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By Gregory DL Morris

Early in August, the U.S. Department of the Interior announced a plan to open half of the Strategic Petroleum Reserve in the far north of Alaska to development. The proposal, for which details are still being decided, would grant access to an estimated 550 million barrels of oil and 8.7 trillion cubic feet of natural gas. Bringing that resource to market will take several years, and will have to be done in some of the most difficult operating conditions on the planet.

Even academic and governmental risk-assessment organizations are just starting to try to quantify the perils. For example, the Marine Board of the National Transportation Research Board, part of the National Research Council, is holding a meeting in Seattle in October to address the topic of Arctic oil and gas development.

"This meeting and this topic signal very clearly that the policy-setting agencies in the U.S. are taking risk management seriously on this subject," said Karlene Roberts, director of the Center for Catastrophic Risk Management (CCRM) at the University of California at Berkeley, who has just been appointed to the Marine Board, and will attend her first meeting at the Seattle conference.

"Up to this point," she said, "they took an engineering approach, but now they are taking a risk management approach. There will be a very big job framing this debate because it has not been well thought through to this point."

Roberts stressed that does not mean risks are ignored. Far from it. The oil and gas industry does not have a spotless record in the Arctic, but neither have there been any major nonshipping catastrophes.

Risk assessors noted that the Exxon Valdez disaster in 1989 -- for which Exxon paid a total of $4.3 billion to remediate the ecologically fragile Prince William Sound off of the south coast of Alaska -- was a maritime accident, not a problem with exploration or production. Ships run aground all the time, all over the world.

What worries all parties -- oil companies, regulators and underwriters -- is the vast potential for damage if there were to be an Arctic exploration or production disaster on the order of the Macondo tragedy in the Gulf of Mexico in April 2010. That explosion killed 11 workers and destroyed the Deepwater Horizon drilling rig, for which BP has already pledged $20 billion for claims and remediation.

The CCRM participated in the Deepwater Horizon Study Group, although Roberts was not closely involved.

OPPORTUNITIES AND RISKS

"What is really interesting is that no one really knows the multiple and interdependent risks involved in Arctic oil and gas development," said Roberts. "What is also unknown is how the various stakeholders will interact -- the oil companies and the government entities. And all of this is played out against the extreme fragility of the Arctic environment."

Lloyd's also emphasized that point in a comprehensive 60-page report issued in April 2012, "Arctic Opening: Opportunity and Risk in the High North." The report stated plainly, "there is a range of potential pollution sources within the Arctic, including mines, oil and gas installations, current industrial sites and, in the Russian Arctic, nuclear waste from both civilian and military nuclear installations, and from nuclear weapons testing. However, the risk of an oil spill, with multiple implications for the way in which oil and gas companies drill and operate in the Arctic, is probably the most relevant. It represents the greatest risk in terms of environmental damage, potential cost and insurance."

The Arctic environment is infamously harsh, frequently deadly, but also exquisitely delicate. "I have worked with several of the oil companies, and talked with officials at many of the others," said Roberts. "They are extremely concerned about all of the risk management issues. At Berkeley, we developed the concept of 'high-reliability management' to prevent accidents, and we hope those principles will be applied to further development."

The stakes are huge. In anticipation of access to oil and gas, Royal Dutch Shell, already a major operator of legacy developments on the North Slope, has spent $4.5 billion for leasing rights and drill and response ships to work those leases. However, several weeks before Interior announced its plan for developing the reserve, one of Shell's two drill ships, moored at Dutch Harbor in the Aleutian Islands, dragged its anchor and almost ran aground.

Also, the ship being outfitted to respond to any spill was not ready to be deployed by late August. Shell has issued statements that it still hopes to begin work this year, but the working season ends between late September and late October when sea ice closes in. BP and Norwegian state company Statoil are also in the chase to develop Alaska reserves.

Federal authority prevails in the deepwater, but near shore and onshore is state jurisdiction. After the Macondo disaster, the Alaska Oil & Gas Commission sent a white paper to Gov. Sean Parnell, outlining what measures were being taken to prevent a similar catastrophe.

"Most of us at OGC come from industry, and so have some formal training in process safety analysis," said Commissioner Cathy Foerster. "A few on staff come from a government background so they have different risk training and experience, but that is complementary. In either case, risk management is part of our line responsibility."

Resource recovery regulation is divided among three agencies in Alaska: OGC is the technical regulator for hydrocarbons, testing equipment and procedures. The Department of Natural Resources is the landowner, controlling leasing; and the Department of Environmental Conservation supervises emergency response and remediation.

"After Macondo, we did a gap analysis on regulation, and an important gap came to light," said Foerster. "DEC has the statutory authority to see a blowout contingency plan, but cannot approve it or demand changes, even if the plan is 'run like crazy.' Most operators are conscientious, I don't think anyone wants an incident, but at present no one in the state has the authority to mandate a proper contingency plan.

"We have asked for that authority because we issue the drilling permits, and we expect to get it soon. That is a gap we are fixing," she said.

The federal government does require a contingency plan, which is why Shell is outfitting a dedicated vessel for its offshore program.

Another gap that Foerster is fixing pertains to bonding. "Currently, producers on state lands are required to post a bond of $100,000 for the first well, and a further $200,000 to cover any additional wells," she said. "That is hardly enough. We are changing the bonding rules, and also asking for an emergency well-response fund to be established and built up to at least $10 million." There is some time. On average, it takes seven years from a lease sale, through exploration to commercial production.

One risk that OGC has identified in cooperation with federal authorities is the danger of shallow pockets of gas.

"Almost all the blowouts we have had have been from that cause," said Foerster. "We have added a requirement that seismic surveys look for those shallow pockets. Before that, the surveys would often only look deep because they were trying to pinpoint the pay zones."

Arctic oil and gas development has not been a major commercial risk-transfer market, because the big companies in play tend to self-insure, especially at the lower tiers of a tower. Several brokers, underwriters and reinsurers confirmed that there has been an uptick in owners exploring the commercial market, but none would comment on the size or scope of that potential business.

Hub International, with its oil and gas business based in New Orleans and Lafayette, La., is one broker that is getting involved -- in the subArctic.

"We just finished putting together a big program in the Cook Inlet," south of Anchorage, said Harper Johnson, senior risk consultant for Hub. "We are also seeing a lot of activity in the Beaufort Sea on the North Slope. There is a lot of interest in some of the old drill sites."

New techniques, especially directional drilling and hydraulic fracturing, which were developed onshore, are now being taken offshore. It was smaller, independent companies, not the global majors, that pioneered those new techniques, and are the ones with the most expertise. They are also the companies that will have to turn to commercial insurance markets.

"The Arctic is definitely an interesting market," said Johnson. "We don't see anyone rushing in, [it's] more of a wait-and-see as the major oil companies do some initial development. It will also take some time to develop sound contingency plans. But we are confident they will be successful. As they are, the major players will come into the market, and we will definitely be looking at providing them with coverage and capacity."

GREGORY DL MORRIS has covered the oil and gas industry for more than 20 years. He can be reached at riskletters@lrp.com.

October 1, 2012

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