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Image source: Royal Dutch Shell.

Oil and Alaska have maintained a close relationship since oil producers started pumping crude from the Alaskan North Slope region in the 1970s. For decades, Alaskan oil has created a large portion of the U.S.'s overall production, while the proceeds from oil created the bulk of the Alaskan economy.

Recently, though, the U.S. Energy Information Administration (EIA) delivered a very sobering truth: By 2030, expected Alaska production will fall by 50% from current levels, at which time it will barely contribute to the expected U.S. average production of 10 million barrels of oil per day (BOE/D). The EIA report shouldn't come as a huge surprise, though. Here's why.

Diminishing production

At its peak in the late 80s, the Alaska oil and gas industry was producing roughly 2 million barrels of oil per day. Large oil producers reaped the benefits of enormous oil reservoirs, such as the Prudhoe Bay oil field on Alaska's North Slope, which, with 25 billion proven barrels of reserves, constituted the largest oil field in the U.S.

Peak oil production can't last forever, though, and Alaskan production began its slow descent to today's average of 600,000 BOE/D, according to the Alaska Oil and Gas Association. As if to add insult to injury, an EIA report last year knocked Prudhoe Bay from the country's largest producer down to third in both production and reserves, behind the Texas Eagle Ford and Spraberry Trend shale resrevoirs.

The production decreases are caused by the difficulty of drilling in the complex offshore fields, as well as the rapid advances in onshore shale oil production in the Lower 48. It's simply becoming less economical for companies to invest in Alaskan oil fields.

Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B) represents one of the best -- and most talked-about -- examples. Last year, the company famously opted to pull out of its offshore positions after spending $7 billion in unsuccessful efforts to find oil in the Chukchi Sea. It stated that it couldn't find commercially viable sources of oil. Shell abandoned further efforts to extend its leases last month. 

Additionally, Repsol (NASDAQOTH:REPYY), a Spanish oil company and the last oil producer in the Chukchi Sea, just announced it is abandoning 55 drilling leases in the region and will pull out of its remaining 38 by next year. 

Is there any good news?

Let's not shake the death rattle just yet. For the first time in a decade, the Alaskan North Slope oil production rose by 3% during the fiscal year. Oil production from new fields such as ExxonMobil's (NYSE:XOM) Point Thomson came online after several years of development. Added production also came from ConocoPhillips' (NYSE:COP) CD5 field in the National Petroleum Reserve-Alaska. 

Additionally, Prudhoe Bay's recovery rates have been bumped up from an estimated 40% to a revised 60% because its oil field producers, which include BP (NYSE:BP) as the primary operator, along with active partners ExxonMobil and ConocoPhillips, are beginning to use new methods to extract the crude. Many of these methods are replicated from the innovative shale oil production, which includes multi-lateral wells. 

To add further good news, the U.S. Bureau of Ocean Energy Management said that despite Shell's inability to find commercially viable oil, significant reserves of potential oil exist in regions such as the Chukchi Sea.  This is an important distinction.  Potential oil is not the same thing as commercially viable oil.  After spending $7 billion to unsuccessfully extract the potential oil, Shell could not justify the further expenses at today's oil prices to make it commercially viable.  Potential oil, though, means that as prices recover and companies continue to find innovative new ways to extract it from the icy waters and complex rock formations, these reserves could potentially be revisited in the future. The Obama administration is already considering new permits beginning in 2020. 

What will happen?

A slew of factors are working against Alaska. Despite its North American dominance in the 1980s and 1990s, major oil producers found far cheaper oil in shale deposits in Texas, Oklahoma, and North Dakota. The fact is, it is not easy to drill for oil in the offshore Alaskan oil fields. Add in the advances in renewable technologies that have slowly been cutting into the nation's energy requirements, and it's easy to write Alaska off altogether.

But all is not lost. The offshore reserves remain vast -- meaning some of the largest in the world. Shale oil once seemed unattainable. Today, because of innovative drilling techniques, it has reshaped the world's oil markets. Those methods are already being applied in Alaska.

If Shell's $7 billion gamble is any indication, though, you should think twice about investing in a company that seems bullish on Alaska. ConocoPhillips is having some success in its CD5 position, and BP continues to produce from its pre-established Prudhoe Bay positions, but until companies prove they can economically explore, develop, and produce in Alaska, it's best to leave those ventures on ice.
