OFFSHORE DRILLING:

Is Arctic oil exploration dead in the U.S.?

A year ago this September, Royal Dutch Shell PLC began the first new oil drilling in U.S. Arctic waters in more than two decades. The company spent $5 billion and dispatched an armada of ships and equipment to offshore Alaska to evaluate the energy resources on its federal leases.

From the beginning, however, Shell's operation faced a multitude of problems -- everything from lingering sea ice to a damaged oil spill containment dome. The Dutch company was never able to secure the permits needed to drill into the hydrocarbon zone on its leases.

The final straw came after the summer season ended. As Shell left Alaska waters, the Coast Guard found multiple technical violations on the Discoverer drill rig, and the Kulluk drill rig ran aground on its way to Seattle.

In the aftermath, Shell's operations were pilloried in a federal report, and the company canceled this year's drilling plans. There's no word yet on exploring in 2014 (EnergyWire, March 15).

Some industry experts have predicted that Shell's setbacks, together with the shale oil and gas boom in the lower 48, have seriously damaged the prospects for Arctic exploration.

But Shell's much-publicized failure hasn't discouraged the world's top energy companies from actively securing long-term oil and gas resources along other Arctic shores, primarily in offshore Russia.

If massive oil reserves are discovered in other parts of the Arctic, the United States would be pressured to speed up drilling off Alaska's shores, said Surya Rajan, senior manager of research for IHS, a commercial analysis company.

"As long as the other countries are moving forward and they demonstrate safe and environmentally friendly operations, the U.S. will look much more seriously at opening up activity and permitting these things a bit quicker," he noted.

Still, the question remains: Is Arctic oil exploration dead in the United States? Not likely, according to most energy experts.

Shell CFO Simon Henry recently told investors that the company is staying the course in Alaska. "According to the probability of success, which has not changed, we still expect to drill," Henry said in a May earnings teleconference.

At the same time, the Obama administration is paving the way for new Arctic drilling. In the coming weeks, the Interior Department is expected to formally ask for public comment on which regions of the Chukchi Sea should be opened for future exploration and development.

Under the administration's five-year plan for offshore oil development, Interior will consider selling Chukchi leases in 2016 and Beaufort Sea leases in 2017 (EnergyWire, June 28).

"From a resource perspective, none of the major oil and gas players are going to abandon the Arctic," Rajan said. "It's going to be very important, just from a portfolio perspective."

Tempered enthusiasm

In 2008, the U.S. Geological Survey raised international interest in Arctic oil and gas resources when it released the first-ever estimate of the region's undiscovered and technically recoverable conventional oil and natural gas resources.

The report estimated that the territory north of the Arctic Circle holds 90 billion barrels of oil and 1,669 trillion cubic feet of natural gas, with a staggering 84 percent of those hydrocarbons located offshore.

The vast majority of the oil and gas is located in the West Siberian Basin, Alaska's Arctic and the East Barents Basin. The Bureau of Ocean Energy Management has estimated that Alaska's offshore region contains 23 billion barrels of oil.

At the time the USGS assessment was released, the Interior Department had already held several lease sales in the American Arctic, including a record-breaking 2008 sale in the Chukchi Sea that brought in $2.7 billion.

In that offering, Shell opened its wallet the widest, spending $2.1 billion for 275 Chukchi tracts, including $105.3 million for a single site. ConocoPhillips Co. came in second, paying $506 million for 98 leases. Those bids were based on two years of seismic data that the companies had separately collected in the region.

In the years that followed, however, the economics of the oil and gas industry dramatically changed as more companies adopted hydraulic fracturing and directional drilling technologies to tap into unconventional shale formations in the lower 48 states.

Now the growth of shale oil and gas development, together with Shell's ill-fated 2012 drilling program, has tempered market enthusiasm for Arctic energy development.

In February, an Ernst & Young report warned that despite Alaska's bountiful offshore oil resources, Arctic projects are vulnerable to high cost overruns, long lead times and a lack of support facilities, all of which could sour investment in the region (EnergyWire, Feb. 8).

Shell's inability to sink a drill bit into its Arctic leases continues to weigh heavily on the minds of top energy executives. Harald Norvik, a board member at ConocoPhillips and former CEO of Statoil, recently told Reuters that interest in Arctic energy "is very high, but nevertheless there is more and more concern about the environment and risk part of it."

ConocoPhillips had been seeking to drill off Alaska's shores in 2014 but canceled its plans earlier this year, citing regulatory uncertainty (EnergyWire, April 11).

Despite those concerns, the world's energy giants are queuing up to drill in the Russian Arctic. Shell signed a deal with state energy company Gazprom to jointly explore in the Russian half of the Chukchi Sea. Eni, Exxon Mobil and Statoil are each partnering with state oil giant Rosneft on separate offshore oil projects in other parts of the Russian Arctic.

Norway recently announced plans to allow oil exploration in the northern Barents Sea, adjacent to the Arctic Ocean. Meanwhile, Statoil and Chevron are conducting seismic studies this summer off Canada's Arctic coastline.

Analysts note that the world's eight Arctic nations are far more politically stable than the oil-rich Middle East and African nations. Alaska's oil resources are located in shallow water -- a bonus for companies that are increasingly searching for oil and gas in the deepwater reaches of the Gulf of Mexico.

Rajan of IHS predicted that in the next five years, Arctic exploration will gradually expand not only in Russia, but also in Alaska, Canada, Greenland and Norway. "Looking beyond 2015, there's a potential for 20 wells per year or more going forward," he said.

For the foreseeable future, however, don't expect the multinational energy companies to begin building the infrastructure needed to bring that oil to market.

"The companies are in the exploration and appraisal stage," noted Rajan. "At this stage, it is full steam ahead. All they're trying to do is establish where the oil is, how much is there and what is the geographic extent."

Added Kevin Casey of the Arctic Institute: "When we're looking at Arctic development, it's amazing about how slow it moves. Exploration, financing, planning and development -- these are 10-, 15-, 20-year endeavors."

In the U.S., a year of catch-up

While other countries move forward in the Arctic Ocean, the United States is using 2013 to rethink its approach to the region.

For decades, Washington has acted as an absentee landlord for Alaska, only acknowledging the importance of the nation's northernmost state for military purposes, North Slope oil, and polar bear and caribou habitat.

With climate change leaving the Arctic Ocean ice-free for longer periods each summer, other nations have developed plans to capitalize on energy and mineral development, shipping, fishing, and tourism in the Far North.

But the United States has been slow to respond. In the run-up to the May Arctic Council ministerial meeting, the United States was the only member nation not to have a comprehensive Arctic strategy.

Days before the meeting, the White House issued a vague Arctic white paper that critics said did little to clarify the administration's game plan for the region (EnergyWire, May 13).

Since then, top administration officials have held listening sessions in Alaska and are beginning to draft a governmentwide action plan for Arctic management. That policy paper is expected to be released later this year.

"There's been a dramatic change in the United States' recognition of our role in the Arctic," former Interior Deputy Secretary David Hayes observed in an interview.

"We're evaluating how we organize as a government to implement integrated Arctic management and work across the silos of our various Cabinet agencies and other parts of the government," said Hayes, who headed the administration's Arctic program until he left Interior at the end of June.

The Interior Department is also taking a series of controversial regulatory steps that could shape oil and gas development in offshore Alaska for years to come.

Regulators are writing new ground rules for future Arctic energy exploration and development. The administration also is drawing up a "targeted" leasing program. The aim is to allow oil companies, conservationists and Native communities that hunt and fish in the frigid waters to identify the territories that are most critical to their needs.

New Arctic regulations are certain to reignite past battles between the oil interests and environmental activists over Alaska's future.

Industry officials warn that energy companies will avoid the American Arctic if the regulators draft overprescriptive exploration standards.

"The big question is, what will a new regulatory environment look like?" said Richard Ranger, senior policy adviser for the American Petroleum Institute. "We hope the policies developed by the federal government will encourage exploration and not impose limiting restrictions that don't have a risk-based justification."

He cautioned that the industry will resist proposals that limit offshore energy leasing. "If targeted leasing as a longer-term strategy were to have the effect of taking acreage and offshore prospects off of the table, we will have difficulty with it," he said.

But environmentalists see things differently. They want the federal government to permanently ban oil and gas exploration in some parts -- if not all -- of the Arctic.

"Our interest is, how do we put the areas that are important for species and important for subsistence hunters off-limits for future lease sales?" said Marilyn Heiman, director of the Pew Charitable Trusts' U.S. Arctic program. "We don't want to fight these battles every year in places like Barrow Canyon or Hannah Scholl."

Lois Epstein, Arctic program director for the Wilderness Society, called on the administration to adopt Arctic drilling standards that are stricter than the mandates Shell agreed to follow during the 2012 drilling season.

"It's going to be very important to not just issue a proposed rule that codifies what Shell had to do last year, and say that's enough," she argued.

Epstein also opposes new oil and gas leasing in the American Arctic. "Just because the White House has an all-of-the-above strategy doesn't mean you drill everywhere and you have to include the Arctic," she said.

But Epstein also acknowledged that the administration is likely to move forward with new energy development along Alaska's northern shores.

She noted that in recent meetings with environmentalists, BOEM Director Tommy Beaudreau "pushed back pretty hard on that."

"He said, 'We're planning to do this lease sale because we need to get information from the industry about what they're really interested in,'" she reported.

All eyes on Shell

For the time being, Shell's proposed drilling program is the only game in town in the American Arctic.

"The main event in the near term is going to be the outcome of Shell's program," said API's Ranger. "I'm not trying to hang the whole thing on Shell, but that's a company that obviously has the assets to proceed in an environment of high uncertainty and considerable cost."

Shell's success or failure will be pivotal to the future of offshore energy development in Alaska, he added.

"Watching the Shell program as it goes forward is going to have a huge influence on what level of investment and interest then proceed in the U.S. Arctic," Ranger said.

Shell has not yet declared whether it will apply for permits to drill next year in the Beaufort and Chukchi seas.

As Shell spokesman Curtis Smith explained, "Future exploration plans for offshore Alaska will depend on a number of factors, including the readiness of our rigs and our confidence that lessons learned from our 2012 drilling program have been fully incorporated."

Smith added, "The Kullluk is currently in a shipyard in Singapore, and the Noble Discoverer is in a shipyard in South Korea. I don't have a detailed scope of work for either rig at this time."

In the last several months, Shell has made major changes to its corporate leadership that industry analysts say may demonstrate the company's continued commitment to Arctic drilling.

In April, Shell appointed Ann Pickard to oversee the company's U.S. Arctic operations, replacing David Lawrence, who left the company "by mutual consent."

Pickard, who was head of Shell's Australian gas export division, was dubbed "the bravest woman in oil" in 2008 by Fortune magazine for her deft handling of the company's troubled Nigerian oil program.

"Putting someone with such extensive experience on top of their U.S. Arctic program would probably indicate that they are still serious about it," noted Rajan of IHS.

More recently, Shell also appointed a new CEO: Ben van Beurden, the company's downstream director. Industry analysts say van Beurden is not expected to alter Shell's long-term Alaska strategy (EnergyWire, July 10).

But Shell is still licking its wounds after last summer's headline-grabbing technical failures. A Greenpeace activist gleefully asserted that Shell did more to set back Arctic drilling than any of that group's publicity stunts.

"Putting aside the question of the carbon impact of Arctic drilling, the technical challenges are insurmountable," said Ben Ayliffe, international Arctic campaign director for Greenpeace, which is battling Shell's Arctic program. "And if a company the size of Shell can't get it right, that sends a pretty clear message to the rest of the industry."

Other environmental activists insist that it's only a matter of time before Shell gives up its expensive leases and leaves the American Arctic.

"On Arctic Ocean development, I wouldn't be surprised if Shell withdraws when they find an appropriate time," Epstein said. "And then the other dominoes will fall after that," with ConocoPhillips and Statoil also pulling out of the region.

But Pew's Heiman, who worked at the Energy Department during the Clinton administration, asserted that the current lull in the American Arctic won't last.

"It's temporarily quiet," she said. "I'm not as optimistic as some people are" that the energy companies will abandon their offshore Alaska leases.

"Right now the Interior Department is making plans to hold new lease sales," she said. "It's business as usual. Even though Shell is not drilling this summer, we don't know what's going to happen next summer."

Shell and the other major oil companies continue to be lured to the Arctic by the promise of vast oil reserves. All signs are that Shell's Chukchi Sea leases could hold a massive oil reserve, noted Mark Oberstoetter, Wood MacKenzie upstream analyst for the United States and Canada.

"Obviously, they need to drill the wells to prove it up," Oberstoetter said. "But they wouldn't have stuck around for as long as they have or spend the billions on leases without thinking there's something big there."

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