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RCA halts Enstar/Marathon hearing Commission adjourns hearing to consider response to objection by Marathon to order compelling discovery of LNG cost data Alan Bailey Petroleum News
A Regulatory Commission of Alaska public hearing on the proposed new gas supply contract between Enstar Natural Gas Co. and Marathon Oil Corp. jolted to an abrupt halt on July 13 when Administrative Law Judge T.W. Patch adjourned the proceedings at the point when Marathon was about to take the witness stand for cross examination. Marathon has objected to complying with a discovery request from Tesoro Corp. for confidential information about the production and transportation costs of the liquefied natural gas that Marathon supplies from the Kenai Peninsula to Japan. RCA had ordered Marathon to comply with the request.
“The commission cannot proceed until it has fully considered Marathon’s conduct and the consequences that flow from it. … The commission can only continue the hearing after the matter has been dealt with,” Patch said, in adjourning the hearing.
The commission had previously set rules for the handling of confidential material, including the signing of non-disclosure agreements by attorneys involved in the case. However, Marathon said that the LNG data are of an especially confidential nature and that the company had signed a non-disclosure agreement for the data with ConocoPhillips, the operator of the Kenai LNG plant.
“Complying with the order will put Marathon in the position of either breaching … agreements with ConocoPhillips or violating a commission order, neither of which is a very appealing place to be,” Mark Lewis, counsel for Marathon, said earlier in the hearing.
Announced in November Tony Izzo, president and CEO of Enstar, announced the new gas supply contract with Marathon in November, saying that, together with other supply contracts, the new contract would ensure gas supplies for Enstar customers through 2016. Gas demand in Southcentral Alaska has started to exceed supply, thus prompting concerns about whether sufficient gas will be available in the future. Without the new contract Enstar could start to run short of gas as early as 2009, Izzo said.
But, following the age-old laws of supply and demand, gas prices in the Cook Inlet area have been increasing. Two previous Enstar contracts, one with Unocal in 2001 and the other with NorthStar in 2004, have indexed gas prices to the Henry Hub gas market in the Lower 48. That represents a substantial hike in price relative to the low prices that Alaska gas consumers have enjoyed in the past.
Under the new Marathon contract, the price that Enstar will pay for the gas would be based on a 12-month trailing average of gas prices at the Henry Hub gas market in the Lower 48, with discounts if that index price climbs above $6 per thousand cubic feet. The price will have a floor of $4.25 per mcf and a cap of $15 per mcf. There is an additional charge for peak gas volumes supplied at volume rates in excess of contracted peak volumes.
Enstar and the gas producers have argued that the linkage to Lower 48 prices results from a need to attract new investment into Cook Inlet gas exploration — there’s little or no incentive for companies to explore for gas in the Cook Inlet basin if those same companies can explore for gas at higher prices elsewhere in the United States (or overseas). And without new Cook Inlet gas exploration, gas supplies in the Anchorage area will surely run dry before too long.
But does the Henry Hub index raise the price too high? And will the new contract effectively exclude new producers from the high-value gas utility market, thus reducing competition in the Cook Inlet area?
These questions have sparked intense debate, culminating in the many hours of statements and cross-examinations that have already taken place in the adjourned RCA hearing.
Enstar accountable In opening statements at the hearing, Julian Mason, counsel for Enstar, said that Enstar is held accountable if it cannot supply gas to meet its customers needs.
And although the Cook Inlet gas scarcity is causing higher prices, those higher prices are also triggering new gas exploration and development, he said. Mason also said that price capping the gas, as some have suggested, has historically resulted in gas shortages in the United States.
Mason also said that Cook Inlet was the only reliable source of gas for Enstar “in 2009 and 2010 and perhaps for many years after” because of uncertainties regarding either a future gas line connection from the North Slope or the possibility of importing LNG to Southcentral Alaska (some people have said that the proposed development of a gas spur line into Southcentral eliminates the need for further Cook Inlet gas exploration).
“What this contract does is preserve for Enstar a set of options, so that when the facts are actually known (about other options) it can make the choices that are best for the ratepayers,” Mason said.
And Mason argued for the use of the Henry Hub index as a basis for gas pricing. Everybody agrees on the use of a commodity price index and Henry Hub is the principle gas reference in North America, he said.
Nik Patel, counsel for Marathon, said that the Henry Hub pricing in the Enstar contract with Unocal had encouraged Marathon to explore for more gas.
“Marathon undertook sizable efforts to increase its reserve base in order to … position itself for the future of supplying gas here in the Cook Inlet,” Patel said. “… Exploration is exactly what the commission wanted to encourage here. Exploration is exactly what Marathon did.”
Patel said that some people have proposed using markets other than Henry Hub for price indexing because those other markets have enjoyed lower prices than Henry Hub. However, the supply and demand characteristics of the other markets do not resemble the Cook Inlet market, he said.
High pricing But Robin Brena, counsel for Tesoro, took issue with the use of the Henry Hub pricing.
“Five years ago Enstar’s ratepayers paid the lowest price for gas in the western United States and Canada. Five years from now if the commission adopts the Henry Hub index Enstar’s ratepayers will pay the highest price for gas in the western United States and Canada,” Brena said. “… Why should Enstar’s ratepayers pay Marathon a windfall profit to blow down proven reserves?”
Tesoro uses 4.5 million cubic feet per day of Cook Inlet natural gas at its Kenai Peninsula refinery, Brena said. A $1 per thousand cubic feet increase in the price of gas results in $5 million per year off the Tesoro refinery’s bottom line, he said.
Brena said that Tesoro is not asking RCA to reject the contract outright, but that the company wants “some economic rationality to this deal.”
In particular, Brena said that the proposed gas price is above the local market rate because Marathon can continue to sell gas to Japan.
“The sale to Japan would be at substantially lower prices than anything you’ve been asked to consider,” Brena said.
If the commission starts approving prices that take the marketplace out of balance then the end result will be that you won’t have industry in this state on the demand side, he said.
Brena said that when, in the future, southern California has LNG receiving terminals it will make more sense to export Cook Inlet LNG to California rather than Japan. And if a gas pipeline in future connects the Cook Inlet to the Lower 48 through Canada, Alberta hub pricing will determine Cook Inlet prices. Hence, Tesoro is pushing the use of price indexes other than Henry Hub, to determine Cook Inlet prices.
“We didn’t choose these indexes because they were geographically close,” Brena said. “We chose the three indexes we did because they’re the only three places our gas from this inlet will ever go.”
And Brena wants Marathon’s disputed LNG cost data, so that he can calculate a current netback price for LNG sold in Japan without depending on estimated costs.
What next? “This is starting to feel a little bit like I may be Gary Cooper at high noon,” said Enstar counsel Mason in his comments on the impasse over the discovery request to Marathon. “The central theme here should not be an ongoing feud between Tesoro refinery and Marathon Oil Company.”
The data in question relate to a 10-year old contract that expires at about the time that the new contract activates, Mason commented.
And Lewis offered, as a way out, that Marathon would not challenge LNG production and transportation cost estimates presented by a Tesoro expert witness.
Brena said that there is no feud between Marathon and Tesoro and that he had nothing critical to say about Marathon. But given the substantial increase in proposed pricing, “they ought to step up with some information.”
But now everyone awaits an RCA ruling.
“You will be informed of the commission’s further action by order,” said Patch, as the hearing adjourned.
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