The Fuse

New Oil Discovery Pivotal to Alaska’s Oil Future

by Nick Cunningham | October 12, 2016

In early October, a small oil and gas exploration company announced that it had made a “world class” oil discovery on Alaska’s northern coast, a field that could reverse the state’s declining output and restore government coffers after revenue declined sharply from the collapse in oil prices.

The project could eventually bring 200,000 barrels of oil per day online, a substantial sum that may rescue the Trans Alaskan Pipeline from being forced to shut down because of low oil flows. In that context, the field is crucial to the future of Alaska’s entire oil industry.

The project could eventually bring 200,000 b/d on line, a substantial sum that may rescue the Trans Alaskan Pipeline from being forced to shut down because of low oil flows. In that context, the field is crucial to the future of Alaska’s entire oil industry.

Aside from its enormous potential, the project has several other factors working in its favor, including its location, a supportive government, and willing buyers for the field’s oil. Nevertheless, the project is not a foregone conclusion. Technical challenges remain, and above all, producing oil in Smith Bay will be expensive and likely require oil prices to be higher than current levels.

Smith Bay discovery is “world class”

The field, located in Smith Bay, could hold as much as 6 billion barrels of oil, with about 2.4 billion barrels that ultimately recoverable. With the state’s entire remaining oil reserves estimated to be about 2.86 billion barrels as of 2014, the Caelus Energy discovery could instantly cause Alaska’s oil reserves to increase by 80 percent, as Bloomberg noted. The Smith Bay project is the largest discovery on Alaska’s North Slope in four decades.

alaska

Alaska was once thought to have been mostly written off, with aging oil fields entering decline. Indeed, the state’s oil production has eroded over the past three decades, falling from a peak of more than 2 million barrels per day (mbd) in the 1980s to less than 500,000 barrels per day currently. But declining output does not mean that there is not oil that can be tapped. In fact, there is a long history of oil-producing regions seeing their reserves rise and beat expectations. More oil fields are eventually discovered over time, while advancements in technology also unlock previously unreachable reserves.

The USGS concludes that it is entirely common that oil fields, even fields that are already producing, see their reserves increase over time as drilling improves.

In its World Petroleum Assessment 2000, the USGS noted that “in the 15 years between 1982 and 1996, the estimated total recoverable oil volume in a data set of 186 non-U.S. oil fields having sizes larger than 500 million barrels of oil increased by 26 percent, or about 160 billion barrels of oil.” The Lower 48 is another example. The U.S. was thought to have passed its peak decades ago, but advancements in hydraulic fracturing and horizontal drilling opened up new reserves. The report concludes that it is entirely common that oil fields, even fields that are already producing, see their reserves increase over time as drilling improves. Although the assessment was completed more than a decade and a half ago, it’s just as relevant today.

The USGS analysis highlights the huge upside potential for Caelus Energy. The Smith Bay discovery could be the largest in decades, and ultimately might contain more oil than the company currently suspects. The implications for Alaska are hard to overstate. Crucially for the oil market, the reserves were discovered in an area where the political environment is stable and doesn’t have to deal with as many above-ground risks, such as those found in volatile producer countries such as Venezuela, Libya, and Nigeria, along with others that don’t provide sweet enough terms to attract investment from IOCs.

Alaska needs Smith Bay project

The Smith Bay discovery is all the more important because Alaska’s oil industry is faltering.

The Smith Bay discovery is all the more important because Alaska’s oil industry is faltering. Shell abandoned its Arctic drilling campaign last year, essentially killing off drilling in the Chukchi Sea for years to come. Meanwhile, North Slope output has been falling for decades since peaking at over 2 mbd in 1988. But the declines continue: Production dropped to 475,000 b/d in September, compared to 494,000 barrels per day a year earlier.

Slumping output throws the Trans Alaskan Pipeline into jeopardy. The pipeline, which has the capacity to carry over 2 mbd of oil from Alaska’s North Slope to its southern coast, has seen oil flows drop to dangerously low levels. A 2011 study found that the threat of damage to the pipeline rises when its throughput drops below 550,000 barrels per day. Low oil flows can lead to low temperatures, which can cause water to separate from the oil and freeze, corroding the pipeline. Below 350,000 b/d the soil around the pipeline can freeze, which can cause damage if the pipeline moves. With the Trans Alaskan Pipeline’s flows already down below 500,000 b/d, the threat to all North Slope oil production rises by the month.

The only solution is putting more oil into the pipeline. Since the Caelus Energy discovery could bring 200,000 barrels per day online, it would extend the life of the pipeline. Oil produced from Smith Bay and sent through the pipeline would have plenty of willing customers–California refineries or any number of importers in Asia.

It is no surprise then that the state government will be highly supportive of development. “In this day and age of technology and regulatory requirements, I am sure it will be done safely,” Alaskan Governor Bill Walker said. “We look forward to the discovery being turned into oil in the pipeline.”

Moreover, unlike some other high-profile Alaskan oil ventures that have attracted federal scrutiny–such as Shell’s plan to drill in the Chukchi Sea–the Caelus Energy discovery is just off the coast of the National Petroleum Reserve-Alaska in shallow water. Although technically complex, Caelus will likely face a smoother regulatory battle at the federal level than Shell did.

Very big question marks

While eager to see the Smith Bay discovery developed, the Alaskan government is currently in a bind with plummeting state revenues from low oil prices.

While eager to see the Smith Bay discovery developed, the Alaskan government is currently in a bind with plummeting state revenues from low oil prices. In 2014, Alaska brought in $7.4 billion in oil revenues, a figure that is expected to shrink by 86 percent to just $1 billion in 2017. The state is set to issue its largest bond sale in its history in mid-October, looking to raise $2.4 billion to cover its obligations to state employee retirement funds. S&P Ratings said it would likely cut Alaska’s credit rating one notch after the sale.

The financial predicament, sparked by the crash in oil prices, now threatens to eat the oil industry itself. In recent years, the state government has slashed taxes and increased incentives for oil companies in an effort to reverse the decline in production. The tax changes gave the industry nearly $1 billion per year since 2007, Bloomberg reports. But now the state can no longer afford such largesse. This year, the government is trimming incentives and the Governor even froze $430 million in tax rebates to companies in order to plug its massive $3.5 billion budget deficit. The industry is warning that the moves will kill off the budding resurgence in drilling. “Other states and countries are looking at how we incentivize companies to keep investing,” Kara Moriarty, president of the Alaska Oil and Gas Association, told Bloomberg. “Alaska is looking at just the opposite.” Alaska is pleading for more oil production, but desperate for cash, it is cutting its assistance to oil explorers.

The incentives could be pivotal for Caelus Energy. “Without the state tax credit programs, none of this would’ve happened, and I’m not sure Caelus would’ve come to explore in Alaska,” Jim Musselman, the Caelus Energy’s CEO, said in a statement. “We’re proof that the credit programs work.”

The company estimates that production will not begin until the 2020s, at the earliest.

With or without the state incentives, developing the Smith Bay discovery will be expensive. Caelus will need to sink barges in the bay to create manmade islands, through which the company will drill to access the field. But drilling can only take place in winter months, and as of now, the next appraisal well and seismic surveying will not be drilled until 2018 at the earliest. Caelus Energy will also need to construct a 125-mile pipeline to carry the oil from Smith Bay to Prudhoe Bay, where it can access the Trans Alaskan Pipeline System. Developing the whole operation could cost as much as $10 billion, and Caelus estimates it may require an oil price above $65 per barrel. The company estimates that production will not begin until the 2020s, at the earliest.

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