JUNEAU -- Caelus Energy, which this year bought independent oil company Pioneer Natural Resources' Alaska operations, has been given preliminary approval for big reductions in the royalties it will pay the state when its new Nuna development on the North Slope comes into production.
The Department of Natural Resources says that dropping the royalty rate from 12.5 percent to 5 percent will make development of Nuna economical and bring new oil production to Alaska.
Division of Oil & Gas Director Bill Barron said companies have to prove they need the reduced royalties.
"It's a tool for the state to allow the company to move forward in economically or technically challenging projects that probably would not go forward, save royalty relief," he said.
The royalty relief recommendation, formally made by Department of Natural Resources Commissioner Joe Balash on Oct. 28, now begins a 30-day public comment period before finalization.
It was sought by Texas-based Caelus on July 1. Caelus operates the Oooguruk field, which it bought from Pioneer. Nuna targets the Torok oil reservoir and is an onshore development just south of Oooguruk in the Colville River delta.
The royalty reduction comes on top of Alaska's oil production tax structure, a net-profits tax designed to take into consideration developments with higher costs. Royalties and production taxes are the state's two largest sources of oil revenue, but companies also pay income and property taxes.
Royalties are what Alaska receives from its ownership of the resource, and a portion of royalties flows to the Alaska Permanent Fund.
Last year Gov. Sean Parnell proposed Senate Bill 21 as a way to reduce oil production taxes, and Alaska voters in August rejected a citizen initiative to repeal the bill.
Sen. Bill Wielechowski, D-Anchorage, supported the initiative and said Friday that Senate Bill 21 wasn't needed to make oil production in Alaska profitable when royalty relief was available.
"We've had this royalty reduction process in place for years," he said. "If they genuinely find that the project is marginal and would benefit from royalty relief, they can already get tax breaks," he said.
Wielechowski said Caelus' seeking of reduced royalties shows the problem with blanket production tax relief.
"Apparently Senate Bill 21 didn't provide it, or it wasn't enough, and companies are coming back and wanting more," he said.
Barron said Nuna is drilling into what is known as a "tight" oil reservoir, from which it is very difficult to extract oil.
"They are going to have to do some interesting drilling techniques," he said, including horizontal drilling and hydraulic fracturing, already becoming common on the Slope.
"Because of those technical issues it will be very costly in terms of drilling, completion and processing," he said.
Barron said the Nuna development would likely not be done without the 60 percent reduction in royalties.
The royalty relief is not permanent but will remain in place until Caelus reaches a gross revenue target of $1.25 billion. The exact time that target is reached will depend on price and production rate, Barron said.
The department said the royalty reduction has the potential to result in $1.4 billion in state revenue, but it did not say what numbers were used to calculate that revenue projection.
The Alaska Department of Revenue reported Friday that Alaska North Slope crude oil dropped to near $75 dollars a barrel, but Barron said he expects Caelus' Nuna development to remain economically viable and go forward despite the drop in prices.
If Caelus doesn't make progress toward production or get into production by March 31, 2017, the royalty reduction will be rescinded.
The last time Alaska granted a royalty reduction was in 2008 for Eni's Nikaitchuq project, and before that for the Oooguruk project now operated by Caelus.
"Both of those were success stories," Barron said.