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New Enstar contracts face opposition Enstar blames state for rejection of earlier contract; says AG now criticizing lack of things 2005 contract would have provided Kristen Nelson Petroleum News
Utility approval issues may sound like a yawner, but from comments filed to date Enstar Natural Gas Co.’s request for approval of its new gas supply contracts is shaping up as a doozy of a fight.
The State of Alaska — along with Chugach Electric Association — is mounting serious opposition to the natural gas distribution company’s latest attempt to secure natural gas to meet its near-term supply needs in Cook Inlet.
The Regulatory Commission of Alaska is looking at whether natural gas supply contracts Enstar signed with ConocoPhillips Alaska and Marathon Oil Co. earlier this year will provide a reliable source of supply at a reasonable price. Those contracts were part of a settlement between the state and the two Cook Inlet natural gas producers in which the state agreed to support a two-year extension of the export license for the liquefied natural gas plant at Nikiski in exchange for assurance that local needs for natural gas are met and that local suppliers have access to the LNG facility, owned by ConocoPhillips and Marathon.
The majority of Enstar’s gas is supplied by Chevron, under a contract with Union Oil Company of California; Unocal is now part of Chevron. The Unocal contract, approved by the commission in 2001, uses a three-year trailing average Henry Hub price. The commission rejected a 2005 contract with Marathon that used similar pricing.
Enstar’s contracts with ConocoPhillips and Marathon are for requirements not covered by Chevron, although, as Chevron pointed out to the commission in a May 21 letter, there is still the issue of “unmet requirements.” Chevron has provided these unmet requirements, but effective Jan. 1, 2009, it will convert to a fixed quantity supplier, leaving open the issue of how well the new contracts will mesh with the Chevron contract, since Enstar has said that after Jan. 1 variations in its needs would be absorbed proportionately by all contracts.
The commission has received filings and has scheduled a hearing the last week of July and the first week of August.
Running argument The Cook Inlet producers have long argued — and the regulator appeared to agree in 2001 — that Cook Inlet prices are artificially low because the gas is stranded, but that prices tied to Lower 48 gas prices are necessary if local exploration and development projects are to be competitive with investment opportunities in the Lower 48.
In 2006 RCA rejected — based on price — a contract Enstar negotiated with Marathon in 2005 that, like the 2001 Unocal contract, was tied to Lower 48 natural gas prices. The Attorney General’s Regulatory Affairs and Public Advocacy Section opposed that contract and also opposes the new contracts.
Chugach Electric and other Cook Inlet natural gas purchasers also oppose the new contracts.
In a filing in mid-May Enstar told the commission that the Attorney General’s comments are based on a “fundamental misunderstanding of the commercial reality” Enstar faces “after the Attorney General successfully argued for the rejection” of the 2005 contract with Marathon.
“The direct consequence of the Attorney General’s advocacy was to place Enstar in a very difficult position, facing a looming supply shortfall in January 2009,” Enstar said. The Attorney General’s comments on the current contracts assume the commission order rejecting that contract should have “empowered Enstar to obtain from the producers every favorable term mentioned” in the order rejecting that contract, the company said.
That did not occur, Enstar said, “because the producers are not legally obliged to accept contract terms that they view as inconsistent with current market realities.” While many of the concerns raised about the Marathon contract are addressed in the new contracts, Enstar said, “The commercial reality that the Attorney General does not appear to understand is that the gas producers in Cook Inlet are not regulated by the RCA and they cannot be compelled to accept every contract term that Enstar demands or the Attorney General might desire.”
Hosie testifies for Chugach Chugach Electric brought in attorney Spencer Hosie who argued in pre-filed testimony that the issue is not whether Cook Inlet offers the best investment opportunities for companies holding oil and gas leases, but whether the gas can be sold for a price that makes production reasonably economic.
Hosie said the Enstar argument is that if the RCA does not approve the proposed contracts that the producers may not continue to invest in Cook Inlet and that they may shut-in some gas rather than sell to Enstar on other terms.
Those are “hollow threats,” he said, because under their oil and gas leases the producers have “a duty to develop and market their gas.”
“These obligations ensure that further development and exploration of Cook Inlet will continue even at current price levels,” Hosie said.
Because of the relationship created in an oil and gas lease — “a type of ‘cooperative venture,’ where the landowner relies on the producers to develop the field and market the production for the benefit of both,” producers aren’t free to make development decisions based solely on their own interests, Hosie argued. “Instead, all decisions, including decisions to develop and invest capital, must be made with ‘due regard’ for the interests of the royalty owner, the landowner. In simple terms, while the producers need not treat the royalty owner any better than they treat themselves, they may not treat the royalty owner worse.”
The landowner will always want the field developed “fully and promptly,” he said. But the leaseholder may be short of capital or may see an opportunity to invest elsewhere and earn a better return. But while these are legitimate reasons, “under the lease agreement, given the relationship of mutual benefit, the producer is no longer free to make these decisions based on what it alone wants,” Hosie said.
Producers have an obligation to go forward if a project is “reasonably profitable,” he said.
Hosie said the work the companies have put into earning an extension of their export license is proof that Cook Inlet natural gas is profitable.
The producers, through Enstar (neither ConocoPhillips nor Marathon are parties to the action before RCA), are not arguing that existing Cook Inlet prices are uneconomic, Hosie said. “Instead, MOC and COP simply assert, through Enstar, that they will take their development dollars elsewhere absent an increase in Cook Inlet prices.” This is not a demand that the Cook Inlet gas business be made profitable, “but rather that it simply be made more profitable,” Hosie said.
If the producers shut in Cook Inlet production or refused to develop fields, they “would be in breach of their lease obligations,” he said.
“Contrary to the point made in Mr. Dubay’s testimony, Cook Inlet producers are not free to take their development dollars elsewhere without restriction: That is exactly contrary to the fundamental bargain long-since made. Those producers have the obligation to go forward with any Cook Inlet production and development reasonably economic on its own terms,” Hosie said.
Contracts cover shortfall Dubay said in his prefiled testimony that the contracts cover expected shortfalls of 2.1 billion cubic feet in 2009 (of a total requirement of 32.3 bcf), growing to 10.7 bcf in 2013.
Enstar’s first attempt to fill the shortfall, with the APL-5 contract it negotiated with Marathon, was rejected by the commission.
The new contracts provide a total of 37.8 bcf through 2013, completely satisfying Enstar’s annual volume and deliverability needs in 2009 and 2010. The contracts provide volumes for 2011 through 2013, but not full deliverability. That, Dubay said, is expected to be met by new storage or peak-shaving facilities to be owned by Enstar.
The term is shorter than most of Enstar’s contracts partly in response to criticism from the commission and the Department of Natural Resources that Cook Inlet utilities should have shorter gas supply contracts and also to bridge to Enstar’s development of storage facilities and a small-diameter line from the Brooks Range foothills, which if it proves to be an economic project, could be delivering gas within about five years, Dubay said. (This was prior to the July 7 announcement of a line north from Cook Inlet to Fairbanks and possibly on to the Foothills; see story on page 1 of this issue.)
AG’s office: Contract terms not fair, just or reasonable Economist Cristina Klein, in pre-filed testimony for the Attorney General’s Regulatory Affairs and Public Advocacy Section, said she concluded, after a review of the gas sales agreements, that: “The pricing and terms of the COP and MOC GSAs are not fair, just or reasonable.”
Klein said Enstar passes its gas costs through to ratepayers, lessening “substantially” its incentive to negotiate for the lowest cost. Its bargaining power was lessened because it was “in imminent need of gas,” only Marathon and ConocoPhillips responded to Enstar’s request for proposals and “no other supplier would agree to be an unmet requirements provider for any year after 2008,” she said. Klein also said the state’s settlement on the LNG export license agreement noted that negotiations between Enstar, ConocoPhillips and Marathon were “subject to the willingness of the negotiating parties to act in a reasonable manner in light of market conditions.”
There are only a few large sellers of natural gas in Cook Inlet, and in some cases Enstar’s transactions have been with one seller. “I would describe such transactions as monopolistic,” Klein said. “The single seller has substantial market power, particularly if it is selling a product that is necessary, rather than optional.”
As for options, Klein noted that Enstar’s LNG peak shaving plant plan indicates that due to Federal Energy Regulatory Commission and other regulatory requirements, “LNG importing facilities could not be in place and operational by the winter of 2011-2012.”
Enstar’s customers are also captive, she said, citing a 2008 estimate that it would cost a homeowner $15,000 to convert from natural gas to heating oil, which is less efficient and more costly than natural gas.
Klein said if the contracts are approved, some of the costs, such as “what seem to be particularly stringent ‘take-or-pay’ type fees” in the Marathon contract, should be absorbed by Enstar, rather than passed on to customers because “Enstar appears to have accepted a high level of risk that costs will be incurred under these provisions” in the contract.
Contracts are a whole In comments Enstar said the Attorney General’s comments on whether individual terms are just and reasonable is a “fundamental misconception.” The company said it should not be required to prove that every individual contract term is just and reasonable, but rather that the contract as a whole is just and reasonable.
“The proper standard of review is that each contract must be judged as a whole, not picked apart term-by-term, as the Attorney General always tries to do.”
Enstar said it was particularly disappointed by the Attorney General’s criticism of Enstar’s readiness to provide its own storage, given that the Attorney General opposed the 2005 contract and criticized Enstar at that time for not having its own storage facilities.
The 2005 contract, Enstar said, provided for its unmet requirements through 2016. “After the Attorney General succeeded in blocking APL-5 (the 2005 contract), no supplier was willing to step forward to fill the role of Enstar’s Unmet Requirements supplier or to meet Enstar’s peaking needs past the first quarter of 2011.”
This was partly caused, Enstar asserted, by the rejection of the 2005 contract, under which Marathon would have made infrastructure requirements. Marathon did not make those investments after the contract was rejected. “Investment dollars presumably went elsewhere, valuable time was lost, and the burden of developing storage shifted to Enstar,” the company said.
In response to comments by electric utilities (in addition to Chugach, Golden Valley, Homer Electric and Matanuska Electric also commented), Enstar said Chugach appears to be using Enstar’s contract approval “to apply indirect pressure on the Cook Inlet producers in negotiating future gas supply contracts for electric power production. Enstar can ill-afford to have this critically important proceeding hijacked for this improper purpose.”
The other electric utilities, Enstar said, appear to have relied on Chugach to negotiate for them, and Chugach now has “looming gas supply problems.”
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