Nikaitchuq primed for royalty reduction

Falling oil prices likely to trigger a reduction in royalty rate on three leases at Eni US Operating’s offshore North Slope unit

Eric Lidji

For Petroleum News

If oil prices remain at their current levels over the coming weeks, they will trigger a reduction in the royalty rate at the youngest producing oil field on the North Slope.

Should the average monthly price of Alaska North Slope crude oil fall below $48 per barrel, the royalty rate at the Nikaitchuq unit would automatically drop to 5 percent under the terms of a royalty modification the state approved for the unit back in January 2008.

If the change occurs, the state would take less revenue from the unit than it currently does, and unit operator Eni US Operating Co. Inc. would keep more of the revenue it currently generates, although the specifics of the arrangement would temper the impact.

The exact financial value of the change is difficult to measure because it depends on the price of oil and the amount of production, both of which are always fluctuating. But if oil prices remained just below the $48 per barrel threshold and oil production remained constant, the state would lose some $1.026 million per month from the reduced royalty.

Eni requested royalty modification in October 2007, as it was deciding whether to sanction a major development effort at the Nikaitchuq unit, off the coast of Oliktok Point.

After determining that the project “does not meet prudent-investor standards for economic feasibility,” the Alaska Department of Natural Resources approved the request in January 2008. The approval came with terms, many of which are important today.

First, the 5 percent royalty rate would only goes into effect when oil prices fell below $42.64 per barrel, a threshold adjusted for inflation each May for the coming year.

Through the end of April 2015, the threshold is $48 per barrel, according to the state.

Regardless of oil prices, the royalty modification would also go into effect if production falls below 4,000 barrels per day during the first 10 years of sustained production.

Second, the royalty rate would only go into effect if Eni spent $822 million on Nikaitchuq activities through the first six years of development and $1.398 billion through the first 11 years. The company has met the first target, according to the state.

Third, the royalty reduction would only cover production from the Schrader Bluff OA reservoir. Recently, Eni has been appraising the potential of the Schrader Bluff N reservoir and has expressed an interest in a Sag River reservoir at Nikaitchuq. If the company ultimately sanctions those pools, neither would qualify for royalty reduction.

Fourth, the royalty reduction only applies to production from leases committed to a participating area within six years of the project being sanctioned. So even though Eni is currently producing oil from 11 leases at the Nikaitchuq unit, only production from the three leases in the Schrader Bluff participating area qualify for royalty reduction.

Fifth, the royalty modification program ends after 25 years of sustained production.

When Eni sanctioned a $1.45 billion development program at Nikaitchuq in January 2008, Alaska oil prices were averaging some $91 per barrel. When the unit entered sustained production in April 2011, Alaska oil prices were averaging some $120 per barrel.

On January 23, Alaska oil prices averaged $46.74 per barrel.

The royalty modification program has been used somewhat sparingly in Alaska, with only three projects approved for modified royalty terms over the past two decades.

Before Nikaitchuq, the state modified the royalty rates on nine leases at the Pioneer Natural Resources Alaska Inc. operated Oooguruk unit. Earlier this year, the state lowered the royalty rate on the five Oooguruk leases associated with the Nuna satellite of the offshore field, which is now operated by Caelus Natural Resources Alaska Inc.