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Commercial Question

Arctic drilling: Shell exploring the cold waters of the Arctic

updated on 22 September 2015

Question

With falling oil prices and the high costs of safety and transportation, why is Shell still set on drilling in the Arctic?

Answer

Many of us have heard or read about the three-tonne 'polar bear' that has accompanied Emma Thompson in a week-long demonstration in London against Arctic drilling. The bus-sized polar bear was paraded in front of Shell's headquarters in London during the first week of September.

The issue is that the floating ice cap in the Arctic has been shrinking at an alarming speed for several years. In 2012 the ice covering the Arctic Ocean was reportedly half the size it was when satellite monitoring commenced 30 years ago. Any drilling for oil could cause devastating effects.

In the last few years, oil industry players have started forming a collective opinion and at times have explicitly stated that drilling in the Arctic is potentially a bad idea. An analysis of the cost and the risks of Arctic drilling has led to the emergence of new conventional wisdom. However, while firms express visions of corporate social responsibility (CSR), at times this may be more of a branding issue than a real impetus to commit to the social enterprise. However, this needs to change. Companies have to realise that CSR has become more than just branding; therefore, there is a line which oil companies cannot cross and drilling in the Arctic seems to be one.

There are also the very high costs of Arctic drilling to consider. These high costs are due to, but not limited to, the greater engineering challenges caused by the more severe weather and sheer remoteness of the Arctic, as well as the thorough safety measures required, such as the addition of a separate back-up rig nearby. Any project also needs to take into account the Arctic's very unstable environment, with shifting ice patterns, two-foot-thick ice sheets, roiling seas, temperatures reaching -50ºC and gale-force winds.

There is also the issue of transport along the 800-mile long Trans-Alaska Pipeline System (TAPS), a pipeline which is the only fully developed transportation route in the Arctic. TAPS transportation costs on average $4.50 per barrel, in contrast to the transportation of barrels from, for example, Valdez in the United States, which costs only about half this rate even though the distance is more than twice the length of the TAPS pipeline.

The collapse in oil prices by more than 50% since last summer (when the rate was $60.00 per barrel) also means that the potential revenue is believed by many not to outweigh the risk and exploration costs.

Warnings not heard

The Save the Arctic campaign at Rio+20 saw Sir Richard Branson speaking on the pressing need for individuals and companies to move away from carbon fuels. Among those present was Puma chairman, Jochen Zeits, who was one of the first to sign the Greenpeace Arctic scroll. Nick Butler, BP's former senior strategy executive, wrote in the Financial Times that the setbacks experienced by Shell in the Arctic should cause it to pull out.

In 2012 Lloyd's of London explicitly warned companies not to "rush in [but instead to] step back and think carefully about the consequences of that action". WestLB, a German bank, also announced that it would not provide financing for offshore oil and gas drilling in the Arctic region since the "risks and costs are simply too high".

As early as September 2012, Christophe de Margerie, chief executive of oil giant Total, warned oil companies that the Arctic drilling was bad business. He said that not only would "[o]il on Greenland be a disaster", but "[a] leak would do too much damage to the image of the company".

Last month, former BP chief John Browne said that Shell's Arctic programme was "risky". He is not alone and in recent years we have seen a number of large oil companies pulling out of the region, such as Chevron, ExxonMobil and ConocoPhillips of the United States, as well as Denmark's Dong Energy, Norway's largest energy group, Statoil, and France's GDF Suez and Total.

The beginning of Shell's exploration attempts

Despite the warnings, Shell initiated its work in the Arctic in 2012, but the exploration was stopped after problems arose including oil and rig fire and safety failures. It made an investment of approximately $7 billion, but this resulted in the drilling of not a single well when key parts of Shell's infrastructure failed to obtain safety permits and unpredictable ice patterns interrupted its plans.

So why is Shell going back? Why is it so set on the Arctic drilling scheme?

US conditional approval

The Obama administration recently gave conditional approval to Shell's plans to drill in Arctic waters. After several setbacks, including a Greenpeace blockade detaining Shell's icebreaker vessel, Fennica in Portland, Shell claimed to be ready to explore for oil safely. However, is there ever a safe way to explore oil in such a dangerous area as the Arctic? Many do not think so.

Environmental scientists attacked the US decision and cautioned that Shell's "risky and ill-conceived exploration" plan could "lead to a disaster in the Arctic". Tim Donaghy, a Greenpeace senior research specialist also blamed the US federal regulators for "catering to an ill-prepared company in a region that doesn't tolerate cutting corners". He also pointed out that "Shell has a history of dangerous malfunctioning in the Arctic, while global scientists agree that Arctic oil must stay in the ground if we're to avoid catastrophic climate change."

Donaghy went on to express his grief at the Obama administration's approval of Shell's plans and said the approval was an example of regulators "looking the other way while Shell gets away with shortcomings that could lead to a disaster in the Arctic".

The question as to why Shell is still proceeding with this project is left unanswered. The only clear reason is that Shell is still confident that it has "a good plan". Shell fails to listen to the market and has already caused international scandal. If it was to fail in its mission, the repercussions could be immense - both commercially and environmentally.

Update

Today (Monday 28 September 2015) Shell has announced it is stopping its Arctic exploration plans for the foreseeable future. Shell has said that only small amounts of oil and gas have been discovered, which are insufficient to permit further drilling in the area.

 

This is Shell’s second major setback in the area after its exploration was interrupted in 2012 due to a drill breaking free and grounding nearby. In total Shell has spent around $7 billion in its exploration efforts in the Arctic in the last 10 years. For its latest exploration attempt, Shell is likely to face a loss of $ 4.1 billion for abandoning the current well, which is itself valued at $3 billion plus another $1.1 billion for “future contractual commitments”.

However, Shell’s Upstream Americas business director, Marvin E. Odum did point out that: “Shell continues to see important exploration potential in the basin and the area is likely to ultimately be of strategic importance to Alaska and the United States”. It seems that Shell is still holding on to hope that it will one day return to the Arctic. Whether that day ever comes will need to be considered carefully in light of commercial and environmental issues.  

Marcela Marotti is a trainee solicitor at Clyde & Co.