Pumping Up TAPS: Impediments to filling TAPS

Insights, advice for legislators from small Alaska independent run by former ARCO exec

Following is a letter Jim Weeks, managing member of Alaska independent UltraStar Exploration, sent to Rep. Paul Seaton, co-chairman of the Alaska Legislature’s House Resources Committee for an early November meeting about impediments to filling the Trans Alaska Pipeline System, or TAPS. Weeks is a former long-time senior vice president of ARCO Alaska. His letter has been edited slightly, to meet Petroleum News formatting and space requirements.

There is a single phrase to describe what determines and impedes the sustaining of volumes through the TAPS as the legacy fields on the North Slope continue to decline. And that is “cost structure.” The lower the state can make the cost of producing and shipping liquid hydrocarbons through TAPS, the longer the resource will last and the more oil will ultimately be produced. With lower cost structure, more new fields will be found, brought on line and last longer.

We’ve got to stop thinking about a world beyond petroleum, and spending significant money trying to force-fit projects of marginal significance into the energy mix. Oil has been good to and for all of the State of Alaska, and there is no reason to believe it cannot be for decades to come. We are advantaged in that we have world-class oil fields producing into a world-class pipeline. So let us stay in the game, compete fiercely for investment dollars, and extend the field lives as long as possible — through as low a cost structure as possible.

Following is what can the state do, both in the near and long term:

1. Reduce state’s take

I know there is a contingent of legislators with the firm belief that rig counts are up, employment is up, etc. etc. because of ACES, the state’s current production tax, so everything is fine, and the state is enjoying huge windfall budget surpluses as a result of currently high oil prices and ACES progressivity tax rates. It is like we’re intoxicated on the high revenue stream, and we want it to continue.

But everything is not fine. Sure, the tax credits authorized in ACES are a tremendous incentive to companies like ours and others who are currently exploring, and we certainly hope the credits stay in place for a long time. UltraStar’s last well, in 2009, would not have been drilled without them.

But UltraStar and the smaller players cannot meaningfully increase TAPS throughput. We simply don’t have the balance sheet or the leasehold. The major leaseholders, BP, ConocoPhillips and ExxonMobil who do have the balance sheets and lease positions, need to participate, but are not because of the tax structure of ACES.

Sure, they receive the same tax credits we do, but to them these credits are nice, but pale compared to the huge tax bill they pay each month.

They are not drilling wildcat wells, and if HB 110 were passed, would no doubt pick up the pace of development of heavy oil resources in both the Prudhoe Bay and Kuparuk River units, overlying the primary productive zones.

There is a target of 50 billion barrels of heavy oil in the West Sak/Schrader Bluff and Ugnu formations. These are known, drilled, proven resources. There is nothing speculative about them except their technical feasibility and economic viability.

They are shallower, thus colder, and the reservoir rocks haven’t been buried to a depth sufficient to consolidate the sandstones. Being colder, the oil is viscous, like molasses, and the sandstone formations are like beach sand.

But the size of the targets cannot be ignored. Combined, they are orders of magnitude bigger than all the prospects of the current group of independents combined, with the possible exception of resource plays, which I’ll discuss later.

Probably the most significant challenge faced by these economically and technically challenged heavy oil resources is that production from them is subject to the very high production taxes in ACES, which is exactly the wrong direction the state should be headed. This heavy oil already costs significantly more to develop, and on top of that they are burdened by an exorbitantly high marginal tax rate. Exactly the wrong strategy for a tax policy with filling TAPS as a goal.

In the oil business, it never fails that when a field is being developed and waterflood is being implemented, the reservoir engineers, subversive creatures that they are (I can say this because once upon a time I were one), select the best oil producers to be converted to water injectors. So oil stops coming out and water starts going in.

Once this happens, of course, the immediate impact on the daily oil production rate from those converted wells drops significantly, as, depending upon the waterflood pattern, 40-50 percent of the total wells in a field can be injectors. This near-term production loss is more than made up over the long term, as waterfloods generally increase ultimate recovery by 25-50 percent or so.

But the near-term effects on revenue are quite painful. Waterflooding is often compared to delayed gratification. It takes an adult to appreciate it.

The current situation in Alaska is analogous to waterflooding a reservoir. With his proposed ACES revisions, the governor wants to implement a waterflood, to significantly increase ultimate recovery in the long term.

Those opposed to his plan want to continue to enjoy the high brought on by the immediate gratification from the double effect of the high tax rates in ACES coupled with high oil prices.

It is far better to lower taxes now on existing production, and particularly production of heavy oil, so we can enjoy the benefits of lots of new production for many years to come.

It mystifies me why the state would impose one of the highest marginal tax rates in the world on one of the highest cost resources in the world, heavy oil on the North Slope.

It is the only resource there that can make a significantly positive difference in the near term.

It is huge, it is known to be there, and it is connected to the roads, pipelines and processing plants.

So let’s go after it in a frenzy.

2. Roads to resources

Thanks to the Murkowski administration, which adopted the strategy, and the Parnell administration, which continues pursuing it, progress has been made and continues to be made, and that is good.

On the North Slope, there are two proposals: one for a road connection from the Dalton Highway east to Bullen Point, and one to the west to Umiat, which is further advanced. The governor is certainly behind Roads to Resources, and thanks to you in the Legislature these projects continue to move forward. I fear they will not get done without continued push from both the administration and Legislature.

These projects are under attack by aboriginal groups expressing concern of the impact they may have on subsistence lifestyle and the usual environmental groups, who oppose anything that may enhance the economics of resource development, and concerns about funding.

I think that funding could be the Achilles heel for these needed projects, which will lower the cost of exploration and development far in excess of what anyone can now envision.

I implore you and your colleagues in the Legislature to think out of the box to structure creative ways for these important projects to get done.

Think of when the U.S. Congress authorized the construction of the trans-continental railroad. They did not do a lot of cost/benefit analyses, and they gave the railroads every other section of land, checkerboard style, on both sides of the right of way as incentive to build the tracks and terminals.

The state owns virtually all of the land these roads are proposed to pass through. Perhaps you should do something similar, or even, heaven forbid, consider investing, yes investing, a very small percentage (1-2 percent), of the Alaska Permanent Fund in these roads.

I said investing, not spending, a small percentage. The returns will be enormous. I’ll guarantee you the U.S. Congress did not do a bunch of net present value calculations when they authorized the railroad, nor the Eisenhower Interstate Highway system, both of which are extremely important to the national economy.

But investing permanent fund earnings now on infrastructure projects that will pay off handsomely in the future may decrease the fund’s principle and earnings and the dividend check. So the people would be risking the instant gratification they currently receive from an annual permanent dividend fund check for a greater delayed gratification from a potentially much larger future PFD check. All enabled by revenue from the resources that will be developed as a result of having lower access and extraction costs.

How about a rail extension of the Alaska Railroad to the North Slope and points east and west?

How many times is the state going to re-build and re-repair the road and bridges on the Dalton Highway?

Some will say it is too late for a railroad extension to make any sense. That it should have happened 30 years ago.

I contend that the North Slope is still in its late adolescence. I was raised in an oil field in south-central Wyoming that was first drilled in the mid-1910s. It is nearly 100 years old now and is still producing, not only oil, but good paying jobs and taxes for the State of Wyoming and Sweetwater County. And it has yet to experience the shale oil boom that is expanding into the area. That boom is in the Niobrara Shale in northwest Colorado and southern Wyoming, about 50 miles south of my home town.

I wish Great Bear great success with its plans to test the viability of oil production from the known shales on the North Slope. Success here will definitely be a game changer for Alaska and the North Slope, and Alaska should be ready with the infrastructure to make that game as competitive as possible.

Every new well at Prudhoe requires 50 truckloads of freight to supply it. The pipe, mud, cement, equipment, supplies and materials that go into the ground.

Because of their large horizontal components, shale oil wells will require probably twice as many truck loads per well, and much, much more fracturing and completion services.

Lowering the cost of transportation to the North Slope will add enormously the number of ultimate wells drilled and barrels of oil produced.

3. Ice roads and pads

As it now is, the successful bidder at a lease sale is awarded a contract to explore, develop and extract oil and gas from that lease. The contract stipulates that there will be no exploration on the lease except from approved ice roads and pads, built only when there is sufficient snow cover and frozen depth to carry the heavy loading of drilling rigs and equipment.

This restricts the exploration drilling window to generally mid-January to no later than about April 15, depending upon the status of the well.

So there is essentially a 90-day period in which to construct the ice road and pad and move in the rig and associated 50 truckloads of parts, plus camps, shops, generators, fuel storage tanks and other supporting facilities.

This restrictive window allows for one, and certainly no more than two, wells to be drilled per rig per season.

Companies like Repsol, with nearly 400,000 acres to explore and delineate, will require multiple years to prove up commercial reserves and make plans for development. So they will need to re-build the needed ice roads and pads multiple times before development decisions are made.

Linc Energy faces a similar challenge at Umiat.

The state should let private industry decide the most efficient and lowest cost manner to conduct exploration.

Ice roads and pads may be the best way forward for close in exploration. But for access to locations farther from the road system, re-building ice roads every year for several years gets pretty expensive.

The leaseholder should not be restricted from using any method, with appropriate approvals of course, to access his or her leases.

If existing, or newly constructed permanent or semi-permanent gravel roads, airstrips and drilling pads would be more cost effective, they should be allowed.

This could provide year round access to the leases being explored, and shorten times from lease to production by years. The ability to drill throughout the year will also significantly shave the winter peaking demand for drilling equipment, materials and manpower, thereby further reducing costs.

An all-weather road to the location of the drilling also provides year round access for emergency response equipment and personnel, adding another level of safety to the already very high operating standards for humans and the environment.

Thanks for the opportunity to comment.