Coming to the table

Gasline negotiations with state could take two years, says BP’s Bob Reynolds; state must appoint team and empower itself legally to negotiate

Kristen Nelson

PNA Editor-in-Chief

There are four things BP believes are necessary before Alaska North Slope gas can be commercialized: federal enabling legislation; resolution of First Nations and federal land claims issues in Canada; improvement in project economics and advancement in technology; and Alaska fiscal certainty.

That fourth item, “clear, simple and certain fiscal terms for Alaska,” is going to require a lot of negotiation — maybe as much as two years of negotiation” — between the state and the producers, says Bob Reynolds, BP Exploration (Alaska) Inc.’s manager of state taxes and royalties.

Reynolds, speaking Jan. 21 to the International Association of Energy Economists, said the state first needs to empower itself to come to the negotiating table by enacting legislation that would allow such negotiation. He said a bill such as the stranded gas act, which gave the state authority to negotiate terms of a gas sale for a liquefied natural gas project, would be useful. A reauthorization of this act has been introduced in this session, extending the time limit and including a gas pipeline project.

Once the state has given itself authority to negotiate, it needs to appoint a negotiating team, and then, once both sides are sitting at the table, “there needs to be an educational process,” Reynolds said.

“I think the owners need to understand more about what the state needs, what the state wants, what the state is worried about.” The producers need to be willing to share “enough information that we can actually try to anticipate the future.”

It’s difficult to say where the negotiations would go from there, Reynolds said, “but one would hope that at that point some of the terms … that would be acceptable would become clear in and of themselves just from the exchange of information.”

What’s at issue

Fiscal certainty is crucial, he said, because government’s take from the project is so large (as much as 84 percent of total discounted cash flow) that “relatively small changes in the government take … could have potentially almost disastrous consequences to the investor or the industry’s share of the pie.”

Issues which could change the state’s take, he said, include gas prices and valuation, the state’s sensitivity to profit margin, tariff determination, royalty in value vs. royalty in kind and the take on gas.

Issues behind tax and royalties

In the state’s regressive tax regime, “the state trades upside price — in other words they don’t take as much of upside price — in return for relative insensitivity to low prices.” When gas taxes are negotiated one question will be: “does the state still want to have that kind of risk distribution?”

Appropriate gaming behaviors — “behavior by both sides to maximize their positions” — is another issue. It’s expected behavior, Reynolds said, “assuming people know what the rules are…” Determining which gaming behaviors each side can perform is difficult, but “if you don’t do it before the $20 billion is spent, you’ll end up doing it in front of a judge years later,” he said.

And then you have to decide how each side will address the need to change terms in the agreement as circumstances change: “You need to figure out a way to determine what changes trigger a renegotiation and what kind of protocol that renegotiation will follow.”

And you want “to minimize the cost of administration for both sides.”

How to look at the issues

You can do it line-by-line, going through every provision of the five forms of taxation in the state (unitary income tax, production tax, royalty and net-profit share and property tax). But, he said, “for some of those five regimes there is no controlling law or regulation that says what to do. I.e. we don’t have agreements for major gas sales in several areas, most particularly royalties.”

So even a line-by-line approach would require some negotiation.

At the opposite end of the spectrum is a payment in lieu, Reynolds said. The state and the producers could just agree on a fee that is in lieu of some or all of the different take regimes and “we’ll just pay a flat a mount on a prescribed schedule.”

You could combine taxes and royalties.

Or you could do partial modifications, “take elements of the existing regime and then do other simplifications” such as taking the gas at a given point times prices times an effective rate and not deal with tariff issues at all.

And “if we couldn’t agree on terms for the payment of taxes and royalties per se, an alternative would be for the state to take an equivalent amount of gas and market it themselves and see what they could get for it.”

Impediments

One form of agreement, a fiscal contract, would set out what the industry would pay, but a challenge would be whether one Legislature can bind another, and “we’ll ultimately have to leave that to the courts to decide.”

A compensating royalty is another option: you let the Legislature do whatever it chooses to do in the future, but when it increases taxes by a dollar, royalty decreases by a dollar.

Another approach, used internationally, Reynolds said, is for the state to set up an agency with contracting ability and have that agency contract with the producers. The producers would pay the agency, which would give proceeds to state government.

And there are hybrid options — but the first step is to get people to the table.

“BP is on record saying we’re willing to start that negotiation any time,” Reynolds said. “We stand ready and willing.”