At first glance, things seem to be looking up in Alaska’s Cook Inlet gas industry.
New gas supply contracts linked to Lower 48 Henry Hub prices have encouraged companies such as Marathon Oil Corp. and Aurora Gas LLC to explore for gas and bring new gas fields on stream — increased pricing ought to enable Cook Inlet gas exploration to compete with exploration elsewhere. A state areawide leasing program in the Cook Inlet basin has encouraged leasing. And according to the Alaska Department of Natural Resources Cook Inlet gas reserves increased from 2,032.8 billion cubic feet at year-end 2003 to 2,087.5 bcf for year end 2005.
A long-awaited resolution to a dispute regarding access to the Cook Inlet Gas Gathering System that crosses the Cook Inlet means that there’s now an interconnected, regulated gas pipeline infrastructure north from Trading Bay on the west side of the Inlet and north from Ninilchik on the east side of the Inlet. The recent instigation of bidirectional flow in the Beluga gas line on the west side of the Inlet and the pending resolution of a tariff dispute for that line also bode well for improved access to the Cook Inlet pipeline infrastructure.
And Chevron has established gas storage facilities at Swanson River on the Kenai Peninsula and Pretty Creek on the west side of the Inlet, to alleviate supply problems during peak winter demand; Marathon also plans to instigate gas storage in the Beluga gas field.
A new contract between Marathon and Enstar Natural Gas Co., the main Southcentral gas utility, should now ensure adequate gas supplies for Enstar through 2016.
The production cliff
But the residents of Southcentral Alaska have become increasingly familiar with the graph that shows projected gas production from the Cook Inlet basin dropping over a cliff within the next few years. And even if gas supplies can be assured for heating and electricity generation, the industrial facilities on the Kenai Peninsula remain under threat. Agrium’s Nikiski fertilizer plant is looking to convert from the use of natural gas to the use of gas generated from coal. And, in the absence of increased Cook Inlet gas deliverability, the Nikiski liquefied natural gas plant will struggle to renew its export license in the first quarter of 2009.
So why isn’t the Cook Inlet area awash with companies actively searching for gas? A 2004 U.S. Department of Energy report stated that there might be as much as 10 trillion to 14 trillion cubic feet of undiscovered, conventional natural gas in the Cook Inlet basin.
In the Resource Development Council annual conference, held in Anchorage in mid-November, Scott Pfoff, president of Aurora Power Resources Inc., and John Barnes, Marathon’s Alaska business unit manager, reviewed some of the issues facing the Cook Inlet gas industry.
Difficult gas market
Pfoff focused on some of the market challenges.
“Having pounded the pavements in downtown Houston, downtown New York and in Calgary in search of private equity capital … we never had any problem selling anybody on the technical merits of looking for oil and gas in the Cook Inlet basin,” Pfoff said. “… The problem came when I got up and tried to talk about the market. There is no spot market up here — you don’t just find gas, hook it up to the nearest pipeline and start selling it. You’ve got to have contracts; you’ve got to have a way to sell your gas.”
Pfoff said that the gas utilities establish long-term contracts with gas suppliers, because the utilities want to ensure continuity of gas supplies for their consumers. But new contracts do not then become available until the utilities enter their next round of supply negotiations, he said.
“Somebody wanting to come in today a make a major investment and find gas and put it on production is not going to have markets available to them for quite some years down the road,” Pfoff said.
And David Boelens, vice president of Alaska operations for Aurora, has questioned whether long-term supply contracts are really in the best interests of gas consumers. Allowing new producers to compete in the gas market might reduce prices, he has told Petroleum News.
A plethora of gas supply contracts, all at different price levels, has led to another issue — the state’s royalty and tax assessments use “prevailing value,” a weighted average of gas prices from the region. That can result in a gas producer paying royalties and taxes based on a gas value that is higher than the price that the producer is actually obtaining.
“Sometimes we’re being required to pay royalties and taxes on values much higher than we’re able to achieve in the market. And it’s issue that I think we will need to address,” Pfoff said.
Barnes talked about the commercial problems resulting from extreme seasonal fluctuations in gas demand.
“Seasonal gas pricing doesn’t really exist,” Barnes said. “There’s a significant difference in demand between summer and winter but not a lot of price difference.”
Industrial uses of gas can help smooth out seasonal demand, but there’s a shortage of industrial customers in the Cook Inlet area.
“There aren’t enough multi-year industrial contracts,” Barnes said. “… Industrial consumers are important to a successful (gas) industry.”
Permitting complexity
The complexity of permitting in the Cook Inlet area compounds the commercial issues. Barnes commented on the many forms and reports that are required to drill a well in the Cook Inlet basin.
“That all takes time and can slow down projects,” he said.
There are a lot of people in the agencies doing a good job, but it’s a very complicated situation, Barnes said.
“There’s ample opportunity, I think, for the state to work to try to improve that situation,” he said.
Barnes commended the Regulatory Commission of Alaska on its efforts to streamline the process for pipeline regulation. But significant hurdles remain, Barnes said — for example the need to set a tariff before knowing what the pipeline will cost.
Veteran Alaska geologist Arlen Ehm also emphasized the permitting issues in his testimony to the Alaska House Special Committee on Oil and Gas on Nov. 21. Ehm cited situations where it proved impossible to access leased land for drilling. He also cited the complexity of the permitting paperwork.
“One of the biggest problems is the Coastal Zone Questionnaire with its myriad of questions of which only a fraction actually applies to oil and gas operations,” Ehm said.
Small independent oil and gas companies also testified to the committee about the high cost of bonding and permitting in Alaska. Petroleum News has determined that the Alaska Oil and Gas Commission requires a $100,000 bond to drill a single well or a $200,000 bond to drill multiple wells. The Alaska Department of Natural Resources requires a $10,000 bond for any lease activity.
But the Alaska Department of Environmental Conservation requires proof of financial responsibility for $1.43 million to drill a well that may encounter oil — DEC waives this requirement if the operator can demonstrate to AOGCC that the well will not encounter oil. DEC proof of financial responsibility for a shallow gas well is $35,875.
Dual management
Mark Myers, ex-director of Alaska’s Division of Oil and Gas, has told Petroleum News that the complexity of the permitting in the Cook Inlet area is partly a result of dual management between state and federal agencies.
“One of the things that you have to recognize in Cook Inlet is that you’ve got the big wildlife refuge and you’ve got the state critical habitat areas,” Myers said. “That puts into play a dual management structure, where the permitting process is more complicated.”
Also there’s a continuing issue regarding the role of oil and gas in the Kenai National Wildlife Refuge — whether new oil and gas development should be allowed and, if so, under what conditions, Myers said.
The land ownership situation is also complex. In addition to state and federal land “you’ve got Native owned lands in the area and you’ve got a fair amount of fee simple land scattered throughout the area … and you have some split estate surface owner issues,” Myers said. “You (also) have an overlap of an extreme number of different (land and water) users and types of users.”
The level of concern from local residents regarding oil and gas development varies between different parts of the Kenai Peninsula and can complicate the permitting process, he said.
High risks and costs
Then you have to consider the high risk and cost of doing business in the Cook Inlet region, especially in remote areas distant from the existing natural gas and transportation infrastructures. Operations on the west side of the Inlet are particularly expensive because of the lack of road access and the need to barge equipment and supplies during the periods when the Cook Inlet is ice free.
Add those risks and costs to the marketing and permitting issues and it’s not too difficult to see why more companies haven’t entered the Cook Inlet gas business.
So, what needs to happen to encourage development of the trillions of cubic feet of natural gas that probably still lie in the Cook Inlet basin?
Ehm thinks that tax and royalty incentives for small independent oil and gas companies would help alleviate the cost factors.
“This could be a lowering of the state’s royalty for the initial production and could be increased with time or with the increase in volume of production,” Ehm said. “Severance taxes and property taxes could be lowered in a similar manner.”
Myers thinks that there is scope for improvement in the permitting system. For example, the state has looked into implementing a universal, electronic permitting system — perhaps something like that could help. The Alaska Department of Natural Resources has taken a central role in streamlining the state permitting process, Myers said. Perhaps more state/federal coordination could be done and standard permit templates could be used for similar activities in the same area — Ken Boyd, another previous DOG director, has championed this type of approach.
“(But) it’s complicated and how do you do it better and then how do you also respect the multiple use nature of the Kenai?” Myers cautioned.
Natural gas market is the key
However, Myers thinks that the key to a flourishing Cook Inlet natural gas industry is the gas market. Resolve the issues that hamper the gas market and solutions to other issues will emerge.
“You have a difficult situation trying to get folks to invest capital up here,” he said.
Companies need to be exploring for some of the larger opportunities, rather than just exploring on the fringes of the basin, he said. And to support that type of exploration, Myers particularly commends the proposals for state incentives to bring a jack-up rig to the Cook Inlet.
“(But) we (also) need, I think, to have a way to sell a large volume of gas into the market at higher prices,” he said.
A more robust export market or a value-added manufacturing market could enable someone to monetize a larger discovery, he thinks. The Agrium fertilizer plant is limited in what it can pay for gas but LNG seems a high value export product.
A bidirectional spur line
The implications of a North Slope gas spur line to Southcentral Alaska particularly intrigue Myers, especially if that line were to have expansion capability and capabilities for bidirectional flow. A spur line could link the Cook Inlet area to North Slope gas and to the Lower 48 gas market, thus fostering a vibrant gas industry in Southcentral Alaska.
“You actually could see that being an export line as much as an import line, should exploration really be successful in the Inlet,” Myers said.
But if implemented the wrong way, a spur line could provide a disincentive for exploration and development in the Cook Inlet.
“Access to the major (North Slope) pipeline, both intake and offtake, is a critical role,” Myers said. “You need predictability in being able to do that and a tariff structure that supports it.”
Then you would have full access to Lower 48 markets and Lower 48 prices, he said.
So what does all this mean? With an impending production cliff, plans for a North Slope gas line and gas exploration occurring in Alaska’s Susitna and Nenana basins, the Cook Inlet gas industry seems to be heading for some significant changes. Will it fall over the cliff or really start to flourish?
“We’re on the verge of something but I don’t know whether it’s a boom or bust,” Barnes said. “The outcome is going to be determined by how the challenges are met — by the industry, by the regulatory permitting bodies, by consumers, by outside forces.”
