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Spencer Hosie: Alaska has no gas line because Exxon doesn’t want one; state will prevail in Point Thomson litigation
Alaska doesn’t have a gas pipeline because ExxonMobil doesn’t want to build one, a top U.S. trial attorney told the Alaska Senate Judiciary committee on May 7. “If they wanted a pipeline, you’d have a pipeline,” said Spencer Hosie, a senior partner in San Francisco’s Hosie Frost Large & McArthur.
Hosie says Exxon, a partner with BP and ConocoPhillips in known gas resources on the North Slope, makes more money investing its capital elsewhere, including the $41 billion it spent in the last two years buying back its stock — an action that bolstered Exxon’s per-share value but did nothing for the State of Alaska’s effort to develop and market its stranded North Slope natural gas resources.
In his comments to the committee Hosie, who has won cases against Exxon and other corporate giants such as Microsoft Corp., made a number of startling points that the Murkowski administration stopped listening to in the months before the firing of Alaska Department of Natural Resources Commissioner Tom Irwin.
But Irwin is back as DNR’s commissioner and he and Alaska’s current governor, Sarah Palin, are obviously paying close attention to Hosie.
Although the North Slope is thought to hold more than 211 trillion cubic feet of gas, most of the 35 tcf of proved gas reserves are in the Prudhoe Bay and Point Thomson units. Exxon, ConocoPhillips and unit operator BP each own about one-third of the hydrocarbon in Prudhoe. The undeveloped, 30-year-old Point Thomson unit was recently terminated by the state — a decision unit operator Exxon and its partners, BP, Chevron and ConocoPhillips, are contesting in Alaska Superior Court.
Following is what Hosie had to say to members of the Senate Judiciary Committee.
First, the State of Alaska is going to prevail in the pending Point Thomson cases brought by unit operator Exxon and its partners. The state will get its Point Thomson leases back to resell to oil companies willing to develop them, Hosie said.
“The parties will likely spend the next 60 days fighting about … procedural questions. But on the substance of the issue — on the substance of what I call the move-it or lose-it point — the state is exactly right. And the state will win at the end of the day.”
When asked if the State of Alaska could make a compelling argument to the Superior Court that a lawsuit involving Point Thomson or a North Slope gas line needed to be expedited, Hosie said yes. “In fact, the state, as I understand it, has emphasized the need for prompt treatment in the Point Thomson case in Anchorage and Judge Gleason is moving that case forward very quickly, very quickly indeed.” (See decision on related litigation in sidebar to this story.)
Exxon told SEC Point Thomson was economic In 2005, Exxon told the U.S. Securities and Exchange Commission that Point Thomson was economically feasible, Hosie said. In its annual report to SEC the company said the unit was “economically feasible” based on 2005 prices and economics. “Period. Full stop. That is in their 10K. … Exxon made that conclusion and its auditors Price Waterhouse Cooper — PWC — signed off on it. … That is what Exxon really thinks about Point Thomson. Exxon is not misleading the SEC. Exxon is not misleading Wall Street.”
If you’re a major oil company with a development opportunity in Kazakhstan or Qatar, Hosie said (Exxon has both), and you don’t move oil and gas projects forward, there’s “severe financial consequences,” including losing your right to develop, losing the resources.
So, Hosie said, some oil companies spend their money there, instead of in Alaska.
“My own personal view is that Exxon and the others have not until very recently considered the risk of losing the resource real in the State of Alaska. Putting that differently, they thought they could safely warehouse these resources here.”
Don’t assume all oil companies are alike But don’t assume other oil companies are just like Exxon, Hosie cautioned more than once in his presentation.
Many companies doing business in Alaska have “a very different view” of investing in the state than Exxon, including Exxon’s partners on the North Slope. “There are very different companies with different approaches and different appetites for development. And it’s important that the state not think that Exxon’s view of the world is necessarily Chevron’s, is necessarily ConocoPhillips’.” Oil companies think about these things differently internally. They are fighting about these things internally now, I am sure, and it’s important to recognize that. Even though they may speak with a unified voice to you, they are very different companies with, I think … fundamentally different willingnesses to go forward with a project here.”
Chasing very high rates of return The problem is, some oil companies have “very high internal hurdle rates, rates of return,” as a corporate policy that governs all of their investments, Hosie said. Even if an Alaska project shows a 25 percent profit, if that company has an internal hurdle rate of 30 or 40, 45 percent, the Alaska project won’t get built, he said.
So what do the courts view as a reasonable rate of return? It varies between 6-10 percent, Hosie said. “It’s not 30 percent. Look at what bond rates are, look at what investment-rating debt pays. Those are the kinds of metrics that courts and adjudicators look to for the definition of reasonable profitability.”
As its “partner” via the DL1 lease agreements in the Prudhoe Bay unit and former Point Thomson unit, Hosie said the State of Alaska is “entitled” to know what Exxon and its partners’ internal rates of return are, especially since the companies are getting the “lion’s share of the value” of the oil and gas in the two units — 87.5 percent and the state is getting a “modest” 12.5 percent, which is “very low” in today’s world.
“They have upstream investment guidelines that govern where they invest money and what the gating hurdles are and what the return on investment has to be in order to green light a project. …It’s all there in their internal documents. … Yes, you are entitled to it (internal rates of return), particularly if they have come to you and said the project is not economic unless you change your royalty percentage or change your tax review. In making those kinds of requests, and I appreciate that was in prior administrations, the industry is essentially trying to re-cut the deal,” he said.
By law, Exxon must consider Alaska’s best interest, too If Exxon won’t tell you what its internal rate of return is for Alaska, put a motion before the court in the pending Point Thomson litigation, or “ask Exxon to give me permission to show them to you because I have them,” Hosie said. “But I can’t show them to you because they were produced under a protective order.”
For “many, many decades courts have recognized that an oil and gas lease creates a special relationship of mutual interdependence; a bargain that oil companies doing business on the North Slope make in their initial lease agreements as interpreted by the courts,” he said.
This means that an oil company under a lease is “no longer free to make decisions based on its unilateral economic best interest. Instead, it has to make development decisions based on its interests and the economic best interest of the royalty owner,” in this case the State of Alaska.
Oftentimes the economic interests of both parties are aligned. For example, Hosie said, both have common interest in high oil prices. But there are circumstances where the economic interests of the oil company and the royalty owner diverge, “making an oil company disinclined to produce — at least right now,” he said.
For example, a company can be “long on a particular resource. A company that has too much gas on the West Coast doesn’t value gas; at least not now,” he said. A company that has a lot of capital but for various reasons prefers to invest it elsewhere — i.e. in places like Kazakhstan or Qatar that don’t dicker with companies that want to warehouse resources.
Under oil and gas case law, Hosie said if a project in Alaska is “reasonably economic, then the oil company has an obligation to go forward. And that’s how the implied duty to develop solves this conflict between a royalty owner who says I really want my field produced and an oil company that says, you know what, you’re just one voice among many and we’re going to go do something else with our capital dollars right now.”
It is unacceptable for an oil company “30 years down the road to say, oh incidentally, this project may be reasonably economic but we think we can get a bigger bang for our buck in Kazakhstan or Qatar or in Mississippi or in East Texas,” he said.
Palin’s version of AGIA way to go Is Palin’s Alaska Gasline Inducement Act the appropriate vehicle for the state to get a gas line?
“It is,” Hosie said. The $500 million catalyst is important to help “a third party get past certain regulatory hurdles” that will make a gas line a reality. “It’s in the state’s best interest to make that happen.”
The law is “clear,” he said. “They have to use it or lose it.” If a third party is willing to build a gas pipeline from the North Slope and goes to Exxon and the other North Slope producers and offers to buy gas at “a reasonable market price,” those producers have to sell. They have “an implied legal duty” in their lease agreements with the state. If Exxon and its partners refuse, “they violate the implied duty because … they would effectively be bottling up the resource indefinitely.”
That is what the courts call “in-ground warehousing, speculative warehousing of a hydrocarbon,” Hosie said.
But the “right remedy is not necessarily to spark off a complicated litigation,” he said. But to say, “listen, if you think it’s not economic, we’d like it back please.”
It’s really that clear in the law, Hosie said. They don’t get to have it both ways. They don’t get to say, it’s not economic so we won’t build it, but we’re going to hold onto the gas. In this country, in this state, they have to move it or lose it. They can’t bottle it up indefinitely. That’s contrary to every tenet of oil and gas law in this country.”
Therriault: Other companies tried to buy out Exxon Sen. Gene Therriault asked Hosie if other companies had tried to buy Exxon’s interest in Point Thomson, would that help demonstrate the project’s economic viability?
“It’s my understanding that companies that are part of the overall leaseholders (BP, Chevron, ConocoPhillips) have made attempts” to buy Exxon’s interest “and outside companies have approached Exxon and been shooed away,” Therriault said.
“Absolutely yes,” said Hosie. “If you have another major oil company, or even a smaller oil company, that has a foothold on the North Slope and wants more, if they’re coming to Exxon and offering to take over the Exxon leases and pay a significant bonus, that’s because they think it’s an economic project. I have no doubt that the state could generate significant bids if it re-lets the Point Thomson leases today. Huge bonuses.”
“Six zeroes or nine zeroes?” asked Therriault.
“Nine zeroes,” Hosie replied.
Give it to companies who will build it Hollis French, chairman of the Senate Judiciary Committee, said he has gotten himself “locked in a mindset” of having to prove the gas line and Point Thomson projects are economic. “I have to keep marshalling state experts, state economists, outside analysts to prove that this is economic when your perspective is, they’ve (Exxon and its partners) got the answer. We just haven’t forced it out of them.”
“Exactly, Mr. Chairman, I’ll even answer that,” Hosie said. “You can’t as a royalty owner prove it’s economic. You don’t have access to the engineering studies; you don’t the reservoir data they have. It’s not what you do. That’s why you have them. That’s why they’re getting 87.5 percent of production. That’s their expertise. The last thing a royalty owner wants is a long, drawn-out litigation with an oil company about whether a big project is economic or not. That’s not the fight that you want, but it’s not the fight you need to fight. You simply have to make them tell you, make them decide, are you going to build it or are you going to give it back? And if they give it back you can re-lease it to an oil company, a major or consortium of independents or of minors, with specific time tables. ‘We will release it to you but we need a bonus of this and we need you to do the following things on the following schedule.’ That’s your right as the royalty owner. What is improper here is essentially the state has been in limbo through these interminable negotiations, sliding down a slippery slope.”
Black letter rules of law Therriault said in conversations he had had with the previous governor’s chief of staff about the work Hosie had done, he was “warned … that there was a hole in your argument. … So what’s the flaw? … What’s the hole that he referenced?”
“I will say that no one in the prior administration commented to me that there was a … flaw in my argument, and if they thought that, I would have appreciated them pointing that out to me because I do not think that there is,” Hosie said.
“For an oil and gas lawyer who does what I do and has done it day in and day out for many, many years, these are not abstract shades of gray concepts. There is a duty to develop. It is in the DL1 lease form. They do have the obligation to go forward. If they don’t want to go forward, there is a price to saying no, and that price is they have to surrender that resource back to the state. Those are black letter rules of law,” Hosie said.
—Kay Cashman
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