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Legislators hear state challenges of liquefied natural gas project
For years the state wanted to see Alaska North Slope natural gas go to Lower 48 markets in a large-diameter gas pipeline. That dream ended with the recent boom in Lower 48 natural gas production. The state’s focus is now on a liquefied natural gas project which would sell ANS natural gas into Asian markets as LNG.
The Department of Natural Resources recently released an ANS royalty study by Black & Veatch (see story in Nov. 24 issue) and House Resources heard a partial overview of the Black & Veatch study Nov. 22, although the meeting was cut short by inclement weather.
Commissioner of Natural Resources Joe Balash told legislators the focus of the Black & Veatch study was on royalty questions because royalty “is the primary way in which Alaskans benefit from the ownership of the resource.”
He said more than 10 years ago when there was a serious effort to take ANS natural gas into the North American natural gas hub at AECO in Canada, the state, and in particular DNR, “developed a pretty solid understanding ... of how our terms affect the players in a project — either the shippers or the transporters or the state.”
The state developed an understanding and solutions for potential hurdles which would be faced by project sponsors and firm shippers. “And I think that we also understood how to maximize our opportunity,” Balash said, as well as accommodations the state would need to make to maximize the opportunity for an overland project to the AECO hub.
LNG market different Then came LNG.
Balash said the Black & Veatch study brought to light “two really, really big differences between a North America project and an LNG project” — the market and the transportation system and how it is regulated.
With a pipeline project, gas is moving from the North Slope “into a very deep, very liquid and very transparent hub — that being the Alberta trading hub” leaving “very little to argue about with regard to the value of the commodity in the market.”
That means, he said, that a lot of valuation issues for the state are “very straightforward.”
But in the LNG market the price paid for the gas is based on “very specific and detailed commercial terms embodied in sales and purchase agreements. And those SPAs are all unique,” Balash said. There will be similarities and common features, “but each one is specifically its own deal and that makes for an opaque market and an opaque manner in which you value the commodities.”
That presents a challenge, he said, when it comes to determining the value of the state’s royalty.
The second difference is in the transportation system and how it is regulated.
With the North American model the natural gas starts on the North Slope in the producing fields and “the royalty then happens at the lease boundary, the unit boundary, and from that point all the way to market it’s moved through a regulated transportation system,” Balash said, regulation which covers access by third parties and rates.
If necessary, he said, the state can rely on that regulation to determine “costs that will be deducted from our market value for purposes of transporting the commodity.”
LNG plant not regulated With an LNG project, the gas treatment plant on the North Slope and the pipeline would be regulated by the Federal Energy Regulatory Commission or the Regulatory Commission of Alaska, “but the liquefaction terminal is unique in that regard,” because FERC only regulates the liquefaction facility for environmental and health and safety issues.
FERC doesn’t “regulate for access; they don’t regulate for rates today,” Balash said.
“So, we’re left with no regulatory backstop to access the appropriate charge for that liquefaction service. And we’ve taken to referring to it as a little bit of a black box.”
Asked by Rep. Mike Hawker, R-Anchorage, whether the state could regulate LNG ratemaking where FERC doesn’t, Balash said he’d asked that question and had been told by counsel that “Congress has reserved to the FERC exclusive jurisdiction on this question,” adding that while the state could pick a fight over the issue, the advice he’s gotten doesn’t incline him to take that tack.
Hawker said it seemed odd to him that the federal government “would leave such a gaping hole in regulatory authority.”
Deepa Poduval of Black & Veatch said it was her understanding that “the LNG was never intended to serve U.S. consumers and the need was not felt to protect international consumers or buyers of this LNG for ratemaking purposes.”
What’s reasonable? Regulation of the liquefaction facility for ratemaking purposes is significant because of the cost that could be assigned to the liquefaction.
The state’s lease terms allow lessees to take certain deductions in moving the state’s hydrocarbons to market, including “a reasonable transportation charge,” Balash said.
“Well, if you’ve got an unregulated facility that has to be constructed, the question becomes, what’s reasonable?”
It presents a challenge to the state because the project sponsors are talking about an integrated system, which makes sense since they have the natural gas and want to make sure they can depend on the transportation system, he said.
But with an integrated system, costs can be moved and financing can be structured in a way that makes the most sense for the person deciding, which in this case would be the project sponsor.
“That is not necessarily going to line up with our interests in relatively speaking lower tariffs for those charges,” Balash said.
He said it’s the “root of a misalignment that has plagued the State of Alaska and the lessees at Prudhoe Bay in particular ... and has caused us to fight, viciously at times, over matters that relate back to our royalty interests.”
Cost shifting issue Hawker asked Balash about the cost-shifting issue. “When you’re thinking about moving costs in sufficient volumes to affect the outcome of the project economics, what’s the vehicle or means that you see as the way those costs would be shifted?”
Balash said the big factor is debt and equity relative to the parts of the project. While the debt-equity ratio for the pipeline might result in a reasonable tariff, the producers might establish “a different capital structure for the liquefaction plant.”
The capital structure, he said, “is a huge driver in the ultimate charge that comes out and is deducted against our market value.” The state has the most concern around the liquefaction facility, Balash said, “about how we come to an agreement with project sponsors on what would be reasonable.”
“Because the risks associated with the project from their perspective will drive them to a higher number and our interests in a lower charge will push us to a lower number.”
Balash said closing that gap won’t be easy, and “it’s that financing structure that I’m referring to when I talk about the cost shifting.”
So it isn’t hard costs that would be shifted, it’s “a debt and financing cost,” Hawker said.
Balash said broadly that was correct, although “there are some ways in which costs can be allocated differently within an integrated project structure ... but those are, relatively speaking, minor in comparison” to the effect of the capital structure.
Settlement possible? Once royalty payments are made on LNG, the state would audit those payments and “if we thought that they had shortchanged us because they overcharged for the liquefaction, our remedy, if we couldn’t resolve it amicably, would be to go to court,” Balash said.
That’s how the litigation started over the valuation of Alaska North Slope crude oil, he said, litigation which was ultimately resolved by settlements on methodologies.
“There’s probably an opportunity to reach a settlement up front before a project like this would go forward,” Balash said. “And I think the companies would probably be motivated to reach that settlement so that they could go forward and they would be able to estimate their royalty obligations.”
That would still require coming to a mutually agreed understanding on return on equity rates for the project, which would require coming to “an agreement on what the cost of capital should be for deducting the transportation charges,” a number the state would want to keep low while the sponsors would have requirements they wouldn’t want to — or couldn’t — go below.
“And those are probably two different numbers.”
—Kristen Nelson
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