Micciche: More questions than answers

Soldotna Republican says he’s willing to listen and keep an open mind about Walker’s AKLNG plan, but needs details — and soon

STEVE QUINN

For Petroleum News

Sen. Peter Micciche says he’s tired of rhetoric carrying the day and would like to see resource development decisions “made with a calculator and sound policy.” The Soldotna Republican, a member of the Senate Resources and Finance committees, recently listened to the joint Resources committee hearings discussing the prospects of an AKLNG project. He shared his thoughts with Petroleum news via email and several phone conversations.

Petroleum News: After back-to-back hearings with the two Resources committees, what questions do you still have about how the project advances?

Micciche: Respectfully speaking, at this time I have more questions for the administration and AGDC than I have answers. Now that the administration has clearly stated that their desire is to move toward a state-controlled project, I want to know their vision for where their parameters and boundaries of operation, ownership and control structure are drawn.

Since 2014, my impression of the changes to the AGDC board and staff have been that we have evolved from a measured and legislatively supported structure under SB 138 to a “learn as you go” team that has been less organized and far less responsive to the Legislature’s questions and concerns. The path has taken us off of the interstate so to speak and onto what seems to be a less-travelled route that is strewn with unconventional and significantly less-proven “back roads” that this pipeline/liquefaction project could take.

I have a responsibility to my district and the people of Alaska that we do not put the state on the hook for a disproportionate level of financial risk. Some seem to have the “build it at all costs” philosophy … one I do not share. Although, this project is extremely important to my district (the terminus of the pipeline and the liquefaction facility) for obvious reasons associated with energy, jobs and investment, as well as to the people of Alaska due to revenue to the GF and wide-spread natural gas distribution for in-state use, incentive for exploration and stable North Slope oil production volumes, etc. one must constantly weigh the benefits against the risk and exposure.

Therefore, my most significant question … if I were only permitted one, would be: “At what level of risk under the current price environment, future dismal projected market conditions and the looming challenge for this project to remain globally competitive would the administration and AGDC believe that the risk is too great to proceed at this time”?

I also agree with (the Legislature’s consultants) enalytica from their presentation to joint Resources on the mechanical critical questions that must be answered prior to gaining my support for a state-led or owned project: Why state ownership? What’s the organizational plan? What’s the project structure? What’s the plan for securing/confirming tax-exemption? What’s the financing plan? Who are the target investors? What’s the risk-sharing strategy?

Ultimately, I will remain courteous, listen carefully and fairly evaluate the options and project potential presented by AGDC and the administration. All of us would like to see this project move forward, I believe the execution and governance structure of a deal and the relative speed of the project’s FEED progress is what’s in question at this time. The devil, in this case, is truly in the $45-60 billion details.

Petroleum News: Do you see this as the state taking over an uneconomic project?

Micciche: I’ve stated in the past that an Alaska gas pipeline and export project has been actively discussed since I had acne and my voice cracked with puberty. I will be 55 this year and we remain without a clear path forward. The difficulty has always been about the challenging economics of an Alaska project. Of course, due to the time/value of money any Alaska gas pipeline project built 25 years ago would likely seem like a brilliant move today.

However, looking at the global market, as well as our Asia-Pacific market-of-interest for LNG where we sit today, I have become uncomfortable in this project’s ability to compete at this time. According to the International Gas Union 2016 World Gas LNG Report: “The decline in oil prices and growing weakness in Pacific demand led all global LNG price markers to fall in 2015, from an average $15.60/MMBtu in 2014 to $9.77/MMBtu in 2015. Japanese import prices, which are primarily linked to oil, fell most dramatically, dropping 78% between January and December 2015.” The fall has continued and today the Japanese import price hovers near the $6 mark.

Global commodity markets are dynamic and complicated. Many experts, or at least half of them, fear that this low price environment may remain for quite some time; perhaps becoming the new norm.

You have to ask, how could anyone expect us to compete in a $6-7 per million Btu market from what we know about today’s AKLNG cost of supply? Issues become more complicated from there on the demand side. As of January of 2016, there is 301.5 million tons per annum of viable existing liquefaction capacity with another 142 million tons under construction globally for an eventual total of 434 million tons liquefaction capacity.

If proposed liquefaction capacity comes to fruition, the eventual total could reach a whopping 890 million tons (although it is unlikely many to most of the proposed projects will become or remain economic).

As liquefaction capacity has increased dramatically, demand has remained relatively stagnant. Although the highest year ever for LNG trading at 244.8 million tons occurred in 2015, it will likely take several to many years for a balance to occur in the market. As the IGU Report also states: “New LNG supplies combined with weaker economic growth, increased competition from competing fuels, and drastically lower oil prices will place downward pressure on LNG prices.”

Another significant factor that challenges the ability to finance the AKLNG project and one brought about largely by the availability of uncontracted supply, is the evolution of the longevity of long term contracts. Since the days of the late ’60s, the market has become organized, sophisticated and has evolved from nearly exclusively long-term LNG contracts that would negotiate generously to purchase nearly all available cargos in the past, to a significantly greater and growing proportion of spot, short-term and medium term contracts.

Now that we’ve kind of framed some of the challenges, let’s get back to your question. Is the state taking over an uneconomic project? The question is difficult to answer directly. I can say flatly, no, I will not support the state taking over an uneconomic project. Yet, there are far more factors to consider and questions that must be answered prior to such a determination. Can Alaska out-perform the cost of supply of our competitors? Do viable funding options and federal tax advantages exist in a structure that will provide Alaska with a solid economic edge in the market place? Will conditions change dramatically in the 20-30 year horizon of the project to help push the risk profile into the acceptable “green light” range? These are the questions I will be asking before I can support a state-lead project.

Today, honestly, our ability to compete in this current and projected LNG trade environment seems unlikely, but a project as important as AKLNG is to the people of this state is worthy of adequate and focused additional due diligence.

Petroleum News: Wood Mackenzie's presentation, though critical of the state’s chances, seemed to provide some hope that the state can move forward with a project. What is your takeaway from its brief presentation?

Micciche: The Wood Mackenzie report largely reiterates the answers I discussed when you asked if the state is taking control of an uneconomic project. They clarified that the AKLNG project is one of the least competitive projects on a cost of supply basis compared with likely competitors. As far as cost of supply reduction levers discussed in the report, a debt financed, tolling project owned by the state of Alaska has piqued my interest. I have more to learn about such an option prior to commenting further.

There are other levers that could potentially assist in a successful project, yet many of those “levers” come in the form of credits and other subsidies currently less-than-popular with a large proportion of the administration’s base. Tax incentives, accelerated depreciation, royalty relief and similar incentives are unlikely to be offered. The few areas where the state could assist in a meaningful way with the potential to reduce the cost of supply, such as the tax exempt status of the state’s interest seem cloudy at this point as to whether or not the IRS would rule in favor.

The report also explains that time must be invested to understand and account for the more peripheral benefits to Alaska and for Alaskans. Those benefits have been discussed by the Legislature for years, such as jobs, an in-state gas supply, monetizing the state’s share of gas that today remains stranded and potential increases in oil production once finding gas is no longer a liability when reserves one day have an avenue to the marketplace.

Petroleum News: What are your thoughts on the tax exempt status pursuits?

Micciche: I am clearly not an expert in federal tax issues and certainly encourage AGDC to eventually request a formal ruling from the IRS. I reviewed the Manley and Brautigam Aug. 22 letter to the Legislative Budget and Audit Committee, Jermain Dunnagan & Owens letter, and the Alaska Gasline Port Authority letters from 1999 and 2000.

The letter seems to sum it up effectively: “(T)he IRS is historically dedicated to limiting tax exempt financing. According to the US Congress Joint Committee on Taxation, the tax exempt bond subsidy is generally considered to be inefficient because, in most cases, the cost in terms of forgone tax revenues exceeds the value of the subsidy to state and local governmental issuers.”

Throughout my prior life, work and public service experience, I’ve been more accustomed to similar suggestions as the tax exempt status being more thoroughly vetted prior to being ready for prime time release. I encourage AGDC and the administration to further develop ideas prior to introduction in order to improve the credibility of both organizations.

I would categorize my faith in any substantive federal tax relief that could significantly benefit the economics of the project as being doubtful at best, unless the state is willing to take on the lion’s share of the financial liability of the project. From where I sit today after reviewing the letters, there seems to be a risk/benefit exchange largely weighted to the negative on liability for the state in order for an exemption to be realized. I have much more to learn on the subject, however dueling opinions need further clarification.

Petroleum News: Is it still prudent to move forward, even at a slower pace? The other alternative seems to be to mothball the project entirely, which could make things too expensive to dust off and try again when investment dollars are available.

Micciche: I believe that although the economics of the project have clearly become rather challenging, the potential benefits have never diminished. Therefore, I strongly believe that there is a need to evaluate significantly slowing the spend by revising the FEED schedule, while keeping the project alive. I could spend several minutes reiterating the benefits of an AKLNG project.

In my district, the community has supported and participated in the project since its inception. Field work, land acquisition, community engagement and other related processes have resulted in increased employment and investment. The community remains prepared to support and engage whenever the opportunity arises.

The benefits to Alaskans along the route likely to enjoy in-state natural gas are also undeniable. From air quality issues in Fairbanks to the cost of energy throughout the spine of Alaska, this project will create economic opportunities unparalleled since the construction of TAPS.

Alaska cannot afford to retract from forward progress and energy relief for everyone from seniors and families in Fairbanks to potential industrial anchors located throughout the state. As most know, I have been involved in the LNG industry most of my life. In addition to the people benefitting from significant revenue for generations from the sale of currently stranded gas reserves to support quality state services, I envision an eventual Alaska that enjoys coastal distribution of LNG in ice-free areas, supplemented by traditional hydrocarbon sources and economic renewables.

Alaskans must not lose hope in the future viability of any project. Market conditions are dynamic by nature. What none of us have before us is a commodity price crystal ball. The crude market, which often dictates LNG prices in the few remaining traditional oil-linked regions, has and can change dramatically in a period of time that sometimes seems like overnight.

I sincerely hope that producers will remain involved at some significant level and that the administration will nourish stronger relationships that encourage their participation. I believe that the AKLNG project or a similar concept will eventually occur or the state will continue down a road of limited economic diversification and an overexposure to the effects of a single commodity. However, it must be built only after adequate due diligence proves an acceptable level of risk exposure measured against adequate benefits to the people of our great state. Although most are supportive of a successful, responsible project, building at all costs is not an option and I hope a message that rings clear in the halls of the Legislature, the administration and AGDC.

Petroleum News: We know that the AKLNG project terminus happens to be in your district. What is the mood on the Kenai Peninsula right now considering it seems like the project may be stalled at this point?

Micciche: It’s interesting. You know I sit down with many people and groups in my district to discuss the project. It comes up often. This project would be a major positive economic driver on the Kenai for many years to come when and if it comes to fruition. Whether they are project supporters or not folks are keenly interested. In fact, I stopped by Kaladi Brothers in Soldotna this morning on the way to the landfill (there is no municipal trash service on the Kenai) and was stopped at a table full of gentlemen wanting to know about the status of the project.

To explain the risk to Alaskans of the “built it at all costs” philosophy this morning I talked about what happened during the Gulf of Mexico regasification folly which began in the early to mid-2000s. Sabine Pass LNG in Cameron Parish, Louisiana, is a prime example of why persistent risk reduction and diligence is so incredibly important prior to the state becoming involved in owning or controlling a larger proportion of an AKLNG project.

Sabine Pass is one of several LNG regasification facilities that were built in the Gulf region that represented billions invested between the various facilities. The Sabine Pass facility is the largest receiving and re-gas terminal in the world. The facility was ready for service in 2008, yet it was prepared for a market that no longer existed. Timing was everything in this case. By the time the LNG import terminals were ready for service, the natural gas shale boom resulted in an oversupply in the market and few cargos were ever received by the terminals.

Why is this discussion relevant in a coffee shop? Several reasons. First, I am not poking at most of the great energy industry minds that made the final investment decisions to construct Gulf LNG import terminals. No one could have foreseen the success and effects on supply of shale gas in the U.S. The point is, while corporations may be capable of absorbing such market reversals through the proportional impacts on millions of shareholders, our 740,000 Alaskan shareholders and potential taxpayers simply cannot absorb a similar mistake in the tens of billions of dollars.

Petroleum News: Let’s take a look ahead to next session. Another bill looking to change our state’s tax credit and tax structure is expected. What are your thoughts on that?

Micciche: Look at how that entire conversation was framed last year. It seemed like the administration was focused on SB 128 (Permanent Fund bill) only the votes for 128 seemed to target were on those from the left who were more focused on tax credits, tax credits largely created by the left. On the harder right you had the discussion until you cut enough we are not going to support SB 128. What the public has to understand is we had to drag people across the finish line to support the changes that did occur in HB 247. It gets into how far are people willing to go into SB 21. I think we pushed folks on the right to the limit of what they think we should be doing right now. They believe just as the industry does in stable tax policy. Although tax policy should be somewhat flexible as time and conditions change, any wide scale change to our tax policy is going to be difficult next year.

Petroleum News: Do you believe the state has a stable tax regime across all price points?

Micciche: Well with a net tax system the state is always going to be exposed at the lower end, but with SB 21 and as supplemented by HB 247 is certainly better than ACES for the state. When I think about what’s best for Alaska and what keeps companies investing in Alaska, I do. I think we’ve got the right balance under these current conditions while keeping projects we expect to see coming on line moving forward. If you think about it, the reduction in decline and the first production increase occurring last year in this price environment. It’s really something that didn’t seem to get a lot of attention.

So ultimately my job as a legislator is to find a balance that is in the best interest to the people of the state of Alaska. Remaining rigid on either side has simply not been effective. The changes the far left wanted to make on tax policy would have been equally ineffective as no changes whatsoever. I think where we are is a balance. That balance can change as conditions change. I hope the others won’t have a no changes at any costs philosophy or on the other side what seems to be a continued disdain for a stable tax environment. Rigidity has been counter-productive and legislators need to operate with open minds and take the time to understand tax policy.