On Sept. 28 the Regulatory Commission of Alaska rejected the gas pricing formula in Enstar Natural Gas Co.’s new Cook Inlet gas supply contract with Marathon. But a series of RCA filings since that ruling reveal the depth of controversy regarding natural gas pricing in Southcentral Alaska. And behind that controversy lie question marks over how or whether adequate gas supplies can be maintained from the Cook Inlet basin.
Following precedents set by earlier Enstar contracts with Unocal and NorthStar, the new Marathon/Enstar contract indexed gas prices to the Henry Hub gas market in the Lower 48. Marathon-Enstar said that Lower 48 indexed prices are needed to attract investment in exploration for new Cook Inlet gas reserves. Enstar also said that the new contract would guarantee gas supplies from proven gas reserves for its customers through 2016.
RCA, in a majority decision, disagreed, saying that the contract did not guarantee continuity of supplies and that it would result in an unjustified price hike.
“Enstar did not meet its burden of demonstrating that gas supplies pledged under the contract are reliable and that the price is reasonable,” the commission said in its ruling. Enstar had not taken into account Marathon’s previous commitments to other customers; those previous commitments could take precedent over the commitments in the new contract, the commission said.
The commission said that the price levels in the earlier contracts indexed to the Henry Hub market had not resulted in the discovery of new gas reserves in the Cook Inlet basin.
“Despite Enstar’s ratepayers funding millions of dollars in an ‘exploration and development’ incentive plan, Cook Inlet reserves have declined. … We must reluctantly conclude … that the now five-year-old economic experiment promoted by Enstar in both the Unocal and NorthStar contracts has not produced noticeable results,” the commission said.
However, under Enstar’s general tariff terms, the commission did allow Enstar to purchase gas from Marathon under the new contract, provided that these purchases result in a decrease in the average cost of gas.
“We note, however, that Enstar’s tariff allows it to add base supply contracts having the effect of decreasing the cost of system gas without our approval,” the commission said. “We allow Enstar to add TA139-4 (the tariff advice letter that included the new contract) to its base supply under those limited conditions.”
RCA commissioners Dave Harbour and Mark Johnson dissented from the commission’s ruling.
Harbour: responsibly negotiated
In his dissenting statement, Harbour disagreed that Enstar had failed to assure future gas supplies for its customers.
“Enstar responsibly negotiated a contract, the terms of which could coincide … with the construction of a North Slope gas pipeline and accompanying spur line to Southcentral Alaska,” Harbour said. “… I commend the parties for creating a way to accommodate the possible arrival of North Slope gas while also having a backup plan.”
Harbour particularly slammed the commission’s rejection of the pricing formula in the contract. He said that the commission had overturned a precedent to use a Henry Hub price index “without offering sufficient reason for changing course.” And the requirement that new gas prices should lower the average cost of gas could drive prices down to a level where Marathon might seek other sales opportunities.
“The (commission) majority should have been more concerned about the risk that its decision could cause Marathon to pursue another opportunity, leaving Enstar with little opportunity for filling the 2009-2016 supply gap with proven reserves at favorable terms,” Harbour said.
If the commission majority had been more reluctant to change the course of gas price precedents, it would “still mourn with me local, rising utility bill prices, while courageously recognizing that the price signal was our responsible effort to support sustained supplies,” Harbour said.
Johnson: lack of clarity
Johnson, in his dissenting statement, criticized the ruling for what he said was a lack of an objective assessment of Cook Inlet gas supply and demand and, consequently, a lack of clarity concerning the commission’s expectations for a gas supply contract.
“The majority’s yardstick does not provide a standard that will enable Enstar or potential suppliers to reach a level of certainty required for commercial transactions nor will they be able to evaluate or manage regulatory risk,” Johnson said.
He found inconsistencies in the separate analyses of reliability of supply and reasonable pricing — these two issues are inextricably linked, he thinks. And Johnson rejected the commission majority’s view that the new contract did not establish a reliable gas supply for Enstar. He cited statements by an engineer that Marathon had access to sufficient proven reserves to meet the terms of the contract.
Johnson also rejected the view that Henry Hub pricing has not encouraged exploration for new Cook Inlet gas reserves and he cited sources of evidence for increased exploration activity in the region.
“All of these sources establish that since the introduction of market-based prices for natural gas, energy companies are exploring for and developing natural gas in Cook Inlet,” Johnson said.
Gas prices, both for new discoveries and for proven reserves, should be set by supply and demand in the market, with the regulators intervening to protect consumers from any abuse of monopoly power, Johnson said. The gas supply in Cook Inlet is diminishing while the cost of exploration is increasing, he said.
“Enstar and Marathon represent a willing buyer and a willing seller, respectively,” Johnson said. “… I conclude that the agreement between the parties was the product of good faith negotiations conducted at arms-length.”
RCA has authorized the use of a Henry Hub price index on two prior occasions and financial market regulators scrutinize the Henry Hub transactions, Johnson said. At the same time, trying to link contract prices with the average cost of Cook Inlet gas makes no sense since the average cost is a calculated value based on previous gas contracts rather than current market conditions.
Attorney general intervenes
During the RCA hearing on the proposed gas supply contract, David W. Márquez, attorney general for the State of Alaska, expressed numerous concerns about the proposed contract. He especially questioned potential gas price levels and the use of the Henry Hub price index.
And following the commission’s Sept. 28 ruling, Márquez submitted a petition for partial reconsideration, saying that the commission should reject the entire contract, rather than allowing contract gas purchases that lower the average cost of gas.
The attorney general said that allowing gas prices that decrease the average cost of system gas would enable Marathon and Enstar to float the price slightly below an average price that is “principally tied” to a Henry Hub index, because Enstar would obtain much of its gas from the Unocal Henry Hub-indexed contract by the time that the new Marathon contract goes into effect in 2009.
In effect, the new contract would use a Henry Hub index of the type that the commission is rejecting.
The attorney general also pointed out that any gas sales under the new contract would pass gas transportation fees and production taxes through to gas consumers, an arrangement that the commission had rejected in its ruling.
Enstar requests clarification
On Oct. 16 Enstar filed a petition for reconsideration, requesting clarification of the commission’s ruling and suggesting changes to the proposed contract to address the commission’s concerns.
“The (contract) regulatory proceeding has cost the parties well over $1 million and has taken almost a year,” Enstar said. “… If a contract is rejected out-right … the negotiation and approval cycle must be repeated because the parties, and most importantly the producers, do not know what will be acceptable a year or more in the future when the Commission hears the evidence supporting a new contract.”
On the other hand, approval of the contract, with amendments, could conclude the deal, Enstar said.
Enstar said that calculating a gas price using the average cost of Cook Inlet gas presents a timing problem, because the average cost cannot normally be calculated until after the end of the year, while the annual price under the Marathon contract would need to be set before the end of the year.
Enstar also reiterated the attorney general’s point, that using the average gas price would, in effect, peg the price under the new contract to a Henry Hub index, as in the Unocal contract. But the Unocal contract uses a 36-month trailing average Henry Hub price, rather than the 12-month trailing average that Enstar believes would now be more appropriate.
In conclusion, Enstar asked the commission to allow amendments to the proposed contract that remove the pass-through of transportation and tax costs; change the proposed price caps; use a 12-month trailing average Henry Hub price index; and eliminate peaking gas provisions and fees.
Marathon also petitions
Marathon has also petitioned for reconsideration of the RCA ruling, saying that the company has put significant effort into natural gas development in the Cook Inlet basin and has accepted investment risk in doing so.
“The commission has exposed Enstar and its residential and commercial gas consumers to the risk of not having sufficient gas supply under contract and to great uncertainty as to whether Enstar’s unmet requirements can be met by another supplier,” Marathon said, emphasizing that Marathon was the only company to offer to fill the gap in Enstar’s future supply needs.
Marathon presented a series of arguments against the commission’s findings. In particular, Marathon said that there is no evidence that foreign sourced gas could substitute for gas produced in the Cook Inlet; that Henry Hub pricing has become a “key criterion to Marathon, and presumably other gas producers, to commit capital to explore for new reserves in the Cook Inlet”; and that no-one has presented evidence that Marathon would not provide a reliable supply of gas under the contract.
Tesoro opposes Marathon
Tesoro, a major user of Cook Inlet natural gas at its Nikiski refinery on the Kenai Peninsula, has filed to oppose Marathon’s petition. During the RCA hearing Tesoro protested vigorously the pricing formula in the new contract.
“Five years ago Enstar’s ratepayers paid the lowest price for gas in the western United States and Canada. Five years from now if the commission adopts the Henry Hub index Enstar’s ratepayers will pay the highest price for gas in the western United States and Canada,” said Robin Brena, counsel for Tesoro, during the hearing. “… Why should Enstar’s ratepayers pay Marathon a windfall profit to blow down proven reserves?”
In its opposition to Marathon’s petition, Tesoro said that during the RCA hearing Enstar was unable to furnish evidence to demonstrate that the new contract assured the reliability of gas supplies from Marathon. Tesoro also said that the commission had correctly concluded that Enstar had failed to demonstrate that the proposed gas pricing formula was reasonable.
Tesoro said that Marathon had not raised the question of gas supply shortages during the RCA hearing and that Marathon’s expert witnesses had testified that the supply-demand situation in the Cook Inlet is now somewhat similar to that in the Lower 48.
“Whether or not there is a shortage of supply is not the issue here, but rather the reliability of supply and the reasonableness of price offered,” Tesoro said.
Tesoro also accused Marathon of stonewalling the discovery of cost and risk data relating to gas exploration.
Van Dyke comments
And in the latest twist of the Marathon/Enstar contract saga, Bill Van Dyke, acting director of Alaska’s Division of Oil and Gas, has sent a letter to RCA, commenting on several aspects of the commission’s ruling.
In particular Van Dyke commented on the pricing of Cook Inlet gas.
“Since 2001 … Cook Inlet gas prices have risen from approximately $1.20 per thousand cubic feet to over $5.00 per thousand cubic feet. Exploration activities indicated by wells drilled, geologic and geophysical field activity, and interest in oil and gas leasing have all risen too. In my opinion there is a direct correlation between expected gas prices and exploration for gas,” Van Dyke said. “… In my view the Unocal (gas pricing) experiment was a smashing success. Significant new reserves have been developed on the lower Kenai Peninsula and a new pipeline has been constructed there.”
And Van Dyke commented that the key issue is whether Enstar can secure the gas supplies that it needs, and not whether gas reserves have increased or decreased.
