State gets mixed reviews on proposed royalty gas sale

Views of producers of natural gas, and utilities and other industrial users range from expressions of concern to outright rejection

Kristen Nelson

Petroleum News Editor-in-Chief

Part 1 of this story, in the June 20 issue of Petroleum News, contained an overview of the state of Alaska’s request for expressions of interest in a royalty in kind sale of its Cook Inlet natural gas, and includes a summary of responses from Agrium, the Kenai Peninsula Borough, Forest Oil and Fairbanks Natural Gas.

Those views were favorable to a sale — or at least to the Alaska Department of Natural Resources Division of Oil and Gas proceeding with a best interest finding for the proposed sale.

The views of Cook Inlet natural gas producers, the other industrial user in the inlet, the Nikiski liquefied natural gas plant, and utilities, are basically opposed to the sale idea, and most told the state that they feel such a sale would not be in the state’s best interest.

ConocoPhillips a seller, buyer and consumer

ConocoPhillips produces natural gas at the Beluga field on the west side, and at the Tyonek platform in the North Cook Inlet field.

The company said it “understands that one focus for the state’s evaluation of an RIK gas sale at this time is a noncompetitive sale for industrial feed gas purposes, including, potentially, a noncompetitive sale to Agrium, the owner of an export fertilizer manufacturing plant in Kenai.”

ConocoPhillips said a royalty in kind sale of Cook Inlet gas “cannot avoid adverse impacts on other operations and utilities that depend on the use of royalty gas taken in value by the state.

“An RIK sale would simply shift the current tightness in the Cook Inlet gas market from parties whose current gas-short situations result from their own business decisions, to other parties who would be put into the same gas-short situations as a direct result of the state’s RIK sale.”

ConocoPhillips said it also believes the price in a non-competitive sale would be lower than what the state currently receives, so there would be a revenue loss to the state.

The ConocoPhillips-Marathon LNG plant could be adversely impacted, ConocoPhillips said, because if the state’s royalty gas from the North Cook Inlet unit — which now goes to the LNG plant — was sold elsewhere, ConocoPhillips would need to find other sources of gas for the LNG plant.

At the Beluga River unit, sale of royalty in kind gas would “have a negative impact upon utilities as well as industrial operations,” the company said, noting that on cold days the Beluga River unit is producing at maximum volumes to both industrial and gas and electric utilities. “At the very least, directing (Beluga River unit) gas away from the utilities decreases the ultimate amount of gas available to supply the utility contracts over the long term,” the company said.

Marathon questions transportation availability

Diversion of some or all of this natural gas to a preferred consumer would amount to a state subsidy, Marathon said, “which over the long term would distort markets and hinder future industrial developments. Subsidizing an uneconomic plant would shift the economic burden to all other local consumers,” the company said, and “would not create any new gas supplies.”

Agrium’s gas supply is at risk, Marathon said, because it requires a low price because of competition in a world fertilizer market. For many years the “gas oversupply” in Cook Inlet “allowed Agrium and its predecessor to compete successfully in the world market. More recently, however, the natural gas market has tightened significantly, putting economic pressure on Agrium.”

Marathon also said it believes there would be transportation problems.

“Aggregating and redirecting royalty gas from each of 25-odd fields and various pipelines in the Cook Inlet to Agrium’s plant would be a complex undertaking,” the company said, and argued that neither Agrium nor the state “presently have the resources to identify, measure and transport these volumes on a daily basis.”

Unocal concerned about impacts on ‘fragile’ Cook Inlet gas market

The company said it expects that, if the state decides to go ahead and accept bids for Cook Inlet royalty gas, it would “structure the bid process in such way as to not increase our costs as operators or further complicate or create an unworkable delivery system in Cook Inlet.”

Unocal said that until “exploration creates a more secure supply of deliverable gas in Cook Inlet,” royalty in kind sales “will be fraught with complications and unintended consequences.” Unocal said it believes a sale of the state’s royalty gas “may only result in shifting the gas short fall from one consumer to another.”

In addition to the shortage of supply, Unocal said the “seasonal nature of deliveries, demand profiles, complicated field balancing, exchange arrangements, royalty settlement agreements and fragile interplay of the gas consumers in Cook Inlet” could lead to “a multitude of untended consequences.”

The company said the needs of industrial and utility consumers “are dramatically different,” and argued that “an increase in gas sale pricing,” which has “stimulated the desired response of increased exploration and higher valuation for the state,” demonstrate the “supply and demand marketplace is working.”

Utilities opposed

Chugach said its Beluga River contract provides that if royalty gas is taken in kind, the volumes it receives would be reduced, and said it is concerned that if the state sells its royalty gas in kind, such a sale “could reduce volumes of gas available under Chugach’s existing contracts and cause Chugach to have to purchase higher priced gas.”

Chugach said that because it has contracts in place, it is not in a position to purchase royalty gas, but could be harmed by such a sale, and recommended that the state not sell its royalty in kind gas unless Chugach “can be assured it will not reduce the volumes available under our contracts with the Beluga producers.”

Enstar Natural Gas told the state it is purchasing some 27 bcf annually, and has about 200 bcf committed under long-term contracts, contracts which will meet its needs through 2007, so does not have any immediate “need or ability” to purchase royalty in kind gas.

However, Enstar said, any sale of the state’s royalty gas “will reduce the amount of gas available for the use of residential and industrial gas customers, including the Anchorage electrical utilities.” Because discoveries have not kept pace with gas use, the company said, if the state sells its royalty gas “in order to increase current gas use without adding new discoveries” there will be “shortages and price increases for all Southcentral Alaska consumers.”

Enstar said it explored a royalty in kind purchase in the mid-1990s, but decided it was not in its best interest, or the state’s, to pursue a royalty in kind purchase.

“Instead, Enstar believed then, as it does now, that it is preferable for buyers of significant volumes of gas to be proactive in encouraging exploration for new sources of gas.”

This is what it has done, Enstar said, by contracting with Unocal to meet its long-term needs, which Unocal agreed to do by exploring for gas, and committing that gas to Enstar.

“This contract has resulted in significant drilling and other economic activity and new gas reserves at prices that benefit the consumers and the state,” Enstar said. “This ‘free market’ solution benefits all gas consumers, as it induces new exploration and brings new gas to market, extending the supply of gas in the region.”

Municipal Light & Power told the state that its one-third interest in the Beluga River field will meet its gas requirements for electrical generation of some 10.5 bcf a year and does not expect to purchase additional gas until 2010.

But if the state takes its royalty gas in kind, the utility said, “this will accelerate the time at which ML&P will need to purchase gas.”

The utility said gas sold to utilities has historically “yielded higher values than for other uses,” and said it believes it is in the best interest “of all concerned” that supplies to utilities are “not impaired.”