More Issues
Search
•
RSS Feed
|
False Profits: The Business Case Against Drilling In The Arctic National Wildlife Refuge
3/18/2003
 False_Profits.pdf
|
Executive Summary
Foreword
Once again, Congress is
poised to debate whether or not to drill for oil in the Arctic National Wildlife
Refuge. However, the political and economic context for this debate is very
different than a year ago. Oil prices at the end of February 2003 were at a
12 year high, skyrocketing by 20 percent in just two months. The Bush administration
has invested significant military and political capital in a potential war with
Iraq. On a more practical level, the leadership of several key Senate committees
landed in the hands of drilling proponents after the November 2002 elections.
Despite this shift, a central
question remains: does drilling in the Arctic Refuge make economic sense from
the perspective of the oil companies that would have to make the investment?
This report demonstrates
what should be obvious to any investor, executive, or decision-maker: Refuge
drilling is not likely to meet the investment criteria used by the major oil
companies. Oil from the Refuge would be extremely expensive to find and transport
to market. Since Arctic drilling is a politically charged, high profile environmental
issue, a company choosing to drill in the Refuge also could suffer damage to
its shareholder value and brand image, as Exxon did following the Valdez spill
in 1989. Using the companies’ own assessment criteria, drilling of any sort
in the coastal plain of the Arctic Refuge would be a high-cost, low rewards
investment.
The multinational oil giant
BP has indicated—by action if not by so many words—that it may agree. In November
2002, BP withdrew from Arctic Power, which lobbies on behalf of the oil industry
and state of Alaska to open up the Arctic Refuge to drilling. BP’s decision
to abstain from the political debate came in the midst of other moves to diversify
away from drilling in Alaska’s “frontier” areas. In doing so, BP sent an important
message that reinforces the one detailed in this report: drilling in the Arctic
Refuge is not a sound investment, politically or economically.
As members of the House
and Senate once again confront this issue, drilling proponents are likely to
argue that drilling in the Arctic Refuge will provide stimulus to the weak U.S.
economy. Fortunately, the PIRGs have reissued this report, and it is no less
important today than it was last year. As the analysis shows, based on rate
of return criteria established by the major oil companies of the world, there
appears to be little economic justification for drilling in the Arctic Refuge,
one of America’s last wild and untouched places.
Eban Goodstein
Associate Professor of Economics
Lewis and Clark College
March 7, 2003
Executive
Summary
The past few years have
witnessed a vigorous debate in Congress over how America should meet its current
and future energy needs. Proponents of increased domestic drilling, including
the Bush administration and several members of Congress, have focused much of
their energy on attempts to open the Arctic National Wildlife Refuge in Alaska
to oil and gas development. What they have failed to consider, however, is whether
any of the oil that lies beneath the Arctic Refuge could or would be profitably
pumped out of the ground.
The answer, when considering
issues of concern to the major integrated oil companies, is no.
The major oil companies
are extremely conservative about how and where they invest their capital. Although
oil prices may be at record highs now, oil prices are volatile and random and
often defy long-term predictions. When evaluating a future project, such as
the Arctic Refuge, companies make assumptions that allow them to remain profitable
even when oil prices are low and to benefit fully from high price conditions.
Requiring potential projects to pass these conservative investment screens is
simply a matter of responsible business practice by the industry.
Using the companies’ own
assessment criteria, drilling in the coastal plain of the Arctic Refuge is an
unattractive investment. Oil from the Arctic Refuge would be extremely expensive
to find and transport to market. According to the U.S. Geological Survey (USGS),
the Arctic Refuge would not produce any economically recoverable oil until reaching
a price of $17.17/barrel (in 2003 dollars), assuming a 12 percent return on
the companies’ investment. This fails the major oil companies’ investment criteria
in four fundamental ways:
• Most major oil companies
assess potential projects such as the Arctic Refuge using lower oil price assumptions,
ranging from $12.70 to $16.20 (normalized to Alaskan North Slope (ANS) crude
prices).
• Even at low price evaluations,
oil companies today routinely require a return on capital from their investments
of between 13 and 18 percent; none of the major companies use a figure as low
as 12 percent as the standard rate of return. An investment involving greater
risk, such as the Arctic Refuge, would need to offer an even higher return for
the companies to consider investing.
• According to USGS estimates,
North Slope oil prices would have to sell at more than $19 ANS before oil companies
would begin to see the returns of up to 18 percent that they demand.
• The USGS figures do not
include lease payments to the federal government and state of Alaska, increasing
the cost of drilling and further eroding the economics of Refuge oil.
In addition to being expensive,
Arctic Refuge oil also is fraught with risk. In the aftermath of the Enron scandal
– where undisclosed financial risks cost shareholders billions of dollars –
these risks deserve the fullest scrutiny.
• Insecurity of the Alaskan
Pipeline. Any company planning to drill in the Arctic Refuge would be placing
a multi-billion dollar bet on the security and stability of a single, aging,
indefensible pipeline. The only way to transport North Slope oil to market is
through the 800- mile Trans Alaska Pipeline System, which passes through some
of the wildest places left on earth. In today’s uncertain world climate, betting
billions of investment dollars on the security of a single pipeline is a high
risk in and of itself, let alone the other possible environmental risks involved
with Arctic Refuge drilling.
• Risk to Shareholder Value
and Brand Equity. Arctic Refuge drilling is an extremely prominent and divisive
issue in the United States. A majority of Americans opposes drilling the Arctic
Refuge, and substantial public outrage likely awaits any company that invests
in Arctic Refuge drilling. Public backlash against a company that drills in
the Arctic Refuge could reduce profits, tarnish the company’s brand image and
damage shareholder value.
• Alaska is a Declining
Oil Province. A company investing in Arctic Refuge oil would be investing in
the long-term future of a declining province, one marked by harsh conditions,
high fixed costs, deteriorating infrastructure, and geology that flummoxes even
a major company like BP.
In fact, BP may be recognizing
these risks. Over the past two years, BP has sent several signals indicating
its hesitation about Arctic Refuge drilling and its future in Alaska overall.
In June 2002, company CEO Lord John Browne, speaking at an industry event in
Anchorage, announced that the company would be “discontinuing frontier exploration”
for oil in Alaska. In November 2002, BP withdrew from Arctic Power, the lobbying
group that represents several oil companies and the State of Alaska on behalf
of drilling in the Arctic Refuge. These actions and others indicate that BP
may have come to the same conclusion as this report: Arctic Refuge oil is not
worth the investment and risk.
|
