Legislature(2007 - 2008)SENATE FINANCE 532
05/03/2007 01:30 PM Senate FINANCE
| Audio | Topic |
|---|---|
| Start | |
| SB104 | |
| HB121 | |
| SB72 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | SB 104 | TELECONFERENCED | |
| + | SB 72 | TELECONFERENCED | |
| + | HB 121 | TELECONFERENCED | |
| + | TELECONFERENCED |
1:32:07 PM CS FOR SENATE BILL NO. 104(JUD) "An Act relating to the Alaska Gasline Inducement Act; establishing the Alaska Gasline Inducement Act matching contribution fund; providing for an Alaska Gasline Inducement Act coordinator; making conforming amendments; and providing for an effective date." This was the seventeenth hearing for this bill in the Senate Finance Committee. 1:32:14 PM DAN DICKINSON, Certified Public Accountant, Certified Management Accountant, continued his presentation from the previous meeting utilizing a PowerPoint titled, "Presentation to the Alaska Legislature Senate Finance Committee May 3, 2007" [copy on file]. Page 41 Internal Rate of return Step One: Model An Owned Project [Spreadsheet calculating the internal rate of return of 21 percent over ten years on a capital expenditure of $20,000 and production of 1,000 units each year with operating costs of 0.1 dollars and revenue of $5 for each unit.] Page 42 Internal Rate of Return Step Two: Model Capital Component of Tariff Using PAYMENT function [Spreadsheet related to the previous page that calculates a ten percent interest rate on the loan to purchase the equipment with annual payments of $3,254.91 and the loan repaid in ten years.] Mr. Dickinson used as an example a machine that produced "widgets" in detailing the spreadsheets. 1:35:18 PM Page 43 Internal Rate of Return Step Three: Model Third Party Line with no FT but with tariff [Spreadsheet utilizing the data from the previous spreadsheets to calculate an internal rate of return of "#NUM!" over ten years with the annual tariff of $3,354.90, annual revenues of $5,000 and subsequent annual cash flows of $1,645.10.] Mr. Dickinson derived the amount of the tariff by adding the operating cost of $100 per year to the payment cost of $3,254.91 per year. The Excel software program would be unable to calculate the internal rate of return from this data because "if you just have a positive series of cash flows your rate of return is infinite". In determining whether to "do something" and "the answer is yeah you get money in every year then of course the answer is yes you do it." Attempting to compare this to "some other thing", given that "you're not capital constrained, it didn't cost you anything" the conclusion would be "you've got a series of positive cash flows that gives you an infinite rate of return." 1:36:32 PM Mr. Dickinson suggested that "essentially the underlying calculation where you get those 80 and 90 percent rate of returns on the pipeline are because you've essentially done this calculation." This does not include whether the producer had made a firm transportation (FT) commitment. 1:37:04 PM Page 44 Step Four: Model Third Party Line with some additional capital [Spreadsheet identical to that of Page 43 except with a negative cash flow (investment cost) of $100 in Year 0, and a calculated internal rate of return of 1645%.] Mr. Dickinson stated that this spreadsheet factors upstream costs. He spoke to the 8 billion cubic feet (bcf) per day of gas in Prudhoe Bay that was re-injected. This gas had been processed and only required "a little bit of treatment and put it in the pipeline." If producers agreed to ship this gas through a third party-owned pipeline, but required that the pipeline must traverse to the location of existing facilities and thus no capital outlay would be required of the producers, the rate of return to the producers would be infinite. The rate of return would remain high if the producers incurred "a couple hook up costs" as reflected in the spreadsheet. 1:38:10 PM Page 45 Internal Rate of Return Step Five: Model Third Party Line with some more additional capital [Spreadsheet identical to the previous with the exception of a $2,000 investment cost and a recalculated internal rate of return of 82 percent.] Mr. Dickinson noted that the producers could invest more capital, giving as an example the lease holdings at Point Thomson. At that location the gas was not "ready to go into a pipeline" and "billions of dollars of costs" would be necessary to develop the entire field. In this instance the rate of return would be lower. 1:38:23 PM Page 46 Step Six: Model Third Party Line with yet more additional capital [Spreadsheet identical to the previous two pages with the exception of an investment cost of $6,750 and a recalculated internal rate of return of 21 percent.] Mr. Dickinson explained this spreadsheet demonstrated "just how much capital costs you'd have to put in to bring it back down to a rate of return of 21 percent, which was what it was calculated … on the original project." 1:38:38 PM Mr. Dickinson expressed the following. My point is, if you take the FT commitment and you say that is zero effect on a producer's finances, and you compare that to a situation in which the producer lays all the cash out, you're [going to] get a position where you're [going to] find that you create these absolutely fabulous rates of return. And the answer is that's not an appropriate analysis. If that analysis were appropriate, then the State - we could just end all this nonsense now. The State could step forward and say we'll make the FT commitment if it really doesn't affect our finances. If it doesn't affect our credit rating, we can promise everyone that their [Alaska Permanent Fund] dividends won't be affected, why not do it. The State should step forward and do this risk-less thing and do the FT commitment. But if in fact making an FT commitment needs to be reflected and needs to be dealt with to analyze a situation correctly, then - it's not a question of if, it is necessary to do that; if you don't, if you simply ignore that FT commitment, you're not analyzing the situation correctly. 1:39:49 PM Page 47 FASB 47 Disclosure of Long Term Obligations (1981) · This statement requires that an enterprise disclosure its commitments under unconditional obligations that are associated with suppliers' financing arrangements. Such obligations often are in the form of take-or-pay contracts and throughput contracts. Mr. Dickinson identified FASB as the Financial Accounting Standards Board. He read this provision of the Board into the record explaining that it was written at a time when leasing "and things like that first started appearing" as "off-sheet balance financing". The FASB determined that the off-sheet balancing information must be included in an entity's financial reports to allow reviewers a "fair picture". Firm transportation commitments were take-or-pay or "throughput" contracts. 1:41:07 PM Page 48 FASB 47 Disclosure of Long Term Obligations (1981) · Example 2 · 27. C Company has entered into a throughput agreement with a natural gas pipeline providing that C will provide specified quantities of natural gas (representing a portion of capacity) for transportation through the pipeline each period while the debt used to finance the pipeline remains outstanding. The tariff approved by the Federal Energy Regulatory Commission contains two provisions, a demand charge and a commodity charge. The demand charge is computed to cover debt service, depreciation, and certain expected expenses. Mr. Dickinson announced he would bypass most language of FASB 47 and address Paragraph 27. He read the information into the record. The example of C Company used by FASB was "absolutely right on; … absolutely on point". 1:42:03 PM Page 49 FASB 47 Disclosure of Long Term Obligations (1981) · 27. (cont.) The commodity charge is intended to cover other expenses and provide a return on the pipeline company's investment. C Company must pay the demand charge based on the contract quantity regardless of actual quantities shipped, while the commodity charge is applied to actual quantities shipped. Accordingly, the demand charge multiplied by the contracted quantity represents a fixed and determinable amount. Mr. Dickinson continued reading Paragraph 27. 1:42:34 PM Page 50 FASB 47 Disclosure of Long Term Obligations (1981) · 28. C' disclosure might be as follows: o C company has signed an agreement providing for the availability of needed transportation capacity through 1990. Under that agreement, the company must make specified minimum payments monthly. The aggregate amounts of such required payments at December 31, 19X1 is as follows (in thousands): Mr. Dickinson began reading Paragraph 28 to the Committee. 1:43:08 PM Page 51 FASB Disclosure of Long Term Obligations (1981) · 28 (cont.) · 19X2 $5,000 · 19X3 5,000 · 19X4 5,000 · 19X5 4,000 · 19X6 4,000 · Later years 26,000 · Total 49,000 · Less: Amount representing interest (9,000) Total at present value $40,000 Mr. Dickinson noted how this information relates to the previous page. 1:43:25 PM Page 52 FASB Disclosure of Long Term Obligations (1981) · 28 (cont.) · In addition the company is required to pay additional amount depending on actual quantities shipped under the agreement. The companies total payments under the agreement were (in thousands) $6,000 in 19W9 and $5,000 both in 19X0 and in 19X1. Mr. Dickinson told of this additional requirement. 1:43:32 PM Page 53 Contractual Commitments [Page taken from an annual financial statement of BP detailing Expected payments by period under contractual obligations and commercial commitments, and Unconditional purchase obligations payments due by period.] Mr. Dickinson directed attention to the Unconditional purchase obligations payments due by period. 1:43:56 PM Page 54 BPs 2003 20(f) · Unconditional purchase obligations (d) · (d) Represents any agreement to purchase goods or services that is enforceable and legally binding and that specifies all significant terms. The amounts shown include arrangements to secure long-term access to supplies of crude oil, natural gas feedstocks and pipeline systems. · Obligations set out for five years, after five years and in total Mr. Dickinson read this information, noting it provided an explanation of the information contained on BP's financial statement shown on Page 53. Any FT commitment made by the company would be reflected in this section of its financial statements. The company was obligated to disclose the commitments to provide a "fair accounting" of its financial position under the rules of the FASB. 1:44:54 PM Page 55 Why does this matter? · Moody' Investors Service · Authors (or "Contacts"): · Barbara Havlicek, Kevin Stoklosa, Greg Jonas, Laura Levenstein, Pamela Stumpp, Michel Madelain, Trevor Pijper, Wofgang Draak, Waylon Iserhoff, Brian Cahill, Thomas Keller, Takohiro Morita · The Analysis of Off-Balance Sheet Exposures, A Global Perspective · July 2004 Mr. Dickinson informed that FASB's intent was to ensure that those evaluating financial statements "are getting a fair look at what the company is doing." Moody Investment Services was employed to evaluate the financial condition of a company by parties interested in investing in that company. 1:45:36 PM Page 56 Moody's Rating Methodology · Take-Or-Pay Contracts · Take or pay contracts are another form of purchase commitment typically found in the … energy industry. … Such contracts can be problematic if market conditions and raw material prices change or if the price of the end product drops. Regardless of whether [or] not the contract becomes problematic, Moody's factors payments under take-or-pay contracts into the analysis of future cash flows and may also adjust the balance sheet if necessary. (Havlicek page 7) Mr. Dickinson noted this statement was cited from The Analysis of Off-Balance Sheet Exposures, A Global Perspective. He read it into the record then explained that analysis of an FT commitment was not solely based on gas prices. 1:46:32 PM Page 57 Why does this matter? · Standard & Poor's · Authors (and "Analytical Contacts"): · Solomon B. Samson, Scott Sprinzen, Emmanuel Cubois- Pelerin, Kenneth C. Pfeil · Corporate Ratings Criteria · 2006 Mr. Dickinson spoke to the policy of Standard & Poor in analyzing FT commitments. 1:46:44 PM Page 58 Standard and Poor's Rating Methodology · Off balance-sheet financing o Analysis of liabilities is not limited to those shown on the company's balance sheet. Off balance-sheet items factored into the leverage analysis include the following: ƒOperating leases ƒGuarantees, debt of joint ventures and unconsolidated subsidiaries ƒTake-or-pay contracts and obligations under throughput and deficiency agreements… o (Samson pgs. 28-29) Mr. Dickinson read this information into the record. 1:47:07 PM Page 59 Standard and Poor's Rating Methodology · Various methodologies are used to determine the proper adjustment value for each off-balance-sheet item. In some cases, the adjustment is straightforward. For example, the amount of guaranteed debt can simply be added to the guarantor's liabilities. Other adjustments are more complex or less precise. (Samson pg. 29) Mr. Dickinson continued reading, noting this represented the manner in which Standard and Poor analyzed off balance-sheet items. Mr. Dickinson remarked, "The point is, one way of dealing with this IRR … if you sign a FT commitment, you capitalize the present value of that, you stick that in the cash flow." He was unsure if this practice would be appropriate in the FT commitments made for the Alaska natural gas pipeline. However, accounting rules required that this information must be disclosed because "it's absolutely critical to understand a company's finances." Those utilizing such a disclosure must employ "their judgments" to "correctly analyze how to best do it." He guaranteed that "in almost every case, ignoring it is not the way to do it." A rate of return generated by ignoring this "seems fabulous" but possibly "may need to include that FT commitment and figure out just what that FT commitment means." 1:48:19 PM Page 60 Closing Thought: · E.C. Capen and D.F. Casey The Economics of Creative Financing Society of Petroleum Engineers 11664 (1983) Mr. Dickinson cited from this article, which was published at the time that awareness was given to off balance-sheet financing. He opined, "In a journal not known for its humor," this article attempted to address how companies internally "deal with those projects". 1:48:48 PM Page 61 Closing Thought: · Now and then, someone comes in and announces that he has discovered the businessman's equivalent to the Fountain of Youth - a corporate money tree. The person will instruct us that his pet project (PP) need not compete for cash in the budgeting process because he has found a benefactor, Mr. S. Claus, willing to put up the money at not cost save some "small monthly payments" to be worked out later. These payments should come from PP's profits and represent no real drain in the company. Mr. Dickinson read this quote from the article, defining the monthly payments as tariff payments. 1:49:23 PM Page 62 Close of Closing Thought · To be sure we seldom see requests as blatant as portrayed above, but we nevertheless sense some misunderstandings about how to evaluate projects that have alternatives to outright purchase of goods and equipment. Has the old maxim of prohibiting free lunches somehow been set aside with regard to so called creative financing? No, more likely the lunch costs more than normal, but we're not always sure who pays. (Capen & Casey pg. 241) Mr. Dickinson continued reading from the article. 1:49:46 PM Mr. Dickinson summarized as follows. The point I'm trying to make with this quotation and with the other development is this is an error that folks make when they look at IRR. It's supposed to be based on cash flows, but you need to look at opportunity costs, you need to look at everything when you're doing that analysis. To answer the specific question that I was asked, I believe this was not done in the material that you were presented and that's why you see rates of return of 20, 30, 40, 50 percent. I don't think this project generates those kinds of rates of return. I hope this analysis showed the way to correctly analyze it and probably get a more appropriate rate of return. 1:50:35 PM Senator Elton asked if analyses of the liability of an FT commitment factors in a negative netback. He understood that liability would only exist in the event of a negative netback. 1:51:13 PM Mr. Dickinson corrected that the payments would still be required in situations that did not involve a negative netback, such as an "interruption in the flow" in which the full amount could not be tendered. 1:51:53 PM Senator Elton surmised that a pause in flow created a negative net back. 1:52:08 PM Mr. Dickinson affirmed. 1:52:10 PM Senator Elton asked if Standard and Poor or Moody's Investor Service evaluations must include the possibility "that you get to a negative netback" and subsequently a value or "judgment call" was made. 1:52:39 PM Mr. Dickinson affirmed, citing the publication of Moody's Investment Service reference to "whether it's troubled or not you need to analyze it correctly". He hypothesized that the credit worthiness of a company that made multiple FT commitments would be "no longer as high" and would experience "balance sheet impairment". A credit guarantee that was never used would have zero cost; however, the credit worthiness "under various circumstances" must be considered. The cost to a company in underwriting debt was "precisely the cost of balance sheet impairment". 1:53:47 PM Mr. Dickinson recalled the situation in the 1980s at the time that the matter was "controversial", companies asserted they only undertook projects expected to be profitable, that the cost of the lease would be covered by the revenue generated, and therefore the FT commitments did not require disclosure. The BP financial statement in which following the disclosure of the unconditional purchasing obligations a notation was made stating that the risk associated with the contracts was "discussed in a separate item". The separate explanation would likely claim that in the event that gas prices remained at the current rate, $5 payments on the FT commitments would not be necessary. Mr. Dickinson analogized that if the only risk was "simply that it's not going to be paid" the State should assume that risk. Issuing a "financial instrument - signing a contract that says 'we're [going to] make these payments for the next 20 years' that represents a real cost to a company" as an "actual impairment". 1:55:09 PM Senator Elton had been told that the analysis conducted by Anthony Scott of the Department of Natural Resources utilized the same assumptions as used by ConocoPhillips. Senator Elton asked if Mr. Dickinson had conducted an analysis utilizing his own assumptions. 1:55:50 PM Mr. Dickinson admitted he had not conducted an analysis. He did not advocate that the "off balance-sheet" must be disclosed, but rather that they could not be ignored. Capital costs and other expenses would be the same in both analyses. 1:56:50 PM Senator Elton had been pressured to not "trust" Mr. Scott's analysis; however it was based on the same data and utilized the same "approach" as ConocoPhillips analysis. Additionally, no other analyses had been presented to contradict Mr. Scott's. 1:57:27 PM Mr. Dickinson countered that for "a fly and a human being … 97 percent of the DNA are the same, but the other three percent is critical". He guaranteed that the ConocoPhillips' analysis would not predict the same rate of return as analysis "that suggests ignoring the financial obligations, leases or other commitments". This was the critical difference. Mr. Dickinson stated that he was not a commercial credit analyst and suggested asking such an analyst "how this works". He acknowledged that he did not provide an "alternative answer" to the analysis prepared by Mr. Scott, informing that he had not been requested to do so. 1:58:40 PM Senator Thomas spoke to the upstream risk concerns. The confirmed reserves of 35 trillion cubic feet (tcf) had been known "for a long time" and 150 - 200 tcf of reserves was estimated to exist in the North Slope region. He surmised that confirming a portion of the estimated reserves would reduce the risk. He asked the impact on the risk of the project if 60 tcf of reserves was confirmed to exist in the "developed area, from the Alpine field eastward". 1:59:36 PM Mr. Dickinson responded that "part of issue" was the length of the FT commitments, whether ten, 15 or 20 years. A lender or creditor would consider the affect of increased confirmed reserves if the FT commitments were 20 or 25 years. The existing confirmed reserves of 35 tcf were sufficient for shorter term FT commitments. He agreed that the amount of confirmed reserves was "one of the three or four main" contributors to the risk level, and was a factor that "increases over time" and would be "sensitive to the length of the FT commitment". More confirmed reserves "makes everybody happier." However he posed, "but then are you trying to do an expansion, get it in sooner or will it play out in longer life and flesh out the outer years of the commitment". This was the primary factor in accessing the risk. AT EASE 2:01:06 PM The bill was HELD in Committee.
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