Alaska Republican Gov. Mike Dunleavy, flanked by deputies, recently announced part of his proposed incentive package aimed at rejuvenating natural gas production in Cook Inlet, the declining petroleum basin outside Anchorage.
The proposal, which would need legislative approval, comes with some urgency because urban Alaskans depend on Cook Inlet gas to heat their homes and generate the vast majority of their electricity. And the inlet’s leading company, Hilcorp, has warned that it expects its reserves to run low starting in the next few years.
Dunleavy hopes that his legislative proposal can make Cook Inlet’s gas industry great again, by generating more drilling and development.
The problem is that, by itself, it won’t. Here’s why.
One of the biggest obstacles to drilling wells — which can be used to produce both oil and gas from basins like Cook Inlet — is risk. Drilling costs an enormous amount of money, and your payoff isn’t guaranteed: Companies can spend tens of millions of dollars to punch holes in the ground or the ocean floor and end up with what’s known as a “dry hole,” with no petroleum to show for it.
That risk is magnified in Cook Inlet. It’s the state’s oldest major oil and gas basin, with the first discovery in 1957. While state geologists say there’s still ample gas left, it’s gotten much harder to find and produce.
To drill in the inlet, companies have to contend with enormous tides, harsh weather and protections for fish and wildlife like endangered beluga whales. And with only a small handful of operators left, support costs are high: While competition between multiple contracting companies used to keep prices down, many of them have closed up shop.
What kind of rational capitalist — and trust me, oil executives are rational capitalists — would take a chance on Cook Inlet in this type of environment? Particularly when you could be investing your money in other places, like the North Slope, where prospects are far more lucrative if you find them. And when Alaska’s urban electric utilities say they plan to aggressively shift to generating power from renewable sources rather than gas.
“It’s a risky, risky business, and a lot of companies fail,” Jon Katchen, an Anchorage attorney with a long history in natural resources, told me. He added: “A lot of companies drill dry holes.”
The Dunleavy administration’s proposed solutions to this problem, so far, would do little to address this fundamental problem of risk. Instead, they’re geared toward boosting the reward for a successful strike, by reducing the fees, known as royalties, that companies typically have to pay the state when extracting oil and gas from public land.
But it takes years for wildcatters to go from drilling exploratory wells to installing the substantial infrastructure needed to actually produce and pipe out their petroleum products — meaning that companies would wait a long time before realizing any royalty-related benefit.
This is where we get to the third rail of oil and gas policy: tax credits.
Tax credits are, in this context, essentially a euphemism for “writing checks to oil and gas companies” — a concept that is understandably polarizing. But speaking in purely rational capitalist terms, it’s clear that this strategy is an effective way to reduce the risk that’s discouraging companies from Cook Inlet drilling — allowing them to recover, perhaps, 30% of their expenses.
Alaska policymakers tried this once before, starting nearly two decades ago, when they were warned of a similar Cook Inlet supply crunch. The Legislature created tax credits that “returned up to 40% of certain exploration costs, and gave a 100% reimbursement to the first company to use a jack-up rig to drill a new Cook Inlet exploration well — work that hadn’t been done there in almost 20 years,” according to a report by the Alaska Public Interest Research Group, or AKPIRG.
The policy worked to revive gas production in the inlet. But it also cost the state dearly: some $1.5 billion, according to AKPIRG’s analysis. And in retrospect, many former legislators and energy industry experts say the credit program was too generous and broad, attracting some dubious players to the state.
Nonetheless, some of my oil and gas industry sources say that such tax credits would be a far more powerful tool than royalty reduction if Dunleavy’s administration and the Legislature want to see more drilling rigs in the inlet. Such credits could be more narrowly drawn, perhaps even with a state review process before drilling is approved.
But this is where things get interesting: Any discussion about the state actually spending money on natural gas projects inevitably raises the question of opportunity costs.
Why should Alaska’s citizens spend money to help drill oil and gas wells — which may or may not end up yielding new energy supplies — when we could invest that same cash in projects that come with less risk? You might have to drill three different wells to find oil and gas, but you don’t have to build three different wind or solar farms to get one that generates electricity.
Of course, this issue isn’t that simple. We probably need all of the above — wind, solar and hydroelectric projects, plus some additional Cook Inlet gas to make sure we can still heat our homes and get us to the point when electric utilities are generating more power from renewables.
But being clearer, sooner, about what’s likely needed to rejuvenate Cook Inlet gas production — cold, hard cash — will help give the Alaska public a better understanding of the true costs, benefits and tradeoffs of the different tools available to policymakers.
Expect those tradeoffs to be the subject of intense debate in the upcoming legislative session that starts in January. I’ll be watching, and you should, too.
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