What I learned aboard Shell's grounded Alaskan oil rigJanuary 3, 2013: 8:58 AM ET
Last year, Fortune went inside the Kulluk, the oil-drilling ship Shell planned to use to tap oil reserves in the Arctic Ocean. Now those hopes may be dashed.
By Jon Birger
FORTUNE -- Last March I became the first journalist in 25 years to board the Kulluk, the Shell oil-drilling ship now at the center of an environmental drama unfolding in the Gulf of Alaska.
The Kulluk is a circular-shaped drilling barge, 266 feet in diameter, that is equipped to hold 100 workers and operate in extreme weather conditions. When I toured it, the Kulluk was docked in Seattle, undergoing the last of $292 million in modifications before being deployed to Alaska's Arctic coast. It was one of two Royal Dutch Shell (RDSA) vessels set to commence exploratory drilling in the Arctic Ocean coast last summer. Shell officials believed the Kulluk and its sister ship, the Noble Discoverer, would find massive new oil fields underneath Alaska's icy, northern waters -- oil fields Shell hoped would some day become the company's biggest source of crude oil. (See Fortune's May issue: Why Shell is betting billions to drill for oil in Alaska)
Unfortunately for Shell, bad weather forced the company to curtail last summer's drilling plans, and now Mother Nature has dealt an even harsher blow to Shell's hopes of getting a timely return on the nearly $5 billion the company has already invested in Alaska. On Monday night, as the Kulluk was being towed back to Seattle during a severe winter storm, the drilling vessel broke free from a tow line and ran aground on an uninhabited island. Even if a worst-case scenario were to be averted -- the Kulluk's fuel tanks, which hold an estimated 140,000 gallons of diesel and 12,000 gallons of lubricants, are apparently intact -- the accident could force Shell to shelve its Alaskan drilling for yet another year.
Shell's drilling permits require it to use two drilling vessels, just in case one is needed to drill a relief well in the event of a blowout. Shell is supposed to resume drilling this summer, but it's unclear whether the Kulluk can be repaired in time for summer drilling (assuming the vessel is salvageable) and even less likely that Shell could find a suitable replacement for the Kulluk and secure the necessary permits for a new ship. In the meantime, some politicians in Washington are sure to demand another delay -- if not a complete halt -- to Shell's offshore plans. "Oil companies keep saying they can conquer the Arctic, but the Arctic keeps disagreeing with the oil companies," U.S. Rep. Ed Markey, a Massachusetts Democrat on the Natural Resources Committee, said Tuesday in a statement. "Drilling expansion could prove disastrous for this sensitive environment."
One personal takeaway from my March 2012 tour of the Kulluk was that while Shell seemed incredibly well-prepared for avoiding a repeat of the blowout protector failure that doomed BP's Deepwater Horizon in the Gulf of Mexico -- the Kulluk's blowout protector boasts a extra cut-off valve and other state-of-the-art safety features -- Shell seemed less worried about the unique weather conditions in Alaska. Pete Slaiby, the Shell executive in charge of the Alaskan offshore drilling project, used to work in the North Sea, and Slaiby believed the harsh conditions in the North Sea helped prepare him for what his crews would face in Alaska.
Comparing drilling conditions in the North Sea to those in the Arctic Ocean is difficult because oil companies have so little experience drilling in the Arctic. But the drilling experts I spoke with expected the Arctic to be much more challenging. Also, Native Alaskans familiar with ice flows and extreme offshore weather had serious doubts about Shell's ability to safely operate drilling rigs and production platforms.
Two days before my Kulluk tour, I traveled to Barrow, Alaska, the northern-most municipality in the U.S., to meet with Edward Itta, an Inupiat Eskimo leader and the former mayor of the North Slope Borough (which includes Barrow as well as the Prudhoe Bay oil hub). Itta had started his mayoral term as a staunch opponent of offshore drilling but eventually softened his stance after Shell agreed to concessions such as halting drilling during the Inupiat's annual bowhead whale hunt.
During our conversations, Itta was obviously quite conflicted about Shell's plans and about his own decision to endorse them. He confided he was having a hard time sleeping, fearful that an oil spill could destroy his people's hunting-and-fishing culture. A whaling-boat captain himself, Itta told me stories of Arctic hurricanes and crushing ice flows he thought would pose a threat to any drilling ships or permanent oil-production platforms in their paths. The Kulluk seemed especially vulnerable since it has no internal propulsion system and had to be towed in order to be moved.
For the record, Itta is not some anti-fossil-fuel greenie. Nearly all the North Slope's tax revenues derive from oil and gas production, and Itta understands that finding new oil to replace the declining production out of Prudhoe Bay will be crucial to maintaining the improved standard of living in Barrow. But in Itta's view, it makes more sense to allow onshore drilling in ANWR (a.k.a. the Arctic National Wildlife Refuge -- sacred ground for many environmentalists) than to proceed with offshore drilling in the Arctic Ocean's Beaufort and Chukchi Seas. "You can clean up oil so much easier onshore," Itta told me. "The risks are not even comparable."
Before my reporting trip to Alaska and Seattle, I called up one of the wiser energy analysts I know -- someone employed by a money manager with a large equity stake in Royal Dutch Shell. On previous occasions, this analyst had expressed admiration for Shell's technological prowess and its large investment in R&D. Aware of his fondness for Shell, I asked the analyst what he thought of Shell's Alaska plans. His answer surprised me.
"To me," the analyst said at the time, "it looks like a bad decision by an otherwise well-run company." It wasn't that he doubted there was a lot of oil up there or that he feared an environmental catastrophe. His concern was strategic: The short summer drilling season (when sea ice gives way to open water) gave Shell too little margin for error and made it too hard for Shell to earn a timely return on its investment.
The Kulluk accident, he now says, bears this out: "I didn't expect to see so many things go wrong in their first year, but it shows you how hard it is to do what they want to do. In this business, the name of the game is 'time to first cash flow,' and if you can't get first cash flow for at least 10 years, then it's going to be awfully hard to earn a decent return on the project."
He wasn't the only skeptic. Larry McKinney is executive director at the Harte Research Institute for Gulf of Mexico Studies at Texas A&M, which frequently works with the oil industry. Given the ice and weather conditions, McKinney predicted that it would be "a technological miracle if something bad doesn't happen."
I called McKinney again after the Kulluk accident. He reiterated his initial concern, noting that the Kulluk accident will give "ammunition" to those who oppose offshore drilling. "The conditions are extreme up there," he said, "which means something is going to happen, unfortunately." And when things do go wrong in the Arctic, small problems have outsized business impacts. "A two-month delay in the Arctic is not a two-month delay," McKinney said. "A two-month delay could wipe out the entire drilling season."