Shell investors warned about Arctic exploration risks

Shell’s strategy for drilling in the Arctic is clearly a priority for the company; it has spent nearly $4 billion and five years preparing to drill in the area. Shell is already a partner in Sakhalin-2 in Russia, its headline offshore Arctic-conditions project. It intends to begin drilling in the Arctic this summer, from July through to October, focusing efforts on the Beaufort Sea and Chukchi Sea. However, the report, ‘Out in the Cold: Investor Risk in Shell’s Arctic Exploration’ released by Platform, Greenpeace and FairPensions, clearly outlines the dangers of venturing into this frontier without considerable assessment of both the financial and environmental risks.

Commercial viability

Arctic exploration is unavoidably accompanied by very high extraction costs. Furthermore, the Platform report suggests that reserves in the Arctic ‘may not be as bountiful as the oft-quoted US Geological figures suggest.’ To be commercially feasible, projects may require tax breaks and political will to get off the ground. Research cited by the report suggests that development costs and development time will be high, making the economic return potentially low in the medium-term.

Inadequate spill response plans

Shell was only granted permission to begin drilling in the Arctic after the US government finally approved its disaster response plan earlier this year. After the 2010 Deepwater Horizon leak in the Gulf of Mexico, the US Department of the Interior required Shell to prepare for a blowout three times larger, to include planning for adverse weather conditions, and to develop special equipment and strategies to respond to a loss of well control and a spill.

However, despite government approval, the report warns that current technology and infrastructure is still not equipped to deal with a major spill. ‘Limited access will mean oil companies will not have the long months that were available to those tackling the Deepwater Horizon disaster to find a solution to any major spill. The infrastructure to mount a large-scale response is not in place.’

Questions also remain about the lack of testing that has been carried out on its well containment equipment, particularly in icy conditions.

Financial impact of a spill

Another risk to investors, the report suggests, is that it is unclear exactly what the financial impact would be in the event of a major spill and the resulting clean-up operation.

‘Shell and other companies acknowledge the ineffectiveness of existing technology to deal with such a spill but have chosen to focus on the supposed low probability of it happening rather than prepare for its inevitable high impact,’ the report’s briefing paper reads.

Furthermore, the report says, ‘The Deepwater Horizon disaster serves as a stark warning of the high financial and environmental impacts of ‘low probability’ events.’

Lack of transparency and poor practice by partners

The report further warns that Shell’s association with its partners in Russia in the Sakhalin-2 project carries with it substantial financial risk. Major cost-overruns in the past have been historically absorbed by Shell and its partners, without any disclosure on the cost recovery. The report also cites previous incidents where partners breached significant environmental and safety practices, which could thereby put Shell at risk.

Funding challenges

The fact that many of the funders of Shell’s Russian project, Sakhalin-2, are facing pressure to refuse funding to extensions of that project, do not bode well for other projects’ chances. Many international financial institutions and banks bound by the Equator Principles abide by social and environmental guidelines which may prove a barrier to funding Arctic projects.

Already, the major German project finance provider West LB announced in April that it would not provide project finance for oil developments in the Arctic due to the high risks and costs – perhaps setting an example for other providers.

The new oil rush?

Shell is the first oil company to make drilling of the Arctic a major priority. If it strikes oil this summer, campaigners such as Greenpeace warn, ‘other global oil giants will quickly follow and spark a dangerous Arctic oil rush.’

The dangers are not limited to the environment, the report warns. ‘Investors should consider whether potential failing at Shell’s Arctic-conditions projects… pose a significant risk to the overall financial health of the Shell group.’