http://online.wsj.com/article/SB1234...

By GUY CHAZAN

HAMMERFEST, Norway -- A Norwegian oil company has gone to the ends of the earth -- almost literally -- to get at some of the world's last untapped energy resources.

StatoilHydro ASA operates a pioneering venture deep inside the Arctic Circle, energy's final frontier. The company pumps natural gas from under the freezing waters of the Barents Sea, cools it into a liquid and exports it to Europe and the U.S.

The project, called Snoehvit, has taken StatoilHydro and the entire oil and gas industry into uncharted territory. Before, no one had ever produced liquefied natural gas in the Arctic -- or in Europe, for that matter. And blazing that trail has been fraught with problems, putting Snoehvit behind schedule and over budget.

But the lure of the Arctic has proved irresistible, and not only for StatoilHydro. The region is thought to contain just over a fifth of the world's undiscovered oil and gas resources. Even conservative estimates put its reserves at 100 billion barrels of oil.

Allan Klo

Statoilhydro's pioneering liquefied natural gas plant on an island off Hammerfest in Norway has encountered an array of problems.

That has made it a huge draw for Western oil companies frozen out of places like the Middle East. Last year, in a record lease sale, Royal Dutch Shell PLC paid $2.1 billion for exploration blocks in the Chukchi Sea, off the coast of Alaska.

The oil companies are being aided by climate change. Lashed by storms and strewn with icebergs, the Arctic is one of the most hostile environments on earth. But global warming is melting the polar ice cap, opening up new shipping routes and unlocking once-inaccessible mineral deposits.

When a Russian submarine planted a flag under the North Pole in 2007, some predicted a scramble for the region's riches. But the Arctic will still take decades to develop. It is isolated from traditional markets, manpower and material. And environmental groups are resisting the development of a region they view as pristine wilderness.

Shell was forced to give up plans to drill in Alaska's Beaufort Sea this year after a legal challenge from green organizations. And the WWF, a global conservation group, has called for a moratorium on all new oil and gas exploration in the Arctic, saying the environmental risks are too high.

With the world mired in recession, credit markets tightening and cash flows evaporating, the economics of Arctic oil are also looking more doubtful than they did even a year ago. Producing oil offshore there costs between $35 and $40 a barrel. With crude now trading at around that level, some Arctic projects will struggle to break even.

The Snoehvit gas field -- the name means Snow White in Norwegian -- was discovered in 1984 off Hammerfest, a small fishing community that is the northern-most town in the world. Despite strong opposition from local activists, who said the Barents Sea should be off limits to Big Oil, Norway's parliament passed a development plan for the field in 2002.

From the start, Snoehvit was to be a showcase for StatoilHydro's expertise. Rather than using offshore drilling platforms that might disturb fisheries and interfere with sea traffic, it would pump Snoehvit's gas from remote-controlled wells on the seabed.

That entailed building a 90-mile multiphase pipeline -- the longest in the world -- to carry the volatile mixture of unprocessed gas, condensate and water to shore. The gas was to be processed on Melkoya, a small island near Hammerfest, and sent as LNG to Europe and the U.S. Carbon dioxide stripped from the gas would be sent back offshore and reinjected into the seabed.

But StatoilHydro faced gargantuan challenges. Most LNG plants are built on site. But Hammerfest lacked the infrastructure and manpower to construct one. So the plant had to be built thousands of miles away in Spain and sent to Norway aboard the world's largest heavy-lift vessel, Blue Marlin. The 33,000-ton plant was then floated into a dry dock blasted out of Melkoya. The operation required a full moon, a high tide and "a lot of voodoo," says Knut Henrik Dalland, vice president of Hammerfest LNG, the Statoilhydro-led venture.

From the start, Statoilhydro faced criticism, especially for its choice of a contractor. It selected Germany's Linde AG, passing over Norway's own Aker Kvaerner ASA, which was much more experienced at delivering big, complex projects for Norway's Continental Shelf. "They went with the low-cost option," says Gudmund Halle Isfeldt, an analyst at Norwegian bank DnB NOR.

StatoilHydro concedes that the plan for Snoehvit was "immature" when the project got the go-ahead. "The technical solution, the design and so on should have been more advanced before the final investment decision on Snoehvit was taken," Mr. Dalland says.

The plant finally started production in September 2007, a year behind schedule. But it took months to get it working properly. During that time, excess gas that wasn't being treated in the plant had to be flared, or burnt off. The practice is usually banned in Norway as harmful to the environment, but the local authorities granted Statoilhydro emission permits.

"The town was covered in soot," says Svein Joerstad, editor of a local newspaper. "Cars, boats, houses were turned black. There was a lot of anger." Last May, the authorities in Oslo disclosed that flaring at Snoehvit was the main factor behind a nearly 3% rise in Norway's greenhouse gas emissions in 2007.

The plant was also shut down repeatedly for repairs. Engineers discovered that its seawater heat exchangers -- which play a key role in the gas liquefaction process -- were leaking. Two had to be replaced; four others will be switched later this year. Each outage has been accompanied by more flaring.

"The problem with being so close to the community is that when you have a 100-meter high flame, with black soot coming from it, it's very visible," Mr. Dalland says.

In October, StatoilHydro was forced to raise its cost estimates for Snoehvit drastically. The price tag for the first phase was set at $7.73 billion, up nearly 50% from the original estimate of $5.24 billion. The cost for the next three phases was increased $1.2 billion to $3.34 billion.

"It has been a disaster for the company," says Mr. Halle Isfeldt, the analyst. He concedes that Statoilhydro is gaining more experience running the LNG plant and is rectifying the last remaining design flaws, but, he says, the falling price of LNG will put the project under even more financial strain.

StatoilHydro, on the other hand, is upbeat. The plant is currently running at 80% to 90% of capacity, up from around 60% last year, company officials say. Outages are typical for the run-in period of a big LNG project, and flaring will soon be a thing of the past. Sure, they say, the start-up period has been troubled, but this is a field with a production life of up to 40 years.

They concede, though, that plans to expand the LNG plant are on hold. Despite a lot of drilling, the gas needed to supply it has failed to materialize. "We haven't found the key to the Barents yet, the El Dorado," Mr. Dalland says.

Write to Guy Chazan at guy.chazan@wsj.com