A showdown is brewing between the state of Alaska and ConocoPhillips Alaska Inc. over a potentially resource-rich plot of acreage south of the Colville River unit.
The state is refusing to allow ConocoPhillips to incorporate the acreage into the unit unless the company provides $14 million in bonds and other payments, drills an exploration well this winter and commits to a future development program in the area.
ConocoPhillips had yet to provide a response to the state by the time Petroleum News went to print but previously cancelled plans to drill an exploration well on the expansion acreage this winter, saying it was heeding the request of local community groups.
In a Feb. 17 decision, Department of Natural Resources Commissioner Andrew T. Mack denied a longstanding request from ConocoPhillips to add 9,146.60 acres to the unit unless the company provides a $2.5 million performance bond for an exploration well planned for this winter, a $10 million performance bond to guarantee oil production from the area within the next five years and a $1.5 million “bonus bid replacement payment.”
Mack gave ConocoPhillips 10 days to accept the conditions. The company had yet to provide a response by March 1, according to the Department of Natural Resources.
If ConocoPhillips accepts the conditions, the state would include them in the plan of exploration and plan of development for the expansion area. “Failure to comply with these terms can put the entire unit in default,” Mack wrote, suggesting that the expansion area, if approved, could become a shackle on the third most productive unit in Alaska.
Fastest route
The Department of Natural Resources regularly requires oil and natural gas operators to post performance bonds to backstop their drilling commitments. But bonus bid replacement payments and performance bonds to guarantee production are much rarer.
According to Mack, the unusual ruling was an attempt to get the best deal for the state.
If the state allowed the expansion to proceed, according to the ruling, it would lose the benefit of getting a bonus bid from allowing the leases to expire and being leased anew.
But the administrative process of making the acreage available through a future lease sale is time consuming. Development - and all its assorted financial benefits to the state through royalties and production taxes - could occur more quickly through expansion.
At issue is the speed of development, according to Mack.
In its application, ConocoPhillips discussed its preference for “sequential development” of acreage within the Colville River unit. The company has brought previous Colville River unit satellites into production incrementally, in part to manage processing capacity.
Mack rejected this approach for the expansion acreage, writing, “Conoco may find sequential development advantageous because it reduces cost, but the delay in resource development and the elimination of competition is a cost to the State. Because of temporal discounting, the delay in resource development reduces the value to the State of the eventual production. If the expansion area leases were allowed to expire and the area be offered in a new lease sale, another lessee might develop the expansion area more quickly than Conoco as it develops other resources near the Alpine field.”
If ConocoPhillips pursued “expedited development” of the expansion area, he added, production might come more quickly than under a different lessee. The proposed bonds and the replacement payment are an attempt to guarantee that expedited development.
The ruling would allow ConocoPhillips to add the expansion acreage into the Colville River unit if it commits to drilling an exploration well in the area by May 31, 2017. If the first well is a dry hole, ConocoPhillips would be required to drill a second well by May 31, 2018. The proposed conditions would also require ConocoPhillips to fast-track an oil development program in the expansion acreage in an effort to bring the expansion area into sustained production by May 31, 2022, and provide annual updates along the way.
The state would return the $2.5 million bond if ConocoPhillips met the drilling deadline and the $10 million bond if the company met the production deadline. The $1.5 million payment is meant to compensate the state for theoretical losses from a future lease sale.
Well cancelled
Those drilling commitments already present a complication.
As part of its request to expand the unit, ConocoPhillips had proposed drilling the Putu No. 1 exploration well this winter within the proposed expansion area. The well would have satisfied the proposed work commitment. But ConocoPhillips canceled the program.
“After meeting with leadership from the community of Nuiqsut in December, ConocoPhillips was asked to postpone the Putu exploration drilling program until next winter,” ConocoPhillips spokeswoman Natalie Lowman wrote in a Feb. 22 email. “This decision was a collaborative process with Nuiqsut leaders that recognized the need to balance the drilling opportunity with the needs and support of the community.”
According to the state, though, the decision to delay drilling plans conflicts with earlier assurances from ConocoPhillips. The company previously told the state that it had an active surface use agreement with landowner Kuukpik Corp., according to the ruling.
The state has not seen the surface use agreement, according to the ruling. Whether the existing surface use agreement extends to the proposed expansion area is “a key consideration” for deciding whether to expand the unit, Mack wrote. Failure to secure a surface use agreement is one reason why former operator Brooks Range Petroleum Corp. failed to develop the acreage when it was included in the former Tofkat unit, he added.
In addition to the current surface use agreement between ConocoPhillips and Kuukpik, Mack referenced an earlier 1992 agreement between Arctic Slope Regional Corp. and Kuukpik that also allows for oil and gas activities on the leases. “With multiple agreements in place allowing surface use, Commissioner will not be inclined to consider a need for community engagement as justification for further delays,” Mack wrote.
Asked about the surface use agreement and the delayed exploration well, Lowman told Petroleum News by email on March 1, “ConocoPhillips has a confidential surface use agreement with Kuukpik that allows us access to their land. However the SUA is not a permit to drill and does not eliminate the North Slope Borough permitting process or any other required permits or authorizations. In December we met with leadership from the community of Nuiqsut, and determined that, due to delays in DNR approvals, we would not have adequate time to engage with the local community as part of the standard local permitting process. This decision was a collaborative process with Nuiqsut leaders that recognized the need to balance the drilling opportunity with the needs and support of the community. While we were prepared to drill the well this winter, postponing the exploration program will allow us to work with the community and the North Slope Borough to address their concerns over drilling within three miles of the village.”
Numerous attempts
The ruling extends an already long-standing dispute between the state and the company.
ConocoPhillips initially asked to include the acreage in the Colville River unit back in 2002. The state agreed to the expansion later that year. But the state contracted the acreage out of the unit in 2004 after ConocoPhillips failed to meet a drilling commitment.
In 2016, the state cited this failure to drill in 2004 as a reason for denying the current expansion request. Although the state later reversed that decision, it clearly remains bothered by the earlier lack of performance. In the current ruling, Mack wrote, “Conoco’s past failure to develop this acreage may not be indicative of its willingness and ability to develop it now, but it does demonstrate the ongoing costs to the State as the acreage has changed hands and moved in and out of units for years without development.”
At the time of that initial expansion, the acreage was known as the Titania prospect. A joint venture operated by Brooks Range Petroleum Corp. subsequently acquired the acreage through a lease sale and began referring to the leases as the Tofkat prospect.
Brooks Range Petroleum Corp. drilled the Tofkat No. 1 well and two sidetracks in early 2008 and encountered hydrocarbons. The company formed the Tofkat unit in late October 2011 and proposed various drilling programs over the years. But the state terminated the unit in late March 2016, after the company failed to drill in the area.
On March 31, 2016, ConocoPhillips asked the state to expand the Colville River unit to include the leases in the former Tofkat unit. The state rejected the application less than a week later, claiming that ConocoPhillips had no working interest in the leases at the time.
The company filed lease assignments in mid-May and again requested an expansion.
While seven of the leases in the former Tofkat unit were still within their primary terms, the other 15 leases had already expired and passed into their 90-day secondary term.
In mid-June, the state approved the assignments for those leases still within their primary terms but rejected the others. ConocoPhillips appealed the decision and re-filed its request toward the end of June. But the state once again denied the request in late July.
Some time after issuing those decisions, former Division of Oil and Gas Director Corri Feige left her position. In a pair of decisions from early November, Mack reversed both decisions. In the first ruling, he allowed ConocoPhillips to keep all the leases, including those in their secondary terms. In the second ruling, he agreed to reconsider the revised application from late June. The current ruling is the result of that reconsideration.
Nanushuk
In the conditions Mack proposed for allowing the expansion, he required ConocoPhillips to drill its exploration wells into the Nanushuk formation at the expansion area.
The detail suggests one reason why the state and the company are at odds over the leases.
The Nanushuk formation is relevant to Armstrong Energy Inc.’s discovery at the Pikka unit. Around the time of that announcement, U.S. Geological Survey geologist David Houseknecht suggested that the discovery represented a new North Slope oil play. He said that Caelus Energy’s discovery in the Smith Bay region also fit into the play.
The three Tofkat wells and sidetracks from 2008 “encountered two intervals of hydrocarbon bearing strata within the shelfal Nanushuk Formation,” according to the ruling. The wells also encountered a primary target in the Kuparuk C sandstones.
The state also believes that the west side of the expansion area has potential in the Jurassic Alpine C reservoir. The Tofkat wells were not deep enough to target the Jurassic.
New pad
Even if the state and ConocoPhillips work out a deal for drilling the proposed Putu No. 1 well, the five-year development timeline for the area could present another problem.
In previous filings, the company noted that a development in the area might require a new drilling pad, which would trigger an environmental review from the U.S. Army Corps of Engineers. The review could take at least three years to complete, according to ConocoPhillips estimates. As a result, ConocoPhillips projected production by late 2024.
But ConocoPhillips could sidestep this potential regulatory delay by developing the area using extended reach drilling from the existing CD-4 pad. “If the expansion area cannot be significantly developed from the CD4 pad and a new pad is needed to develop the majority of the expansion area resources, unitization provides little difference to expedited development as a new pad would need to be built in either case,” Mack wrote.
Similarly, Mack noted, a data exchange with Armstrong could speed up development.
Armstrong had planned to drill its Pikka No. 1 exploration well in the vicinity this winter. The company previously told Petroleum News that it agreed to cancel the project at the request of local groups in Nuiqsut and to instead share information with ConocoPhillips.
It is unclear how the current developments would impact that partnership.
