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Vol. 13, No. 33 Week of August 17, 2008
Providing coverage of Alaska and northern Canada's oil and gas industry

Hosie: Cook Inlet producers have market power but can’t hold gas ransom over price

What is a fair price to pay for Cook Inlet utility gas? That’s the question that’s been at the core of the Regulatory Commission of Alaska’s July 28 to Aug. 13 hearing into Enstar Natural Gas Co.’s new gas supply contracts with Marathon Oil Company and ConocoPhillips Alaska.

Enstar and the producers have negotiated gas prices indexed to baskets of prices at various North American gas trading hubs, with additional price markups to cover different levels of peak winter demand. Enstar will pass the price it pays for gas through to its customers as part of the company’s fees for gas supplies.

Attract investment

Both the Cook Inlet producers and Enstar have long argued that gas prices in the Cook Inlet need to be indexed to prices elsewhere to attract new oil company exploration dollars into the Cook Inlet region. Cheap gas supplies in the past have reflected an excess of gas discovered during oil exploration many decades ago — an increasingly tight gas supply situation in the region is now driving the need for higher gas prices to encourage new gas exploration, people have said.

And with shortfalls in Enstar’s current contracted gas supplies scheduled to appear in January 2009, the clock is ticking for RCA approval of some form of new Enstar gas supply agreement.

But although the RCA commissioners have a gun at their heads to give the go ahead for some form of new gas supply deal, the producers cannot use the threat of supply shortages as a means of forcing a gas supply agreement at unreasonably high prices, Spencer Hosie told the RCA hearing on Aug. 8. Hosie, a top U.S. trial attorney, was testifying for Chugach Electric, a major Anchorage electric utility. Chugach is itself negotiating with the Cook Inlet gas producers over new supply contracts for gas for power generation.

“If the producers were to throttle back their production in the Cook Inlet to police a commercial price negotiation they would violate their agreements with the State of Alaska,” Hosie said.

Plan of development

The operator of a state unit with a well certified as capable of production must agree on a detailed plan of development with the state, Hosie said. That plan of development will typically spell out targets for production — failure to meet those production commitments can result in unit termination.

“There are these obligations,” Hosie said. “The producers can’t hold development hostage in a commercial pricing negotiation.”

Loss of the profitable units in the Cook Inlet is an inconceivable outcome for the producers, Hosie said. And Hosie also dismissed as inconceivable the idea that the producers would cut supplies to local utilities while maintaining production by boosting LNG exports from the Kenai Peninsula LNG plant. And the producers would run afoul of technical issues with the gas fields if they tried to warehouse gas in the fields, rather than produce it, he said.

“They are going to produce. They are going to develop. They are going to have gas to sell. I think at the end of the day they are going to have to take care of the local industries first,” Hosie said. “Local consumers should not be penalized because they live in a production basin.”

Internal targets

Hosie said that although oil companies set their own internal targets for rates of returns from gas field development and production, those targets come into play when negotiating unit plans of development with the state, not as part of gas supply contract negotiations.

So, is there enough information in the record to determine a reasonable price for the gas, asked Commissioner Kate Giard?

“I have certainly seen no evidence to suggest that production in the Cook Inlet at historical gas prices has been viewed other than profitable,” Hosie said.

Hosie said that in his view the new contract prices were intended to make an already profitable situation more profitable. But the only people who have the real information (on the economics) are the producers, Hosie said. And the producers are not participating in the hearing, he said.

Historically, gas prices in Alaska have been lower than in the Lower 48. Hosie said that he suspects that under the terms of the new Enstar contracts the producers would benefit from their most profitable gas prices anywhere and he questioned why this should happen. If Cook Inlet prices are brought into line with the Lower 48, why should all the Cook Inlet reserves be repriced? And, why should the producers enjoy Lower 48 city gate prices for gas that is produced close to market in the Cook Inlet?

Hosie also said that, despite great concern in the early 2000s about pending Cook Inlet gas supply shortages, the gas reserves situation in the Cook Inlet didn’t seem especially unusual when compared with the Lower 48.

“To the extent people believe there’s a shortage, producers have the ability to extract a higher price,” Hosie said.

The producers have market power in the Cook Inlet, he said.

—Alan Bailey

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