscal targets for 2014, based on projected cash inflows from Kashagan at up to three percent of gross domestic product.
Past oil project delays have been seized upon by the government as a chance to levy hefty fines and boost its share of future production revenues.
Unfortunately for everyone involved, the best way of defusing rising stakeholder tensions hangs on oil company contractors getting to grips with the sweep and complexity of the project's engineering challenges.
But smooth operation at the current juncture looks largely out of reach.
Efforts to contain equipment breakdowns offshore has given rise to black humour among the ranks of engineers.
An engineer with one of the western oil companies involved in Kashagan who recently returned from the site said technical breakdowns on production-critical equipment keep workers juggling priorities.
Particularly singled out for complaint are the platform's two main compressors, designed to keep oil flowing by maintaining reservoir pressure and stripping out the gas component of oil production.
"They're a mess...we call one 'the widow maker' and the other 'the rotating bomb'," said the engineer. "That's how we tell them apart when assigning work orders," he said.
Furthermore an inspection robot, called a PIG, sent to scan the inside of Kashagan's pipelines for data and clues is sending back patchy data.
"The problem is the PIG has a 60 percent reliability rate." the first source just back from Kashagan said. "Its not like an X-ray. It's like a blurred X-ray."
Additional reporting by Dmitry Solovyov in Almaty and Dmitry Zhdannikov in London; editing by Philippa Fletcher