Balash describes enabling legislation

DNR commissioner talks about what Legislature will be asked to approve to allow state’s equity participation in Alaska LNG project

Steve Quinn

For Petroleum News

Joe Balash hasn’t been commissioner for the Department of Resources very long, slightly longer than two months. But his frontline experience in the state’s efforts to advance a natural gas pipeline runs deeper than most in Alaska.

Balash has been on a legislative or executive branch staff since Gov. Frank Murkowski’s administration attempted to secure a contract with North Slope producers ExxonMobil, ConocoPhillips and BP in 2006.

Balash worked for the Legislative Budget & Audit Committee for two years while the Legislature reviewed Murkowski’s contract under the Stranded Gas Development Act.

He then worked for former Gov. Sarah Palin as a special assistant on energy issues, particularly the Alaska Gasline Inducement Act, one of Palin’s signature pieces of legislation.

Gov. Sean Parnell retained Balash, but as a deputy commissioner working under Dan Sullivan. He oversaw the divisions of Oil and Gas and Geological and Geophysical Surveys as well as the Mental Health Trust Land Office, the State Pipeline Coordinator’s Office and the Gas Pipeline Project Office. He was also a member of Gov. Parnell’s gas-line team.

But last fall Balash found himself working as acting commissioner while Sullivan accepted a deployment assignment with the U.S. Marines, a prelude of the job he now has. On Nov. 13, not long after Sullivan’s resignation to pursue a seat on the U.S. Senate, Balash became commissioner.

Balash is now busy preparing to work with the Legislature in pursuit of statutory changes that support recent gas line agreements with TransCanada, ExxonMobil, ConocoPhillips, BP and the Alaska Gasline Development Corp.

The state signed two agreements, known as a memorandum of understanding, MOU, and Heads Of Agreement, HOA.

Balash sat down with Petroleum News to discuss the agreements and what he believes can be done this session to advance a project featuring a large-diameter line running from the North Slope to a liquefied natural gas plant in Nikiski.

Petroleum News: Let’s start with the session. What do you want from lawmakers to advance a gas line project?

Balash: In broad terms there are things that we need for AGDC, things that we need for the Department of Natural Resources and things that we need for the Department of Revenue. With regard to AGDC, we are going to ask the Legislature to establish a subsidiary to carry the state’s interest in the large project. That way we can maintain very clear missions and objectives for each organization and not have competing claims for resources or personnel, and we need to make clear that the subsidiary can in fact own liquefaction.

HB4, when originally set up to imbue AGDC with all of its powers, was relatively silent on the matter of liquefaction and so you can take a liberal view of their authority to say, ‘well if they are not prohibited of course they can because they can own things.’ Or you can take a very conservative view and say, ‘if it doesn’t give them the power, they don’t have the power.’ That will become really important at the time when underwriters get involved and there are financings being undertaken. We want to go ahead and make it very clear now that in fact a subsidiary can in fact carry in interest in liquefaction.

Petroleum News: So why doesn’t DNR carry that interest, or even DOR?

Balash: Because DNR is and will remain a state agency with day-to-day duties to carry out the management of the state’s resources. Same is true for DOR. It makes a lot of sense for there to be a specific corporate entity to carry out these interests. Now, going back to the legislation, we need the authority for DNR, in consultation with DOR, to negotiate agreements with the companies. Those agreements need to go upstream to the producers and downstream to the service providers. As far as the state’s equity position goes, our royalty rates are pretty well set out in the lease and unit agreements, but we do have a couple of instances where we have a net profit share lease or a sliding scale royalty where it really would make sense to flatten the royalty for those properties. Now, that doesn’t mean everything just goes to the lowest number but we will arrive at some point in between. Let’s say you have a sliding scale that starts at 12.5 and goes up to 20. It doesn’t mean we will wind up with a single royalty rate of 12.5 or a single royalty rate of 20. We will probably land somewhere in between. But we will fix it so that we can very clearly identify the state’s royalty interest as a matter of the equity gas. We need the authority to amend those leases, amend those agreements in that way.

For the Department of Revenue, in order to establish the equity interest in the gas that is represented by production tax, we need to move away from a net tax to a gross tax and then allow a taxpayer to pay that tax in gas. By taking that approach, we arrive at a fixed number for each property. Those fixed numbers then are what represents the state’s overall equity position, first in the gas but then gets carried through each of the components of the project. The state’s revenue will be derived from the sale price of the LNG. That is the legislation in a nutshell. The contracts we are asking the authority to negotiate are contracts that, if they are going to be long-term in nature are going to need legislative approval. The ones that matter, the ones that affect the state’s bottom line in the long term are the ones that will have to come back to the Legislature at a later date.

Petroleum News: Do you have a sense of a timeline for this project?

Balash: Where the project is now, they have begun some of the pre-FEED (front-end engineering and design) activities. Assuming we are successful in the legislative arena, the project sponsors would execute the pre-FEED agreements. That process would be completed, taking 12-18 months. So that would take us from the second quarter 2014 into 2015, somewhere between second and fourth quarter and pre-FEED would be completed. We would be developing the contractual agreements both upstream and downstream during that period, then bringing them forward publically for review and ultimately for legislative approval. I would think most likely we would be looking at a special session during the fall of 2015. But if things took a little bit longer, it’s conceivable things could drift into 2016.

The idea would be that action would move us from pre-FEED into FEED. That would take us into 2017 or 2018. After FEED, would come FID — final investment decision. Construction would take, depending upon a couple of things, four to six years. We would be looking at first gas somewhere in the 2022-2025 timeframe. The shorter each of these phases takes, the sooner we get gas to Alaskans.

One of the things I think is going to be most telling, and we’ll get a start on this year — again, assuming success from the Legislature — we will get a sense of the market from the buyers of LNG just how much appetite they have for Alaska LNG. There are a lot of things that we think add up to make this a very competitive project in the portfolio of supply that’s out there competing for those buyers. Until we actually start that process, we won’t know for sure.

That’s one of the things is contained in the Heads Of Agreement. The producer parties will initiate marketing efforts during this phase of development. That’s important for a number of reasons. A number of parties in Asian markets, especially in Japan, have heard about Alaska in the past. They may have heard it from a variety of voices. This is going to be one of the first times they will have heard about the possible delivery of Alaska LNG from the producers.

We’ve gotten some feedback from various parties, even some of our own contacts, that Alaska LNG is not part of what’s being marketed by these companies right now. They are offering LNG for sale, obviously, but it’s from places other than Alaska. One of the important things to us in the development of this Heads Of Agreement was the clear demarcation of the marketing to begin.

Petroleum News: There are some familiar features of this plan and the Stranded Gas Act. Among several things, both have the state taking an equity stake; both have the state taking royalty in kind; both have private negotiations, based on regulatory guidelines that get presented to the lawmakers. Are you going back to the Murkowski deal?

Balash: No. Absolutely not.

I would distinguish this from that effort in a number of ways. The first is the transparency here. We are stepping forward here through the Heads Of Agreement with a transparent description of the party’s intent and asking for the authority to paper these broad terms and principles. So we have in the HOA landed on what can best be described as a term sheet. We are taking that term sheet to the Legislature and asking for permission to paper it. If the Legislature gives us the permission, we will paper it, complete our due diligence during pre-FEED and then come back with more definitive agreements to be considered.

Going back in time to that 2005-2006 period — and frankly, you can rewind the clock a little bit further than that. In that effort, the authorization to negotiate was provided by the Legislature in the form of the Stranded Gas Act. The Murkowski administration then conducted negotiations behind the confidentiality provisions of that law, but the agreement they emerged with went beyond those guidelines, went beyond those parameters. That’s why they had to ask for amendments to the underlying Stranded Gas Development Act in order to facilitate the agreement they had struck.

In addition, that particular process had the effect of putting all of the state’s chips in on a single hand, and locked in not only a number of things about gas but also things about oil — right then and there in one vote.

That is not anything at all like what we are trying to do here. In this process, we are asking the legislature to set the take terms, but we are not asking them to lock anything in — and we won’t — until the producers are prepared, the other sponsor parties are prepared, to make additional commitments.

I have a little bit of perspective here as I was the staff to the Budget & Audit Committee. I managed their work. I remember clearly in May and June of 2006 people talking about this provision and that provision in the overall deal. We assembled the contractors — our experts — together one night and basically their takeaway was you can quibble over some of those details, but where the SGDA deal falls short is the state is not getting anything. There was no real commitment. It was incredibly unbalanced in favor of the other parties and I think that’s due at least in part in the manner in which it was negotiated. Then Gov. Murkowski kept promising ‘we are going to have a deal, we are going to have a deal.’ In some ways that exposed him as a negotiator. He was the one setting the expectation. I think some of the other parties were able to use that to their commercial advantage at the table.

In this case, Gov. Parnell has been loath to set expectations because he didn’t want to provide that same commercial advantage to the counter parties. He also has made it very clear to the companies at the highest levels that this is going to require a balanced approach with commensurate commitments on either side. We are prepared to take some steps and they need take some steps, and we are going to repeat that process until all of the parties are fully committed to the project. We are not going to put all of our chips in one hand.

Petroleum News: So the state has an equity in almost every stage?

Balash: That’s right. Even the agreement with TransCanada is rooted in the state’s ownership position. We’ve set out an initial contract term, and that has a depreciation schedule that goes along with it. TransCanada is looking at realizing all the depreciation during that initial term, but at the end of that term the state has the option to call back its equity interest from TransCanada and buy them out at the netbook value. If they fully depreciated their interest in the project, that netbook value is going to be really, really low. We never lose sight of that equity perspective. As an owner state, it’s important that we act like an owner state and I think we are doing that here.

Petroleum News: So do you have a sense of the breakdown of the equity of the project?

Balash: I’ve got a lot of ways to look at it and break it down. The HOA contemplates the state coming in somewhere between 20 and 25 percent. If the state is 20 then the residual positions are: Exxon is at 34.6; BP is at 22.5; Conoco is at 22.9. If the state is at 25 percent, Exxon is at 32.5; BP at 21.1 and Conoco at 21.4.

Petroleum News: So would this make Exxon the operator the way BP is the operator of TAPS?

Balash: That is something that would need to formally be voted on in the equity structures and agreements. Very clearly Exxon is the lead party in the development phase right now. There likely would be different operators in phases of the project. You see that reflected in the project team chart where the team lead is ExxonMobil, the integration lead is ExxonMobil, but the liquefaction plant is Conoco, the pipelines is TransCanada, and for the producing fields — upstream — that’s BP. That’s an important point I want to build on. Overall, size matters, right, your position in the equity structure matters. One of the reasons that Commissioner Rodell and I decided to put all of our gas into TransCanada capacity in the GTP and pipeline is to make sure their block overall was big enough to command a lead role so that should give them an edge in getting to be the operator of the pipeline long-term, certainly into the execution of construction.

Petroleum News: One of the criticisms of SGA and, conversely, one of the praises of AGIA is that it would encourage competition and new entrants into exploration and field development. Does this path keep that in mind?

Balash: Absolutely. Those features in AGIA embodied in some of the must-haves really were about furthering key state interests. One of those was low tariffs. Another is an expansion policy. In the Heads Of Agreement, we have landed on key terms and principles to advance both of those. The first is low tariffs. The way AGIA sought to advance a low tariff was by requiring a minimal threshold for debt in the capital structure (70 percent financing; 30 percent cash). Part of the reason for that is historically the state has been interested in low tariffs and the producers not so much. That’s not what drives their decision making because they are paying themselves. So we had a misalignment of interests between ourselves and the producers where the tariff ends up. For the state it’s low, low, low. That’s the answer every time for a variety of reasons. It results in a greater royalty value, a greater tax value and it makes our property between Prudhoe Bay and Point Thomson more valuable. In this overall commercial structure identified in the HOA the state will be in position to establish the financing of its infrastructure and the producers will be free to pursue whatever financing they require. That has proven to be a powerful path because each party is free to pursue its own ends.

For us, it’s embodied in the terms we struck with TransCanada. We are not pursuing equity just so we can be in the pipeline business. What we are after is establishing terms of service that achieve state interests — key state interests. In this case, low tariffs. We got with TransCanada a 75-25 debt equity structure, which is huge. It allows us to get an independent pipeline company operating a significant portion of the pipeline, and they will be free, as one of the parties, to expand the components of the project when they have additional customers. The expansion principles in the Heads Of Agreement really are one of most important pieces that we’ve landed in all of this. What the principles say — and it’s in the appendix, appendix A — is that any party can expand any component of the project so long as they are prepared to do so at their sole risk. What that means is the other parties won’t be affected. For instance if there is additional demand for capacity that’s in-state, TransCanada will be free to expand to meet that demand. The other parties can participate in the expansion, but they are under no obligation to do so. A lot of that stuff as far as the pipeline and GTP, we’ve been around the horn with companies over the years. And we had a pretty good handle on how this would work. What’s really different about LNG projects is the regulation of liquefaction.

Liquefaction terminals and liquefaction trains are regulated solely by the Federal Energy Regulatory Commission under Section 3 of the Natural Gas Act. That regulation is largely for environmental health and safety. They don’t regulate for access and they don’t regulate for rates. No matter how good the terms were for access and expansion on the pipeline and GTP, it wasn’t going to mean anything if we didn’t do something about the liquefaction.

So in these expansion principles in Appendix A, we’ve landed on a process for expansions to take place on any component except for the liquefaction trains. However, any party can add a liquefaction train. As best as we can tell, that’s a pretty unique feature. Ordinarily you would see some other mechanism, even if it were a majority vote among the parties, to add a train. In this case a single party can add a train, but they have to be willing to pay for it. That’s a really big deal and something we think was and is critical to the state’s long-term future. We will be able to show in a couple of weeks, as we get through the legislative presentations, what that means potentially for the state.

EDITOR’S NOTE: Part 2 of this Q&A will appear in the Feb. 2 issue.