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Providing coverage of Alaska and northern Canada's oil and gas industry
February 2010

Vol. 15, No. 7 Week of February 14, 2010

Alliance hears pluses, minuses on Alaska

State has good geology but small market; limited support services, infrastructure; high costs and mixed messages from government

Kristen Nelson

Petroleum News

The question asked at this year’s Alaska Support Industry Alliance annual meet Alaska conference — are “Happy Days ... Here Again” for the Alaska oil and gas industry or are they “Gone with the Wind” — was addressed by a panel of five speakers from Alaska’s oil and gas, refining and transportation industries.

On balance, the speakers on the Jan 22 panel found more to be concerned about than otherwise, in remarks that spanned the geographic scope of the Alaska oil and gas business from Cook Inlet to the North Slope, and addressed challenges from exploration through development to transportation and refining.

Cook Inlet concerns

Carrie Lockhart, Alaska asset team leader for Marathon Oil, said it’s more difficult to talk about things that are not going well, “And the deliverability and reliability of natural gas in Cook Inlet or Southcentral Alaska is not going well.”

Last year there was interaction among many stakeholders in the area to address two issues, Lockhart said, “the need for peaking and storage mechanisms across Cook Inlet” but also the need for “contingency plans across the inlet in the event of a what if.”

Contingency plan work includes producers, utilities, communities and the state, she said.

“Those are coming together” and a lot of work is going into those plans, although “… contingency plans probably should have been put in place long, long ago because you never know when there’s going to be a critical upset whether it’s Mother Nature or a facility disruption.”

On the supply side, “Easy oil is gone,” Lockhart said. “It takes more technology to tap into these resources that are much higher risk — things we wouldn’t have dreamt of developing two decades ago we’re going after today.”

But that increases the costs and the recoveries are lower, which makes it more challenging for these projects to compete for financing at the corporate level.

The Cook Inlet market is also a challenge because the local market, the utilities in Cook Inlet, “is very small and the local utility market alone will not enable large-scale exploration or development.”

Companies will not invest where capital will be stranded for lack of a market, Lockhart said.

There is no silver bullet — no single fix — for Cook Inlet.

“There has to be a market outlet for the gas,” regulation “needs to be predictable and sensible” and projects have to be economic to compete at the corporate level, she said.

North Slope issues

Dick Garrard, geosciences manager for FEX, said he was not speaking for the company, but was presenting “observations regarding exploration that I’ve made over 15 years here exploring in Alaska.”

Garrard said he looked at Alaska Oil and Gas Conservation Commission records for exploration — a commission category that includes both wildcats and exploration appraisal wells.

“And as far as I can understand we may be seeing, optimistically, up to four or five wells drilled in Alaska, exploration wells, this winter,” a number which includes re-entries of old wells and continuation of earlier drilling.

“Going back in the records I can’t come across another year where we’ve had less (exploration) activity, right up until 1956, and that precedes the Swanson River discovery,” Garrard said.

And for the first time in a long time there will be no exploration seismic shot in Alaska this winter, he said.

Leasing activity, too, “may reach an all-time low this year.”

So what are the positives and negatives for oil and gas activity in Alaska?

T-H-E C-U-P in Alaska is positive, Garrard said, using an acronym for: technology, hydrocarbon charge, exploration and development incentives, cooperation, under explored and pipeline capacity.

There is superb technology, particularly 3-D seismic, enabling “us to see things that we’ve never seen before.”

The North Slope has a “prolific” hydrocarbon charge, with “bidirectional charge going up onto the Barrow Arch — multiple source rocks,” resulting in a good chance that wells drilled on the North Slope will find hydrocarbons.

The state offers exploration and development incentives, something Garrard called “a step in the right direction” which helps with exploration costs in remote areas.

The cooperation from state agencies, particularly the Division of Oil and Gas and the Division of Geological and Geophysical Surveys, is a plus, he said, and the state has “very talented people” in those agencies who are very helpful for new companies coming into the state and “can be a fantastic source of information.”

In the National Petroleum Reserve-Alaska and the Foothills of the Brooks Range the state is under explored, with one well for about every 300 square miles.

And there is pipeline space available, with the trans-Alaska oil pipeline running at about 30 percent of capacity.

On the negative side are what Garrard catalogued as C-R-I-T-T-E-R factors:

• Cycle times are “painfully long” with 14 years in NPR-A, for example. An investor isn’t going to invest in a project that can take 14 years from discovery to first oil, he said.

• Reservoir quality is challenged, with reservoirs at new discoveries thin with low-quality permeability and expensive to produce, requiring long horizontal wells and fracture stimulation.

“The resource is there — it’s more expensive to get out,” he said.

• “I” is for infrastructure, specifically the lack thereof. Very little new infrastructure has been built on the North Slope in the last 30 years, Garrard said. And there is no infrastructure near NPR-A. The State of Alaska is looking at a road to Umiat, he said, but the federal government is not looking at linking that road into NPR-A.

• Technical data is not available, he said, noting that unlike other parts of the world Alaska has no provision for releasing old seismic data.

• Taxes are also an issue, he said, because in Alaska companies don’t get to keep a lot of the upside. At $80 a barrel, he said, ACES takes three times what the tax was under the old system, referred to as ELF, for economic limit factor.

• And Alaska is expensive, “incredibly expensive,” Garrard said. Work is seasonal, he said, but “it is logistics which … is the huge cost. It’s not the drilling and it’s not the materials; it’s the logistics that seems to … make it so expensive in Alaska.”

• Regulations “are onerous,” he said. Companies are invited to explore for oil and gas and then there are “agencies that seem to come in and do everything they can to prevent you exploring.”

Alaska needs to “be more competitive on a global scale,” Garrard said, because everything is negotiable except the geology.

Alaska has the geology, “but we’re not drilling enough exploration wells,” and without the exploration wells “we cannot hope to succeed at adding reserves.”

The development side

Ken Sheffield, president of Pioneer Natural Resources Alaska, said “development operations … must make enough profit to cover not only the successful exploration but all the unsuccessful exploration”; it’s where a company makes its money.

Remaining oil on the North Slope is “in remote areas both nearshore and offshore; it’s in smaller and lower quality reservoirs” and it’s heavy oil.

Technology is advancing, he said, with horizontal and extended reach drilling and hydraulic fracturing.

“But with the tough reservoirs that we’re given, it requires more wells and more cost to get the same amount of oil out of the ground.”

On the North Slope “development continues to be challenged by high costs.”

“Our unique geography contributes significantly to that, (both) the high cost of transportation to bring supplies and materials up to the slope (and) the high cost to get our oil to the markets on the West Coast,” Sheffield said.

Other contributing factors are “a relatively small service market which limits competition” and upgrades required to operate in the cold weather on the North Slope.

“And construction up on the North Slope is very inefficient and costs quite a bit more,” Sheffield said.

After the huge cost increases over the last three years, costs have dropped back “quite a bit” in the Lower 48, but haven’t dropped back by as much in Alaska, where “it’s just a little tougher” with the state’s small service market.

The regulatory environment is also challenging, he said.

“We operate in a unique pristine environment,” with “complex regulatory processes” sometimes with overlapping federal, state and local jurisdictions, and “all this complexity costs us time and costs us money,” and the cumulative impact “makes Alaska a very tough place to operate.”

And Alaska projects have to compete for capital.

Sheffield said the state needs to focus on things it can control.

“We need to get new areas open to responsible development,” he said.

“We need to work for regulatory certainty and regulatory streamlining.”

“And on the fiscal policy side, with all the challenges that there are to development, I think the state needs to err on the side of more investment,” he said, and specified the increased tax credits that have been proposed.

As for the tax rate and progressivity, Alaska projects compete against projects that “don’t have escalating tax rates. So we will be at a significant disadvantage as compared to those projects,” Sheffield said.

The transportation side

Greg Jones, senior vice president of Alyeska Pipeline Service Co., said while “Alyeska has just finished its best year on record from a performance standpoint,” the challenges and opportunities facing Alaska’s oil industry come together and impact the state in the trans-Alaska oil pipeline.

Throughput on the line peaked at 2.1 million barrels per day in 1988, Jones said, is at some 680,000 bpd currently and at the current rate of decline will be at 500,000 bpd in 2014.

And “declining throughput poses significant technical challenges for the pipeline,” he said.

In 1988 it took just four days for a barrel of oil to go from the North Slope to Valdez; today it takes about 12 days.

“By 2014 we anticipate the crude temperature will be approaching or dipping below 32 degrees and even today when we have slowdown, for instance with high winds in Valdez … we begin approaching ranges in the mid-30s,” Jones said.

The trans-Alaska oil pipeline was designed to move warm crude oil and with dropping temperatures “we have to anticipate more wax buildup, water dropout, freezing and frost heaves.”

In Valdez the tanks no longer shed snow because of cooler oil temperatures and snow has to be removed from them manually.

Alyeska has a $10 million study under way to look at the technical issues, he said, and has “already updated and converted three of our pump stations and we have one more to go.”

Other investments by the pipeline’s owners will be required in the future to extend the pipeline’s viability, Jones said.

But there are also economic challenges, because as throughput declines, “the cost for transporting each barrel increases and that cost will be compounded by any additional investment.”

Taxes are also a factor, he said, with a three-fold increase when the State of Alaska changed the way it valued the pipeline from an income approach to what it would take to replace the line today.

All this increases the transportation cost and “this increasing cost per barrel decreases Alaska’s attractiveness for oil and gas development; if we do nothing to change the economics of running the pipeline, our costs per barrel will quintuple in the next two and a half decades,” he said.

Even if Alyeska cuts 3.5 percent out of its expenses each year, “the cost per barrel will still double by 2033.”

Alyeska’s 2010 capital and expense budget is down some $100 million from 2009, Jones said, and the company recently reduced the number of its employees and contractors.

“Some of these decisions are very hard and they’re not popular, but we have to face the economic reality of declining throughput,” Jones said.

Refining Alaska’s crude oil

Kip Knudsen, Tesoro Alaska external affairs manager, said neither “Happy Days” nor “Gone with the Wind,” describes the U.S. refinery sector — “the only movie title that comes to mind is ‘Armageddon,’” with seven North American refineries closed permanently or indefinitely and recent talk about another closing.

But refining is a cyclical industry and it might survive, he said.

Alaska has its own particular refinery issues.

While the Tesoro Nikiski refinery is in one of the world’s premier oil regions, the company currently has to use 20 to 30 percent foreign crudes, because it can’t buy enough Alaska crude oil.

This “amazing statistic … makes people mad,” Knudsen said. “They think somehow we’re shunning Alaska oil.”

The company would buy all its crude in Alaska if it could, but there isn’t enough crude oil available to meet all of the needs of the Nikiski refinery, and Tesoro has “to go as far away as Nigeria now to buy crude that looks like … North Slope” crude oil.

Over the long run, that isn’t good, he said.

“Obviously you build a refinery … where either the market is or the crude is and we’re a little bit challenged by both.”

Not only isn’t there enough Alaska crude, but Alaska is a small gasoline and diesel market.

Then, he said, add the fact that the company has spent $200 million over the last five years just to stay in the gasoline and diesel business in Alaska, and has another investment coming up this summer to take benzene out of the gasoline.

Add to that the fact that it hasn’t gotten any easier to operate ships in Cook Inlet since 1989.

Then there are support industries, Knudsen said.

“Nikiski used to be a booming place with all kinds of support industries — many of you have suffered through this decline,” he said.

And there are efforts by some to change how the market operates.

“Government needs to maintain a level playing field,” Knudsen said.

Beyond that, either consumers or taxpayers will pay for any government-mandated actions, “because when government intervenes they generally end up making it a more expensive process,” he said.






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