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Renewed promise of cook inlet oil and gas: resources are truly consequential.

Cook Inlet oil and gas businesses are waiting and wondering. Their costs of exploration and production could rise and affect investment decisions, depending on whether and how the state of Alaska reshapes its capital credits program. Since 2010, those credits have encouraged exploration and production in Cook Inlet.

Oil and gas activity in Cook Inlet may be a tiny fraction of that on the North Slope--Cook Inlet oil production amounting to a mere 3 percent of the North Slope volume--but for consumers in Southcentral Alaska, the Cook Inlet basin resources are truly consequential.

Oil and natural gas from Cook Inlet are the major sources of heat and electricity for Southcentral Alaskans. Natural gas from Cook Inlet provides heat to homes and businesses in Anchorage, the Kenai Peninsula, and the Matanuska-Susitna Borough.

More than 80 percent of the electricity for communities from Homer to Talkeetna is generated from Cook Inlet natural gas, according to the Alaska Oil and Gas Association (AOGA).

Facing declines in the production from Cook Inlet oil and gas fields, Southcentral Alaska communities in 2009 were concerned about energy shortages. Options considered included importing liquefied natural gas and energy conservation.

Then, in 2010, the Alaska Legislature passed the Cook Inlet Recovery Act, or House Bill 280, which expanded capital credits available to Cook Inlet producers and advanced construction of a natural gas storage facility intended to balance supply and demand. Cook Inlet oil and gas activity has increased substantially since availability of the larger tax credits. New wells have been drilled, platforms have been upgraded, natural gas reserve estimates have risen, and oil and gas production have increased.

AOGA reports that since 2010, seventy-five new oil and gas wells have been drilled, new gas fields have been discovered, oil production rose by 80 percent, and the expanded gas storage in the Cook Inlet natural gas storage facility has helped stabilize production.

Recently one Southcentral utility was able to contract for natural gas supplies at reduced costs: Homer Electric Association inked a new deal with Furie Operating Alaska LLC of League City, Texas, to receive future gas from a newly discovered offshore gas resource in the Kitchen Lights Unit north of Nikiski.

Mike Salzetti, Homer Electric Association's manager of fuel supply and renewable energy development, explains that the contract, which is awaiting regulatory approval, provides for gas to be supplied from April 1,2016, through 2018. The agreement is the first in several years for which the price of gas fell. "The cost has been on an upward trend with about a 3 to 4 percent escalation factor each year," says Salzetti. "We will be paying less for gas in 2016 than HEA was paying for gas in 2014."

Exploration, such as reserve delineation in the Cosmopolitan and Kitchen Lights units by companies taking advantage of state incentives, has resulted in discovery of additional producible reserves of oil and gas. In existing production infrastructure, new techniques are being implemented to mitigate problem wells and manage system pressures, also raising estimates of remaining reserves in the Cook Inlet basin.

Although large future sources of gas have been discovered, development of those new fields requires large investments to construct production infrastructure. The currently available resources will not meet the long-term demands of Southcentral utilities. Companies poised to develop resources that could supply gas to meet future energy demand are now wary of losing the incentives that helped make decisions to invest in Cook Inlet.

C. Benjamin Johnson, president and CEO of BlueCrest Energy, Inc., headquartered in Fort Worth, Texas, says estimates indicate current gas production will meet local demand for four to five years. The development time frames for bringing new gas supplies to market are at least three to five years, he adds.

The Resource

The Cook Inlet area contains thirty-four currently or historically producing oil and gas fields. The Division of Oil and Gas under the Alaska Department of Natural Resources reports that as of year-end 2014, the Cook Inlet basin had produced 8,308 billion cubic feet of gas and 1.35 billion barrels of oil. The division's estimate of "proven and probable remaining gas reserves" in existing fields at that time, excluding undeveloped fields such as the Kitchen Lights and Cosmopolitan units, was approximately 1,183 billion cubic feet of gas.

According to data provided by the Alaska Oil and Gas Conservation Commission, Cook Inlet gas production declined annually from 2005 through 2013, dropping from 210.4 billion to 95.6 billion cubic feet of gas. In 2014, the commission tally of Cook Inlet gas production rose to 109.6 billion cubic feet. From 2004 through 2009, Alaska Oil and Gas Conservation Commission data for annual Cook Inlet oil production show a decline from 2004 to 2009, recording a fall from 8.2 million to 2.7 million barrels of oil, followed by increases through 2014, when 6.3 million barrels of oil were produced.

Local Economic Impact

The economy of the Kenai Peninsula Borough (KPB) benefits from property taxes paid by lease holders and the jobs and income of borough residents created by oil and gas activities in Cook Inlet and operation of Tesoro's refinery. McDowell Group, in its report "The Role of the Oil and Gas Industry in Alaska's Economy," prepared in May 2014 for AOGA, examines impacts of the Cook Inlet oil and gas industry on the KPB economy. The findings show that, in 2013, six thousand jobs and $430 million in wages can be attributed to positions with primary employers and support services, as well as jobs indirectly created by the Cook Inlet oil and gas industry in the public and private sectors and the presence of North Slope workers residing in the borough.

Craig Chapman, KPB Finance Director, says that Cook Inlet oil and gas businesses represent eight of the ten top property tax payers in the KPB. Tax revenues collected from Cook Inlet oil and gas properties compose 20 percent of the borough tax base. State assessments of Cook Inlet oil and gas assets increased more than 60 percent from 2012 to 2015, contributing to higher revenues for the KPB.

The KPB would receive a significant economic boost from the proposed Alaska LNG project. Nikiski, on the east side of Cook Inlet, has been identified as the site for the liquefaction plant and marine terminal.

Larry Persily, a former presidential appointee to the Federal Office for Alaska Gas Line Projects and currently contracted to assist the KPB mayor on oil and gas issues, says, "The additional tax base would have a huge impact on the KPB." Land has already been bought in anticipation of the proposed infrastructure, and Persily indicates that construction of the infrastructure could start in 2019.

Prominent Recent Players

The commercial landscape has changed since Alaska lured businesses to Cook Inlet with greater incentives; large firms have been replaced by smaller, independent companies for which the credits have helped to fund exploration and production.

Hilcorp Alaska LLC, the subsidiary of a Texas-based company, entered the Cook Inlet oil and gas arena in late 2011, acquiring assets from Chevron. Hilcorp began operating ten offshore platforms and two onshore fields acquired from Chevron on January 1, 2012. Later that year, Hilcorp also acquired the Cook Inlet assets of Marathon Oil Corporation and became the dominant producer of oil and gas in Cook Inlet.

Hilcorp drilled twenty-two new wells and completed eighty-eight well workovers in 2014. In July 2015, the company executed an agreement to purchase the Middle Ground Shoal assets of XTO Energy, Inc., a subsidiary of ExxonMobil Corporation, in Cook Inlet. Awaiting state and regulatory approval, the latest acquisition is expected to close this fall.

Among significant new gas resources recently defined is the Kitchen Lights Unit, where Furie, formerly Escopeta Oil and Gas, used the Spartan 151 rig to drill the first of what is expected to be three production wells. According to Bruce Webb, senior vice president of Furie, the newly installed production platform was expected to begin producing 15 million to 20 million cubic feet per day of gas in November. This production level meets the needs of currently contracted customers and can be expanded. The additional two production wells are expected to be completed in the first half of 2016.

Becoming the sixth producer to seek oil and gas resources from the Cosmopolitan Unit north of Anchor Point in Cook Inlet, BlueCrest acquired unit leases in 2012 and 2013. Johnson explains that the company brought a different approach to be able to better assess the oil resource. "We decided we would drill a new well vertically from offshore and penetrate all zones from the top down," says Johnson.

The findings from the 2013 well identified four new oil zones, above the two previously known oil zones, and discovered more than six gas zones above the oil. Johnson says BlueCrest has invested $200 million to date to develop the oil resource. A $30 million loan from the Alaska Industrial Development and Export Authority has helped finance the $44 million onshore drilling rig and associated facilities that will be used to reach the oil zones three miles from shore.

"Our total investment required to get to the point at which we are bringing in enough revenues to be cashflow positive is approximately $500 million," says Johnson. He adds that BlueCrest is relying on tax credits allowed under existing law to partially offset the costs of oil resource development for the Cosmopolitan Unit.

Johnson says, "We anticipate the benefit to the state for paying these credits over the next three years will be roughly a 400 percent return on the cost of the credits." The return in state royalties was calculated assuming a price of $55 per barrel of oil and tax credits for 2016 through 2018 that would be payable by the state under existing law.

The natural gas reservoirs in the Cosmopolitan Unit are separate from the oil and are too shallow to reach from onshore. Development of the gas will require offshore platforms. The only offshore drilling rig in Cook Inlet is the Spartan 151 jack-up rig brought to Alaska by Furie to develop its Kitchen Lights Unit. Furie has released the rig, which currently remains in Alaska to drill Cosmopolitan gas for BlueCrest in 2016.

"Gas development is on hold pending resolution of the state tax credit issue," says Johnson. If the rig leaves because BlueCrest doesn't commence drilling next year, costs to bring an offshore rig to Alaska at a later date will be high. Johnson explains that if BlueCrest proceeds in 2016, the company would drill three new gas wells. Construction of the first gas platform would follow in 2017, and gas could be produced by 2018.

Johnson says that BlueCrest cannot commit to 2016 offshore drilling without confidence in the ability to complete the entire development. "The credits are a critical part of investment in development of these fields," he explains. "We don't want to spend hundreds of millions of dollars and then find out the credits needed to get us to the finish line are not going to be there."

Another Cook Inlet oil and gas company is Miller Energy Resources, based in Knoxville, Tennessee. The business acquired Cook Inlet Energy LLC, owner of several western Cook Inlet properties, in 2009.

Miller Energy has been charged with reporting inflated values of Cook Inlet oil and gas properties owned by Cook Inlet Energy. The Securities and Exchange Commission alleges the value of oil and gas properties acquired in 2009 were overvalued by $400 million. Miller Energy is working toward a settlement with the Securities and Exchange Commission. A $6.4 million payment of tax credits from the state of Alaska to Cook Inlet Energy in September toward a 2014 tax-credit certificate is helping the business pay down debts. On October 1, Miller Energy filed for Chapter 11 bankruptcy protection and reorganization.

Threatened Tax Credit Changes

Concern about state of Alaska revenue declines and the increasing deficit resulting from the drop in oil revenues that fund state spending has brought scrutiny of oil and gas tax credits. During the budget process, Democratic lawmakers called for scaling back the credits.

During a July 1 press conference, Governor Bill Walker announced his veto of $200 million in tax credit payments. Although the action saved money this year, the state remains obligated to pay the credits. Walker said his veto was intended to start a discussion on how the tax credit program may be restructured to reduce state capital spending.

In September and October, a tax credit working group convened by Senator Cathy Giessel, an Anchorage Republican chairing the Senate Resources Committee, heard presentations from representatives of the Cook Inlet oil and gas companies, utilities, the investment community, and state natural resource and revenue departments.

Companies such as BlueCrest, Furie, and Hilcorp have indicated that the stability of tax structure is integral to providing confidence required for continued investments. Projects are typically long term, and companies that have already committed to development of known fields based on the existing tax structure seek assurance that the state will honor commitments.

Kara Moriarty, president and CEO of AOGA, notes that many speakers at the working group meetings indicated that the incentives for spurring Cook Inlet production have not yet had time to create gas production infrastructure capable of meeting the long-term supply needs of utilities. "The credits are definitely an important tool for the state and industry to continue to increase investment and production," she says. "The incentives let industry know the state is open for business."

Moriarty explains that the tax credits have increased investment, productivity, and jobs. She adds that predictability is needed for the industry to have confidence that Alaska is a good place for business. "The state has to be very cautious while looking at changing policy by altering credits and consider how that might change investor behavior," she says. "Even talk has caused unnecessary scrutiny."

RELATED ARTICLE: Municipality of anchorage seeks to acquire cook inlet gas assets.

By Judy Griffin

The Municipality of Anchorage submitted a bid to acquire ConocoPhillips gas properties in Cook Inlet on October 9. The terms of the offer won't be disclosed until the competitive bidding process is complete.

The interests offered by ConocoPhillips consist of a one-third interest in the Beluga River gas field, the North Cook Inlet gas field, and 5,700 acres of leased lands in and around Cook Inlet. The oil and gas producer had stated it prefers sale of the assets "to a single buyer for cash."

The Beluga River gas field is on the upper west side of Cook Inlet. Through its Municipal Light and Power (ML&P) electric utility, the city has owned one third of this field since 1996. Hilcorp Alaska LLC also owns one third. ConocoPhillips has been operating the lease.

The Municipality calculates that sourcing gas from the Cook Inlet field has saved ratepayers $239 million. Myer Hutchinson, communications director in the Office of Mayor Ethan Berkowitz, explains that figure represents the annual cost of gas for ML&P compared to the costs paid by Chugach Electric Association for Cook Inlet gas during the same time period.

According to Hutchinson, ML&P will need additional gas by 2018, and the sale represents an opportunity to lock in supply that likely could meet its needs for twenty years. "Historically speaking, the Beluga River gas field has been a significant provider of gas for Anchorage markets," says Hutchinson. "The purchase of additional gas properties could be very beneficial for the Municipality, ML&P, and ratepayers at ML&P."

Judy Griffin, a former editor of Alaska Business Monthly, is a freelance writer in Anchorage.
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Title Annotation:OIL & GAS
Comment:Renewed promise of cook inlet oil and gas: resources are truly consequential.(OIL & GAS)
Author:Griffin, Judy
Publication:Alaska Business Monthly
Geographic Code:1U9AK
Date:Dec 1, 2015
Words:2613
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