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Cook Inlet without Tax Credits

Set to roll back this year, end next year


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Gas flare tower on offshore oil rig in Cook Inlet.

© Chris Arend / AlaskaStock.com

In 2009, an energy crisis threatened Southcentral Alaska.

For decades, communities in the region between Homer and Talkeetna were fueled by oil and gas from Cook Inlet. According to the Alaska Oil and Gas Association (AOGA), 80 percent of the electricity in the region was generated by natural gas. But by the early 2000s, production declined. Agrium closed its fertilizer plant in Nikiski and industrial users also scaled back. Utilities had trouble securing long-term supply contracts and Anchorage residents were threatened with brownouts during a period of extreme cold in 2008-2009.

In response, the Alaska Legislature passed the “Cook Inlet Recovery Act,” HB280, which expanded capital credits for Cook Inlet producers. It also spurred the construction of a large natural gas storage facility. The credits also attracted smaller, independent oil companies to Cook Inlet.

Over the next four years, independents such as Hilcorp Alaska, BlueCrest Energy Inc., Furie Operating Alaska, and Glacier Oil & Gas Corporation moved into Cook Inlet, drilling dozens of new oil and gas wells and upgrading the infrastructure in the region. They discovered new gas fields and, in a period of a few years, revitalized the petroleum industry in Cook Inlet, accounting for 25 percent of jobs in the Kenai Peninsula Borough, according to a 2014 study by the McDowell Group.

 

Significant Changes

The state’s tax incentives were lauded for sparking much of the new production. Faced with a multi-billion-dollar budget shortage due to low oil prices, Alaska Governor Bill Walker proposed major changes to the tax credits.

In February last year, AOGA issued a statement against Walker’s proposed changes, saying, “Companies are already cutting back at these low prices and this proposed legislation [SB130 and HB247] will chill future investments.”

HB247 made significant changes to the tax structure, rolling back credits in 2017 and ending them in 2018. Then, in June 2016, Walker vetoed $430 million in tax credits to oil companies already in the budget. The veto doesn’t stop the payments, but defers them indefinitely. Walker said the credits are at odds with the state’s need to generate revenue from oil and gas.

Kara Moriarty, president of the Alaska Oil and Gas Association, said in a statement the veto was short-sighted.

“The state is obligated to make good on its commitments,” Moriarty’s statement says. “A misguided move like this sends chills through the investment community, as well as an industry already battered by low oil prices.

“Today’s veto tells investors Alaska is closed for business and will go back on its own policy whenever the price of oil fluctuates. For investors looking to make billion-dollar decisions, this makes an already risky investment that much riskier.”

 

Financial Limbo

Larry Persily, oil and gas advisor for the Kenai Peninsula Borough, says the abrupt changes in the tax structure signal instability that will affect future financing.

“In good faith, whether you like credits or not, they [oil companies] approved a capital plan for the company. They went out and borrowed the money. They did the work, and now they’re not getting paid. That certainly has messed up their checkbook,” he says.

“It’s frozen the financing, which then stifles the development if you can’t get the money,” he says. “These are not big companies that do the work out of their own cash flow. Exxon did Point Thomson out of their own cash flow. BlueCrest has to raise money. Furie has to raise money.”

The tax credit changes and Walker’s veto are being felt in Cook Inlet. The tax credits were key to making exploration and development in Cook Inlet feasible, the oil companies say. Furie and BlueCrest have been the biggest recipients of tax credits in the region. Hilcorp is looking at long-term fallout.

Hilcorp, which has made significant investments in Cook Inlet, is the largest supplier of natural gas in the area.

“Hilcorp remains committed to making the investments necessary to support Alaskans’ energy needs,” the company says in a statement in early January. “The changes made last session to the Cook Inlet tax structure and the potential for additional changes do negatively affect us and are a factor in determining our planned level of investment in Alaska for 2017 and beyond.”

 

Furie and Bluecrest

Both Furie’s Kitchen Lights Unit and BlueCrest’s Cosmopolitan project have started production.

Benji Johnson, president of Texas-based BlueCrest, says while the veto merely defers the payments the state owes the oil company, it’s money they were basing their investments on. He’s hoping to see some sort of accommodation made to the smaller independents who are at a particular disadvantage because they have invested in projects that aren’t yet producing.

BlueCrest says its funding plan for initial development of its Cosmopolitan development totals $525 million. Some of the funding came from the Alaska Industrial Development and Export Authority, a $30 million line of credit to buy a drilling rig. After Walker’s veto, BlueCrest asked AIDEA to modify the terms of the loan. In early December 2016, AIDEA agreed to the changes.

In March 2016, before the legislation was passed and Walker issued his veto, Johnson testified before the House Resources Committee about the Cosmopolitan Project. BlueCrest has received about $24 million in tax credits and was owed about $121 million for spending in 2015 and 2016.

The company drilled a vertical well from offshore in 2013, confirming zones previously identified by ConocoPhillips and Pioneer. It also found at least six new productive gas zones and four new productive oil zones. The reservoirs are about three miles offshore. The oil can be reached from onshore sites, and development began in 2014, “relying on the existing tax structure.”

The gas reservoirs are shallower and can only be reached with offshore wells and platforms. Johnson’s report notes “gas development is now on hold, pending confidence of tax credit continuation or reasonable alternative.”

Bruce Webb, Furie senior vice president, says the company certainly took advantage of tax credits to develop its $700 million Kitchen Lights Unit. Furie drilled the first offshore well in the unit in 2011 using a jack-up rig. By 2015, an offshore platform and onshore processing facility in Nikiski went online. Furie started producing gas in late 2015 and has a long-term contract with Homer Electric Association. It is looking at drilling for oil in 2018 and 2019.

 

Market Demand

Persily says it’s important to separate the oil and gas projects in Cook Inlet. The real problem isn’t necessarily tax credits, but market demand.

“If you can find oil in Cook Inlet, there’s always a market for it,” he says. “Gas, long-term, the market is more the issue. Right now, the utilities don’t need gas. They’re pretty much covered with contracts for the next several years.

“If you’re looking for gas, which Furie is, or have found gas and you’re looking at production, losing tax credits is certainly going to affect your financial decisions. But if you don’t have anyone who wants to buy the gas, tax credits don’t matter.”

 

 

This article first appeared in the February 2017 print edition of Alaska Business Monthly.

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