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Early trades created two participating areas at Prudhoe Oil, gas interests not aligned; litigation over Phillips Petroleum’s acquisition of ARCO Alaska was opportunity to solve problem Kristen Nelson PNA News Editor
When the major Prudhoe Bay owners aligned their interests in mid-April, they solved a problem which has existed since the Prudhoe Bay unit was formed. Because there was no agreed-upon price for the field’s natural gas — because there was no way to get the gas to market — the field owners formed two participating areas, one for oil and one for gas.
Prof. James Smith of Southern Methodist University, who studied the issue and prepared a report for the Alaska Oil and Gas Conservation Commission in 1997, said that when the parties were unable to form a single participating area at Prudhoe, “the traders carefully crafted provisions of the Prudhoe Bay Unit Operating Agreement … in a manner that was intended to achieve a balance of interests and to commit all parties to what appeared to be an effective plan of development.” The approach, Smith said, appears to have worked during the first phase of field development.
“However,” he said, “by the mid-1980s the system of trades designed to balance the competing interests and produce consensus on major development issues appears to have broken down.”
The problem, Smith said, was that company economics did not match unit economics because Prudhoe was not one unit but two participating areas — the oil rim and the gas cap. A certain balance may have been achieved among interests of competing owners, he said, but that is not the same as the alignment which a unit creates. “Within a properly functioning unit,” Smith said, “the distinction between company-based and unit-based economics would be transparent and innocuous. By looking at the unit, each owner would see an image of himself. The same tradeoffs, opportunities, and costs facing one would be shared by all.”
Balance couldn’t hold up over time The balance at Prudhoe Bay was created by fixed trades — it couldn’t hold up over time against changes in prices, costs and reservoir performance.
The Alaska Oil and Gas Conservation Commission was considering forced unitization at Prudhoe Bay, and Smith said that such a proceeding would have a risk of an adverse outcome to owners. “I believe,” he told the commission, “that the owners’ reluctance to put their whole equity at risk in any single proceeding has played a dominant role in the failure of the previous voluntary efforts to achieve a single participating area. Rather than putting the whole pie up for grabs at once, the owners prefer to continue working within a framework that deals with a series of somewhat smaller and more compartmentalized issues.”
Smith said that, “While certain technical differences and commercial conflicts might remain, I believe that representatives of all the major owners agree that consolidation of the two participating areas into a single equity structure, once achieved, would go very far towards eliminating the conflicts that have accompanied development of the Prudhoe oil pool.” Smith said that the fundamental conflict driving disputes within the Prudhoe Bay unit, including those around gas handling expansion, fuel gas and the recent miscible injectant-natural gas liquids conflict, “is the fact that the owners have varying stakes in oil versus gas-related projects.”
Quite an opportunity Phillips Petroleum Co. Chairman and CEO Jim Mulva said April 26 in Anchorage that “we did not anticipate some of the events that took place during the past six months — much less during the past six weeks.”
But, he said, those events presented “quite an opportunity.”
Mulva said that the companies “thought over time that we’d move toward alignment of interests between the oil rim and the gas cap, as well as moving toward one operator.”
When the Phillips purchase of ARCO Alaska Inc. was announced in mid-March, he said, “we indicated then that would be something for determination at a later point in time, maybe over the next several years.”
But over the last six weeks, he said, “it became an opportunity to solve that once and for all, because there have been these differences over alignment over quite a number of years.”
The real value to us, he said, is that “now that we are aligned, we would expect … development of oil and gas opportunities will go even more smoothly and maybe more quickly than it would have gone otherwise.”
“So it was a unique situation. We seized upon the opportunity and … think it will create value … for companies and for the state,” he said.
The ExxonMobil litigation was unexpected, he said, because BP and Phillips didn’t feel there was a basis for litigation of preferential rights.
“But as we got into discussions and negotiations … (it) became an opportunity to deal with both alignment and single operatorship.
“That was really the opportunity the oil companies saw. Probably the right time and place to do this.”
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