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Vol. 15, No. 22 Week of May 30, 2010
Providing coverage of Alaska and northern Canada's oil and gas industry

Contracts: 2 for 2

RCA approves two-year gas supply contract between Enstar and Marathon

Eric Lidji

For Petroleum News

The Regulatory Commission of Alaska approved a gas supply contract between Enstar Natural Gas and Marathon Oil Co. on May 24, saying it served the public interest.

The contract gives Enstar about 90 percent of the natural gas it needs for 2011 and 2012, and prices that gas by averaging futures prices on the New York Mercantile Exchange.

A concurrent statement by one commissioner said that supply concerns played a larger role in approving the contract than price concerns, as per a new law enacted this year.

The approval is the second this year. On May 17, the RCA approved a contract between Chugach Electric Association and Marathon. In 2009, the RCA approved contacts between Chugach and ConocoPhillips, and between Enstar and Anchor Point Energy.

Prior to that run, the RCA had not approved a utility gas supply contract since 2001.

Shortfalls still remain

The new contract, called APL-8, supplies 6.8 billion cubic feet in 2011 and 7.2 billion cubic feet in 2012, with a maximum daily delivery of 29 million cubic feet. The contract also allows Enstar to ask for additional volumes beyond these daily and yearly levels, “excess gas” that Marathon can chose to provide if it has the extra volumes available.

While the contract improves Enstar’s supply situation, significant uncertainty remains.

First, Enstar still faces shortfalls of 900 mmcf in 2011 and 1.1 bcf in 2012.

Second, under the terms of the contract, Marathon can provide smaller volumes in the winter of 2011 and 2012 if the liquefied natural gas export facility on the Kenai Peninsula discontinues operations. The plant allows Marathon to store excess volumes in the summer, when natural gas demand falls, and without the plant Marathon worries it may have to shut in wells during the summer, creating the likelihood of declining production.

Marathon has until Oct. 15, 2011, to tell Enstar if plans to curtail deliveries.

Contract uses futures pricing

The contract prices natural gas using futures on the New York Mercantile Exchange, with an inflation-adjusted floor and ceiling, and tiered pricing at different levels of demand.

Chugach used a similar pricing mechanism, but reached slightly different prices.

For Enstar, deliveries up to 9 mmcf per day are priced on a three-month average of Nymex futures. Deliveries between 9 mmcf and 29 mmcf per day are priced at 140 percent of that index, a premium Enstar said is needed to address seasonal demand.

Enstar said it restrained the Nymex index with a price collar, a floor of $6.85 per mcf and a ceiling of $9.70 per mcf, adjusted quarterly for inflation. The interruptible “excess gas,” however, includes a price ceiling based on the equivalent price of heating oil.

Price tug of war still alive

The RCA approved the contract without a formal investigation and hearing.

The contract got considerable support early on, with favorable comments from the Kenai Peninsula Borough, the Municipality of Anchorage, the Anchorage and Anchor Point Chambers of Commerce, and two industry groups, the Resource Development Council and the Alaska Support Industry Alliance. Chugach Electric Association, the second largest natural gas user in the state, also commented in support of the contract.

During a comment period, the state Attorney General’s office questioned the pricing provisions in the contract — specifically how Enstar reached specific floors, collars, premiums and adjustments — but noted the need for reliable gas supply in the region.

The AG made similar comments about the Chugach-Marathon contract, but its comments about Enstar included one unique criticism: that the “excess gas” pricing threatened to become unreasonable. If called upon in March 2010, the gas would have been priced at $15.06 per mcf. Enstar believes those excess volumes would be both small and rare.

The AG did not recommend an evidentiary hearing, the formal investigation process where contracts get a thorough examination, saying that without access to producer cost information, such a hearing wouldn’t yield any useful information. The AG made similar comments about the Chugach-Marathon contract, leading two commissioners to say that using costs to determine prices amounted to a “back door” regulation of producers.

A group of five Democratic lawmakers questioned several pricing provisions in the Enstar-Marathon contract, which they said “may be unreasonably high given the low price of gas worldwide,” pointing to Henry Hub prices hovering around $4 per mcf.

But speaker of the House Mike Chenault, R-Nikiski, said the forward looking pricing of the contract, based on natural gas futures, balanced the three-year trailing average of Henry Hub prices that Enstar uses to price its largest existing contract by volume.

In a backhanded concurring statement, Commissioner Kate Giard addressed the concerns of the Democratic lawmakers. “Regrettably,” she wrote, “a new law passed by the legislature this session requires us to emphasize reliable supply over reasonable price.”

That “new law” was House Bill 280, also known as the Cook Inlet Recovery Act. Co-sponsored by Chenault and Rep. Mike Hawker, R-Anchorage and co-chair of the House Finance Committee, the bill offered incentives for storage and exploration, and guidance for contract deliberations, telling the RCA to “consider whether a utility could meet its responsibility to the public in a timely manner and without undue risk to the public if the commission fails to approve a rate or a gas supply contract proposed by the utility.”

Giard said the statute now guides RCA decision making on supply contracts: “As I understand the law, so long as a public utility has the foresight to unequivocally state that without the contract the utility will be short of supply, our approval is required. The new law seems to allow gas supply at any price and, so, I concur in the approval of this gas supply contract between Enstar and Marathon. I do so because it provides reliable supply, not because the pricing terms are reasonable for Alaska’s consumers.”

Difficulty finding supplies

Those supplies are proving increasingly difficult to find.

Enstar issued a request for proposals in January 2009, looking for contracts that met the pricing guidelines that the RCA set out after rejecting two previous Enstar contracts, but did not get a response from Cook Inlet producers. Enstar issued a second request, and solicited information on possible ways to price supplies, but got the same results.

Last summer, the RCA approved a contract between Enstar and Anchor Point Energy, a subsidiary of the independent Armstrong Cook Inlet. The contract didn’t cover enough natural gas to meet all of Enstar’s near-term supply needs. But, Enstar claims, the approval of the contract, along with the approval of a contract between Chugach and ConocoPhillips, opened to doors to the negotiations that culminated with APL-8.

Where Enstar will find the volumes it needs to meet demand in 2011 and 2012 (and the considerable volumes needed to meet long term demand beyond that), remains unknown.

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