Legislature(2003 - 2004)

05/06/2003 09:01 AM Senate FIN

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
                                                                                                                                
     CS FOR HOUSE BILL NO. 57(FIN)                                                                                              
     "An Act amending the manner of determining the royalty                                                                     
     received by the state on gas production as it relates to the                                                               
     manufacture of certain value-added products."                                                                              
                                                                                                                                
                                                                                                                                
This  was the first  hearing  for this  bill in  the Senate  Finance                                                            
Committee.                                                                                                                      
                                                                                                                                
Co-Chair Wilken  stated this bill "allows the Department  of Natural                                                            
Resources commissioner  to adjust  the value of the State's  royalty                                                            
share for gas  used by a manufacturer  for agricultural chemicals."                                                             
He noted a proposed  committee substitute "Version  C" was submitted                                                            
to the Committee by the  sponsor. He requested a presentation of the                                                            
bill and a comparison of  "Version C" to the House Finance committee                                                            
substitute [referred to as "Version X"].                                                                                        
                                                                                                                                
REPRESENTATIVE  MIKE CHENAULT,  Sponsor, explained  this bill  "adds                                                            
certainty  to in-State  value-added  manufacturing".  Currently,  he                                                            
informed,  royalty  prices are  calculated  in four  different  ways                                                            
which causes problems for  manufacturers because the price of gas is                                                            
uncertain,  as well as the royalty  owed on that gas.  He  explained                                                            
that four years after the  sale of product, an audit could determine                                                            
that the price was considerably  higher, costing the manufacturer $4                                                            
to $5 million  in additional royalties.  He stated this legislation                                                             
would permit  manufacturers  to negotiate  the price  of the  gas to                                                            
allow the  manufacturers  to sell it  at a price  that allows  for a                                                            
profit.                                                                                                                         
                                                                                                                                
SENATOR  TOM WAGONER  clarified  this  legislation  pertains to  the                                                            
"price of the State royalty share of gas".                                                                                      
                                                                                                                                
Senator  Bunde  commented  that residents  of  the  Kenai  Peninsula                                                            
oppose  the  level of  State  spending;  however,  this legislation                                                             
proposes increased State  funding. He understood the need to support                                                            
viable industry. He asked the estimated cost to the State.                                                                      
                                                                                                                                
Representative  Chenault cited the  fiscal note, which predicts  the                                                            
cost to be between zero  and $11,5 million in lost royalty payments.                                                            
He listed  the factors,  including the negotiations  reached  by the                                                            
commissioner, employment  opportunities and tangible benefits to the                                                            
communities.                                                                                                                    
                                                                                                                                
Senator Taylor asked the version the sponsor supports.                                                                          
                                                                                                                                
Representative  Chenault   responded  that  the proposed   committee                                                            
substitute,  Version "C"  mirrors Senate  companion legislation  and                                                            
reflects a compromise agreed upon by the Senate.                                                                                
                                                                                                                                
Senator Wagoner reiterated Version "C" is the preferred version.                                                                
                                                                                                                                
Senator  Taylor moved  for adoption  of CS HB  57, 23-LS0303\C  as a                                                            
working draft.                                                                                                                  
                                                                                                                                
Without objection the committee  substitute was ADOPTED as a working                                                            
draft.                                                                                                                          
                                                                                                                                
Senator Taylor revisited the potential cost to the State.                                                                       
                                                                                                                                
Senator Wagoner  clarified the maximum $11.5 million  predicted loss                                                            
of royalty revenues would occur over a period of several years.                                                                 
                                                                                                                                
Senator Taylor asked if  this estimate is based on the provisions of                                                            
committee  substitute Version  "C"  or the House  Finance  committee                                                            
substitute.                                                                                                                     
                                                                                                                                
Representative Chenault replied Version "C".                                                                                    
                                                                                                                                
Co-Chair Wilken  noted a draft fiscal note, dated  5/5/03, addresses                                                            
the provisions in Version "C".                                                                                                  
                                                                                                                                
Senator Hoffman  expressed concern that chemical fertilizing  plants                                                            
nationwide  are currently  failing because  the methane gas  used in                                                            
stock feed  is worth more than the  finished product. He  questioned                                                            
therefore the benefits of this legislation to provide jobs.                                                                     
                                                                                                                                
Representative  Chenault  could not  speak to  businesses  elsewhere                                                            
failing, but  stressed the economic  impact the loss of jobs  on the                                                            
Kenai Peninsula  that would occur  if the local facility  failed. He                                                            
informed that  personnel layoffs are currently under  consideration,                                                            
although he attributed  this to new ownership and  because the plant                                                            
is operating at 70 percent of capacity.                                                                                         
                                                                                                                                
Senator Hoffman  asked if the sponsor would consider  a shorter time                                                            
period  for a  negotiated  price to  minimize  the loss  of  royalty                                                            
revenues.                                                                                                                       
                                                                                                                                
Representative  Chenault indicated he would have to  give the matter                                                            
consideration before offering support.                                                                                          
                                                                                                                                
Co-Chair Wilken  referenced page 2  of the draft fiscal note,  which                                                            
details the potential  loss of royalties over the  five-year period.                                                            
                                                                                                                                
Co-Chair Wilken asked for  an explanation of the current process and                                                            
why  the  royalty  rate  changes.  He  also  asked   for  additional                                                            
information on the impact on the State general fund.                                                                            
                                                                                                                                
Representative  Chenault remarked  that this  bill would not  affect                                                            
current  contracts  for  gas supplies.  He  explained  the  existing                                                            
process  whereby the  State  and the  producer negotiate  a  royalty                                                            
amount  without  input of  the  manufacturer.  He stated  that  upon                                                            
review  after  four  years,  the  State  could  determine  that  the                                                            
negotiated royalty was not a "fair price".                                                                                      
                                                                                                                                
Co-Chair  Wilken  asked for  an example  of  the producers  in  this                                                            
context.                                                                                                                        
                                                                                                                                
Representative  Chenault exampled  Unocal and Marathon, noting  that                                                            
all gas producers are involved in the royalty negotiation.                                                                      
                                                                                                                                
Co-Chair  Wilken  clarified  the  producer  negotiates  a  long-term                                                            
contract for the "price of that feed stock" with the State.                                                                     
                                                                                                                                
Senator Wagoner  told the Committee  that the previous owner  of the                                                            
manufacturing   plant  also   discovered  and   produced  the   gas.                                                            
Currently, he said, Union  Oil produces the gas, and Agrium operates                                                            
as the manufacturer.                                                                                                            
                                                                                                                                
Co-Chair Wilken  next clarified the States receives  12.5 percent in                                                            
royalty from Unocal,  the producer, which sells that  gas to Agrium.                                                            
                                                                                                                                
Representative Chenault  affirmed and continued that the State could                                                            
conduct an  audit of the  royalty price negotiated  with Unocal  and                                                            
subsequently  could determine that  Unocal paid less than  the worth                                                            
of the gas.                                                                                                                     
                                                                                                                                
Co-Chair   Wilken  understood   an  agreement   of  the  price   was                                                            
negotiated.                                                                                                                     
                                                                                                                                
Representative  Chenault reiterated the existence  of four different                                                            
methods to calculate the  royalty amount. As a result, he stated the                                                            
State  could determine  additional  payment  is required,  at  which                                                            
point, Unocal would collect the funds from Agrium.                                                                              
                                                                                                                                
                                                                                                                                
SFC 03 # 78, Side A 10:36 AM                                                                                                    
                                                                                                                                
                                                                                                                                
Co-Chair  Wilken  asked  if  retroactive  price  adjustments  are  a                                                            
condition of the agreements between Unocal and Agrium.                                                                          
                                                                                                                                
Representative Chenault affirmed.                                                                                               
                                                                                                                                
Representative  Chenault   reiterated  this  legislation  would  not                                                            
impact current  contracts, however  in future contract negotiations                                                             
Agrium,  i.e. the manufacturer,  would participate  in negotiations                                                             
and the royalty price would  remain at the negotiated amount for the                                                            
term of the contract.                                                                                                           
                                                                                                                                
Co-Chair Wilken asked if  Unocal were able to receive a higher price                                                            
from the  sale of  gas to  a buyer  other than  Agrium, whether  the                                                            
difference would be assessed to Agrium.                                                                                         
                                                                                                                                
Senator Wagoner  told of  the contract providing  that Unocal  would                                                            
supply gas to  Agrium at a negotiated price. He noted  one exception                                                            
is increased utility demand during winter months.                                                                               
                                                                                                                                
Representative  Chenault emphasized  this legislation would  provide                                                            
assurances   that  under   the  terms  of   future  contracts,   the                                                            
manufacturer would pay the negotiated royalty price.                                                                            
                                                                                                                                
Co-Chair Wilken  asked if new contracts  would be implemented  in FY                                                            
05 and FY 06.                                                                                                                   
                                                                                                                                
Representative  Chenault informed that one long-term  contract is in                                                            
effect currently  and that  the remainder of  the gas purchases  are                                                            
subject  to  "spot  market".  He  stated  that  the  manufacture  is                                                            
attempting  to purchase  an adequate  supply of  gas to operate  the                                                            
facility.                                                                                                                       
                                                                                                                                
Senator Wagoner  furthered this legislation allows  the commissioner                                                            
to negotiate profit  sharing with Agrium if determined  to be in the                                                            
best interest of the State.                                                                                                     
                                                                                                                                
KEVIN  BANKS,  Division  of  Oil  and  Gas,  Department  of  Natural                                                            
Resources,  testified via  teleconference from  an offnet  location,                                                            
that leases negotiated  since statehood are market-value  leases. He                                                            
explained that  the royalty value is subject to an  evaluation using                                                            
four  different  measures  to  determine  the market  value  of  the                                                            
royalty.  He  noted that  some  leases  in other  states  are  gross                                                            
proceeds leases, which  provides that the royalty paid by the lessee                                                            
is equal to the  amount that the lessee sold the gas.  He stated the                                                            
sale price of  the gas is one of the four measurements  utilized for                                                            
determining market value  of royalty in Alaska and that the State is                                                            
allowed to consider  the price between the lessee  and its customers                                                            
compared  to the  market  value  as measured  by  other mechanisms.                                                             
Therefore,  he pointed  out, the sale  price and  the royalty  price                                                            
could differ  under  the provisions  of the lease  agreement  if the                                                            
market value is higher.                                                                                                         
                                                                                                                                
Mr. Banks stated  that determinations of higher royalty  amounts are                                                            
often made after an audit  and after the initial royalties have been                                                            
paid. In  these instances,  he said, the lessee  is required  to pay                                                            
additional royalty amounts two or more years later.                                                                             
                                                                                                                                
Mr. Banks pointed  out that gas supply contracts commonly  allow the                                                            
lessee and its  customer to agree to an "excess royalties"  term. He                                                            
exampled  contracts between  gas producers  operating in Cook  Inlet                                                            
and utility companies include this provision.                                                                                   
                                                                                                                                
Mr. Banks outlined the  fiscal note estimates the amount of gas that                                                            
would be sold  to Agrium and other  entities, such as utilities,  in                                                            
the future,  not including gas currently  under contract.  He stated                                                            
the fiscal  note assumes that a royalty  contract would provide  for                                                            
the State to  collect additional royalties  in the event  the market                                                            
value is determined higher.                                                                                                     
                                                                                                                                
Co-Chair Wilken asked if  an audit calculates the price of gas if it                                                            
were  sold to  a utility  company,  compared  to the  price  charged                                                            
Agrium, and  collects the difference  from Agrium. He asked  if this                                                            
legislation eliminates  this review and stipulates that the value of                                                            
gas sold to utility  companies has no bearing on the  royalty amount                                                            
due from Agrium.                                                                                                                
                                                                                                                                
Mr. Banks affirmed.                                                                                                             
                                                                                                                                
Co-Chair Wilken clarified  that this bill establishes a procedure by                                                            
which  the royalty  price  is determined  through  negotiation,  and                                                            
asked which parties are involved in these negotiations.                                                                         
                                                                                                                                
Mr. Banks replied  the suppliers and  Agrium negotiate and  that the                                                            
State has no involvement.                                                                                                       
                                                                                                                                
Co-Chair Wilken  asked if the State  is therefore relinquishing  the                                                            
utility value, or alternative  customer value of gas sold to Agrium,                                                            
and  for  the  benefit   of  fertilizer  production   on  the  Kenai                                                            
Peninsula.                                                                                                                      
                                                                                                                                
Mr. Banks affirmed.  He pointed out  that Version "C" provides  that                                                            
the commissioner  has  the discretion  to  set a  royalty price  for                                                            
between  $2 and  $2.43, as  exampled in  the draft  fiscal note.  He                                                            
stated that  under normal circumstances  the value is $2.43  and the                                                            
contract value is $2.00.                                                                                                        
                                                                                                                                
Co-Chair  Wilken  asked how  the commissioner  would  determine  the                                                            
actual amount.                                                                                                                  
                                                                                                                                
Mr. Banks  replied the  commissioner must  ensure that the  contract                                                            
price is not  unreasonable low, and  that the prospective  reduction                                                            
in royalty  receipts would be balanced  by employment opportunities                                                             
in the fertilizer manufacturing plant.                                                                                          
                                                                                                                                
Senator  Hoffman  asked  how  often  during  six-year  term  of  the                                                            
contract would the commissioner  make a determination of the royalty                                                            
amount, once or more often.                                                                                                     
                                                                                                                                
Mr. Banks explained  the process,  whereby each lessee would  submit                                                            
an application  to commissioner and provide the terms  of a contract                                                            
with Agrium listing the  negotiated prices. He said this information                                                            
would be used  in calculating the royalty and would  occur only once                                                            
in the life of the contract.                                                                                                    
                                                                                                                                
Co-Chair  Wilken  announced  the  bill  would  no  report  from  the                                                            
Committee during this hearing.                                                                                                  
                                                                                                                                
MIKE NUGENT,  General Manager,  Kenai Nitrogen  Operations,  Agrium,                                                            
testified  via teleconference   from an  offnet location  that  this                                                            
legislation  is "one piece of a pie,  which could provide  producers                                                            
in Cook Inlet with stability,  and Agrium with certainty of what the                                                            
are to manufacture  the products we sell." He informed  that natural                                                            
gas is the major raw material used to develop products.                                                                         
                                                                                                                                
Mr.  Nugent asserted  the  nitrogen  facility is  one  of few  major                                                            
value-added  manufacturing  operations   in Alaska,  is  the  second                                                            
largest  producer of  nitrogen products  in the  United States,  and                                                            
that six-percent  of  the total  nitrogen products  are produced  in                                                            
North  America. He  listed  the Pacific  Rim countries  that  import                                                            
Agrium products, including  Korea, Taiwan, Mexico, and Thailand, and                                                            
the need to  be competitive in world  markets. He remarked  that the                                                            
company currently is competitive  because of the facility's location                                                            
close  to markets,  the  highly  skilled  workforce and  the  stable                                                            
political  climate;  unlike  the  competitors   located  in  Russia,                                                            
Indonesia,  Saudi  Arabia and  Venezuela.  However,  he pointed  out                                                            
these  countries enjoy  "extremely  low" natural  gas prices,  which                                                            
puts Agrium  at a  disadvantage.  He stated  this legislation  would                                                            
lessen the disadvantage.                                                                                                        
                                                                                                                                
Mr. Nugent informed  that this bill would allow the  commissioner to                                                            
accept the  price negotiated by the  producer and the manufacturer,                                                             
Agrium, as the amount by which royalties would be calculated.                                                                   
                                                                                                                                
Mr. Nugent  pointed out the  fiscal note  does not reflect  economic                                                            
impacts provided  by Agrium, including wages, purchase  of goods and                                                            
services,  taxes and  new development  to Alaska,  and instead  only                                                            
considers the  price of natural gas. He stated that  the analysis is                                                            
based  on  forecasts,  which  involve  several  variables  that  are                                                            
difficult  to  predict, such  as  volume,  price and  ownership.  He                                                            
furthered that  the analysis assumes  that the facility is  operated                                                            
at full capacity.                                                                                                               
                                                                                                                                
Mr.  Nugent  shared that  the  facility  is not  operating  at  full                                                            
capacity  because  Cook  Inlet  suppliers   are  unable  to  deliver                                                            
adequate  natural gas  supplies. He  stated the  plant is  currently                                                            
operating at 75 percent  of capacity, which results in lower revenue                                                            
for the State  of approximately $2  million if 2003. He warned  that                                                            
unless able  to fund producer to supply  a large quality  of natural                                                            
gas  at a  competitive  price, Agrium  could  eventually  fail as  a                                                            
business  and  the State  and  local communities  would  receive  no                                                            
revenues from the operation.                                                                                                    
                                                                                                                                
Mr.  Nugent told  of repeated  discussions  with  producers in  Cook                                                            
Inlet  in which the  primary concerns  were  the additional  royalty                                                            
charges the  producer is subject to.  He cited a letter to  the City                                                            
of Kenai from Aurora Power  Resources, Inc. dated February 11, 2003,                                                            
which reads as follows [copy on file].                                                                                          
                                                                                                                                
     Aurora  Gas, LLC is  aggressively pursuing  the development  of                                                            
     natural  gas producing properties,  primarily on the  West side                                                            
     of Cook  Inlet. Oil  and gas exploration  and development  is a                                                            
     high  cost, high-risk  endeavor. As a  producer looking  for to                                                            
     market  our natural gas  there is a  great hesitation  to enter                                                            
     into a  gas sales agreement with  a purchaser, such  as Agrium,                                                            
     because  it adds  yet another layer  of risk  to a producer.  A                                                            
     producer  selling  gas to  Agrium runs  the risk,  in fact  the                                                            
     probability,  that  certain  years  after  selling its  gas  to                                                            
     Agrium, the State  will assert a claim that royalty needs to be                                                            
     paid  on  a  higher  value  than  the  arms  length  negotiated                                                            
     contract price. This  additional royalty, plus interest accrued                                                            
     at  a higher-than-market  rate, would  have to  be born  by the                                                            
     producer and/or by the purchaser.                                                                                          
                                                                                                                                
     It is for this reason  that Aurora Gas, LLC and its natural gas                                                            
     marketing  affiliate,  Aurora  Power Resources,  Inc.  strongly                                                            
     endorse  this legislation and  the concept that royalty  should                                                            
     be  paid  on  the basis  of  arms  length  negotiated  contract                                                            
     prices.   Accordingly,   we  salute  and   support  the   draft                                                            
     resolution in support  of HB 57 and urge the Kenai City Council                                                            
     to adopt same.                                                                                                             
                                                                                                                                
Mr.  Nugent spoke  of the  increased  difficulty  of development  of                                                            
natural gas reserves caused by the unknown State royalty values.                                                                
                                                                                                                                
Senator Taylor noted he  was absent during portions of the testimony                                                            
asked why the chair intended to hold the bill in Committee.                                                                     
                                                                                                                                
Co-Chair Wilken indicated questions related to the fiscal note.                                                                 
                                                                                                                                
Senator Bunde  referenced Mr. Nugent's testimony asserting  that the                                                            
fiscal note does  not take into account taxes collected  from Agrium                                                            
in determining  the cost of this legislation.  He requested  further                                                            
information on this matter, specifically what taxes.                                                                            
                                                                                                                                
Co-Chair  Wilken  instructed  the  sponsor  to  provide  a  detailed                                                            
sponsor statement explaining the bill.                                                                                          
                                                                                                                                
Co-Chair Wilken ordered the bill HELD in Committee.                                                                             
                                                                                                                                

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