Alaska gas needs to compete

Negotiations unpopular after Stranded Gas Act, but necessary for a gas line so producers know what terms to plug into their costs

Steve Quinn

For Petroleum News

Larry Persily has been federal coordinator for an Alaska natural gas pipeline project since 2010. Much of the job he and his team of researchers and writers do is track the fast-changing world of natural gas markets.

In a few years significant price changes and abundant supplies have altered the global markets and changed the course of pipeline route discussions since the state Legislature passed the Alaska Gasline Inducement Act, AGIA, in 2007 and awarded a license to pursue a permit one year later.

Persily sat down with Petroleum News to discuss the prospects of a large-diameter line to a tidewater liquefied natural gas plant and the in-state line being pursued by the Alaska Gasline Development Corp., and where the state stacks up against its competitors worldwide.

Petroleum News: With all of these project announcements worldwide, why don’t we have a pipeline under construction right now?

Persily: If you take their estimate — $45 billion to $65 billion — at the high end of that, it would be the most expensive oil and gas project ever around the world. As much as Exxon is filthy rich and as much as BP, despite their problems, still is a big corporation and as much as Conoco a big player in oil and gas, $45 billion to $65 billion is a huge amount of risk. It’s a big piece to bite off if you’re not confident that it’s going to work out. Certainly oil and gas companies make bad investments. Badami for BP is a good example. They’ve all had investments around the world they’ve had to write off because they didn’t turn out as well. It’s not like 10 $5 billion projects. It’s one big, $50 billion or $60 billion project. Just the sheer size increases the risk and creates a higher hurdle to get over.

The other is, yes this may be our window. This may be the time when we can finally sell gas into the world market. Well, us and 20 other projects. If you really want to talk dreams, there is one export plant under construction in Louisiana (Sabine), one that has been permitted in Texas (Freeport) and 19 others for the United States waiting for federal approvals. The last time I counted there are 10 projects in British Columbia that have been proposed. Of those 31 for North America, at best four, five or six get built. You’ve got 100 tcf plus in Tanzania and Mozambique; you have 40 to 50 tcf of gas in offshore Israel in the Eastern Mediterranean; Russia has more gas than they need; Australia has got seven export projects under construction and talk of more. Yes, there’s a market out there for us, but also half the damn world. It’s a very cost-competitive environment.

When Fukushima went down and Japan shut its nuclear plants, they didn’t ask how much. They just said can you deliver gas. Qatar said we’ve got spare capacity. Eighteen dollars. Japan said sure, we’ll take it. In 2011, Japan ran its first trade deficit in 31 years. Things have changed. A new project has come on line in Australia. Papua New Guinea has a new one coming on line next year. As new supply comes in and buyers say wait I don’t have to pay higher prices anymore. It’s a price-competitive market now. Can Alaska sell gas to the rest of the world? Sure. Will we get $18? No. For this project to go ahead, Alaska gas is going to have to be competitive on price. Nobody is going to pay a lot of extra money just because it’s from Alaska. The little silver hand saying made in Alaska isn’t going to matter squat for LNG. It’s not like Copper River salmon where some bozo will pay a huge premium in Seattle to put it on the menu because some yuppie will pay $40 for a salmon dinner.

Companies have to feel really confident on their cost estimate. If you think it’s $50 billion and it turns out to be $70 billion, they can’t afford that kind of overrun. They have got to have reasonable assurances of a predictable fiscal structure so as they look at their construction costs, look at what the market will bear for gas, they can calculate in how much tax is going to cost them.

Petroleum News: With that in mind, let’s talk about that. When do you negotiate fiscal terms? Before there is a project determined or after?

Persily: You’ve got to negotiate them first. To go through FERC is a billion dollars. The Department of Energy export license is a $50 application fee. It’s pretty amazing. The application fee to export natural gas is less than an application fee for a passport to export a person. With FERC to go through the EIS for an 800-mile pipeline to the biggest liquefaction plant in North America, I’m going to say $1 billion. I’m not going to do that if I’ve got no clue as to whether the fiscal terms are reasonable. That’s an expensive option to buy. So they are spending $100 million. So you spend that much buying an option, not $1 billion.

If I were them, I’m not going to spend that kind of money. Maybe I don’t have a signed deal, but I’ve got a pretty good sense I can work something out on fiscal terms. Also Alaskans need to know. We are going to face a decision in this state about 2015 after AGDC goes out for its quote open season. That’s when you’re going to look, and say here are the economics on this turkey. Good or bad the state may need to put some money into it. At that point, if you are faced with the projections for the state-sponsored, in-state mini gas line, and you know now you’ve got the good sense of how much is the gas going to cost and how much are you going to have to pour into this thing, don’t you want to look at the other stack of papers on your desk and say, but for these terms maybe I can get the big line and have someone else pay for it.

I think you need to be working on those negotiations so you can compare the two and make a decision. Alaskans want something built. But let’s make a decision based on reality not on what ifs, I think and this may happen. Again, it’s so competitive. You can’t afford to wait forever. People talk about the window, the window: Well there are lots of windows. Buyers sign long-term contracts, but they stagger them out. Every time a contract expires, they open them up to negotiations; then you have an opportunity. A lot of contracts signed on projects that came on line 10 or 20 years ago, are expiring.

So Alaska has two opportunities. One is to meet increasing demand in China, in India, in Japan, in Korea. The other is to replace suppliers of existing contracts that are coming up for expiration the next 10 years. Alaska needs the pipeline. We need to make a decision so let’s see what negotiation is possible.

Petroleum News: You weren’t a big fan of AGIA when it was being rolled out. Has any good come from AGIA?

Persily: I always thought AGIA was oversold. It was promoted by the Palin administration as the end-all, be-all to get a pipeline. I felt that was misleading. AGIA was a way to get a building permit. AGIA said, even if the project was not economically viable in exchange for taking $500 million in state reimbursement, you’ve got to get a building permit from FERC anyhow. Most people wouldn’t get a building permit without customers, but AGIA required it. AGIA will get you the permit, but it doesn’t do anything to get you the financing.

It doesn’t get you the project. AGIA was oversold and people need to accept that and stop being so mad and say it didn’t get us anything. It was never going to get us anything other than some headlines. At this point, if I were the governor, well they signed a deal, let it play out. We’ve gone through $300 million out of the $500 million. In the end, we will still get the data they are gathering — it’s not like it’s a total waste — which will be of value if anybody ever builds something. Is it the state’s wisest investment? Probably not. Does the state of Alaska have a history of wise investments? No. Can I think of any wise investments the state made? Well, Red Dog. ... I’m still thinking. It did help to the extent that it probably nudged people along and they wouldn’t be doing as much if they weren’t getting 90 cents on the dollar. If in the end it becomes a piece of the puzzle that gets you to finally get a gas line then it was worth it. Do I think there is a better chance that will work than the $430 million we are giving to AGDC? It’s also a gamble. Obviously we like to gamble in this state.

Persily: They are doing a good job putting their environmental work, the engineering; they have put a business plan together. They are doing what the Legislature asked them to do. And they are doing it well. All the tariff information they trot out in front of the Legislature is based on being 100 percent full, 500 million cubic feet a day. That’s more than twice the entire in-state demand, most of which is served by Cook Inlet, probably not forever. So if you are reasonable in your projections, at best in 2020 I see in-state demand again — that’s if you get Donlin, maybe another mine, Fairbanks and top off the tank in Cook Inlet. I don’t see it approaching 200 million cubic feet — at best. So if that’s all the gas you move through there, the tariff is much higher than the promotional material. If you get an export customer, which was their reasonable business plan at the very beginning, then you’ve got some other problems: is the Conoco plant in 2020 still operational; does the plant need further investment; can they get an export permit. Then economics come into play. (AGDC is) assuming gas coming down the line is about $8. That’s OK for Enstar and Chugach, but when you liquefy it and put it on a tanker that becomes very expensive gas in the Asian market. I’m not convinced — and I could be wrong — but I don’t think the economics work for exporting gas if it cost that much money to get to the doorstep of the liquefaction plant, so I’ll be curious to see what comes out in the open season. I’d be surprised if they get enough volume instate to make it work; I’d be surprised if they get large volumes of export customers. If it goes that way, the Legislature is going to have to say well is there a big line in our future, if not what’s it going to cost us with state cash on a small line to buy down the cost so people can afford the tariff. That will be an interesting political debate, probably as much on politics as on economics. I wish them well. I’m skeptical that it’s going to work financially, but I’m also skeptical on a big line, so I’m not picking on one or the other.

Petroleum News: Could coal re-emerge as a competitor for a fuel source?

Persily: The Obama administration is going to propose stricter rules for coal plants. Congress will go apoplectic, particularly the U.S. House. They will equate regulating coal emissions with destruction of Western civilization as we know it. The Republican leadership in the House and coal states will say over their dead body. Given all that, coal plant operators are business people, maybe with political pressure we can delay some of these rules, but we can’t put it off forever. So you’re seeing more and more power plant generators going with gas. I see coal continuing to lose share, albeit slowly.

Petroleum News: Your office has looked at global competitors. Let’s look at some of those competitors, starting with Australia.

Persily: Let’s see, one new project came on line last year; seven are under construction. By the end of this decade Australia will overtake Qatar as the world’s largest selling LNG producer. They’ve had tremendous cost overruns. Part of this is, the industry wasn’t very smart. They tried building everything at once. It’s the classic overheating the economy. One thing that makes many of Australia’s projects very expensive is, unlike Prudhoe Bay, they are developing the liquefaction plant terminal, but they are also developing the production field, all these coal-seam gas projects.

They are out there drilling hundreds, thousands, of wells, developing reserves, so it makes it much more capital intensive. So Australia gas is expensive. The good thing for Alaska is the projects have supply contracted out, so they are not really our competitor. These projects that come on line, their gas is presold, most of it, so they are really not a competitor. The good thing is for all there is some controversy that will make it harder for investors to bankroll expansion or another wave of Australia projects.

Petroleum News: OK, what about Russia?

Persily: The problem with Russia is a project doesn’t have to make economic sense in Russia. The government doesn’t care. The best way to put it is they have their problems, too. There is Vladivostok — right across the Sea of Japan from Japan, a great location for an LNG plant. The problem is getting the gas to Vladivostok is a 2,000-mile pipeline at $13 million a mile. The bad thing from Alaska’s perspective is if the government decides they want to do it, it’s not like they’ve got to get a two-thirds majority in a challenged Legislature. As long as they are making money from their vast oil and gas resources, they can in effect subsidize it. Russia would like to sell gas to China but they don’t really trust each other. Europe was their big market and Europe is pushing back. They are tired of getting screwed by Gazprom on expensive gas. They are going to have to, like Alaska, charge a competitive rate for gas. That’s unknown at this time.

Petroleum News: OK, Canada, or British Columbia really?

Persily: Their problem is green field development. Unlike Prudhoe, there are no production facilities. They’ve got to drill hundreds and thousands of wells; they’ve got to build base camps and roads and airports and water and sewer, and get the gas into production. They have got to go through two mountain ranges; they have to go through First Nations lands and those land claims have not been settled. Now gas is benign compared to oil but you’ve had a lot of controversy in British Columbia over proposed oil sands pipelines, which First Nations have generally opposed. You’ve got to convince them that’s oil — that’s bad — and this is natural gas and that’s good. Coastal First Nations are starting to say what about air quality from all of these tankers and these liquefactions plants and their emissions. The government is very supportive in British Columbia for obvious reasons in that it will be a huge economic boon. For example in Prince Rupert, the best route is along the highway through Skeena River Valley but there is no room for a pipeline and it’s a salmon-producing river. Now you think how do I get into Rupert? It’s another example of none of those have gone to final investment decision and ordering steel to build it because they all have problems just like Alaska. There are about eight or 10 proposals, but they are not all going to get built. It’s which one can get a project designed that gets environmentally reviewed, First Nations approval, community approval and some customers. The proponents of BC LNG projects say we need high oil linked prices and so far the market has not responded by signing contracts. That’s going to be a problem for them. Like Alaska they can afford to charge a little more for the gas because they are so much closer. The BC government is also talking about a tax on exports and has said we’ll know next year. The industry has said great, you’ll know next year: Well, we need to know. The government is negotiating fiscal terms with at least one project sponsor and hopes to have something this year, just like Alaska eventually will have to do. Companies are saying I need to know the tax regime before I go too deep into this.

Petroleum News: And the Lower 48 — or I should say the Gulf?

Persily: Even the U.S. Gulf has all those projects and access to the most liquid, prolific natural gas market in the world and even with the expanded Panama Canal open next year, it’s still a long way (from Asian markets). The Panama Canal authority has not said here is our rate card for big LNG tankers. Everyone in the industry figures the authority is not stupid. They’ve got $5 billion to pay off on this expansion. They are going to figure out what it costs to send a tanker around South America and into Asia, and how much you can save by going through the Panama Canal, and they are going to want to see the savings go into their pocket. The difference between sending an LNG tanker from Alaska to Japan and sending one from Corpus Christi (Texas) to Japan, or from Louisiana to Japan, I’ve seen estimates that could be anywhere from $2 to $3 per million Btu cheaper on tanker charges. That’s a big advantage. Is there a lot of gas in the Lower 48? Yes? Is one project under construction? Yeah. Is another one approved? Yes. But, they are going to have high tanker charges and if U.S. prices climb and you’ve got to pay $5 or $6, then Alaska should be able to compete on price and the gas will go somewhere else.

Petroleum News: Do you have any concluding thoughts?

Persily: As far as the market, hopefully TransCanada-Exxon-BP-Conoco by the end of this year will come to the state with another amendment in AGIA, which will give us more indication when they will apply to FERC for an LNG project. Hopefully the state and the companies will engage in fiscal talks that at some point is going to have to come before the Legislature. I think it’s going to take a while. People do not have fond memories of Frank Murkowski’s negotiations on the Stranded Gas Act, but they need to separate from that. Good negotiations, productive negotiations can work out. Even if the Parnell administration started negotiations on Labor Day, they aren’t going to have a deal by January. It’s too complex. It’s hard to tell Alaskans to be patient when they’ve been waiting for 40 years, but I do see a decision point in 2014 or 2015 when you have more information on the big project and you have the information you need on the financial viability on the small line. It’s a good time as any to make a decision on what the state is going to do for the next 40 or 50 years.