Aurora at crossroads in Cook Inlet

Wildcat drilling changes the company’s investment risk profile while a lawsuit with Enstar places question marks over the Moquawkie area

Alan Bailey

Petroleum News

Since the company’s formation in 2000 Aurora Gas has established itself as small, independent explorer and producer, bringing natural gas to market in Alaska’s Cook Inlet. The company now operates five gas fields — the Nicolai Creek, Moquawkie, Lone Creek, Three Mile Creek and Kaloa fields — on the west side of the Inlet. But an initial relatively low-risk strategy of drilling close to known gas accumulations has run its course and the company has in the past couple of years started to turn its attention to drilling wildcat wells.

A successful exploration well at Three Mile Creek in 2004 was followed in 2005 by the Aspen well — Aspen did not encounter commercial quantities of gas. And the Long Lake 2 natural gas exploration well, drilled in 2006, also proved to be a dry hole. All of these wells are on the west side of the Cook Inlet.

In March 2006 Aurora Gas and Swift Energy announced a joint venture to explore some of Aurora Gas’s Cook Inlet acreage. And in April 2006 the joint venture drilled a dry hole at the Endeavour oil prospect in the southwestern Kenai Peninsula.

Now Kaiser Francis Oil Co. of Tulsa, Okla., which owns more than 90 percent of Aurora Gas, is taking a hard look at whether it wants to spend more money on Cook Inlet exploration wells.

Kaiser Francis has been a great investor in Aurora Gas, Scott Pfoff, president of Aurora Gas, told Petroleum News on March 9.

“They have a certain risk profile that they like to tackle and that’s what we’ve provided them,” Pfoff said. But now that most of the low hanging fruits of bypass plays and well re-entries, involving known gas pools, have been worked, Kaiser is evaluating its future interest level, he said. And that future might require a new owner with an interest in more high-risk/high-reward projects.

Pfoff expects that Kaiser’s appraisal of the Cook Inlet situation will take about a couple of months. But, meanwhile, no funding is available for new exploration projects.

“They’ve basically put the brakes on us,” Pfoff said.

Moquawkie litigation

Aurora Gas has said that its decision to cease delivery resulted from gas production becoming uneconomic at the contract price of $3 per thousand cubic feet and that, under the terms of the contract with Enstar, Aurora Gas maintained the right to suspend gas deliveries, if the contract price were to prove uneconomic.

“The main thing that we’ve asserted is that it is not economic for us to produce and sell gas at the contract price,” Pfoff said.

Pfoff said that the way in which the State of Alaska calculates royalties Cook Inlet gas production compounds the problem. Essentially, for Cook Inlet gas sold to a utility, the state calculates royalties as a percentage of what the state terms the “prevailing value” of the gas. That prevailing value is the weighted average cost of all Cook Inlet utility gas. But because of relatively high pricing in the major Cook Inlet gas supply contracts, that prevailing value is typically much higher than the gas price in Aurora Gas’s Enstar contract. And the consequence of paying royalties based on high prevailing values is to reduce the effective price of the Moquawkie gas significantly below the $3 contract price, Pfoff said.

Compensation

“They’re asserting that they’re having to buy replacement gas at a higher rate, so they’re coming after us for the difference,” Pfoff said.

Pfoff said that Enstar is claiming the cost differential on the total volume of gas specified in the contract, although Aurora Gas does not have enough gas to fully meet the contract specifications and the contract does not guarantee deliverability.

In response to the litigation Aurora Gas has shut down all exploration and field development work in and around the four gas fields, in the company’s core Moquawkie area.

“Until we get this dispute resolved one way or the other we’re pretty well shut down in that core area,” Pfoff said. “… We’re not going to do anything of significance in the core area at the contract price. We cannot do it. It just doesn’t work. … It’s very frustrating because we’d much rather be out there drilling wells.”

And, if Aurora Gas loses the Enstar case, the company will essentially be out of business in its core operations area, Pfoff said. The company would just produce the existing wells as best it could at a declining rate, said Ed Jones, Aurora Gas’s executive vice president engineering-operations.

“It’s a declining asset and it declines all the more if we can’t spend money to keep it up,” Jones said.

No plans for 2007 drilling

In particular, the Swift Energy joint venture is very much alive, he said. Swift has an interest in various packages of Aurora Gas acreage, outside the producing gas fields. And after drilling the Endeavour well in 2006, Swift has first pick on where to drill a second well — participation in Endeavour earned Swift the right to an interest in Aurora Gas’s other oil prospective acreage.

“The agreement that we signed with them contemplated at least two wells,” Jones said. “… They probably have some economic incentive to see that at least one more well gets drilled. …At this point they can choose what one they want to go after next.”

Pfoff said that since the drilling of the Endeavour well Swift has been preoccupied with an acquisition in Louisiana.

“I think they’re back (now), taking a serious look at the inlet and what prospect they want to drill next,” he said.

Potential oil prospects include Aspen, just west of Tyonek on the west side of Cook Inlet, where Aurora Gas drilled the 2005 gas exploration well.

“There are a couple of potential locations there, and they are interested in those,” Jones said.

But the Aspen oil prospect lies deep below the 2005 gas target and would be expensive to drill.

“We also have some oil prospects around Nikolai Creek that are a little shallower and maybe a little less expensive,” Jones said.

In November 2005 Aurora Gas signed an agreement with Trading Bay Oil and Gas to take a majority interest in the Hanna prospect on the west side of the Cook Inlet. An original plan to drill a well in 2006 into the Hanna gas prospect was postponed. Pfoff said that, in addition to that relatively shallow gas prospect, Aurora Gas identified a deeper gas prospect and a deep oil prospect at Hanna. Aurora Gas is now hoping to find a partner to share the cost of drilling the deeper gas prospect and the company advertised that prospect at the February 2007 NAPE expo.

The gas market

“Even though it’s tough on the pocketbooks of consumers I think we’ve made good progress in bringing the price of gas up to where it needs to be,” Pfoff said.

Pfoff commented that he understands the dismay of consumers when they see steadily increasing gas bills but that people need to understand that companies like Aurora Gas have to put money into the ground to develop new gas resources. And operating on the west side of Cook Inlet is very expensive, with little infrastructure and everything having to be flown or barged in.

“So we know what it takes to get gas out of the ground and get it to market,” Pfoff said. “There’s a lot of gas out there that we could do that very thing with it if there were $7, $8 prices available to us.”

But there is no spot market in which to sell gas because all of the gas demand is hooked into contracts with the producers. That creates uncertainty for a company new to the region that wants to develop a new gas field.

“It’s the ultimate irony that we’re faced with the situation where there’s declining (gas) deliverability … but a new player coming in to drill a gas well in Cook Inlet has no assurance of selling its gas for several years out even if it makes a discovery,” Pfoff said.

In 2006 the Regulatory Commission of Alaska rejected a proposed new gas supply contract between Marathon and Enstar because the commission viewed the pricing formula in the contract as too high. But Aurora Gas’s only real objection to that contract was the fact that it would have accounted for all of Enstar’s unfulfilled future needs for several years and would not have left any room for new gas suppliers.

Some people have suggested that RCA should force gas supply contracts to set aside some percentage of the gas demand for a spot market. Since, however, the two major Anchorage power utilities, Chugach Electric Association and Municipal Light and Power, have secured gas supplies for several years to come, Enstar would have to take the brunt of supporting the enforced spot market.

“Unfortunately that puts Enstar in the crosshairs and I don’t think Enstar should necessarily have to be the only one that guarantees a market,” Pfoff said. “… Maybe there’s a way to re-juggle all of this between the utilities, the (Kenai Peninsula) LNG plant and Agrium (owner of the Kenai Peninsula fertilizer plant), where somehow we get people to realize the importance of having some open market available for new players coming into the Inlet.”

Gas line not a threat

“We don’t see it as threat to our business,” Jones said, commenting that a gas spur line connecting to a main North Slope gas export line would tie Southcentral Alaska gas prices into Lower 48 prices.

The biggest impact of a gas line on Southcentral Alaska would be the impact of gas line development on the local economy — if the project gets going there will be growth in Anchorage and that will translate to a bigger demand on the local utilities, Pfoff said. But the need for significant Southcentral industrial gas demand to justify the cost of a spur line presents a significant challenge, he said.

Besides, there is still plenty of gas to find in the Cook Inlet basin, Pfoff thinks.

“I think it would be a shame to not continue to try to explore for and develop the gas … in Cook Inlet,” Pfoff said.

And Jones thinks that one of the biggest issues facing Cook Inlet gas development is the need for new drilling and completion technologies to improve gas recovery from the Cook Inlet basin’s notoriously challenging gas reservoirs.

“Drilling and completion is really the issue that we see right now as critical,” Jones said. “… We need to do some things to improve the effectiveness of our well completions, to get higher initial deliveries and higher long-term recoveries from each well bore.”

But Aurora Gas’s current pre-occupation is to clear up the Enstar litigation and figure out where to go from here, hopefully with a renewed exploration and development program.

“These are real jobs. There are guys who have worked for us six summers in a row,” Pfoff said. “… There’s a lot of direct payroll from us and then there’s all the domino effect with the service companies and that kind of work.”

But the logistics, weather conditions, strict regulatory climate, high costs and difficult geology of the western Cook Inlet present formidable challenges.

“We have six, seven years of going to school in the Cook Inlet. It’s certainly a difficult school,” Pfoff said. “… We’ve done it. We’ve had a moderate amount of success. We’d like to build on that.”

“We’re not pessimistic about it … there’s a lot of potential here,” said Jones.