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House Resources reviews RIK contract State wants to sell royalty oil to Tesoro Refinery on the Kenai Peninsula; committee passes bill to Finance without amendment ALAN BAILEY Petroleum News
On March 28 the Alaska House Resources Committee reviewed House Bill 373, a bill approving the sale of state royalty oil to Tesoro Refining and Marketing Co. The committee passed the bill to House Finance without amendment. Tesoro wants to use the oil as part of its feedstock for its oil refinery at Nikiski on the Kenai Peninsula.
The state can obtain its royalties from North Slope oil production either in value or in kind. Obtained in value, the state takes as payment the royalty percentage of the wellhead value of oil that is sold by the oil producers. Taken in kind, the state obtains the royalty percentage of the oil produced and then makes money by itself selling the royalty oil. The state generally sells its royalty in kind oil to in-state oil refiners.
Royalty in kind preferred The state has a preference to obtain royalty in kind but also obtains some royalties in value as a means of calibrating the oil pricing and for other purposes. However, with a Flint Hills operated refinery near Fairbanks having closed down in June 2014, and with a previous royalty in kind sales contract with Tesoro having terminated on Jan. 31 of this year, the state is currently in the unusual situation of obtaining all of its North Slope oil royalties as royalty in value, Jim Shine, special projects assistant in the Alaska Department of Natural Resources commissioner’s office, told House Resources.
It is particularly advantageous for the state to obtain its royalties in kind because of the pricing formula used for in-kind oil when sold in state, Shine explained. Essentially, that pricing is based on the price of North Slope oil sold on the U.S. West Coast, but with a per-barrel amount subtracted from that price to account for the fact that the oil used in Alaska does not have to be transported to the West Coast to market. And, while producers typically allow around $3.50 per barrel as that marine transportation cost when calculating the wellhead value of the oil, the royalty in kind pricing only subtracts a $1.95 “location differential,” thus rendering the in-kind oil more valuable to the state, Shine said.
Two responses When in early 2015 the state issued a solicitation for interest in royalty oil purchases, only two in-state refiners, Tesoro and PetroStar, responded - Tesoro has its Nikiski refinery, while PetroStar operates refineries in North Pole and Valdez. Then, with Tesoro, but not PetroStar, meeting the state’s pricing requirements, the state proceeded with a non-competitive contract negotiation with Tesoro, Shine said. The result was a five-year contract for the purchase by Tesoro of 20,000 to 25,000 barrels per day of royalty oil, probably starting on Aug. 1, 2016.
The contract has passed muster with a state best interest finding but, because it has a duration of more than a year, it requires approval through state legislation - hence House Bill 373 and Senate Bill 205, the two bills that would approve the contract. The contract as presented has been modified to take account of some public comments made during the best interest finding process and on March 15 was unanimously approved by the state’s Royalty Board, Shine said.
The Department of Natural Resources has estimated that the Tesoro contract will, over the life of the contract, result in additional state revenues of $45 million to $56 million relative to revenues that would have been obtained from royalties in value for the volumes of oil involved in the contract. And the in-state refining of the oil coupled with the in-state use of many of the refinery products will help the Alaska economy, Shine said.
More oil available Shine said that, including oil earmarked for the Tesoro contract, currently the state has 50,000 to 52,000 barrels per day of royalty oil available for sale in kind but that, given current North Slope oil production decline trends, those volumes will likely drop to 36,000 to 38,000 barrels per day over the course of the contract.
Because, therefore, the Tesoro contract does not account for all of the state’s potential royalty in kind sales, the state is negotiating with PetroStar on additional in-kind royalty oil sales contracts. As an immediate measure, the state is negotiating a short-term, one year PetroStar contract that will not require legislative approval. Concurrently, the state is negotiating a longer term four-year contract that will require the full approval process and will commence at the end of the one-year contract, Shine said. The consequence will be contracts with PetroStar that terminate in 2021, at around the same time as the Tesoro contract. At that time the state will have a clearer idea of available royalty oil volumes beyond 2021, Shine said.
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