Energy Independence: Alaska Heats Up

by Aaron Levitt | May 16, 2012 11:29 am

Over the last few weeks in InvestorPlace’s series on America’s quest for energy independence[1], we’ve highlighted the many ways new advances in drilling technology have unlocked a virtual ocean of oil and natural gas all across the U.S., bringing energy self-sufficiency into view. We’ve done so with the specific aim of pointing out the many opportunities and potential pitfalls facing investors in the country’s revitalized energy sector.

So far, the bulk of our analysis has focused on the huge potential in new fields and the infrastructure needed to turn new reserves into healthy profits.

Nonetheless, some old dogs are learning a few new tricks. These same drilling advances that brought the Marcellus shale into the energy lexicon are also breathing in new life into old fields. Since BP’s (NYSE:BP[2]) Deepwater Horizon disaster, the Gulf of Mexico is again a hotbed of energy activity[3] and is proving itself once more as a huge contributor to our energy mix.

Another decidedly old-school and often-ignored producing region is Alaska. Long a major piece of America’s energy puzzle, the state’s ultimate potential could finally be tapped as these new drilling advances make their way northward.

For investors, playing that potential could lead to outsized gains for years to come.

A Continuing Dominance

Initially explored in earnest during the 1960s, Alaska’s Prudhoe Bay oil field sets the record as North America’s largest producing region at nearly 213,500 acres, originally containing more than 25 billion barrels of oil equivalent. The discovery by the old Atlantic Richfield single-handily established Alaska’s dominance as a producer of hydrocarbons in the U.S. Now, that dominance is set to continue with new exploration efforts across the state.

While Prudhoe Bay — which is operated by BP, Exxon Mobil (NYSE:XOM[4]) and ConocoPhillips (NYSE:COP[5]) — has seen production dwindle since its heyday and now contains roughly only 2 billion barrels of oil equivalent (BOE), recent new surveys point to an energy rebirth in Alaska.

The U.S. Geological Survey (USGS) recently completed its first assessment of technically recoverable oil and gas resources across the three main geological formations of Alaska’s North Slope. The Shublik, Kingak and Hue Shale formations have a long history of oil and gas reserves in conventional accumulations. Prudhoe Bay sits across these rocks. However, no attempt has been made to pro­duce oil or gas directly from the source rocks via hydraulic fracturing, or fracking.

What the USGS found surprised even some energy experts. Alaska’s North Slope shale formations could contain roughly half of as much natural gas as is located in Pennsylvania’s Marcellus shale and could be worth nearly $2 trillion dollars at today’s prices. Overall, Alaska’s North Slope[6] could contain as much as 2 billion barrels of oil and 80 trillion cubic feet (Tcf) of gas in technically recoverable onshore shale resources. The region could also hold more than 500 million barrels of natural gas liquids (NGLs).

The USGS’s unconventional shale estimates are in addition to its 2010 assessment of the entire National Petroleum Reserve in Alaska[7] (NPRA). It concluded that the largest undisturbed land mass in the U.S. contained more than 896 million barrels of undiscovered oil and 53 Tcf of natural gas in conventional supplies.

However, Alaska’s oil and gas potential doesn’t stop with its onshore assets. The state’s frozen Arctic seas could contain another bounty. While seismic firm[8] CCG Veritas (NYSE:CGV[9]) has recently announced plans to conduct the region’s highest-density 3D survey ever, preliminary results for the frigid waters are staggering. The Arctic Ocean region, including the Chukchi and Beaufort Seas, are estimated to contain enough reserves to fuel 25 million cars for 35 years.

Taken as a whole, Alaska’s vast onshore and offshore energy resources prompted U.S. Interior Secretary Ken Salazar to remark that they hold “great promise and economic opportunity” for the people of Alaska and across the nation.

Despite the prospects, the road won’t be smooth. As in the Lower 48, a lack of infrastructure has prevented exploration efforts across the bulk of Alaska. The state does contain the mammoth Trans-Alaska Pipeline System (TAPS), but even that has its problems. With production dwindling in Prudhoe Bay, the flow of oil through the pipeline has shrunk as well. Analysts estimate that below 300,000 barrels per day, the oil in the pipeline will become waxy and clog the pipe.

That could see the complete shutdown of the gathering system. At the same time, Alaska’s current tax/revenue system[10] is deterring investment and contributing to the decline in the state’s oil production. And let’s not forget about the potential risks involved when drilling in frigid temperatures and environmentally sensitive areas.

Betting on the 49th State

Even with these problems, Alaska’s long-term potential as major contributor to America’s energy security is certainly there. Infrastructure can be built, and some state policymakers are moving to reduce taxes collected from the oil industry. Investors can play both Alaska’s current status and its future.

Acting as a grantor trust[11], the BP Prudhoe Bay Royalty Trust (NYSE:BPT[12]) could be great way to play Alaska’s current production. At their core, grantor or royalty trusts are “carved” out of an underlying mineral deposit and sold off to investors. The trusts are strictly finance vehicles with no production operations, and their corporate tax structures require that essentially all of the royalty income received must be paid to unit holders. Distributions are tied to the price of the underlying commodity, whether it’s coal, oil or natural gas.

With oil trading in the $95 to $110 dollar range, Prudhoe Bay Trust is currently paying out a monster 8.9% dividend. While the trust has finite lifespan, the underlying assets should provide unit holders with strong dividends for years to come.

After five years of battling with bureaucratic red tape, Royal Dutch Shell (NYSE:RDS-A[13], RDS-B[14]) — my perennial favorite energy major — could be one of the best ways to play Alaska’s future promise. The company is poised to be the first energy firm to drill in the state’s Arctic since the 1990s as the U.S. Interior Department’s Bureau of Safety & Environmental Enforcement recently approved Shell’s 450-page oil-spill response plan.

With this approval in hand[15], Shell has begun the process of moving icebreakers and drilling equipment into the Beaufort Sea. It anticipates that production will begin later this year. Once again, the company’s first-mover status will benefit shareholders over the long term.

As of this writing, Aaron Levitt doesn’t own any securities mentioned here.

Endnotes:
  1. America’s quest for energy independence: http://investorplace.com/hot-topics/energy-independence/
  2. BP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BP
  3. Gulf of Mexico is again a hotbed of energy activity: http://investorplace.com/2012/05/energy-independence-the-gulfs-growing-role/
  4. XOM: http://studio-5.financialcontent.com/investplace/quote?Symbol=XOM
  5. COP: http://studio-5.financialcontent.com/investplace/quote?Symbol=COP
  6. Alaska’s North Slope: http://www.upstreamonline.com/live/article305169.ece
  7. National Petroleum Reserve in Alaska: http://www.usgs.gov/newsroom/article.asp?ID=2622#.T7PADVLh98E
  8. seismic firm: http://investorplace.com/2012/04/the-oil-majors-secret-seismic-data-firms/
  9. CGV: http://studio-5.financialcontent.com/investplace/quote?Symbol=CGV
  10. Alaska’s current tax/revenue system: http://www.ft.com/intl/cms/s/0/c033457a-734b-11e1-aab3-00144feab49a.html#axzz1uwmLkl4Z
  11. grantor trust: http://investorplace.com/2012/01/drilling-for-energy-dividends-with-royalty-trusts/
  12. BPT: http://studio-5.financialcontent.com/investplace/quote?Symbol=BPT
  13. RDS-A: http://studio-5.financialcontent.com/investplace/quote?Symbol=RDS-A
  14. RDS-B: http://studio-5.financialcontent.com/investplace/quote?Symbol=RDS-B
  15. With this approval in hand: http://www.businessweek.com/ap/2012-05/D9UH9VAG0.htm

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