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New administration faces vexing royalty question for Slope oil field

  • Author: Alex DeMarban
  • Updated: September 28, 2016
  • Published December 2, 2014

In one of its first steps, Gov. Bill Walker's fledgling administration is reviewing a recommendation by its predecessor to offer temporary royalty relief to Caelus Energy Alaska, a complex decision that supporters say could cost the state tens of millions of dollars but bring in more than $1 billion in the next three decades.

A critic of the idea, Rep. Les Gara, D-Anchorage, said at a public hearing Tuesday he's hopeful Walker will reverse the preliminary finding for the independent oil company, which hopes to pursue production at the difficult-to-develop Nuna project on Alaska's North Slope.

If Caelus is successful, oil is expected to flow from the field for 30 years, with production peaking at about 15,000 barrels a day.

Gara said Caelus is "already getting a deal so sweet it causes cavities."

As it is, the state will receive little to no production-tax value from the new field under the tax overhaul passed by the Legislature, Gara said.

Mark Myers, Walker's incoming commissioner of the Department of Natural Resources, was visiting the department's Anchorage offices on Tuesday and meeting with other directors, a spokesperson said.

Myers said that the administration has started to review the finding made by former commissioner Joe Balash in late October.

The public comment period is set to close Dec. 12. A decision by the new administration on whether to finalize the proposal is expected to come shortly after that, and will be made by either acting DNR commissioner Marty Rutherford or incoming commissioner Myers, after he assumes the office in January.

The decision is a difficult balancing act for a state desperately in need of new oil production that's also trying to maximize the value of its fields. Compounding the dilemma are a budget deficit that at current oil prices is said to be around $10 million a day, and a shrinking savings account that could fall by more than $3 billion this year.

State lawmakers are also gathering information about the royalty relief, with the Legislative Budget and Audit Committee hosting a hearing on the project Tuesday.

At that hearing, Bill Barron, head of the Division of Oil and Gas, said the division maintains that reducing the company's royalty rates to 5 percent, for a limited number of years, is in the best interests of the state.

"It's a well-crafted and very thoughtful royalty modification designed to jumpstart a project," he said after describing what appeared to be an extensive review by the division before the finding was made.

Royalty oil is the landowner's share of the oil -- in this case, the state's share -- and it's often set at 12.5 percent. That is the rate for about 75 percent of the affected Nuna area. The royalty rate for the remainder of the area is 16.7 percent.

Barron said the state would lose about $44 million in total income if the reduction is approved. But it would gain about $1.3 billion over the life of the project if it is developed.

The deal lays out firm timelines for the company, including that production begin before April 2017 or Caelus loses the deal, Barron said. He said development at Nuna could possibly "crack the nut" on similarly challenged fields across the Slope, in part because the proposal calls for Dallas-based Caelus to take the unusual step of publicizing how it reaches production.

Barron said part of the division's analysis of the idea included a look at the nature of the company itself and its access to capital. Caelus, which acquired the Alaska assets of Pioneer Natural Resources in April, is an unusual company on the Slope that's dependent on a limited pool of private equity, unlike the oil giants such as BP or Chevron, which have widely diversified portfolios, that traditionally dominate Slope operations.

A successful development can attract additional activity by independents, he said.

"If we can structure an arrangement, and I think we have, that will make these projects economically viable for private equity to come into state, that will be a positive step forward for the state," Barron said.

The royalty reduction would last until Caelus grosses $1.25 billion in revenue.

Pat Foley, senior vice president of the company in Alaska, said that revenue level was expected to be reached by about 2020. At that point, the royalty would increase to its normal rates.

Gara, who attended the committee hearing along with a handful of other lawmakers, asked why Caelus should get royalty relief when it purchased Pioneer's Alaska leases intending to launch exploration drilling, but knowing it would be asked to pay traditional royalty rates.

"You're paying very little production tax on it, something worth a near-zero or negative present value to the state, and now on top of that, after purchasing this, you want a royalty reduction of over 70 percent," Gara said.

Foley replied that the 70 percent reduction was an unfair characterization because it would last a limited period of time before the rates rise. He said Pioneer had drilled costly exploration wells and concluded that development at Nuna -- using water flooding to fracture the shale there to release trapped oil -- was possible.

"But they also came to the conclusion that they were not going to continue their business in Alaska and they sold all of their assets to Caelus," said Foley.

Pioneer left Alaska to increase its stake in a promising Texas oil field.

Foley also said the Nuna prospect was just part of the acquisition, one that can be developed with better terms.

"We purchased the entire business and this is one piece of it, one project, that with royalty modification will be sanctioned and will go forward on the timetable we talked about," said Foley, who had headed Pioneer's operations in Alaska.

After the meeting, Foley said Caelus had reached out to new Gov. Walker last week to introduce him to the project and the royalty proposal. Walker, who has called for more independent operators on the Slope and became governor on Monday, met personally with Caelus officials, Foley said.

"He is engaged and willing to learn," said Foley.