Providing coverage of Alaska and northern Canada's oil and gas industry
April 2013

Vol. 18, No. 14 Week of April 07, 2013

State looks to sew up royalty oil deal

Under proposed five-year contract, Flint Hills Resources would buy up to 30,000 barrels of crude per day for North Pole refinery

Wesley Loy

For Petroleum News

The administration of Gov. Sean Parnell is seeking legislative approval for the sale of state royalty oil to Alaska’s largest refinery.

Under a proposed five-year contract, the crude would go to Flint Hills Resources, operator of the refinery at North Pole, near Fairbanks.

As of April 3, the state Senate was nearing passage of a bill (Senate Bill 86) to approve the sale. A similar bill in the House (HB 188) remained in committee.

A “best interest finding” prepared by the state Department of Natural Resources said selling royalty oil to Flint Hills would be a good deal for the state and the company.

The state has supplied royalty oil to the refinery for more than three decades, ever since it began operations in 1979. The refinery has gone through a succession of owners, from Earth Resources to Mapco to Williams to Flint Hills.

Flint Hills is a subsidiary of Koch Industries Inc. of Wichita, Kan.

Contract worth billions

Royalty oil is the state’s share of the oil that companies produce from leased, state-owned land.

Most of the oil produced on the North Slope, where Alaska’s largest fields are located, comes from state leases, and so the royalty oil is substantial and hugely valuable. The state receives a royalty share of 12.5 percent or more.

The state’s proposed supply contract with Flint Hills would replace an existing 10-year contract that expires on March 31, 2014.

The state would supply 18,000 to 30,000 barrels per day of royalty oil to Flint Hills.

If Flint Hills buys the maximum amount, it will equate to roughly half of the state’s projected daily North Slope royalty volume through fiscal year 2019, DNR said in its best interest finding.

The contract is forecasted to yield between $3.5 billion and $5.9 billion in state revenue.

The Alaska Royalty Oil and Gas Development Advisory Board reviewed DNR’s best interest finding, and recommended the Legislature approve the Flint Hills contract.

Sales options

The state has two options for converting its royalty oil into cash.

It can take the oil “in kind” and sell it directly to customers such as Flint Hills. Or it can take the oil “in value,” where the North Slope lessees market the crude with their own production and then pay the state for its royalty share.

State law presumes it’s in the state’s best interest to take royalty oil in kind and sell it to an in-state buyer.

But the law doesn’t allow giving the in-state buyer a big discount. Rather, the state must receive a price for its royalty oil that’s no less, on average, than what it would receive by having the lessees market it.

DNR explored auctioning the oil, which it has done occasionally in the past, but decided a negotiated deal with Flint Hills would be best.

The North Pole refinery currently is the state’s only royalty-in-kind customer.

The proposed contract is good for the refinery, and also benefits the state, DNR said.

That Flint Hills is willing to enter into another royalty oil contract shows the company sees some financial advantage in sourcing some of its crude from the state rather than relying entirely on supplies from private companies, the best interest finding said.

Flint Hills indicated the North Pole refinery “has experienced on-going financial pressures and that refinery operations might cease in the absence of a new ... contract,” the finding said.

State benefits

The refinery is important for the state’s economy as a major fuel producer, and as an employer of 129 Alaskans in high-paying jobs, DNR said.

The proposed contract contains two “special commitments” to the state.

First, Flint Hills can extend the contract for five more years if it makes a large capital investment at the refinery, or “enters into a binding agreement to support a solution to bring natural gas from the North Slope into the Interior.” The Interior is eager for gas to substitute for expensive heating fuel, and to improve local air quality.

Second, Flint Hills agrees to continue to maintain wholesale gasoline price parity between Fairbanks and Anchorage. This commitment already has been in effect for 10 years.

The North Pole refinery draws its crude from the nearby trans-Alaska oil pipeline. The current draw is 82,000 to 84,000 barrels per day. From this, the refinery makes 22,000 to 25,000 barrels of refined product, injecting residual crude back into the pipeline.

The refinery produces about 672,000 gallons of jet fuel per day, shipping most of it on the Alaska Railroad to Anchorage’s international airport, which is a major refueling stop for trans-Pacific air freighters. The refinery also makes about 143,000 gallons of gasoline per day and 41,000 gallons of home heating fuel, plus several byproducts.

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