Analysis: Oil prices collapse, again; What does it mean for Alaska?

Oil prices plunged to historic lows Monday as markets staggered from weak demand. There’s now a huge slug of new supply headed for the U.S. in tankers carrying Saudi crude oil. The ships are on the way and they’re prepared to dump new supply in the domestic market.

A production curtailment pact between Russia and Saudi Arabia has been agreed but it isn’t enough, experts believe. It also was agreed before the tankers set sail, so the pain will worsen before it gets better.

If there’s an upside to this it is that lower crude oil prices means lower prices for gasoline, heating, marine and aviation fuel which in ordinary times would boost the economy.

But these are not ordinary times. With the nation’s economy in extreme slow-motion due to the COVID-19 virus there’s little demand for fuel.

No one is driving, and no one is flying.

For Alaska, the near-term effects include a contraction in oil industry activity that has already started with recent decisions by ConocoPhillips and BP to curtail North Slope drilling and put six to seven rigs in storage mode.

There is still some drilling. Hilcorp Energy and Eni Oil and Gas were reported to be still active with rigs in fields they operate, but this could change.

The immediate impact will also be on state revenues in the last quarter of the fiscal year – April, May and June – which will increase a $730 million budget deficit estimated for the current fiscal year and hasten the drawdown of liquid assets remaining in the state Constitutional Budget Reserve.

Silver lining: State budget depends less on oil

One silver lining in this bleak scene is that the state budget is much less dependent on oil and gas revenues than it was a few years ago thanks to a decision by the Legislature two years ago to tap a portion of the Permanent Fund’s earnings, which are still ample.

Even before the immediate crisis the Permanent Fund was estimated to pay over half the state’s general fund budget and oil less than a third of state’s general fund budget over the next decade, University of Alaska economists have estimated.

This year the Fund has contributed $2.9 billion toward the state’s approximate $4.4 billion general fund budget. Next year the amount will be $3.1 billion.

There are still substantial funds in reserves, too. The Constitutional Budget Reserve, the state’s main savings account, has about $2 billion. That will be eroded by bigger deficits, now larger than expected, but it is a cushion. About $500 million must be kept in the CBR to meet the state’s ongoing cash obligations, like payroll.

Finally, the Permanent Fund’s earnings reserve, the Fund’s accumulated income, is at about $12 billion and can be drawn on in an emergency. That would be a last resort, however, because drawing down the earnings account would reduce the Fund’s overall earnings, cutting into what is paid to support the budget.

Oil is important to the state’s economy. Although oil is less important for the state budget it is still important for the economy.

The North Slope and Cook Inlet oilfields are big job engines for Interior and Southcentral Alaska because of all the support services needed. Drilling is particularly important because when they are working rigs require fuel and chemicals and specialized machinery, all which must be transported to the slope or Inlet, as well as skilled, highly paid workers.

By one estimate the amount of truck traffic on the Dalton Highway, the north-south industrial road serving the slope, will be cut in half by the recent layoffs of rigs.

The irony is that the petroleum industry was just beginning to add jobs again after its severe contraction following the 2015 oil price collapse.

New oil is being discovered on the slope and new production projects are planned. Some of those will now be delayed until markets recover.

Again, a bit of silver lining: It’s known that a lot more oil is on the slope and that exploration by at least one company, Oil Search, found even more in drilling this winter season, which is just ending. The oil will be there when the recovery comes.

Could some high-cost Alaska production be shut down?

One worry, however, is that the tanking of oil prices will result in some higher-cost Alaska production being shut in.

This is possible because at current prices some Cook Inlet and North Slope wells, and even small fields, may be operating in the red.

If wells are shut in it will have an impact on oil production. That is gradually declining in any event because the larger oil fields are aging, taking wells off-line will speed that. The effect may not be huge. That’s because there can be technical problems when producing wells are shut off (it may be difficult to restart them at their former rates) and as a result companies will make great efforts to avoid this.

But it has happened in Alaska. When oil prices collapsed in 1985 Conoco (forerunner to the present ConocoPhillips) temporarily shut down the Milne Point field on the slope, which was then small.

Companies will do this if they feel they have to. In a move last week that surprised oil industry observers ConocoPhillips shuttered one fourth of its lower 48 oil production as a response to the worsening supply glut. So far the reduction hasn’t affected Alaska because much of ConocoPhillips’ production in the state is “sold forward” in long-term contracts, at higher prices, so for now the company’s Alaska operations are somewhat sheltered, ConocoPhillips told financial analysts in a briefing.

However, the company also told the analysts said it could not rule out reducing output in North Slope fields where it is in total ownership and control, mainly the Alpine and Kuparuk River fields. Prudhoe Bay is less likely to be affected, at least for the short term, because ConocoPhillips, BP and ExxonMobil all own shares of the field and all three must agree to any curtailment of output under their operating agreements. Prudhoe still produces over half the total slope output.