The Walker administration on Tuesday approved plans to offer the oil company Caelus a reduction in royalty payments on its state leases if it would quickly develop an oil project on Alaska's North Slope that could produce 15,000 to 18,000 barrels a day.
"A substantial benefit the state receives from a royalty modification agreement is that Caelus is committed to develop the project soon," Acting Natural Resources Commissioner Marty Rutherford wrote in a 22-page decision Tuesday. "Various deadlines make royalty relief conditional on (the company) sanctioning the project within the next three months and proceeding to first production in 2017."
A spokesman for Caelus, which applied for the incentives last year when oil prices were more than double what they are today, could not be reached for comment Wednesday. The company would have to start capital expenditures by September and invest at least $260 million in the project by Sept. 30, 2017, targeting territory west of the Kuparuk oil field.
This is the third time the state has granted reduced royalty payments as an oil industry incentive for a project since 1995.
The decision, which ratifies a proposal released by the Parnell administration in late October, would temporarily reduce the amount of state royalty oil to 5 percent on five leases at Caelus' Nuna development, instead of 12.5 percent to 16.7 percent. The royalties would return to the original levels after the company has gross revenues of $1.25 billion.
With oil prices at $90 per barrel, that could happen with about four years of production, the state estimates, but it would take longer at lower prices. One provision in the agreement says that if the company demonstrates that it reaches an 80 percent Alaska hire level, royalty relief would last a bit longer than otherwise.
Without the incentives, expected to total $66 million over the life of the field, the proposed investment by Caelus is not economically feasible, Rutherford wrote. The state modeled the project under many different assumptions using a 17.5 percent real rate of return on investment and determined the project would not meet that goal on at least 50 percent of the model runs.
"Based on these mediocre economic results relative to the risk of loss, Caelus has made a clear and convincing case that without royalty modification the investment in the Nuna project is uneconomic," Rutherford wrote.
When the Alaska Permanent Fund invests in oil and gas ventures, it seeks a 25 percent rate of return, the state said in response to criticism that the 17.5 percent investment return rate was too high and other public comments.
"DNR believes it does not have the option to obtain full royalties on the project because doing so will make the project uneconomic," the department said.
"Lower oil prices will make the project less economic, thereby making the finding that the project without royalty modification is uneconomic more clear and convincing," the department said.
Either with or without a reduction in royalty payments to the state, production taxes would be less than zero under the provisions of Senate Bill 21, the law that restructured Alaska's oil tax system in 2014.
The law allows an extra tax break for so-called "new" oil. The loss on a discounted basis would be $71 million if the royalty is not changed and $60 million under the action approved by DNR.
The department said that in approving the SB 21 tax change, the Legislature could have said that a company could not get both a royalty reduction and the 20 percent gross value reduction tax break for new oil, but lawmakers did not prevent that combination. The Legislature did say that in cases where a 30 percent gross value reduction applies, a company is not allowed to receive an incentive in the form of a royalty reduction.
Anchorage Rep. Les Gara, who had questioned whether the Parnell administration had done sufficient analysis on the Caelus request, said Wednesday he is satisfied that the agreement has had a fresh review. He said the idea that the state production tax would be a negative number on the field illustrates one of the problems with SB 21 that was not understood by the Legislature or the public.
The department said, however, that while a production tax that costs the state money on this project was not enough to make it a attractive investment, the production tax is only part of the revenue picture. The state would collect money in other ways. State revenue would total $1.26 billion, with about half of that from royalty payments and about $400 million from a profit-sharing agreement. If the project doesn't go forward, the state would collect nothing.
On balance, the state would benefit from offering the incentives because of that flow of funds and because the project would extend the life of the Torok reservoir, a shallow formation that is difficult to develop near the Kuparuk oil production facilities. "Caelus is confident it has developed the key to developing challenging reservoirs like the Torok formation," Rutherford said.
The agreement includes provisions to share information about what technology the company uses to deal with the subsurface rocks in the southern part of the Torok reservoir, which would help other companies improve oil extraction elsewhere on the North Slope.
Without the incentives, the total value to the state would be $1.33 billion, while the incentives would reduce that to $1.26 billion, the decision says.
Caelus, established in 2011, is a privately held international energy company that says it is "focused on the identification, pursuit and development of unique opportunities across the energy sector."
Caelus entered a deal to buy the Alaska assets of Pioneer Natural Resources Co. last April for $300 million in cash, "plus other considerations." The company has said it is backed by funds linked to Apollo Global Management, a private equity firm.
CORRECTION: The action by the Walker administration to lower the royalty payments from the proposed Nuna oil filed development was the third time the state has granted such relief under state law to oil companies. An earlier version of this story mistakenly reported that it was the fourth. The story has been updated to reflect the correct information.