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Two words: logistics and politics. These make Alaska’s oil industry unique. It is the longest domestic supply chain in the industry. Alaska’s North Slope is the nation’s most remote and coldest source of crude oil. This environment requires customized equipment able to handle months of subzero temperatures.
Logistics is critical to keeping the oil flowing. But politics is critical too. Since Alaska’s government is cash-strapped right now due to low oil prices — and its dependency on the oil industry for 90% of its tax revenue — politicians watch the North Slope very carefully. Since practically all the land in the North Slope is owned by either the federal or state government, the oil companies must devote time and money to acquire leases and pay taxes on production. In Alaska, oil and politics are hard to separate.
Oil exploration is a global industry. Large multinational companies invest a lot of time and billions of dollars exploring, drilling and transporting their product to market. With more than 100 different types traded on the world market, crude oil is anything but homogeneous. Therefore, quality and end use are differentiating factors. Of course, one thing they all have in common is that they need to be shipped from the wellhead to a refinery.
Shipping a primary product like crude oil involves a lot of infrastructure and planning. This means that producers need to be cognizant of cost control. This is particularly true in Alaska. Opportunities exist because Alaska has extensive, proven reserves that await drilling. But challenges come from the fact that the oil must be gotten to market in order to earn revenue. The revenue flow is determined by prices set in world markets, while many costs are determined by local and regional markets. Therefore, revenue flows are often more volatile than cost. Alaska is arguably the most intricate and costly example of crude oil logistics in the world.
Alaska North Slope (ANS) crude, which is a medium grade, has been produced in the range of 400,000-600,000 barrels per day since 2010. Of course, this is nowhere near the peak of around 2 million barrels per day in the mid-1980s. Notable crashes in the world price occurred in 1986, 2008 and 2014. Of course, COVID-19 did not spare ANS crude from falling from $57 per barrel in January of this year to $12 in April before it started to rise again.
COVID-19 tops lists of risks for 2020
A white paper released on June 16 by FreightWaves and nVision Global surveyed oil and gas industry executives. The COVID-19 pandemic topped the list of risks for 2020. Second on the list was an increase in transportation rates. Though each of these scored in the moderate range of risk, it is interesting to compare the two.
COVID-19, like any invisible foe, tends to be considered riskier than it might be because not everyone can agree on how to deal with it. Also, its effects are economy-wide, meaning that, at any time, jurisdictions might be placed into a lockdown for an indefinite period of time. This risk attitude is like a higher fear of flying versus driving despite the statistics on air and road safety. Compared to driving, air passengers have less control in the process, and if something should go wrong, the consequences appear more dire. Being all in it together, and dependent on one another, COVID-19 adds to the feeling of increased risk.
Transportation, unlike viruses, is easier for the oil and gas industry to understand. It also offers the industry some degree of control because of the conveyances they own and their ability to negotiate with any for-hire carriers they might need. Nonetheless, the expressed concern over rising transportation rates is a perennial issue in the industry. This is because it relies, to varying degrees, on all five modes of transportation — truck, rail, air carrier, ocean vessel and pipeline. Each mode faces different challenges at different times. Transportation’s share of total cost is always higher for primary products than for manufactured products. Therefore, any rise in transportation rates is felt with greater intensity.
Sensitivity to time and cost is particularly important in Alaska. It is detached from the Lower 48 in an area subject to extreme cold, earthquakes and volcanoes. The small population is widely dispersed, with minimal infrastructure to provide connectivity. North Slope activity requires all supplies to be shipped in from Anchorage and Fairbanks. About 25% of the cost of crude oil production in Alaska is tied up in transportation costs.
One way to Lower 48
There is only one way to get ANS crude to the marketplace. The 800-mile Trans-Alaska Pipeline System (TAPS) pumps the oil to the Port of Valdez before it heads to refineries in the Lower 48 via tanker ships. However, Alaska has five small refineries with a total capacity to handle about 170,000 barrels per day. This provides for much of the state’s demand for refined products like gasoline, diesel and jet fuel; but imports are still necessary. This explains, in part, why gasoline is relatively expensive in such an oil-rich state. Of course, even at current capacity, in-state refining involves well below half the daily crude oil output from the North Slope.
Transportation into and out of oil-rich states like North Dakota and Texas offers several more options than does Alaska. Other than the 400-mile Dalton Highway (also called the haul road) from Fairbanks, air is the only way to get workers and supplies to and from the North Slope. Even the Dalton Highway is subject to closures due to snow drifts and seasonal flooding.
All workers fly in via Ted Stevens Anchorage International Airport (ANC) and typically work two-week shifts. The remoteness requires them to live in company-provided housing with nowhere else to go. Thus, a lot of responsibility rests on TAPS and ANC as singular transport nodes. If an emergency impacted an oil site in the Lower 48, relief and civilization are on the other side of the impact area. In Alaska, however, the other side of the impact area is typically hundreds of miles of forest, tundra or ocean. Risk mitigation in Alaska is necessarily more costly.
Higher transportation and risk mitigation costs mean that oil producers need pronounced economies of scale to validate drilling in the North Slope. This means relatively higher up-front costs — which, of course, presents other sorts of financial risks. Part of these up-front costs involve building lengthy ice roads and ice pads to reach drilling sites and stage the equipment. Why all the man-made ice? Since tundra is mushy, it would make the required infrastructure unstable. This means that most of the site drilling must take place during the deep freeze and darkness of the Arctic winter. Since the ice melts in the spring, the ice-building process must be repeated a few months later. Given the lead time it takes to build the multi-hundred-mile network of ice roads and ice pads once the winter freeze has set in, the typical timeline for actual drilling is only from January through April. By contrast, operations in the Lower 48 do not face such short timelines.
Oil exploration, production and transportation in Alaska is a unique process. It enriched the state and prompted a lot of innovations. But the costs involved have at times been a source of frustration both to the oil companies and to the politicians. While oil and politics in Alaska are hard to separate, the mixture they create is by no means a smooth one.
Click here for more FreightWaves commentaries by Darren Prokop.