Increasing costs cloud view of prices

As oil prices fall to levels not seen since mid-2000s, costs are becoming more important for assessing the near term in Alaska

Eric Lidji

Petroleum News

Some say Alaska survived $40 oil in the past. Others say $40 ain’t what it used to be.

Unveiling her fiscal year 2010 budget on Dec. 15, Gov. Sarah Palin said oil at $40 to $42 a barrel would have been considered “healthy” a couple of years ago, and even “relatively high, compared to some years.” She added that “compared to the $140 that we were blessed with many months ago, the $40-something a barrel looks relatively low.”

With the sharp run up in oil prices over the past three years, Alaska became accustomed to benchmarks that would have been unthinkable just a decade ago. But after peaking at $144.59 per barrel in early July, oil prices began tumbling in October and November.

Through the first three weeks of December, the delivered price of Alaska North Slope crude oil averaged around $38 a barrel, a price not seen since 2005. And on Dec. 19, Alaska crude oil traded below $30 a barrel for the first time since Dec. 5, 2003.

While prices remain well above the infamous $10 oil Alaska faced and survived in 1999, many in the industry say $40 today doesn’t buy what it bought just a few years ago.

“The fundamental cost of our business has changed over the past couple of years,” Jim Bowles, president of ConocoPhillips Alaska, told members of the Resource Development Council during their annual conference in Anchorage in mid-November.

At the same event, outgoing BP Exploration (Alaska) President Doug Suttles estimated oil industry costs have increased between 15 and 20 percent per year for the past few years.

Costs associated with new upstream oil and gas facilities have risen 9.2 percent over the past six months, according to the Upstream Capital Costs Index, published twice each year by the affiliated consulting firms IHS and Cambridge Energy Research Associates.

CERA and IHS create the index using information from their proprietary databases.

The index shows upstream costs doubling since 2005 after several years of only slight growth. A piece of equipment costing $100 at the start of the decade now costs $230.

The cost increases over the past six months can be traced in large part to the parallel rise in oil prices, which increased demand for materials and equipment. As such, the fall in oil prices over September and October has already started to dampen the cost of business.

“Hidden in these substantial increases are the first signs of what may be a change in direction,” Daniel Yergin, CERA chairman and IHS executive vice president, said in a statement released with the report. “Moderation in the last two months of the third quarter was a response to the unfolding financial crisis and the spending cutbacks and points to a precursor to a downward turn in the direction of the (Upstream Capital Costs Index).”

Tax code measures costs

For decades, state economists primarily relied on two figures to estimate oil revenue: the projected price of oil and the projected amount of oil that would be produced in Alaska.

But a new production tax code enacted in 2006, and revised last year, created a credit program to deduct certain capital expenses, like exploration work, from tax payments.

The state issued $662.2 million in these credits during fiscal year 2008.

The winter of 2007-08 was a banner season for exploration in northern Alaska, as exploration and production companies started 14 wells and sidetracks, worked to bring new prospects online and conducted major seismic programs on Alaska lands and waters.

This winter is shaping up to be just as busy across northern Alaska, with companies planning to drill between 13 and 15 wells, and conduct several major seismic programs.

But sinking oil prices and the global credit crunch threaten to dampen industry interest in high cost environments like the North Slope. So far, that business climate hasn’t led to major cutbacks in Alaska, but some companies have spoken about adjusting spending.

The state doesn’t expect a slowdown in exploration activity this year. The most recent projections for this fiscal year show tax credits increasing 16.5 percent to $771.8 million.

For the coming fiscal year, beginning July 1, the projections show tax credits falling 7.2 percent to $715.6 million, highlighting an expected slowdown in work, and not a reduction in industry costs, according to Cherie Nienhuis, acting chief economist with the state tax division.

“I think this reflects that a bit,” Nienhuis said about the most recent revenue forecast.

Although Alaska is a unique cost environment in some regards, Nienhuis said the state estimates tax credits by combining actual receipts with global economic indicators like the cost of materials and labor, as well as the relationship between costs and oil prices.

Oooguruk confuses budget

The decline doesn’t represent a drop in exploration work, though. The budget line only covers exploration companies that don’t produce oil yet, and therefore don’t pay taxes.

The tax credit information is highly proprietary, but the change from year to year can probably be traced to Pioneer Natural Resources and Eni Petroleum, the partners that brought the offshore Oooguruk unit online this past June. The companies can now deduct expenses from their tax payments, rather than request reimbursements from the state.