Arctic Analysis: Taxes and Arctic Resource Development

By Kevin Casey Two recent developments have called attention to the role that taxation plays in oil and gas exploration and development in the Arctic. First came announcements by BP and ConocoPhillips of significant new investments in Alaska’s North Slope in response to the state’s recent reduction in oil taxes.[1] Second came the decision by Statoil to delay its planned investment in the Johan Castberg field in the Barents Sea after the Norwegian government announced an increase in the tax rate on oil and gas producers.[2] The prevailing interpretation of these events, plain to see in the headlines, is that tax increases stifle investment while tax decreases encourage development and exploration. While these maxims are partly true, a closer look at the similarities and differences between these two examples reveals that taxation is only one of many important factors that shape investment decisions such as these in the Arctic. While taxation will continue to play an important role in shaping Arctic energy development, this role should not be exaggerated.

First, let’s look at the Alaskan example. On May 21 Alaska Governor Sean Parnell signed into law Senate Bill 21.[3] The bill, the result of lengthy deliberations in the Alaska legislature, seeks to correct the perceived deficiencies of the last adjustment to Alaska’s oil tax regime, the Alaska Clear and Equitable Share (ACES) Act which was passed in 2007 during the governorship of Sarah Palin. ACES established a 25% baseline tax and a progressive surcharge on net profits pegged to the price of oil. Under ACES, as prices rose, the state took a higher cut in taxes, approaching and exceeding 75% at high prices.[4] ACES provided various credits, particularly aimed at increasing production in new fields. In spite of these credits, investment in the North Slope continued to lag and production declines continued. Industry complained that progressive surcharges severely limited upside profit potential on large projects, thus discouraging investment.[5] Without significant investment, production levels were in danger of falling below 500,000 barrels a day, a development which would cause significant problems for the Trans-Alaska Pipeline.[6]

The purpose of Senate Bill 21 was to establish a more attractive climate for investment on the North Slope. The bill did away with the progressivity of ACES and set a flat rate on oil profits at 35%, placing the total government take (including federal income taxes) at around 60-62%.[7] The bill also sought to correct perceived imbalances in ACES subsidies and credits for new investment. ACES provided credits of up to 60% of the cost of production, but only on new fields outside of existing North Slope units.[8] This acted as a disincentive for production improvements for existing fields. The new tax bill extends these credits to new developments within legacy fields, encouraging new investment that will increase efficiency and production at these fields. Will the bill have the intended effect?  Both BP and ConocoPhillips announced new investments at legacy fields, rather than in new fields.[9]

On the surface, Norway suffers from some of the same problems as Alaska: falling production from legacy fields and expansion into new fields in remote locations like the Barents Sea that require significant investments to bring on-line. Both Norway and Alaska depend heavily on oil and gas revenues. Oil and gas taxes make up between 80 and 90 percent of Alaska’s general fund budget on a yearly basis.[10] While oil and gas revenues make up a smaller portion of Norway’s government revenues (26% in 2012), these revenues remain essential for funding the country’s generous welfare programs.[11] There are, however, significant structural differences between the two countries’ approaches to the oil industry. First, Norway does not charge royalties on oil and gas while exacting higher overall taxes through corporate and production taxes, which together yield a 78% government take.[12] Second, Norway derives additional profits from oil and gas through its 67% interest in Statoil and through participation in offshore oil and gas projects by state-run Petoro. All of Petoro’s revenues from shares in particular leases are either reinvested or transferred to state coffers.[13] Third, Norway’s declining crude oil production has been tempered somewhat by increased production of natural gas which has continued to buoy revenues.[14] Alaska is also rich in gas, but plans for a pipeline to bring North Slope gas to market have not come to fruition due to high costs, and the state’s production has languished.[15]

Norway’s recent modifications to its oil and gas taxes were much more modest than Alaska’s, and reflect both different objectives and differences between Norway’s tax structure and Alaska’s. Norway intends to enact a 1% increase in the tax on oil company profits while at the same time balancing that with a 1% decrease in its corporate tax rate.[16] Norway’s decision to raise taxes was not driven by the need to develop more revenue, or to stop exploration and development of new fields (though that may be a second-order impact), but rather to correct an economic imbalance brought about by continued growth of the oil sector in comparison to Norway’s other industries.[17]  The oil sector dwarfs Norway’s other industries in share of GDP (23%) and total exports (52%).[18] This can tend to crowd out other industries by distorting the labor market, monopolizing investment and driving inflation. By raising taxes on the oil industry while dropping them on other sectors, the government hopes to cool the oil sector and provide more breathing room for non-oil sector growth.  Norway’s tax decision, then, is driven by macroeconomic concerns, and not narrowly by concerns with oil production.

The industry’s response to the tax reforms in Alaska and Norway was swift and predictable. Oil majors that had lobbied heavily for tax reform in Alaska welcomed the new law. BP and ConocoPhillips announced new investments focused on increasing production at legacy fields on the North Slope,[19] through skeptics say the timing of these announcements was more political than anything. And the controversy over the new law is far from over: a petition to submit the new law to a state-wide referendum is on track to collect the required signatures by 13 July.[20] In Norway, Statoil announced that the 1% tax increase would cause it to rethink its development plan for the Johan Castberg project in the Barents Sea, though once again taxes are only part of the story. Statoil is still uncertain about resource estimates for the field and delays in development of shore-based infrastructure to support the project.[21] In both cases, it is difficult to separate out what is political posturing on the part of industry and what the actual impact of the new tax rates will be.

A final and somewhat intangible element of the ongoing debate on oil and gas taxes in Alaska and Norway is the importance of a stable and predictable investment climate. Industry obviously likes stability as it allows them to more accurately predict the costs and revenues of large projects that can stretch over many years. The fact that a government can choose to modify tax rates at any time adds an element of risk and uncertainty. The larger and more long-term the project, the more the risk. A prominent industry critique of Norway’s tax increase is that the government’s decision to tweak tax rates undercuts the country’s reputation for a stable investment environment.[22] While stability is certainly an important factor that investors must consider, it is also difficult to quantify and highly subjective. While Alaska’s oil tax reforms were much more radical than Norway’s, we heard little from the oil industry about how Alaska’s reforms undercut a stable and predictable investment environment.

What does all this mean, if anything, about the future of oil and gas development in the Arctic? First, these recent events show that the factors impacting development decisions in each Arctic state are diverse, highly contextual, and politically charged. Taxation and its relationship to overall fiscal policy is an important factor but hardly the only factor. However, because the development of Arctic resources will in the near term be characterized by high investment requirements and narrow profit margins, small changes in tax policy have the ability to make or break individual development projects. Second, political decisions on taxation will be made based mostly on factors that are in some senses exogenous to the issue of Arctic energy development. As such, it is important to understand the role that national and regional fiscal policies (and the politics that drive them) play in encouraging or inhibiting Arctic energy development. Third, the elephant in the room remains tight oil and gas. As unconventional resource extraction continues to expand around the globe, tight oil and gas plays are presenting more attractive investment opportunities for major oil companies and competing for a limited pool of global investment funds. Statoil has made significant investments in tight oil and gas development in Australia and the US, and is exploring similar opportunities in China and Argentina.[23] The additional downward pressure on resource prices will continue to affect calculations on Arctic energy development in places like Norway and Alaska. Though taxation remains an important factor in shaping these calculations, it remains one among many and we should be careful not to exaggerate its influence.  It is the complex interaction of all these factors and not one alone which will determine the course of Arctic energy development. 

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[1] Dlouhy, Jennifer. “BP to spend $1 billion in Alaska’s North Slope,” FuelFix, June 2, 2013, http://fuelfix.com/blog/2013/06/02/bp-to-spend-1-billion-in-alaskas-north-slope-2/.

[2] Reed, Alastair. “Statoil delays Barents Sea oilfield project after tax boost,” Bloomberg, June 5, 2013, http://www.bloomberg.com/news/2013-06-05/statoil-delays-castberg-oil-project-amid-unexpected-tax-rise-1-.html.

[3] A full text of the law can be found here: http://www.legis.state.ak.us/basis/get_bill_text.asp?hsid=SB0021Z&session=28.

[4] Alexander Weber, Nicole Crighton, Maria Keating and Dale Berg. “Alaska’s Clear and Equitable Share (“ACES”) production tax and available credits,” What’s News in Tax, KPMG (2011), 2., http://www.us.kpmg.com/microsite/taxnewsflash/2011/Feb/AK_ACES.pdf

[5] Marks, Roger. “Alaska’s oil and gas production tax severely limits upside profit potential,” Oil and Gas Journal, September 1, 2013.  http://www.ogfj.com/articles/print/volume-7/issue-9/features-/alaska_s-oil_and_gas.html.

[6] Alyeska Pipeline Service Company. Final Report: Low Flow Impact Study, June 15, 2011, 1,  http://www.alyeska-pipe.com/assets/uploads/pagestructure/TAPS_Operations_LowFlow/editor_uploads/LoFIS_Summary_Report_P6%2027_FullReport.pdf.

[7] Bradner, Tim. “Senate passes oil tax reform,” Alaska Journal of Commerce, March, 2013.  http://www.alaskajournal.com/Alaska-Journal-of-Commerce/March-Issue-3-2013/Senate-passes-oil-tax-reform/.

[8] Keithley, Brad. “Alaska oil policy – Out of alignment,” Thoughts on Alaska Oil and Gas, November 4, 2012, http://bgkeithley.com/2012/11/04/the-third-in-the-alaska-business-monthly-series-alaska-oil-policy-out-of-alignment-from-the-november-2012-alaska-business-monthly/.

[9] “ConocoPhillips Plans to Increase Investment in Alaska Following Oil Tax Reform Legislation,” Alaska Business Monthly, http://www.akbizmag.com/Alaska-Business-Monthly/April-2013/ConocoPhillips-Plans-to-Increase-Investment-in-Alaska-Following-Oil-Tax-Reform-Legislation/.  DeMarban, Alex. “BP to add rigs, wells on Alaska's North Slope after oil-tax cut,” Alaska Dispatch, June 3, 2013, http://www.alaskadispatch.com/article/20130603/bp-add-rigs-wells-alaskas-north-slope-after-oil-tax-cut.

[10] Alaska’s Oil and Gas Fiscal Regime – A Closer Look from a Global Perspective, Alaska Department of Revenue, January, 2012, 9,  http://www.revenue.state.ak.us/acloserlook.pdf.  In 2012, oil revenues accounted for a record 92% of Alaska’s general fund budget.

[11]Norway Country Analysis Brief, US Energy Information Administration, December 17, 2012, http://www.eia.gov/countries/analysisbriefs/Norway/norway.pdf.

[12] Alaska’s Oil and Gas Fiscal Regime – A Closer Look from a Global Perspective, 29.

[13] Persily, Larry. “Norway’s different approach to oil and gas development,” Office of the Federal Coordinator for Alaska Natural Gas Transportation Projects, September 7, 2011,  http://www.arcticgas.gov/norway%E2%80%99s-different-approach-to-oil-and-gas-development.  This revenue and investment stream, known as the State Direct Financial Interest (SDFI), accounts for a significant portion of Norway’s revenues from oil and gas on a yearly basis.  Petoro generally takes a 20% stake in new leases.  Petoro’s revenues account for anywhere from 30 to 50% of the state’s total oil and gas revenues in any given year.

[14] Lars-Jakob Alveberg and Eldbjørg Vaage Melberg, eds., Facts 2013: The Norwegian Petroleum Sector, Ministry of Petroleum and Energy, March 2013, 23, http://npd.no/en/Publications/Facts/Facts-2013/.

[15] US Energy Information Administration, “Alaska Natural Gas Marketed Production,” http://www.eia.gov/dnav/ng/hist/n9050ak2a.htm.

[16] Treloar, Stevan. “Norway raises oil taxes in bid to ease cost pressures on economy,” Bloomberg News, May 5, 2013, http://www.businessweek.com/news/2013-05-05/norway-raises-oil-taxes-in-bid-to-ease-cost-pressures-on-economy. 

[17] Keithley, Brad. “Alaska Oil – Missing the Point,” Thoughts on Alaska Oil and Gas, May 6, 2013.  http://bgkeithley.com/2013/05/06/alaska-oil-missing-the-point/.

[18] Lars-Jakob Alveberg and Eldbjørg Vaage Melberg, eds., Facts 2013: The Norwegian Petroleum Sector, Ministry of Petroleum and Energy, March 2013, 23, http://npd.no/en/Publications/Facts/Facts-2013/.

[19] Bradner, Tim. “Slope investments may top $5B with BP plans,” Alaska Journal of Commerce, June 6, 2013, http://www.alaskajournal.com/Alaska-Journal-of-Commerce/June-Issue-2-2013/Slope-investments-may-top-5B-with-BP-plans/.

[20] Martin, Eli. “Deadline looming, Alaska oil tax repeal petition gains momentum,” Alaska Dispatch, June 11, 2013.  http://www.alaskadispatch.com/article/20130611/deadline-looming-alaska-oil-tax-repeal-petition-gains-momentum.

[21] “Statoil recommends Johan Castberg project delay,” Oil and Gas Journal, June 10, 2013, http://www.ogj.com/articles/print/volume-111/issue-6a/general-interest/statoil-recommends-johan-castberg-project-delay.html.

[22] Reed, Alastair. “Statoil Delays Barents Sea Oilfield Project After Tax Boost,” Bloomberg, June 5, 2013.  http://www.bloomberg.com/news/2013-06-05/statoil-delays-castberg-oil-project-amid-unexpected-tax-rise-1-.html.

[23] Paton, James. “Statoil seeking shale oil opportunities in Australia, China.” Bloomberg, September 21, 2012, http://www.bloomberg.com/news/2012-09-21/statoil-seeking-shale-oil-opportunities-in-australia-china.html.

[24] Chris Arsenault. Retrieved February 20th 2012 from snippits-and-slappits.blogspot.com/2011/05/wikileaks-battle-to-carve-up-arctic.html

Arctic Oil and Gas: Assessing the Potential for Hydrocarbon Development in the Polar Region

By Andreas Østhagen The U.S. Geological Survey (USGS) world petroleum assessment from 2000 estimated that 25% of the remaining recoverable undiscovered oil and gas resources in the world were located in the Arctic region. Although these figures proved inaccurate and were subsequently revised downward, e.g. in the 2008 Circum-Arctic Resource Appraisal, the assessment was sufficient to brand the Arctic region as a “new energy province.” In the following years a number of international oil companies, such as Shell Oil, Total, and ExxonMobil, secured drilling rights during various licensing rounds. The significant hydrocarbon reserves contributed to the Arctic region being moved into the focus of world politics over the past decade. With the hope to gain access to the debate surrounding the quickly changing region a number of countries, including China, Singapore and Italy, submitted applications for permanent observer status on the Arctic Council.

A closer examination of oil and gas development in the “High North” reveals that despite significant undiscovered reserves a nuanced investigation of the concept of Arctic oil and gas is needed before any accurate and reliable predictions can be made on the future of the region hydrocarbon potential.

First, Arctic petroleum development is inherently dependent on commercial profitability. Sustained high oil and gas price levels, in combination with the cost of extraction, are the main determinants in the decision to invest in Arctic extraction. Price levels for oil have remained at an annual average of almost $100 per barrel since 2008 allowing for an interest in Arctic resources to develop. The International Energy Agency (IEA), and the world markets, however, expect the price to fall in the long term. The IEA also argues that the cost of Arctic oil production will be very high, ranging anywhere between forty to one hundred dollars per barrel. Should these predictions come true, the profitability of Arctic oil extraction will be dramatically reduced.

Similarly, the natural gas spot price for the North American market has  seen a remarkable shift over the last decade. Natural gas prices rose sharply prior to 2009, prompting interest in Arctic natural gas. In 2010, however, following a sudden boom in domestic shale gas production, the United States embarked on a path to self-sufficiency with price levels dropping subsequently for the whole of North America. As a result natural gas from the High North will not be as profitable as originally predicted.

A second obstacle to Arctic petroleum development is environmental concerns. In the North American Arctic, as elsewhere, the public is concerned about the environmental risks related to oil and gas extraction. The 1989 oil spill from the tanker Exxon Valdez in Alaska, and more recently, the Deepwater Horizon accident in the Gulf of Mexico in 2010, serve as public reminders of the potential consequences of drilling activity in ecologically sensitive areas. Greenpeace’s “Save the Arctic” campaign has successfully taken advantage of this public sentiment. Litigation and activism by indigenous communities and local NGOs have also successed in halting halted much of the Chukchi Sea development in Alaska.

As more and more attention is paid to the Arctic, it becomes increasingly difficult for political decision makers, cognizant on their public image, to strike the right balance between economic interests on one hand and environmental risk on the other. Discussions concerning Arctic oil and gas activities often inspire protests and public outcry and the power of civic engagement, in terms of halting or delaying the processes of oil and gas development, should not be underestimated.

A third hindrance comes from the friction caused when regional interests collide with those of the Federal government. The people and local governments of Alaska, for example, are increasingly interested in mineral and oil extraction to boost local employment levels and tax bases. Washington, D.C., however, is wary of the political consequences of moving forward with unpopular oil and gas projects. The deadlock between these two competing interests constitutes yet another hindrance for the rapid petroleum development in the Arctic.

Although the Arctic undoubtedly contains a vast amount of natural resources, its status as a “new energy province” should not go unquestioned. As highlighted, there are significant economic and political factors that need to be considered before Arctic oil and gas development becomes a reality. Canada takes over the chair of the Arctic Council in May of this year, followed by the United States in 2015. Awareness of these issues is therefore essential, as the debate on drilling for oil and gas in the North American Arctic will only intensify in the future.

This article was first published in The Fletcher Forum of World Affairs and is re-published here with permission.

Interview with Ruth Davis, Senior Political Advisor at Greenpeace International (Part 2/3)

By Tom Fries Greenpeace's "Save the Arctic" campaign has had several different high-profile initiatives, including the "Arctic Ready" website collecting fake Shell ads, phalanxes of polar bears protesting at Shell stations around the world, and the highly-publicized recent action at the Prirazlomnoya platform in Russia. But the campaign can seem like something of a blunt instrument - polar bears good; Shell bad. But is that really all there is? In this podcast, Tom Fries talks with Ruth Davis, Senior Political Advisor at Greenpeace International, about the particular policies that Greenpeace is looking for, how the "Save the Arctic" campaign fits in to the broader portfolio of Greenpeace's activities, and why it is that Greenpeace feels people outside the Arctic should have a say in what is done there.

Offshore Oil Drilling in the U.S. Arctic, Part Three: Concerns and Recommendations

This article is the third of three in a series on Offshore Oil Drilling in the U.S. Arctic.

By Nicholas Cunningham On February 17, 2012, the U.S. Department of Interior (DOI) approved of Shell Gulf of Mexico Inc.’s Oil Spill Response Plan (OSRP), the last major hurdle to allowing Shell to move forward with offshore oil drilling in the Chukchi Sea.[i]In theory, Shell has developed a plan to guard against the environmental fallout of a hazardous incident, including a well blowout. Shell has safety vessels standing by, oil collection equipment on hand, and technology ready to drill a relief well in the event it needs to stop a blowout.

The reformed Department of Interior believes Shell has adequately demonstrated safety preparedness and response, ensuring against another environmental crisis comparable to the BP/Deepwater Horizon incident in 2010. However, Shell’s OSRP is unproven. It does not fill the fundamental gaps that pervade the regulatory structure of offshore oil drilling, nor does it ensure against a catastrophic blowout.  Very little has changed since the blowout in the Gulf of Mexico – there have been only minor reforms to environmental and safety oversight and no legislative action to address the root causes. Also, the science on Arctic ecosystems remains insufficient, and the effects of such a spill are unknown. Before offshore oil drilling commences in the Arctic, these problems need to be addressed.

CONCERNS

Environmental Sensitivity and Risks to Marine Ecosystems

The Chukchi and Beaufort Seas are home to a diverse array of marine life, including salmon, herring, walrus, seals, whales, and waterfowl.5 Additionally, the Chukchi Sea is home to higher occurrences of benthic marine fauna relative to other Arctic habitats.6 Scientific understanding of these ecosystems and the anthropogenic effects on them, are both not yet sufficiently understood.

Oil drilling in the marine environment has been shown to have deleterious effects on the marine environment. Evidence suggests that noise from seismic surveys conducted during oil exploration damage acoustic animals such as whales, which can ultimately lead to fatalities if within close proximity.[ii]While whales can generally alter migration patterns to avoid such dangers, an increase in industrial activity may push whales further away from preferred habitats, potentially damaging feeding or spawning patterns. Increased tanker traffic associated with higher oil exploration and production will worsen noise pollution in the Chukchi and Beaufort Seas.

Additionally, the impacts of hydrocarbon releases in the marine environment have been shown to cause detrimental impacts on reproductive health, immunological and neurological functioning, as well as higher incidences of mortality for marine wildlife.[iii]Contaminants from oil and gas drilling are also believed to travel higher up on the food chain, ultimately having cascading effects for marine ecosystems. Shell’s 2012 exploration plans include drilling exploratory wells in the Chukchi Sea, where bowhead whales migrate to during the spring months.[iv]

The National Wildlife Federation released a report in April 2012 detailing some of the scientific findings of the effects on the Gulf of Mexico from the Deepwater Horizon incident. An estimated 523 dolphins were reported stranded in the oil spill area, 95% of which were dead.[v] These strandings are four times the historic average. The Gulf of Mexico is also the spawning grounds of the Bluefin Tuna, and contact with oil may have reduced juvenile Bluefin Tuna by as much as 20%.[vi]These are only a few examples of the damage that can be done due to an oil discharge. While scientific evidence suggests drilling will damage the marine environment, the full impacts are not well understood, which will be discussed further below.

Lack of Science on Arctic Ecosystems

Ultimately, the effects of a very large oil spill on the marine environment in the Chukchi and Beaufort Seas are unknown. Since oil production in the Arctic thus far has been limited, impacts have not been thoroughly studied.[vii]Moreover, even the effects of the Deepwater Horizon blowout are so far unknown; the full effects will require years of careful scientific study.

The lack of scientific evidence presents critical concerns about further oil and gas development in the Arctic. The U.S. Geological Survey released a report in June 2011, detailing the gaps in scientific knowledge on the effects of an oil spill in the Arctic.[viii] In particular, the USGS report notes that “[n]umerous efforts have been unsuccessful at developing a transparent, quantitative, and comprehensive method to assess cumulative impacts.”[ix]The report issued three recommendations, “(1) large-scale synthesis of data and information, (2) enhanced dialog and collaborative science planning, and (3) a more transparent and inclusive planning and decision-making process.”

However, the acquisition of scientific knowledge on the Arctic has been relegated to a secondary priority when oil and gas development are in question. When BOEMRE submitted the supplemental environmental impact statement to comply with the court order that allowed Lease Sale 193 to proceed, BOEMRE ostensibly agreed that science should guide permitting decisions, but its submission allowed Shell to move to the next phase of permitting. Oceana, a marine conservation group, criticized BOEMRE and its SEIS, noting that despite submitting additional forecasts on the impact of a “very large oil spill” on the environment, the models were simply conjecture. [x]Literally nothing has changed about the general lack of scientific knowledge that exists on effects of Arctic ecosystems from oil drilling.

Inherent Risk of Deepwater Drilling

Offshore oil drilling is a highly complex and technologically advanced industrial activity. The Deepwater Horizon blowout demonstrated that despite innovative technology, drilling is inherently a risky operation and safety is not absolutely certain. The problems with drilling safety are compounded in the Arctic. Shorter days, harsh weather, presence of ice and lack of infrastructure are just some of the additional problems in the Chukchi and Beaufort Seas that do not exist in the Gulf of Mexico. Aware of these risks, Shell has only been given legal permission to drill during the warmer months of July to October.[xi]

Additionally, lessons learned from the Deepwater Horizon blowout have not translated into increased safety for offshore oil and gas drilling. As of mid-April 2012, French oil and gas firm Total was still struggling with a weeks-old gas leak off the coast of Scotland.[xii]A massive natural gas leak continues to flow uncontrolled, sparking concerns that if ignited, a massive explosion could occur. Total has begun to drill a relief well to kill the leak. Also, Chevron Corp. faces up to $22 billion in environmental damages in Brazil, for allowing 3,000 barrels of crude oil to leak into the ocean off the coast of Rio de Janeiro in November 2011.[xiii]Executives are potentially facing time in prison. Shell is also facing litigation in Nigeria for its accident at its Bonga offshore oil facility in December 2011. Fifty-five local communities in Nigeria impacted by the oil spill are filing a case against Shell for spilling 40,000 barrels of oil into the ocean.[xiv]While the industry would claim that drilling operations have grown much safer since the Deepwater Horizon and that these are isolated incidents, they merely demonstrate that offshore oil drilling remains inherently risky.

Inadequate Resources for Regulatory Oversight

Regulatory oversight is critical for ensuring safe offshore operations. Inspections of drilling equipment and operations were woefully inadequate. The newly reconstituted BOEMRE vowed to increase inspections and allocate more resources to oversight. However, oversight remains inadequate. Oceana noted in a new report that only one-quarter of the inspectors needed to effectively oversee the Gulf of Mexico have been hired.[xv]Additionally, inspections of platforms actually declined by 13% from 2010 to 2011.

Moreover, a lack of safety culture within the industry and the pursuit of cost cutting to enhance profits have exacerbated risk. Records of BP’s oil spill response plan submitted to the Department of Interior show a careless approach to safety. According to the National Commission on the BP oil spill, the designated lead person for oil spill response on BP’s application had been deceased for several years before the submission.[xvi]  Also, BP listed seals and walruses as animals that could be affected by an oil spill. Since seals and walruses do not live in the Gulf of Mexico, the error proves that BP must have literally copied an application from a different drilling project.[xvii]

Unproven Oil Spill Response

While the technology used in deepwater oil extraction has dramatically improved over the last several decades, oil spill response has remained largely unchanged. Although the U.S. government has setup several bodies [xviii]to address oil spill response and recovery, there has been little innovation in oil spill response.

In the event of an oil spill, response and cleanup operations involve oil containment, skimming, and even burning. These are techniques that have not changed since the Exxon Valdez spill in 1989.[xix]Shell has included similar operations in its oil spill response plan for the Arctic.

Moreover, confusion reigned during the response to the blowout in the Gulf of Mexico. Under the Oil Pollution Control Act of 1990, the “responsible party” (BP in this case) plays an active role in responding and controlling the oil spill. This created confusion as the Coast Guard was forced to alternately cede control and take the lead at different points in the response.

In the Arctic, the situation is unchanged. Shell has planned to use skimming for oil spill containment, and a “capping stack” to contain a well, similar to one used in the BP response. The Government Accountability Office noted in a report in February 2012 that these technologies could face technical and logistical problems in the Arctic. If a blowout were to occur at the end of drilling season in October, surface ice could prevent an effective response.[xx]Also, ice near the seafloor could prevent the use of the capping stack to contain the well. Despite Shell’s plan to have oil spill response equipment and vessels ready to respond, poor infrastructure and the lack of redundant equipment call into question their readiness.[xxi]

RECOMMENDATIONS

Based on the problems identified above, Arctic drilling plans should be suspended until the multiple gaps can be closed. The following recommendations should be considered to address these issues:

Congress should codify enhanced regulations by the Department of Interior

The Department of Interior took several steps in the aftermath of the Deepwater Horizon blowout, implementing rules to address drilling safety and technology. In particular, the Interim Drilling Safety Rule required higher technology standards for the blowout preventer and the blind shear rams, as well as other technical and safety requirements. The Workplace Safety Rule established performance-based standards for the workplace, including safety protocol, management practices, and environmental safeguards to address the safety culture onboard drilling rigs.

Both of these rules have addressed some safety and operational gaps. However, the longevity and permanence of these rules is uncertain, as executive initiatives can easily be undone in subsequent administrations. Were an administration more favorable to oil drilling to assume office, these rules could be scrapped. To address this, Congress should codify these rules into law, effectively shielding them from political whims.

More resources should be allocated to BOEM and BSEE

Effective regulatory oversight requires the resources to do so. Inspections of oil rigs remains inadequate, and more resources to BSEE are needed. Industry safety culture may not change on its own, and only rigorous oversight will ensure technical and operational standards are being complied with. Also, BOEM should be allocated more resources to enhance review and oversight of lease applications. The oil industry has shown a pattern of submitting lease applications with false or incomplete data while still receiving regulatory approvals. More resources are needed to bolster oversight.

A high-level commission on Arctic science should be established

The effects of oil spills on the marine environment are still not well understood, particularly in the Arctic. While exposure to oil spills damages many species of marine life, the full effects on the broader ecosystems remains unclear. A high-level commission to study the ecosystems in the Arctic should be setup, and its charter should include studying the effects on the marine environment of an oil discharge in the Chukchi and Beaufort Seas. The results could be used to determine the best course for permitting oil drilling leases in the Arctic.

Federal resources should be dedicated to oil spill response

Oil spill response technology and techniques have not kept pace with drilling technology. As offshore oil operators move further into deepwater, oil spill response has remained largely unchanged for decades. To ensure oil spills can be contained, innovation is needed in oil spill response. The Interagency Coordinating Committee on Oil Pollution Research (ICCOPR) was setup under the Oil Pollution Act of 1990 to conduct research on oil pollution, but only recently began a program on spill response. It currently lacks sufficient resources to drive innovation in oil spill response. Congress should allocate federal resources to the ICCOPR to boost oil spill response research.

Offshore oil drilling in the Chukchi and Beaufort Seas should be suspended until other recommendations are implemented

As noted above, despite advancements in technology, offshore oil drilling is inherently risky. Drilling in new frontiers, such as the Arctic, presents additional risks that do not exist in warmer regions. Until safety can be assured and the effects of oil on the marine environment are scientifically understood, oil drilling in the Chukchi and Beaufort Seas should be put on hold.

CONCLUSION
Shell will begin exploratory drilling in the Chukchi Sea in the summer of 2012, marking the beginning of a new era in offshore oil drilling. The Arctic represents the last great frontier for oil exploration, with a potentially large prize for those companies willing to invest in the region and brave the harsh Arctic elements. However, risks abound. The Deepwater Horizon blowout demonstrated the dangers of offshore oil drilling and the lack of oversight of an industry that has repeatedly cut corners to boost profits. The National Commission on the oil spill convincingly detailed the gaps that exist in the regulatory regime, but little has been reformed. Without robust regulatory oversight, one cannot be assured the problems onboard the Deepwater Horizon will not be repeated in the Chukchi and Beaufort Seas.  Moreover, the lack of scientific understanding of the ecosystems in the Arctic suggests the magnitude of the impacts of oil drilling and a potential oil discharge is unknown. Until these issues can be resolved, offshore oil drilling in the Chukchi and Beaufort Seas should not move forward.

[i] U.S. Department of the Interior. (2012, February 17). BSEE Issues Approval for Shell Chukchi Sea Oil Spill Response Plan. Washington DC.
[ii] Laboratory of Applied-Acoustics. (2012). Sons de Mar. Retrieved April 10, 2012, from
http://www.sonsdemar.eu/sonsdemar.php

[iii] Huntington, H. (2009). A Preliminary Assessment of Threats to Arctic Marine Mammals and Their Conservation in Coming Decades. Marine Policy, 78.
[iv] MarineBio. (2002). Bowhead Whales. Retrieved April 10, 2012, from MarineBio web site: http://marinebio.org/species.asp?id=278
[v] National Wildlife Federation. (2012). A Degraded Gulf of Mexico: Wildlife and Wetlands Two Years Into the Gulf Oil Disaster. NWF. 4.

[vi] Ibid. 5.
[vii] Huntington, H. (2009). A Preliminary Assessment of Threats to Arctic Marine Mammals and Their Conservation in Coming Decades. Marine Policy, 79.
[viii] Holland-Bartels, L., & Pierce, B. (2011). An Evaluation of the Science Needs to Inform Decisions on Outer Continental Shelf Energy Development in the Chukchi and Beaufort Seas, Alaska. Washington DC: USGS.

[ix] Ibid.
[x] Oceana. (2011, August 18). Final Supplemental Environmental Impact Statement Released for Chukchi Sea Lease Sale 193. Retrieved March 26, 2012, from Oceana web site: http://oceana.org/en/news-media/press-center/press-releases/final-supplemental-environmental-impact-statement-released-for-chukchi-sea-lease-sale-193
[xi] Shell (May 2011). Bird Strike Avoidance and Lighting Plan Chukchi Sea, Alaska. 1. http://alaska.boemre.gov/ref/ProjectHistory/2012_Shell_CK/revisedEP/AppendixI.pdf
[xii] Urquhart, F. (2012, April 19). Total gas leak: No marine contamination found near Elgin platform. news.scotsman.com, http://www.scotsman.com/news/environment/total-gas-leak-no-marine-contamination-found-near-elgin-platform-1-2240907#.
[xiii] Millard, P., & Brasileiro, A. (2012, April 4). Chevron Brazil Suits Double to $22 Billion With New Claim. Bloomberg News, pp. http://www.businessweek.com/news/2012-04-03/chevron-sued-for-another-11-billion-on-brazil-oil-spill
[xiv] Amaize, E. (2012, March 27). Bonga spill: 55 communities sue NOSDRA, Shell. Vanguard, pp. http://www.vanguardngr.com/2012/03/bonga-spill-55-communities-sue-nosdra-shell/.
[xv] Oceana. (2012). Offshore Drilling Reform: Report Card 2012. Washington DC: Oceana.
[xvi] National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling. (2011). Deep Water: The Gulf Oil Disaster and the Future of Offshore Drilling. 133.
[xvii] Ibid. 133.
[xviii] The Interagency Coordinating Committee on Oil Pollution Research (ICCOPR) was created under the Oil Pollution Act of 1990 and its purpose was to establish a comprehensive federal research program for oil pollution. Also, under the same legislation, the Oil Spill Recovery Institute (OSRI) was established, which was another multiagency advisory board for oil spill response and recovery.
[xix] Ibid. 133.
[xx] Government Accountability Office. (2012). Interior Has Strengthened Its Oversight of Subsea Well Containment, but Should Improve Its Documentation. Washington DC: GAO. 23.
[xxi] Ibid. 24.

Offshore Oil Drilling in the U.S. Arctic, Part Two: The Legacy of Deepwater Horizon

This article is the second of three in a series on Offshore Oil Drilling in the U.S. Arctic. 

By Nicholas Cunningham On April 20, 2010, the Macondo well controlled by BP and the rig operator, Transocean, experienced a blowout, resulting in the worst environmental catastrophe in U.S. history.[i]The Deepwater Horizon rig suffered multiple explosions causing the death of eleven workers, ultimately sinking in a fiery blaze after two days. The gusher of oil continued for 87 days, with an estimated total of 4.9 million barrels of oil dumped into the ocean before the well was finally sealed.[ii]

The causes of the failure were multiple, with a series of failures along multiple steps in the drilling process culminating in the eventual blowout. The National Commission setup by President Obama to investigate the causes of the blowout detailed the failures in its final report. For one, the regulators responsible for drilling safety had a conflict of interest, responsible for both oversight and revenue collection. The Minerals Management Service (MMS) had the incentive to approve an expansion of offshore oil drilling due to the billions of dollars of revenues from lease sales and royalty payments, which conflicted with its expressed mandate of environmental protection and drilling safety.[iii]

Furthermore, the oversight that was conducted by MMS was often inadequate. MMS regulators would conduct both annual inspections of rigs as well as unannounced inspections, as required under the 1978 OCSLA amendments.[iv]Inspectors would check for compliance in pollution control, drilling, well completion, electrical and personal safety among other requirements. However, over the past few decades, offshore oil drilling has mushroomed and the resources available to MMS have not kept pace.[v]

Safety regulations governing the practices of offshore drilling were also found to be inadequate. Despite several high profile oil spills in the late 1980’s, including the Exxon Valdezspill, MMS failed to enact meaningful reform.[vi]MMS considered several measures to make the regulatory regime more rigorous, but delayed rulemaking, under the pressure from the American Petroleum Institute (API), an industry trade group.[vii]Twenty years passed without an upgrade in regulatory oversight. The BP Commission argues that an informal understanding coalesced between the industry and the regulators, with the oil industry convincing the regulators that technology had progressed so considerably that regulations were not needed.[viii]Instead, MMS merely urged the industry to take voluntary action to operate safely.

REFORMS IN THE WAKE OF THE DEEPWATER HORIZON BLOWOUT

Regulatory Reforms

The Minerals Management Service (MMS) was temporarily reconstituted as the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE). However, final reforms were made in October 2011, by dividing the functions of the now defunct MMS into three bodies: the Office of Natural Resources Revenue, responsible for revenue collection; the Bureau of Ocean Energy Management (BOEM), responsible for administering the development of mineral resources on the OCS; and the Bureau of Safety and Environmental Enforcement (BSEE), responsible for environmental regulations and enforcement.[ix]These three agencies were intended to enhance regulatory oversight by reducing the conflict of interest between collecting revenue from the very industry it was meant to regulate.

BOEMRE and its successor agencies issued several regulatory reforms after learning lessons from the Deepwater Horizon incident. BOEMRE issued the “Interim Drilling Safety Rule” on October 12, 2010, which made several reforms to technical drilling safety requirements. For example, industry best practices according to the American Petroleum Institute were made mandatory instead of voluntary.[x]Also, independent third party verification is required for the proper functioning of the blind shear rams, a crucial component of the Blowout Preventer (BOP), which is the last line of defense in the event of a well blowout. Rig operators must demonstrate their preparation for a “worst-case discharge,” and their steps to deal with a blowout scenario.[xi]BOEMRE would also begin using multi-person inspection teams for inspections of offshore oil and gas rigs.

Another reform implemented by BOEMRE is the requirement for offshore oil rig operators to implement Safety and Environment Management Systems (SEMS), known as the “Workplace Safety Rule.”[xii]The SEMS requires performance-based standards for equipment, management, safety practices, environmental safeguards, and clear protocol to address hazards in all of these categories. The Workplace Safety Rule was established in order to address the human error that was so evident in the Deepwater Horizon disaster.

Legislative Reforms

In the immediate aftermath of the blowout, a flurry of activity occupied the time of the U.S. Congress, as public outrage was at a peak. The House of Representatives held 32 hearings on the matter while 27 hearings were held in the Senate.[xiii]Over 150 pieces of legislation were introduced to reform the offshore drilling process and regulatory regime.  However, Congress has failed to take steps to address drilling safety and incorporate lessons learned from the Deepwater Horizon incident. While there were several attempts to pass legislation, particularly in the first few months after the blowout, enough bipartisan support could not be mustered to implement legislative changes. Once the well was contained, and the oil stopped flowing, the impetus for reform melted away.

The White House pushed a legislative package three weeks after the blowout to increase funding for regulatory oversight, raise liability limits on responsible parties for disasters, and increase a tax on the oil industry to pay into the Oil Liability Trust Fund from 8 cents per barrel to 9 cents.[xiv]The White House bill did not pass. More recently, the RESTORE Act passed as part of a larger transportation bill in March 2012, which would dedicate 80% of penalties BP might pay in the future under the Clean Water Act to restoration of the Gulf of Mexico.[xv] While this bill may be signed into law and will benefit restoration activities, it does not affect regulatory oversight.

With the oil industry and some members of Congress upset over a temporary drilling moratorium enacted by the President and the perceived intentional delays in permitting, political attention shifted from a regulatory regime that was not strong enough, to one that was overly burdensome. A bill introduced in March 2011 sought to establish deadlines for permitting, forcing the Department of Interior to accelerate the permitting process.[xvi]While this too did not pass, the significant support it received from a sizable faction of Congress demonstrated the political momentum for strengthening the regulatory regime had passed. The U.S. had experienced its worst environmental disaster in history, and not only did Congress not tighten oversight, but now the political winds had shifted to weaken it.

ACTIONS TAKEN TO ADDRESS DRILLING SAFETY IN THE ARCTIC

With warming temperatures from climate change causing glaciers to retreat, and an increasing global need for energy supplies, the Arctic is the next frontier for energy development. However, offshore oil drilling in the Arctic involves higher innate risk relative to drilling in warmer waters such as the Gulf of Mexico, including harsher weather, shorter days, varying amounts of ice coverage, and less developed infrastructure. The memory of the Deepwater Horizon blowout remains fresh, and with the failures leading to that incident in mind, the Obama administration and the oil industry have taken a series of steps to enhance safety for Arctic exploration.

President Obama signed Executive Order 13580 on July 12, 2011, to establish the Interagency Working Group on Coordination of Domestic Energy Development and Permitting in Alaska.[xvii]The working group, chaired by the Deputy Secretary of Interior David Hayes, will coordinate efforts across all federal agencies to develop energy in the Arctic. The move is meant to streamline governmental work on offshore oil development, share information, and more efficiently issue permits for drilling. Engaging with local Alaskan communities as well as preparedness and response to an emergency situation is also a key objective of the working group.            

Shell Gulf of Mexico, Inc. promises to be at the forefront of oil exploration in the Arctic, specifically in the Chukchi Sea and the Beaufort Sea. It acquired leases for exploration in the Chukchi Sea during Lease Sale 193, which took place in February 2008. Figure 2 shows the leases issued in Lease Sale 193 in the Chukchi Sea.

The lease sale drew criticism from environmental groups that opposed Arctic drilling on the basis of a lack of understanding of the effects of an oil spill on the marine environment. Earthjustice filed a suit against the Minerals Management Service on behalf of a variety of stakeholders [xviii]and in July 2010 a federal judge ruled that MMS had not adequately considered the environmental impacts of oil and gas development on the surrounding environment as required under the National Environmental Policy Act.[xix]The court also ruled that MMS had failed to consider the impacts of increased natural gas development in the Chukchi Sea. The ruling halted all oil and gas activities in the area, effectively suspending Lease Sale 193 until MMS conducted a proper environmental impact statement.

To comply with the court order, the reformed BOEMRE issued a supplemental environmental impact statement (SEIS), published in the Federal Register on August 26, 2011, which detailed a revised environmental analysis, including the effects of a hypothetical Very Large Oil Spill (VLOS).[xx]

Shell Gulf of Mexico also produced an Oil Spill Response Plan, detailing their preparedness for a worst case discharge in the Arctic. The plan commits Shell to planning for several contingencies that were not required before the Deepwater Horizon incident. For instance, Shell must have ready access to a “capping stack,” to shut off the flow of oil in the event other systems fail.[xxi]Additionally, Shell must be prepared to drill a relief well within a few days in the event of a blowout, a process that took BP months to do. Shell committed to having an oil spill response fleet onshore near the drilling rigs, 24 hours a day, 7 days a week, during drilling operations. Also, if a well were to blowout, Shell promised to have its response fleet onsite within 60 minutes. Finally, Shell has agreed to limit drilling when whales are present, and also cease drilling if ice coverage returns earlier in the year than expected.

Part 3 of this series will be published on Thursday, July 19.

[i] Lavelle, M. (2010, May 27). Gulf Oil Spill Worst in U.S. History; Drilling Postponed. National Geographic, pp. http://news.nationalgeographic.com/news/2010/05/100527energy-nation-gulf-oil-spill-top-kill-obama/.
[ii] U.S. Geological Survey. (2011). Assessment of Flow Rate Estimates for the Deepwater Horizon/Macondo Well Oil Spill. Washington DC: Department of Interior.
[iii] National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling. (2011). Deep Water: The Gulf Oil Disaster and the Future of Offshore Drilling. 56.
[iv] Ibid. 68.
[v] Ibid. 68.
[vi] Ibid. 70.
[vii] Ibid. 71.
[viii] Ibid. 71.
[ix] Bureau of Ocean Energy Mangement, Regulation and Enforcement. (2011). The Reorganization of the Former MMS. Washington DC: Department of Interior. Retreived from BOEMRE web site: http://www.boemre.gov/reorganization.htm
[x] Bureau of Ocean Energy Mangement, Regulation and Enforcement. (2011). Fact Sheet: The Drilling Safety Rule. Washington DC: Department of Interior.
[xi] Bureau of Ocean Energy Mangement, Regulation and Enforcement. (2011). Regulatory Reform. Retrieved from BOEMRE web site: http://www.boemre.gov/Reforms.htm
[xii] Ibid.
[xiii] Hagerty, C., & Ramseur, J. (2010, September 19). Deepwater Horizon Oil Spill: Highlighted Actions and Issues. Retrieved April 18, 2012, from Environmental Legislation: http://environmental-legislation.blogspot.com/2010/09/deepwater-horizon-oil-spill-highlighted.html
[xiv] The White House. (2010, May 12). Fact Sheet: Deepwater Horizon Oil Spill Legislative Package. Retrieved April 18 http://www.whitehouse.gov/the-press-office/fact-sheet-deepwater-horizon-oil-spill-legislative-package, 2012, from White House Office of the Press Secretary.
[xv] Editorial Staff. (2012, April 17). Momentum for Restore Act in Congress: An Editorial. The Times-Picayune.
[xvi] Congressional Research Service. (2011). Offshore Oil and Gas Development: Legal Framework. Washington DC: CRS. 6.
[xvii] Department of Interior. (2011, December). Interagency Working Group on Alaska Energy. Retrieved March 25, 2012, from DOI web site: http://www.doi.gov/alaskaenergy/index.cfm
[xviii] Earthjustice represented the Native Village of Point Hope, City of Point Hope, Inupiat Community of the Arctic Slope, Alaska Wilderness League, Center for Biological Diversity, Defenders of Wildlife, National Audubon Society, Natural Resources Defense Council, Northern Alaska Environmental Center, Oceana, Pacific Environment, Resisting Environmental Destruction on Indigenous Lands (REDOIL), Sierra Club, The Wilderness Society and World Wildlife Fund.
[xix] Center for Biological Diversity. (2010, July 21). Federal Court Halts Oil and Gas Activities Under Chukchi Sea Lease Sale. Retrieved March 25, 2012, from CBD web site: http://www.biologicaldiversity.org/news/press_releases/2010/chukchi-leases-07-21-2010.html
[xx] Bureau of Ocean Energy Mangement, Regulation and Enforcement. (2011). BOEMRE Releases Final Supplemental Environmental Impact Statement for Chukchi Sea Lease Sale 193.  Retrieved from BOEMRE web site: http://www.boemre.gov/ooc/press/2011/press0818a.htm

[xxi] Bureau of Safety and Environmental Enforcement. (2012, February 17). Obama Administration Announces Major Steps toward Science-Based Energy Exploration in the Arctic. Retrieved March 27, 2012, from BSEE web site: http://www.bsee.gov/BSEE-Newsroom/PressReleases/2012/press02172012.aspx.