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Providing coverage of Alaska and northern Canada's oil and gas industry
August 2006

Vol. 11, No. 32 Week of August 06, 2006

Basin control a concern for consultants

Gas pipeline sponsors say construction cost control goal of ownership; post-completion pipeline becomes a portfolio issue

By Kristen Nelson

Petroleum News

Basin control and cost control were the opposing issues of concern when the Alaska Senate Special Committee on Natural Gas Development heard July 31 from legislative consultants and the gas pipeline sponsors in a final round of discussion before the committee took up amendments to the Stranded Gas Development Act.

Consultants also provided written comments on basin control.

Don Shepler of Greenberg Traurig said reasonable certainty of line expansion at an appropriate price would resolve basin control issues. In a July 31 memo to legislators he urged the state to get those commitments in writing so expansion requirements in the contract “will effectively mimic the incentives that independent pipeline owners have to expand to satisfy new demand.”

He told the committee that if there were an independent pipeline — a pipeline company strictly in the pipeline business with no ownership upstream — the pipeline would not present a basin-control issue.

Access is “paramount” in the minds of non-owner producers, those who complete upstream with owners, he said. There may be other layers of basin control, such as how leases are administered and how they revert back to the state, Shepler said, but “my experience is in access” issues.

Time will be critical in pipeline access, he said, and for an independent pipeline expansions are the lifeblood of business because a pipeline makes a return on equity based on how much steel they put in the ground: the larger the facility the larger the return.

Shepler said he asked Econ One to look at equity return for pipeline owners on the tariff and said that at projected rates it would be 20-25 cents per thousand cubic feet of capacity at a $5.50 mid-level estimated market place. With an estimated tariff of $2.50, the netback would be $3 an mcf, so pipeline owners who are also producers would get $3 for their gas and 20-25 cents for ownership in the pipeline. Producer owners have a far greater stake in the upstream than they do in the pipeline, Shepler said.

Mismatch greater for expansion

When you move to expansion, he said, the mismatch is greater. Additional pipeline profit from expansion could probably be measured in pennies per mcf.

Shepler said his concern, from the perspective of non-owner producers, is that the owners don’t have financial incentive to expand the pipeline except to the extent they have their own gas to ship. He said he thought it would be a “tough argument” in the board rooms of pipeline owners to argue for expansion funding.

Dave Van Tuyl, BP Exploration (Alaska)’s gas commercial manager, said he agreed with Shepler that an independent pipeline is primarily motivated to put steel in the ground, to expand its rate base.

But, he said, that’s because they don’t have an incentive to reduce the rate base, and that’s the rub: BP wants to own and build the pipeline to ensure the highest netback possible, and that requires the lowest-cost project.

Wendy King, ConocoPhillips Alaska’s director of external strategies for Alaska North Slope gas development, said the companies will ultimately pay the cost of this mega-project through the transportation costs. The Federal Energy Regulatory Commission allows cost recovery in the tariff, she said, and the shippers carry the risk of cost overruns.

How big will line be?

Sen. Ben Stevens, R-Anchorage, asked Shepler about a footnote in his memo and how that relates to expansion.

Shepler said discussions about expansion have been based on the assumption that the project sponsors would build a 52-inch line to carry 4.5 billion cubic feet a day, expandable to 6 bcf a day with additional compression.

But there is nothing in the contract that commits the parties to the 4.5-bcf a day design capacity that could be expanded to 6 bcf with the relatively inexpensive addition of compression, he said. Shepler said the state noted in its fiscal interest finding that the sponsor group was the only group committed to building a larger-diameter line; other proponents had proposed smaller diameter, he said.

Because there is no prohibition against changing the qualified project plan, or no state veto over changes, the project plan may evolve and the pipeline that is built may not have expansion build into it. “We don’t know what will be built,” Shepler told the committee. We understand from the sponsors that it could be expanded to 6 bcf a day, but that’s not in the contract.

“If that’s the agreement it should be in the contract,” he said.

Sen. Tom Wagoner, R-Kenai, said he understood that it would be much less expensive to increase to 6 bcf a day with a 52-inch line than with a 48-inch line, and Shepler agreed. “That’s my understanding,” he said, “that smaller pipeline can’t be expanded as readily as a larger pipeline.” No one but the sponsor group was willing to go with a 52-inch line, he said.

Committee Chair Ralph Seekins, R-Fairbanks, asked about incentives to an independent pipeline to control costs, and Shepler noted that the producers raised the cost issue: “that’s why they want to build the line.” A lower cost for expansion to reduce costs would be an advantage to everyone — the problem is lack of commitment in the contract. Shepler said he thinks the state needs a “belt as well as suspenders.”

Why producer ownership?

Consultant Rick Harper said he’s wrestled with the issue of why the producers would want to own a pipeline when the returns aren’t what they get for their exploration and production business. The FERC-mandated returns on a pipeline are below what the companies would normally be shooting for, he said.

Shepler said the Alliance pipeline started out as a consortium of nine or 10 producers that wanted a pipeline built to monetize their upstream resources. Once the line was built, he said, they sold their interests.

Harper said Alliance was a situation where there weren’t competing offers to build the line and something had to be done to de-bottleneck Canada’s Western Sedimentary basin; it was a different time and different circumstance, he said.

Harper, formerly with ARCO, said from that company’s perspective an exploration and production company didn’t want to be in the pipeline business because it let regulators “get inside the tent.” He acknowledged that was probably not such a big concern now.

Producers will pay

Martin Massey of ExxonMobil said the producers want to build the pipeline because “we’re the ones that are going to pay for it.” It’s a matter of economics, he said: how do you value giving a firm transportation commitment to someone else? The project is huge and risky, he said, costing billions and will have an impact on all of us. “Given the magnitude we feel like since we’re paying for it we need to be the ones that manage the construction.”

He said maybe the companies wouldn’t own the pipeline forever, but would own it “until we get it built.”

BP’s Van Tuyl said he agreed with Massey that the producers were reluctant pipeline owners, and said they were involved because this was a basin-opening pipeline.

Van Tuyl said once the pipeline is built and delivered “then pipeline ownership becomes a portfolio choice.” A company may want a low-risk, low-return pipeline in its portfolio, he said, but the goal of ownership right now is to make sure the pipeline is delivered on time and on cost. He said he thinks the state would want to be associated with companies like the gas project sponsors that do this sort of project around the world.

King agreed, telling committee members “we ultimately will pay the cost of this mega-project” through the transportation costs. Shippers, she said, carry the risk of cost overruns, and also bring mega-project skills to the project.

Massey added that because producers don’t own a lot of pipelines in the United States, “people think we want to own this one for anti-competitive reasons.” He said that’s where that concern may come from. The companies have attempted to address that with FERC and what’s in the contract. “It’s not basin-control,” he said, adding that concerns in that area have been addressed with the administration in the contract.

Shepler’s suggestions

In his memo Shepler made a number of specific suggestions and said contract language “should be developed to require ‘voluntary expansion’ to meet growing market demand,” as well as requiring that all expansion proposals be on a rolled-in pricing basis. He said such measures would reduce or even eliminate basin control by the producer-owners.

His suggestions include:

• Requiring periodic open seasons at least every three to five years to determine the demand for expansion capacity.

• The state — and any producer — should have authority to initiate expansions, including during construction “upon request by creditworthy shippers in reasonable engineering increments” and the pipeline should be required “to propose and defend the use of rolled-in pricing for such expansion capacity.”

• The state and any producer should have authority to initiate expansions for creditworthy shippers in less than reasonable engineering increments if “the new shippers make an appropriate contribution in aid of construction such that the expansion will not adversely affect the economics of the pipeline system.”

• The state and any producer should have authority to initiate open seasons “without time limitations” and veto open season timing decisions “as it believes necessary to foster full and fair competition.”

These provisions, Shepler said, should replace Article 8.7 of the draft contract.






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