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Oil industry's troubled waters.

Despite several bright spots last year, Alaska oil industry's long-term prospects remain dimmed by the decline of Prudhoe Bay, the still-undecided fate of ANWR and other disappointing developments.

In November, Alaska's oil industry was dealt a major blow when the U.S. Senate failed to pass an energy bill that would have opened the Coastal Plain of the Arctic National Wildlife Refuge (ANWR) to exploratory drilling. While statewide oil production remained high and new discoveries were made in Cook Inlet, those psychological boosts were offset by the ANWR letdown, the discovery of dry holes in other areas and the looming decline of the Prudhoe Bay field.

To complicate matters, developing countries undergoing geopolitical changes are luring oil companies. This puts Alaska at an increasing disadvantage in competition for finite exploration and development budgets.

The mixed messages of the past year also portend continued uncertainty about the current condition and future prospects for Alaska's oil industry. While approximately 250 jobs were lost at Arco Alaska alone in the company's combined efforts with BP Exploration (Alaska) to consolidate Prudhoe Bay operations, 2,000 short-term jobs will be gained over the next few years during construction of Arco's GHX-2, or gas-handling expansion, project. The GHX-2 facility will boost Prudhoe oil recovery because producers will be able to process an increasing amount of gas associated with oil production.

Although, for the past three years, exploration indicators remained stable, "exploration crew months" have been half to a third of what they were before 1986. Engineering and technological innovations have enabled producers to reap more oil from Alaska's Prudhoe Bay and Kenai Peninsula fields, but frontier acreage is in very short supply nationwide.

Assessments of the oil industry's health are guarded and somewhat divergent. Tom Cook, Alaska exploration representative for Chevron USA notes that, on the whole, the sector is "somewhat sickly," but cautions against characterizing the oil industry as homogeneous. As an oilfield professional specializing in exploration, Cook says what he sees down the road is not encouraging.

Dudley Platt, a state petroleum economist for the Oil and Gas Audit Division of the Alaska Department of Revenue, reports 1991 was a pretty good year. "The industry is definitely leaner, but they're making more oil per employee," says Platt.

The failure to remove the present ban on exploratory drilling in the Arctic refuge was one of the oil industry's biggest disappointments in 1991. In the fall, a measure to open the refuge was successfully filibustered by opponents, effectively killing the comprehensive energy bill of which it was a part. Whether the measure will be considered again is not clear and at this point appears to be dead until the next presidential race.

The failure to open ANWR creates anxieties throughout the industry. The refuge is believed to offer the best hope of bringing new oil on-stream in sufficient quantities to replace output from existing North Slope fields, thereby keeping the pipeline and its related infrastructure functioning.

But timing is critical. The calendar for exploring and developing refuge lands is affected by the projected schedule of Prudhoe's declining production levels. The pipeline system needs about 600,000 barrels of oil per day to sustain optimum mechanical viability, according to Marnie Isaacs, a spokeswoman for Alyeska Pipeline Service Co. of Anchorage.

Recently pipeline throughput has averaged roughly 1.8 million barrels a day. But according to an Alaska Department of Revenue forecast, the anticipated decline in Prudhoe Bay production will cause North Slope oil pumped through the pipeline to drop to 618,000 barrels a day in 2005.

"The real crunch time is now," says Al Hastings, external affairs director for Conoco Inc. in Anchorage. "If they don't find and develop the fields in the next few years, it'll be hard to justify bringing something on line if you know you'll have to shut it off in 2012."

Complicating this scenario is the omnipresent snag of state regulatory policies. "The problem is, as volume in the pipeline declines, the tariffs actually increase. When you factor that in with the price of oil, the cost of transportation is a killer, it kills projects," Hastings says.

Proof Positive. On the brighter side, if a cup is half empty, it may also be half full. 1991 often was punctuated with optimistic headlines from Alaska's oil patch, notably on the North Slope. The state's oil production from January through October totaled 568.25 million barrels, compared with 552.27 million barrels for the same period in 1990. This represents an increase of 2.9 percent, or 16.25 million barrels.

Says state petroleum economist Platt, "The $64,000 question is the industry's ability to sustain production levels. They've always done better than expected." He points out that engineers are getting more out of North Slope reservoirs -- Prudhoe Bay, Endicott and Kuparuk -- than was expected.

"The Kuparuk field is one of the big reasons we're making more oil. It has continued to hit new records and surprise people both inside and outside of Arco," Platt adds.

Another production milestone in 1991 was a so-called co-mingling agreement between the state and producers of the Point McIntyre, Lisburne and Niakuk fields, which makes production of those fields more economically attractive. "The co-mingling agreement put in place a mechanism that allows companies to go the next step in bringing the 100,000-barrel-per-day Point McIntyre field on line without any hassle from us. We tried to streamline the process," says Platt. As a result, producers are able to share facilities and to reduce additional physical plant costs and the expense of measuring field production separately.

For a state whose government budget depends heavily on oil royalties and taxes, the production sector's performance for the year is good news. To top it off, the exploration sector also posted gains.

Platt is effusive about the Cook Inlet discoveries announced last year. Besides a 1,100-barrel per day Sunfish well drilled by Arco/Phillips, Stewart Petroleum Co. of Anchorage made a discovery of "apparent commercial quantities" at the West McArthur River Unit No. 1 well. Stewart is an Alaskan-owned independent enterprise whose drilling venture is backed by Alaskan and Korean investors.

Although Stewart released no specific data, citing the need for further studies, the company reports its strike is in the so-called Hemlock formation, one of the most prolific zones in the Cook Inlet Basin. The well is near a field that already has produced more than 500 million barrels of crude oil.

"This could very well be the largest discovery in Cook Inlet in 25 years," says Platt. "It's very significant. What's important about it is that it keeps the existing Kenai oil infrastructure going."

With new technology and the relatively lower cost of working in the inlet compared to the Arctic, the discoveries have renewed industry interest in the area. Most Cook Inlet drilling occurred during the 1960s. With the 1969 discovery at Prudhoe Bay, the industry galloped off en masse to the new El Dorado. "Now, they're coming back and finding all the smaller pools that they suspected were there. The Cook Inlet Basin is coming alive again," says Platt.

Several companies have announced new or updated plans for further Cook Inlet exploration. Despite the closure of its Kenai refinery last year, Chevron USA expects to begin drilling a well onshore near Trading Bay. Also, Arco Alaska is developing several oil and gas wells and is considering others near the Swanson River field on the Kenai Peninsula.

On the North Slope, Conoco is drilling three exploratory wells this winter, one to confirm the size of its Badami discovery, announced last July. The company also plans to drill in state waters about two and a half miles north of Milne Point. A third well, the Sequoia wildcat well, is located about 18 miles south of Pump Station 1 of the trans-Alaska pipeline.

Also, Chevron expects to spend $500 million over the next several years for 8 to 10 exploratory wells and to make capital investments at the Milne Point field, which is operated by Conoco. Chevron has a 37 percent interest in Milne Point, smallest of the five producing North Slope fields.

By contrast, Chevron spent only $150 million over the last five years on Alaska exploration. Nonetheless, such substantial spending by big oil companies will help maintain the exploration sector at its present level, but is not projected to create any new jobs.

Among other exploratory activities around the state, Arco intends to drill an exploratory well near Big Lake in the Matanuska-Susitna Valley and an offshore well near Barrow. Amoco began offshore drilling in the Beaufort Sea near Kaktovik last September, and Amerada Hess recently collected seismic data in the Beaufort Sea.

Pales by Comparison. Despite these positive announcements, the oil exploration sector remains small in comparison to past years. The decreased activity reflects shrinking budgets, high costs, dismal results from recent drilling activity and limited acreage available for exploration.

According to Conoco's Hastings, "The exploration record for drilling in Alaska is one commercial discovery for every 50 wells drilled. So you need 50 wells a year for a new discovery to come on line." At the current rate of drilling, with only 12 wells being drilled this winter, there's a projected four-to-five-year spread between discoveries.

Meanwhile, Prudhoe Bay continues its inexorable production decline of 10 percent per year. "There are not enough fields out there waiting to be developed and come on line to replace the declining production," says Hastings.

Jim Haynes, natural resource manager with the Division of Oil and Gas of the Alaska Department of Natural Resources, says the state has little in the way of new acreage to offer for lease. One recent sale drew only four bidders. Says Haynes, "It wasn't even worth having the sale, except we're supposed to have them."

Especially disappointing have been the offshore exploratory wells drilled in the last few years. Last year, after drilling in the Chukchi Sea, both Shell Western E&P and Chevron decided not to pursue further activity for the time being. Drilling in Norton Sound, the Gulf of Alaska, lower Cook Inlet and the St. George Basin of the Bering Sea has produced similar results: dry holes or reservoirs too small or too remote to develop.

Says Chevron's Cook, "That leaves you with the Beaufort Sea, where the economics are terrible. You need a huge field to make it work. You have some real harsh economics."

He's also unhappy with the federal moratorium on drilling in Bristol Bay, where Chevron alone has invested approximately $20 million, just in leases. The moratorium was renewed last fall for a third year.

Overseas Allure. Frustrations experienced in Alaska have contributed to a growing trend of oil companies allocating exploration resources elsewhere. Also accelerating the trend are invitations from developing countries that are eager to explore and exploit their petroleum potential.

Many oil industry observers fear that an overseas exodus will cripple the domestic industry by putting limited supplies -- such as drilling rigs and pipe -- to work elsewhere. Should political efforts to open new domestic acreage finally prove successful, the U.S. oil industry may be unable to respond.

The Oil and Gas Audit Division's Platt agrees that decisions to invest overseas in places such as the Russian republics are not isolated occurrences in the American oil industry. "You're seeing an increasing push by the domestic oil industry to go international. There are opportunities that never existed before," he says.

Platt points out that areas previously off-limits to oil exploration are now opening as dramatic changes alter the world's political and economic landscape. Among the nations affected are Malaysia, Colombia, the Falkland Islands, Vietnam, the former Soviet Union and the Amazon River Basin.

Also, many prospective countries are "not as far along in their environmental regulations, so there's a sense that they don't have numerous permits to go through," Platt explains. He notes, too, that some nations are offering incentives to firms to entice them to cultivate oil industries.

Conoco's Hastings points out that environmental protection dollars go farther in areas that are less costly to operate in or are less environmentally sensitive than the Arctic. For example, republics of the former Soviet Union are attractive to companies because of enormous reserves and the perception that operations there can be conducted at lower cost than in northern Alaska.

A subsidiary of Tulsa, Okla.-based Parker Drilling Co. recently received a $12.5 million loan from the European Bank for Reconstruction and Development to modify and winterize three Siberian drilling rigs. The deal is just one example of numerous relationships being established despite the risk of doing business in the remnants of the broken Soviet empire.

"It's on the top of the list for a lot of companies simply because there's so much reserves there. You're talking several hundred billion barrels. It has reserves on the order of Saudi Arabia," says Hastings.

How the overseas investment trend will affect Alaska is unknown. Hastings believes a combination of costs, regulation and taxation policies and area closures will have a negative effect.

On another discouraging note, he points out that the state has had a tendency to use the huge and highly profitable Prudhoe Bay field as the benchmark for setting taxes, tariffs and royalty rates. These policies neglected to make sufficient allowance for the marginality of more typical, smaller fields. "In Alaska, you need to be big or you need to be out," he adds.

Companies are talking seriously about pulling out. Amoco and Chevron have dramatically reduced their Alaska operations; Shell Western E&P may follow suit.

Hastings cautions against attributing too much blame for oil company withdrawals on last fall's ANWR vote, noting that most of the major players are either multinational corporations or domestic companies with long-standing international operations. "I think this is a trend that's been there for a long time that's accelerated now because so many areas are off-limits in the United States," he says.

But Hastings does think reallocation of resources by international oil firms could bode ill for Alaska. "If you look at the guys that are leaving, that ought to be real cause for concern for the state of Alaska. There are a couple of significant companies, and when they decide they don't want to be operating in Alaska anymore, someone ought to be asking why," says Hastings.

If an exodus occurs, Hastings isn't concerned about an equipment shortage; he's concerned about a shortfall of human resources. "There are enough rigs in Alaska that the capacity to drill exploratory wells will be adequate or more than adequate to the opportunity. The problem is finding good crews to man them," he says. With the dramatic downturn in the industry in 1986, a lot of qualified workers from the oilfield service industry left Alaska, Hastings explains.

One serious implication of firms pulling out is that most oil companies need partners to share the high-cost risk of drilling. The cost of drilling exploratory wells has soared, and the risk of failing to strike a commercially viable field remains high -- 90 percent of wells drilled turn out to be dry holes. To offset the cost and risk, oil companies typically form partnerships that allow them to participate through a more manageable investment.

Clearly, because of the known resources and potential for future finds, there always will be companies interested in Alaska. The question is, will there be enough to accomplish the necessary pooling of resources to carry out an effective drilling program?

Chevron's Cook agrees that the departure of too many companies would have a "chilling effect" on Alaska's ability to discover viable new fields. He notes that the failure to authorize exploratory drilling in ANWR is the latest in a long line of discouragements that could force companies to pull stakes and look elsewhere. "Alaska is not the only game in town," he says.

Against this backdrop, the Alaska oil industry continues to do its yeoman work to squeeze every drop from existing fields. Many oil industry executives, such as Cook, believe the ANWR setback is temporary. "We were a lot closer than people expected. Another way to say that is that some of our work has paid off. We were beat on procedure, not on merit. I'm not ready to give up on that issue. The merit is clearly there, and the need," he says.
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Author:Richardson, Jeffrey
Publication:Alaska Business Monthly
Date:Feb 1, 1992
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