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ISER looks at structural, technical changes in oil industry Study concludes oil prices may “lurch erratically toward a new long-term course significantly lower than the historical average” Kristen Nelson PNA News Editor
The owners would probably keep existing North Slope oil fields producing even at sustained single-digit crude prices — but prices in that range wouldn’t be enough to justify continued investment.
That is one of the conclusions in a recently released fiscal policy paper by University of Alaska Anchorage Institute of Social and Economic Research economist and policy analyst Arlon R. Tussing and ISER editor Linda Leask.
The report concludes that while not enough is known right now to draw firm conclusions, technical and structural changes in the oil industry over the past 20 years may have created “a scenario in which oil prices lurch erratically toward a new long-term course significantly lower than the historical average….”
Impact on Alaska? Even at $5 a barrel, it would still make more sense economically for the owners to keep North Slope fields producing than to shut them down, the report says. But investment in new fields, or even in additional development wells and well workovers, wouldn’t happen at that price and production would decline more steeply than now predicted.
The minimum per-barrel figure is based on considering all investments already made as fixed costs and looking at only the incremental or variable cost to produce and transport Alaska North Slope crude, which, the report says “is substantially less than $5 per barrel.”
“The vast preponderance of the cost of producing North Slope oil at a given time,” the report says, “is ‘sunk’ or ‘fixed.’ Once made, the investment in wells, processing facilities, roads and other infrastructure cannot be undone. Also, the salvage value of most of the equipment is less than the cost of transporting it to some other part of the world.”
“Moreover,” the report notes, “the leaseholders will be obliged to clean up sites once production ceases and they abandon the leases.”
The North Slope’s largest producers are, the report says, in the best position to withstand price slumps because of production and development cost advantages based on existing infrastructure and ownership shares in the trans-Alaska pipeline and feeder lines. But, the report says, “while low oil prices are unlikely to shut down much of the established production on the North Slope, price expectations do have a powerful influence on future output. Future production levels — both from existing and undeveloped fields — depend heavily on new investments. If North Slope producers became convinced that single-digit oil prices were permanent, they would undoubtedly take a hard look at any continuing investments. Oil production is dynamic — and without new investments in well workovers and new development wells, North Slope production would decline more rapidly than is currently forecast.”
The average price of crude oil during the last 10 years has been one-third less than in the previous 10 years, the report says, and industry investment on the North Slope was down by one-half (in nominal dollars) “…and field development slowed but never came close to ending.”
Worldwide, the report says, average crude prices (in 1998 dollars) over more than a century have been $15.05 a barrel. The lowest price (in 1998 dollars) was $7.50 a barrel in 1931.
High prices drove changes When Prudhoe Bay production began, the report says, the general belief was that the world was running out of oil. High oil prices reflected that belief.
“Alaska’s economic growth and ascent to wealth in the last generation,” the report notes, “are largely due to exceptionally fortunate timing. The peak flow of oil from the huge Prudhoe Bay field — which the state government owns — coincided almost exactly with the all-time peak in world oil prices that attended the Iranian revolution and the war between Iran and Iraq.”
Those high prices, however, encouraged conservation, changes to cheaper energy sources and more exploration in non-OPEC countries — all of which drove oil prices down.
Proved oil reserves worldwide, the report says, have increased 60 percent in the last two decades, from 653 billion barrels in 1977 to 1,037 billion barrels in 1997. While most of this growth in proved reserves has been in OPEC countries, proved reserves outside the Middle East have increased by 25 percent and OPEC’s share of world production has dropped to around 40 percent from around 55 percent in 1974.
Technology changes reduce cost of drilling, producing “Technological advances have made oil easier to find and cheaper to produce,” the report says. Advanced computer analysis, particularly three- and four-dimensional seismic, have made it easier to target oil. And directional drilling and coiled tubing have made it easier to drill and get casing to the oil.
And over the operating life of a field, many kinds of technical improvements have increased the percentage of oil in place that can be produced.
Technological advances, the report says, have made a huge increase in the efficiency of drilling. In the Lower 48, onshore drilling costs (in 1998 dollars) dropped from $97 a foot in 1976 to $75 a foot in 1997, while in Alaska the cost dropped from $836 a foot in 1976 to $218 a foot in 1997.
On the extraction side, “the ratio of industry employees to volumes of oil and gas produced” has fallen an average of 4.5 percent a year since 1982, a decline of nearly 50 percent in 16 years.
Alaska’s industry Over the last 20 years, the report says, “producers have invested billions of dollars in North Slope facilities and equipment. …made organizational changes — such as sharing facilities among operators and forming alliances with service companies — that have improved operating efficiency. They have sharply cut their costs by investing in improved technology. And in the past decade, they have settled most of their long-running tax and royalty disputes with the state government, controlling uncertainty from that source about future costs.”
And — a change the report calls crucial — “state and federal regulators have cooperated with the industry in speeding up the design, planning, permitting and construction of facilities, which together have shrunk the typical spread between decision and operation by more than half.”
The greatest savings in North Slope production over the last two decades have come from improved technology, the report says. “Horizontal drilling with coiled tubing and multilateral completions have probably been the most significant technological influences on North Slope costs in recent years and will continue to be so for the foreseeable future.”
The BP Amoco acquisition of ARCO On the proposed acquisition of ARCO by BP Amoco, the report notes that if the acquisition goes through, “BP would be by far the largest Alaska operator and Exxon a distant second.” That is a substantial change from the existing situation where — considering both oil and gas and developed and undeveloped fields — ARCO, BP and Exxon each control roughly equal shares on the North Slope.
“The merged company would control almost half the crude oil supply to California and the West Coast…” raising concerns in some quarters, such as the government of California, about BP Amoco’s ability to control prices. But, the report notes, other analysts “believe that ANS prices cannot rise much as a result of the merger, because the substantial share of crude oil that is imported from other countries puts a ceiling on West Coast oil prices.”
Operating efficiencies on the North Slope as a result of the acquisition have been cited by both BP Amoco and ARCO as making ANS crude more competitive and encouraging more North Slope development. And the report notes that, while savings from North Slope consolidations are only one goal of the merger, that goal is an important one.
“If federal regulators approved the sale only on the condition that BP sell a major part of the companies’ combined producing assets in Alaska,” the report speculates, “the remaining deal might not be attractive enough for both parties to go through with.”
Editor’s Note: The report, ISER Fiscal Policy Papers No. 11, “The Changing Oil Industry: Will it Affect Oil Prices?”, is available on the Internet: http://www.iser.uaa.alaska.edu/home.htm
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