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Vol. 15, No. 39 Week of September 26, 2010
Providing coverage of Alaska and northern Canada's oil and gas industry

Escopeta appeals

Denied petition for reconsideration, company challenges $4M deposit

Eric Lidji

For Petroleum News

Escopeta Oil has appealed the State of Alaska’s decision to put the Kitchen Lights unit in default.

In paperwork filed on Sept. 17, the Houston-based independent challenged the conditions that the Alaska Department of Natural Resources set out in July for Escopeta to retain ownership of the offshore Cook Inlet unit. Escopeta believes those conditions are beyond the state’s authority, and don’t serve the best interest of the public or the company.

Escopeta wants the Alaska Superior Court to remand the case back to DNR for a fresh hearing, and to take the Kitchen Lights unit out of default until the matter is resolved.

The state said it would not discuss the appeal, as it is an ongoing legal matter.

Escopeta: deposit “arbitrary”

The state formed the Kitchen Lights unit from three smaller offshore units in July 2009, setting out deadlines for operator Escopeta to secure the jack-up rig needed for drilling in shallow waters, get the rig to Cook Inlet and drill exploration wells on the leases.

That deal came after several years where Escopeta almost lined up everything needed for the drilling program, beating previous attempts, but still ultimately missing deadlines.

The new deadlines required Escopeta to have a jack-up rig under contract and headed for Alaska on a heavy lift vessel by June 30, 2010, in order to drill by the end of the year. On May 30, Escopeta asked for six more months to get the rig and drill the first well. The company said it needed the extra time to finalize several contracts under negotiation and modify a warm weather jack-up rig for the colder climates of sub-Arctic Alaska, and noted that the Gulf of Mexico oil spill upped the insurance rates on offshore rigs.

DNR put the unit in default in mid-July, essentially granting the extension if Escopeta completed three tasks. Within 90 days, Escopeta needed to put down a $4 million security deposit, the estimated final payment on the jack-up rig. Then, that rig needed to be on its way to Alaska by February and drilling an exploration well by the end of September 2011.

Escopeta, in an Aug. 4 letter, asked DNR to reconsider.

Escopeta called the deposit “unprecedented,” “arbitrary” and “capricious” and wrote that DNR violated confidentiality agreements in the way that it came up with the deposit amount. Escopeta also wrote that $4 million didn’t represent the actual loss DNR might face by granting the extension. As an alternative to the deposit, Escopeta proposed a $764,000 “performance bond,” or $11.20 per acre for the 68,136 acres at Kitchen Lights that could be made available at the next Cook Inlet areawide lease sale in May 2011.

On Aug. 11, DNR responded, writing that if it did not approve the request for reconsideration within 30 days, the default would hold. The decision became final in late August, leaving Escopeta with the choice of appealing to the Alaska Superior Court.

Confidentiality issues

The 24 points of appeal focus largely on the $4 million security deposit that the state is requiring Escopeta to put down by mid-October in order to keep the Kitchen Lights unit.

That deposit relates to a jack-up rig, a mobile drilling system crucial for drilling in the shallow waters of Cook Inlet. The deposit represented “an estimated portion of what would be the final payment, due at the time of delivery of the rig to its destination, for mobilization and transportation of the drilling rig to Cook Inlet, Alaska,” the state wrote at the time, and the $4 million figure was “based on confidential contracts” for a jack-up rig and a heavy-lift vessel that Escopeta gave the state back in 2006, during a previous attempt to line up a drilling program on the leases that are now part of Kitchen Lights.

Those 2006 contracts ultimately fell through. This summer, Escopeta was negotiating with rig contractor Pride International, but Escopeta President Danny Davis told Petroleum News Sept. 23 that contract fell through and he is now negotiating with Spartan Offshore Drilling.

In its Aug. 4 letter, Escopeta wrote that the deposit, based on 2006 contracts, “may or may not be representative of the current contract costs,” because of market impacts caused by the Gulf of Mexico oil spill and the subsequent offshore drilling moratorium.

If Escopeta made the security deposit and later secured a jack-up rig and heavy lift vessel, the state would have returned the money in time for Escopeta to make its final payment.

Davis told Petroleum News in July, “I’d have rather done it with a 180-day extension,” without a deposit, but added, “I think we’ll have the money.”

Legal authority questioned

Now, Escopeta says the state doesn’t have the legal authority to require a deposit.

The company also claims the state breached its contract with Escopeta by basing the amount of the deposit on data in those confidential third-party contracts from 2006.

Davis’ confidence in July came from Senate Bill 309, a tax credit created earlier this year by the Alaska Legislature that pays up to $25 million of the cost of the first well drilled into the pre-Tertiary zone of Cook Inlet using a jack-up rig. (The bill offers a lesser credit for two subsequent wells.)

Davis still loves the credit, but he told Petroleum News on Sept. 23 that potential investors wanted more clarity about how quickly the state would refund expenses.

While Escopeta saw SB 309 as a way to attract investors, the state saw it as a way to increase competition in an underexplored area. In July, the state said that since the passage of the bill “several new companies have expressed a strong interest in Cook Inlet leases.” Because of that interest, the state wrote in its default notice to Escopeta, “it is not in the State’s interest to unconditionally approve work obligation delays that simply prolong unitization and result in warehousing with no exploration and development.”

In its appeal, Escopeta said that by considering SB 309, the interest of other companies and the desire to increase competition, the state showed that it was biased in its decision.

Hunting for a rig since 2003

The appeal is the latest in a long back-and-forth between Escopeta and the state.

Escopeta first took interest in Alaska in the early 1990s, but didn’t begin accumulating a major land position in the Cook Inlet basin until areawide lease sales in 1999 and 2001.

That acreage included the offshore Kitchen and East Kitchen prospects. After re-analyzing 20-year-old 2-D seismic data from the area, Escopeta got excited about the prospects and said it wanted to get a jack-up rig and drill in the summer of 2003.

That effort didn’t materialize, but in 2004, the U.S. Geologic Survey issued a report that hypothesizes about “missing giants,” major undiscovered oil and gas fields, in the Cook Inlet basin. Escopeta believed Kitchen and East Kitchen were two of those missing giants.

Escopeta got close in 2006, securing a jack-up rig and a heavy-lift vessel to bring it to Alaska, as well as a waiver of the Jones Act that requires U.S. flagged vessels to be used between U.S. ports. The waiver is necessary because of the general lack of American ships capable of making the trip. (Davis told Petroleum News on Sept. 23 that he is waiting to hear from the Obama Administration whether that waiver is still valid.)

After a partner backed out, Escopeta began searching for new investors.

The state formed the Kitchen unit over both prospects in January 2007, keeping leases from expiring, but required Escopeta to drill a well by the end of 2007 or lose the unit.

When it became clear Escopeta would miss that deadline, the state put the unit in default, giving the company until the end of 2008 to drill a well at the Kitchen unit. By that point, Escopeta was working with Pacific Energy, an independent with neighboring offshore acreage in Cook Inlet, to bring a jack-up rig to Alaska. A third independent with nearby offshore leases, Renaissance Alaska, also hoped to get time on any jack-up rig.

Toward the end of 2008, Escopeta still did not have a jack-up rig, and asked the state for an additional two years to fulfill the work commitments at the Kitchen unit. The state denied that request, but ultimately came up with an alternative idea: combining the holdings of Escopeta, Pacific Energy and Renaissance Alaska into a single, giant unit.

Kitchen Lights formed in 2009

The state formed the consolidated Kitchen Lights unit in July 2009, and the various leaseholders either sold or farmed-out their acreage to unit operator Escopeta.

Under the terms of the new unit, the state gave Escopeta until June 30, 2010, to have a jack-up rig headed to Alaska on a heavy-lift vessel in order to drill by Dec. 31, 2010.

In May 2010, Gov. Sean Parnell signed SB 309 into law, making $67.5 million available to the first three companies to use a jack-up rig to drill new wells in Cook Inlet.

At the time, Davis called the bill “fantastic,” but said it put the first company — the one trying to negotiate a multiyear contract with a rig company — at a disadvantage.

In late May, Escopeta asked for a 180-day extension to its work commitments. The company said it had negotiated unsuccessfully with three rig companies, but was making headway in negotiations with Pride International Inc. Even so, Escopeta said it couldn’t get a jack-up rig modified for the icy Cook Inlet and bound for Alaska until early 2011.

At that point, the state put the unit back into default and required the deposit.

Division of Oil and Gas Director Kevin Banks told Petroleum News on July 19 that he chose to put Kitchen Lights in default again, rather than simply terminating it, because, “This will assure more clearly that (Escopeta President Danny Davis has) been given the appropriate due process that perhaps terminating it today perhaps would not do.”

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