The state is reducing the royalty rate on five leases at the proposed Nuna development.
If operator Caelus Natural Resources Alaska LLC sanctions the project by the end of the year and meets spending and development targets through early 2017, the Alaska Department of Natural Resources will lower its royalty rate to 5 percent on the leases.
The existing royalty rates on those fives leases are 12.5 percent and 16.667 percent.
The reduced rate would remain in effect until Caelus earns a set amount of revenue from the Nuna development project. The project involves building onshore facilities to target a section of the Torok formation too far to reach from existing Oooguruk unit facilities.
The company had argued that the project would have been uneconomic without the reduction. After examining confidential data, the state agreed with that conclusion.
The state is taking comments on the proposed reduction through Nov. 28 and has pro-active offered to review its rational for the reduction to legislative authorities.
11 leases requested
The Dallas-based Caelus had asked the state for royalty reduction on 11 leases associated with the Nuna development, which covers the southern reaches of the Oooguruk unit.
Those leases had different royalty terms. ADL 355036, ADL 355037, ADL 355038 and ADL 355039 had a 12.5 percent royalty rate and a 30 percent net profit share. The remaining seven leases - ADL 390434, ADL 390697, ADL 390505, ADL 390506, ADL 392133, ADL 392157 and ADL 392158 - had a 16.6667 percent royalty rate.
Caelus had wanted a flat 5 percent royalty rate on all 11 leases until the project reached payout - meaning revenues covered upfront costs. At that point, the rates would have increased by 1.875 percent annually, for four years, and then returned to original levels.
The four leases with 12.5 percent rates were issued in 1983 and later incorporated into the Kuukpik unit. Although the state terminated the unit in June 2001, the four leases were held by productive wells. The leases are now included in the Oooguruk unit.
Through a series of deals over the past decade, Caelus operates the leases and owns a 70 percent working interest. Eni US Operating Co. Inc. owns the remaining 30 percent.
The state issued the seven leases with 16.6667 percent rates in 2004, 2005, 2012 and 2013. Caelus currently operates these leases and owns 100 percent working interest.
All 11 leases are associated with the Torok formation at Oooguruk. But the state only agreed to modify the rates on five leases associated directly with the proposed Nuna development: ADL 355038, ADL 355039, ADL 390434, ADL 390697 and ADL 392158.
Exploring Torok
Pioneer Natural Resources Alaska Inc. brought the Oooguruk unit into production in June 2008 from two pools: a Kuparuk reservoir and a deeper and larger Nuiqsut reservoir.
But every exploration and development well at the unit was also passing through the Torok formation, a shallower reservoir. Pioneer began targeted this formation explicitly in early 2010 and the state subsequently formed a Torok participating area in 2011.
Wells from the existing gravel island at Oooguruk could only reach so far.
In early 2012 and early 2013, Pioneer drilled the Nuna No. 1 and Nuna No. 2 wells to appraise the Torok formation in the southern part of the unit. Those wells yielded a discovery in the range of 75 million to 100 million barrels and convinced Pioneer to propose an onshore development program to complement the existing offshore effort.
Doing the math
Publicly, Caelus appeared to be enthusiastic about the Nuna project when it acquired the Oooguruk unit from Pioneer Natural Resources Alaska in late 2013 and early 2014.
Privately, the company was doing the math.
In its July 2014 application, Caelus told the state that it wouldn’t pursue Nuna without royalty modification. The company provided economic models and information underpinning its cost and production assumptions. All those documents are confidential.
State statutes allow the Department of Natural Resources to toy with royalty rates if rising costs or falling commodity prices threaten the economics of an oil or gas field.
A state review revised the company’s models in several ways.
One involved running a series of scenarios rather than “just that of the most conservative reserve potential.” Another involved using state forecasts for prices and costs.
The review also considered how accessing financing on private markets - as opposed to using cash reserves, as an established company could do - would impact economics.
The review convinced the state to modify the royalty structure on five leases.
Under the state’s proposal, the reduction to 5 percent royalty on the five leases would remain in effect until Caelus brings in $1.25 billion from Torok production at the Nuna facilities. Any production revenue would be offset by a fixed 6 percent “backout” provision associated with the renting capacity at Kuparuk River unit facilities.
By basing the royalty reduction on a revenue target rather than installing a net profit sharing structure, the state avoids paying for cost overruns, according to the state. The current production revenue would be measured at the Kuparuk River pipeline tie-in.
Requirements
The modification requires Caelus to meet certain requirements.
First, Caelus must sanction the project by the end of the year. Then, Caelus must start spending money on the project by March 31, 2015, and spend at least $260 million by March 31, 2017. Finally, Caelus must start production at Nuna by March 31, 2017.
If Caelus misses any of those targets, it would lose the royalty reduction.
After two years of sustained production, Caelus must provide the state with a public account of its development activities, including costs, facilities design and forecasts.
“The purpose of this document will be to share the project learnings with DNR and the North Slope operators free of charge to enable all developers to better develop the state’s natural resources,” DNR Commissioner Joe Balash wrote in his Oct. 28 ruling. The Nuna project is targeting a Brookian play. Given the number of undeveloped Brookian plays on the North Slope, the state is particularly interested making this information public.
The reduction would belong exclusively to Caelus, meaning that Caelus would need permission from the state to transfer the rates to another operator, should it sell the unit.
