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Vol. 19, No. 28 Week of July 13, 2014
Providing coverage of Alaska and northern Canada's oil and gas industry

FNG seeks rate hike

Interior utility wants to recover cost of abandoned North Slope LNG project

Eric Lidji

For Petroleum News

In its first rate case since becoming a certificated utility some 17 years ago, Fairbanks Natural Gas LLC is asking state regulators for a 6.92 percent service rate increase.

The local distribution company is asking the Regulatory Commission of Alaska to approve a permanent rate increase and to install a mechanism that would allow the company to more easily pass along fluctuations in commodity prices in the future.

The increase would offset a nearly $1.4 million deficit expected under current rates.

The request is the first rate case since Fairbanks Natural Gas started its life in 1997. The company operated under its inception rates until 2002, when regulators exempted the company from economic regulation. Fairbanks Natural Gas voluntarily accepted rate regulation in late 2012 as a way to settle a long-running dispute with state officials.

The rate case is a direct result (and a requirement) of the settlement, but it also incorporates costs associated with an abandoned attempt to build a North Slope liquefied natural gas plant to offset concerns about dwindling supplies in the Cook Inlet basin.

Given the upheavals in the Interior energy market at the moment, including state-backed plans to truck LNG to the region from a proposed North Slope plant, Fairbanks Natural Gas said it expects the proposed rates to be obsolete by 2016, and also expects to file rate cases “on a frequent basis until things settle down, hopefully by the end of the decade.”

A transition

The rate case marks the beginning of a transition for Fairbanks Natural Gas.

After a supply disruption in Cook Inlet in late 2006 threatened consumers in Fairbanks, the RCA told Fairbanks Natural Gas to find an alternative source of supplies and the company launched an ambitious program to move its supply to the North Slope by building a liquefied natural gas terminal and establishing a trucking operation.

“While it may sound simple enough to build an LNG production facility on the North Slope and begin providing additional gas supplies to Fairbanks, the reality is much different,” President Dan Britton wrote in a recent affidavit supporting the rate increase.

For starters, Fairbanks Natural Gas spent more than two years negotiating a supply contract with one of the North Slope producers. Even with the contract in hand, the utility needed anchor tenants to justify the cost of the facility. While the utility made some initial progress with Golden Valley Electric Association and Flint Hills Resources Alaska Inc., those two large industrial users later split off to develop a separate LNG facility.

At the same time, Britton said, a series of state and industry ventures to bring North Slope natural gas to Southcentral threatened to make the Fairbanks Natural Gas proposal obsolete. Eventually, Fairbanks Natural Gas approached the state about forming a public-private partnership, which led to the passage of the $325 million Interior Energy Plan.

Opportunity for public financing

The plan presented an opportunity for Fairbanks Natural Gas to get public financing for the LNG plant, assistance with the trucking operation and an expansion of its service area to include much of the Fairbanks North Star Borough. Considering the historically high cost of heating oil compared to natural gas, the scenario would have certainly made Fairbanks Natural Gas a near-monopoly in the Interior heating market. The utility voluntarily accepted rate regulation, in part, because monopolization would have made regulation inevitable.

“(Fairbanks Natural Gas) always thought that at some future time economic regulation would be appropriate,” Britton wrote. “We thought, however, that (Fairbanks Natural Gas) would be subject to regulation when it developed a much larger market share and its position in the market was much more comparable to a typical gas distribution utility.”

Instead, though, the Alaska Industrial Development and Export Authority chose MWH Americas Inc. to be its private sector partner for the LNG facility and the Regulatory Commission of Alaska gave the municipal Interior Gas Utility a certificate to operate in the those areas of the Interior where Fairbanks Natural Gas had hoped to expand.

The requested rate increase would, in part, cover the $5 million the company spent on developing the abandoned North Slope LNG project over the past eight years. The $5 million represents roughly one quarter of the utility’s rate base, according to Britton.

Still needs supplies

Those setbacks have necessitated a change of strategy, according to Britton.

“While it was not initially our goal, FNG is ready to accept economic and political realities and transition towards a more traditional gas distribution company model, in which FNG’s primary role is to provide rate regulated gas distribution service,” Britton wrote.

This year and next year, Fairbanks Natural Gas is adding 30 miles of pipeline to its existing system, which will allow the utility to serve some 1,300 additional customers.

Those customers, though, cannot join the system without supplies, Britton noted.

While Fairbanks Natural Gas intends to purchase supplies from the proposed North Slope LNG plant being promoted under the Interior Energy Plan, the success of the plant remains uncertain. If the program gets delayed, or is unsuccessful, Fairbanks Natural Gas would be unable to add those customers unless it could first find additional supplies.

Currently, Fairbanks Natural Gas purchases its supplies from its affiliated Titan Alaska LNG LLC, which holds a contract for Cook Inlet supplies through March 31, 2018, “and anticipates being able to obtain additional gas supplies after that date,” Britton wrote.

Last year, Fairbanks Natural Gas also purchased supplies from the Kenai LNG facility, and the utility expects to do the same over the next two winters, according to Britton.

Advantages to smaller operation

Britton said his company would have preferred to expand its role to include the upstream component of the supply chain, but acknowledged there were advantages to its smaller operation. With an LNG plant in place, the utility would be able to avoid the financial and technical risks of liquefying and transporting natural gas (although the utility would still have to bear the risk of re-gasifying the LNG once it arrives in Fairbanks, a risk that traditional pipeline-supplied utilities like Enstar Natural Gas Co. are able to avoid). And, as a utility focused only on distribution, Fairbanks Natural Gas won’t need to worry about the potential of a major North Slope gas pipeline making the LNG plant irrelevant.

Still, Britton wrote, the return to regulation will bring challenges.

The reliance on LNG creates higher capital costs for Fairbanks Natural Gas than for other, similar distribution companies, he wrote. Those costs would be difficult to recover if customers leave because of supply disruptions or competition from heating oil.

Fairbanks Natural Gas is particularly worried about large interruptible customers leaving the company if heating oil prices come down in the future. The utility “could accept this risk when it was not regulated, because it could make up any losses when heating oil prices increased,” Britton wrote. Over the long run, he added, Fairbanks Natural Gas may need to revise its terms for providing interruptible service to address this imbalance.

When it expected to become an expansive monopoly, Fairbanks Natural Gas believed the costs of regulation would be offset by the benefits of state financing. Whether the calculation remains valid is an open question. The proposed rate increase, in part, offsets the cost of preparing the rate case, Britton wrote. But, on the other side, regulation allowed the utility to secure a $15 million loan from AIDEA “on very generous terms.”

Why FNG lost twice

Regulation also highlights the complexities of the Fairbanks Natural Gas business model.

When the company started, it separated its rate-regulated distribution operation and its unregulated LNG operations as a way to seek different types of investors for each component of its business, according to Britton. When the company became exempt from rate regulation in 2003, it combined the two operations for the sake of convenience.

The return to regulation necessitated a return to the original structure, Britton wrote, which is why Fairbanks Natural Gas handed over the LNG operation to Titan last year.

“In hindsight,” Britton wrote, “I wish that we had separated the businesses years ago, and made a more complete separation of ownership.” Fairbanks Natural Gas thought common ownership between its distribution and liquefaction entities would strengthen its application to expand its service area and its application to be the private sector partner for the Interior Energy Plan. “In retrospect, it seems clear that the common ownership structure hurt both its presentation to the RCA and its presentation to AIDEA.”

The RCA rejected the expansion request because the Fairbanks Natural Gas proposal relied too heavily on sales to Golden Valley Electric Association. If Fairbanks Natural Gas had been focused solely on providing distribution services, it wouldn’t have needed to worry about having an industrial anchor, such as the Interior electric cooperative.

When it came to making a case to AIDEA, other Fairbanks utilities worried about Fairbanks Natural Gas being on both sides of the negotiating table, according to Britton.

Cook Inlet prices

The rate case also reveals some of the intricacies of the Cook Inlet gas market.

Fairbanks Natural Gas currently gets the majority of its supplies through its contract with Titan, but the utility finished a contract with Aurora Gas LLC on May 31. The Aurora contract sold supplies for $6 per thousand cubic feet, according to Fairbanks Natural Gas.

Now, Titan is acquiring its supplies from Hilcorp Alaska LLC at a base price of $6.86 per mcf and a swing price of $8.58 per mcf. Those rates will jump to $7.13 per mcf and $8.91 per mcf, respectively, next year, according to Fairbanks Natural Gas.

Including associated operational and transportation costs, Fairbanks Natural Gas expects to pay $15.06 per mcf under the Titan contract for the remainder of the year. By comparison, the company noted, its contract with ConocoPhillips for interruptible supplies - which are usually cheaper - from the Kenai LNG plant is a delivered price of $17.35 per mcf.

While Fairbanks Natural Gas had previously adjusted its rates at will to respond to changing commodity prices in the market, the proposed rate increase would segment costs. The proposed rates would include a component for fixed costs and a Gas Cost Adjustment that would allow the utility to tinker its rates as gas prices fluctuate.

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