January 18, 2011 / 5:40 PM / 8 years ago

Analysis: BP and Russia Arctic foray necessary but costly

MOSCOW (Reuters) - BP and Russia have little choice but to look to the Arctic for future oil, but remoteness, year-round ice and sub-zero temperatures mean the cost of drilling could far outstrip initial estimates.

An iceberg floats in sea ice in the Arctic circle. REUTERS/Svebor Kranjc

The British major and Russia’s largest oil producer Rosneft have aligned to develop three offshore blocks in the Kara Sea, putting BP on the map as the first foreign company to be allowed access to Russia’s untapped Arctic reserves.

While BP will only receive a one-third stake in the joint venture, it will front all exploration costs, which are likely to be staggering given the project’s extreme Arctic conditions.

“It doesn’t take long for the billions to pile up when you are working with ice and with a narrow drilling period,” an executive, based in Russia for a major oil services firm, told Reuters on condition of anonymity.

Drilling a well through the thick ice at depths of 100-200 meters could cost from $150 million, he said, adding that BP and Rosneft were likely to start off with 5 to 10 wells.

Oil analyst Valery Nesterov of Troika Dialog said the cost to drill one well could reach as much as $200 million.

BP’s has so far pledged $2 billion toward exploration.

The companies say the three Kara Sea blocks could potentially contain oil reserves equal to the volumes of the UK North Sea, meaning the end of the rainbow could hold around 60 billion barrels of black gold.

“This is only the initial sum, the investment plan will be revised over and over again. The scope and difficulty of this project knows no parallel in the world, and the investment may be huge,” said Nesterov at Troika.

Even long before the exploratory drilling phase, which Rosneft has said will begin in 2015, BP is likely to need to shell out billions for seismic exploration and the anchoring of drilling and oil collection infrastructure.

“You’ve got to have rigs equipped to work under Arctic conditions. That will easily run you $1 million a day. Then you to have special support vessels and ice breakers to haul them out there,” the oil services company manager said.

Bringing Arctic oil to market is also costly. To start, oil may only be pumped in summer, when icebreakers are not needed.

“But as they proceed they will get used to climactic conditions and constraints and figure out a technical solution to start producing year-round, like in Sakhalin,” said David Dusseault, a Russian energy policy expert at the University of Helsinki.

On Russia’s Far-East island of Sakhalin, the Gazprom-led Sakhalin-I project only started exporting oil year-round in 2008 after building sub-sea oil and gas pipelines that lead to an on-shore terminal.

NO ALTERNATIVE?

Much depends on the outcome of the BP-Rosneft tie-up that the companies hope will lead to commercial oil in a decade. It will be deeply significant for the future of Russia’s status as a hydrocarbon superpower and, in the wake of last year’s oil spill off the United States, BP’s entire existence.

Russia, the world’s top crude producer whose federal budget feeds on oil tax revenues, will need to invest over 8.6 trillion rubles ($280 billion) to keep pumping oil at current record levels until 2020, Prime Minister Vladimir Putin said in October.

And with most of its West Siberian reserves fast approaching expiry, the country’s Arctic shelf, which holds an estimated 51 billion barrels of oil and 87 trillion cubic meters of gas, is the most promising frontier.

BP, meanwhile, needs to significantly replenish its reserves book left battered as it sells assets to raise cash for the clean up of the Gulf of Mexico spill, estimated at $40 billion.

“BP didn’t have a choice. They need to build their reserve stock back up, and where are they going to go to find them? Luckily they are already a known entity in Russia,” said Dusseault.

Since 2003 around one quarter of BP’s annual production has come out of its Russian joint venture TNK-BP half owned by a quartet of Russia-connected billionaires.

The Russian opportunity comes at a time when the spill has tarnished BP’s reputation elsewhere, said Ed Morse, global head of commodities research at Credit Suisse.

“BP is looking at reputational risk ... and it is now focusing on areas where its expertise is welcome,” he said.

Russia’s top energy official, Igor Sechin, has said that experience in cleaning up the spill was in fact one of the reasons Russia chose BP as its Arctic partner.

While few analysts dispute that it was a wise move for both Russia and BP to embark on their first major Arctic foray, BP should be prepared for unforeseen costs associated with exploring and drilling for oil under ice.

“(The Arctic) could be very promising, nobody really knows how much of oil and gas there is and whether it’s worthwhile to develop. Nobody (has) actually drilled there. The reserves are estimates on geological surveys,” said Julius Walker, a senior oil analyst at the International Energy Agency.

Additional reporting by Melissa Akin; Writing by Jessica Bachman; Editing by Anthony Barker

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