Alaska Gov. Bill Walker has fired opening shots in what may become a messy legal battle with the state attempting to take ownership of natural gas in the Prudhoe Bay field, presumably for a state-led gas pipeline project the governor is now promoting.
What raises the issue is a June 30 decision by Alaska’s Division of Oil and Gas denying approval of a key operating permit for the Prudhoe Bay oil and gas field to BP, the field operator.
The division said BP’s proposed 2016 Plan of Development for Prudhoe, a kind of permit, met requirements for management of oil production but failed in that it did not provide information on activities related to marketing of gas that is in the reservoir along with oil.
BP now uses the gas to produce oil and will do that until a natural gas pipeline is built from the North Slope.
In a letter to BP the division gave the field owners, which also include ConocoPhillips and ExxonMobil, until Sept. 1 to provide the information on gas marketing. The current Plan of Development for Prudhoe was to expire June 30 but was extended to Nov. 1.
Managed out of governor’s office
Although division Director Corri Feige signed the letter to BP the matter is really being managed by the governor’s office according to sources familiar with the proceeding, who asked not to be identified.
Former acting state Resources Commissioner Marty Rutherford, who resigned June 30, is reported to have opposed the action but was unsuccessful. Walker’s newly appointed Commissioner of Natural Resources Andy Mack took over from Rutherford July 1.
State officials are not commenting on what the next step would be if Prudhoe’s owners, who are also the state’s partners in the Alaska LNG Project, fail to comply. The presumed action would be a notice of default on Prudhoe Bay leases and the start of a lengthy legal proceeding for the state to take back the leases.
The companies are unlikely to comply with the governor’s requests, based on previous correspondence on the issue. They argue that individual companies’ marketing efforts are proprietary information the state is seeking to obtain through a regulatory-type proceeding. Also, the state may violate anti-trust laws because it will be marketing its own state royalty gas in competition with the producer companies.
In the June 30 letter the state administration responded to these arguments saying confidential information can be protected by agreement and that there are no antitrust issues because the state laws give authority for the information request.
Court fight could cloud legal status of Prudhoe gas
At worst the dispute would become a testy court fight, clouding the legal status of 26 trillion cubic feet of gas in Prudhoe and effectively ending any hopes for a gas pipeline for years. A better outcome, and what may be the governor’s intention, is to goad North Slope producers into advancing the Alaska LNG Project.
There is now hesitancy among some Alaska LNG partners over continuing to spend money in light of prices for oil and liquefied natural gas. Walker appears to have already concluded that the Alaska LNG partnership is not progressing, however.
Alaska Gasline Development Corp., the state gas corporation representing the state’s interests in Alaska LNG, has already presented a plan for a state-led alternative gas project to the industry partners, AGDC President Keith Meyer told state legislators in a hearing June 29.
Making gas available to third party projects
Meanwhile, the June 30 letter lays out what is expected from the companies: “The (producers) have cited the lack of a pipeline as justification for not achieving major gas sales while simultaneously not taking firm strides toward making gas available to a third party project. This is not consistent with obligations to take reasonable steps to market the natural gas found at Prudhoe Bay,” including one advanced by the state, the letter said.
The division went on to cite the producers’ “duty to make gas available to third party projects on commercially-reasonable terms.” Earlier, the letter asked the companies to define an “acceptable offtake project” or on what basis the companies would sell gas. Legal battles will likely center on what “commercially reasonable terms” might be.
One attorney knowledgeable on oil and gas leasing, speaking on background, said lease owners do “have an implied legal obligation to develop, produce and market the gas. However, they are required to do so only if a prudent operator could be expected to make a reasonable profit from doing so.”
“DNR’s letter appears to be an opening shot intended to start eliciting ammunition (information) to be used eventually if and when there is a legal battle,” the attorney said.
‘Duty to market’
Walker and his former Attorney General Craig Richards have previously argued that the North Slope producers should be pressed on the “duty to market” terms in the leases and to make gas available to an independent pipeline project. Richards recently resigned as AG for personal reasons but remains an advisor to Walker.
Walker and Richards made the arguments years ago when the two were with the Alaska Gasline Port Authority, a municipal group formed to promote a North Slope gas pipeline. Walker was executive director of the port authority and Richards was chief counsel.
A legal fight is likely to center on what “commercially reasonable terms” might be. The three producers have already agreed to sell gas under commercially reasonable terms to a third party, including the state, in commitments given to the governor last fall. BP and ConocoPhillips made the commitments to Walker in letters while ExxonMobil is said to have made the commitment verbally.
If the producers do consider a proposal from a third party, including the state, the companies will certainty seek guarantees of financial solvency by the gas purchasers. In its present situation the state cannot pass this test unless it commits the Permanent Fund as a backstop, a guarantee that may have to be approved by the state’s voters.
Views of potential customers not clear
As to LNG customers stepping forward with financial commitments, it is not clear why major Asian utilities, for example, would take a big chance to secure supplies from a costly gas project in Alaska built by an entity without experience in managing large megaprojects, the AGDC, when there are alternative LNG supplies available from projects owned and managed by experienced companies.
Another big unknown in a state effort to take possession of Prudhoe gas is just how it would be accomplished. In the early days of Prudhoe production there was a group of Prudhoe leases overlying the “gas cap” in the reservoir which held most of the gas and another group of leases over the “oil rim” or parts of the reservoir with more oil. Leases with more gas than oil were distinct from leases with more oil than gas. These were identified in separate Participating Areas in the field.
Several years ago the interests of the gas cap and oil rim owners were integrated - the same companies held the leases but in different percentages. Now the interests are the same in all leases.
No longer distinct areas
From a technical point of view, the oil and gas in the Prudhoe reservoir are no longer in distinct areas. The gas cap has expanded over the years as oil was produced, so that oil and gas are now so mingled in the reservoir that carving out distinct “gas” and “oil” areas will be difficult, if not impossible. Also, water has been injected into the gas cap to sustain the reservoir pressure, all to produce more oil.
In this situation, the state taking possession of “gas” leases is unworkable. The only solution would be the state taking possession of the entire field, to include the oil as well as gas.
The geologists and technical staff in the Division of Oil and Gas understand all this clearly but attorneys in the Department of Law or staff in the governor’s office, or even the governor, may not.
People familiar with the proceedings and who have reviewed the correspondence have remarked that the parts of the letters to BP from the division dealing with gas marketing appear to be written by someone who is not technically knowledgeable on oil and gas. In contrast, the parts of the letters dealing with oil management reflect technical competence of the authors of those parts.
The conclusion being drawn is that Department of Law attorneys wrote the parts of the letters dealing with gas and Division of Oil and Gas staff wrote the parts dealing with oil.
Former Commissioner Marty Rutherford was reported to be unhappy with the meddling in the Division of Oil and Gas regulatory functions by state attorneys and the governor’s office.
