* Kilometres of Kashagan pipelines defective-sources
* Could be cheaper to replace onshore section
* Project costing around $45 mln a day in lost revenues
* Kazakhstan raises pressure with $737 mln fine
By Oleg Vukmanovic and Stephen Jewkes
MILAN, April 2 (Reuters) - Western oil majors struggling torestart production at one of the world's biggest offshoreoilfields in Kazakhstan have found that whole kilometres ofpipeline are defective, two people recently returned from the$50 billion project say.
Replacing the damaged section altogether may be a better betthan trying to repair it.
Oil company investigators have yet to announce conclusionsabout what went wrong at Kashagan in October, when onshore pipescarrying corrosive gases sprang leaks and brought offshoreproduction in the Caspian Sea to a halt a month after start-up.
Yet early accounts of findings collected from engineering,banking and industry sources, some of whom have just returnedfrom the site, reveal that the scope of technical faults maydelay oil flows longer than expected.
The project has presented huge engineering challengesthroughout the 13 years since work began. Much of it is built onartificial islands to avoid damage from pack ice in a shallowsea that freezes for five months a year.
The oil is 4,200 metres (4,590 yards) below the seabed atvery high pressure, and the associated gas reaching the surfaceis mixed with some of the highest concentrations of toxic,metal-eating hydrogen sulphide (H2S) ever encountered.
It has now emerged that sulphur-laden sour gas burped outfrom the oil field during production last year may have weakenedlong stretches of processing pipelines, two sources said.
"The problem goes on for kilometre after kilometre, it's asystemic problem," an industry source briefed by Kashaganengineers told Reuters.
That defective stretch of pipeline runs mainly throughhard-to-reach swampy terrain, making intervention costly anddifficult.
A banker briefed by management of one of the companiesinvolved in engineering work said he was told the best course ofaction could instead be to lay a new line alongside the old one.
"It is cheaper to build a new parallel line than to pull upand repair the old one," the banker said.
A Kashagan consortium spokesman declined to comment beyondsaying that no decision has yet been taken on the pipelinerehabilitation plan. At the same time it delayed the release ofits final results into the pipeline investigation to thesecond-quarter.
COMPRESSORS
Problems with an inspection robot designed to help detectwhat is wrong were not helping, another source, who makesfrequent trips to Kashagan, said, and compressors designed tokeep the oil flowing were causing extra headaches.
Two compressors are known among the thousands of workers onKashagan as "the widow maker" and "the rotating bomb",nicknames, a consortium spokesman pointed out, which refer notto unsafe working conditions but to the complexity of the kit.
Output remains stuck at zero despite initial projections of180,000 barrels per day in the early phase of productionbuild-up on a field that aims to produce 1.66 million barrels aday at peak - as much as OPEC member Angola.
According to Reuters calculations, by mid-year, lost revenueis likely to amount to between $4 billion and $12 billion.
A second engineer associated with the project said theconsortium's decision to keep the pipelines outside in harshconditions may have stripped away their corrosion-resistantcoating, rendering them more vulnerable to leaks.
"The storage was the problem, the pipes were left in thedesert for too many months and this altered the coating of thepipes," the source, a specialist in inner-tube coatings onKashagan said.
The consortium over-estimated the acidity of the sour gaswhen they built and treated the pipelines, the source added, "soit can't have been a problem of estimating the content of acid".
Another source with one of the Kashagan stakeholders alsosaid that the span of pipeline under scrutiny is kilometreslong, with coatings at the heart of the problem.
The consortium said only that toxic gas lay behind theproblem. "Sulphur stress cracking was identified as the rootcause of the pipeline issues," the spokesman said. "This processoccurs if steel of high hardness is exposed to highconcentrations of H2S (hydrogen sulphide) under high pressure inthe presence of water," the spokesman said.
"This mechanism is not at all related to normal corrosion(formation of rust) but solely to the hardness of the steel".
Last month, infuriated Kazakh officials slapped a $737million ecological damage fine on the consortium, which includesEni, Exxon Mobil, Royal Dutch Shell,Total, and Kazakh state-run KazMunaiGas.
The penalty is the strongest signal to date from Kazakhstanthat it is running out of patience, while the consortium'sdecision to fight the fine could raise tensions with agovernment grown more assertive with foreign investors.
The consortium, which was meant to start its first output 10years ago, has already seen KazMunaiGas taking a large stake inthe project last decade following previous delays that angeredthe government.
A repeat of that scenario together with the state's possiblerefusal to pay a chunk of development costs are the main threatsto the group just as the restart date remains deeply uncertain.
"The project stopped production as a result of pipelineissues with the hydrocarbons coming onshore," Shell's chieffinancial officer Simon Henry said last month.
"All the partners have contributed their technical expertiseto look at how this challenge of running the pipelines can beaddressed. There is no decision yet about how best to do this orwhen production can be restarted," he added.
"DRAGGING ON"
Kazakh officials have said they have no plans to nationalisethe project so far and say they hope it could restart in thesecond half of 2014 and produce 22 million barrels of crude bythe end of the year.
Up to now, Kashagan has missed out on around $2.7 billion inoil revenue, a fact likely to cast a shadow over statedecision-making.
The contractual terms stipulate the government may refuse toreimburse the costs, potentially the entire $50 billion bill, ifthe consortium misses the final deadline. That was set by thestate as October 2013.
The Kashagan spokesman said that output had in fact brieflyreached commercial levels, as written in the contract, of 75,000bpd before its shutdown, but not for long enough to count.
A nine-month delay from September 2013 to July 2014 willcost the consortium at least $12 billion of lost oil revenuesbased on full scale output of 450,000 barrels per day.
Even if minimal output levels of 150,000 bpd are taken intoaccount, lost revenues would still be a hefty $4 billion,according to Reuters calculations.^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For a graphic on Kashagan - http://link.reuters.com/pen92v ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
"It's dragging on. Everyone's losing money, big money, andso they all want to get on with it. But there are technicalproblems," said a source just back from Kashagan.
For its part, the central Asian state urgently needsproduction revenues to hit its fiscal targets for 2014, based onprojected cash inflows from Kashagan at up to three percent ofgross domestic product.
Past oil project delays have been seized upon by thegovernment as a chance to levy hefty fines and boost its shareof future production revenues.
Unfortunately for everyone involved, the best way ofdefusing rising stakeholder tensions hangs on oil companycontractors getting to grips with the sweep and complexity ofthe project's engineering challenges.
But smooth operation at the current juncture looks largelyout of reach.
Efforts to contain equipment breakdowns offshore has givenrise to black humour among the ranks of engineers.
An engineer with one of the western oil companies involvedin Kashagan who recently returned from the site said technicalbreakdowns on production-critical equipment keep workersjuggling priorities.
Particularly singled out for complaint are the platform'stwo main compressors, designed to keep oil flowing bymaintaining reservoir pressure and stripping out the gascomponent of oil production.
"They're a mess...we call one 'the widow maker' and theother 'the rotating bomb'," said the engineer. "That's how wetell them apart when assigning work orders," he said.
Furthermore an inspection robot, called a PIG, sent to scanthe inside of Kashagan's pipelines for data and clues is sendingback patchy data.
"The problem is the PIG has a 60 percent reliability rate."the first source just back from Kashagan said. "Its not like anX-ray. It's like a blurred X-ray."
(Additional reporting by Dmitry Solovyov in Almaty and DmitryZhdannikov in London; editing by Philippa Fletcher)
