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The Arctic Ocean – Drilling on Top of the World

The Companies Attempting to Penetrate the Icy Kingdom in their Search for Natural Resources

by Anthony Broadfoot

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In its 2008 report, the US Geological Survey (USGS) estimated that around 90 billion barrels of undiscovered and technically recoverable (reachable via current industry practices and technologies) oil exists in the Arctic Circle. According to the report, there is an estimated 1,670 trillion cubic feet of natural gas and 44 billion barrels of natural gas liquids in some 25 geologically defined areas. If truly present, these deposits amount to 22 per cent of the world’s total undiscovered, technically recoverable oil and gas resources. More than half of the estimated reserves are located in three geological regions of the Arctic – the Amerasia Basin, Arctic Alaska, and the East Greenland Rift Basins.

After the report was published, USGS Director Mark Myers came out with a clarifying statement:

"Before we can make decisions about our future use of oil and gas and related decisions about protecting endangered species, native communities and the health of our planet, we need to know what's out there......With this assessment, we're providing the same information to everyone in the world so that the global community can make those difficult decisions."

The USGS findings immediately excited the interest of oil & gas companies looking to expand their business into new resource-rich locations.

Cairn Energy’s Woes In Search of Black Gold

As the Arctic ice sheet melts away, more and more companies are rushing through newly opened shipping routes to reach places where no one has drilled before. Cairn Energy (LON:CNE) was one of the first enthusiasts to head towards the Arctic in its quest for oil and dreamlike profits.

Cairn Energy, an FTSE 250 company headquartered in Edinburgh, currently produces 33,000 barrels of oil per day with its largest operations located in India, where it has made more than 20 discoveries. Almost five years since it started its drilling operations in Greenland, the company has invested $1.2 billion (£755 million) in its Arctic campaign. But in December 2011, Cairn announced it was calling time on its exploration with the last two wells coming up dry, marking its seventh and eighth consecutive unsuccessful attempts, and deciding instead to spend some months studying the gathered data and seismic imagery of the region. Cairn Energy remains hopeful that it will find partners with the necessary funding for a future exploration and development joint-venture. The company owns licenses for 11 blocks in offshore Greenland with an area of 102,000 sq km – close to the size of the North Sea.

The market was harsh on Cairn’s failure to strike oil with the company’s shares marked down more than 40 per cent in 2011. Despite the letdowns, CEO Simon Thomson struck an optimistic note:

“Whilst we have yet to make a commercial discovery, we remain encouraged that all of the ingredients for success are in evidence. Evaluation of data across Cairn’s blocks is ongoing against a backdrop of active farm-out discussions for selected areas.”

At the beginning of 2012, Cairn managed to enlist the help of Statoil (NYSE:STO), an oil company majority-owned by the Norwegian government. In return for a 30 per cent stake in Cairn’s Pitu block off the west coast of Greenland, Statoil paid a “signature bonus” and committed to funding a share of back-dated and future exploration costs .

In August, Cairn CEO Thomson said Cairn Energy will resume its Greenland drilling operations in two years. The new drilling site will be precisely where Statoil acquired a share – the Pitu block. According to Thomson, there’s a one in four chance of finding oil in that prospect, comparing very favourably with previous campaigns, where the odds were one in 10. “Risk has come down considerably,” he added in an attempt to encourage shareholders, many of whom are less than enamoured after shouldering the hefty write-offs from the company’s previous oil prospecting endeavours in the region.

Following the $5.4 billion (£3.4 billion) sale of a large stake in its India business, Cairn has around $927 million (£533 million) at its disposal to finance further drilling but it also has interests in offshore Lebanon and Spain. Analysts viewed the India sale as a transformation from reliable oil producer into risky exploration company, betting on prospects of striking oil in the Arctic, where no significant commercial discoveries have yet been made. Said Laura Loppacher of stockbroker Jefferies International, “There is a worry among investors that Cairn will spend a lot more money in Greenland. Investors lost a lot of money on Greenland so the mood towards it is not fantastic, resulting in low enthusiasm for funding additional drilling with a high exposure.”

For the first half of 2012, Cairn Energy has reported a pre-tax loss of £31.5 million compared with a loss of £141.3 million last year.

Gazprom Gives Up

Gazprom (MCX:GAZP), Russia’s largest company and the world’s largest natural gas extractor, has decided to end one of its most ambitious and expensive projects –the Stokman natural gas field in the Barent Sea. Gazprom and its partners Total (NYSE:TOT) and Statoil are to abandon the enterprise because of high developing costs.

The project appears to have gone sour for several reasons:

Location: Stokman is located 600km off the northern coast of Russia. The sea there is infested with icebergs and in darkness for six-months of the year.

The Market: The extracted natural gas was mainly intended for the large and promising US market but with recent shale gas discoveries, the US natural gas reserves went from deficit to surplus and demand for Stokman’s natural gas plummeted. To compound this factor, European countries are progressively finding cheaper alternatives to what Gazprom has to offer, placing the Russian giant in a rigid position.

Better Alternatives: Vast new gas reserves have been discovered in more accessible regions such as Mozambique and Tanzania along the coast of East Africa. Developing costs there are much lower than in the Arctic and oil & gas companies are already well advanced in their drilling operations.

Partnership Relations: The partnership between Gazprom, Total and Statoil has not turned out to be a fruitful one with the companies continuously arguing over strategy in developing the Stokman field. Total and Statoil were also largely dissatisfied with the fiscal terms offered by the Russian government.

Some analysts saw the discontinuation of the project as a good thing. “This is positive. Finally, someone has blown the whistle and said this isn’t going to work and we don’t want to spend any more management time or money on this. I wish they’d do this more often.” observed Jonathan Stern, director of gas research at the Oxford Institute of Energy Studies.

Gazprom’s capitulation on the Stokman project shows that even if discovered resources (3.9 trillion cubic meters of natural gas – enough to meet the world’s demand for a year) could be extracted, the costs and management efforts for such an ambitious campaign are extremely daunting. It is doubtful whether companies are sufficiently dedicated and have the necessary capacity and technology to truly penetrate the depths of the Arctic and extract its valuable resources.

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