Balash: State would be equal in LNG

DNR commissioner says agreements give Alaska an opportunity for a co-venturer role in a North Slope liquefied natural gas project

Steve Quinn

For Petroleum News

Alaska Natural Resources Commissioner Joe Balash has been busy briefing the Legislature on two agreements among the state, North Slope leaseholders, TransCanada and the Alaska Gasline Development Corp.

He knows he’s facing a reasonably supportive, yet still suspect audience in the Legislature who, as Sen. Finance co-Chair Kevin Meyer noted, have a sense of déjà vu, citing previous attempts to advance a gas line which have brought hope but little more.

He has to defend why Gov. Sean Parnell’s administration is essentially setting aside the Alaska Gasline Inducement Act, a path once supported by Balash and Parnell, and why the heads of agreement is the first and necessary step toward a binding agreement.

Soon he’ll be touting Parnell’s gas line legislation — House Bill 277 and Senate Bill 138 — before the respective chambers.

Balash sat down with Petroleum News to discuss recent developments since the Legislature adjourned last April and what’s ahead for this session.

Petroleum News: So AGIA is essentially set aside and you’re embarking on a new path with this legislation. You were a proponent of AGIA during its roll out. What do you believe it accomplished and what do you believe are its limitations?

Balash: In terms of what it accomplished, I think the governor’s speech to the Alliance did a good job of covering the history. In 2007, the state was in this incredibly unique and in some ways awkward place. The previous efforts drove us into a ditch. I don’t think anyone was really sure how to get out of it. Alaska had to clearly state what its interests were. That really was the root of the must-haves, trying to identify those things that were critical to the state’s long-term interest.

Now in the promotion of those interests, people got caught up in the must-haves themselves. Those were a means to an end. The specifics of them aren’t what’s important, but the underlying interests behind them were. That process that caused agencies and the public to think long and hard about what mattered most to us, those interests are preserved in one form or another in the heads of agreement or in the MOU with TransCanada.

Ultimately, AGIA has proven to not be the final vehicle, the final framework, but it did accomplish a couple of things. When the state of Alaska did state clearly what its position was and what framework it was going to use. it caused a couple of things to happen. No. 1, ExxonMobil aligned with TransCanada. That was a really big move on their part. It provided and afforded an opening in the dialogue between state agencies and one of the North Slope producers, in fact the producer that has the most gas on the North Slope.

At the same time, BP and ConocoPhillips established the Denali project. What was great, frankly, about that was it forged a bit of competition between the AGIA project — APP — and Denali. It helped us get a sense of what the competitive zone is for pipeline service on a major project like this in terms of the capital structure — debt-equity — in terms of the return on equity and that was good. That helped set the bar for us to consider what to do in this case with Alaska LNG. A lot of good work was done, a lot of technical work, a lot of environmental baseline work that’s being contributed to Alaska LNG. I would hesitate to put a specific amount of time on it, but there is no question having that information contributed by TransCanada and Exxon, along with the information that BP and Conoco gathered at Denali, all of that is being contributed to the Alaska LNG effort — no question that will save time and money, versus what it will cost to start from scratch.

Beyond that, there were some technical things. As part of the open season process, there had to be an in-state demand study. That’s done and was made public. It’s proven to be useful in any number of applications by public parties and private parties; it continues to be a very good planning document.

Petroleum News: So it got you as far as it could. What became the limitations beyond the obvious market changes driven by shale gas in the Lower 48?

Balash: As far as AGIA having outlived its usefulness, part of the reason for that is the way AGIA was structured. It clearly was striving for a give-for-get kind of relationship or transaction between the state and various parties. But it was founded on the notion of a sponsor. That’s ultimately what we wound up with, a sponsor in TransCanada, a sponsor who was prepared to take on the obligations and fulfill the responsibilities. Where we’ve wound up is more of a joint venture approach, not a sponsor driven approach. There were a number of things in the underlying law and framework that broke down, especially as it relates in moving through different gates in the development process and the sanctioning process where each party in this joint venture is going to be responsible for its own decisions, its own cash calls. It’s not going to be in the hands of one party. That was a problem that proved difficult to overcome.

AGIA was built around Section 7 of the (federal) Natural Gas Act, which contemplated an overland pipeline to a very liquid market at the Alberta hub. It keyed certain dates for filing regulatory paperwork and accepting certificates, things that didn’t fit in the LNG context. How is it that the licensee was going to accept a certificate that didn’t exist? Things like that broke down. While we could have attempted to rewrite the underlying law — the AGIA statute — it would have proven to be a very difficult and tedious exercise, one that would have asked the Legislature to get deep into the weeds. You’ll see that’s not the approach we are taking here. We are going to ask the Legislature for some broad authority with some sideboards, and utilize the HOA to provide the guidance to say what we are going to do with that authority, and provide expectations as to what people can expect at the other end of the papering process.

The other thing fundamentally different between 2007 and now is the nature of an LNG project itself. At the end of the day, both projects are underwritten by contracts, but for an overland pipeline the contract is the shipper, the company with the gas taking that gas to a liquid hub. In the LNG context, the contract that matters is the SPA — the sales and purchase agreement. You now have the buyer involved. That’s a variable that is, as I’ve said, fundamentally different from an overland project. When you are dealing with a deep — a very deep and very liquid — market like AECO (Alberta gas storage hub) you don’t have to worry about whether you’re going to be able sell your gas. The only difference is whether you can sell your gas. You’re going to be able to sell it. The only question is whether it’s a market-clearing price as established through a lot of trades every day. LNG contracts, on the other hand, are all one-off deals. There are some broad parameters the market has set, but it’s all about the delivery of a specific cargo to a specific buyer on a specific set of terms for many, many years.

Now you’re having to deal with commercial interests beyond the state and the deals, something really AGIA didn’t contemplate adequately. It certainly contemplated LNG projects. For example the regulations established in 2010 went into great detail on how to calculate value in the pipeline configuration, but when it came to LNG, it kind of punted because it’s hard. Until you have the contracts or contract terms with buyers, you don’t know how to calculate value. That is something that we just at the end of the day, we couldn’t wrestle to the ground. We thought it was best to move on and move forward.

Petroleum News: So why does TransCanada still have a role if they don’t bring a share of natural gas to the project?

Balash: The still bring value. The fact that they are the premier pipeline company in North America still matters. They have a very good reputation of delivering projects on time and on budget, which is something of great concern to us as potentially an equity player. It’s going to matter greatly to us that it comes in on budget. When that FID (final investment decision) is made, the state is going to be squarely in the middle of that decision, and we need to have confidence in the numbers coming in. Additionally, the state’s interest in having an independent player who is free to act like an independent player is important to our long-term success. We have a huge wealth of undeveloped, unexplored resource on the North Slope, and the best way to get that resource explored, developed and monetized is through competition. That’s how we are going to maximize our value as a state. Having an independent player who is squarely in the middle of these agreements, who has an ability to expand the pipeline infrastructure, that is going to be very important to our long-term future. When it comes to the commercial terms, TransCanada was prepared to step up to the plate and meet us on terms that the other players frankly weren’t. We would have no problem sitting back in our traditional tax and royalty mode if the producers were prepared to commit to a capital structure. We found fairly early on that wasn’t in the cards. Part of that goes to the commercial needs of each of those companies. For some of them, they are going to want to go 100 percent equity (financing the pipeline project). That may work for them; it may work for their buyers; it may work for their boards. The problem for us would have been, 100 percent equity would have resulted in very high tariffs and leave us with very little wellhead value for royalty and tax purposes. That didn’t work for us. We had to find a way for things to work for everybody. The fact that TransCanada is prepared to commit to a capital structure that results in a low tariff works for us. It’s going to save us from having to generate $4 billion to $6 billion in capital of our own. We are not going to pay TransCanada until they put the project into service. Between 2022 and 2025 we are going to pay TransCanada if they provide a service or if there is a termination of our agreement. Otherwise, we are not going to be reimbursing them anymore.

Petroleum News: Ok, so we’ve talked about Trans Canada. Let’s talk about AGDC. Why do they continue to have a role, in this case the LNG plant?

Balash: In thinking about where the returns are in this project: There are returns in the upstream; there are returns in the midstream; there are returns in the liquefaction. Those returns in the liquefaction have the potential to be the biggest. We have a very strong interest in seeing those returns in the capital financing segment of the project being structured in favor of the state’s interest just like with the pipeline and GTP. One might ask, gosh, if TransCanada is so great why don’t you have them as a partner in the liquefaction, too? No. 1, they don’t really know much about liquefaction. It’s outside their core competency. They don’t necessarily have the ability to deliver a lot of value to us beyond financing. Additionally, the market, the buyers of LNG, have expressed through their actions in other markets and other projects, an interest in acquiring equity in the liquefaction. It’s not unusual to see Mitsubishi or Kogas with an equity stake in liquefaction. So we needed to be free to potentially bring in some other partners for that portion of the project. Ultimately, the reason to go with AGDC, or more specifically a subsidiary of AGDC, rather than the agencies themselves: long term, DNR and DOR need to carry out the day-to-day business of those agencies and not necessarily be in the LNG business or managing the LNG business.

Petroleum News: Let’s switch to some things that have come into place the last year and a half: the Point Thomson agreement and most recently Nikiski being named the frontrunner for the terminus. Let’s start with Point Thomson. You were, for lack of a better term, on point with the settlement. Have you been out there yet?

Balash: I have not. I was just speaking with one of the representatives of the development company. Formerly you could only fly out by helicopter and so it was very sketchy in terms of weather cooperating and getting out there. However, they have completed construction of the airstrip, so fixed wing aircraft can get up there. I’m looking forward to getting up there.

Petroleum News: How has that agreement helped, if at all, getting the state to where it is now?

Balash: The dialogue between the state of Alaska and Exxon Mobil, the operator up there, was an important event. The opportunity to identify interests and ultimately bridge gaps between us in order to accomplish respective interests really was a good way to start. The fact that ExxonMobil came to the settlement table with a willingness to agree that dammit, this is the state’s land and if nothing happens it comes back to the state. That is the overarching theory and philosophy behind that settlement. In order for ExxonMobil to get clear title to any of the gas, they have to earn it. That starts with the IPS, the initial production system. They have to be in first production by 2016 in order to earn the first part of the acreage back. Then they have to more fully develop the field and they have to commit to that development by 2019. If they fail to do so, there are consequences and they don’t get all of the field. If they do commit by 2019, then they get all of it, and one of the ways they can commit is to sanction a major gas sale project like the Alaska LNG project. It took a while for the state and ExxonMobil to come to an agreement and that was led by then Attorney General Dan Sullivan. They reached a term sheet agreement in late 2010. They reached a basic term sheet agreement in late 2010. They spent a long time in 2011 papering it and that portfolio went with him when he went from the Department of Law to DNR. By late summer the state and ExxonMobil were agreed on the specific paper, which I would point out, the attorney general at that point was John Burns, who is now chairman of the board at AGDC.

By late summer of 2011, BP and ConocoPhillips had abandoned Denali. It was May or June when they formally pulled the plug. Those two companies took a look at the terms the state and ExxonMobil had agreed to and said, gosh, this is going to be expensive. It’s going to cost billions of dollars and we are going to get 10,000 barrels of production out of this. Exxon said we see this as a strategic investment in order to facilitate North Slope gas, which is a huge asset for all of us. It forced a dialogue about how North Slope gas was going to get commercialized. It was those conversations that led to the meeting in January of 2012 where the governor met with the three CEOs (from BP, ExxonMobil, ConocoPhillips) in Anchorage. At the time, we looked high and low and have yet to hear anybody identify a time when all three company CEOs met with the governor in Alaska — in Alaska. It hasn’t happened before and it hasn’t happened since. It paved the way for the ultimate resolution of the dispute there at Point Thomson. It also set us on a course to align on the fundamental road map for commercialization on ANS gas. The settlement itself came out March 30, 2012, and I’ve got to say the operator has come through on every commitment so far. There were a number of doubting Thomases on the hill and throughout the state, saying we were hoodwinked or snookered. Well, you know what? They’ve come through and they delivered. They are spending a lot of money right now and they are employing an incredibly high percentage of Alaskans on this project, and we look forward to seeing them maintain this track record.

Petroleum News: And how about Nikiski, which is a more recent development. How does that help toward the bigger picture?

Balash: It helped clarify for the state this question about equity participation. We no longer had to worry about maintaining parallel paths between AGDC and the big project where the costs of one wouldn’t necessarily complement the costs of the other. Having the same basic alignment on route and destination proved to be very, very helpful at least on the administration side, having some closer on that particular question.

Petroleum News: How will this package — Point Thomson agreement; Nikiski; these pair of agreements among the producers, AGDC and the state — help toward gaining public trust. Not to suggest a widespread distrust.

Balash: I think there is a mistrust, number one. There are a lot of reasons for the mistrust. Most of it boils down to the lack of alignment between the producers and the state of Alaska. In the early days of Prudhoe, Gov. Egan wanted the state to own a piece of TAPS.

Back then we were resource rich and cash poor. (It failed in the Senate in 1972). History would show Alaska has lived to regret that. We’ve had decades of disputes on how to value TAPS, how to charge tariffs for oil and there is no question that has had a negative impact on the overall climate here, and it has led the citizens of Alaska to be quite skeptical because of that lack of alignment between the companies interest and our interest as the owners of the resource.

Petroleum News: Between all of the attempts to advance a project, there still are people who don’t believe there will ever be a project. I understand markets can change things again, but what gives you confidence this is step that will get Alaska closer?

Balash: There is no guarantee here, but what’s different in this approach is that we have moved in a way to align our interests and the producers’ interests in a way that hasn’t been done before. I think that this actually is something that might be worth pointing out in the SGDA (Stranded Gas Development Act) experience. It’s fair to say in the SGDA package, the state was truly a minority shareholder, a minority owner. In this package we are a co-venturer. We are an equal partner. It doesn’t mean we have the biggest (share). It doesn’t mean we get to call all of the shots. But we are equal.

Under Gov. Parnell’s leadership, we get to assert that quality that will only bear fruit if it holds up. Right now we have good intentions. That’s what we see in this heads of agreement. When the rubber hits the road and the other agreements are negotiated, we’ll see if all of the parties live up to that intent. Then ultimately the public will see that. It is going to take more than signatures on this agreement to overcome the years of cynicism that has built up. There is an antidote to cynicism. It’s opportunity and results. We have an opportunity through this agreement. Now, if the Legislature gives us authority to move forward, it’s going to be up all of the parties, especially the producers, to deliver on results.

EDITOR’S NOTE: part 1 of this Q&A ran in the Jan. 26 issue of Petroleum News.