Producers 2022: HEX hanging in there with Kitchen Lights unit
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John Hendrix talks about Sterling evaluations, ongoing tax battle with Revenue
Kay Cashman Petroleum News
Long-time Alaskan John Hendrix is the only owner of an oil and gas company operating in the state. While other oil and gas companies establish local offices, they are based outside Alaska.
Via his newly formed HEX Cook Inlet, in July 2020 Hendrix acquired the natural gas producing company Furie Operating Alaska and its partners Cornucopia Oil & Gas Co. and Corsair Oil & Gas in bankruptcy proceedings. The centerpiece of the purchase was the offshore Kitchen Lights unit, its Julius R. production platform, a 15-mile subsea gathering line and an onshore natural gas processing facility at Nikiski on the Kenai Peninsula.
The Kitchen Lights unit, or KLU, is the largest unit in the Cook Inlet basin by acreage and has been seen as a source of growth for the basin.
Hendrix was raised in Homer, Alaska, and is an engineer. He has close to four decades of experience in the energy industry in Alaska, the Lower 48 and internationally with Apache, BP and Schlumberger.
That experience includes managing Apache’s Cook Inlet operations from 2012 until 2016, when the company let its leases drop because of some of the same challenges HEX faces today.
A few bad apples In July and August 2022 interviews with Petroleum News, Hendrix talked about Furie’s successes under his ownership along with the challenges the company has faced in the last two years.
Although Hendrix thinks the commissioners of Alaska’s Department of Revenue and Department of Natural Resources are doing a good job to improve the business climate for oil and gas companies working in the state, he said some obstacles remain.
Alaska is an expensive place to operate, he said, likening the regulatory regime to a field spiked with land mines: “Yes, you can get across the field but you don’t know what kind of regulatory land mine you’re going to step on along the way that might cause your investment to go up in smoke,” he said, noting most of those ‘mines’ involve required federal permitting on federal and state acreage.
One of the mines HEX has run into was a property tax valuation by the Alaska Department of Revenue that was “more than four times what the IRS allowed the KLU assets to be depreciated from. … How can the state turn around and value it four times more than the IRS will allow me to depreciate? And it’s been audited. This is the kind of stuff that kills you. I must pay $1.6 million every year in property taxes until this is settled,” Hendrix said.
The company appealed Revenue’s decision to the State Assessment Review Board. SARB upheld Revenue’s decision so now the issue is headed to court in January 2023.
Estimating it will take about three years to reach a final decision in the courts, it means Hendrix will have “more than $5 million tied up in this matter, not including attorney fees.”
Hendrix said Revenue’s assessment was “unfair and excessive,” and money that should be used for well work to produce more natural gas for Southcentral Alaska’s residents that rely on gas to heat and electrify their homes and businesses.
“We had hoped the state of Alaska would come to the table and settle this through mediation that was recommended by the judge, but as of now they remain uncommitted. The Kenai Peninsula Borough is in favor of mediation.”
Until the lawsuit is settled, in or out of court, HEX cannot afford to invest in any more major capital improvements at Kitchen Lights.
“We’d hoped for a settlement, which would have saved everyone, including the state of Alaska money, but that hasn’t happened,” Hendrix said. And in September 2022 he confirmed that state officials would still not come to the table.
“The state of Alaska makes how many billions off oil and gas, yet the Department of Revenue has no definition for proved or proven or proven reserves. ... we’re hoping to help them get there some day,” Hendrix said.
Production, court In the meantime, HEX is trying to keep gas production level, although he’d prefer to be investing the money he’s paying in excess taxes into KLU improvements that would increase output.
He’s already proven he can boost production, although he is still working to prove up reserves in the unit:
Output data from the Alaska Oil and Gas Conservation Commission for the KLU averaged 13,946 thousand cubic feet of natural gas per day in July 2022 which is 7.5% of Cook Inlet basin production. In July 2020 KLU averaged 12,678 mcf per day.
A settlement could save a lot of time and money for all the parties involved.
“We are an Alaskan company. Out of every $100 made, we spend $30 in paying for royalties and property tax. On top of that we have payroll, daily operating expenses, so it is a challenge,” Hendrix said.
Had to fix everything At the time HEX acquired Furie, KLU was an underperforming field in need of fixing, but with considerable potential.
On Dec. 18, 2020, Hendrix said, “When we took over Kitchen Lights, we basically had to go in and fix everything.” This statement was confirmed by DNR’s Division of Oil and Gas.
“I took a gamble on buying KLU; I know that. But I figured I should be able to trust my state government to treat me fairly and help me navigate through the challenges of operating in the Cook Inlet,” he told PN.
Most active bidder Hendrix has been the most active bidder in Cook Inlet basin lease sales for the last two years.
He was one of two companies in the 2021 lease bid round. In the most recent state Cook Inlet basin lease sale in May 2022, Furie was the only bidder, winning two leases.
“Our predecessor had already relinquished those. I decided we needed to pick them up because they are close enough to where we want to produce in the future. It’s all about shoring up acreage surrounding our platform,” Hendrix said.
Sterling opportunities Furie under its previous owners brought the unit into production from a single well in November of 2015 and subsequently drilled three more production wells, with the last being the KLU A-4 well in October 2018.
By the time HEX took control, one of the four wells was offline, awaiting upgrades and repairs. And the three other producing wells were underperforming.
HEX’s goal was, and continues to be, having all four existing wells producing natural gas - hopefully from both the Beluga and Sterling formations, with much of the upside in the unproved Sterling.
As of Sept. 19, one of the four wells was producing from the Sterling. Two other wells are capable of producing from the Beluga, but one is shut-in from April to October because the utilities only want the gas in the winter months.
According to one natural gas producer, the utilities want producers to produce 350 million SCF of gas per day for them in winter and then they cut the Cook Inlet producers back to 50 million from April to October. So as a group the producers only sell 1/7 of what they make in the summer.
A produced water handling system was installed in 2021 primarily for the Sterling formation.
“We view the Sterling as a great opportunity; that is if we get this right and get it producing natural gas year-round, we might be able to add a year to the life to the field,” he said.
“The big thing is, proved reserves have to be economical and right now we’re testing to see if we can get it to that point.”
The Sterling is what cost Furie’s previous owners $17 million when they froze the flowline in the winter of 2019 due to excess water production.
“We spent about $1.8 million on it,” Hendrix said, referring to the water handling system. “Udelhoven installed it,” he said, pointing to the fact that unlike the previous Furie owners Hendrix’s companies employ Alaskans - and use Alaska, not Outside, contractors.
Several months ago HEX’s Furie put the A-1 Sterling well into test. The test has been “encouraging,” Hendrix said.
Since then, KLU A-2A and KLU A-4 have also been tested and evaluations are ongoing.
Because of the inability to comingle Beluga and Sterling production, HEX is strategically placing individual zones in test to minimize any disruptions to overall production, he said.
Unfortunately, Hendrix told PN on Sept. 19 that the “KLU A-4 Sterling tests were disappointing.”
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