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If anyone needs more proof that diminishing supplies of
easy oil are forcing the world's oil majors to venture into ever-riskier, more
complicated, and more expensive areas in their search for new reserves, look
no further than Royal Dutch Shell's (NYSE:RDS.A) pending voyage into the
Arctic.
Shell is about to set sail on a mission that has been
eight years and more than $4 billion in the making… and all that is
before first well is even spudded. Environmental wrangling, legal battles,
regulatory changes, and technological developments have all played a role in
the saga to date. But persistence pays: Shell now has two drilling rigs ready
to go and is just waiting for the receding ice to expose its targets.
When Shell's drills penetrate those targets, they might
tap into a vast wealth of oil. Alaska's outer continental shelf is thought to
host billions of barrels of recoverable oil and trillions of cubic feet of
natural gas. Those hydrocarbons, however, will not be easy to access.
The challenge is not water depth – Shell's Arctic
targets sit beneath just 150 feet of water, which is nothing compared to the
5,000 feet of water that covers many drill targets in the Gulf of Mexico. But
those 150 feet of water bring with them crushing ice floes, frigid
temperatures, Arctic storms, and total darkness for 70 days a year. And those
are just the technical challenges. On the regulatory side, Shell has had to
contend with environmentalists and native groups vehemently opposed to Arctic
offshore drilling, a complete overhaul of the US offshore drilling regulatory
system that generated new spill preparedness requirements, and the reality
that their rigs will be working in a delicate ecosystem alongside key
migration routes for bowhead whales and walruses.
It's about as challenging as oil exploration can be.
And yet there the company goes, setting off on an adventure that – if
the company is lucky and all goes according to plan – will enable to
Shell to start producing Arctic oil in another eight or nine years, and after
a total investment of roughly $7 billion.
Shell is going to these incredible lengths to find oil
because the company feels it has to. The world's oil giants are in a constant
battle to find significant new oil reserves that they think can become
tomorrow's producing fields. Since a century of oil production has depleted
most of the world's easy oil deposits, the Shells of the world have no choice
but to explore in increasingly challenging conditions to find those
significant new reserves.
Just ten years ago it would have been inconceivable to
spend $4.5 billion getting ready to test an oil target. But ten years ago oil
was only worth about $25 a barrel. Today prices have almost quadrupled,
reflecting rising global demand juxtaposed against sliding export volumes
from many of the world's major suppliers. With Big Oil increasingly forced to
search for oil in the frigid Arctic, in the ultradeep
waters of the Gulf, in the shifting salt formations off Brazil, or in any
number of unstable countries where politicians and terrorists pose almost
equal threats, production costs are inexorably rising.
The result: oil prices cannot help but climb in the coming
years. For a perfect example of why costs are climbing, read on.
Shell's
Arctic Dream
Shell has been trying to spud these Arctic wells for
almost a decade. In 2002 the federal government began selling offshore leases
in Alaska; Shell purchased its first blocks in 2005 and has picked up
additional acreage since. In late 2006 the company submitted a plan to
explore its Beaufort Sea blocks; the Mineral Management Service (MMS) –
the umbrella organization that has since been broken apart into the Bureau of
Ocean Energy Management (BOEM), the Bureau of Safety and Environmental
Enforcement (BSEE), and the Bureau of Ocean Energy Management, Regulation,
and Enforcement (BOEMRE) – approved the proposal a few months later.
That first approval sparked the first court challenge,
a pattern Shell would see repeated time and again in subsequent years. The
Ninth Circuit Court of Appeals denied MMS's approval, claiming the offshore
regulator had not required Shell to complete a sufficiently detailed analysis
of potential environmental impacts. This derailed exploration for two years,
eventually forcing Shell to submit a new exploration plan in 2009. The MMS
approved the new plan, and this time the Ninth Circuit upheld the decision.
Things were starting to roll in the right direction for
Shell, until the company's Arctic plans ran up against an unforeseen
obstacle: the Deepwater Horizon disaster in the
Gulf of Mexico. That fatal explosion and five-million-barrel oil spill led to
a moratorium on offshore Arctic drilling that lasted through the summer of
2010 and resulted in a raft of regulatory changes. Shell had to start over again.
The company submitted its third Arctic exploration plan
in May 2011. The BOEM and BSEE both eventually approved the plan. A coalition
of environmental and indigenous groups again found reason to sue, but the
court sided with the new offshore regulatory bureaus and upheld the permits.
The ducks are now all in a row and Shell is ready to
go, but the company isn't taking any chances. In an attempt to head off yet
another last-minute postponement, Shell has even filed a pre-emptive lawsuit
against environmental groups that might file a legal challenge to Shell's oil
spill response plan. By doing so, the company is forcing the courts to go through
and essentially approve Shell's plans before anyone has a chance to challenge
them. It's a lesson learned in time.
Big Gamble,
Massive Potential
Before sinking a single well, Shell will have already
invested eight years and $4.5 billion in its Alaskan project – $2.3
billion on equipment and personnel plus $2.2 billion for the leases –
and yet the company is still years and billions of dollars away from a
potential payday. The wells Shell will begin drilling in July are only to
probe for hydrocarbons; they are not designed for production. If those drills
do find oil, it would take another seven to ten years to drill production
wells, install production platforms, and build the on- and offshore pipelines
needed to move this Arctic oil to customers. By then, Shell's upfront
investment could well top $7 billion.
Why is the company dedicating so much time and money to
this project? For two reasons. First, the easy oil is gone, which means
majors simply have to contend with risks and challenges of this nature if
they want to replenish their reserve books. Second, if estimates are even
close to correct, there is a heck of a lot of oil and gas in the Arctic.
The USGS estimates that the Beaufort Sea holds 2-7
billion barrels of economically recoverable oil and 3 -20 trillion cubic feet
of economically recoverable natural gas. The Chukchi Sea could hold as much
as 12 billion barrels of oil and 54 trillion cubic feet of natural gas.
Alaska's outer-continental shelf as a whole is thought to hold 27 billion
barrels of recoverable oil and 130 trillion cubic feet of natural gas.
More generally, the waters of the Arctic are thought to
hold some 22% of the world's undiscovered oil and gas. With such massive
hydrocarbon resources at stake, Big Oil is doing its utmost to prove that it
can operate safely in the Arctic. But the shadow of BP's Deepwater
Horizon oil spill still looms large over the entire offshore drilling
industry. Nowhere are those shadows darker and longer than in ecologically
sensitive areas like the Arctic.
Environmentalists and the peoples indigenous to the
region are very concerned. They claim that any oil spill that seeps
underneath the ice pack will be essentially impossible to clean up and will
irreversibly damage a pristine ecosystem.
Shell is taking its environmental responsibilities
seriously. For example, in the 1980s and 1990s the brave souls who attempted
to drill in the Arctic often used icebreakers to plow a path to icebound
drilling sites. Today, however, Shell has committed to avoid using
icebreakers as a means of minimizing disturbances to wildlife, including
polar bears.
Leaving the ice undisturbed is just one aspect of
Shell's environmental planning. The company spent $150 million refurbishing
the 29-year-old drilling rig that will probe the Berger prospect in the
Chukchi Sea. Four new diesel engines and a series of filters and scrubbers
mean the rig produces far less nitric oxide, nitrogen dioxide, and particulates
than it did before the refit. The refurbishments also include a 4,200-barrel
waste storage facility that will store all wastewater, ballast water, and
drilling muds and cuttings. The rig will not discharge anything into the
waters of the Arctic; instead all of these waste fluids will be carried to
the lower 48 for disposal at a certified landfill.
In terms of emergency response, a preconstructed
capping stack will be positioned on a nearby vessel, ready to deploy in case
of a well blowout that can't be controlled using the beefed-up blowout
preventers that will be installed on each well. The capping stack was modeled
on the equipment that finally stopped the oil flowing out of BP's Macondo well in the Gulf of Mexico – now, instead
of having to build one after a blowout occurs, one is prefabricated and ready
to go.
Long-Term
Vision
Permits are in place, a pre-emptive court challenge is
under way, and Shell's extensively refitted drillships
are almost ready to sail. Now the biggest obstacle in Shell's path is nature
itself. In recent years the summer ice melt-off in the Arctic has often set
new records, a pattern many climate scientists say is linked to global
warming. This year, however, a high-pressure zone over the coast of Alaska,
cold winter temperatures, and particular ocean currents have resulted in
unusually large amounts of ice along Alaska's northern coast and down into
the Bering Sea.
The National Weather Service says Alaska is an iceberg,
covered in quantities of ice not seen in more than a decade. And that means
Shell's already short window of opportunity may be even shorter than
expected. Normally, the region of the Chukchi Sea that covers Shell's Berger
prospect is accessible by mid-July. This year, it may be locked in ice until
late July or early August.
Shell has pledged to stop drilling by October 31 in the
Beaufort Sea. In the more northerly Chukchi Sea, the company has to be
finished drilling by September 24. Both deadlines are intended to ensure that
the wells are drilled, completed, and sealed off at least a month before the
sea ice arrives, so that if a spill does occur the company will have time to
implement a fix. But it also means that Shell will have less than three
months to set up, drill and test its exploratory wells, seal them up, and
depart. That is a very tight timeline.
How ironic. Shell has been working for years to get its
Arctic opportunity. Now the moment has finally arrived, and the company will
be in a frantic rush to get it done in time.
And years is actually an understatement. Shell's
current Arctic endeavor may have started in 2005, but the company has been
eyeing Arctic oil for decades. The company owned leases and drilled wells in
the Chukchi and Beaufort Seas in the 1980s and 1990s, abandoning them only
because the $20-a-barrel oil prices of the day did not justify further work.
Today, however, oil prices are four times higher, and
Shell says it expects its 410 Alaskan offshore leases to become the company's
biggest source of crude globally within 10 to 20 years. Shell knows there are
huge oil resources in the Arctic and plans to make those resources a mainstay
of its operations for decades to come.
The company has support from the state of Alaska, which
has a strong economic interest in helping oil majors find more oil and gas in
the Arctic. More than 90% of Alaska's state revenue comes from oil and gas;
but oil production from state lands, which include the mega Kuparak and Prudhoe Bay oil fields, is on the decline
after peaking at more than two million barrels a day in the late 1980s.
Lower production volumes are not only a concern because
they mean smaller revenues flowing into state coffers. The bigger concern is
that declining volumes are threatening the viability of the Trans-Alaska
Pipeline, which takes Alaska's oil south. Last year the pipeline's operator, Alyeska Pipeline Service, released a report questioning
whether the pipeline will be able to operate safely if throughputs continue
to decline.
Lower volumes mean the oil moves through the pipe more
slowly. The more slowly the oil moves through the line, the greater the risk
that water will separate from the oil and freeze at the bottom of the pipe,
causing corrosion and cracks. If volumes fall below 350,000 barrels a day, Alyeska says it cannot promise that it will be able to
keep the line operational.
It all means there will be a lot of eyes on Shell this
summer. Alaskans, indigenous peoples, environmentalists, global oil majors,
US politicians, Chinese industrialists, analysts, and investors will all be watching
to see if Big Oil can cleanly and safely find big oil reserves in the Arctic.
Big Oil will also be watching China, as the Asian
powerhouse has been locking up energy deposits around the world at an
alarming rate. Since 2005, it has spent over $75 billion and have closed no fewer than 45 oil deals – including
one in the US. This energy grab has created intense competition with the US
that some have likened to a new Cold War.
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