BP Adds More ‘Northern Exposure’

by Aaron Levitt | June 5, 2013 10:45 am

BP Adds More ‘Northern Exposure’

After years of waning energy dominance, Alaska might finally be back onto the road to recovery[1].

Initially explored in earnest during the 1960s, Alaska’s Prudhoe Bay[2] oil field is 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-handedly established Alaska’s dominance as a producer of hydrocarbons in the U.S. However, during the past few years, production in the North Slope dwindled and new exploration was hampered by a regressive tax scheme.

But now, beleaguered energy giant BP (BP[3]) — trying to put its woes behind it — has recently announced it plans to open up its checkbook and begin drilling in the North state once again. All because taxes are no longer an issue.

The removal of the previous royalty system could mean “The Last Frontier” won’t be a frontier any longer.

Plenty of Potential

Alaska has had a tough time with energy production lately.

According to the U.S. Energy Information Administration, the state slid into fourth place in terms of energy output this past March — falling behind California — as the rest of the states embraced fracking. That’s a shame, as Alaska is still full of potential energy reserves.

The U.S. Geological Survey’s last assessment of technically recoverable energy resources across the three main geological formations of Alaska’s North Slope found a staggering amount of oil and gas. Overall, the region could contain as much as 2 billion barrels of oil and 80 trillion cubic feet of gas in technically recoverable onshore shale resources. Additionally, the North Slope could also hold more than 500 million barrels of natural gas liquids.

That basically puts Alaska’s North Slope on par with Pennsylvania’s Marcellus shale, and the region could contain natural gas worth nearly $2 trillion at today’s prices.

By the way, those numbers don’t include all the energy located in the National Petroleum Reserve, nor the state’s vast offshore potential either.

However, despite the potential, attempts to tap those reserves have been fraught with issues — particularly economic ones.

It’s expensive to drill in Alaska. Extreme temperatures and remoteness of locations tack additional costs onto production. Adding to these costs were the nation’s high tax/royalty rates on drilling. Alaska relies heavily on oil revenues for its state spending and residents have collected annual dividend checks for decades from the state’s permanent fund.

The royalty scheme[4] adopted under former Governor Sarah Palin started with a 25% base rate that climbed upward along with the oil prices. E&P firms in the state could be on the hook for a maximum 75% tax on their production. Needless to say, those high rates didn’t inspire much in the way of new investment.

To spur necessary development, Alaska’s legislature removed the old system and replaced it with a flat 35% tax rate on production. By taking advantage of other incentives, oil companies could end up with a new effective tax rate as low as 14%.

Which brings us to BP.

Growing Production

With the new lower tax rules in place, the British integrated giant has decided to add $1 billion in new investment[5] and two drilling rigs to its Alaska North Slope fields over the next five years. It also will evaluate an additional $3 billion worth of new development projects with partners ConocoPhillips (COP[6]) and Exxon Mobil (XOM[7]) in the west end of the Greater Prudhoe Bay area. Additionally, the company said it is considering building new drilling pads and will drill more than 110 new wells in the region.

Adding more production capacity in Alaska is huge news for the firm.

Production at BP — as well as many of its major rivals[8] — has slipped during the past few years as legacy wells have begun to dry up. Generally, when E&P firms can’t find oil quickly enough, they’re stuck with aging fields where overall output is declining. That’s a very bad thing, considering the current high price oil environment.

By adding new production in an area with a vast plethora of hydrocarbon reserves, current production and a well-established infrastructure (*cough* Trans-Alaska Pipeline), BP is playing it safe and saving itself a lot headaches. To gain access to many new plentiful sources of oil and natural gas — save for North American shale — E&P firms have had to scour the globe and sometimes find themselves in not-so-friendly environments. (Argentina comes to mind[9].) By sticking to what it knows well, BP is eliminating many of the risks.

While it will take some time for any new wells to really get pumping, and while the firm won’t provide potential estimates from its decision to drill in the North Slope, BP is making a smart move by expanding one of its core production areas.

That will ultimately benefit long-suffering shareholders of the British giant and could be the much-needed spark to help shares of the firm catch up to its rivals[10]. Shares continue to trade a stubbornly low P/E, especially when compared to its two Prudhoe Bay partners.

However, with more production coming from Alaska, it might not stay that way for long.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Endnotes:
  1. road to recovery: http://investorplace.com/2012/05/energy-independence-alaska-heats-up/
  2. Alaska’s Prudhoe Bay: http://investorplace.com/search/?q=BP+prudhoe+bay&category=all&sort=relevance
  3. BP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BP
  4. royalty scheme: http://business.financialpost.com/2013/06/03/bp-plans-us1b-investment-in-alaska-as-state-lowers-taxes/?__lsa=7bd2-4e6f
  5. $1 billion in new investment: http://abcnews.go.com/US/wireStory/bp-announces-plans-alaska-oil-tax-change-19314063#.Ua884Nj_1w1
  6. COP: http://studio-5.financialcontent.com/investplace/quote?Symbol=COP
  7. XOM: http://studio-5.financialcontent.com/investplace/quote?Symbol=XOM
  8. as well as many of its major rivals: http://investorplace.com/2013/04/big-energy-showdown-chevron-vs-exxon/
  9. Argentina comes to mind: http://investorplace.com/2012/11/energy-investors-flee-argentina-post-haste/
  10. catch up to its rivals: http://investorplace.com/2013/05/wall-street-sorts-through-another-round-of-linn-sanity/

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