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Vol. 11, No. 20 Week of May 14, 2006
Providing coverage of Alaska and northern Canada's oil and gas industry

Gas contract on deck

900-page summer reading list released: contract, fiscal finding, documents

Kristen Nelson

Petroleum News

When Gov. Frank Murkowski greeted Alaska legislators on the first day of the special session, May 10, he jokingly told them he was going to read the 900-plus pages of gas fiscal contract documents, starting at page 1, which were released that day, along with a fiscal best interest finding by the commissioner of the Department of Revenue and back-up documentation.

He had a more serious threat.

The Department of Energy has begun a study looking at a federal corporation to build a gas pipeline from the North Slope, Murkowski said, reminding his audience that when Congress passed enabling legislation for the Alaska North Slope gas pipeline it directed the Secretary of Energy to conduct a study of an alternative if an application for pipeline construction hadn’t been filed with the Federal Energy Regulatory Commission within 18 months of enactment of the legislation. That was in 2004, he said, and that clock is running. The study is under way, Murkowski said, in the pre-scoping phase to establish a staffing and funding framework.

The enabling legislation passed Congress Oct. 11, 2004. It included a provision directing the Secretary of Energy to “conduct a study of alternative approaches to the construction and operation of such an Alaska natural gas transportation project,” if no application was received within 18 months. Congress said the study was to consider establishing a federal government corporation to construct an Alaska natural gas transportation pipeline. (See story in Oct. 17, 2004, issue of Petroleum News.)

Murkowski said he doesn’t think anyone wants to see federal ownership of the pipeline, but if the contract is not consummated, if the state and producers don’t come to agreement and construct a line, “these issues could be taken away from us and we could lose control of the destiny of the State of Alaska.”

The carrot is the benefits a gas line could bring to the state, he said.

Murkowski described the Alaska gas pipeline as “a real bridge to the future of Alaska,” and told legislators “that’s what’s so exciting about this Legislature.”

The administration has been negotiating the contract for two years, the governor said, calling it “a long road to get to the milepost where we are today.” But there are more miles to go, he said, telling legislators “we must do what’s right for Alaska,” adding that the gas pipeline “is not a partisan issue.”

Alaskans expect this administration and this Legislature to get this job done, Murkowski said. After 30 years of waiting the economics support this project now and they didn’t before, he said, telling legislators their decisions would have a “profound and lasting impact” and assuring them they “should have all the time you need to get the job done.”

A 10-day review

The administration began a 10-day review of the project for legislators that afternoon at Centennial Hall in Juneau.

Administration consultant Pedro van Meurs told legislators the “almost unimaginable” size of the Alaska gas pipeline project “may create large profits and government revenues but also has potential for risks.”

Van Meurs talked about barrels of oil equivalent for the project, which allows comparison with both oil and gas projects worldwide, and said there is only one project in the world that is larger, the Kashagan oil field in the Caspian Sea. But Kashagan is estimated to cost $16-$17 billion, while the Alaska gas pipeline is estimated at some $19 billion or $27 billion if the project has to be built to Chicago.

Because other projects, like Kashagan, involve a larger government royalty share, the Alaska project provides the companies with the largest bookable reserve in the world on a single project, he said, and provides the largest total net cash flow in the world.

But the risks are huge: under a low gas price of $3.50 per million Btu and a 50 percent cost overrun “this project has dismal economics,” he said, and would destroy corporate value of all three participants. If the project does not succeed, ConocoPhillips’ stock value could drop and it could become a takeover target.

The availability of takeaway gas line capacity in Alberta is a particular risk, he said. The estimate of available gas capacity has changed almost every year, he said, and depends on oil sands development — if that slows down gas used in those projects would have to go down existing lines — and exploration success. Success in finding gas in western Canada would also add to volumes that have to go down existing pipelines, he said.

Cost overrun is the biggest risk facing the project, he said, noting Shell had a 100 percent cost overrun at Sakhalin II. Cost overruns are common on long lead-time cumbersome projects, van Meurs said.

At low prices the net present value would be $2.5 billion for the project; “if there is a 50 percent cost overrun, net present value approaches minus $3 billion,” he said.

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New oil tax does not make deadline

A bill to rewrite Alaska’s production tax system ended at midnight May 9, victim of a perfect storm: the imminent release of the gas line fiscal contract; politics; the complexity of issues involved; and the mandatory end of the regular session of the Alaska Legislature.

Committees in both House and Senate spent countless hours taking testimony from the administration, their own and the administration’s consultants, the state’s oil and gas producers and explorers and the public. Resources and Finance committees in both the House and Senate wrote, and amended, committee substitutes for the administration bill, and both House and Senate passed the bill, but not the same version.

The House voted shortly after 3:30 a.m. May 9, the last day of the session, passing a committee substitute for the bill the Senate passed April 25. But there were too many changes for the Senate — and no time for a conference committee to work out the differences.

So the PPT, needed to complete the draft gas line fiscal contract that was released for public comment May 10, is expected to become another special session order of business for the Legislature — which started what is expected to be only its first special session May 10.

Political landmines

When Gov. Frank Murkowski addressed the Legislature on the first day of the special session he said political dynamics are the reason legislative bodies rarely have the chance to change tax law. The transfer of wealth is fraught with political landmines, the governor said, noting that the last change, a relatively modest adjustment of the economic limit factor, occurred in 1989 in the aftermath of the Exxon Valdez oil spill.

Murkowski said his aggregation of North Slope satellites last year, a $200 million tax increase, was “not very popular.”

The reason this administration and this Legislature have the opportunity to make major changes in the oil tax is because of the gas line, he said: with development of a gas line a tax change can take place.

“We all know after last night we have to revisit the PPT,” the governor said, telling legislators that the state is losing money every day under the existing production tax system.

Work began in February

The Alaska Legislature began working on the administration’s proposed rewrite of the state’s oil and gas production tax, the production profits tax or PPT on Feb. 22. The bill had referrals to Resources and Finance committees in both houses.

The Senate was the first to pass the measure, and House Finance reworked that bill, returning to the governor’s proposed 20 percent tax rate and 20 percent credit, but including the progressivity factor which has been in all the committee substitutes.

The House Finance progressivity surcharge was based, like a Senate Finances draft, but not the final version the Senate passed, on the net, automatically including increases in the cost of production in the calculation.

Debate on the House floor began Sunday, May 7, and continued Monday evening May 8, running overnight into May 9, the last day of the session, before tying up shortly after 3:30 a.m. with a 29-10 vote to move the bill.

The tax rate was raised to 21.5 on the House floor, but attempts failed to raise the trigger point for the progressivity surcharge, which House Finance set at a North Slope netback of $35.

Senate floor debate began on the bill around 7 p.m. May 9, just five hours before the midnight end of session, with debate 4 to 1 against the bill. The vote was 10-10, defeating adoption. Senate leadership tried again shortly before 11 p.m., but could only get nine votes to rescind the previous vote. The PPT was not brought up again when the Senate returned just before midnight to vote on the capital budget.

House debate lengthy

The House floor debate May 7-9 was wide-ranging, and started with an amendment by Rep. Harry Crawford, D-Anchorage, to dump the profits-based tax in favor of a revision of the existing severance tax on the gross, an amendment which was defeated 28-12.

Anchorage Democratic Reps. Ethan Berkowitz, the House minority leader, and Eric Croft, both candidates for governor, led the charge against the PPT, concluding with a proposal early in the morning May 9 that a vote on PPT be delayed until the gas fiscal contract was public.

Current high oil prices have frequently been the basis of discussion in committees, with legislators pushing progressivity options to increase government share at high oil prices, but on the House floor there was a lot of concern expressed by members of both parties about what would happen under PPT if oil prices returned to a range of prices in the $20s, normal before the recent price run-up.

There was a proposal, which was defeated, to insert a floor in the PPT to protect the state at low oil prices. Administration and legislative consultants have said all along that when you replace a regressive system with a progressive system the proportion of the government’s take increases at high prices but may drop to zero at low oil prices: if the companies have no profit, there is no profit to tax, although the administration testified that one good year would make up for several bad years.

Senate: 25 percent?

Two Republican senators who voted against the House bill, Gary Wilken of Fairbanks and Tom Wagoner of Kenai, both said they wanted to see a 25 percent tax. The version the Senate voted out on April 25 included a 22.5 percent tax.

Wilken said he was aligning himself with the consultants who said a 25 percent tax rate wouldn’t deter investment in Alaska.

He said the Department of Revenue identified 15 changes the House made in the Senate’s bill, and complained that the version the House voted on was cobbled together in the middle of the night, questioning whether the Senate even knew what was in the bill.

Sen. Hollis French, D-Anchorage, had earlier criticized the way the House handled amendments on the floor and said he wouldn’t make an oil tax decision until he’d seen the gas contract. French earlier sued the administration to get release of the gas contract.

Wagoner, like Wilken, objected to the advertising campaign around the PPT, and said he wished there was time to take the bill to a conference committee and work out differences between the House and Senate. He said he thought the tax change was needed, but couldn’t vote for the bill until there was more work done on it.

Sen. Bert Stedman, R-Sitka, who worked on the bill in both Senate Resources and Senate Finance, was the only senator to speak in favor of the bill, noting that while the House tax rate was lower at 21.5 percent, with the House version of progressivity the state would do better at oil prices above $40 than under the Senate version, and as prices advance the state is “substantially better off” under the House version.

Stedman also spoke in favor of a progressivity surcharge on the net, which takes into account the cost of extraction. The cost of extraction will go up over time, he said, and it’s important that the tax structure take that into account if it is going to stand up over time.

—Kristen Nelson