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Vol. 12, No. 6 Week of February 11, 2007
Providing coverage of Alaska and northern Canada's oil and gas industry

Giard defends RCA Enstar/Marathon decision

Alan Bailey

Petroleum News

In a statement issued on Feb. 2, Regulatory Commission of Alaska Chair Kate Giard spelled out the reasoning behind the commission’s majority decision to reject Enstar Natural Gas Co.’s proposed new Cook Inlet natural gas supply contract with Marathon.

Enstar, the main gas utility in Southcentral Alaska, announced its new contract with Marathon in November 2005, saying that the contract would ensure adequate gas supplies for Southcentral gas consumers through to 2016. The price that Enstar would pay for the gas would be based on a 12-month trailing average of the Lower 48 Henry Hub gas market futures.

But following a lengthy public hearing, RCA issued an order on Sept. 28 rejecting the gas pricing in the contract. The commission did allow the supply of gas under the new contract, but only if the contract pricing reduces the average cost of gas to Enstar.

The order represented a majority decision, with commissioners Dave Harbour and Mark Johnson dissenting. In a statement issued in January Harbour criticized the commission majority for placing future Southcentral gas supplies from the Cook Inlet at risk by not allowing gas prices to rise to levels sufficient to encourage new Cook Inlet gas exploration and development.

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 (see the Jan. 21 edition of Petroleum News).

Henry Hub inappropriate

But in her February statement, Giard sharply disagreed with Harbour’s views.

Giard was particularly dismissive of the use of the Lower 48 Henry Hub market as a pricing index for Cook Inlet gas. The use of this index originated in 2001 in a Unocal Cook Inlet gas supply contract with Enstar — Henry Hub pricing was proposed as a means of encouraging oil and gas companies to invest exploration capital in the Cook Inlet rather than in the Lower 48 or elsewhere in the world. Cook Inlet gas prices had in the past remained relatively low.

But, with no gas supply connection between the Cook Inlet and the Lower 48, the use of the Henry Hub index has resulted in Alaska gas consumers suffering unnecessarily high gas rates driven in part by Lower 48 events such as hurricanes, which bear no relationship to market conditions in Alaska, Giard said.

“In entering contracts which create a link between the two markets, Enstar has upset the economic balance existing between Cook Inlet producers and Alaska’s utility ratepayers,” Giard said.

And that economic imbalance has resulted in “unintended windfall profit opportunities for Unocal,” Giard said. “… Alaska ratepayers cannot afford to have Alaska natural gas markets tied to the Henry Hub. It’s an expensive market because it is the wrong market.”

Moreover, the Henry Hub pricing in the Unocal contract has unfairly penalized Marathon, which continues to supply gas to Enstar through legacy contracts with substantially lower gas pricing, Giard said.

Industrial demand drives market

Giard then proceeded to make a case that Cook Inlet industrial gas demand, rather than Lower 48 markets, is driving the Cook Inlet gas market.

“It is the export of LNG and the conversion of gas to fertilizer that contributes to any perceived shortage in Cook Inlet natural gas resources, and it is the export of LNG which is responsible for every single noticeable addition to Cook Inlet reserves over the past 40 years,” Giard said.

Giard said that statements by Richard Barnes, a former president of Enstar, demonstrated that “throughout the history of Cook Inlet’s development” Enstar’s needs for natural gas for Southcentral gas consumers had played second fiddle to the demands of the Kenai Peninsula fertilizer and LNG plants — Giard cited several quotes from Barnes describing occasions when Cook Inlet gas producers had been unwilling to enter contracts that fully met Enstar’s needs because of the commitment of gas reserves to industrial uses.

But gas reserves in the Cook Inlet have fallen substantially since the 1970 heyday of massive, excess stranded gas reserves in the region, thus bringing the reserves-to-production ratio, a measure of how long production can continue using current reserves, down to levels approaching those of the Lower 48. There is little incentive to explore for new gas when that ratio is high, Giard said.

Giard said that in fact there have been only two occasions, one in 1986 and another in 1996, when the producers reported major increases in their estimated Cook Inlet gas reserves. Both of those occasions coincided with pending applications for renewal of the federal export license for LNG from the Nikiski LNG plant on the Kenai Peninsula. The granting of that export license is conditional on the export of LNG being “consistent with public interest,” a stipulation that could be jeopardized if the exporting were to cause shortfalls in local Alaska gas supplies.

“In total, nearly 2.9 trillion cubic feet have been found around the time that ConocoPhillips and Marathon (the LNG plant owners) were involved in the application extension process,” Giard said. “Since the last extension in 1996, proven reserves have continued to decline.”

Competes with Japanese market

So the Cook Inlet gas market is really tied to the Japanese gas market, where Cook Inlet LNG is sold, Giard said. The need to compete in price with that market, rather than the use of an index price from a Lower 48 market, should determine gas prices paid by Alaska ratepayers, she said.

“We need to forge ahead and look at the real connections Alaska has with the rest of the world,” Giard said. “We need to understand who we are competing with for natural gas supplies and ratepayer prices must be benchmarked accordingly.”

But Giard expressed regret that, in rejecting the precedent of using the Henry Hub market as an index for pricing Cook Inlet gas, the commission has unsettled pricing policies and “thus left the Cook Inlet producers with uncertainty as to the ground rules for supplying Alaska’s utilities.”

“I am not proud of this outcome,” Giard said, “Were it not for my strong belief that Henry Hub contracts materially and unfairly tip the scales to the benefit of the producer at the expense of the ratepayer, I would not have made this decision.

“… The commission has an obligation to find balance between the needs of customers for stability and good value in gas supply with the needs of producers for stability in pricing policies and adequate financial rewards for the risks taken to supply the utility market.”

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