Looking for equality

Last year HEX paid $8M in royalties at 25% rate, others paid 13%

Kay Cashman

Petroleum News

John Hendrix, owner of the HEX companies, which include Furie Operating Alaska, the operator and owner of the Cook Inlet Kitchen Lights unit, said June 11 that he is primarily looking for an equalization of royalty rates.

Royalties are paid from gross oil and gas production income. Those receiving royalties do not pay any portion of the cost of drilling or operating a lease. Royalties must be paid even if the operator is losing money.

All royalties are controlled by, and have to be approved by, the state.

Taxes are applied to net income after expenses. Therefore they don't burden the operator as much as royalties.

"We pay more in royalties at 25% in the Kitchen Lights unit than any other oil and gas field on the North Slope and the Cook Inlet basin," Hendrix said.

The average producer royalty rate in Cook Inlet is 13%.

"Even the state Supreme Court understands the issue and ruled in 2023 that royalties, which include overriding royalties, should not exceed 20% on oil and gas properties," Hendrix said.

Since buying Furie "we have been fixing its 'foundation,'" he said, and "trying to resolve this issue and many more. I am proud of our people and what they have done to get us to where we are today. We have now operated this field longer than any other group before us. Currently we are celebrating our fourth year over ownership of the field," Hendrix said.

"But to move forward with major capital spending and drilling we have to fix the royalty burden," he added.

First and foremost, Hendrix's goal at Kitchen Lights is to make it economic to drill new gas wells.

"The state can undo some of the burdens it placed on the unit. But it needs to act soon for us to drill Cook Inlet gas this year," he said.

"Say a well comes in at two-thirds of what we expect. Our margin is so low, we could lose money by putting it on production," Hendrix said.

"We'll continue to produce Kitchen Lights as I bought it. But if you want more gas the state has to fix the royalties to aid in making it economic, competitive and sustainable to help provide gas to Alaskans for decades," Hendrix said.

"We spent $10 million trying to fix wells last year, just to keep production near flat," he said. "To date we have spent $5 million to prepare to drill this year. All in anticipation the royalty issue would be resolved. We have wells identified to drill that could probably produce at least 10 million cubic feet of gas a day. But to do that required us in April to spend $5 million up front on sand control equipment."

With no positive "signals coming from the Legislature, we redesigned the well without sand control and hoped the Legislature would pass timely legislation that would encourage new short and long term gas production from Cook Inlet. Without sand control the well will be limited to only 5 million cubic feet per day," he said.

"We didn't ask for special treatment from the Legislature, we just asked for a level playing field, for equalization. It was good to see DNR come out in support of royalty reduction. I truly believe they understand the issues," Hendrix said.

"Nothing the Legislature passed helped anyone in Cook Inlet to produce more gas in the immediate term. ... The House did a good job but I am very disappointed in the Senate. I blame part of it on myself for not better educating them," he said.

"There is natural gas in the Cook Inlet basin; we just need to all work together to get gas to Alaskans homes. If we don't, Alaskans' heating bills will double. Everyone abandoned Cook Inlet for Prudhoe Bay in the '70s and all of the exploration money went north. Cook Inlet is a very under-explored basin," Hendrix added.

"Being from Homer, I used to own a commercial fishing boat and always think: How would a commercial fisherman feel if he or she caught $100,000 worth of fish and had to give up $25,000 for royalties and overrides before paying expenses? I think we all know the answer.

The tax issue

The state assessed the value of the Kitchen Lights unit at just over $81 million in 2021 and 2022, which was the new replacement value of the Kitchen Lights assets. Hendrix argued that the more appropriate value of the property was the $19 million he paid in mid-2020 when he bought Furie and its' assets through a Delaware bankruptcy court.

Hendrix hoped to reduce his $1.6 million annual property tax to $400,000 but in a May 17 decision Judge Herman Walker ruled that Hendrix had not shown why the state's valuation methodology was flawed.