Editor’s Note: This is the second part of a two-part submission. The first part was published Tuesday.
Oil and natural gas companies are likely to take higher risks due to guaranteed returns on their investments in the exploration of these reserves from the region due to its low political risk as measured by the Political Risk Services Group Index (Canada’s index is 94 as compared to, say, Iran’s index of 45: note that higher the index, lower is the political risk). It is estimated that the Arctic has one of the largest hydrocarbon reserves in the world. Notably, Russia, Greenland, and Norway alone hold 82% of the total Arctic gas resources with the remaining 18% split between the U.S. and Canada. Interesting, Russia, Greenland, and Norway account for 63 percent of the total Arctic oil resources with the remaining 37 percent split between the U.S. and Canada (Figure 1). The U.S. Energy Information Administration (EIA) estimates that in the next 25 years, the overall world consumption of oil and natural gas will increase by 20 percent and 50 percent respectively. Based on this forecast, it is obvious that the oil and natural gas resources in the Arctic will play a significant role in geopolitics (e.g., in November 2014, to stem the slide in Russian exports from oil prices, Russia signed a deal with China to export gas from Siberia via new pipelines in order to replace Europe as its main export market).
The global demand for oil is unlikely to decline mainly due to the emerging markets in China and India, both of whom are not significant oil producers and will have a burgeoning middle class fueling the demand for automobiles and other energy centric consumer products.
Challenges of oil and gas exploration in the Arctic
There is a premium cost to explore the reserves in the Arctic (due to remoteness, lack of infrastructure, extreme weather conditions, and others). Additionally, alternative energy sources may become more competitive if oil and gas costs reach the backstop prices. Increased awareness and government policies to reduce the climate effects caused by fossil fuel pollutants, as well as, increasing taxes on the use of fossil fuels all may significantly impact the demand for such products. The resultant ramifications from these challenges may impact the supply and demand for oil and gas leading to reduced production and consumption of such products with alternative sources of energy becoming more viable. The EIA recently opined that oil prices are likely to average $83 a barrel in 2015.
Strong declines in commodity prices typically signify a supply-demand imbalance. As to how low the oil prices can go may depend on how much China’s economy slows down as the world’s largest consumer of oil.
Alaska’s immediate concerns: Declining oil
Fossil fuels in general, and in particular oil, are traded in an imperfectly competitive market with limited number of suppliers and numerous consumers. In the international gas market, the global price setting is complex as consumers and suppliers are, for the most part, tangled together by long-term purchase agreements that involve drilling, transportation, and investment in infrastructure development activities thus discouraging a switch to a cheaper supplier.
EIA’s Annual Energy Outlook in 2012 presented a price scenario analysis for the Alaska North Slope production (Figure 2). To maintain the current oil production level in the Arctic, the price of oil must maintain a threshold price of $80 and above per barrel. The same study indicates that Arctic oil and gas production will increase significantly if the oil price crosses $130 per barrel taking into account estimated global demand and supply projection near 2030. In the worst case scenario, if oil prices were to fall below $75 a barrel, the oil flow through the Trans-Alaska Pipeline System (TAPS) might decline to a level of non-operational capacity. EIA also estimates that the offshore Arctic production costs (including drilling, production facilities, operating, and decommissioning) to be circa $35-$40 per barrel. However, in an interesting observation outlined in the study by the Arctic Monitoring and Assessment Program it shows that historically, the increased development in the Arctic (viz., increased permits issued by the governments, exploration and discovery wells, ground monitoring, seismic analysis, production wells) is not nearly correlated to high oil prices. We feel that if oil prices go up, Alaska’s current oil production trend may be reversed.
There might also be operational issues with the declining oil supply flowing from North Slope to Valdez. According to the Alyeska Pipeline Service Company estimates low crude oil flow rates through the TAPS below 600,000 barrels per day might lead to technical issues (e.g., pipeline corrosion by potential water drop out from crude oil, ice formation, wax precipitation, deposition and displacement of buried pipelines from soil freeze and thaw as pipeline operating temperatures decrease).
The Arctic will continue to be a focus and will be a major hub for operations for oil and gas companies, arctic and non-arctic nations, and environmental groups due to the reasons enunciated earlier in this article. A number of factors make the Arctic attractive (low political risks, most arctic nations belong to the western capitalist economies, entrepreneurial communities driven by aggressive local and federal government business-friendly policies). Some oil and gas companies have formed consortium to explore the Arctic and leverage each other’s capabilities for resource optimization. Russia, which holds the largest reserves of Arctic oil and natural gas, has nationalized its energy sector. As a consequence, global political and economic trends are less likely to impact Russia’s aggressive strategy in resource exploration and market share. This may force other Arctic nations to follow suit and pave the way for a busier Arctic passage. Needless to say, Arctic nations have been granting exploration licenses to oil companies who have invested approximately $5 billion in just the last decade. The Arctic serves as a backup for the oil companies’ long term supply strategy. There are also bilateral collaborative efforts through government/non-government agencies addressing the various issues of Arctic resource development ranging from physical infrastructure, logistical and operational support, and multilateral research opportunities to investments. The U.S. Arctic Research Commission, in its recent white paper on oil spills in Arctic, recommends future work in areas such as: oil spill response technologies for cleanup and recovery of oil, data management tools and long term effects, thereby providing a clear roadmap for strategic development of natural resources.
In coda, at the confluence of smart resource extraction, hidden riches, and the preservation of pristine landscape, stands the Arctic as an enigmatic and mystic place for the future.
• Shiva Hullavarad is the enterprise content management administrator for the University of Alaska System. Hullavarad has graduate degrees in physics and in business administration and has authored 70 publications. Ashok K. Roy is the Chief Financial Officer of the University of Alaska system and an associate professor of business administration at the University of Alaska Fairbanks. Roy holds six university degrees and five professional certifications, and has authored over 88 publications.