Project Management Institute

Drilling, Downed

CASE ANALYSIS

Investors of the Sakhalin II project to supply liquefied natural gas to Asian markets have been blindsided by dramatic cost and schedule overruns.

THE SPARSELY POPULATED Russian island of Sakhalin, north of Japan in the Pacific Ocean, is one of the major development areas in the Far East for drilling and processing oil and natural gas.

In 1994, Sakhalin Energy Investment Co. (SEIC), a joint venture of international investors, was established to implement Sakhalin II, a project that would supply oil and gas to Asian markets.

The project's first phase, drilling the offshore Piltun-Astokhskoye oil field northeast of Sakhalin, was successful, producing oil in summer months since 1999. In May 2003, the second—US$10 billion—phase of the project got underway with the goal to develop year-round oil production and to produce liquefied natural gas (LNG). Its scope includes a second Piltun-Astokhskoye rig and another offshore platform at the Lunskoye natural gas field east of Sakhalin. Additional construction includes an offshore processing facility and pipelines to transport oil and gas to the southern part of the island where winter ice will not prevent vessels from loading oil and gas year-round—the phase 1 development of the Piltun-Astokhskoye field exports oil only during the summer.

The project is being performed under a production sharing agreement (PSA) with the Russian state. SEIC will pay royalties during the project and then share revenues with the Russian Federation after investments are paid back.

In July 2005, Shell announced that project costs are anticipated to rise from $10 billion to $20 billion and that the first revenues from LNG deliveries will be delayed from November 2007 to summer 2008. Rising steel prices and overly optimistic original estimates are to blame for most of the doubled price tag—which also was impacted by a weak U.S. dollar and Russian inflation. “Consider that on 7 July 2005, only a week before the shareholders learned of the setback, Royal Dutch/Shell had signed a Memorandum of Understanding with the Russian company Gazprom to make it another SEIC shareholder,” says Oliver F. Lehmann, PMP, vice president of professional development of the PMI Troubled Projects Specific Interest Group. The fact that Shell, the number-one shareholder and stakeholder of the project, signed an agreement under wrong expectations indicates a lack of communications and control, Mr. Lehmann asserts.

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“Every shareholder in an oil and gas exploitation project is aware of the high risk exposure caused by geological, technical and political uncertainties,” Mr. Lehmann says. “In such a situation, and with the reduced margins under PSA contracts, it is essential that variances on time, effort and cost are getting reviewed in short cycles and that key stakeholders including the project shareholders are getting updated immediately when estimates need to be modified. By now it seems clear that the agreement has been based on inaccuracies, and Gazprom rightfully is demanding renegotiation. If project managers had kept shareholders better informed, it could have saved them all from the humiliation and damage of reputation they are now facing.”

 

If you know of a troubled project in which a project manager could have (or did) save the day, share your lessons learned. Contact pmnetwork@imaginepub.com.

This material has been reproduced with the permission of the copyright owner. Unauthorized reproduction of this material is strictly prohibited. For permission to reproduce this material, please contact PMI.

NOVEMBER 2005 | PM NETWORK

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