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ACES production tax works for harvest PFC Energy describes portfolios of North Slope majors for Senate Finance; Alaska core area for Conoco; harvest area for BP, Exxon Kristen Nelson Petroleum News
As the Alaska Legislature discusses proposals for changes in the state’s oil and gas production tax, Alaska’s Clear and Equitable Share or ACES, frequent references have been made to North Slope producers being in harvest mode.
That’s not been perceived as a good thing.
PFC Energy, consultants hired by the Legislative Budget and Audit Committee to work on oil tax issues, spent a good deal of time March 15 talking about what harvest mode means to companies and why a given company may be in harvest mode in a given area.
Jerry Kepes, a PFC Energy partner and head of upstream and gas for the firm, told legislators that ACES appears to be a successful tax policy if the goal is harvesting an existing resource, but not successful for new development. (See oil tax story on page 1 of this issue.)
Portions of portfolios Kepes presented a PFC Energy analysis of the major North Slope producers, with information from PFC’s global databases developed over a 25-year period.
He described it as an assessment of the companies, “their portfolios, the importance of different parts of their portfolios, what’s important to them, how they move cash flows in and around different parts of the portfolio— what’s strategic; what’s not strategic.”
PFC has divided each portfolio into parts.
Core areas for a company are areas where production, cash flow and reserves are “material to the overall scale of that company’s portfolio.” A core area “is returning cash flow or returning cash from investments already made” and also has “substantial growth opportunities.”
“A core area for a company represents an area that gives repeatable, profitable investment opportunities over decades. That’s where these companies really make their money,” Kepes said.
A new venture area is one where a company does not have producing assets, or only very minor producing assets. It may have exploration blocks and commitments to drill, “but does not have positive cash flow,” he said.
A company may be testing “the viability or commercial viability of activities” in a country and the commitment may be “a bit more tentative.” If a company drills seven dry holes in a new venture, they may depart at that point, “so the commitment to a country at new venture stage is mild at best.”
A focus area is one where a company has made a substantial discovery or thinks there are substantial resources. “And they are in the process of considering substantial new investments,” Kepes said. But either “the materiality is not as high as that for the core area or it’s not producing any positive cash flow yet, because it might be pure investment stage.”
He characterized it as a longer lasting commitment than a new venture, “but it’s not quite a core status.”
The harvest area In a harvest area, “the company does not see growth opportunities or sees only minor growth opportunities. And therefore it does not meet the definition of the core area which is repeatable, profitable investments over decades going forward,” Kepes said.
Core areas “in due course eventually turn into harvest areas because of the maturation of the basin in a given portfolio.”
A harvest area “could still be material, it could still be very profitable, but because the growth opportunity is not there for them — or they don’t think it’s viable for them — the amount of new investment that they’re going to make is going to be limited because, again, they don’t see the growth opportunity.”
And there will be more of a focus on generating cash flow that can be used in other parts of the portfolio where there are growth opportunities.
Over the life cycle of assets in a portfolio, assets “go through different cycles, in some cases requiring years of substantial investment, and no positive cash flow being produced, and other parts of the portfolio at the same time, other areas are generating substantial cash flows in harvest-area like conditions which are then used to invest in these new-growth areas.”
Alaska harvest area for BP Kepes said that in PFC’s opinion, Alaska is a harvest area for BP, as is the UK North Sea.
Factors contributing to harvest area status include maturing basins and fields where in some cases the cost of extending a field life can be very high. “Or you might have new field discoveries but they’re very small and so they’re not material for a company of that size,” Kepes said.
A harvest area isn’t something a company wants to do, he said, “but basin maturity, field maturity, cost, fiscal structure, the competitive landscape — all these drive to create a situation where a company might not recognize or might not be able to capture or may not be able to see profitable growth opportunities and therefore they would use the cash flow elsewhere.”
“It doesn’t mean that they don’t reinvest; they do. But they don’t reinvest as much as if they did see those growth opportunities.”
Core for ConocoPhillips, harvest for Exxon While Alaska is a harvest area for BP, it is a core area for ConocoPhillips.
Why is this different than for BP?
One reason is that “ConocoPhillips has several areas of activity in Alaska,” Kepes said, including exploration activity offshore, Cook Inlet “which is essentially a harvest area” for ConocoPhillips and the North Slope, which is also a harvest area.
But looking at “all of the components of ConocoPhillips’ interests in Alaska, that’s what causes us to keep it a core area designation,” even though on the North Slope the company essentially has the same assets as BP and ExxonMobil.
Alaska is a harvest area for ExxonMobil, as is the North Sea, Kepes said.
Size matters In discussing the company’s portfolios, Kepes said that BP and ExxonMobil, both with production in the range of 4 million barrels a day, are of a size that makes it very difficult to grow.
Materiality matters: A 5,000 barrel-a-day production streams means “very different things” for a company producing 100,000 bpd than it does for BP, which is producing “close to 4 million barrels per day.”
For large companies — like BP and ExxonMobil — it’s very difficult to grow. At 4 million barrels a day and a 6-7 percent a year decline rate, “just to stay even, they’ve got to generate new production volumes ... at substantial numbers,” he said.
Growth is a challenge for big companies because of their size and they are interested in growth if they can find it with the kind of returns they need for the market.
Companies work to sustain their portfolios as parts are declining and parts can be grown, Kepes said.
“Every large company has harvest areas, has growth areas or core areas (and) other areas where they’re testing new exploration ideas,” he said.
Change at Conoco Kepes said that after the split is finalized in April of ConocoPhillips into its upstream and downstream components — the downstream to be called Phillips66 and the upstream retaining the ConocoPhillips name — “what’s not material to ConocoPhillips as an integrated company will be more important to ConocoPhillips as an independent.”
The asset base for ConocoPhillips will be different and the company will be smaller as an upstream company.
“The same asset that was less material to the bigger ConocoPhillips integrated company, on a materiality basis alone, will be more important to ConocoPhillips as an independent upstream company.”
Kepes said there may be some shifts in strategy.
ConocoPhillips as an independent E&P company will be smaller, he said, and while changes won’t happen immediately they will occur once that new company is spun off.
As an independent, ConocoPhillips will “have to establish the basis upon which they’re going to compete,” Kepes said. “Are they going to deliver growth? Are they going to deliver financial returns? What’s it going to offer the investor?”
He said that’s a big challenge and “ConocoPhillips as an independent upstream company is going to be looking at some of these issues differently; they have to because it will be different for them.”
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