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Vol. 11, No. 9 Week of February 26, 2006
Providing coverage of Alaska and northern Canada's oil and gas industry

Port authority solves Jones Act tanker issues

But authority needs gas; Y-line concept envisions 1 bcf as LNG to West Coast, majority of gas to Canadian border bound for Lower 48

By Kristen Nelson

Petroleum News

The Alaska Gasline Port Authority appears to have solved its Jones Act tanker issues through a memorandum of understanding with Totem Ocean Trailer Express, but has not solved its biggest problem — securing gas.

Former Attorney General Charlie Cole, a member of the port authority’s board of directors, told legislators at the end of a Feb. 16 presentation that it would be most helpful if the Legislature could help persuade the producers to sell the port authority gas.

The port authority filed an antitrust suit against BP and ExxonMobil in December after it had been unable to get North Slope producers to sell or commit gas to its project. BP, ConocoPhillips and ExxonMobil are negotiating with the state for a fiscal contract under the state’s Stranded Gas Development Act for their own proposed 4.5 billion cubic feet a day pipeline project to the Lower 48.

Getting legislators to urge the producers to provide gas to a port authority project may be difficult if many legislators have the concern expressed by House Majority Leader John Coghill, R-North Pole. Coghill told the port authority he was “not a big fan” of state ownership: “I struggle with a public corporation owning and operating” one of the state’s largest resources. He also said the track record of public ownership hasn’t been good.

The port authority gave a presentation and answered legislator’s questions at an open Republican caucus in Juneau, describing its Y-line project: gas to Valdez for liquefied natural gas which would be sold on the West Coast and a pipeline to the Canadian border to meet up with a line going south to the U.S. Midwest.

The port authority was represented by its board chairman, Jim Whitaker, a former legislator who is mayor of the Fairbanks North Star Borough; Bill Walker, the authority’s general counsel and project manager; Travis Gibbs, an attorney with Nixon Peabody; Bill Deaver, president and chief operating officer of Totem Ocean Trailer Express, Radoslav Shipkoff of Greengate LLC, an energy industry financial advisory group, and Cole.

IRS private letter ruling

Gibbs, formerly with O’Melveny and Myers, the law firm which has been working with the port authority for a number of years, reviewed the Internal Revenue Service private letter ruling he helped the port authority obtain.

The main issue is whether or not the port authority is a political subdivision: Because the port authority has the power of eminent domain, he said, it meets the qualification of a political subdivision and does not pay federal income tax on its income.

Sen. Gene Therriault, R-North Pole, asked if the port authority’s income would be tax exempt even though it was earned outside of the state. Gibbs said the issue is where the revenue ends up, not where it is generated, and noted that a lot of utilities, also tax exempt, earn income outside of their home states.

Rep. Mike Hawker, R-Anchorage, asked Gibbs if the port authority’s project hasn’t changed substantially since it obtained the IRS private letter ruling and also asked about the small proportion of gas from a project that would be used within the state.

Gibbs said the federal government understood that only a small portion of the natural gas in a port authority project would be consumed inside the state. He said the project description was extraneous to the real issue in the ruling, “which is whether or not the port authority is a political subdivision.” If the state owned a portion of a line selling gas outside the state it wouldn’t be taxed; the question with the port authority is no different, he said.

Whitaker said a great deal of scrutiny has been given to both the port authority request and the IRS response. “Bechtel Corporation spent a great deal of time studying it before they invested tens of millions of dollars. Sempra Corporation did the same before they invested tens of millions of dollars.

“We’re very comfortable with the letter ruling,” Whitaker said. “We know what it says: it says you are a governmental entity, you are not subject to taxes.”

TOTE memorandum of understanding

Since the port authority plans to ship LNG from Alaska to West Coast ports, it would have to meet Jones Act requirements for U.S.-built, owned and crewed tankers.

LNG tankers are not currently being built in the United States and Walker said the port authority was investigating the possibility of waivers when Totem Ocean Trailer Express suggested an alternative. TOTE now has a memorandum of understanding with the port authority.

Deaver said that under this MOU TOTE would manage the vessel phase-in program, oversee construction and crew and manage any ships that are built. The authority would own the ships, he said, so TOTE’s “piece of the business would be actually very, very small.”

He said that the lead for the construction of TOTE’s most recently constructed ships was also the lead in the construction of the last LNG tankers built on the East Coast in the late 1970s and early 1980s.

“We believe that LNG tankers can be built in the U.S. to meet the financial needs of this project,” Deaver said.

Jones Act now less restrictive

The Jones Act was very restrictive in the 1950s and 1960s, requiring all work to be done in the United States.

Today, however, “it primarily says that the hull and the superstructure have to the built in the U.S.,” Deaver said.

Most large machinery needed is not even built domestically, and foreign steel plates can now be used “if they’re not available in the United States readily or if the lead time is too long.”

The difference with U.S. yards is that they have “family wage jobs” which increases the cost.

Deaver said TOTE is looking for ways to reduce the cost of U.S. LNG tanker construction. In the last five years cooperative agreements have been reached between U.S. and foreign yards, and TOTE went to the builder of its new Alaska ships and asked if they would see what agreement they could reach with a foreign yard.

The shipbuilder sat down with Daewoo in Korea and cut a deal for a technology transfer allowing it to buy all of the CAD drawings for specific ships, he said. A complete set of drawings will cost $2.5 million, compared to $20 million a ship ($40 million total) that TOTE spent doing engineering itself on its two new ships, Deaver said. The shipbuilder also struck a purchasing agreement with Daewoo, giving them purchasing power with component makers equivalent to a yard building 20 ships a year.

125 LNG carriers on books

There are about 125 large LNG carriers on the order books or being built today, he said, primarily in Japan and Korea.

“The major oil companies are all buying these types of ships. It’s very, very possible that we would have similar ships or identical ships to what some of the big oil companies would have internationally.”

Rep. Ralph Samuels, R-Anchorage, asked Deaver about timelines to build the ships and how much they would cost.

Deaver said eight ships are being discussed, but he said it would be unrealistic to have them all built for LNG startup.

The plan is to bring vessels into the trade and get them re-flagged for a period of time on the condition that the permanent fleet would be built domestically.

Samuels said he was aware of 16 LNG tankers ever built in the United States, three of which have been scrapped and one of which is out of the trade. Those ships are all currently flagged outside of the United States, he said, and it takes an act of Congress and bringing a boat’s environmental standards up to date to re-flag.

Deaver agreed that “it is a fairly complicated task” to have a tanker re-flagged but said TOTE believes it is a doable task, “because it’s not realistic to expect one to go out and build eight ships and have them all available day one.”

Samuels asked what the ships would cost.

Deaver said a similar ship being built in Korea would cost $200 million, and it would “be well north of what it would cost you in Korea” to build in the United States.

Phase-in fleet

Re-flagging would be done to provide tonnage on a temporary basis while the port authority’s fleet is being built.

Coghill asked if Alaska’s delegation was supportive of an act of Congress to temporarily re-flag LNG tankers.

Deaver said the discussion so far has been “within the maritime community about this” and everyone there is supportive because of the jobs in construction and the jobs onboard. He said they think congressional consent could be obtained during a session.

Walker said Exxon is an example where re-flagging has been done: they got permission to re-flag for “a finite period of time” because they couldn’t get their double hulls built in time.

Whitaker said getting gas for the project is the first issue. “If gas is made available, at that point many of the issues relative to shipping will begin to solidify and that’s the order in which things move.”

He said TOTE has done a lot of work and there are ship cost components in the authority’s model. He said the port authority’s model “has as much surety as any project can have at this stage” and agreed that shipping is a requirement for the project to move forward.

Permits in hand

Walker discussed the permits the port authority has optioned from Yukon Pacific Corp.

Bechtel looked at the permits before it agreed to become involved, “to put tens of millions of dollars” into the project “upfront because we couldn’t afford to hire them to do a cost estimate.” Sempra looked at the permits: In fact, Walker said, they sent 15 people to Anchorage to review them. “At the conclusion of that they signed the agreements and put in nearly 10 million dollars into this project.”

Walker said not all of the permits are exactly what is needed now: some will need to be amended, but “we think projects that have significant years of permitting done have a significant advantage over those that do not.”

Samuels noted that one of the authority’s slides said Yukon Pacific spent $150 million; he asked what the port authority paid for the permits. Walker said they paid a down payment of a million dollars and will pay $15 million a year for 10 years out of project revenues once the project is up and running.

Jurisdiction an issue

Samuels asked if the Federal Energy Regulatory Commission would have jurisdiction over the project.

For purposes of the loan guarantee the port authority is FERC-exempt, Walker said, and will go directly to the Department of Energy.

Most likely there will be a negotiated jurisdiction of some sort by FERC; the authority doesn’t want to get into jurisdictional issues with FERC, he said.

An export license is one of the things the authority acquired from Yukon Pacific, but Walker said the plan is to ship LNG to the Lower 48, and while it could land at Kitimat in British Columbia the gas won’t be used in Canada, so the export license wouldn’t be needed.

Therriault asked if federal agencies had any concerns about the location of the liquefaction facility in relation to the Alyeska Valdez Marine Terminal in light of 9-11, and Walker said the port authority had not been asked about that. The permit has been issued, he said, and there is “appropriate separation from the terminal.” Whitaker noted that the authority has given site visits to federal agencies and they understand the proximity.

Either branch now viable

Shipkoff, a director at Greengate advisors in Washington, D.C., an independent financial firm, said when the Y-line concept was introduced in 2000, the natural gas price environment “was very different from what it is today and it appeared that the project was economic only when you achieved sufficient economies of scale by making the project large enough to carry a large enough volume to amortize the various cost components.” Today, however, “the project does not require the Y-line concept to be economic; either one of the two legs can stand on their own.”

Shipkoff said for the Y-line the port authority would start with 4.5 billion cubic feet a day at Prudhoe Bay. The pipeline would have a tie-in at Glennallen for a spur line to take gas to Southcentral Alaska. The facilities at Valdez would integrate liquefaction and LPG (propane and butane) extraction facilities. “There’s a cost-savings element associated with that because unlike ... the pipeline-only component where you need LPG extraction facilities standing on their own, in this case they will be integrated within the liquefaction operation at practically no incremental cost.”

The plan is to send about 1 bcf of natural gas to the West Coast as LNG, using one liquefaction train. If a larger market is available, especially if a pipeline through Canada is delayed, additional trains could be added, allowing the project to phase in capital at the liquefaction facility, Shipkoff said.

Walker said the port authority has received proposals from four receiving terminals that are trying to get permitted on the West Coast. Sempra, which has begun construction at Costal Azul in Baja California, Mexico, also continues to express interest in Alaska LNG, he said.

Y-line issues

The pipeline to the Lower 48 is estimated at 3 bcf a day, although that in part depends on the preferences of a partner who would meet the port authority at the Alaska-Canada border, Shipkoff said.

Samuels asked if the port authority was talking to TransCanada.

Whitaker said the port authority has “very few confidentiality considerations” but who a Canadian partner would be is one of them.

Shipkoff said the importance of the Y-line is that Alaska doesn’t have all of its eggs in one basket — it would have market options. The West Coast market might be lost to LNG if the project doesn’t happen quickly enough, he said, but the pipeline would take gas into the Midwest market.

The ability to share the line to Delta Junction results in economies of scale, and lowers per-unit costs, Shipkoff said, and also allows for future expansions, up to 6 bcf or higher down the road. Because of the shared component of the pipeline larger volumes can be carried, increasing the netback, he said.

The port authority has based its economics on the state’s current fiscal regime, and is not asking for any changes, he said.

Rep. Eric Croft, D-Anchorage, said the Legislature is struggling with the constitutionality of the producers’ request for fiscal certainty. Walker said the port authority is not asking for any fiscal certainty into the future.

Samuels asked how the port authority would sell the gas and Walker said they envisioned using Sempra, which has talked about putting $4.5 billion into the project, he said, and has told the port authority that if it can get the gas, they would be back.

Economic basis

Shipkoff said the port authority’s economics are based on a Lower 48 price of $5 per thousand cubic feet for natural gas because that seems to be the price at which projects are able to attract financing today.

The port authority is looking at netbacks in the range of $2.50 to $2.75 per thousand cubic feet, he said.

Samuels asked how much of the port authority’s total economics are driven by liquids in the gas, and what happens if the gas is drier than expected.

Shipkoff said the project works with no uplift from liquids at all, although the ability to extract propane and butane in Valdez does provide additional benefits. No uplift from ethane extraction is included in the economics, he said.

Samuels said with 4.5 bcf going overland the cost would be spread over more gas and the tariff would drop; if all the gas goes to LNG the cost of the line and facilities are spread over more gas and the tariff goes down. With the Y-line, he said, it seems the port authority loses both ways because it can’t spread it costs.

Shipkoff disagreed. He said the cost is spread over a larger volume. If LNG goes first, he said, the netback would be lower on a short-term basis by about 80 cents, until the line to Canada can share the costs.

The distribution to Alaska communities, a minimum of $50,000 and rising based on population, is estimated at $150 million per year, Shipkoff said. The object is to have a number which keeps the project economic and competitive, he said.

Samuels asked if FERC is going to allow the port authority to put the community distributions into the tariff, if the producers ship on a port authority project, rather than selling gas to the authority. Walker said the port authority has discussed the community distribution with FERC. Shipkoff said the authority would size the distribution in such a way that it matched a return which would be allowed to a company building a project and the taxes which a private company would pay.

Comparison to other LNG projects

Shipkoff said they are frequently asked about cost issues for an LNG project with an 800-mile pipeline.

What’s important, he said, is that the pipeline is just one of the multiple components of bringing gas to market, which include the pipeline, liquefaction, shipping and regasifying.

The combined cost of all components for the port authority project will be competitive with international projects targeting U.S. markets, he said. The big variability is the cost of shipping gas over water. Shipkoff said the port authority projects that its cost to ship will be the lowest, more than offsetting the cost of transporting the gas by pipeline.

Compared to a range of cost structures to land LNG in the United States he said the port authority believes it will be in the range.

The project also benefits from lower costs on liquefaction because the efficiency of liquefaction is dependent on ambient conditions and Valdez is expected to have a 25-30 percent efficiency gain, more than offsetting higher labor costs at a Valdez LNG plant.

The upstream cost will also be lower for this project than for many other projects, especially those developing offshore gas.

Risks to Alaska of losing market

Walker said the port authority is focusing on Alaska risks, particularly the risk that Alaska could lose the U.S. market. Once gas is in balance, he said, it will be harder for a project of this size to get into those markets.

Another risk is that the loan guarantee expires Oct. 7, 2007, and the port authority doesn’t believe Alaska will be able to go back and get it extended if the deadline passes.

The increased cost of construction over time is also a risk. Walker said Bechtel had updated the port authority’s cost numbers in May and the cost of steel had virtually doubled.

Sen. Fred Dyson, R-Eagle River, asked about the port authority’s statement that Alaska is in a race to secure a place in the Lower 48 market. Shipkoff said there are a number of projects targeting the Gulf Coast, with more than 6 bcf headed toward the United States in the near term.

Dyson also asked about the cost issue, and Shipkoff said the port authority project would be competitive with other LNG.

Walker said the price in the Midwest is going to be the same: the race is getting there with all the competing projects. While some projects will make more money than others, the port authority project is competitive, he said: The risk is that once all those other projects are landed Alaska won’t be able to get its gas into the market.

Rep. Kurt Olson, R-Kenai, asked how much the port authority has spent and Walker said about $150 million. Olson asked how much of that the port authority has actually spent and Walker said about $10 million.

Olson also asked if the port authority would support language allowing an exit from the authority, referring to the North Slope Borough, which said in 2004 that it wanted out of the port authority because it needed to focus on protecting the borough’s taxing authority. The North Slope Borough, the City of Valdez and the Fairbanks North Star Borough formed the port authority in 1999.

Whitaker said there are ongoing discussions with the North Slope Borough and Walker said the concern is to make sure that whatever happens doesn’t damage the project. He said it would be a loss for the state if changes in port authority legislation caused financing problems for the project.

Cole: no risks to state

Cole raised the issue of risk to the state from the producers’ project.

He told legislators the port authority poses no economic risk to the state because the port authority is not asking the state to make any economic contribution to the project or to change its taxes. He said the producers’ project does present economic risks to the state, and wondered if acceptance of those risks is in the best interest of the state.

Cole also said the state will face conflicts if it purchases a substantial interest in the gas line, conflicts such as rates to be charged for intra-state transport of gas, conflict over regulation of safety of the line and labor and other relationships.

Cole said the port authority project presents few conflicts compared to a project in which the state has a substantial financial interest.

He told legislators that if they consider a contract by the administration they should pay attention to how conflicts will be resolved.

The port authority project obviously “has some hurdles,” Cole said, but so do all the projects: You can’t look at anyone’s project and say we have a clear shot down the runway.

He also said the port authority project can bring gas to market sooner than other projects.

The gas purchase issue

House Speaker John Harris, R-Valdez, noted the port authority has filed suit against the producers to try to get gas. The biggest issue out there is gas acquisition, he said, and asked how the authority was going to get the gas to make the project a reality.

Walker said the authority’s “first choice” was to negotiate and when that wasn’t successful they filed antitrust litigation. He said the port authority has reason to believe that litigation will be successful.

Harris asked how long the lawsuit was expected to take and Walker said he wouldn’t guess: some litigation is resolved quickly, he said, and some goes on for a long time.

Harris asked if the port authority offered to buy the gas; Walker said they did. He said they offered a few years back and then more recently offered a netback price (market price less transportation costs). The port authority has also asked the producers what they want — what price and what terms, he said.

Walker said the producers wouldn’t give the authority a price and terms; “we’ve never gotten a number from them.”

Harris, who chaired the event, said TransCanada would be making a presentation in a couple of weeks.

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Steve Porter: Risk lies with shippers

Kristen Nelson

Following the Alaska Gasline Port Authority presentation to an open Republican caucus Feb. 16, the administration got a chance to respond.

Steve Porter, deputy commissioner of Revenue, told legislators that since the port authority is a public entity they don’t have a lot of confidentiality issues: “They were very open,” he said of the port authority presentation.

He said there are two strategies for getting the producers to move North Slope gas: litigation and negotiation.

The state, he said, “has chosen to attempt the negotiation strategy first.” Porter said the administration believes negotiation is “the most efficient and the quickest way to get gas to the Lower 48. We do not believe a litigation strategy will get us there very quickly.”

The state has tried in the past to extract value or money out of the producers through litigation. “I think that Exxon Valdez issues and the continuation of that litigation has probably proved a few things to us,” he said.

Risk and a netback proposal

Porter said one of the important things to understand about the port authority proposal “is that it’s truly a netback proposal.”

That’s a concern to the state and the producers because “in a netback world the risk doesn’t lie with the people that are building the pipeline.”

Universities have done studies on public mega-projects, and one of the things those studies found is that project supporters “aren’t accountable for the risks associated with cost overruns,” so public projects have “substantial cost overruns because there isn’t an accountability process in place.”

“And in a private world, that accountability, the risks and the accountability, generally mesh,” Porter said.

The producers have the greatest incentive to make sure that the pipeline “comes in at cost or under cost because they’re going to pay the tariff.”

If the Fairbanks North Star Borough, the City of Valdez, the North Slope Borough “double the cost of the pipe ... they don’t pay anything incrementally. They don’t pay any incremental increases. It comes out of the tariff.”

If the state is shipping gas, the state too is paying that tariff, he said.

That increased cost is “a loss for everybody,” Porter said, coming out of the pockets of both the producers and the state and going into the tariff.

He told the legislators “it’s very important to understand that equation: that you always make sure that the risk of cost overrun, or the risks, are closely tied to the people who will benefit.”

Producer problems

Rep. Ralph Samuels, R-Anchorage, said he and Rep. Eric Croft, D-Anchorage, both have concerns about a producer-built line. Samuels said Croft is concerned that one of the companies doesn’t want to build the pipeline now and will warehouse the gas until the market suits them.

He said his concern “is that a producer-owned pipeline locks up the basin.” He cited the state’s experience with the trans-Alaska oil pipeline over tariffs, and the experience of “the small oil producers ... and the heartburn they’ve had and the lawsuits.”

With a third-party pipeline “they want as many customers as they can get getting their gas in the pipeline.”

Both the administration and the Legislature were “very vocal” about the Federal Energy Regulatory Commission providing access.

Samuels said access was the important issue to him, “no matter who builds it, no matter where it goes.”

“Because for the next 50 years, you want anybody who wants to get a molecule of gas in that pipeline, you want them to have access to it.”

He said he understands what the producers bring to the project, “they come by the office and beat on us same as everybody else does.”

“But I just wanted to make sure that you understand,” Samuels told Porter, adding that he’s told the governor and the chief of staff the same thing: “The problem that we have with the producers is our experience with the producers.”

Build and sell

Porter responded that in an ideal world, “if you could have your cake and eat it too ... you would have the producers build the pipeline and not own it.” Then a third party or the state could make decisions about expansions.

He acknowledged that the state must make sure it protects explorers other than the producers so they have “the opportunity to have access to that pipeline. You’re absolutely correct; that’s one of our obligations.”

Sen. Gene Therriault, R-North Pole, said the producers have built other pipelines and sold them and not operated them. If that’s a possibility, what level of incentives should the state offer if the producers might not operate the pipeline?

Porter said the incentives are “not really related to the pipeline.”

“Ultimately the producers can own it, the state can own it. It gets a regulated rate of return and a third party can own it.”

Ownership of the pipe isn’t the issue, Porter said.

The two issues that are the most important are the firm transportation commitment, “that’s where the risk is. ... You’re committing to pay that tariff for a number of years” and that’s what allows the port authority or anybody else to build the pipe.

Upstream fiscal certainty is the other big issue, “whether or not the state has the opportunity, the ability, the right, to increase the taxes on that upstream.” That’s the issue the state is dealing with now, he said.

Ownership of the pipeline isn’t where the risk is: “The risk is in building the pipe” and getting it completed, and in upstream fiscal certainty.

With firm transportation commitments, “you’d have a number of companies that would step up to the plate and be glad to build a pipeline.” The shipping risk, Porter said, “if the state takes that on ... that’s a bigger risk to the state than owning the pipeline, because that’s a long-term obligation of paying that tariff over time.”