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Vol. 16, No. 15 Week of April 10, 2011
Providing coverage of Alaska and northern Canada's oil and gas industry

AIDEA’s new Endeavour

Public corporation votes to invest $30 million in a jack-up rig for Alaska

Eric Lidji

For Petroleum News

The State of Alaska could soon be in the drilling business.

In a unanimous vote on April 1, the board of the Alaska Industrial Development and Export Authority gave the go ahead for the public corporation to partner with Kenai Offshore Ventures LLC by spending up to $30 million toward the cost of a jack-up rig.

Kenai Offshore Ventures is a joint venture between the Australian independent Buccaneer Energy Ltd. and the marine company Ezion Holdings Ltd.

Project Endeavour, as the $85 million venture is now known, involves buying a jack-up rig for Buccaneer to use at its offshore Cook Inlet prospects and to lease out to other offshore operators in both Cook Inlet and the Arctic as a way to generate revenue.

The AIDEA board voted on the deal after spending an hour discussing it in executive session, but despite the vote neither the funding nor the partnership is a done deal yet.

AIDEA and Kenai Offshore Ventures must first sign a joint ownership agreement that defines the nature of the public-private partnership, expected to happen by mid-April, and then Buccaneer and Ezion must meet several conditions over the next few months.

Likelihood of two jack-ups

Still, the vote furthers the likelihood that two jack-up rigs will be operating in Cook Inlet this summer after nearly two decades without even one in the basin. Houston-based independent Escopeta Oil is currently shipping the Spartan 151 jack-up rig to Alaska.

While the board unanimously voted to move forward and many members praised the work of AIDEA staff in negotiating the complex deal in such a short amount of time, many also noted the riskiness of spending $30 million on an exploration program.

“I’m suitably uncomfortable, and that’s probably good,” board member Gary Wilken said, adding that he saw it as a “test case” for what AIDEA could accomplish.

“I, too, have a little bit of butterflies in my stomach on this deal,” board member Ron Arvin said, but added that he was confident it would be “a good investment for AIDEA.”

“I’m extremely uncomfortable, primarily due to the size of dollars being requested with little if any financial capability on the other side,” board member Robert Sheldon said, adding that he was on the fence about how to vote until hearing certain details in executive session and seeing the “fail safes” included in the proposed agreement. He also said Alaska had opportunities for job creation not available to other states right now.

AIDEA believes the investment will help create hundreds of new jobs, increase oil and gas production in Alaska and boost the economy of the Southcentral region.

Project Endeavour involves buying and upgrading a jack-up rig docked in Singapore — currently the Transocean Adriatic XI — and transporting it to Cook Inlet this summer.

Eyeing the Adriatic XI

Once the two sides sign their deal, AIDEA would hold an 85.7 percent interest in the project and Kenai Offshore Ventures would hold the remaining 14.3 percent, but before AIDEA is obligated to spend money, Buccaneer and Ezion must meet 15 conditions.

Those include contributing at least $5 million to the project, securing the remaining $50 million needed to fund the venture, executing a contract to buy a jack-up rig from Transocean Ltd. and signing the contracts needed to upgrade the rig for use in Alaska.

Kenai Offshore Ventures is in discussions with a “large Asian based bank” for the $50 million loan, but offered no further details. Under the terms of the agreement, the lender could invest up to $56 million in the project, decreasing AIDEA’s commitment and stake.

The Adriatic XI rig can drill wells up to 25,000 feet deep through as much as 300 feet of water, is compatible for cold weather operation and can be modified to include enhanced blowout prevention equipment, according to an evaluation by AIDEA consultants.

In addition, Buccaneer must commit to drill four wells in Cook Inlet using the rig and Ezion must loan the project $3.3 million during a pre-funding start-up period.

Once those conditions are met and AIDEA begins funding the program, Buccaneer and Ezion must meet six other conditions to keep the deal from going into default. Those include contracting a company to bring the rig to Cook Inlet, drafting organizational and management documents and fully permitting a drilling program by Aug. 31, 2011.

Buccaneer must also establish a five-year agreement through a new operating company to charter the rig for $60,000 per day, for a guarantee of $21.9 million in annual revenue.

Six-year investment plan

AIDEA would make its investment back through drilling revenues and tax credits.

Kenai Offshore Ventures would repay AIDEA over six years with an 8 percent annual dividend. Any repayment not made in one year would jump to the next year, and any payments made after year six would have a 10 percent annual dividend. Under its financial model, AIDEA stands to make more than $10 million through the venture.

Kenai Offshore Ventures can also buy out AIDEA at any point before the end of 2013.

Once the rig is in operation, any cash flow would pay for limited operating expenses, followed by paying down the senior debt facility, Ezion’s initial loan and AIDEA’s loan, and then payments to reserve accounts and other potential owners. Once Buccaneer begins collecting tax credits from drilling, it must also repay some of AIDEA’s loan.

If the rig goes into default or liquidation, Buccaneer must pledge between $4.5 million and $7 million of its State of Alaska tax credits to AIDEA and give AIDEA a 3.5 percent overriding royalty interest on all its worldwide holdings. AIDEA would also get the first right of refusal to buy the $50 million loan from the senior lender, if it so chooses.

Two rigs not a deal breaker

In a talking points document, AIDEA said that its decision to invest in the project is “anchored” in Buccaneer leases, saying that if the first four wells are successful, the company would likely drill another seven to 10 wells, making the rig unavailable for long stretches of time. Owning a portion of the rig, “secures the long-term commitment of this robust drilling rig for Alaska waters,” AIDEA said, adding that the Spartan 151 did not “represent a similar long-term commitment to Alaska” because it was leased, not bought.

Escopeta negotiated a 120-day option to buy the Spartan 151, but has not yet taken it.

That said, AIDEA lists 22 offshore wells that could be drilled in Cook Inlet using a jack-up. It remains unclear how many of those projects could or would come to pass.

The list includes the four wells Buccaneer is obligated to drill, four wells Escopeta plans to drill at its Kitchen Lights unit using its own jack-up rig, two wells at the Cosmopolitan unit that operator Pioneer Natural Resources relinquished earlier this year, eight wells on leases operated by Chevron and three wells on leases operated by Cook Inlet Energy.

Having two jack-up rigs in Cook Inlet would take some of those wells off the table and make most up for grabs, but AIDEA believes a second rig would still “generate significant investment returns.” After taking into account various tax credits offered by the state, all the wells drilled by the first rig would cost about $10 million each net and the wells drilled by the second jack-up would cost about $14 million net per well, according to AIDEA analysis.

Through a one-time credit created last year, the first well drilled to a certain depth in Cook Inlet using the jack-up rig is eligible for up to $25 million from the state, and the second and third wells drilled using the same rig become eligible for significant, though increasingly smaller tax credits. The AIDEA model is based on additional tax credits available to a company for exploration drilling through Alaska’s Clear and Equitable Share.

If all goes according to plan, the Adriatic XI would arrive in late July and start drilling in August. The Spartan 151 is scheduled to arrive in May and start drilling soon after.

Permitting risk remains high

Taking all that into account, AIDEA is categorizing Endeavour as low to medium risk.

The largest risk, according to AIDEA, is the regulatory and permitting risk because of the “tight but achievable” timetable in place to get a rig mobilized and drilling by summer.

AIDEA said if the closing of the deal is delayed, “there is a high probability that the 2011 drilling season will be missed, and some risk that the project will not proceed at all.”

But, AIDEA said, Buccaneer has already applied for all its major permits.

The Alaska Department of Environmental Conversation recently issued a notice saying that it planned to issue an air permit for Buccaneer to drill in Cook Inlet.

AIDEA sees smaller, but still significant risks, in financing the project, completing the various contracts required to move forward and competing in the market place, and much smaller but still notable risks for getting the rig to Alaska and operating it safely.

Ten months in the making

The deal came together in less than a year.

Buccaneer pitched the idea to AIDEA in June 2010 under a different structure, proposing to form a consortium that would buy and operate a drilling rig, using a combination of AIDEA investments and a one-time bond available from the federal stimulus program.

AIDEA began performing due diligence on the project in November.

Unable to find buyers for the bonds, though, Buccaneer and AIDEA looked to find an alternative business arrangement, spending several months trading ideas. In February, AIDEA got board approval to negotiate a financial structure based on those discussions.

The final elements of the plan came together within two weeks of the vote.

Escopeta rig on its way

The vote increases the competition between two independent oil companies looking to bring a jack-up rig to Alaska to drill in Cook Inlet: Buccaneer and Escopeta.

“Escopeta is currently transporting a jack-up rig to Cook Inlet, and we intend to make it available to companies that are interested in using it to drill for oil or gas,” Steve Sutherlin, a contractor for Escopeta, told the board during a public comment period.

Sutherlin is a former Petroleum News writer and minority owner in the company.

Escopeta is privately funded and President Danny Davis has said he worries his firm will be in direct competition in a limited market with a state agency that has “deep pockets.”

Interim Chair Michael Felix asked Sutherlin if Escopeta had a suitable Jones Act waiver, needed to move goods on a foreign flagged vessel between two domestic ports. The Spartan 151 is currently en route from the Gulf of Mexico to Alaska, via South America.

“If you could produce the Jones Act waiver it would clear up a lot of stuff for us then, because no one’s been able to do that,” Felix told Sutherlin.

Sutherlin said that Escopeta received a waiver in 2006 that is not rig specific and is looking to get a “fresh waiver” from federal authorities, but noted that when a previous operator brought a jack-up rig to Cook Inlet without the waiver, it simply paid a fine.

“We could end up paying a fine, but the enforcement arm of (the U.S. Department of Homeland Security) is the Coast Guard and the Coast Guard has assured us that they will not inhibit our ability to unload our cargo in and continue to drill,” Sutherlin said.

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