HB 325 - ROYALTY SUSPENSION: N. SLOPE HEAVY OIL Number 0155 JEFFREY LOGAN, Legislative Assistant to Representative Green, sponsor of HB 325, presented the sponsor statement: "House Bill 325 allows the producers of heavy oil to forego the payment of royalty to the state on the first 500 barrels of heavy oil produced each day, for a period of up to five years. The heavy oil considered in this bill is a thick, tar-like hydrocarbon that is more difficult to produce than the lighter, more conventional oil and gas. The purpose of suspending the royalty is to encourage the lessees of heavy oil deposits to do field research and hopefully develop the maximum amount of recoverable oil in a timely manner. "House Bill 325 requires no application; the suspension is automatic. In order to receive the suspension, the producer must simply submit documentation to DNR certifying that the oil produced meets the definition of `heavy oil' and monitor the production rate to satisfy the requirements in the bill. "House Bill 325, we believe, sends a message to potential investors world-wide that the 19th Alaska Legislature supports the development of heavy oil in Alaska." Number 0260 CO-CHAIR GREEN thanked Mr. Logan and called on Kenneth Boyd to testify. Co-Chair Green mentioned that there had been speculation that the principles of HB 325 had been covered in legislation passed the previous year. He asked Mr. Boyd whether his comments would center around that topic. Number 356 KENNETH A. BOYD, Director, Division of Oil and Gas, Department of Natural Resources (DNR), responded via teleconference from Anchorage. He referred to his testimony at a previous hearing on HB 325 in the House Special Committee on Oil and Gas and said he would not repeat that testimony. He explained that DNR was not objecting to the development of heavy oil. However, under HB 325, he said, there was no showing of need required to get the relief requested, regardless of the economics of the company or the field. He stated that DNR believed HB 207, which had passed unanimously in the House of Representatives the previous year, was applicable. He referred to term (B) and said DNR realized there was overhead to that, in terms of time, but that it protected the state of Alaska's interests. There was then a real showing of need by each individual company, he said, with economics differing for each company and field. Mr. Boyd reiterated that DNR believed HB 207 could be used. Number 396 CO-CHAIR GREEN replied that there had been concern, at least on his part, as sponsor of HB 325, because he had been unable to see how one area containing heavy oil would be included in the three different categories covered in HB 207. He added he had not seen that area as a potential field or as an uneconomic field; therefore, he did not see how it fit within HB 207. Co-Chair Green asked Mr. Boyd to explain how he thought it might work. Number 0453 MR. BOYD answered that the point was that it was an uneconomic field under the current terms; they were asking for relief to make their field economic. He explained that the premise of HB 207 was to allow for production that would not otherwise be economically feasible. He added that there were three different types of fields, with the first type being a new field. He said that was where most of the debate had centered, on the idea that the fields had to be delineated. That was something new in Alaska law. MR. BOYD concluded by saying that obviously there was some concern; however, the Administration had no problem with adding a term or clarifying (B) in HB 207 if that solved the problem. He thought it would be fairly simple to amend (B) to specifically modify heavy oil. Personally, he added, he did not believe that was necessary, but it could certainly be done. Number 0579 CO-CHAIRMAN GREEN explained his concern that it would not necessarily fall into the category of a field that had reached its economic limit, where the cost per barrel had increased. He said the cost per barrel in this case would go down, due to increased numbers of barrels produced and technological advances being implemented. He expressed apprehension there might be a "crack" in HB 207 that this could fall into. Number 0586 MR. BOYD replied that again, he did not believe that to be true. He thought the spirit of the bill was to allow for production not otherwise economically feasible. He reiterated that he thought (B) was applicable. He added that if the committee and the companies were concerned, however, DNR was willing to work to fix HB 207. Again, he said, DNR did not object to development of heavy oil. It was everybody's goal. However, DNR thought there should be economic calculations showing need and how to solve it. He said he did not believe the answers could be known until the analysis was done. He asserted that HB 207 provided the opportunity for that analysis. He reiterated DNR's willingness to try to modify HB 207 to alleviate concerns, despite their belief that it was already applicable. Number 0650 CO-CHAIRMAN GREEN responded that his concern was the need for a degree of certainty, by the applicant, that when dealing with this specific type of oil, which was difficult and expensive to produce, there would not be a discretionary response. He said that if HB 207 could be worked to make it certain and nondiscretionary, he believed there might be an avenue. He added that he understood DNR's desire to ensure that the yardsticks of production rate and net-back well head price were reasonable numbers. He asked Mr. Boyd whether his understanding was that they might be working toward that end. Number 0712 MR. BOYD replied that he could not say as to the certainty part. He said the bill talked about economic fields and pools, which included any kind of oil that occurred in a field or pool. He believed DNR could work to fix the bill if, in fact, the committee believed it needed fixing. Again, he said, those terms and conditions would be different for each field or pool, as well as for each company. He added that he could say the Administration would be happy to work with the committee to look at HB 207 as a way to ensure certainty. But he could not say that it would become a "slam dunk" certainty. Number 0765 CO-CHAIRMAN GREEN suggested they go ahead and discuss the bill in committee. He expressed a high degree of interest in working with the Administration on HB 207. He added that at this time, there might be a "sticking point" on certainty; however, he said, they might be able to work that out. Number 0823 CO-CHAIRMAN GREEN welcomed Co-Chair Williams, who joined the committee via teleconference from Ketchikan. Co-Chair Green then confirmed that committee members present via teleconference from Ketchikan and Anchorage had packets from the presenters. Number 0867 ED BEHM, Heavy Oil Team Leader, Milne Point Unit, OXY USA Incorporated, gave a slide presentation on behalf of his company, accompanied by hard-copy handouts containing similar information. He said he had responsibility for Alaska and California, where OXY USA also produced heavy oil. He noted that Alaska's ideas the previous year on trying to attract independent producers had grabbed OXY USA's interest. He explained that when his company had first brought their ideas to Co-Chairman Green, Alaska had a pretty dismal outlook for Schrader Bluff production for the Milne Point Unit. The Department of Revenue had only expected $60 million to come from the project. Now, however, that amount could be increased to $400 million by providing incentives. MR. BEHM explained that OXY USA, the last original owner in the Milne Point Unit, was a large independent doing no refining or marketing, with no financial interest in the TransAlaska Pipeline System (TAPS). He said OXY USA's economics in Alaska were tied to well head prices on production. He added that he personally had been involved since 1984, almost his whole career, trying to make this project work. Number 1046 MR. BEHM pointed out that the project was located just north of the Kuparuk River Unit, which also had heavy oil. Currently, he said, OXY USA was spending approximately $50 million over a three-year period developing the deeper zones, which were commercially viable based on the current economic environment. He said that over the past four years, the unit had doubled in productive area. He added that BP Exploration (Alaska) Inc. had done a wonderful job of exploiting a resource that OXY USA had struggled with during the entire unit's history. Number 1073 MR. BEHM explained that OXY USA had three producing horizons at Milne Point, the deepest being at Sag River, which generated light oil of about 35 gravity. There, OXY USA produced 500 to 1,000 barrels per day. Most of the production, he said, came from the Kuparuk Formation, with 24,000 barrels per day. The area they struggled with, he said, was Schrader Bluff. There, OXY USA produced 3,000 barrels per day out of a pilot done five years earlier. They had spent approximately $9 per barrel developing that pilot. MR. BEHM explained that the key problems with heavy and light oil were different. Low-gravity oil, which was thick and sluggish, took a long time to extract from the wells and was difficult to move, like ketchup that was hard to get out of a bottle; it was hard to make money off those wells, which were capital-intensive. Furthermore, sand control required expensive hardware in the wells. A typical shallow well, he said, cost as much as a deeper well in most cases. He added that on federal lands and in countries like Venezuela and Canada, there had been recognition that heavy oil and tar sands required special help to develop the resource. Otherwise, he said, the oil would remain in the ground. Number 1167 MR. BEHM discussed a map entitled "Schrader Bluff Oil Accumulation" and said it referred to the four-pad area OXY USA had developed during their pilot, which was the basis of Mr. Behm's economic projections. Mr. Behm then referred to information in the handout entitled "Previous Heavy Oil Experience" and explained that OXY USA had spent $126 million on 22 wells; on average, those wells produced 275 barrels of oil per day. In California, OXY USA would be happy with that production. But with the high cost of doing business in Alaska and getting the oil to market, he said, that was an abysmal rate. MR. BEHM explained that OXY USA expected to recover 13.5 million barrels of oil. With capital alone, not including operating expenses and overhead, it cost $9.30 per barrel just to get the wells in the ground and get the production on line. With a $10 well head price in Alaska, he said, that was a disaster from an economical standpoint. However, from a technical standpoint, OXY USA had blazed a trail. Mr. Behm added that the 3,000 barrels per day currently produced covered OXY USA's expenses. The problem was in adding more wells to that producing base. Number 1273 MR. BEHM discussed "hurdle rate," an oil industry term for the bottom line for making a project budgetable. He pointed out that the numbers he would show the committee did not include the cost of borrowing capital; overhead, accounting, legal and environmental costs; or risk factors. If a company could get a rate of return greater than 15 percent, he said, there would begin to be profit. Mr. Behm said there had been a worldwide study, conducted by Arthur D. Little, that also suggested 15 percent as the rate of return necessary to make Alaska oil competitive, for example, with Venezuela, which attracted large amounts of capital for heavy oil development. Number 1421 MR. BEHM explained that OXY USA had tried to do a nonspeculative analysis, using the state of Alaska's forecast for oil prices. He interpreted data from the handout entitled "Typical Heavy Oil Well Economics." Specifically, he explained why OXY USA had used data from the five best wells from their pilot experience; BP was working hard on technology and OXY USA assumed in the future their average wells would be as good as those five best wells because of improved technology. For well costs, they had used an average of actual money spent drilling wells during their previous experience. Other actual costs that OXY USA had incurred historically included facility costs, operating expenses, taxes and other fixed costs. Many of the numbers used as the basis for projection, then, were not speculative. If BP could prove up some of the technology they were working on, he said, OXY USA believed they could get approximately a 12.8 percent to 13 percent return. The handout further showed that it would take 6.5 years for OXY USA to get its money back. He added that in the oil business, where prices fluctuated heavily, that was a long time to wait for money. Lastly, he said, if it cost 15 percent just to stay in business, and their company took a discount rate against a well, for every well drilled, they lost $300,000 to the company. Number 1510 MR. BEHM said HB 325 embodied the idea of what OXY USA was proposing. Basically, HB 325 was applicable to the North Slope, for heavy oil of 20 gravity or worse. They wanted to suspend royalty payments on a per-well basis for the first five years and the first 500 barrels per day. He explained that after that point, a company should make a profit, which the state of Alaska should share in with the company. The process had to be simple and automatic. Simplicity was important. OXY USA could not afford to spend money on accounting or anything that did not add value. MR. BEHM referred to data included in the bar graph handout,"Suspension Incentives in Other Jurisdictions." He said this idea had been piloted successfully in seven states, with Texas's high cost gas being a good example. Incentives under this scenario would be tied to new capital investment for long-lived projects. As shown in the handout, "The Effect of Royalty Suspension on Schrader Bluff Economics," the rate of return could rise from 12.8 percent to 15.9 percent, which would be budgetable. Payback periods, not including interest, would be shortened from 6.5 to 5.4 years. And finally, instead of losing $300,000 on every $2 million well drilled, a company would make $100,000. This was a 5 percent return, he said, and was a reasonable profit. He added that if BP could advance the technology further, then perhaps OXY USA could make more than that. Number 1678 CO-CHAIRMAN GREEN referred to the bar graph showing the company making 5 percent on their money and asked if that presumed that the rest of that life would be at normal royalty rates. Number 1792 MR. BEHM affirmed that was correct. They would revert back to normal royalty rates. He added that in the oil industry, as soon as a company made production from a field, that field decreased in reserve life. If they did not add new wells, they would basically go out of business. He said that even if royalties started five years after a well was drilled, it took ten years, if a company spent money every year developing the full resource, to actually make a profit on the whole idea. In other words, the state would start getting royalties five years before the oil company or person laying out the capital began to see a positive cash flow. Most of the profits were over the very, very long term. It was a long- lived asset that would be around for many years once it was developed. Number 1791 CO-CHAIRMAN GREEN asked if the reason the state would actually get royalties before the ten-year period was up was because those first five-year increments were now starting to pay full royalties. MR. BEHM said that was correct. If a company began drilling in 1995, royalties would begin in the year 2000. He referred to the slide presentation and said that if the wells were added together, they had perhaps a 40-year life. In California, he added, OXY USA's heavy oil wells had been around since 1914. Once the wells were there, he said, engineers could make a lot of things happen over a substantial period of time. Number 1830 REPRESENTATIVE RAMONA BARNES spoke via teleconference from Anchorage, expressing that she had been listening to the testimony. MR. BEHM presented data from the handout entitled "Two Paths for Schrader Bluff" and addressed a question he had heard earlier. He stated that OXY USA no longer had a marginal field at the Milne Point Unit as far as the total project, because they were spending a lot of money developing the Kuparuk and the Cascade units to the south. He said they were happy with investing money and were bringing in good wells. The point was, with the debate, of trying to attract more capital to the state of Alaska and to do more. That was why OXY USA had brought the idea forward. He explained that instead of getting up to a peak and then declining at a rapid rate, if Schrader Bluff were developed in a long-term program, it would produce 80,000 barrels per day past the year 2006. He said their goal as engineers was to add value, and this was a way to add value where they had seen none before. Number 1854 CO-CHAIRMAN GREEN asked if it would be fair to say that somewhere in the range of 60,000 to 80,000 barrels per day would continue the infrastructure viability, at least somewhat. He asked Mr. Behm if he had considered benefits for keeping other projects viable, for example, when the pipeline could no longer operate. Number 1951 MR. BEHM responded that they had not included any value for paying royalties on the Kuparuk and other projects. He explained that OXY USA would not have to abandon those projects so early because fixed costs would be spread over all the Schrader Bluff barrels as well. That was a big benefit, he said. By adding more oil to the pipeline, the tariffs everywhere else would become lower, with the state of Alaska receiving additional revenues that it would not have otherwise received, since other fields were on a decline. MR. BEHM added that in the Lower 48, they had learned that going out of business was a costly, painful thing to do. It was much easier to manage an incline than a decline. MR. BEHM concluded by saying OXY USA was glad the Administration and the Alaska State Legislature were interested in attracting independent investment to Alaska. He said OXY USA's original $60 million in royalties to the state might increase to over $400 million if HB 325 was enacted. Number 1974 REPRESENTATIVE JOHN DAVIES asked Mr. Behm what the Alaska-hire percentage was at OXY USA. MR. BEHM replied that BP, not OXY USA, was the operating partner in Alaska. REPRESENTATIVE DAVIES asked if that meant that all the investment opportunities came through BP's operation. MR. BEHM responded yes, at this time. He added that was 99 percent true; OXY USA had interest in two gas wells in Kenai that were uneconomic. REPRESENTATIVE DAVIES asked if Mr. Behm knew what BP's percentage was for Alaska-hires. CO-CHAIRMAN GREEN suggested that question might better be posed to the BP representative who was to speak at the meeting. Number 2034 REPRESENTATIVE DAVIES asked Mr. Behm to relate the process involved in developing a field, given that OXY USA was covering operating expenses at present on exploration wells, and given that once a well was in production, it stayed in production for a long time. He specifically wanted to know how OXY USA actually lost $300,000 per well, without the 5-year "holiday." MR. BEHM replied that the concern was in recovering capital investment, as well as day-to-day costs. The Schrader Bluff wells today, he said, covered day-to-day costs of doing business and were therefore profitable to operate. But they would not pay back the capital it took to put the wells in, with the margin available after expenses. It cost $9 per barrel to put them in, but OXY USA had to pay $3 to $4 per barrel in operating expenses. Number 2066 REPRESENTATIVE DAVIES further asked if the five-years/500-barrels- a-day numbers came from working the spreadsheet. He wondered where those numbers originated. MR. BEHM said that was a good question. He explained they had used trial and error. Once they were above the 15 percent with five years, they had looked at it and asked why it would make sense to propose it that way. They had then seen that it tied in to getting their money back, and everything fell into place. REPRESENTATIVE DAVIES noted that in a sense, that was sort of a coincidence. MR. BEHM agreed and added it just fit that way. Number 2105 REPRESENTATIVE DAVIES asked about the 500 barrels and whether OXY USA expected to be producing more or less than that. MR. BEHM responded that what happened in an oil field development was a distribution of production. Although an average well made 275 barrels per day, some had produced up to 600 barrels per day for a period of time. If they could obtain some of the benefits of the 500-barrel-a-day wells to carry some of the 200-barrel-a-day wells, on average they figured to net out approximately 400 barrels per day of early production. It was a way to get the very best wells to carry the average wells, so that the overall project made sense. He figured a typical well might be 350-400 barrels per day. Number 2150 CO-CHAIRMAN GREEN questioned whether with a limit below that, the five-year payout would then be extended because they would not get the benefit from the better wells to cover the others. MR. BEHM replied that if the floor were cut from 500 to 400, another year of royalty suspension might be needed, for example, to achieve the same economic result. Number 2167 REPRESENTATIVE DAVIES asked if the calculation was on a per-well basis or on an average over the field. MR. BEHM responded that it was per well. REPRESENTATIVE DAVIES commented that if an individual well was producing at 600 barrels, then the state would receive a full royalty on that top 100. MR. BEHM affirmed that was correct; the state would get a full royalty on the increment above that floor amount. Number 2195 CO-CHAIRMAN GREEN noted that HB 325 differed from HB 207 in that a company was dealing with individual wells, as opposed to a project. REPRESENTATIVE DAVIES asked if Co-Chairman Green was saying HB 207 dealt with the whole project. CO-CHAIRMAN GREEN affirmed that was correct. Number 2208 REPRESENTATIVE DAVIES stated that he had two other questions. He referred to Mr. Behm's economics and said that generally he believed, from what Mr. Behm had shown the committee, that it was a "Missouri approach." He expressed concern about the assumptions regarding well costs, facility costs and operating costs. He said OXY USA was using a relatively small operation as a basis, then scaling that up and projecting it into a larger operation. Usually as there was an increase in size, he noted, one recognized some efficiencies of scale. BP was working on better technology, he observed. Representative Davies asked Mr. Behm for his opinion on the sensitivity, in the overall calculations in terms of getting to the hurdle rate, to well costs, facility costs and operating costs. He wanted to know what the sensitivity rate would be. Number 2248 MR. BEHM replied that OXY USA had just completed a post-audit review on what they considered the commercial development on the North Slope. He said they had not yet made a 20 percent rate of return on the good wells they were developing. He did not think they would be moving the window around a lot as far as rate of return; he thought they were dealing with small percentages of difference. He did not see that as a big issue. He gave an example of an economic scenario and added that he thought making an analogy between classes was more effective than analyzing every single marginal heavy oil well for its own merit. He asserted that they were talking about a struggling class. He further stated that they could not afford to over-engineer the process. Number 2305 CO-CHAIR GREEN asked whether, if it were going to cost $500, for example, and take five years to pay out, a company could, through technology, reduce the total cumulative cost to $400, with a four- year payout. He suggested that if money were invested early in the five-year period, with the payout extended, it would not be a linear change; it would not be merely a four-year reduction. He asserted that the sensitivity involved not only the total amounts but timing as to when the money was invested and when it would be returned. It was extremely complex. Number 2337 REPRESENTATIVE DAVIES commented that he thought Mr. Behm's presentation was reasonable; however, he could not be comfortable with it without looking at some of the complexities and seeing a spreadsheet or two. He added he wanted to get a feel for where the sensitivities were in the calculation. He referred to Mr. Behm's earlier indication that OXY USA had approximately 9 percent of the investment at this point, with BP having the remainder. MR. BEHM affirmed that was correct. REPRESENTATIVE DAVIES suggested that BP was quite different from OXY USA in their investment position; BP was a partner in TAPS. MR. BEHM said that was also correct. REPRESENTATIVE DAVIES expressed that one of his problems with the legislation was the different economic positions of the various companies in the exact same fields. While it might make sense, for example, to offer a company like OXY USA this kind of break, it might not make sense to offer BP the same break. Representative Davies stated that he would like a response to his concern. Number 2430 MR. BEHM indicated that he could not speak for BP; however, from his perspective, at 9 percent, this was the largest capital project that OXY USA had going in the domestic United States. For OXY USA, it was a significant, core asset. 9 percent of a lot was still a lot. Furthermore, historically, when Conoco, Chevron and OXY USA had tried to make a go of it, they had been misaligned. What was to one company's advantage was not to another company's. He asserted it was a disaster; nothing got done. He explained that OXY USA had quit drilling wells and said it was a lose-lose deal for everybody. Now, on the other hand, having worked hard to align goals and get companies on equal footing through cross-assignment of interests on all the tracts, they could do what was technically and economically best for the unit. Anything divisive they did, he said, could snowball into a disastrous relationship like the one they had previously. He added it was a "soft dollar" issue but an important one; to attract capital to these kinds of projects, he felt it was better to keep everybody the same. TAPE 96-8, SIDE B Number 0001 CO-CHAIRMAN GREEN wondered how closely the state of Alaska could scrutinize an investor's plans before the project became overburdened, sending companies to Canada or Venezuela for heavy oil. MR. BEHM responded that companies were just asking for enough incentive to get these projects on the budget. He added that did not guarantee funding. Number 0064 REPRESENTATIVE DAVIES explained that the legislature wanted to encourage the development. But at the same time, the state had a fiduciary interest in knowing that they were not just taking a company's word for it. He reiterated that Mr. Behm had made a reasonable presentation thus far. Nonetheless, Representative Davies was concerned because HB 207, passed the previous year, was in his view supposed to have taken care of the problem. He noted that part of that legislation was the provision that there be a good faith demonstration that a marginal field was actually marginal. If it was, the legislature wanted to figure out concessions to make it happen. If it was not, they would be suckers to offer the concession. At its lowest common denominator, he explained, the job of the legislature was to make sure, on behalf of the people of Alaska, that they were not suckers. He suggested that the legislature needed to ask a lot of hard, detailed questions and perhaps actually look at spreadsheets; that, he said, was what the commissioner would have done under HB 207. Number 0089 REPRESENTATIVE DON LONG stated that the legislation appeared to be site-specific. He wondered why it only referred to the North Slope. CO-CHAIRMAN GREEN offered to answer that question, as he was sponsor of the bill. He explained that it was site-specific because the North Slope was the only place they knew of, other than Katalla, with heavy oil. It was the area most likely to be developed. He added that it was not site-specific but actually time-specific. It provided a window of opportunity for any project that could be brought on during the short window to enhance the opportunity to field test concepts and work on technological advancements. Having been in the oil industry, he added, even with this incentive there was no guarantee there would be an economic project. He suggested there might be a way for companies to squeeze some profit out of it. He stated his belief that it behooved the state to grant an incentive. He added that there was no way that all of the 27 billion to 50 billion barrels of heavy oil on the North Slope, if one considered areas with a heavy oil residual in the bottom of the reservoirs, could be extracted within a ten-year window. Number 0174 REPRESENTATIVE LONG asked why 500 barrels per day had been chosen, rather than a unit payout. MR. BEHM replied he would love to answer that question. When talking payout, auditing and accounting, he said, OXY USA did not have people to calculate that for every well, every time. Rather, they preferred to agree on something simple that looked about right. His company could not afford the administrative costs of micro-managing every piece of investment. Number 0225 CO-CHAIRMAN GREEN commented that as Representative Davies had pointed out, OXY USA was not a member of TAPS, whereas BP was. Co- Chairman Green noted that there could likely be a difference of when the payout occurred between the companies as well; this would double the auditing problem. MR. BEHM agreed, saying that was the heartburn. OXY USA, a large independent, was moving to small business ideas because they could not afford all the costs associated with thinking like big business used to think. Number 0225 CO-CHAIRMAN GREEN asked if any committee members had questions. He noted that BP would be making a presentation and that some of the questions already posed might be better answered by their representative. Number 0260 BRUCE J. POLICKY, MPU Exploitation Manager, BP Exploration (Alaska) Inc., made a presentation via teleconference in Anchorage. He explained that he was responsible for subsurface development within Milne Point, which included the Schrader Bluff heavy oil as well as other projects. He said he would touch on development history, key in on BP's activities the past couple of years at Milne Point, and discuss potential projects under the right economic conditions. MR. POLICKY referred during his presentation to a handout entitled "Heavy Oil Potential at Milne Point," dated January 26, 1996. The page entitled "North Slope Fields" showed a map including Milne Point, the northernmost producing unit on the North Slope. Mr. Policky said BP had acquired Chevron and Conoco interests and begun operating at Milne Point on January 1, 1994. He said BP currently owned 91 percent of Milne Point, with the other 9 percent owned by OXY USA. He pointed out the green section of the map, outlining the Schrader Bluff/West Sak Oil. He commented on the tremendously large area covered and noted that it went under the Prudhoe Bay, Milne Point and Kuparuk River units. CO-CHAIRMAN GREEN noted that only two of the committee members on teleconference had access to the color presentation. Number 0373 MR. POLICKY continued, explaining that the total resource for Schrader Bluff/West Sak approached 26 billion barrels of oil in place. However, not all the oil was the same in that accumulation. To the north and east, he said, the reservoir tended to be deeper and therefore hotter, with higher oil gravities relative to the rest of the area. He explained that as oil gravity became lower, it became thicker and harder to produce. Towards the southwest, he said, the reservoir got shallower and closer to the permafrost, with even lower gravities. What types of development might work well in one area might not work in other areas. Number 0426 MR. POLICKY illustrated the impact of gravity on oil flow by passing around samples to the committee. The samples were of 35 gravity, 22 gravity and 14 gravity oil; these three oils were currently being produced at Milne Point, he said. MR. POLICKY referred to the map entitled "Schrader Bluff Heavy Oil Development" and said it was a cartoon view. The development at acquisition was the Tract 14 pilot project. Pink areas on the map depicted development since 1994, mainly in 1995. Finally, the largest outline represented the accumulation within Milne Point, which BP estimated to be 2.25 billion barrels underlying the Milne Point Unit, of which Tract 14 represented approximately 10 percent. He noted that Tract 14 actually represented less than 1 percent of the overall in-place resource. He explained that BP was trying to go from an extremely small pilot and branch out in developing other areas. He added that the Tract 14 area was probably one of the easier places to develop relative to future developments in the area. However, that was speculative until they actually drilled wells. Number 0516 REPRESENTATIVE DAVIES wondered, when Mr. Policky referred to development in other places, if that meant there were producing wells there, rather than wells being tested. MR. POLICKY replied that he would cover that topic. He said BP had drilled six wells in 1995 in those regions; they were in the process of completing the wells and bringing them on production in the coming months. Number 0544 MR. POLICKY presented a brief history of Tract 14 development. Started by Conoco in 1991, Tract 14 had either 21 or 22 wells drilled. The initial rates were approximately 275 barrels per day. Despite the advancement of completion technology and well technology, the project economics were not good enough to continue development. However, although commercial development had ceased, the project remained on production. MR. POLICKY explained that he had been involved with the field since BP took it over. Early on, they had noticed that while the Tract 14 pilot project produced only 3,000 barrels per day, once the wells were producing, the performance stayed fairly constant, with minimal decline compared to that experienced elsewhere. That was characteristic of heavy oil. BP was encouraged by the potential and were trying to lay a foundation for future development. Number 0617 MR. POLICKY continued, saying that for the current year, BP was trying to significantly lower the $9.30-per-barrel development cost by reducing capital requirements and operating costs. He said that a large degree of uncertainty stifled development; this uncertainty could be in any number of areas including reservoir performance, costs or fiscal terms. So far, OXY USA and BP had invested $15 million in 1995, drilling six wells and recompleting three others. They had also initiated approximately $1 million in reservoir and facility studies aimed at reducing costs. Although they had seen some improvement in drilling costs, it was not as good as they had hoped. Completion costs were still problematic, but they had seen some improvement in submersible pump life. He emphasized that there was still a high degree of uncertainty. Number 0685 MR. POLICKY referred to the cartoon schematic entitled "Schrader Bluff Technology," which depicted a typical well. First, BP was attempting to develop a field with fewer new pads, utilizing more existing infrastructure. Second, frac pac technology was being used to try to increase production rates; this was a two-edged sword, however, as frac pacs were one of the largest cost drivers of the completion. Third, BP installed a sand filter in the well; this was important to prevent failure of submersible pumps. Finally, the schematic illustrated heat trace freeze protection. Mr. Policky noted that Conoco had tried numerous ways of keeping wells from literally freezing, an essential component of production in the permafrost. He said the completions totalled approximately $1 million apiece, with a cost of more than $700,000 to drill a well. In addition, he said, the facility costs were sizable for each well, dependent on location, with costs ranging from $500,000 to $1 million per well. Number 0780 MR. POLICKY said there was more than one way to prove up commercial viability of a field. BP had been working on cost reductions and increased production for the past two years; however, those two items alone did not make this project viable. To be successful, they needed improved economics. He cautioned that a large-scale development was unlikely without incentives. He added that there was a large "prize" at Schrader Bluff, with 2 billion barrels of oil in place. What was important, however, was not oil in place but recovery of that oil. BP estimated the potential recovery at 200 to 800 million barrels. Mr. Policky added that BP used a scenario of recovering 300 million barrels from 230 wells. The key, he said, was expansion of the adjacent fields. Number 0808 REPRESENTATIVE DAVIES asked if the 200 to 800 million barrels of oil at Schrader Bluff was under the Milne Point area. MR. POLICKY affirmed it was just the Milne Point area. The accumulations within the Kuparuk River and Prudhoe Bay units would have at least as great a potential, with more than 20 billion barrels located within the Kuparuk River Unit. Mr. Policky noted that oil properties and reservoir depths changed from Milne Point to the Kuparuk River units; one could not assume similar recovery rates. He added that BP viewed Milne Point as a "sweet spot" for the accumulation. Number 0927 MR. POLICKY addressed potential impacts of HB 325, saying it would reduce investment uncertainty in a number of areas, defining the terms companies would work under and assisting with revenue recovery in the early stages. It would encourage investment and send a positive signal to BP; it would also accelerate the pace and increase the scope of development. Mr. Policky clarified that he would be surprised if they successfully developed the entire heavy oil resource on the North Slope. Certain areas would always be too expensive and too challenging to develop. However, with an incentive program, there would be more development than otherwise. Number 0985 MR. POLICKY referred to the production profile handout and explained it was based on actual performance to date from Tract 14. The graph progressed for 41 years; however, he said, BP's actual history was only five years. MR. POLICKY said one approach to heavy oil was delay, to wait and see how things turned out. However, he was concerned about development momentum. He noted that in 1985 to 1986, ARCO had also attempted a heavy oil project in the Kuparuk River Unit, investing $135 million. They had recovered less than $1 million barrels of oil; that project remained shut in to date. Five years later, Conoco had given it another go, with the partners investing $125 million. Although commercial development of that project stopped, the project did remain on production. Now, five years later, he said, BP was attempting heavy oil development once again. He likened the situation to a baseball game, and said if they lost momentum, it would be the third strike. Mr. Policky concluded his remarks by saying that to him, any deferral put ultimate recovery at risk. Number 1137 REPRESENTATIVE DAVIES asked Mr. Policky about BP's Alaska-hire rate. MR. POLICKY replied he believed it to be 87 percent. REPRESENTATIVE DAVIES asked if Mr. Policky could provide a geographic distribution as to where those people were from. MR. POLICKY responded that he did not have that information. Number 1169 REPRESENTATIVE DAVIES further asked whether Mr. Policky could provide some sense of how big a difference BP's involvement with TAPS would make in getting to the 15 percent hurdle rate. MR. POLICKY replied that it made a difference, but the difference was pretty small. TAPS had its own operating expenses and cost structure associated with that, he said. However, being an owner, there were some benefits to it. BP would also benefit, he asserted, just as would the state of Alaska, from increased throughput through TAPS on a project like this. The important thing with heavy oil was the cost of the wells and the infrastructure specific to this project. Each company had different hurdle rates for investments. The good news for BP was that they had a lot of investment opportunities around the world; in fact, they had more opportunities than ability to spend capital. When talking hurdles, it was not only achieving hurdles but decisions about where to invest. Number 1220 CO-CHAIRMAN GREEN commented that some people might have the perception, when looking at the pipeline tariff, that it went entirely back to the owners. He said that the minuscule amount that came back to the pipeline owner was not a make-or-break amount. It might change the time line, but would not determine whether an investment were made. Number 1225 MR. POLICKY added that when BP ran economics, they did so without considering benefits from TAPS, for the very reason Co-Chairman Green had stated. Number 1401 DALE BONDURANT testified via teleconference from Kenai, stating that he was a 48-year resident of Alaska. He said it was a sickening crime that so many politicians were willing to give Alaska's publicly owned resources to the "poor" oil companies. Big oil bragged how willing they were to rape Alaska's public-owned resources if the state would only be more cooperative. To put it in a better perspective, he said, oil was under $3 per barrel when the decision to build the pipeline was made. "Boo hoo," he said, "it makes me cry. Oil is now over $16, I think today it's $18, a barrel, and the poor oil companies are really doing Alaska a favor." Oil companies talked about the billions they had invested in Alaska, but never said thanks for the trillions they have profited from Alaska's resources. Now, he said, they were, without pretense, demanding to be given a valuable, nonrenewable resource with little or even no royalty tax payments. MR. BONDURANT continued, saying oil companies complained about the difficulty of producing in Alaska but adamantly demanded the right to expand their highly profitable operations. Even when they had agreed to pay a certain rate of royalty tax, he said, they were not even willing to meet that obligation. He asserted that the people of Alaska were the real owners, yet the oil companies would not let the people know what the real bottom-line profits were. He said that if estimates of trillions of dollars of profit seemed a fantastic guess, then the oil companies should qualify it with actual, audited figures. He noted that there was a downward trend in settlements, where they now were barely in the $1 million range. Oil companies continued to threaten to leave Alaska. "Well, good- bye," he said, adding that those threats were as old as the industry. Number 1555 MR. BONDURANT referred to the early stages of the Swanson Oil Field, when there were threats to stop drilling unless environmental safeguards were lifted. He said the companies drilled anyway, and now they pointed out that they can drill within conservation considerations. However, the industry continued a history of circumventing such restrictions, pumping back toxic waste, refusing to monitor storage dumps, resisting proper tanker escorts and denying the existence of terminal air pollution. Oil companies spent thousands of dollars on TV, lobbying and public relations, he said, to propagandize how well they treated Alaskans, while asking for more cooperation to exploit the people's public resources. They realized, he said, that the economic returns from the propaganda outperformed even the profits from oil. MR. BONDURANT concluded by saying it was a shame how the oil companies fought royalties even after they had agreed to them. They were making lots of money in Alaska. If they could not make money on the oil and did not want to pay Alaska for the oil, they could leave the oil in the ground. Number 1750 CO-CHAIRMAN GREEN responded that companies have spent billions of dollars in Alaska on dry holes. He thanked Mr. Bondurant and called on Representative Barnes via teleconference. REPRESENTATIVE BARNES stated that it was a well known fact that there was not much oil company activity remaining in Alaska. However, there was activity in Russia, Venezuela and countries in Asia. She expressed concern about resource development dollars being pulled out of Alaska and invested overseas because of lower costs of doing business elsewhere. Number 1904 MR. BOYD reiterated via teleconference that the Administration wanted to see heavy oil developed; they wanted to use the vehicles already established through HB 207 to accomplish this, even if it required some modification. The Administration thought it important to evaluate on a case-by-case basis. Number 1976 CO-CHAIR GREEN asked whether Mr. Boyd or someone else from the Division of Oil and Gas would be willing to work with the committee on the legislation. MR. BOYD replied that it would be his pleasure to do that. Number 1999 REPRESENTATIVE BARNES said that she understood the bill to be site- specific for one area. Furthermore, it was an amendment to HB 207. She said she was ready to make a motion to move the bill from the committee with individual recommendations. CO-CHAIR GREEN responded that they could not do that; there was no quorum present in person as required under the rules. He added that HB 325 would be heard the following Wednesday. He expressed concern that if they waited too long to move the legislation, even though it might be amended again, they might miss the window of opportunity for the current year; he felt that could become catastrophic. Number 2095 REPRESENTATIVE DAVIES asked Mr. Boyd if he could estimate the response time, assuming HB 207 could be applied or fixed, if a company came to the Administration with a request for an exemption under HB 207. MR. BOYD replied that in his earlier testimony before the House Special Committee on Oil and Gas, he had said the time frame would be three to six months. However, in this case, if it were OXY USA and BP, who already had assembled the necessary information, the process could probably move more quickly. The uncertainty would come due to debate as to how to negotiate terms that would allow the companies to proceed and yet protect the state's interests. He finished by saying he would stick with three to six months. Number 2198 REPRESENTATIVE WILLIAMS spoke via teleconference, noting that he was also a member of the House Special Committee on Oil and Gas. He mentioned that he had asked the Administration to submit something in writing specifying their stand on HB 207 and HB 325, discussing the differences. He added they had received testimony from ARCO, BP and OXY USA. Number 2243 MR. BOYD apologized for the delay in responding to Representative Williams's request. He said the commissioner had a letter on his desk regarding the legislation that would be sent to Representative Williams as soon as possible. Number 2299 REPRESENTATIVE BARNES stated she was a firm believer in windows of opportunity, not just as they related to this legislation but in relation to gas on the North Slope as well. She expressed her strong belief that the state had to look for ways to keep the pipeline as full of oil as possible; if the oil flow decreased to a certain number of barrels per day, the pipeline had to be dismantled and shut down. She believed that the state should do everything in its power to encourage additional barrels of oil flowing through the pipeline. Number 2380 REPRESENTATIVE PETE KOTT spoke via teleconference. He expressed that they had heard encouraging remarks from the Administration. He understood that it was possible the Administration would work with the companies involved to produce heavy oil, even if the particular legislation on the table did not pass. He said the companies should be encouraged to continue dialogue with the Administration to keep the avenue open. TAPE 96-9, SIDE A Number 0001 REPRESENTATIVE SCOTT OGAN commented via teleconference, stating that HB 207 might possibly work; however, he said, it was geared toward bigger operators that could afford to go through the scrutiny process. On the other hand, HB 325 removed any ambiguity about the process. Another important issue, he said, was how much control the Administration would have over the process. HB 325 was straight-forward and presented a package that anyone could take advantage of. He noted that BP was the third operator to work on the oil field. With that track record, he felt there might be justifiable reasons to reduce royalties. He concluded that he was supportive of HB 325. Number 0121 CO-CHAIRMAN GREEN offered some concluding comments. He reminded the committee that the legislation affected up to 200 billion barrels of oil in place. He noted there were an additional 25 billion barrels in the Kuparuk, Milne and Schrader Bluff areas; these were, however, more difficult to produce. Furthermore, there were 10 billion to 25 billion barrels of oil in the Tarmat (SPELLING?) area. Co-Chairman Green asserted that the state should have the potential to use this as a pilot to possibly unlock major reserves still in existence. Co-CHAIRMAN GREEN observed, as an aside, that the industry and the state had just pushed the 11 billionth barrel of oil through the pipeline. The $16 billion to $17 billion dollar trust fund in the permanent fund was the result of oil development in Alaska. He commented that approximately 20 companies had left the state because of the difficulty in operating. He asserted that if incentives were necessary, that was part of the reason for HB 325.