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Vol. 10, No. 24 Week of June 12, 2005
Providing coverage of Alaska and northern Canada's oil and gas industry

Pioneer wants a break

Without lease royalties reduced, independent will not ‘vigorously pursue’ Oooguruk

Kay Cashman

Petroleum News Publisher & Managing Editor

The Alaska subsidiary of Pioneer Natural Resources has formally applied for a royalty reduction for four leases adjacent to its proposed Oooguruk oil development offshore the North Slope. All four leases will be included in a unit expansion request that Pioneer expects to file around June 15, the company said in a letter sent in late May to Tom Irwin, commissioner of the Alaska Department of Natural Resources.

Located in Harrison Bay near Thetis Island, the Oooguruk discovery includes “potentially commercial reserves” within the Kuparuk and Nuiqsut (Jurassic) formations; however, the economics of … the project are marginal,” Pioneer told the state.

If it doesn’t get its royalties on the four leases dropped from 12.5 percent to 5 percent, the Dallas-based independent said it “cannot vigorously pursue” development of the Oooguruk unit.

Pioneer has been working with the state for the last six months, reviewing data and trying to find ways to modify the existing lease terms to “encourage timely development” of Oooguruk, a development Pioneer is quick to point out, that has not yet been sanctioned by its board of directors.

The company has said Oooguruk would produce less than 20,000 barrels per day and would be developed in four feet of water from a five-acre drill site. Pioneer hopes to commence construction activities in the first quarter of 2006 and begin production near the end of 2007.

State can make big bucks

Once part of ARCO Alaska’s Kuukpik unit, which has since expired, the four leases in the royalty reduction application bear a lower royalty than the leases currently in the Oooguruk unit, which carry a 16.67 percent royalty. But unlike those in the unit, the four leases are subject to a net profit share interest that allows the state to collect an additional 30 percent once the costs of development have been recovered by Pioneer.

In its royalty relief request, received by the state May 25, Pioneer noted that because of the net profit share provision the state will be able to participate “at a large and significant level in all the project success which results from favorable changes in the price of oil or gas, production rates, projected ultimate recovery, development costs, and operating costs, lower cost performance or production rate upside.”

At Alaska North Slope West Coast oil prices of greater than $40 per barrel, the “expected financial benefits to the state” under the royalty reduction regime proposed by Pioneer “will exceed the benefits associated with a flat one sixth royalty,” which has become the state’s standard royalty in and around existing infrastructure, the company told the state.

$80 million in development costs

In its application Pioneer also asked the state to lump the four leases into a single development account, treating them as one lease. (A state statute establishes an accounting system for the administration of net profit sharing leases which consists of three separate accounts — development, production revenue, and net profit payment.)

The company wants the aggregated development account balance to be formally set at $80 million as of Jan. 1, 2005, which Pioneer said will save audit and accounting expenses — and give investors in the project “relative fiscal certainty.”

Royalty reductions can be a challenge

According to Tim Ryherd of the state Division of Oil and Gas, no applications for royalty relief have been approved by the state to date.

“There is a fairly high hurdle” to qualify, he said.

The applicant has to prove its project needs relief; that without it the project can’t go forward, the division’s senior commercial analyst Kevin Banks told Petroleum News June 7.

“To prove that often requires information that the company may not have or considers confidential, (including) … delineation, a fair amount of information about the resource and pretty good information about the cost of developing the field,” Banks said.

“What we have found in the past is that this kind of information is not available at the time they come in and apply for royalty relief. … They haven’t done the work yet.

“It’s a chicken and egg kind of problem for producers,” Banks said, explaining that producers are often loathe to commit to the amount of investment it takes to obtain the information needed to qualify for the relief until they can be sure they will get the relief.

When asked what kind of investment would be needed, he said to adequately delineate a prospect an applicant might have to drill additional wells, etc.

“It’s a major hurdle for them,” Banks said.

Setting a standard with Pioneer’s royalty relief

“We’re going to work with Pioneer and see if we can thread the needle with this project.” The division will be working under new legislation that streamlined the process for applying for and determining royalty relief – a process that was severely hampered by legislation passed in the mid-1990s, Banks said.

“We have enough tools available to us now,” he said. “For example, a sliding scale royalty could be designed to allow for changes in costs and oil prices.”

Although Banks had not yet reviewed Pioneer’s application, he said if “there is some uncertainty about the resource, we can craft the royalty provision so that the state will get its full royalty if it turns out the resource is bigger than expected. We’re going to look at that and other things with Pioneer.”

Although Pioneer clearly states in its application that it is looking for fiscal certainty for investors and therefore wants development costs fixed at $80 million and a flat royalty reduction to 5 percent, the company also refers to the part of the statute that requires the state to modify the royalty for an increase or decrease in the price of oil or gas by using a sliding scale royalty or other mechanism. That portion of the statute also says a sliding scale royalty “may be based on other relevant factors such as a change in production rates, projected ultimate recovery, development costs, and operating costs,” Pioneer wrote.

Phillips, Unocal, BP once asked for royalty relief

Prior to the 2002 legislative change in the royalty relief statute, the most recent royalty relief request came from Phillips for its Tyonek Deep prospect in Cook Inlet, Banks said.

“My understanding is they backed out because they got caught up in the merger with Conoco,” he said, but there were also problems because of a lack of information to make the determination, he said.

“Before that, an application came in from Unocal for royalty relief on all of their Cook Inlet platforms and through the course of the evaluation the state put together a proposal to provide relief for some of the platforms but not all; some were fine, some were beyond rescue, such as Spark which is shut-in now, and some would have qualified for relief.

“Before a final determination could be reached,” Banks said Unocal “began pursuing a legislative fix and got it.”

The new law allows a platform to “automatically get royalty relief when production falls to a certain amount,” he said.

Before Unocal’s application, BP applied for royalty relief at Milne Point, “but fairly quickly withdrew their application … they elected not to pursue it.”

On fast track to get decision for Pioneer

Banks said the division has “no timetable for making a decision on Pioneer’s (royalty relief) application other than to say that the company undoubtedly needs a decision fairly quickly.”

Whatever is decided, he said, has to be approved by the governor.

“We’re going to try to work on this as fast as we can,” Banks said.

The application for royalty relief was made on behalf of Pioneer and its working interest partner Armstrong Alaska, an affiliate of Denver-based Armstrong Oil & Gas. Armstrong originally assembled the prospect, which was initially called Northwest Kuparuk.

In addition to the four leases, Pioneer said the June 15 unit expansion request will include other state leases adjacent to the Oooguruk unit.



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Wells drilled by others in expansion area

Three exploratory wells were drilled by Pioneer Natural Resources Alaska in 2002 in what is now called the Oooguruk unit – Oooguruk No. 1, Ivik No. 1 and Natchiq No. 1.

In its application to the state of Alaska for royalty relief on four leases that will be included in an upcoming unit expansion, Pioneer said eight additional wells have been drilled within the expansion area, six of which fall in the boundaries of the four leases.

Following is the information Pioneer provided about the wells with its application, beginning with the lease number, well driller and name, and the year the well was drilled. Those with an astrix were certified to be capable of production in paying quantities.

• ADL 355036 ARCO Kalubik No. 1 1992*

• ARCO Kalubik No. 2 1998

• ADL 355037 Texaco Colville Delta No. 1 1985*

Texaco Colville Delta No. 1A 1985

• ADL 355038 Texaco Colville Delta No. 2 1986*

• ADL 355039 Texaco Colville Delta No. 3 1986*

• ADL 379301 Exxon Thetis Island No. 1 1993*

• ADL 389959 ARCO Kalubik No. 3 1998

The four state leases included in Pioneer’s royalty relief application have gone through several transfers of ownership over the years. As a result, current working interest owners include a number of companies. Pioneer and Armstrong have the largest chunks, but OXY and Herbaly LLC also hold substantial portions. Anadarko, Hunt, and Joyce hold 2-4 percent pieces, depending on the lease and the interval.

–Kay Cashman