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Vol. 11, No. 38 Week of September 17, 2006
Providing coverage of Alaska and northern Canada's oil and gas industry

CWN: Re-negotiate

Commonwealth North says gas pipeline contract needs to be re-negotiated

Kristen Nelson

Petroleum News

Commonwealth North, the Anchorage-based public policy organization, has published a study of the proposed gas pipeline fiscal contract, and while praising the work of the administration of Alaska Gov. Frank Murkowski in attempting to get a gas pipeline built, the study found the contract “incomplete” and said the public policy issues it raises should be “re-examined and re-negotiated.”

The group also looked at the gas reserves tax which will be on the November ballot.

“The negative use of taxing authority is poor public policy,” the report concluded. “Implementing a reserves tax on any resource will send a message globally that Alaska is not encouraging exploration or development of its resources. It will also discourage financial market participation in the gas line project.”

The gas fiscal contract, made public in early May, was negotiated with North Slope gas pipeline project sponsors BP, ConocoPhillips and ExxonMobil.

Is the gas stranded?

On the issue of whether the gas is stranded, the report said the administration argues that North Slope gas is stranded because there is no transportation system to take gas to market. Until recently commercialization would have been uneconomic because of low market prices. The opposing view is that the administration used too low a gas price in its economic calculations and that at current prices the gas is not stranded and the state does not need to provide incentives for a gas pipeline.

The Commonwealth North study group concluded it isn’t possible to predict what gas prices will be when North Slope gas reaches the markets in 10 years, nor what the price will be over a 35-year, or longer, pipeline life. While oil prices are high and gas prices traditionally follow along, Alaskans learned in the mid-1980s, and again in the late 1990s, that prices can fall steeply and quickly.

“It is appropriate to assume that the ANS gas is stranded,” the report concluded.

The work commitment issue

On the work commitment issue, defined as the lack of a requirement in the contract that the producers build a pipeline or perform specific work by given dates, the argument for what the contract contains is that the project is so large and complex that planning it “will be a multi-million dollar effort and will have clear deliverables. Efforts to advance the project diligently cannot be disguised or faked by the producers.” Also, schedule-driven commitments “can easily lead to massive cost overruns because schedule rather than sound engineering and construction practices would be driving the process.”

The opposing view holds that without a firm commitment to start the project, the contract does not assure it will ever be built. The state cannot terminate the contract without “clear and convincing evidence” that the producers are not acting diligently. And such a challenge must be resolved by an arbitration panel since the state gives up, in the contract, the right to a court challenge.

The Commonwealth North report calls the lack of a requirement to start construction “troublesome,” especially because the contract is long, the state has an “unusual burden of proof” to meet to prove lack of diligence and its only remedy is termination.

“The contract should provide for work commitments prior to construction that have specific activities and timelines,” the report said, and since schedules can always be revised, the state should have a say in schedule revisions.

Fixed tax, state ownership issues

On whether or not the Alaska Constitution allows fixed tax rates as proposed in the contract, the Commonwealth North report concluded there are reasonable points on both sides of the argument and that the Alaska Supreme Court must resolve the issue. If the contract is signed, the issue should be presented to the court as soon as possible. “If this provision remains in the contract, it should be amended to a shorter time period, and it should be severable from all other parts of the contract.”

On the issue of state ownership, 20 percent state ownership is said to provide economic incentives for the project.

But there are risks — of cost overruns and of the uncertain gas market — involved in ownership. Legislative consultant Econ One found the project economic without Alaska ownership. And, the report said, without a contract for the limited liability corporation details of the proposed ownership arrangement are unknown.

The report concluded there is too little information about the economic consequences to the state of project ownership and of taking all of its gas income in-kind. Both pro and con arguments are persuasive, the report said, depending on assumptions used in economic models, weight applied to risk factors and data selected and analysis of that data.

If the administration is correct, the project will not be built without state participation; if the Legislature’s experts are right, “a pipeline can and will be built with far less dependence” on state financing.

Others have expressed interest in building a pipeline but that would require an agreement by the producers to market their gas through that line, and/or “future oil and gas discoveries in quantities sufficient to support a gas pipeline project” by other companies.

Other costs, royalty and tax gas in-kind

The contract includes state financial liabilities beyond the 20 percent ownership share such as upstream cost allowance, marketing costs and reductions in oil taxes by deductions, credits and allowances for gas investment.

The pro argument is that these liabilities are necessary to get the project built because of high costs of building the pipeline, high risk of significant cost overruns, volatility of gas prices and competing gas projects. The opposing argument is that the state “will be spending, giving and forbearing collections of unknown amounts of money,” and that state obligations in the contract exceed benefits.

The Commonwealth North report concluded that the state should not make financial commitments “without a reasonable projection of the size and duration of these financial liabilities.” The state relies on revenues from its resources “to fulfill its responsibilities to all Alaskans,” and while it needs revenues from natural gas, “not at a price that reduces its revenues below what it could achieve by investing prudently to get a higher rate of return.”

The report also said Alaskans need information about the projected range of the state’s cash liability for the project, and said use of different discount rates and a mixed use of nominal and real dollars in the state’s explanation of the contract “is confusing,” and called for charts that show “a reasonable range” of what the state will have to “spend/forgo/invest annually for the next 40 years,” as well as charts of the revenue the state can expect over that period. “Some projection of the likelihood of such costs and revenues is also appropriate.”

On the issue of the state taking royalty and tax gas in-kind, a total of about 20 percent of the gas, the pro argument is that it improves producer economics; the con argument is that Alaska will lose value by taking gas in-kind.

Commonwealth North called for economic modeling of the range of revenues the state would get from the 20 percent “and the potential loss of revenue compared to receiving cash payments.” The report said that while this provision “does not significantly increase” net revenue to the producers, “it adds a risk factor that has a potentially high negative impact” on the state.

Point Thomson, project regulation

The contract includes Point Thomson lease and development requirements, the argument for this being that Point Thomson gas is necessary for the project, representing some 25 percent of known reserves. The opposing argument is that liquids from Point Thomson could be marketed using the existing trans-Alaska oil pipeline and enforcement of current lease terms could result in liquids development ahead of a gas pipeline and without “a materially detrimental impact on gas pipeline economics.”

“The lease process for developing Point Thomson is being sidestepped by including it in the proposed contract,” the Commonwealth North report concluded. “The public interest favors removing the Point Thomson unit from the contract in order to encourage timely economic development under the existing or renegotiated lease terms.”

The Commonwealth North report also disagrees with contract provisions providing that the Federal Energy Regulatory Commission will have exclusive jurisdiction and that if the Regulatory Commission of Alaska asserts jurisdiction the state will indemnify the producers for any damages. “FERC regulation and RCA regulation should be clearly identified,” the report said, with no indemnification required by the state “for a state agency exerting jurisdiction over any intrastate project.”

The study group report is posted on Commonwealth North’s Web site at

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