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Legislators hear equity ownership issues Consultants say 20-30% LNG ownership, tax changes, would benefit state, producers; LNG price, project cost remain biggest issues Kristen Nelson Petroleum News
While the price of liquefied natural gas and the cost of an LNG project remain the biggest factors influencing economics for a potential project to take North Slope natural gas to market as LNG, state equity participation — combined with natural gas tax changes — look positive for both the state and the North Slope producers.
That was the message House Resources heard Dec. 9 when it continued its review of the Black & Veatch North Slope royalty study, after the committee’s initial meeting Nov. 22 was cut short by inclement weather.
As things stand now, Black & Veatch’s Deepa Poduval said, the government share for an Alaska LNG project, state and federal, is 70 to 80 percent under the tax system established by Senate Bill 21, the More Alaska Production Act.
That government take, she said, “is significant” in the context of LNG projects worldwide.
Black & Veatch looked at the impact of reducing or eliminating royalty, production tax and property tax, but found when the state provided incentives to the project through such a value transfer, the impact of a reduction in state take was dampened because of federal income tax, Poduval said.
What was wanted, she said, was ways for the state to provide value to the project while minimizing leakage to the federal government.
Royalty in kind It would be a benefit to the producers if the state took its royalty in kind, rather than in value, because it would potentially relieve the producers’ obligation to treat, transport, liquefy, ship and market the state’s share of the gas, Poduval said.
The state can take its royalty either in kind or in value. When it takes it in value the producers sell the royalty and pay the state.
If the state took its natural gas in kind it would reduce valuation disputes, reduce commercial uncertainty for the project and provide the state with better market insight.
On the downside, taking gas in kind would expose the state to additional risks, require modifications to current legislation and authority and require the state to develop marketing expertise, Poduval said.
If the state takes its gas in value, there is the advantage that the state is familiar with that method, it wouldn’t have to make firm capacity commitments and auditing and management capabilities are in place. Taking gas in value, however, means there is a lack of transparency, there is no third-party access, there are valuation disputes, gaming over cost deductions is possible and in-value is not the preferred choice of producers.
In addition to the challenge of building its own marketing organization if it took its gas in kind, the state would be competing with the producers’ well-established marketing and global portfolios. The state would also have to make firm capacity commitments along the LNG supply chain, at a cost that could total $1 billion a year, and would face production volume risk if production exceeds or falls short of the state’s sales commitments.
An equity position If the state modified its fiscal terms as an incentive for the project in exchange for an equity position in the project that would be more beneficial to the state than simply reducing its fiscal take, Poduval said. It would create greater alignment between the state and the producers and would lower the upfront capital cost to the producers.
State equity could also allow for equity participation and operation of the pipeline by TransCanada and equity in all phases could result in greater transparency.
It would also allow the state to influence access for third parties in the areas of the project which could most easily become bottlenecks — the pipeline and the marine terminal, Poduval said.
But, equity would not necessarily provide the state a vote in project decision making and the structure of a joint venture agreement would be critical.
Poduval said the state could benefit from granting TransCanada an equity position because the company is an experienced pipeline builder and that expertise would be beneficial to the state. Also, as a non-producer, TransCanada would have every incentive to expand the pipeline and attract more shippers and could help achieve open access, she said.
Equity alternatives Black & Veatch looked at alternatives for a state equity position.
The state could invest across the entire midstream project and receive an equivalent share of gas produced as royalty and as tax gas. Poduval said the study looked at 15 percent and 35 percent equity investment levels as representing the lower and upper bounds of the state’s participation.
The study also looked at the state taking 100 percent ownership of the pipeline with the producers paying a tariff to the state to ship gas on the line. Poduval said the producers would benefit because the state has a lower cost of debt at 5 percent and an equity requirement of 6 percent, equivalent to return on the Constitutional Budget Reserve. The state would benefit from lower tariffs. Upper and lower bounds on the state’s contribution were set with two scenarios, one in which the state financed the pipeline with 100 percent debt and the other with 100 percent equity.
Proportionate to royalty A third alternative had the state taking a 12.5 percent equity stake to correspond to its royalty share. The state’s share of the capacity would be utilized to treat, transport and liquefy royalty gas.
As with the pipeline, the state benefits from a lower cost of debt at 5 percent and a low return on equity requirement of 6 percent. As with the pipeline ownership alternative, the study looked at an alternative with the state’s contribution financed with 100 percent debt and one financed with 100 percent equity.
Poduval said state equity participation at appropriate levels could allow both the state and the producers to retain a higher share of project revenues.
Scenarios modeled in the study found that state equity participation between 20 and 30 percent produced returns at or above the status quo level for the state.
Risk exposures But the state is exposed to a number of risks as an equity investor.
Among those are cost overruns and cash calls for the project. As an equity investor the state would be responsible for its share of any increased costs, a significant risk for the state given the high cost structure of the Alaska LNG project and likely inflationary pressures, Poduval said.
If it were an equity owner the state would also assume all force majeure risk — including the gas treatment plant, the pipeline and the liquefaction facility.
And since the state has no control over upstream operations it would have no control over volumes produced so its capacity could be in excess or insufficient to handle volumes produced. The state would also need to balance production volumes and volumes through the supply chain on a short-term and long-term basis.
The terms negotiated for state participation would need to ensure transparency, Poduval said, and expansion rights would also need to be negotiated within a joint venture agreement.
Risk allocation Poduval said the Alaska LNG project faces various risks that could affect project economics, particularly LNG prices and the capital cost of the project.
While state equity participation can offer benefits to all parties, there are accompanying risks to the state which would have to be managed.
The state has goals of transparency and access for the project, and she said achievement of those would be determined by the commercial terms the state negotiates.
The issue with equity participation, Poduval said, is whether the state can provide value to the producers without losing value itself.
As for a portion of the project where ownership might most benefit the state, Poduval said that was probably the pipeline because it could create the most significant bottleneck to access for companies not involved initially. Liquefaction and the gas treatment plant can be expanded in trains, she said, but for the pipeline — beyond adding some compression, looping the line or additional pipe would be prohibitively expensive.
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