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Providing coverage of Alaska and northern Canada's oil and gas industry
May 2009

Vol. 14, No. 19 Week of May 10, 2009

Differing views on clarity for RCA

Utilities, producers and the state weigh in on RCA proposal to develop a standard contract for Cook Inlet utility gas supplies

Alan Bailey

Petroleum News

The big question is price when it comes to utility natural gas from Alaska’s Cook Inlet: High prices hit the pocketbooks of Southcentral Alaska consumers, while low prices deter gas producers from finding and developing new gas reserves.

And sitting in the middle of the tug-of-war between these opposing gas supply perspectives, while faced with mounting concern over the ability of current gas production from the Cook Inlet to flow utility gas fast enough to meet consumer demand during the depths of the winter, the Regulatory Commission of Alaska has reached something of a gas price impasse, having rejected the pricing in all utility gas supply contracts presented for approval since 2005.

Although RCA does not regulate Cook Inlet gas production, commission approval of the supply contracts is required because gas pricing and other contract provisions become embedded in utility tariffs that RCA regulates; if the commission does not approve a contract, the relevant utility has to try to negotiate a more acceptable contract with the gas producers.

In the interests of some clarity that might resolve the pricing stalemate, the commission has proposed developing a standard utility gas supply contract that would set the expectations for RCA approval of new contracts. Essentially, RCA contract approval would be automatic if a contract were to conform to the RCA standard. And even if a utility and a Cook Inlet gas producer could not agree on terms that entirely meet the RCA stipulations, the standard contract would provide a basis for arguing the case for the noncompliant terms, some commissioners have suggested.

RCA has asked for views on both the desirability and scope of the standard contract approach. And views have come aplenty.

Enstar

Enstar Natural Gas Co, the main Southcentral Alaska gas utility, whose repeated attempts to gain RCA approval of various gas supply contracts have formed the focus of the gas price impasse, expressed sympathy with the commission’s desire to improve the contract approval process but questioned whether the commission has the authority to regulate the prices that utilities pay for gas.

“Enstar believes that the commission lacks the authority to adopt gas pricing regulations for local utilities, directly or indirectly, in the absence of a clear mandate from the Legislature to regulate the wellhead price of Cook Inlet gas and other terms under which gas is supplied to local utilities,” said Matthew Findley, attorney for Enstar, in a letter to RCA Chairman Robert Pickett.

Besides, even if the commission has the authority to impose such regulations, it is highly questionable whether the envisaged regulations would have the desired effect, given that RCA cannot impose pricing terms on Cook Inlet gas producers, Findley said. He cited a recent attempt by the commission to set a price cap for Cook Inlet utility gas, an attempt which resulted in the gas producers declining to offer any new gas supplies to Enstar at prices below the cap.

“The lack of acceptance of that pricing methodology in the market suggests that efforts spent on a regulations docket would be unlikely to yield the intended results,” Findley said.

And the consequent uncertainty over acceptable gas prices would perpetuate reduced levels of investment in developing new Cook Inlet gas reserves, an investment decline which, Findley said, is already happening as a consequence of the recent commission orders rejecting Enstar’s new gas supply contracts in the past few years.

And, given the “rapidly changing market conditions in Cook Inlet and the differing needs of each public utility that purchases gas in Cook Inlet,” the development of a standard gas supply contract would not serve any useful purpose, Findley said.

Marathon opposes price setting

Marathon Oil Co, a major Cook Inlet gas producer, also questioned the advisability of opening an RCA docket to examine contract pricing and other contract terms, saying that reviewing the commission’s approval process and finding ways to support the Cook Inlet gas market would prove more productive.

“Marathon encourages the commission to open a docket to assess the process by which it approves natural gas supply contracts, in order to streamline such process and to provide more consistent guidance for market participants, rather than opening a docket to assess areas that are arguable outside of its jurisdiction and unlikely to result in useful precedent,” said David Risser, Marathon’s manager, North American natural gas marketing. “… History has also taught us that regulation of natural gas pricing has had a disastrous effect on natural gas exploration and development — producers cannot make efficient economic decisions under threat of price controls or utility-type regulation.”

Moreover, it is impossible in the current volatile gas market to establish pricing that would necessarily be applicable in the future, a problem compounded by the differing service level requirements and differing demand levels of different utilities, Risser said.

Conoco favors market dynamics

Cook Inlet gas producer ConocoPhillips expressed similar views to Marathon.

“ConocoPhillips urges the commission to refrain from opening a regulations docket addressing natural gas pricing issues in a prescriptive manner that would inhibit investment,” said Dan Clark, ConocoPhillips manager of Cook Inlet assets. “… The end goal of any regulatory endeavor should be one that enhances the development of indigenous resources, provides security of supply to Cook Inlet end-users and reliability of deliverability. ConocoPhillips believes that free market dynamics should be the first and primary control for the price of natural gas and regulation is generally inappropriate when alternative free market choices exist. … Well meaning attempts at regulation often lack the flexibility to accommodate the shifting risks and rewards characteristic of complex multiparty agreements.”

Armstrong needs viable prices

Armstrong Cook Inlet LLC, a newcomer to the Cook Inlet gas industry, recently drilled a delineation well in the North Fork gas accumulation in the southern Kenai Peninsula and is now looking for a market for the North Fork gas. The biggest problem for would-be independent gas producers in the Cook Inlet basin is market access with viable gas prices, especially given high swings in gas demand, high operational costs, low volumes of drilling and the lack of gas storage facilities in the Cook Inlet region, Ed Kerr, vice president of land and business development for Armstrong, told RCA.

“The best moving forward business plan is for utilities to become proactive in entering into gas contracts on terms that are acceptable to producers, in order to spur the development of gas reserves within the region,” Kerr said. “The RCA should approve gas contracts that have passed the scrutiny of the utilities, as the consequences of not doing so will soon have a devastating negative effect on the citizenry of Alaska, both in their ability to heat their homes with gas and in the cost of such a limited supply of gas.”

Power utilities

Chugach Electric Association, a major Anchorage power utility, has been engaged in multiyear negotiations with gas producers for new fuel supplies for its natural-gas-fired facilities that generate 90 percent of its power. Chugach has become frustrated in its failure so far to land on gas pricing that would not result in what the utility views as unacceptable electricity price hikes for its customers.

“Chugach appreciates the commission’s effort to improve contract approval certainty for public utilities and gas suppliers in Cook Inlet,” Suzanne Gibson, CEA director for energy resources, told RCA. “We are in favor of the commission opening a regulations docket to address pricing issues and hope for wide participation by parties willing to articulate their views.”

In addition to proposing regulation changes, the RCA docket might provide a basis for recommending changes to Alaska statutes, Gibson said. Any proposals coming from the docket need to be based on an analysis of the relationship between gas prices and factors such as contract duration, gas production availability, market availability and gas deliverability, she said.

A standard gas sales contract published by the North American Energy Standards Board could form the basis of an RCA standard contract, Gibson suggested.

Homer Electric Association, a Kenai Peninsula utility that expects to need its own natural-gas-fueled power generation after 2014, also expressed support for the standard contract concept.

“HEA supports the commission’s vision of developing standard contract language or standard contract forms for use with natural gas supply contracts,” said C.R. Baldwin, attorney for HEA. “The proposed docket would appear to be an effective vehicle for developing such contracts, so long as the participants in the docket are fully representative of the suppliers and purchasers of Cook Inlet natural gas, and the contract language reflected a consensus of their views.”

State of Alaska

The State of Alaska submitted comments both from the perspective of the attorney general, as an advocate for the state’s residents, and from the perspective of the Department of Natural Resources, a landowner with an interest in maximizing the value of the state’s natural resources.

The attorney general’s office, while not opposing the concept of developing a standard gas supply contract, questioned whether the development of such a contract would necessarily resolve the core problems that surround the regulation of utility gas supplies in Southcentral Alaska, especially given the recent experience of RCA trying to impose a gas price cap and the complexity of essential contract features such as the payment of production taxes.

“A rulemaking proceeding may result in streamlined GSA (gas supply agreement) reviews. However, rulemaking proceedings will not displace the commission’s responsibility for adjudication of filed GSA proposals, nor does a rulemaking endeavor realistically promise resolution of the core difficulties experienced with Cook Inlet gas pricing issues,” said Chief Assistant Attorney General Patrick O’Tierney.

Marty Rutherford, deputy commissioner of DNR, voiced DNR’s concern about the decline in Cook Inlet gas deliverability. In the absence of a functioning market “in which the dynamics of supply and demand form the foundation of a liquid market,” gas pricing needs to take into account the cost to explore and produce new resources, Rutherford said.

Rutherford expressed her department’s willingness to participate in the development of a standard gas supply contract and set out a list of DNR gas contract expectations, including pricing indexed to current market prices in gas production basins; pricing that recognizes different service levels; and the avoidance of long-term, full requirements contracts.






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