Arctic Holds Great Resource Wealth, But Is Cost-Prohibitive For Now

Includes: NATDQ, SDRL, STO
by: Power Hedge

A recent article published here at Seeking Alpha entitled “The Arctic Is Poised To Be Oil’s Final Frontier” caught my eye. In this article, Hard Assets Investor makes the case for several oil companies that have the potential to profit off of the large amount of untapped oil in the Arctic.

Overall, I agree that the Arctic does offer opportunities for companies with the ability to tap its resources. The Arctic is an area that is very rich in both oil and natural gas. Donald Gautier and his team at the USGS, some of the world’s foremost geologic experts on the Arctic region, make the following estimates about the oil and gas wealth of this area:

  • A total of 17 surveyed sites promise significant finds. There could be up to 90 billion barrels of undiscovered oil in the Arctic. This would represent 13% of the world’s undiscovered reserves.
  • More than half of the estimated oil deposits are located in just three areas: Arctic Alaska, the Canada basin, and Greenland.
  • An enormous amount of natural gas is estimated to be in the Arctic. Estimates of these reserves place the amount at 47.3 trillion cubic meters of gas plus, 44 billion barrels of liquefied petroleum gas. When these reserves are converted into oil equivalent, they are three times as large as the estimated Arctic oil fields. This represents 30% of the world’s undiscovered gas reserves and 20% of undiscovered LPG reserves.
  • There are three areas that are especially important for their gas reserves. These are the West Siberian Basin in Russia, the Arctic Alaska region, and the Eastern Barents Sea, which is shared by Norway and Russia.
  • More than 84% of these estimated reserves are located offshore.
  • The USGS also estimates that 2.41 trillion cubic meters of gas could be extracted in the form of methane hydrates. This is almost enough gas to satisfy the world’s demand for an entire year.

There are many opportunities for investors here, given the mineral wealth that can be found in the Arctic. As the numbers above show, there are many reasons for both oil and natural gas companies to be attracted to the area, but natural gas could be the better play here. Nearly 30% of the world’s undiscovered gas reserves could be found in the Arctic -- that is far too large a percentage to ignore.

One company that could be well positioned to exploit these enormous gas reserves is Norway’s Statoil (NYSE:STO). As I already mentioned, one of the richest sources of natural gas in the Arctic is the eastern Barents Sea. Statoil already has a successful E&P program in the Barents Sea, and the company has recently discovered a large oil field in the Sea. As mentioned above, 84% of the estimated gas reserves in the Arctic are located offshore. Statoil produces an enormous amount of natural gas offshore, and has proven itself to be an expert at extracting oil and gas from many of the harshest regions of the world, including the North Sea and Norwegian Continental Shelf.

Norway is one of five countries with territory bordering the Arctic region. Statoil is by far the largest company in Norway, and considering the Norwegian government’s 2/3 stake in Statoil, it stands to reason that this company will profit from any resources that can be exploited in Norway’s Arctic territory. Statoil also has the equipment and expertise to exploit Arctic oil and gas located outside of Norwegian territory, either on its own or in partnership with another energy company.

Statoil pays an annual dividend of NOK 6.25 ($1.125) per share. This gives the ADR a yield of 4.5% at its current price. This dividend is subject to a 25% Norwegian withholding tax, but due to a tax treaty between the United States and Norway, investors located in the U.S. will only pay a 15% withholding tax.

Another company that is well-positioned to profit off of the resource exploitation in the Arctic region is North Atlantic Drilling Limited (NATDF.PK). North Atlantic Drilling is a spinoff from the much larger SeaDrill Ltd (NYSE:SDRL) and focuses nearly exclusively on drilling in the North Sea and Norwegian Continental Shelf. The company’s expertise at operating in these hostile areas could lend itself well to operating drilling rigs in the Arctic. North Atlantic Drilling currently pays a dividend of $0.035 per share per quarter, giving it a dividend yield of 8.75%.

Another strategy here could be a long position in SeaDrill itself. While SeaDrill no longer has the sub-Arctic and hostile environment that North Atlantic Drilling has, the company still has significant expertise operating in this region. SeaDrill still has two rigs (excluding rigs owned by subsidiaries) that are designed to operate in a harsh or hostile environment and can always construct more. Additionally, SeaDrill owns a 75% stake in North Atlantic Drilling. Therefore, SeaDrill would benefit from any gains or expansion that North Atlantic Drilling delivers, in addition from any gains from regional expansion that SeaDrill itself may deliver. Overall, I believe that North Atlantic Drilling is likely to be the bigger beneficiary of Arctic resource exploitation, but SeaDrill’s large stake ensures that it will also profit from these opportunities.

One of the biggest problems with exploiting the resource wealth of the Arctic is the staggering costs involved. It is not economically viable to tap much the Arctic oil at today’s prices. At $100 per barrel, only about 2.5 billion barrels of oil could be produced off of the coast of Greenland according to the USGS. Even at the incredible price of $300 per barrel, only about 4.1 billion barrels could be produced in the area. That is with a 50% probability and before making a penny of profit or paying any taxes. Higher prices than these would be needed for the area to offer enticing profit opportunities. This area off of the coast of Greenland is estimated to contain about 7.5 billion barrels of oil. Energy prices of that level would be more than sufficient to break the back of the United States’ and many other major economies.

Please note that while the cited article only discusses the exploitation costs in the western Greenland Sea, the same is likely true of the rest of the Arctic region. To put it simply, today’s energy prices are much too low for tapping the Arctic resource wealth to make much economic sense. Future technology advances and higher energy prices should one day make exploiting the Arctic technically and economically feasible, but it is not likely to be in the immediate or near future.

There could still be the potential for profit from the mineral wealth in the area (particularly off of oil and gas in the Barents Sea) but investors are advised to keep the technical and economic realities in mind when analyzing any particular opportunity.

Disclosure: I am long SDRL, STO, and I intend to increase my position in both stocks within the next 72 hours.