* Agreeing terms to coax Shell back will be touch
* UAE likely to consider improving terms after Conoco exit
* Talks so far only at informal level
By Simon Webb and Amena Bakr
DUBAI, June 23 (Reuters) - The United Arab Emirates' would like Royal Dutch Shell (RDSa.L) to step in as its partner at the $10 billion Shah gas project after U.S. major ConocoPhillips (COP.N) withdrew, industry sources in the UAE said on Wednesday.
Agreeing terms would be the biggest issue in coaxing Shell into taking on the project to produce sour gas in the UAE, the world's third-largest oil exporter, sources said.
Shell lost out in the auction for the project in 2007-2008, after long being regarded as the frontrunner and spending substantial resources on preparing its bid.
"ADNOC approached Shell," a UAE-based industry source said. "Shell might not take on the project as a pride issue because they were rejected before. But if there is a talk of money... I think there will be a compromise."
Conoco pulled out of the project in April, part of a global company strategy change to focus on oil and gas exploration and production and move away from refining and processing.
The Shah project is to produce gas, but it also requires multi-billion dollar investment in gas processing facilities of the type that Conoco wants to avoid.
The UAE has said that it will proceed regardless of Conoco's exit, but that it was looking for another international partner to help execute the complex project.
Shell was one of four companies that bid for the contract, which Conoco won in February 2008. The others were the U.S. companies Exxon Mobil (XOM.N) and Occidental (OXY.N).
Shell was seen as the favourite for the deal until just weeks before Conoco won, as the Anglo-Dutch firm had carried out extensive studies at Shah and has played a part in gas production in the UAE for over 30 years.
Shell is a 15 percent shareholder in state-run Abu Dhabi Gas Industries (Gasco). Gasco holds the concession to produce and process natural gas produced at the UAE's onshore fields.
The UAE has approached Shell about Shah since Conoco's withdrawal, but discussion was informal, industry sources said. A Shell UAE spokeswoman declined to comment.
When Conoco withdrew from Shah in April, Shell was lukewarm to the suggestion that it may participate.
"Our own porfolio of opportunities has moved on a bit," said Shell's Chief Financial Officer Simon Henry told a conference call with reporters in late April. "We've got some great stuff elsewhere in the world now."
Agreeing terms that would make the project profitable for Shell and cheap enough for the UAE would be tough, sources said. The UAE subsidises most energy prices to consumers, so the more it pays Shell, the more expensive the subsidy unless the Gulf Arab state raises prices to consumers.
Still, the UAE would either have to raise the price it was willing to pay for the gas to bring Shell on board, or improve the terms in some other way, sources said.
"Shell has all the experience, technology, and knowledge of the field," said a second industry source. "Shell of course is playing coy now, that's part of its negotiating tactics. But I think if they do come back to the table there would be an option there for them."
What Conoco perceived as poor terms played a part in the its withdrawal, sources said. The UAE wanted Conoco to produce the gas for free, and to recover costs and make profit through sales to internationa markets of condensate, a light oil produced with gas.
To make the project profitable, the UAE would have to offer around $5 per million British thermal units (mmbtu) of gas, the second industry source said.
Offering that sort of internal price for gas would mark a big change in the way gas production and costs in the UAE are perceived, he said.
The region's giant oil exporters have seen gas discoveries as failures to find oil. Gas was perceived as a nuisance by-product, and was either burned, reinjected in oil fields or sold cheaply to state petrochemical companies and industry.
Now, gas demand in Saudi Arabia, the UAE, Kuwait and Oman has outstripped supply as their economies have grown and diversified with a petrodollar-fuelled boom. Kuwait is importing liquified natural gas (LNG) at international prices, the UAE is dependent on gas imports from Qatar, and the emirate of Dubai plans to start importing LNG soon.
This is exposing domestic governments to international markets and promoting a change in the value they place on domestic energy supplies.
Paying more for gas would likely facilitate future projects and import schemes, the second industry source said.
The UAE holds the world's seventh-largest gas reserves, at around 227.1 trillion cubic feet, according to BP statistics. Much of the UAE's gas is sour.
The gas at Shah has a content of around 30 percent of deadly hydrogen sulphide, making it tougher to produce than conventional gas reserves.
(Additional reporting by Reem Shamseddine in Khobar, Saudi Arabia; Editing by William Hardy)