A recent auction highlights the headwinds facing American oil producers.
Wednesday’s auction of oil and gas drilling rights on the Alaskan Coastal Plain was worse than disappointing. The lease offering was a culmination of decades of work, opening to development 1.5 million acres that many considered the biggest single prospect in America. The high expectations fell embarrassingly flat when the bids were opened. Half of the acreage could not even muster a qualifying bid. The bidders who did win are stalking-horse bidders, planning to hold the leases and flip them to a bona fide oil company in the years to come. Those bona fide oil companies — who would eventually drill wells to deliver oil to consumers and royalties to the Treasury — opted to pass and invest elsewhere.
The lease sale offered 22 tracts after ten were withdrawn prior to the offering. Of the 22 offered, eleven mustered the minimum bid of $25 per acre, with the highest accepted bid at $33.38 per acre. Put more bluntly, a third of the area was withdrawn, then half of the remaining offering could not muster the minimum bid. The three bidders each managed to take home at least one tract, with one bidder winning nine of eleven tracts. Only two tracts received more than one bid. By any objective standard, this lease sale was a dud.
It gets worse. The winning bidder of nine tracts was the Alaska Industrial Development and Export Authority, which is an arm of the Alaska state government. Given that revenues from these tracts are divided evenly between the federal and state governments, it almost seems like a shell game. The nine tracts required a $10 million investment, and the share of revenue to Alaska will be $7.2 million.
This lease sale is reminiscent of the debate over below-cost timber sales in the American West a generation ago. Back then, the U.S. Forest Service spent more money demarking timber sales than those tracts of timber brought in revenue. That practice led to an unlikely alliance between fiscal conservatives outraged by the management practice and environmentalists concerned about the impacts of more and more logging. The alliance finally shifted the balance in the Western public-land logging debate. A full accounting of the Alaska Coastal Plain lease sale might give rise to a similar opposition coalition.
The Trump administration made a point of resolving a 40-year push to open the coastal plain area of the Arctic National Wildlife Refuge. The economic gains of this opening were a feature of the political push. New acreage and drilling on the North Slope would mean high-paying jobs in Alaska, more oil to help operations on the Trans-Alaska Pipeline System, and a welcome fiscal windfall shared by American and Alaskan taxpayers. As it stands, the federal taxpayer earned $7.2 million. That is a slow start toward the billions over a decade projected by the nonpartisan Congressional Budget Office.
Why was this lease offering so poorly received? For starters, there is too much oil on the pandemic-ravaged global market. Earlier this week, Saudi Arabia pledged to take 1 million barrels a day off the global market in an effort to convince OPEC members and partners to sustain cuts that could provide higher prices in coming months. This behavior is a clear signal that the value of additional oil on the market today is small, if not negative.
As I pointed out previously, this is a bad time to offer oil leases. But there are other factors at play. The expected change in regulatory oversight under the Biden administration likely played a role. So too did the recalcitrance of many banks to underwrite development of leases in this politically sensitive area. Any of the tracts east of Kaktovik are an awfully long way from any market, and the cost of bringing those tracts into commercial production will be especially high. America is literally awash in oil, and finding more in the top-right corner of Alaska is not that high of a priority, especially with strings attached.
Three things will happen now. First, the pace of the global recovery from the pandemic will determine the price of oil. The slower the recovery, the lower the price, and the less attractive North Slope development will be. Second, the incoming Biden administration has signaled opposition to any new leases and may make developing these leases more complicated and expensive. How legal challenges to the leases and regulation of development planning unfold could render the leases worthless. Third, the successful bidders will need to figure out how to get a return on their investments, most likely by partnering with oil producers. This is not unusual — less than 10 percent of federal oil and gas leases ever produce. The long-term return to the federal and Alaska Treasuries depends on receiving lucrative royalties, but a willing private partner with capacity to develop the remote leases will need to be rewarded for their efforts.