Rising costs become more important factor in oil price

Unveiling her fiscal year 2010 budget on Dec. 15, Gov. Sarah Palin said oil at $40 to $42 a barrel would have been considered "healthy" a couple of years ago, and even "relatively high, compared to some years." She added that "compared to the $140 that we were blessed with many months ago, the $40-something a barrel looks relatively low."

With the sharp run-up in oil prices over the past three years, Alaska became accustomed to benchmarks that would have been unthinkable just a decade ago. But after peaking at $144.59 per barrel in early July, oil prices began falling, then started plunging in October.

Through the first three weeks of December, the delivered price of North Slope oil averaged around $36 a barrel, a price not seen since 2004.

While prices remain well above the infamous $10 oil Alaska faced and survived in 1999, many in the industry say $40 today doesn't buy what it bought just a few years ago.

"The fundamental cost of our business has changed over the past couple of years," Jim Bowles, president of Conoco Phillips Alaska, told members of the Resource Development Council during their annual conference in Anchorage in mid-November.

At the same event, outgoing BP Exploration (Alaska) Inc. president Doug Suttles estimated oil industry costs have increased 15 to 20 percent per year for the past few years.

Costs associated with new facilities at oil and gas fields have risen 9.2 percent over the past six months, according to the Upstream Capital Costs Index, published twice each year by the affiliated consulting firms IHS and Cambridge Energy Research Associates.

The index shows oil-field costs doubling since 2005 after several years of only slight growth. A piece of equipment costing $100 at the start of the decade now costs $230.

oil prices raised all costs

The cost increases over the past six months can be traced in large part to the rise in oil prices, which increased demand for materials and equipment. As such, the fall in oil prices over September and October has already started to dampen the cost of business.

"Hidden in these substantial increases are the first signs of what may be a change in direction," said Daniel Yergin, CERA chairman and IHS executive vice president. "Moderation in the last two months of the third quarter was a response to the unfolding financial crisis and the spending cutbacks and points to a precursor to a downward turn in the direction of the (Upstream Capital Costs Index)."

Industry costs now affect state revenue in a way they didn't just a few years ago.

For decades, state economists primarily relied on two figures to estimate oil revenue: the projected price of oil and the projected amount of oil that would be produced in Alaska.

But a new production tax law enacted in 2006 and revised last year lets companies use certain capital expenses, like exploration work, to offset the tax.

The state issued $662 million in these tax credits during fiscal year 2008.

busy explorers

Last winter was a banner season for exploration in northern Alaska, with 14 wells and sidetracks started and other significant exploration occurring.

This winter is shaping up to be just as busy, with companies planning to drill 13 to 15 wells, and conduct several major seismic programs.

But sinking oil prices and the global credit crunch threaten to dampen industry interest in high cost environments like the North Slope. So far, that business climate hasn't led to major cutbacks in Alaska, but some companies have spoken about adjusting spending.

The state doesn't expect a slowdown in exploration activity this winter. The most recent projections for this fiscal year show tax credits increasing to $772 million.

For the state budget year that will start July 1, the projections show tax credits falling to $716 million, highlighting an expected slowdown in work, and not a reduction in industry costs, according to Cherie Nienhuis, acting chief economist with the state tax division.