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Vol. 13, No. 46 Week of November 16, 2008
Providing coverage of Alaska and northern Canada's oil and gas industry

LNG license appeal

Chugach Electric wants producers to commit to meeting local gas needs

Alan Bailey

Petroleum News

In a further twist on the complex issues surrounding natural gas pricing and supplies in Southcentral Alaska, Chugach Electric Association, a major electric utility, has appealed for reconsideration of the terms under which the U.S. Department of Energy has extended the export license for the LNG plant at Nikiski on Alaska’s Kenai Peninsula. In June DOE approved plant owners ConocoPhillips and Marathon’s application to extend the export license beyond its then expiry date of 2009 to a new expiry date in 2011.

On July 30 DOE denied an application by Chugach for a rehearing of the export authorization. And on Sept. 26 the utility made an administrative appeal to the U.S. Court of Appeals for the 9th Circuit, requesting a review of both the export license extension decision and the DOE refusal to rehear that decision. Opening briefs have yet to be filed in the 9th Circuit case.

Supply commitments

In its application for a rehearing, Chugach said that DOE had authorized the LNG export license extension without specifying any conditions that would require the Cook Inlet gas producers to supply gas for local needs. DOE must ensure not only that local gas needs can be met, but also that those needs will be met, Chugach said. And when DOE was in the process of considering the producers’ application for the export license extension, Chugach had requested that the license extension should be contingent on contractual commitments to ensure adequate local gas supplies “for a reasonable future period.”

The gas producers, for their part, have dismissed as unwarranted interference in the gas market any question of enforcing gas supply contracts. The producers have said that the existence or absence of contractual agreements for the supply of gas to utilities relates to private commercial dealings, and not to the question of whether there is enough gas to supply the local market.

“These arguments are nothing more than an attempt to use the Natural Gas Act … public interest standard to create a right of eminent domain to take natural gas from applicants’ export operations for the private use of Chugach, Enstar, Tesoro and Agrium,” the producers said.

DOE agreed with the producers and in justifying its license extension decision said that no one had demonstrated a shortage of domestic gas supplies in the Cook Inlet region.

“Rather, the applicants’ submissions provide a reasonable basis for concluding that local supplies are adequate to support the proposed export as well as meet local demand requirements during the term of the proposed authorization and beyond,” DOE said.

And the State of Alaska supported the export license extension, following an agreement between the state and the LNG plant owners for commitments by the owners to the drilling of new gas wells and to the sale of seismic and well data to potential Cook Inlet oil and gas explorers.

Economic driver

People generally recognize the value of the LNG plant as an economic driver on the Kenai Peninsula. In fact, Chugach does not seek to halt the operation of the plant — it seeks local gas supply assurances.

The existence of the plant as an industrial gas consumer improves the viability of new gas exploration and development in the Cook Inlet basin, as well as being a likely kingpin in the economics of a possible future pipeline that would deliver gas to Southcentral Alaska from the North Slope. Just as importantly, by temporarily curtailing LNG production, the LNG plant backs up critical peak gas flow to Southcentral consumers during the coldest winter days — the gas wells and gas storage facilities around Cook Inlet are no longer capable of meeting by themselves peak deliverability needs during those coldest days.

The LNG plant was originally constructed in the 1960s as a means of marketing large quantities of surplus gas from the newly developed Cook Inlet oil and gas fields. But as gas supplies from Cook Inlet came more into line with gas demand in the early 2000s, gas prices began to rise. Rising gas prices provoked a fierce debate on the appropriate pricing level for Cook Inlet gas, especially since there is no spot market for gas in the region — gas supplies tend to be tied into medium to long-term contracts.

Some have argued that Cook Inlet gas prices should be indexed to gas prices elsewhere in North America, to provide oil and gas companies with an incentive for new investment in Cook Inlet gas exploration and development. Others have said the price should remain relatively low, with the continued operation of the LNG plant demonstrating that there is ample gas in the region to meet local utility needs.

Gas prices are linked both to the cost of electrical power in Southcentral Alaska and to the future availability of gas for power generation.

Tariff cases

And in a series of gas tariff cases involving Enstar Natural Gas Co., the main Southcentral gas utility, the Regulatory Commission of Alaska has wrestled with the issue of equable pricing for the gas.

A gas supply contract between Enstar and Unocal (now part of Chevron) that RCA approved in 2001 used a gas price formula indexed to the Henry Hub market in the Lower 48. In September 2006 RCA rejected an Enstar contract with Marathon that also used Henry Hub pricing, with a majority of the commissioners saying that the Henry Hub pricing was unjustifiably high for the Cook Inlet gas market. And in Enstar’s latest attempt to establish new gas supplies, this time with ConocoPhillips and Marathon, RCA has imposed an index-based gas price cap, using a basket of prices from markets in North American gas production basins.

In an Oct. 31order RCA said that it was imposing the price cap because of the gas producers’ power in a market dominated by just three companies: ConocoPhillips, Marathon and Unocal. And the commission said that it thinks that the extension of the export license for the Nikiski LNG plant is contributing to that market power — the commissioners appear to agree with Chugach in seeing a need for the export license being conditional on supply contracts with utilities.

“The Cook Inlet market is vertically integrated, with the producers as their own best customers through the medium of sales to the LNG export facility,” the commission said. “… It is in the best interest of local utility ratepayers to require the producers to finalize contracts with the local utilities before receiving authorization to export natural gas.”

Supply crisis

Meantime Chugach is facing a crisis in obtaining future gas supplies to drive the gas-fired power plants that generate its electricity — Chugach’s current gas supply contracts date back to the 1980s and all of the contracts will terminate by 2011, attorney Eric Redman and Suzanne Gibson, Chugach vice president of corporate planning and regulatory affairs, told the RCA commissioners in a February 2008 update on Chugach’s fuel supply situation.

“So we have no gas at all beyond those dates,” Redman told the RCA commissioners. “… We have been negotiating with the (gas) producers for more than two years. We haven’t reached agreement on the new contracts. … We and the producers are stuck trying to get to the other side of the stream.”

Chugach supplies 55 percent of the power in the Alaska Railbelt and generates 93 percent of that power from natural gas, Redman said. In addition, a 20-year-old Chugach power supply agreement with Golden Valley Electric Association to displace oil-generated electricity in Fairbanks is running into the Cook Inlet gas supply crunch.

“From Chugach’s point of view we’ve reached the end of the road at the moment with the viability to go on displacing oil generation in Fairbanks,” Redman said.

Gibson said that Chugach is seeking a different gas price structure from Enstar, because Chugach experiences much lower seasonal swings than the gas utility — utility gas is primarily used for space heating that peaks dramatically during the Alaska winters.

But the export of LNG from Nikiski presents a complication in the Cook Inlet gas supply equation, Gibson said.

“We’re entering into a very complex and probably very difficult time with Cook Inlet gas,” Redman said.

“In the long history of Alaska’s LNG facility, extensions of LNG export authority have never before been granted at a time when local electric utility requirements for natural gas remain unmet, as they do today, not just in the future but even during the export extension period,” Chugach said in its rehearing application to DOE. “Chugach believes that in these circumstances, failure to condition the new grant of LNG export authority as Chugach has requested is an error, both of public policy and (given the public interest standard) of law.”



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