Small Cook Inlet producers say they need state government help before drilling for new natural gas

This story was originally published in The Northern Journal.

With time running out before a shortfall in local natural gas production forces Alaska’s urban utilities to import more expensive supplies from outside the state, two small companies say they have reserves that could help fill the gap.

But executives from the two privately owned oil companies, BlueCrest Energy and HEX, say they won’t be able to drill wells to access the gas on their state-leased lands without government help.

While Bluecrest’s plans are longer-term, Anchorage-based HEX is scrambling to prepare for a drilling effort from its Julius R platform, in Cook Inlet offshore of the Kenai Peninsula, before winter sets in.

But that $12 million expense will only be worthwhile, according to HEX President John Hendrix, if officials from the Alaska Department of Natural Resources, or DNR, grant his company’s request for concessions. 

Hendrix said he needs the department to reduce the 12.5% share of HEX’s production that the company is required to pay to the state — what’s known as a royalty. HEX has been pushing for that reduction for months, and Hendrix said he needs an answer by Sept. 3 for the company to proceed with drilling this year.

“DNR’s smart — I think they can put numbers together and be realistic about this. I hope politics doesn’t get involved,” Hendrix said. He added: “I’m trying to save Alaskans.”

Meanwhile, Texas-based Bluecrest isn’t planning to drill before winter. But in the next few years, it hopes to build a new offshore platform in the inlet that could produce huge amounts of gas — if it can secure state loans to match the money it hopes to raise from private investors, said Benjy Johnson, the company’s president.

A previous Bluecrest project went south when Alaska lawmakers slashed the budget for an oil and gas tax credit program — forcing the state agency that loaned Bluecrest $30 million to renegotiate the debt more than a dozen times, and ultimately to agree to forgive millions of dollars in public money that the company owed. 

The decision by lawmakers to cut the tax credit payments, nearly a decade ago, has scared off potential investors, Johnson said in an interview.

“No one is going to do a penny unless the state, somehow, is involved,” he said.

Johnson has not yet made a formal application for state support.

And DNR officials declined to confirm the existence of an application for royalty reduction from HEX, saying it would be confidential until the agency makes a preliminary decision.

But the Dunleavy administration is closely monitoring Cook Inlet producers to make sure that they’re following through on development commitments they’ve made in annual work plans filed with the state, said John Crowther, deputy DNR commissioner.

“This is, essentially, the number one department priority — to be supporting and facilitating as much energy availability as we can,” Crowther said. He added: “Time is of the essence.”

Drilling could push off gas supply gap

For the past two years, pressure has been building on the petroleum producers in Cook Inlet —  the basin southwest of Anchorage that, for decades, has sustained urban Alaska’s natural gas power plants and home and commercial heating units.

The inlet was the site of Alaska’s first big oil strike, with companies like Chevron and Marathon developing big projects and daily production that exceeded 200,000 barrels in the 1970s. 

But as the basin aged and production declined, the big companies sold off their Cook Inlet properties, transferring them to smaller firms that specialize in extracting petroleum from older assets.

Two years ago, Hilcorp, the Texas-based business that produces more than 80% of the gas from Cook Inlet, warned the region’s electric and natural gas utilities not to depend on the company to supply more gas once Hilcorp’s existing contracts expire at different points over the next decade.

In a subsequent report commissioned by the utilities, a consultant said imports of liquefied natural gas, or LNG, could be required to meet demand as soon as 2027 — though the consultant wrote that date could be pushed out as late as the “mid 2030s” if Cook Inlet companies raise the money to drill new wells and find more gas.

Utility leaders have said they can’t count on those local suppliers and are preparing for imports — including discussions with potential gas sellers and planning for the infrastructure needed to store LNG shipped in on tankers.

But the utilities have not yet announced any formal plans. And many Alaska policymakers, who pride themselves on the state’s petroleum-producing heritage, hate the idea of imports — and the substantial price increases expected to come with them — and have been agitating for more local production.

That’s made Hilcorp a target. In a formal letter to the Federal Trade Commission this month, two Anchorage state senators asked the agency to investigate what they called “illegal anticompetitive practices” by the company, and actions by Hilcorp that they say created “scarcity of supply.” 

But DNR officials say Hilcorp is meeting its development obligations under its leases with the state. A company representative told the Anchorage Daily News this month that it expects to drill more than 20 wells in 2024 alone but added that utilities need new sources of natural gas supply because the company’s assets are aging and increasingly depleted.

Officials from Bluecrest and HEX, meanwhile, say they have undeveloped and accessible gas that could put off the gap in supply — but that they need financial help from the state before they will drill.

“I’m going to assume all the risk”

While Bluecrest needs to build a new offshore platform to access its gas deposit, at an expected cost of hundreds of millions of dollars, HEX’s gas can likely be produced with a far smaller investment, according to company officials. And HEX’s annual work plan approved by DNR requires it to conduct new drilling before Jan. 3.

The company’s initial plan involves drilling an offshoot of an existing well from HEX’s offshore platform, into its leased area called the Kitchen Lights Unit. More ambitious drilling plans in future years could access enough gas to supply urban Alaska through the late 2030s, said Hendrix, HEX’s president.

It’s not exactly certain how much gas the first project will yield, Hendrix said. But the targets have been validated by independent firms with high confidence, and the best-case drilling scenario could add nearly 2 billion cubic feet to the annual Cook Inlet supply, he added.

That would be a small but meaningful boost, given utilities’ overall yearly consumption of some 70 billion cubic feet.

But even that initial project would be costly and risky, according to Hendrix. 

There’s currently just one offshore drilling rig in Cook Inlet, owned by Hilcorp. HEX would have to rent it and float it from one of Hilcorp’s platforms to the Julius R. 

The effort would also be the first major drilling project for HEX’s current owners and operators, which poses a higher likelihood of technical problems, Hendrix said. And HEX would have a drilling window of just a few weeks before the onset of icy conditions forces an end to the season, he added.

That’s why the company is pressing for a reduction in the royalties it pays to the state, he said.

Typically, companies pay a royalty rate of 12.5% of the value of oil and gas produced from state land. In HEX’s case, the company pays 12.5% in additional royalties to individuals and private businesses as part of agreements negotiated under HEX’s previous ownership and approved by the state.

That additional royalty is an unusually large amount, and the drilling planned by HEX is “too much risk to take, when you pay 25% off the top,” Hendrix said.

“I’m going to drill on my own. I’m going to assume all the risk,” he said. “We’ve got to make sure we have a return.”

Under state law, the natural resources department can only grant a request for a royalty reduction if a company makes a “clear and convincing showing” that it would result in oil or gas production from a new field, extend the life of an existing one or reestablish production from a field that’s been closed down. DNR said last year that just three applications have been granted since 1995.

If the agency doesn’t approve HEX’s request in time to drill this year, Hendrix said he will continue to push lawmakers to pass a bill to reduce his royalty obligations to align with other Cook Inlet producers — which would allow him to drill next year or the year after, he added.

“We’re not saying, ‘reduce it for everybody.’ Just equalize it so that we’re all on par,” he said.

HEX’s request for lower royalties is not the company’s first attempt to reduce its financial obligations to state and local governments. The company has also challenged its property taxes, in a lawsuit that’s now before the Alaska Supreme Court. 

HEX has also applied to Alaska’s economic development agency, the Alaska Industrial Development and Export Authority, or AIDEA, to help finance future drilling efforts. The authority’s board earlier this month voted to allow its staff to study HEX’s request, using money that would be reimbursed by the company.

Bluecrest eyes new borrowing after agency agrees to loan forgiveness

Bluecrest, meanwhile, has been pitching “some of the world’s largest investors” on its plan to build a new nearshore platform to access natural gas at its Cosmopolitan Unit, said Johnson, the company president.

Bluecrest says its deposit is what’s known in the petroleum industry as “proved” reserves — meaning that its flow has been tested and that an engineering firm has validated it can be produced with 90% probability or higher.

To pay for the platform, Johnson said he envisions some kind of split between private businesses and state-backed loans. In total, the project is expected to cost $400 million or more, Johnson has said.

State investment in the project would address fears from investors that lawmakers could enact tax or other policy measures that would harm the development — which is what happened to Bluecrest’s previous project when the tax credit budget was cut, Johnson said.

Johnson said he understands that policymakers might have questions about putting public money into another Bluecrest project after what happened with the company’s original loan from AIDEA, in 2015.

Bluecrest used the $30 million to pay for a new, high-powered drilling rig that it set up onshore on the Kenai Peninsula.

But the project froze when lawmakers reduced spending on the tax credit program that Bluecrest was counting on to fund its drilling program — and it hasn’t drilled a new well since 2018.

Bluecrest’s loan balance was $13.3 million as of June 30, according to AIDEA. After approving 13 modifications — many of them to delay Bluecrest’s repayment obligations — AIDEA’s board voted in June to allow Bluecrest to make a $3 million payment this year and another $3 million payment next year, plus interest.

At that point, the remaining debt of roughly $7 million will be forgiven, Johnson and AIDEA officials said. 

AIDEA will have received some $38 million in payments, including interest, from Bluecrest over the lifetime of the original $30 million loan, according to Johnson. While AIDEA board members voted unanimously to approve the plan, one of them, Albert Fogle, said at the June meeting that there was a “trust issue” with Bluecrest because of the repeated loan modifications.

A new state loan for the platform project would be credible, said Johnson, because Bluecrest would be bringing large private investors along with them.

“If it was just Bluecrest saying that we’re going to do it, there’s no reason for them to necessarily believe that,” Johnson said. “What is different is that when we do come and we make an application, we will be aligned with large financial capability on our side.”

Alaska officials, meanwhile, say they’re watching Bluecrest closely to ensure it’s complying with the commitments set out in its annual work plan with the state — and could take action if it doesn’t.

“The current Cook Inlet market environment demands operators marshal all available resources and ensure enough natural gas is available for citizens of Alaska,” Derek Nottingham, head of DNR’s oil and gas division, wrote in a letter to the company in June. “The division accordingly expects BlueCrest to develop its proven oil and gas resources in time to meet this critical need.”

Nathaniel Herz welcomes tips at natherz@gmail.com or (907) 793-0312. This article was originally published in Northern Journal, a newsletter from Herz. Subscribe at this link.