Arctic E&P: Norway And Russia Moving Ahead While The Rest Fall Behind

BMI View: Despite the considerable oil and gas potential of the Arctic, the prohibitively high costs and substantial technical challenges of operating in the US, Canadian and Greenlandic Arctic waters has seen the supermajors reduce their exposure, such that we see limited progress in the development of this acreage. Rather, the specific advantages offered to companies operating in the Barents and Kara Seas suggest we will see the majority of Arctic investment focused on Norwegian and Russia areas over the coming years.

The persistently high oil price environment fuelled a great deal of fervour surrounding the Arctic's offshore potential, with E&P companies hailing the acreage as a crucial future oil and gas frontier. With a US Geological Survey estimating mean undiscovered resources of almost 90bn barrels of oil and 47trn cubic metres (tcm) of gas, the rewards are potentially substantial.

However, we are increasingly witnessing a trend of big oil shying away from offshore Arctic ventures as safety and cost factors trump the benefits.

Extensive Undiscovered Resources
Arctic Countries And Seas

Arctic E&P: Norway And Russia Moving Ahead While The Rest Fall Behind

BMI View: Despite the considerable oil and gas potential of the Arctic, the prohibitively high costs and substantial technical challenges of operating in the US, Canadian and Greenlandic Arctic waters has seen the supermajors reduce their exposure, such that we see limited progress in the development of this acreage. Rather, the specific advantages offered to companies operating in the Barents and Kara Seas suggest we will see the majority of Arctic investment focused on Norwegian and Russia areas over the coming years.

The persistently high oil price environment fuelled a great deal of fervour surrounding the Arctic's offshore potential, with E&P companies hailing the acreage as a crucial future oil and gas frontier. With a US Geological Survey estimating mean undiscovered resources of almost 90bn barrels of oil and 47trn cubic metres (tcm) of gas, the rewards are potentially substantial.

However, we are increasingly witnessing a trend of big oil shying away from offshore Arctic ventures as safety and cost factors trump the benefits.

Ultimately, we believe that while this will be too great a hurdle in some regions, especially the US, Canada and Greenland, a less challenging below-ground picture, combined with greater involvement by national oil companies, slightly less impacted by cost curbing, will see Russia and Norway's Arctic acreage developed.

Extensive Undiscovered Resources
Arctic Countries And Seas
Undiscovered Technically Recoverable Resources
Resource Volume
Oil 90bn barrels
Gas 46.76tcm
NGLs 8.5bn barrels
Source: United States Geological Survey

Risks Outweigh Rewards

While the risks of Arctic operations are numerous, they are largely focused on issues of safety, particularly in regard to oil spills, and higher costs. The key inhibitors include:

  • Remote Location - Not only will costs be higher getting facilities to the location, the cost of getting oil or gas to market is increased due to the distance. Labour costs will also need to be greater to tempt workers to these extreme remote areas. Furthermore, in the event of an oil spill or leak it could take days if not weeks to coordinate and implement the clean-up operation.

  • Sea Ice - If any oil from a leak or spill is frozen within an ice sheet, a cleanup operation could take years as oil could be indefinitely trapped within the ice. Although there has been significant research into the area, there is no proven method to completely prevent such an event.

  • Difficult Operating Environment - The fact that in many Arctic areas the sea freezes, brings problems with iceberg management in the warmer seasons. Extra vessels and equipment are required to protect platforms from drifting icebergs, which is particularly dangerous in the foggy and stormy weather conditions often experienced in the Arctic. Further, the cold weather and icy conditions require 'Arctic ready' vessels and machinery, which are more expensive to develop due to the higher strength and design quality required. The low temperatures also create greater production challenges and flow assurance issues, due to the extreme difference between the below and above ground temperatures.

  • Gas Prone In An Oil-Seekers World: The Arctic is expected to be more gas prone, which is less attractive than oil in the current global pricing environment due to the better margins on oil projects. Gas also exacerbates many of the issues involved with the cost of transporting the product great distances to market and ensuring safe production with extreme temperature changes.

  • Tighter Budgets: Rising industry costs in the Arctic, combined with increasing shareholder pressure on companies to reign in excessive spending, has seen the technically challenging Arctic demoted on the list of publicly traded companies' priorities, and we see little to change that trend in the coming years. This is particularly the case considering we forecast fall in oil prices, which would further impact the margins of risky Arctic ventures.

Softening Oil Price Reducing Margins
WTI And Brent Price Forecast (US$bn)

Leaving US, Greenland and Canada

This difficult technical profile has already seen supermajors begin to shy away from developing their Arctic acreage in the US, Greenland and Canada - a trend that we believe is likely to continue in the coming years.

Greenland: In December 2013, it became clear that ExxonMobil was not among the bidders in the much awaited Greenland Sea licensing round. The east coast of Greenland is thought to be particularly sought after as it is the conjugate margin to Norway's prolific continental shelf. However, only four of the 19 blocks offered in this highly prospective acreage were awarded, far fewer than were taken up in the perhaps less prospective Baffin Bay licensing rounds in 2007, 2008 and 2011. Furthermore, ExxonMobil is reportedly planning to hand back its Orsivik licence in the Davis Strait, though this has not been confirmed by the company.

ConocoPhillips also holds acreage in Greenland though under its divestment strategy and growing focus on US onshore it is unlikely to pursue development of its single licence in Baffin Bay. Similarly Chevron recently won two Greenland Sea licenses. However, the escalating costs impacting its vast Australian LNG projects, and a greater focus on onshore shale developments in the US, Argentina and Eastern Europe, suggests to us that there will be little room for investment in risky Arctic developments, at least over the medium term. Finally, BP also won a license in the Greenland Sea, though is still recovering from the crippling effects of its Gulf of Mexico spill on which the company has already paid out over US$42.5bn. It should also be noted that the new licenses in the Greenland Sea come with exploration periods in excess of 15 years, limiting the time pressure on companies to provide tangible results. As with developments in other areas of Greenland, we do not expect companies with recently won licenses to move quickly.

US: In January 2014, Royal Dutch Shell decided to suspend operations in the Chukchi Sea offshore Alaska, potentially withdrawing for good. While this is largely a sensible move due to the difficult experience Shell has faced over the last few years in attempting to drill, it highlights the company's new strategy to exit non-core low margin ventures.

Perhaps more crucial to the reduction in US Arctic offshore activity is a recent decision by the US Ninth Circuit Court of Appeals. The judicial body has ruled that the Department of the Interior (DOI) wrongly awarded licences in the Chukchi Sea off the coast of Alaska. It stated the DOI failed to fully consider all environmental risks inherent in drilling operations, and that the 1bn barrels (bbl) of economically recoverable oil estimated for the area available for leasing, were based on 'inadequate information'.

In April 2013, ConocoPhillips abandoned plans to drill in the Chukchi Sea in 2014, and following the Court of Appeals decision may not be able to continue with developments even in the long term.

Canada: While studies have taken place to assess the potential of Canada's Arctic offshore, the majority of hydrocarbon showings have been gas. Added to the remoteness of its location and corresponding distance to market, the appeal of the Canadian Arctic remains low.

Arctic Challenges More Manageable In Russia And Norway

In contrast, it is our view that Russia and Norway will be the main focus of Arctic capex in the coming years, particularly in the Barents and Kara seas. Indeed, the Arctic territory of these two countries is advantaged by a number of factors lacking in other areas.

The Barents Sea benefits from lack of sea ice reducing many of the major risks affecting other areas of the Arctic. Norway is also home to a stable and relatively attractive fiscal and business environment, as well as being home to one of the best offshore safety records in the industry. The Barents Sea has also recently experienced a number of oil discoveries making it an attractive investment opportunity. Finally, the Barents is comparatively close to the well equipped Norwegian offshore industry, where service vessels can be relatively quickly deployed in reaction to safety and environmental issues.

Meanwhile, the Kara Sea is comparatively shallow with an average depth of just 110m reducing drilling risk and minimising the technical challenges associated with deep water. Furthermore, Russia has been more assertive in managing environmental and media attention in its Arctic region. An improved fiscal regime, which removes export tax on oil from Arctic projects, is also particularly enticing for domestic and international oil companies alike. With Rosneft estimating the Kara Sea to hold 46bn barrels of oil in place, this could prove a decisive incentive.

This is not to say the development in these areas will be without challenges. Even the expertise of Statoil is struggling to cope with the high development costs of the Johan Castberg project, which is likely to be delayed due to increasing cost issues. The company also experienced a number of teething issues with the Snohvit LNG development, particularly with regard to flow assurance issues in the freezing temperatures. Similarly, in Russia, Gazprom Neft's relatively straight forward Prirazlomnoye development was delayed for over two years before coming on-stream in 2013, and reportedly saw major cost increases. That said, we believe a less technically challenging below-ground picture, and greater long-term focus by these NOCs, suggest that Russia and Norway will ultimately see Arctic development over the longer term.

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