Anyone trying to divine the future of the Alaska oil industry based solely on the events of this young decade could be forgiven for taking a pessimistic outlook. ConocoPhillips, the most active company in the state, is not drilling exploration wells for the first time since 1965 (decades before the mergers that created the company). BP, the second largest oil producer in Alaska and the operator of Prudhoe Bay, plans to spend 15 percent less this year on Alaska capital projects than it did in 2009. Those two companies together own 62 percent of the oil that moves down the trans-Alaska oil pipeline, and as the operators of most of the North Slope oil fields and major infrastructure, they also produce or handle much of the remaining 38 percent that other companies own and sell.
These short-term travails come amid larger obstacles for the industry. Lawsuits postpone offshore drilling. Congress stopped debating opening the Arctic National Wildlife Refuge when gas prices fell. Permitting challenges delay production from federal lands. Behind all of that is a steady hum, the sound of North Slope production falling annually and the threat of a pipeline that becomes troublesome at low throughput. So as Alaska enters its fifth decade as an oil-producing basin, what is the future of the oil industry?
For ConocoPhillips, the future is west of the Colville River, the boundary between state and federal lands on the North Slope. The company is gearing up to drill in the Chukchi Sea and deciding whether and how to develop oil discoveries in the National Petroleum Reserve-Alaska. Neither is a sure bet. When ConocoPhillips spent half a billion dollars on Chukchi Sea leases in early 2008, it fit into a larger offshore strategy, adding to the dozens of Beaufort Sea leases the company picked up over the previous decade. In early 2009, though, ConocoPhillips gave back most of its Beaufort Sea leases, saying it didn't see "hub potential" in the area, or a way to improve the economics of an expensive region by developing several smaller oil prospects together. The Chukchi Sea is even more expensive and more remote than the Beaufort, meaning any discovery needs to either be large enough to support standalone production, or it needs hub potential.
Hub potential got ConocoPhillips to the edge of the 23-million acre federal reserve in Northwest Alaska. After bringing the Alpine field online in 2000, the company developed three smaller "satellite" fields, none economic on their own. That westward march is stalled at the Colville River, which ConocoPhillips has been trying to cross since 2005. Negotiations with Native landowners delayed development for years. Those have been resolved, but the feds recently denied ConocoPhillips a crucial permit for environmental reasons. Now, at the very least, the company will begin a lengthy appeals process.
For BP, the future is heavy oil. Over the past decade, the company began promoting a 50-year plan for the state based in part on developing an estimated 20 billion barrels of heavy oil that sits in existing fields. Unlocking heavy oil is expensive, though. Underground pressure naturally pushes normal oil to the surface. For heavier oils, companies can inject water or carbon dioxide underground to rebuild that original pressure. For the heaviest oils, though, that technology isn't enough: Engineers compare it to sucking molasses through a straw. For BP to find a way to produce that molasses, it needs either high enough oil prices to make the deposits economic, or it needs to spend money to develop technologies that bring down the cost of development -- or, more likely, it needs both.
Focusing on the inactivity this winter, though, doesn't tell the whole story about the changes underway in the oil industry, and what they mean for the future of the state.
You also have to look at the activity.
In January, Brooks Range Petroleum Corp. drilled the first exploration well of the season. The company is the operating arm of a venture capital group out of Kansas, and has been drilling wells on the North Slope for several years on behalf of a multi-company joint venture. Also in January, Savant Alaska finished drilling a well at the Badami field on the eastern North Slope. Savant is the local subsidiary of a small company out of Denver, and is drilling at the field -- a problem child on the North Slope -- as part of a deal with BP.
These companies are both independents, a term usually applied to companies without refining operations and often without pipelines, either. While some independents make $100-million profits, most are quite small, especially by the scale of the oil industry. In the past three years, independents have swarmed the North Slope with varying levels of success. Houston-based Renaissance Umiat wants to explore a prospect near Umiat, but struggles with economics. UltraStar Exploration, operated out of a home office in Anchorage, drilled a well last year, but didn't appear to have very good results. Before teaming up with BP, Savant spent considerable time and money on an unsuccessful well in the Beaufort Sea. Brooks Range Petroleum made several oil discoveries through recent exploration, but also had to overcome technical and internal legal challenges.
Some independents have set precedent. Pioneer Natural Resources, large by independent standards, brought the offshore Oooguruk field into production in June 2008, making the Texas company the first independent oil producer in North Slope history. Its partner on that project, the Italian major Eni Petroleum, is working to bring a neighboring offshore field, called Nikaitchuq, into production by the end of this year.
When the Palin Administration proposed Alaska's Clear and Equitable Share in 2007, many viewed it as a way to punish the oil industry with higher taxes after the failed gasline negotiations and federal indictments of 2006. More precisely, though, ACES wanted to split the oil industry into two parts: the big players and everyone else. "Equitable" meant Alaska would increase its tax rate, but also improve the tax credits it offered to companies that spent money exploring in the state. Those incentives proved especially useful for independents and newcomers not yet producing oil in Alaska because it amounted to free money: a check, rather than a tax break. For instance, in early 2008, before bringing Oooguruk online, Pioneer Natural Resources earned nearly $75 million by reimbursing or selling tax credits it got from the state.
It's debatable whether ACES brought new players to Alaska, enticed the indecisive, or merely rewarded companies already intent on drilling. The current situation, though, is clear: More companies are producing or on the verge of producing oil in Alaska than ever before. Yet the state expects oil production to keep falling through the coming decade. Why? Because even if all of those projects came online at the same time and produced at peak levels, they would increase North Slope production rates by only about nine percent. But all those projects won't come online. And North Slope production is falling six percent a year.
This diversification of the oil industry is a mixed blessing, economically. It might mean fewer barrels of oil traveling down the pipeline, and therefore fewer taxable barrels for the state, but it could also mean more jobs. A September 2008 study from the Alaska Department of Labor and Workforce Development found that oil prices drive job growth more than oil production, which is why industry employment today is 50 percent higher than it was in 1988, when oil production was 300 percent higher than it is today but inflation-adjusted prices were about one-third of recent highs. The study showed that jobs tend to leave quicker than they return, but that the lag is never more than a few years. When we look for the cause of recent job cuts, it's worth remembering that oil prices collapsed at the end of 2008 and only partially recovered in 2009.
An oil industry with many smaller players developing smaller fields, rather than a few big players continuing to bring massive fields online, would play a dramatically different role in the economic mix in Alaska. Instead of keeping being the bank for state government, the oil industry would more closely resemble tourism, fishing and mining, important employers that don't generate billions in state revenue. In turn, the Alaska economy would look a lot more like Wyoming or North Dakota's than Venezuela or Iran's.
Aside from the obvious loss of state revenue, there is another financial downside to this scenario: With more projects, the Alaska Department of Natural Resource will need more inspectors, auditors and engineers. The state will need more people to oversee less oil.
If a natural gas pipeline becomes a reality, and if offshore, heavy oil and federal lands come into production, smaller players will become another facet in the diamond. Without those, though, something else -- Permanent Fund withdrawals, a state income tax or dramatic reduction in services -- will have to replace oil money.
Contact Eric Lidji at ericlidji(at)mac.com.