Cook Inlet gas producer assails royalty rates as another seeks state financing

John Hendrix was stressed on Thursday. He temporarily shut down a well that produces 50% of his company’s gas from Cook Inlet for a mandatory state test. The well produces large quantities of water and Hendrix didn’t know if gas would flow again.

“We were biting our nails there on that one,” he said.

The safety-valve test was performed satisfactorily, said Brett Huber, chair of the Alaska Oil and Gas Conservation Commission. Pressure had returned to the well by Friday and Hendrix said he could keep producing gas. Another safety test has been scheduled in October, which could see another round of nail biting.

The well test was the latest challenge facing Hendrix, the owner and operator of HEX Cook Inlet LLC, a privately owned Alaska independent that leases the massive Kitchen Lights Unit near Nikiski. In April, the unit produced just over 5% of the gas that came from Cook Inlet to heat and power the Railbelt.

Hendrix has sought to drill new wells to double production from the unit, which has a substantial proven gas supply for Southcentral Alaska. But he was recently dealt a blow by an Anchorage judge when he lost a long-running property tax dispute with the state.

For decades, the state has assessed oil and gas properties at their replacement value: what it would cost to rebuild all of their producing assets if they were suddenly lost. Hendrix wanted that changed to the market value, or what the assets would currently sell for.

The state assessed the value of the Kitchen Lights Unit at just over $81 million in 2021 and 2022. Hendrix argued that the true value of the property was $18 million after buying Furie Operating out of bankruptcy in 2020 with help from a state loan.

[This oil platform stopped pumping 30 years ago. Alaska still won’t make the owner tear it down.]

Hendrix had sought a major cut to his $1.6 million in yearly property tax payments. Judge Herman Walker said in a 51-page opinion on May 17 that Hendrix had failed to show why the state’s valuation methodology was flawed.

“We’ll survive. But it’s less money that goes into the drill bit,” Hendrix said Wednesday, adding that he was still deciding whether to appeal.

The challenges facing HEX go beyond one well or one property tax dispute. The company pays the standard 12.5% state royalty rate on gas, and then another 12.5% to owners of the unit’s overriding royalty interests. On top of that, HEX covers capital investment costs for the company’s former owners, a requirement from bankruptcy proceedings.

Mark Slaughter, the company’s chief commercial officer, told lawmakers in February that when those factors are combined, HEX can effectively lose 35% of its profits from any gas produced. He said those were “foundational” issues facing the company from the bankruptcy.

Hendrix said the company has applied with the state Department of Natural Resources to reduce its royalty payments, but that has not yet been successful. With a high bar for approval, only three such applications have been granted by the state since 1995. The owners of the unit’s overriding royalty interests have also not been interested in cutting their payment rate, Hendrix said.

The challenges facing the independent come after Hilcorp, by far the most dominant producer of Cook Inlet gas, told Railbelt utilities in 2022 that it did not have enough natural gas reserves in the aging basin to provide for new gas supply contracts after existing ones expire in the coming years.

Since then, the utilities have suggested importing natural gas could be the best available alternative, which could see power and heating bills skyrocket.

Enstar recently took a cautious but concrete step toward importing gas by applying with state regulators to expand its service area and potentially build a pipeline to Port MacKenzie. The natural gas utility said that it has been negotiating with Cook Inlet producers to secure new contracts with limited success.

[Warning of shortfall next year, Enstar takes step toward pipeline that could receive natural gas imports]

The Legislature recently debated several measures intended to incentivize new production. The House passed a bill to substantially cut oil and gas royalties from the basin, but it failed in the Senate. Key senators said there was insufficient evidence presented that foregoing state revenue would see substantially new gas produced.

Hendrix said he had planned to invest $20 million to drill new wells this summer, but that was likely off the table for now.

“We will not drill without royalty relief,” he said Wednesday.

Hendrix has long fought to reduce his state tax obligations. Last year, the Senate hastily withdrew a bill to rewrite state oil and gas property tax assessment laws, which would have cost some municipalities a significant chunk of revenue, after it was revealed by political website the Alaska Landmine that Hendrix was behind the effort and would be its chief beneficiary.

Reserve-based lending

BlueCrest Energy, a Texas-based independent, is set to have 15 days starting June 1 to resolve issues with the state’s investment bank over a $30 million loan issued in 2015.

The Alaska Industrial Development and Export Authority, or AIDEA, loaned BlueCrest the money to help fund an on-shore drilling rig. BlueCrest still owes $13.1 million, plus accruing interest, AIDEA said. The loan has been modified several times since 2015.

As of Friday, BlueCrest is in a forbearance status with its existing loan. The company could make a roughly $1 million repayment by June 16, or formally apply before then to have the loan modified by the AIDEA board and its project finance committee. Or BlueCrest would default.

Benjy Johnson, BlueCrest’s president and CEO, said he was confident the repayment issues would be resolved.

“We have never defaulted before, and we won’t this time,” he said Friday.

Despite those challenges, Johnson wants to secure another loan from the state.

BlueCrest is seeking $400 million to produce gas from the massive Cosmopolitan Unit, largely to buy a platform that will also need permitting. The unit, situated 3 miles offshore close to Anchor Point, has proven reserves to supply years of Southcentral’s total gas needs. Finding investors, though, has been difficult.

”We believe we’ve exhausted every major bank, every major investment fund, every private fund,” Johnson said.

Facing a $2.5 billion deficit, Alaska legislators ended a generous cash-credit program for Cook Inlet oil and gas producers in 2017. BlueCrest relied on those credits for its business plan, and has not drilled a new well since 2018, Johnson said.

Instead of royalty reductions, legislators approved a provision as part of House Bill 50 to specifically authorize AIDEA to issue state loans to producers based on their gas reserves, which is called reserve-based lending.

“The problem in Cook Inlet has always been capital. The gas is there, the capital is not there to develop it. And this, we think, cracks that,” said Sen. Bill Wielechowski, an Anchorage Democrat, earlier in support of the idea.

Hendrix said Wednesday that he was uninterested in a state loan because his project is currently “uneconomic.” BlueCrest, though, is interested.

“We supported that, and I’m really glad to see that,” Johnson said.

Officials at AIDEA say the investment bank currently has $180.6 million uncommitted for financing. But some of those funds are being eyed for other energy projects.

AIDEA would do “robust due diligence” before issuing a reserve-based loan. The Legislature could also appropriate additional funds to help AIDEA finance lending to producers, the investment bank said.

The concept, though, is not without its detractors. The state owns the resource, and leases units to operators to produce gas. Effectively, the state would be using its own resource as collateral to issue a publicly funded loan to a private company.

Longtime oil and gas consultant Brad Keithley said that form of reserve-based lending is potentially unique in the U.S., and “a very odd thing that we’re doing.” He said he thought importing gas was inevitable, and said that a 2023 utilities working group report showed LNG imports could be cheaper than investing in new Cook Inlet production.

“The state should let the market work and not intervene and try to supplant the market by subsidizing the results,” he said.

Without a change, a growing gas shortfall is set to hit Southcentral Alaska in coming years. Analysts say there are few good options for policymakers to incentivize more local production. Wielechowski said the state could demand leases be returned if operators don’t produce gas. But that would likely lead to lengthy lawsuits, he said.

With more than 70% of Alaskans living on the Railbelt, all sides are watching closely to see if independents can address a litany of challenges to help fill the looming supply gap.