Croft Gasline Update #6

Note:  I and my staff will be sending these gasline updates on various aspects of the contract over the next few weeks, to give Alaskans more information about this important topic.  Please feel free to forward this to other people who you think would be interested.  –Eric

Is Alaska's Gas Really "Stranded?"

The Stranded Gas Act

A lot of the debate over the Governor's draft gas contract deals with the special tax terms.

Most of the attention has focused on the locking in of tax rates for up to 45 years and the commitment to take all our tax and royalties in gas rather than cash.  However, there are many other giveaways related to tax credits, state sovereignty, our ability to terminate nonperforming leases, and taking away the right of the people to pass laws through the initiative process.

Historically, a governor wouldn't be able to negotiate any of these terms.  The tax law is the tax law, and would apply to everyone.  However, in 1998 the Legislature granted authority to negotiate, under certain circumstances, special terms for a North Slope natural gas pipeline.  This law has become known as the Stranded Gas Act.

When the law was written, there was an active proposal to build a pipeline to Southcentral Alaska, and export liquefied natural gas (LNG) to Asia.  All the oil companies testified at the hearings for the bill, and said we could be shipping gas by 2007.  The discussions centered on the need to make an Alaska gas project "economical."

At the time the industry's position was that gas simply wasn't economical to get to market without tax concessions.  Natural gas prices had been pretty flat between the mid ‘80s and late '90s, about $2.50 per 1,000 cubic feet (Mcf) at Lower 48 wholesale markets.  But a pipeline is very expensive to build and operate, and the tariff could be over $1.50.  That didn't leave a lot of value at the "wellhead," for state royalties and severance taxes and company profits.

The LNG export project never happened, but the authorizing language stayed on the books as the Stranded Gas Act.

"Stranded" Doesn't Mean What You Think

The dictionary defines "stranded" as "cut off, left behind, brought into or left in a difficult or helpless position."  That more or less describes our North Slope gas, a tremendous resource that is currently not sellable because it has no physical access to market.  Even the Governor's consultant, Pedro Van Meurs, has used the word in this way to describe undeveloped gas resources in Russia and Qatar.

But in Alaska law, "stranded" means something else.  The Stranded Gas Act has a definition in AS 43.82.900(13): "stranded gas" means gas that is not being marketed due to prevailing costs or price conditions as determined by an economic analysis by the commissioner for a particular project.

"Stranded," in other words, has nothing to do with whether there is an actual pipeline.  It is an economic term, and to qualify as stranded the value of the gas must be insufficient to support a free-market pipeline.  The "fiscal impact finding" (FIF), a 607-page supplement to the Governor's 454-page gasline contract, is that "economic analysis."  Without proof that the gas is economically stranded, the administration would not have the authority to negotiate special tax terms.

Natural Gas Since 1998

Gas prices have been on an upward trend since at least 1999.  There has been a steady rise with several peaks of over $15 / Mcf, and prices have settled back to about $6.50 this past month.  Historically, gas prices tracked very closely with oil, with 6 Mcf being worth one barrel of oil.  At current prices, the ratio is closer to 10:1.  Considering this, it is very unlikely that gas prices will go much lower as long as oil remains at or above $40.  Many analysts believe it will never go that low again.

The fiscal impact finding, however, looks at a range of prices from $2.50 to $8.50 and wants to make the project profitable throughout the range.  They want to subsidize a project based on fear of $2.50 gas (the equivalent of $15 to $20 / barrel oil) when there is no indication that will happen.

Special Tax Deal May Be Illegal

To qualify as stranded, the law requires that a pipeline proposal be unprofitable.  The administration's analysts looked at several measures of profitability including cash flow, net present value, and internal rate of return.  They focused on internal rate of return, because that was the only category where they could produce a negative scenario.  At $2.50 gas, a pipeline under existing fiscal terms would deliver a bit less than a 10% rate of return.  That is the worst-case scenario, and it is a reasonable profit, considering how unlikely it is that gas will be at historic lows for any length of time.  At higher prices (less even than today's prices), using all methodologies, this is the most profitable project in the world.  It isn't logical to give away wealth that belongs to Alaskans, when it simply isn't necessary.

The administration is justifying their contract, in essence, by saying that we may not be the most profitable project in the world.  They show figures for comparable projects in other countries, and tell us we don't measure up.  The proposed package of tax breaks and state giveaways would add about 2% to the internal rate of return.

The Legislature's consultant, Daniel Johnston, has serious concerns about some of the economic analyses of competing projects.  One, in particular, is a $20 billion oil pipeline in Kazakhstan that is currently the largest project in the world.  He was personally involved in that project for years, and said the project's rate of return is MUCH LESS than in the governor's analysis.  We should be careful before we make concessions based on our relative competitiveness, if the projects we're being compared to are based on bad data. 

Beyond that, an Alaska project doesn't need the highest return on investment, because it is a safe investment.  A company can be sure that our government will still be here in 20 or 30 years, and nobody is going to come in and nationalize the fields.  The formal term for this is "low political risk."  There is also an $18 billion loan guarantee from the federal government that was approved in 2004.  These two factors will make it much easier for an applicant to get the construction project financed, meaning lower interest rates and greater security.

In addition, because of the high oil prices in recent years, oil companies are flush with cash.  Several recent articles in major publications have discussed how big oil companies have limited places to invest their money, other than just giving bigger dividends to their shareholders.  It's not as if there are tens of billions of dollars worth of projects that are so much better than ours.  Most of the world's oil and gas is in countries with national oil companies, and are closed to investment from multinationals like Exxon and British Petroleum.

The ultimate proof that an Alaska gas project would be economical is that four other groups pursued applications to build a pipeline.  In addition to the All-Alaska Gasline group, several large pipeline companies proposed to build it.  These are not oil companies, they are transportation companies, and they believe they can make money by moving gas through the pipeline.  None wanted or expected special tax terms.  But the North Slope oil companies have refused to sell Alaska's gas through any pipeline they don't own.  Rather than address this clear abuse of their lease requirements, the Governor gave in to the threats and refused to negotiate with these other qualified parties.

The Governor's Deal & Proposed Changes

In 2003, the Legislature passed amendments to the Stranded Gas Act that contained "legislative intent" language.  Although not officially part of the law, it said that any contract that includes taxes in-kind and other royalty adjustments must contain a provision by which the contract may be reopenedby any party.

In other words, the Legislature said in plain English that it did not want a contract that had an open-ended lock-in of tax breaks and concessions.  Unfortunately, the intent language was ignored in the Governor's secret gasline negotiations.  There are literally no provisions for revisiting the tax rates and other contract terms for the full 45-year term of the proposed contract.

In addition, the Governor has negotiated a contract that goes well beyond the authority he was given in the Stranded Gas Act.  At the upcoming special session, we will be asked to pass a bill that amends the Stranded Gas Act to make the deal retroactively legal.  These amendments were introduced last month as HB 2004 / SB 2004.  This bill was discussed in committee towards the end of this past session, and will probably be re-introduced in its original form.  It would make the following important changes:

Conclusion

The Stranded Gas Act, as written, would allow a governor to negotiate gas-in-kind and a few other tax terms, but only if the gas was uneconomical.  According to the Governor's chief of staff, the gas-in-kind provision is the core of the contract and is absolutely non-negotiable.  But the gas is very economical, so the entire contract is inappropriate.  Beyond that, the Governor has given away much more than what he's authorized by the existing terms of the Stranded Gas Act, and now wants the Legislature to give him much looser terms.

We don't need to accept the threats and empty promises of big oil.  Rather than this package of carrots, Alaskans should make better use of the sticks we currently have.  The main reason overseas projects are being developed before ours, is that those countries will take back the leases if a company doesn't move quickly to develop the gas.  If the oil companies refuse to play by the rules, we should get someone else to build our gasline.