Sustainable Arctic Oil & Gas Exploration and Development (from the November 2013 Alaska Business Monthly)

Arctic oil and natural gas resource basins in the Arctic Circle region (click to enlarge).
Source: US Geological Survey

In addition to pieces on this page and elsewhere, I have been writing a monthly op-ed column on oil, gas and fiscal policy issues for the Alaska Business Monthly.  The following piece is the last in that series (at least for awhile), as I go to the bench while some talk about me running for Governor (ABM’s policy understandably is to discontinue any “writings” by formally announced, or potential candidates). This final piece for the ABM was originally published in the November 2013 print edition and is available online here.  In the future I will continue writing a lead monthly article for the blog, called “The Monthly Lead.”

Normally pieces that begin with this title are about the environmental aspects of oil and gas exploration and development in the Arctic. This piece isn’t.

Instead, this piece is about the commercial aspects of oil and gas exploration and development in the Arctic and near-Arctic, and what economic characteristics make ongoing activity sustainable in some regions and not in others. From my perspective, there is a lesson for Alaska in the results.

Arctic Development

In 2009 the federal Energy Information Administration (EIA) published an analysis of “Arctic Oil and Natural Gas Potential.” The analysis concluded, “[o]f the seventeen large Arctic fields located in North America, only three have been developed, all located in Alaska, around the Prudhoe Bay Field complex.”

EIA found that the reason was simple. “Finding large Arctic oil and natural gas deposits is difficult and expensive; developing them as commercially profitable ventures is even more challenging.”

The analysis found that oil and gas resources in other parts of the Arctic have been more fully developed. For example, as of the time of the analysis, forty-three of the forty-five large Arctic fields that had been discovered in Russia up to that point were in production. The analysis recognized that a commercial reason likely explained that result: “Russia’s Arctic resources were predominantly developed under a Soviet command-and-control economy. Many of Russia’s large producing Arctic fields might not have been commercially viable under market-based economics, when they were originally developed.”

Nevertheless, the report concluded that the Russians had both discovered and developed more large Arctic fields than elsewhere in the Arctic.

Outside of Russia, there is another country also with a similarly impressive track record in finding and developing Arctic and near-Arctic oil and gas resources without using a command-and-control approach. That country is Norway.

While not discussed extensively in the 2009 EIA study because of a lack of activity prior to that time owing to a dispute involving its offshore Arctic boundary, coincident with the settlement of that dispute Norway has achieved a string of recent successes in Arctic and near-Arctic exploration.

In fact, in April of this year “The Barrel,” a widely followed industry blog published by highly respected industry information source Platts, ran an article titled, “Norway: the new oil just keeps on coming.”

That article focuses mostly on the country’s new Johan Sverdrup field, the new 2-plus billion barrel oil field first discovered in 2010 that currently is expected to produce 120,000 – 200,000 barrels per day following startup in 2018.

But the article also notes that Johan Sverdrup is not the only recent success story. Earlier this year, for example, Statoil, together with fellow state-owned company Petoro, announced a “significant” new discovery within an already producing license area. Recoverable reserves from that find currently are estimated at up to 150 million barrels of oil equivalent and likely will help extend the life of the field beyond 2030.

The result of these and other developments are having an effect. According to both The Barrel article and subsequent reports, Norway is booming. “Licensing rounds are attracting more bidders than ever — even the previously pedestrian mature area rounds — and according to Statistics Norway, some $35 billion will be spent by the industry in 2013.”

In short, Norway appears to have achieved something approaching sustainability in oil and gas exploration and development activity.

Lessons for Alaska

Are there lessons for Alaska from the emergence in Norway of what appears to be a sustainable exploration and development program? I believe there are.

While there are others, one of the primary differences between the way that Alaska and Norway approach oil development is in the role played by the state. I know, Alaskans argue that we use a free market model, with private industry taking the lead in development.

But we shouldn’t kid ourselves. Alaska state government is as enmeshed in the development of its oil resources as is Norway’s. We just do it in a different way.

In Alaska, for example, the state tries to encourage the development of some projects over others through the use of tax credits and, when those don’t work, outright subsidies in the form of tax “credits” that can be traded in to the state treasury for cash. And in the guise of regulation, we often tell industry where and when to spend its money.

For example, a few years ago the Department of Natural Resources (DNR) directed the industry to spend billions to develop Point Thomson, although based on then-current (and continuing) conditions the most that will result is ten thousand barrels per day of liquids production. In the meantime, potential oil projects elsewhere on the Slope with much higher production potential and which could have benefitted from the injection of the billions being spent on Point Thomson have continued to languish.

More recently, in some instances as a condition of forming new units, approving plans of development for existing ones or approving extensions of existing leases, DNR has required the drilling of costly additional wells when other uses of the money would make more economic sense.

In short, Alaska often takes an active (and sometimes, intrusive) role in oil and gas exploration and development decision-making. But it does so by trying to drive those decisions from the back seat, without putting any of the state’s own skin—in other words, investment—in the game itself. Instead, it pursues its goals by using other people’s money.

The result is often increased costs, increased risks and, by imposing various conditions on industry activity, increased time required to accomplish a project.

Norway takes an entirely different approach. Recognizing that government is involved in any event, Norway puts itself alongside industry in the front seat of the effort as a co-investor. As I wrote in a previous column (“Achieving Alignment,” Alaska Business Monthly, January 2013), through a state-owned enterprise called Petoro, Norway invests its own money as a full partner in the development of the state’s own resources.

That approach produces remarkably different results than Alaska’s. As an investor looking to maximize returns on its money, Norway works alongside industry to identify those opportunities offering the best returns and most efficient use of capital. Petoro sees itself as an oil company, and as a consequence, is positioned and incentivized also to help deal with exploration and development bottlenecks which otherwise get lost in translation from industry to government and sometimes cause long, costly project delays.

The approach also produces two other significant benefits.

First, Petoro focuses solely on the development of Norwegian oil resources. As a result Norway has an entity that is continually focused on identifying new or previously overlooked investment grade opportunities throughout the country. That focus—and Petoro’s credibility in bringing those projects forward because it is prepared to put its money where its mouth is—helps sustain a level of exploration and development activity that otherwise might shift to other areas.

Second, Petoro brings significant, additional cash to bear on the development of the country’s resources. Under the Alaska approach, industry essentially has to carry the state’s share of exploration and development costs. Put another way, industry has to pay 100 percent of the costs and only receives back, on average, around 85 percent of the revenue (before taxes).

That approach adds cost, increases risk, and limits the amount of capital available for such activities.

As a co-investor, Norway bears the cost of its own share of production. That both significantly improves project economics and brings more investment to bear locally.

That is a result Alaska also needs. The EIA analysis reports Alaska North Slope development costs are “1.5 to 2.0 [times the cost of] similar natural gas projects undertaken in Texas.” As a result, Alaska and other Arctic and near-Arctic projects simply require more capital for the same amount of drilling and development than other competing projects.

In 2011 then-DNR Commissioner Dan Sullivan estimated that Alaska needs $4 billion minimum in new investment annually in order to stabilize Alaska’s oil decline. Estimates of current, actual levels are less than half that amount.

As the EIA analysis concludes, “the bottom line for Arctic oil and natural gas potential is that high costs, high risks and lengthy lead-times can all serve to deter their development in preference to the development of less challenging oil and natural gas resources elsewhere in the world.”

The Norway approach addresses all three of those areas. By paying its own way, Norway helps to reduce costs and risks. Through its orientation as a producer, Norway helps to identify early on and resolve bottlenecks that otherwise can cause extended lead times.

Those efforts help explain in significant part Norway’s success in building a sustainable Arctic oil and gas exploration and development effort, and I believe, provides lessons for Alaska. Throughout the Arctic it is inevitable that government will play a role in oil and gas development. How it plays that role appears to make a significant difference. Norway’s approach has produced a sustained exploration and development program.

Addressing the Concerns

In talking about this approach over the last twenty-four months I have encountered two significant objections. First, some argue that the oil companies—those on whom we currently and would continue to rely on for the bulk of the investment dollars—don’t like it. Second, some argue the state shouldn’t be in the oil business.

There are answers to both.

First, the oil companies don’t like the thought of Alaska adopting the approach because currently they see it as another way for the state to disrupt things by meddling and second guessing the companies’ decisions.

The response is simple. There are right ways and wrong ways to implement the approach. Petoro succeeds because it is set up as a professional operation removed from politics, much like Alaska’s Permanent Fund Corporation. The three major oil companies operating in Alaska also operate successfully in Norway alongside Petoro. Alaska can achieve the same results if it sets up an equivalent operation.

The answer to the second objection is equally as simple. Recently the Alaska Chamber of Commerce began running a series of radio ads. The one about the oil industry ends with “all of us are in the oil business.”

It’s that simple. Alaska is in the oil business; the state already is deeply involved. The appropriate question is what is the most productive way to be involved? The Norway experience suggests there is a more sustainable way than Alaska has used up to now.

Bradford G. Keithley is the President and a Principal with Keithley Consulting, LLC, a consultancy he founded that is Alaska-based and focused oil, gas, and fiscal policy. Keithley also publishes the blog, “Thoughts on Alaska Oil & Gas” at bgkeithley.com.