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DNR proposing royalty relief regs The new guidelines aim to clarify and standardize a 15-year-old statute used to induce development at marginally uneconomic fields Eric Lidji For Petroleum News
The Department of Natural Resources is proposing regulations for offering royalty relief.
The regulations aim to codify a 15-year-old statute that allows the State of Alaska to lower its royalty share on leases in order to make an undeveloped field economic.
“Although we’ve had the statute in existence for 15 years, this is the first time we’ve had regulations,” Division of Oil and Gas Director Kevin Banks told Petroleum News.
While the statutes governing royalty modification are unusually detailed because worried lawmakers aimed to close as many potential loopholes as possible, Banks said the cases to date have been “a bit ad hoc” because of the lack of regulations guiding the process.
With the North Slope in its fifth decade of production and a group of companies eyeing untraditional prospects, the department is expecting more royalty relief applications in the near future. It began crafting regulations a year ago to clarify and standardize the process.
Three benchmarks for relief The goal of the eight-paged regulations issued April 14, Banks said, is to guarantee that future applications judge the effectiveness, efficiency and objectivity of royalty relief.
Effectiveness means royalty relief must make a field economic. The department can only reduce the royalty to 5 percent, from its usual 12.5 or 16.67 percent, and “that little bit of a change has to make a material difference in the economics of the project,” Banks said.
Efficiency means that the department can only reduce the royalty to the point where a field becomes economic. “It shouldn’t be any more than what it takes to get what you need from the lessee,” Banks said. “You wouldn’t give any more away than you really had to.”
Objectivity means that the department can only offer royalty relief to “induce a prudent operator to pursue development.” It can’t use royalty relief to make an already economic field in Alaska more economic than some other field in a lessee’s global portfolio.
The regulations also aim to balance the public’s right to know why it is getting a smaller share of its oil and the industry’s right to protect proprietary information. For instance, while the regulations don’t require a company to publicize the actual economics of a project, they do require the company to publicly quantify the benefits of royalty relief.
While only a year in drafting, Banks said the regulations come from five years of on the ground experience, specifically from three royalty relief applications made since 2005.
The department is taking comments on the proposed regulations through May 16.
A rough and slow start Until 1995, the department could only offer royalty relief for aging fields in jeopardy of being shut-in because costs exceeded revenues, and for fields already shut-in for that reason.
As North Slope oil companies began exploring more marginal fields and global oil prices slumped, then-Gov. Tony Knowles proposed expanding the program, allowing the department to offer royalty relief to operators looking to bring new fields into production.
The idea drew heat from lawmakers, who worried that it gave too much power to the Department of Natural Resources commissioner and undermined the competitive bidding process used to lease state lands. After a long legislative debate, though, the proposal eventually became law.
In the first decade of the program, the department only fielded a handful of applications.
BP asked for royalty relief at Milne Point in 1995, but described the application as a “formality” to satisfy partner agreements and said it knew the request would be denied.
Union Oil Co. of California asked for royalty relief in 1997, according to Banks, looking to economically combine 10 Cook Inlet platforms. The department decided that fell outside the scope of the program. Banks said Phillips asked for royalty relief to develop the Tyonek Deep field, but ultimately withdrew the application following its merger with Conoco.
Program builds momentum The program got a second wind in the early 2000s, though, when Armstrong Resources began exploring North Slope prospects and bringing on partners for development.
Pioneer Natural Resources got royalty relief at the Oooguruk unit in late 2005.
In return for reducing the royalty rate on nine leases at the offshore unit to the minimum of 5 percent, the department converted five leases into net profit share leases, giving the state a 30 percent stake in profits once operating costs have been deducted and exploration costs recovered. It also required Pioneer to sanction development before the end of 2007.
Pioneer ultimately brought the field online in June 2008.
Kerr-McGee applied for royalty relief at its Nikaitchuq and Tuvaaq prospects in early 2006, but the department denied the request later that year, saying that the new oil production tax signed into law that summer “materially improved” the economics of the project.
Eni Petroleum acquired the prospects in 2007, combined them and took another stab at getting royalty relief, successfully getting the department to grant royalty relief on 11 leases.
Under the Nikaitchuq deal, the possibility for royalty reduction only lasts for the first 25 years of sustained production at the unit and only kicks in when oil prices fall below a certain threshold. The department also required Eni to sanction development by the end of February 2008, and to hit certain spending targets over the first decade of development.
Eni brought the unit online this past February.
Expecting more applications The success of Pioneer and Eni helped raise the profile of royalty relief, but in recent years the program has become a tool in oil tax debates, such as the one the Alaska Legislature recently engaged in over Gov. Sean Parnell’s proposed oil tax revisions.
Democrats in particular believe the existence of the program, and the fact that it is rarely used, is proof that North Slope fields are profitable under the existing fiscal regime.
“It’s telling that companies rarely seek royalty relief — less than half a dozen times in the past decade,” Rep. Les Gara and Rep. Berta Gardner wrote in the Anchorage Daily News in early 2010. “They’d line up for this break if paying less money to the state would really turn unprofitable fields profitable. But the truth is that field geology and world economics have more to do with investment decisions than Alaska’s tax rules.”
Earlier this year, Gara and Sen. Hollis French asked Parnell to specifically promote the program, rather than push for a change in the production tax code.
Banks believes royalty relief is requested sparingly because the statutes are narrow.
“When you look at it, really only Nikaitchuq and Oooguruk fit that category,” he said, adding that Armstrong might have requested royalty relief for its North Fork unit in the Cook Inlet if existing statutes didn’t already offer incentives for natural gas used in state.
The department expects that more and more projects will be eligible for royalty relief, though, as relative newcomers explore corners of the North Slope overlooked by larger players.
Because an application must follow significant exploration, it’s too early to say who might ask for royalty relief. Candidates include Brooks Range Petroleum Corp., which is exploring in the Gwydyr Bay area and around Nuiqsut; Great Bear Petroleum, which wants to develop North Slope source rock; and the Armstrong subsidiary 70 & 148, which is partnering with GMT Exploration and the Spanish major Repsol on an as-yet-undefined exploration venture in the White Hills area across the central North Slope.
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