High costs raise new questions about Arctic drilling

WASHINGTON – When Shell started buying leases to drill in the Beaufort and Chukchi seas in 2005, the company was betting on Americans’ thirst for any oil locked under those Arctic waters, which could replace declining crude production from Alaska’s North Slope and other onshore resources.

Flash forward eight years, and the scenario has changed dramatically.

Now, energy companies are extracting ever more oil from dense rock formations in South Texas, North Dakota and other states, making the need to tap offshore frontiers less urgent.

And Shell’s first year of drilling on those leases was nothing short of a public relations disaster, with a grounded rig and a drifting drillship highlighting the challenges of searching for crude in the remote and icy waters hundreds of miles north of the Arctic Circle.

The high-profile mishaps have prompted a federal investigation of the perils of Arctic drilling and are spurring some in the oil industry to re-evaluate whether the crude on top of the world is worth the logistical challenges, financial costs and environmental risks of getting to it.

“We have to question how thirsty are we that we have to drill for oil in places where we are putting so much at risk and where human beings are having to cart this equipment around in a time of terrible weather,” said Amy Myers Jaffe, executive director of energy and sustainability at University of California, Davis.

“There might have been a time when the industry could have argued that oil and gas resources were so scarce it might have no choice but to drill in the most sensitive parts of the globe,” Jaffe added. But “we’re having this renaissance in North America where we now have this resource onshore, and we’re willing to take the risk in the Gulf of Mexico. So why are we even doing this in the Arctic? Is it really necessary?”

Consider that since 2005, Shell has invested nearly $5 billion into its Arctic venture, with only two half-completed wells to show for it.

Environmental risks

The potential environmental costs are high, too. Conservationists say there is no proven technology for cleaning up any oil spills in slushy waters, where floating crude could damage a fragile ecosystem that supports sea lions, walruses and migrating whales.

To drill in the region, Shell and other companies have to overcome major logistical hurdles, given that their prospects are located 1,000 miles away from the nearest Coast Guard station in waters that remain dotted with ice even during the relatively warm exploratory season.

Still, a massive prize is beckoning. Geologists estimate 412 billion barrels of oil equivalent are lurking in the Arctic – thought to be about a quarter of the world’s undiscovered conventional crude and natural gas resources.

Melting Arctic ice is allowing drillships to pass through newly accessible waters and inspiring a new oil rush at the top of the globe.

Exxon Mobil is slated to begin drilling in Russia’s Kara Sea next year. Cairn Energy recently announced it would resume its hunt for oil and gas near Greenland’s coast. And Gazprom launched drilling in the Pechora Sea near Russia last year.

Several companies have plans to follow Shell’s lead in U.S. Arctic waters, including ConocoPhillips, which is planning to bore up to two exploratory oil wells in its Devil’s Paw prospect in the Chukchi Sea next year.

Still, some companies are putting the brakes on.

After witnessing Shell’s struggles, Statoil said it would wait until 2015 at the earliest to begin drilling on its own Chukchi Sea leases. And Total SA CEO Christophe de Margerie has insisted the environmental risks are too high to justify Arctic oil drilling.

Leading the way

Shell Oil Co. President Marvin Odum said the firm is committed to Arctic oil exploration, not just near Alaska’s coast.

“The Arctic is a global play,” he noted. “A number of companies are going into the Arctic. Russia (has) big plans to go in and explore and go after that very massive resource space.”

Shell’s Arctic oil pursuit could put the company at the forefront of a northern oil boom, said Tad Patzek, chairman of the University of Texas at Austin’s petroleum and geosystems engineering department.

“Shell is essentially buying an option to produce a potentially huge amount of oil in the Arctic at a relatively small cost (and) taking a measured go-slow approach,” Patzek said. If it pays off, “Shell gets to be a sole operator of a potential treasure trove at a time when everybody will be begging for oil.”

It could be a decade or more before substantial crude starts flowing from Arctic wells, whether into tankers in Russia or yet-to-be-built pipelines off Alaska’s coast.

“This is probably one of the most formidable frontier exploration areas,” noted Surya Rajan, director of the energy research firm IHS CERA. “Not everyone would have the appetite for this.”

But Rajan emphasized the upside to major oil companies, which can sink cash into large-scale, long-term projects dependent on still-undeveloped technology.

“This is important to maintain in your portfolio of opportunities,” Rajan said. “Not for today, but maybe decades out into the future.”