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Vol. 15, No. 21 Week of May 23, 2010
Providing coverage of Alaska and northern Canada's oil and gas industry

Chugach contract OK’d

RCA signs off on CEA supply contract with Marathon, Enstar contract on deck

Eric Lidji

For Petroleum News

State regulators approved a natural gas supply contract between Chugach Electric Association and Marathon Oil Co. on May 17, saying it served the public interest.

The contract gives Chugach all the gas it needs through April 2013, and possibly longer if local supplies suffice.

The contract sets prices using futures on the New York Mercantile Exchange bounded by an inflation-adjusted floor and ceiling, with premiums added for increased demand and discounts available if Chugach someday develops storage.

The Regulatory Commission of Alaska approved the supply contract without a formal investigation, the lengthy process where contracts get a thorough examination. That decision came in large part because state Attorney General Dan Sullivan, who represents the public in ratemaking cases, did not recommend investigating or rejecting the contract.

The ruling bodes well for a contract between Enstar Natural Gas and Marathon currently pending approval from the RCA, but it doesn’t guarantee su cess. While the Chugach and Enstar contracts are similar, they aren’t identical. Enstar used similar pricing mechanisms to those used by Chugach, but is ultimately paying higher prices and buying smaller volumes. The Enstar contract also does not cover all of its unmet needs.

Still, while Sullivan said peak pricing under the proposed Enstar contract could turn out to be unreasonable, he also did not recommend investigating or rejecting the contract.

What about production costs?

The Chugach-Marathon contract is the third in a row to get RCA approval, silencing criticisms about unpredictable regulatory timelines.

Still, many dilemmas facing the Cook Inlet gas market remain unresolved, chief among them being how to price local gas supplies.

Sullivan didn’t say investigations weren’t needed, just that they wouldn’t be productive because producers don’t have to detail costs, making it impossible for regulators to say whether prices are “reasonable.”

Without those figures, Sullivan questioned how Chugach and Enstar reached specific floors, collars, premiums and adjustments.

In a concurrent statement to the ruling, RCA Chairman Robert Pickett and Commissioner Paul Lisankie challenged Sullivan’s assumption, saying the RCA “would effectively be regulating producers” if it used cost data to set prices. Pickett and Lisankie cited federal regulations that purposefully avoid that kind of “back door” regulation of producers.

This cost question has emerged in every major gas supply contract case of the past decade.

During the heated deliberations of 2008, when Enstar proposed two contracts, Alaska Department of Natural Resources Commissioner Tom Irwin said prices must “reflect the cost to find and develop the new resources,” leading RCA Commissioner Kate Giard to respond, “It is elementary that knowing the cost to produce gas is necessary to truly hit the bulls-eye in setting gas prices. We have been denied this information.”

As a remedy, Giard suggested new laws and regulations demanding that information.

While the Legislature spent considerable time this year fashioning bills to make the Cook Inlet more attractive to producers and explorers, no bills touched on the cost question.

What about high prices?

That doesn’t mean lawmakers aren’t being vocal about prices, though.

In a May 13 letter to the RCA, six Democratic lawmakers challenged the prices in the proposed Enstar-Marathon contract (although curiously not in the similarly-priced Chugach-Marathon contract), saying they “may be unreasonably high given the low price of gas worldwide.”

While Henry Hub prices have hovered around $4 per thousand cubic feet for two years and the U.S. Energy Information Administration projects prices to remain below $6 per mcf through 2011, the Enstar-Marathon contract proposes prices that start at nearly $7 per mcf and can more than double during peak demand.

“What accounts for this huge disparity between what Alaskan gas buyers and buyers in the Lower 48 are being asked to pay?” Senators Bill Wielechowski, Hollis French, Bettye Davis and Representatives Pete Petersen and Berta Gardner asked in the letter.

The lawmakers also cited the “substantial incentives” for producers to invest in the Cook Inlet, including a much lower tax rate compared to North Slope oil, recently increased tax credits for exploration and an offer by the state to pay 100 percent of the costs for up to three exploration wells using a jack-up rig.

“Given these massive government subsidies, are the prices being proposed in this contract warranted?” the lawmakers asked.

The lawmakers also questioned the proposed prices in relationship to the prices two Tokyo utilities pay for liquefied natural gas from Cook Inlet, around $8 per mcf over 2008 and 2009.

“Given that this gas must be liquefied, transported almost 4,000 miles and then re-gasified, all at substantial cost to ConocoPhillips and Marathon, the prices being charged to Alaskan consumers appear even more questionable,” they wrote.

The lawmakers said they recognized the importance of reliable gas supplies. “Our only requirement is that the price they charge to Alaskans be fair and reasonable,” they wrote.

Pickett and Lisankie indirectly challenged this idea, writing, “If you accept the proposition that we should regulate purchase prices (presumably lower) when supplies tighten then we should have regulated purchase prices higher to avoid that tightening.”

Increasingly quick timelines

The recent ruling seems to address one concern about the local gas market: the ease with which utilities can get supply contracts approved by regulators. A March 2010 report, commissioned by three local utilities, cited the lack of “predictable timelines” as a major stumbling block.

Since the brawl of 2008, though, which ended with Enstar using a regulatory loophole to get last minute supplies after the RCA rejected two contracts, regulators have not rejected a natural gas supply contract. In fact, it approved the last three contracts without ordering an investigation.

That is in part because the Attorney General’s office kept its distance, bolstering any claims that approving the contracts served the public interest.

Giard and Commissioner Janis Wilson challenged those claims when the RCA approved a 2009 contract between Enstar and a subsidiary of independent Armstrong Cook Inlet, saying the Attorney General needed to be more involved. The recent ruling to approve the Chugach-Marathon contract, though, did not yield dissenting opinions from any of the commissioners.

Utilities might be forcing these swift decisions, according to Sullivan. He noted that contracts are increasingly “of short duration and negotiated very close to the time when the gas will be needed” making them difficult to analyze without disrupting supplies.

Supply concerns remain

Those supply disruptions may come anyway.

The Chugach-Marathon contract provides 42.3 billion cubic feet of gas between April 2011 and December 2014, but only guarantees supplies through April 2013.

Marathon doesn’t yet know whether it can provide the 16.1 bcf Chugach needs in the final 20 months on the contract. Likewise, Marathon has the option of reducing volumes to Enstar if the U.S. Department of Energy doesn’t extend the export license of the liquefied natural gas facility in Nikiski and the resulting drop in deliverability shuts in wells.

Marathon should know this year if the federal government will continue to allow exports, but the company only needs to give Chugach two years notice if it can’t meet demand.

That may not be enough time. Chugach needed five years and nine requests for proposals to get a 2009 contract with ConocoPhillips and its 2010 contract with Marathon.

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