Foreword | Executive Summary | News Release

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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

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.