[The Oil Patch]
(Archived Nov 8, 2005)
The Arctic Refuge Numbers Game: Update
RICHARD A. FINEBERG
As the fate of the Arctic National Wildlife Refuge simmers in the nation's capitol, legislative staff and agency personnel are trying to sort through the uncertainties of geology and oil economics to help policy makers decide whether petroleum that may (or may not) lie beneath the refuge Coastal Plain is worth going after. A previous "Oilpatch" article ("The Arctic Refuge Numbers Game") pointed out that even if ten billion barrels of economically recoverable oil were discovered beneath the Coastal Plain of the Arctic National Wildlife Refuge (a figure that may seem wildly optimistic to many observers), that would bring the nation's total petroleum reserves to approximately 40 billion barrels; the United States would still be more than 400 hundred billion barrels short of the amount of oil it expects to consume between now and 2050. This update explores two numbers issues that are presently central to the Arctic Refuge debate: (1) how much oil companies might be willing to pay for rights to explore on the Arctic Refuge Coastal Plain and develop any oil they may find, and (2) how estimates of the petroleum potential of the Arctic Refuge Coastal Plain are crafted. The stage for this discussion is the nation's capitol, where several significant developments took place during the month of February 2005.
Lease Bonus Bids
In January 2005, the Alaska Wilderness League distributed this writer's report on lease bonus bids to interested staff in the nation's Capitol. The report spotlighted the stark contrast between the lease bonus bid amounts petroleum companies have been willing to pay on Alaska's North Slope in the past 20 years ($53.03 per leased acre, in nominal dollars) and the amount that government agencies believe they will pay on the Arctic Refuge Coastal Plain (upwards of $2,667.00 per leased acre, in nominal dollars).
Lease bonus bid revenues assume particular importance at this time because drilling advocates seek to bypass the normal legislative route by inserting these anticipated revenues into the federal budget (see discussion in the previous "Arctic Refuge Numbers Game"). Inclusion of these revenues in the Budget Act will serve as the decision to open the Arctic Refuge to exploration and drilling. Therefore, attention is immediately focused on the estimate of lease budget revenues and the pending action of the House and Senate Budget Committees. But the function of the Budget Act is to set appropriation limits for subsequent legislation. In other words, the Budget Act is supposed to carry out policy - not make it. And whatever their personal views on Arctic Refuge drilling might be, the Budget Committee chairmen in both houses would prefer not to tack controversial items like the Arctic Refuge onto the Budget Act, which is the principal product of their committees, for this reason: if the Budget Act contains back-door legislation that offends too many people, then that act may not gets passed at all. (1)
The public kick-off for the federal budget cycle took place in early February. Once again, the President did not mention the Arctic Refuge in his State of the Union address. But the proposed FY 2006 budget, released Feb. 7, did include $2.6 billion in revenue from leasing on the Arctic Refuge Coastal Plain. (2) In mid-February, shortly after the proposed budget came out, the Congressional Budget Office (CBO) issued its own estimate of $5.0 billion for Arctic Refuge lease bonus revenue - almost twice the amount estimated by the White House. (3)
Three things make the CBO Arctic Refuge lease bonus estimate worthy of further consideration: (1) the discrepancy between the agency estimate and the historical record; (2) the unexplained difference between the CBO and administration lease estimates; and (3) the fact that CBO has increased its estimate of lease bonus bid revenue without providing detailed information on the derivation of its number or responding to questions about its estimate addressed to CBO.
On Feb. 4, 2005, eleven members of the U.S. Senate (including nine Democrats and two Republicans) posed five specific questions to CBO. Their letter, which cited and attached a copy of this writer's report on lease bonus revenues, noted that "oil companies have been willing to bid, on average, little more than $50 per acre for petroleum leasing rights on Alaska's North Slope," compared to an averages between $2,667 and $10,000 per leased acre necessary to generate CBO's former revenue estimate of $4.0 billion. Observing that the U.S. Geological Survey (USGS) and Energy Information Administration (EIA) omit lease bonus payments from their economic analyses of Arctic Refuge development, the eleven senators asked, "[h]ow has CBO incorporated the effects of these up-front payments into its financial analysis?" Citing the withdrawal of major North Slope producers British Petroleum and ConocoPhillips from Arctic Power, the state-funded lobbying group that advocates drilling in the refuge, the senators also inquired as to "[h]ow to recent developments like these affect . . . your prediction of revenue generation from drilling in the Arctic National Wildlife Refuge?"
This writer met with CBO analysts in Washington February 10 to learn how that agency crafted its estimates of lease bonus revenues. But in a long and free-ranging meeting, CBO staff provided no substantive information about how their model works. While CBO personnel admitted a reluctance to change its previously held position that leasing the Coastal Plain would generate bonus bid revenues of approximately $4.0 billion, agency personnel gave no clue that less than a week later CBO would increase its Arctic Refuge lease bonus bid estimate to $5.0 billion. To the best of this writer's knowledge, as of this date, CBO has not responded substantively to the senators' questions or provided any specific information to justify its estimates of projected budget revenue from Arctic Refuge lease bonus bids. (4)
The proposed White House budget for FY 2006 included $1.2 billion in federal revenue from a lease sale in 2007 and $0.1 billion from a second sale in 2009. These sums are predicated on the assumption that leasing on the Arctic Refuge Coastal Plain will raise a total of $2.6 billion in bonus bids, to be split 50-50 between Alaska and the federal government. In previous years, tucked away in the voluminous budget documents, the Interior Department advised budget makers that the government will lease 400,000 to 600,000 acres of the 1,500,000-acre Coastal Plain. That assumption, applied to the first lease, would bring the Administration's estimate to $4,000 to $6,000 per leased acre. (5)
Figure 1, below, summarizes the lease bonus revenue picture in broad term; this figure is an updated and inflation-adjusted version of the cover figure in the author's Jan. 15 report on lease bonus revenues.
On Feb. 21, the New York Times published an investigative piece on the Arctic Refuge debate by veteran reporter Jeff Gerth that suggested industry lack of interest in the Arctic Refuge. The article quoted an unnamed "Bush adviser" who told the New York Times that
On Feb. 23, citing this writer's January report, four members of the House of Representatives addressed a letter to the White House Office of Management and Budget asking OMB to "provide, in detail, the factors the OMB considered when calculating these extraordinarily high revenues." In a Senate Energy Committee hearing March 1, Alaska Senator Lisa Murkowski stated that she thought the lease bonus estimates were reasonable and asked Interior Secretary Gale Norton what she thought. The Secretary responded that the $2.4 billion figure was conservative and could go higher. The basis for this assertion? Secretary Norton cited CBO's $5.0 billion estimate. (7)
Secretary Norton's response was circular; instead of providing substantive information that would enable policy makers to review the bases for their estimates of lease bonus revenues, Secretary Norton used an estimate whose reliability is in question to prop up another. This writer's report on Arctic Refuge lease bonus revenues ended with this statement:
Despite the various efforts described here to get a clear picture of the models that have produced the government estimates of Arctic Refuge lease bonus estimates, the conclusion of the author's report on lease bonus revenues is as applicable at this writing as it was when the report was issued two months ago. How can such critical questions go unanswered? Part of the answer may be that Arctic Refuge lease bonuses would be only one very small part of a much larger national budget that is filled with numbers that are subject to argument.
Meanwhile, in Washington the deadline for budget decisions looms.
Arctic Refuge Production Profiles
Among the many energy-related subjects on which it reports, the EIA produces occasional estimates of Arctic Refuge production potential and the economic impacts of that production. In its most recent report, issued in March 2004, EIA concluded that development of the Arctic Refuge Coastal Plain would reduce U.S. imports in 2025 from 70 percent to 66 percent, based on peak production of 0.876 million barrels per day (bpd). This estimate, described as the "mean oil resource case," assumed total oil production of 4.21 billion barrels of oil. In its "high oil resource case," EIA projected that imports would be reduced to 64 percent, based on peak production of 1.59 million bpd and total production of 7.48 billion barrels. The EIA tied these estimates to the long-term forecast for oil prices in its 2004 Annual Energy Outlook and drew its estimates of field sizes from a three-year study of Arctic Refuge production potential by USGS, issued in 1998. (8)
Once again, the numbers are suspect.
Annual production estimates, combined, should represent total production from assumed Arctic Refuge discoveries. However, EIA only ran its model through 2025 - the 13th year of a much longer anticipated producing period and the last year of its national energy model to which the Arctic Refuge data were tied. This writer's attempt to match EIA's stated total production with a complete Arctic Refuge development scenario resulted in a peak production rate of approximately 0.700 million bpd, compared to EIA's 0.876 million bpd. From a public policy standpoint, this difference of nearly 20 percent in peak production is significant because annual production rates directly affect estimates of the potential effects of Arctic Refuge development on petroleum imports and other aspects of the economy. Additionally, in the high oil resource case the effects of the outdated model appear to be compounded by optimistic assumptions regarding field size. (9)
As outlined in the author's correspondence with EIA, the annual production estimates in the EIA's March 2004 report are derived from production profiles for the life of the individual fields that, combined, would represent total production from assumed Arctic Refuge discoveries. Annual production rates are typically determined by a combination of factors, such as (1) timing of development, (2) peak production rate (measured as a percentage of total production), (3) years to peak production, (4) years at peak production and (5) rate of decline from peak. The model that EIA used to establish field production profiles for the 2004 report was published in 1991. At that time, with the North Slope in its 14th year of production, there was little experience with North Slope field longevity or decline rates. In 2005, with an additional 14 years of experience on the North Slope, it appears that the outdated model compresses total production into a significantly shorter period of time than Alaska North Slope fields are likely to be in production. The assumptions of high peak production and decline rates are two of the critical model factors leading to this compression.
EIA states that its reports are policy-neutral, and that its goal is "to provide timely, high-quality information and to perform objective, credible analyses in support of the deliberations of both public and private decision makers." (10) Unlike the agencies making lease bonus revenue estimates, EIA deserves credit for making its assumptions and methodology public. When this writer pointed out that newer models were available, an EIA spokesman said the agency will consider that model in a reassessment of Arctic Refuge production estimates. However, substitution of the newer model for the 1991 model will not guarantee success; EIA will attain its stated goal only if it assures that the critical elements of its theoretical models are grounded in reality and applied in a manner that reflects knowledge gained from actual experience.
In this regard, consider EIA's high oil resource case, in which the effects of the outdated model appear to be exacerbated by optimistic assumptions regarding field size. Experience on the North Slope indicates that peak production and decline rates decrease as field sizes increase. Unless the model accounts for this critical piece of information, an assumption of larger fields will exacerbate the compression of total production into fewer years, resulting in higher estimates of annual production, relative to total production.
There is a curious interaction between the two economic issues discussed above. The two agencies that have attempted to assess the economics of Arctic Refuge production potential - EIA and USGS - declined to estimate the costs of lease bonus bids into their economic models. In the EIA "mean oil resource case," if oil companies bid $5.0 billion and produced 4.21 billion barrels of oil, that would increase the the cost of that oil by approximately $1.18 per barrel. That amount would have to be added to exploration and development costs. Not to mention the cost of transporting oil from the point of production on the Arctic Refuge Coastal Plain to the Trans-Alaska Pipeline System at Prudhoe Bay, estimated between $1.30 and $1.80 per barrel. (11) Since CBO and the White House have declined to provide substantive information regarding their models for estimating lease bonus revenues work, it is not possible to say how (or whether) their estimates of potential production from the Arctic Refuge Coastal Plain include these handicaps to development in that remote area, compared to oil already discovered or potentially available in the immediate vicinity of developed infrastructure in the existing Prudhoe Bay complex.
At this writing, it is not known whether good numbers will catch up with the bad ones as the legislative merry-go-round whirls in Washington, DC. In any event, the technical issues presented above are the kind of problems that should be resolved by the committee process. The proposal to insert leasing on the Arctic Refuge Coastal Plain into an omnibus budget bill undercuts the legislative system, in which such complexities would normally be dealt with by a standing committee with legislative responsibility for a piece of stand-alone legislation. In sum, the quest for better numbers adds to the reasons that the decision on the Arctic Refuge should not be dumped into an omnibus budget act.
Stepping back from these economic questions, it should be remembered that the difficulties of refining estimates of the revenue from lease bonus bids and the production potential of the Arctic Refuge Coastal Plain constitute just one part of the effort to bring the best possible information to this policy debate. In a broader context, at least three other arguments strongly tip the scales against Arctic Refuge development:
Notes to "The Arctic Refuge Numbers Game: Update"
1. See discussion in "The Arctic Refuge Numbers Game." Even without a Budget Act, Congress somehow muddles through, sometimes passing continuing resolutions until it can pass individual appropriation and authorization acts. On at least one occasion recent memory - in 1995 - government functions actually stopped temporarily; the Arctic Refuge was on the short list of items that caused this impasse.
2. The entries are scattered in various pages of the budget documents. For proposed lease revenues, see: Office of Management and Budget, The Budget for FY2006, Summary Of Tables, p. 349 (Table S-6)
3. Congressional Budget Office, "Open the Coastal Plain of the Arctic National Wildlife Refuge to Leasing," (in Budget Options, Feb. 2005, "300 - Natural Resources and the Environment," Option #300-09, p. 100).
4. For some of the issues discussed in that meeting, see Richard A. Fineberg, letter to Ms. Kathleen Gramp, Budget Analyst, CBO, Feb. 14, 2005. (This letter was written before word of CBO's new, higher estimate was announced.)
5. Although the acreage language does not appear in this year's proposal, Interior Secretary Gale Norton told the Senate energy Committee March 1 this year's proposal is calculated on the same basis as previous years (unofficial transcript of U.S. Senate Energy and Natural Resources Committee testimony, March 1, 2005).
6. Jeff Gerth, "Big Oil Steps Aside in Battle over Arctic," New York Times, Feb. 21, 2005.
8. U.S. Energy Information Administration, Analysis of Oil and Gas Production in the Arctic National Wildlife Refuge, March 2004 (Report No. SR/OIAF/2004-04), pp. 2, 5, 6, 7.
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