Last week, I summarized the new USGS report on the undiscovered oil and gas resources of the Arctic. This week, I’ll share with you what I learned at the OTC 2009 conference last month about some of the challenges the industry faces in developing those resources.

Arctic drilling is not new. The first successful well was drilled in March 1968, when ARCO struck oil in the Prudhoe Bay field 250 miles north of the Arctic Circle on the North Slope of Alaska, near the Arctic Ocean. The find was the largest oil field in the U.S., with an estimated 13 billion barrels of recoverable oil (BP), twice the total reserves of the East Texas field, and a flow rate of around 400,000 barrels per day (EIA).

The discovery kicked off an exploration spree throughout the Arctic. By the mid-1970s, offshore drilling was under way as well, but offshore production in the Arctic and sub-Arctic has remained limited due to its difficulty. A mere two million barrels of oil, and no gas, have been produced from the Canadian Arctic offshore since 1985.

ConocoPhillips (NYSE: COP) is the second largest Arctic producer after Russia’s Gazprom. Peter Noble, the Chief Naval Architect for ConocoPhillips, ticked off some of the main challenges to Arctic production at the OTC conference.

To begin with, the drillships used in the 70s and 80s are no more. The US hasn’t built new icebreakers since the 1970s under Nixon. With a renewed interest in the Arctic, the oil and gas industry is now designing and building a new class of modern drillships and tankers for the Arctic, able to penetrate deeper waters and deeper reservoirs, and break ice continuously. These are highly specialized ships, made by manufacturers such as Finland’s Wärtsilä Corporation (HEL:WRTBV).

Submersible drilling rigs can be used in the Arctic, but they can only be moved in open water season, and work best in water depths of less than 30 meters (most of the new prospects in the Arctic are in depths up to 1000 meters). Harsh environment semi-submersibles exist, but none are really capable of surviving months of being locked in ice.

Similarly, collecting 3-D seismic data in 600 to 1000 meters of water today is a much more difficult task than shooting 2-D seismic in 30 meters of water was in the 1980s.

What we need to keep going, said Noble, is drilling solutions that can operate in more than “tens of days” in the warm season. Year-round transportation is needed, instead of platforms being inaccessible to tankers for most of the year, while offshore platforms keep pumping into large and expensive storage tanks.

Beyond ships and rigs is a much bigger problem: there is no infrastructure or workforce in the Arctic. Marine vessels, airports, road access, municipal support, and all of the conveniences of civilization simply do not yet exist in the frozen north. There are no deepwater ports either, which limits offloading capabilities.

Completely commonplace activities like trenching and laying pipe are a whole different game in ice covered waters. Simply knowing when to expect ice, and how much, is another area that needs improvement.

Evacuation and rescue operations in the Arctic must be self-sufficient, because it’s so remote; backline support systems are simply too far away. By the same token, mobilizing fast responses to oil spills requires a local self-sufficiency that currently does not yet exist.

Wildlife protection, cooperation with indigenous tribes, and a “don’t spill a drop” ethos mean that oil companies must be extremely careful in the Arctic, and take a holistic view of their activities encompassing the needs of all stockholders in the area, including social needs.

More Than Technical Issues

One such non-technical but crucially important challenge is working successfully with the First Nations (aboriginal tribes) of the Arctic. Many areas under development are the property of Inuit and other natives.

Nick Poushinsky, the Senior Vice President of infrastructure consultancy Stantec (NYSE: STN) explained some of the issues, speaking from his long experience working for the Canadian government in negotiating resource development agreements with aboriginal people. He now works for companies owned by them, which are developing joint venture partnerships with Devon Energy (NYSE: DVN) and ExxonMobil (NYSE: XOM), and working on Beaufort Sea development.

It takes a great deal of effort, he said, to work through issues like royalty regimes, environmental protection, and not interfering with native rights to traditional hunting and fishing. The best time to move ships through the Arctic is in warm, ice-free seasons, which is also when wildlife need to move through it.

Along with environmental concerns and oil spill prevention have come a host of regulatory issues in which conflicts abound; according to Poushinsky, it has “gotten totally out of control.” For example, Americans want to protect polar bears, but at $100,000 a head, the Inuit want to hunt them. The US Environmental Protection Agency will not allow testing and research on the water, so those working toward US development of the resources must turn to Norway and other partners for that.

Royal Dutch Shell (ADR: NYSE: RDS.A) and ConocoPhillips are going well outside their domains of expertise, spending $100 million per year on biological and geological research in the Arctic, studying such things as climate change and environmental factors affecting polar bears, seals, walrus, and whales.

Recognizing the importance of their oil and gas resources, aboriginal peoples are starting to feel their oats and demand a piece of the action, exchanging access to their lands for something else. Their aspirations are very high, but they lack the necessary skills and capabilities to participate in building the Arctic infrastructure. At the same time, crews imported from warmer climes often find the conditions unpleasant, and don’t come back after their first tours. Manpower and training are desperately needed at the earth’s northernmost extremity.

Finally, there are the jurisdictional challenges. Everyone is amused by Russia’s planting of a flag at the Arctic, but that was just a publicity stunt. Real oil and gas production can only happen after successful resolution of border disputes. Canada has ongoing border disputes with Denmark, the US and Russia. The US also has its own border conflicts with Russia. Greenland is seeking revenue that will allow it to separate from Denmark, and Iceland is anxious to retain its share of the spoils because one-third of its exports are derived from energy.

The Race Is Afoot

Still, as Mead Treadwell, chair of US Arctic Research Commission noted, if the US does not exercise its visible presence in the Arctic, we cede it. We can’t put a ‘keep out” sign on the ocean, she said; it’s open to any and all who can get there and develop it.

Nation-states tend to be adversarial in these discussions, Poushinsky observed, taking hardline positions on the issues and refusing to talk to each other. Once the parties sit down and negotiate, results are easier to come by. “We gotta get over this kinda crap,” he sighed in a long-suffering tone.

All speakers seemed to agree that a great deal of international cooperation is needed across the board to develop the Arctic. Environmental studies and protection, seismic surveying, spill prevention, protecting the subsistence of indigenous residents, developing drilling and shipping standards, providing infrastructure, and a slew of other crucial areas all transcend borders.

Yet as I said last week, given the pressure of peak oil on supplies, and a global demand for petroleum that has proven to be remarkably resilient in the global recession of the last year, it seems a foregone conclusion that the Arctic’s buried hydrocarbons will be developed. It’s not a question of if, but when.

And, of course, who will benefit from it.

Until next time,

Chris

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