The memories of the explosion of BP's Deepwater Horizon drilling rig in 2010 are still fresh. The death of 11 crewmen and the subsequent spilling of 5 million barrels of crude oil into the Gulf of Mexico have raised tough questions about domestic drilling. Can the safety assurances of oil companies be trusted? What risks are we and aren't we prepared to take in order to quench our thirst for oil? Oil companies are attempting to restore offshore drilling's reputation while simultaneously seeking access to environmentally sensitive Arctic regions.
Shell and Alaska
Prudhoe Bay Oil Field is a large oil field on Alaska's North Slope. It is the largest oil field in both the United States and in North America covering 213,543 acres and originally containing approximately 25 billion barrels of oil. The amount of recoverable oil in the field is more than double that of the next largest field in the United States, the East Texas oil field. The field is operated by BP (BP) and partners are Exxon Mobil (XOM) and ConocoPhillips (COP).
Production from Prudhoe Bay and other North Slope oilfields has been in steady decline for years. It was down from 2 million barrels a day in 1988 to 560,000 barrels last year. Not only has that cut into local tax revenue, but continued declines could threaten the viability of the entire North Slope oil industry long before the oil actually runs out.
In late Aug 2012, Shell (RDS-A) was granted permission to begin preparatory work on its first well in the Arctic Ocean, moving the company a critical step forward on its tortuous quest to drill for oil off the coast of Alaska. Ken Salazar, the interior secretary, said that Shell could conduct the initial steps in drilling in the Chukchi Sea. Before sinking a single well, Shell will have already invested $4.5 billion in its Alaska project -- $2.3 billion assembling the necessary equipment and personnel on top of the $2.2 billion for the leases. The wells Shell will begin drilling in July are exploratory, not producing.
Typically, only one out of every two or three exploratory wells drilled strikes oil or natural gas. Such modest success rates make Shell's Arctic bet appear risky. However, Shell knows there is oil offshore in Alaska because it owned leases and drilled wells in the Chukchi and Beaufort seas in the 1980s and 1990s. It abandoned them only because the $20-a-barrel prices at the time did not justify the expense of further drilling. "They would not have committed so many resources if they didn't believe this was a sure thing," says Eric van Oort, a former Shell engineer who is now a professor of petroleum engineering at the University of Texas.
One of Shell's strategies in recent years has been to deploy capital in politically stable regions where obstacles to oil and gas development are less daunting than in, say, Nigeria. Shell's Nigerian operations have been hindered by the hijacking of its oil rigs and the all-too-frequent kidnapping of its employees. In Alaska nobody is going to be brandishing guns at Shell workers. Nevertheless, the U.S. permitting process has proved more vexing than anyone at Shell headquarters in The Hague ever anticipated.
The prize that Shell is chasing is worth the ongoing frustration. We talk for an estimated 27 billion barrels of recoverable oil held in Alaska's outer-continental shelf plus another 130 trillion cubic feet of natural gas. At its peak, offshore oil production in the region could top 1.45 million barrels a day. "Shell is making big bet there, but I think it's justified based on the geology," says Oswald Clint, an oil analyst at Sanford C. Bernstein and a geophysicist by training.
Shell says that it expects the 410 Alaskan offshore leases it holds in the Arctic to become the company's biggest source of crude oil globally within 10 to 20 years. The waters of the Chukchi Sea alone are believed to cover a store of up to 20 billion barrels of oil, well over 20 times the amount in the reserve .
Oil Spills in Alaska
Hopefully Shell will not be the third company whose exploration efforts will be associated with a major oil spill in Alaska. Let's check briefly the two oil spills in the history of Alaska:
1) The Exxon Valdez oil spill occurred in Prince William Sound, Alaska, on March 24, 1989, when an oil tanker bound for California struck Prince William Sound's Reef and spilled 260,000 to 750,000 barrels of crude oil. It is considered to be one of the most devastating human-caused environmental disasters. The Valdez spill was the largest ever in U.S. waters until the 2010 Deepwater Horizon oil spill in terms of volume released. However, Prince William Sound's remote location, accessible only by helicopter, plane, and boat, made government and industry response efforts difficult and severely taxed existing plans for response. The region is a shelter for salmon, sea otters, seals and seabirds. The oil, originally extracted at the Prudhoe Bay oil field eventually covered 1,300 miles of coastline and 11,000 square miles of ocean.
2) On March 2, 2006, a worker for BP Exploration (BP) discovered a large oil spill in western Prudhoe Bay. Up to 267,000 US gallons were spilled, making it the largest oil spill on Alaska's north slope to date. The spill was attributed to a pipeline rupture. BP paid a $20M fine for the spill. On November 3, 2008 BP issued a response stating that they "had no record that any concerns about corrosion leading to an oil transit line breach in the foreseeable future ever were communicated to BP." This spill raised a new round of questions from environmental groups about proposed plans to open more land in the region to oil drilling. The North Slope region of Alaska borders the Arctic Ocean and contains most of the state's petroleum reserves. It is also home to thousands of migratory birds, caribou, and other creatures.
The Arctic Failures
The region’s challenges are formidable. They range from icebergs to storms, darkness and fierce cold. There is also no certainty of success as UK-listed explorer Cairn Energy (CNE.L) spent $1B exploring off Greenland and failed to find commercial volumes of oil.
The Pipeline Concern
Alaskan crude oil is transported south via the Trans-Alaska Pipeline, and a 2011 report by the pipeline's operator, Alyeska Pipeline Service Co., raised doubts about whether the pipeline can operate safely if throughputs continue to decline. The slower the oil moves through the pipeline, the greater the risk that water will separate from the crude and freeze at the bottom of the pipeline during winter, causing corrosion and cracks. This and other risks, according to the Alyeska report, "decrease confidence that the pipeline can be reliably operated at throughputs lower than 350,000 barrels per day."
In Barrow, Alaska, the northernmost city in the U.S. it's hard to tell where the land ends and the frozen Arctic Ocean begins. The average temperature stays below freezing for eight months of the year. "It's not looking good," former North Slope Borough Mayor Edward Itta says of the production declines. "And if there's no oil going through the pipeline, that oil infrastructure becomes worthless, and our tax base goes down." All of Barrow's infrastructure was built by oil money, and all of it is now maintained by oil money. "I started realizing," Itta continues, "that my biggest responsibility was maintaining the economic well-being of the borough, and that largely has to do with maintaining oil in the pipeline." The low-flow threat to the pipeline is a huge state issue as well, given that over 90% of Alaska's state revenue come from oil and gas.
New Infrastructure Needed
Alaska needs infrastructure to handle increased shipping through the Bering Strait. It needs infrastructure to get drilling done on its Outer Continental Shelf. And, it needs infrastructure to deal with what happens if drilling goes wrong. Some of those pieces are already falling into place.
At its newly opened aviation center in Deadhorse, Fairweather LLC is already servicing oil and gas companies looking at offshore projects. The center boasts a 20,000 square-foot hangar, 11,000 square feet of office space, 24 individual housing quarters, a dining facility, a medical clinic and medevac support center, and a shared office area that could transform into an incident command center in short order. The company is getting ready to expand its facility to include a warehouse, hangar, office space and housing for between 200 and 300 staff and crew members.
Most of the existing facility has already been rented out, just three months after it opened, said Fairweather business manager Lory Davey. So far, what she’s hearing from oil and gas customers is that they want more of what the aviation center offers.
“You’ve had BP and Conoco Philips up here a long time, and they’ve got their own infrastructure,” Davey said. “New companies like Repsol, Great Bear, Stat Oil, all these new entrants up there don’t necessarily have the infrastructure built out. A lot of companies don’t want to invest in long-term infrastructure in their exploration period. Our building has everything one of those companies would need to operate, under one roof.”
Deadhorse Aviation Center is situated mainly to support oil and gas activity in the Beaufort, Davey said, but could also be a base for operations in the Chukchi. Unlike many northern communities in Alaska, it has the advantage of being on the road system, which makes it cheaper to bring in supplies.
It’s hard to guess where new infrastructure is likely to go as the Arctic oil and gas rush touches the state. But even without taking into account the United States’ drilling program, the increase in shipping traffic alone, due in part from neighboring countries’ drilling, means Alaska will need new facilities.
“There’s a serious concern over lack of infrastructure to support shipping,” Stotts said. “There are no ports, no fueling facilities, no search and rescue. They need to put in communications systems. And of course there’s always a concern over oil spills or heaven forbid a wreckage.”
This year, the U.S. Coast Guard launched Arctic Shield, a mission meant to increase its presence in northern Alaska where more shipping means more chance of someone needing the Coast Guard’s help. But the Coast Guard didn’t have a port large enough to host its cutter in the north. In order to conduct its Spill Oil Response System exercise, USCG Alaska had to float a barge alongside the cutter, and move supplies and equipment between the two vessels as if the barge were a port.
“Our buoy tenders can go into Nome to get supplies and fuel,” said USCG Alaska public affairs officer Veronica Colbath. “But our national security cutter, she has to go all the way to Dutch Harbor.”
The Alaska Department of Transportation is already searching for the best place to put an Arctic port that would serve state and federal agencies, as well as commercial shipping traffic. The first round of research for its Alaska Deep Draft Arctic Ports Study started in 2012 and will conclude this November, with additional investigations continuing in 2013 and 2014. According to the Alaska DOT’s web page for the project, the port’s design, construction and operations would most likely be funded through a public-private partnership.
Other Oil Majors
1) Exxon Mobil, ENI (E) of Italy and Norway’s Statoil (STO) have also signed deals to explore for oil in Russia’s Arctic waters, while others have secured licences to drill off Greenland.
2) Total (TOT) has a number of natural gas ventures in the region, including a stake in the vast Shtokman field in Russia’s Barents Sea. The Total chief executive said gas leaks were easier to deal with than oil spills. Total’s Arctic projects are concentrated in Russia. As well as its stake in Shtokman, it has interests in a number of onshore developments, such as a big liquefied natural gas venture in Russia’s far north known as Yamal LNG. It also operates a Siberian oilfield called Kharyaga.
Total says energy companies should not drill for crude in Arctic waters, marking the first time an oil major has publicly spoken out against offshore oil exploration in the region. Christophe de Margerie, Total’s CEO, told the Financial Times the risk of an oil spill in such an environmentally sensitive area was simply too high. “Oil on Greenland would be a disaster,” he said in an interview. “A leak would do too much damage to the image of the company”.
3) Last spring, Marathon Oil (MRO) announced it was selling substantially all of its Alaska assets to Hilcorp Energy's Alaska subsidiary, including 17M barrels of oil equivalent of net proved reserves across 10 fields in Cook Inlet, plus natural gas storage and interests in natural gas pipeline transmission systems. Marathon estimated the deal at $375M. Marathon Oil has been exploring for, and developing hydrocarbons in Alaska for more than 55 years, with development activities focused on natural gas in the Cook Inlet region.
Marathon’s Alaska manager said that the decision to sell is based on a strategic focus on unconventional U.S. oil shales such as Eagle Ford in Texas, and Bakken in North Dakota. Marathon has about 62 employees in Alaska. Some will transfer elsewhere in the company, but he says most will be retained by Hilcorp.
Bermuda-based Nabors (NBR) is one of the largest drilling companies in the state and it plans on selling its oil field service subsidiary, Peak Oilfield Services which is considered a non-core asset. Peak Oilfield Services specializes in rig moving, custom heavy hauling, crane and rigging services and oilfield transportation.
Involved in commercial drilling operations in the state since 1962, Nabors has a long and storied history in Alaska. Nabors Alaska drilled both the discovery well and the confirmation well in the giant Prudhoe Bay oilfield in 1968. It’s also drilled the only well to date in the Arctic National Wildlife Refuge.
It is worth noting that Nabors Alaska’s CDR-2 rig was delivered to ConocoPhillips nearly three years ago at the Kuparuk River unit. It is the first purpose-built coiled tubing rig designed for the Arctic.
Nabors has also been known in Alaska for its tough, anti-union stances. In the mid-1990s, when it was the Slope’s drilling powerhouse, a group of workers set out to unionize the company. It worked -- to an extent. They got the required cards in to the National Labor Relations Board and went on to win the election. But problems began during negotiations, according to Tim Sharp, who was a union organizer at the time and is now the manager Laborers Local 942 in Fairbanks. He says that Nabors dragged out the negotiations so long they ended up dropping the effort.
The switch is ON and the oil rush in Alaska has just started again. It remains to be seen whether this exploration effort will be beneficial for Shell and whether it will be combined with the lowest negative impact on the environment, the wildlife and the natives' lives.
Disclosure: Long SCS.TO (Second Wave Petroleum) and TT.TO (Terra Energy). Both trade on the Toronto main board.