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North America's Arctic drive slows amid problems

While the far north has been both tempting - and, in some cases, profitable - for a number of majors, the sense of urgency that once drove Arctic exploration is waning

A 30-year-old veteran of the global drilling industry, the Kulluk rig has probably perforated its last well. It now sits in a Singapore dockyard, enjoying infamy as the vessel that ran aground on Alaska's Sitkalidak Island at the end of 2012, suffering terminal damage in the process. Patching it up would be too expensive, says Shell, its owner. So the Kulluk will play no part in the Anglo-Dutch supermajor's quest to find oil and gas in the Arctic. Nor, for now at least, will another damaged bit of the company's Arctic drilling kit, the Noble Discoverer. It can now be found in a South Korean port, its home after Shell had it towed there last year. 

It hasn't been a sunny start for Shell's Arctic campaign. Last November, Shell sent a revised operational plan to the US Department of Interior, saying it wanted to replace the Kulluk with another rig, the Polar Pioneer, and finish work started in 2012 in the Chukchi Sea, which lies north of the Bering Strait in US waters between Alaska and Russia's far east. The company hoped to drill multiple wells during the summer weather window, facing down activists and legislators still questioning Shell's ability to drill safely in the Arctic. Two months later, Shell had baulked. In January, Ben van Beurden, the company's new chief executive, told investors that he wasn't ready to commit any capital or other resources to a drilling campaign offshore Alaska this year.

Looking for oil in North America's Arctic is an expensive business. Even before it has started producing in earnest, Shell had already spent $6 billion on its Arctic campaign, including $2bn just to secure the leases offshore Alaska. (Violations of its pollution permits have been less costly, at $1 million.) The day rate for Transocean's Polar Pioneer, was $620,000. Including discounts, the price just to rent the unit for the four-month campaign would have come in at about $73m.

Some investors, worried by the inflated costs of drilling the Arctic - as well as a vociferous collection of activists opposed to it in principle - will welcome Shell's decision to suspend its Arctic campaign. But for Alaska, which is trying to rescue its flagging production, the news was 'extremely disappointing', in the words of the state's governor, Sean Parnell. Above all, it shows that development of North America's Arctic remains difficult even for the most deep-pocketed and experienced investors. Its harsh conditions, combined with costs that can far exceed those in the Lower 48, mean progress in the play will happen slowly.

This is not for lack of reserves. The US Geological Survey reckons Alaska's Arctic holds 29.96bn barrels of undiscovered technically recoverable crude oil. Other estimates think the trove is even greater. A 2009 study prepared for Shell by the Institute of Social and Economic Research at the University of Alaska said the Outer Continental Shelf region in and around the Beaufort and Chukchi seas, and the North Aleutian basin, together hold undiscovered technically recoverable reserves of as much as 65.8bn barrels of oil and 305 trillion cubic feet of natural gas.

The industry has triumphed in the Arctic before. The Prudhoe Bay field, on Alaska's North Slope, was a lynchpin of US supply for decades. It remains the US' largest field, still holding an estimated 25bn barrels of oil and and gas in place of around 46 trillion cubic feet. At its peak in 1987, Alaska was producing 1.6m barrels a day (b/d): oil supply that flowed down the Trans-Alaska Pipeline system, a project built in the era of the Arab oil crises in the 1970s. BP, one of the North Slope's main producers, used to talk of Alaska as one of the two production and revenue 'pipelines' that fed its entire business.

Alaska wants to recapture something of those glory days. Output in recent years has declined as its fields have matured, leaving production beneath 300,000 b/d - well below new plays such as the Bakken in North Dakota, which should soon be pumping more than 1m b/d. Alaska's authorities think that with the right incentives the downward trend can be stopped. Last May, Parnell ended a tax system based on the crude oil price, replacing the former governor Sarah Palin's regime with what it calls a 'simple, flat production tax'. Operators welcomed the new regime. BP said in response to Parnell's legislation that it was planning $1bn in new investments and would add two new drilling rigs to its North Slope operations by 2016. ConocoPhillips said new rig installations, along with Parnell's tax decision, should lead to an increase in development, helping to stop the decline in its Alaska output.

Offshore work

Italy's Eni is among other firms exploring, at the Nikaitchuq field, located offshore the North Slope. It believes the field may hold 220m barrels of oil, adding it could produce for the next 30 years and reach peak production of 28,000 b/d. Full development includes 22 onshore and 30 offshore wells, which would be drilled from an artificial island. Most of its work this year will be offshore, the firm says.

All told, Alaska's government thinks the new lease of life will increase the state's output by 4% in the next four years, to around 468,000 b/d. Much more could come from the Arctic National Wildlife Refuge (ANWR). The US Geological Survey estimates ANWR, a 19m tract of land in the North Slope, contains 4.2bn barrels of technically recoverable oil. But it has been out of bounds to explorers since 1980, when then-US president Jimmy Carter set aside the tract as a conservation area and banned drilling without congressional approval.

New obstacles may be on the way. Alaskan Arctic campaigns by Shell, and others, may be put on ice after the US Court of Appeals in San Francisco backed a drilling challenge lodged by the Sierra Club and its environmental allies. The court's 38-page ruling said the 1bn barrel estimate used in by the Department of Interior in its environmental assessment of the 2008 lease sale was "arbitrary". Shell's van Buerden said he hoped "relevant [government] agencies," as well as the courts, would resolve the "open legal issues" regarding the lease. But for now, environmental campaigners said they shouldn't be drilling at all. The courts could yet declare null and void the leases granted in the 2008 sale.

The high cost of operating in the Arctic, and the lure of bigger plays in more favourable climates, is drawing the industry's focus away from Arctic plays. Ernst & Young, a consultancy, rates the general fiscal terms of doing business in North America's Arctic as "every unfavourable" when compared with similar operations in Russia, Norway and Greenland. For US fields on their own, the country's energy department says project development in Alaska may cost significantly more in terms of overall capital expense when compared to similar projects in, say, Texas, the country's biggest producing state. Parnell's tax measure may help generate interest, but it could be some time before any talks about new large-scale development plans. Operating expenses in the Arctic may be as abnormal now as the climate itself.

Shifting market dynamics are also undermining the attractiveness of the Arctic. When the majors began looking towards the Arctic's frontier sectors again a few years ago, oil prices were steadily rising, supplies were constrained and drilling opportunities elsewhere were being choked off. The surge in tight oil and other unconventional sources of supply since then has changed the companies' calculation.

Canada's Arctic potential is an example of this. Stephen Harper, the country's prime minister, has repeatedly stressed the importance of the north, pledging consolidation of Canadian territory there. But oil and gas development has been painfully slow. Canada's first Arctic exploration well was spudded more than 50 years ago off Melville Island, several hundred kms northeast of the North Slope of Alaska. Since then, only about 110 wells have been drilled in the Canadian waters of the Arctic Archipelago. In the late 1960s, Panarctic Oil was formed in response to the Canadian government's Arctic oil and gas ambitions. By 1974, oil had been discovered at Bent Horn in the far north. The field is small, however, at about 12m barrels, though two shipments were carried by sea every year for 11 years until operations ended in 1996. In total, only 2.8m barrels of oil were produced during Canada's Arctic experiment. At the same time, advances in extraction technology and rising crude prices had brought the Athabasca oil sands in Alberta into play. While Canada's Arctic development has stalled, output of the province's bitumen has soared, and will reach 3.2m b/d by 2020, according to the Canadian Association of Petroleum Producers.

Pipeline problems

Canada's most ambitious northern project, the Mackenzie Valley pipeline project, has suffered a similar fate as the Arctic experiment. Proposed in the early 1970s, the 1,220 km natural gas pipeline was meant to bring as much as 650 trillion cf of natural gas from the Beaufort Sea though the Northwest Territories and into existing networks in Canada. The project was shelved in the late 1970s because of land claim issues with the First Nations groups. Attempts to revive it faltered amid the rise of North America's shale gas plays. In theory, it could eventually morph into another source of supplies for Asia, with exports off British Columbia's coast. It would compete, however, with rival projects in less extreme climates that would feed proposed liquefied natural gas hubs in the province.

Will events overtake the majors' oil campaigns off Alaska, too? It remains a difficult play to crack. Alaska's drilling season is already cut short by the presence of winter sea ice. Summer thaws complicate operations as the arctic tundra turns to slush. Meanwhile, any reserve production requires navigation of difficult transit options to bring energy resources to markets that lie thousands of kilometres from the fields. Warming trends, new technology and a lingering interest in frontier development in general means Arctic campaigns are inevitable. Shell says it will be back. But with much of North America enjoying a bonanza of supply brought on by unconventional oil developments, Arctic exploration beyond the experimental stage will take a back seat to campaigns elsewhere in the world.

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