Legislature(2005 - 2006)BUTROVICH 205

05/02/2005 03:30 PM RESOURCES

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03:39:11 PM Start
03:40:15 PM HB71
06:06:18 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Heard & Held
   CSHB  71(FIN)am-OIL& GAS EXPLORATION CREDIT & LEASE TERMS                                                                
CHAIR THOMAS WAGONER announced HB 71 to be up for consideration.                                                                
3:41:26 PM                                                                                                                    
SENATOR BEN STEVENS joined the committee.                                                                                       
BONNIE ROBSON, Consultant  to the  Legislative  Budget and  Audit                                                               
Committee, read her testimony, which is as follows:                                                                             
              "Reasonably Profitable" Legislation                                                                               
                    HB 71, Sections 1 and 2                                                                                   
 Testimony of Bonnie Robson, Consultant to Legislative Budget &                                                               
             Before the Senate Resources Committee                                                                            
                          May 2, 2005                                                                                         
On April 20, counsel for  the Administration testified before the                                                               
Legislative Budget & Audit Committee  about a bargain struck when                                                               
the  state leased  its lands  at Prudhoe  Bay and  Point Thomson.                                                               
The bargain, he  said, was that the state  relinquished 7/8ths of                                                               
production,  retaining  only  1/8    to  itself  as  royalty.  In                                                               
exchange, the lessees promised to  develop and market the State's                                                               
oil and gas when reasonably profitable  to do so.  However, HB 71                                                               
does not resolve  any dispute the lessees may  raise over whether                                                             
the obligation to  develop and market exists,  but simply defines                                                               
reasonably  profitable and  related terms.   The  definition only                                                               
gets used if  the obligation does, in fact, exist.   Also, if the                                                               
obligation does, in fact, exist,  the proposed legislation sets a                                                               
time clock  for getting Alaska gas  to market - seven  years from                                                               
the  date of  administrative decision  -because time  is money  -                                                               
substantially  more than  $1 billion  per  year to  the State  at                                                               
current gas prices.                                                                                                             
This legislation is  otherwise modest in its ambitions.   It uses                                                               
average prices  and average returns.   It  does not create  a new                                                               
obligation if  one does not  already exist.   It does  not create                                                               
new  remedies for  breach  of existing  obligations.   It  simply                                                               
defines an undefined term in both  old and new oil and gas leases                                                               
and unit agreements rather than  leaving that definition to other                                                               
branches of government.  It  gives the administration guidance on                                                               
a tool  it already has  and can choose to  use or not  in getting                                                               
North Slope gas  to market.  And, if and  when the Administration                                                               
chooses to use  that tool, it sets a seven-year  clock on getting                                                               
gas  to market.    The seven-year  clock, when  and  if used,  is                                                               
intended  to assure  not just  the promise  of a  pipeline or  an                                                               
option  on changes  to tax  and royalties  terms in  the event  a                                                               
pipeline  is built,  but  the pipeline  itself,  at the  earliest                                                               
reasonable date, bringing jobs to  Alaskans, affordable energy to                                                               
Alaskans and Americans, and billions  of dollars to the state and                                                               
its  municipalities before  declining oil  revenues diminish  our                                                               
northern way of life.                                                                                                           
For  those  who  wish  to  explore  further  some  of  the  legal                                                               
underpinnings of  the lessees'  duty to  develop and  market gas,                                                               
the next  page of these prepared  remarks sets forth a  sample of                                                               
the  explicit  language contained  in  the  state's oil  and  gas                                                               
leases, the Prudhoe Bay unit  agreement, and the Pt. Thomson unit                                                               
Is There a Legal Obligation to Develop and Market Gas                                                                         
   When "Reasonably Profitable"?                                                                                            
·    Spencer Hosie testified that there  is an obligation implied                                                             
     in oil and gas leases:  to develop and market oil and gas                                                                  
     when "reasonably profitable."                                                                                              
·    The State's  oil and  gas lease  agreements and  Prudhoe Bay                                                               
     and Pt. Thomson unit agreements also contain explicit                                                                    
     language to the same or similar effect.  Examples follow:                                                                  
·    The Leases state:                                                                                                      
     ½    The lessee is granted the exclusive right to state                                                                    
          lands "for  the sole and only  purposes of exploration,                                                               
          development, production, processing  and marketing oil,                                                               
          gas, and associated  substances produced therewith, and                                                               
          of  installing  pipe  lines and  structures...to  find,                                                               
          produce, save,  store, treat, process,  transport, take                                                               
          care of and market all such substances"(DL-1, para. 1)                                                                
     ½     "This lease contemplates the reasonable development                                                                  
          of said land for oil and gas as the facts may                                                                         
          justify."(DL-1, para. 19)                                                                                             
     ½    "DILIGENCE....   Lessee   shall   exercise   reasonable                                                               
         diligence in...producing...." (DL-1, para. 20)                                                                         
·    The Prudhoe Bay Unit Agreement states:                                                                                 
     ½    "To  the  end  that  Unitized  Substances  economically                                                               
          recoverable  may  be   increased....  Working  Interest                                                               
          Owners shall  with due diligence develop  the Unit Area                                                               
          in   accordance   with   good...production   practices.                                                               
          Such...production  practices shall  include  a plan  of                                                               
          development  and  operation...designed  to  efficiently                                                               
          and  economically  produce  Unitized  Substances."(Sec.                                                               
     ½    "Rate of Prospecting, Development  and Production.  The                                                               
          Director [of  the State of Alaska's  Division of Lands,                                                               
          i.e. DNR] is  hereby vested with authority  to alter or                                                               
          modify  from time  to  time the  quantity  and rate  of                                                               
          production . . .  limited to alteration or modification                                                               
          in the public interest...."(Sec. 4.3)                                                                                 
·    The Pt. Thomson Unit Agreement states:                                                                                 
     ½    "PLAN  OF  FURTHER  DEVELOPMENT AND  OPERATION....  Any                                                               
          plan...shall  be  as  complete   and  adequate  as  the                                                               
          Director  may  determine  to be  necessary  for  timely                                                               
          development . .  . of the oil and gas  resources of the                                                               
          unitized area...."(Para. 10)                                                                                          
     ½     "Rate  of  Prospecting,  Development  and  Production.                                                               
          The Director  is hereby vested with  authority to alter                                                               
          or modify  from time to  time the quantity and  rate of                                                               
          production . . .  limited to alteration or modification                                                               
         in the public interest . . . ."     (Para. 21)                                                                         
·    But  this  legislation  does  not  attempt  to  resolve  any                                                           
     dispute over  whether the obligation  to develop  and market                                                           
     gas exists when it is reasonably  profitable to do so.  This                                                           
     legislation  simply  interprets  reasonably  profitable  and                                                               
     related terms where the obligation is found to exist.                                                                      
Again, this legislation  does not attempt to  resolve any dispute                                                               
over  whether the  obligation to  develop and  market gas  exists                                                               
when  it is  reasonably profitable  to do  so.   This legislation                                                               
simply  interprets  "reasonably  profitable"  and  related  terms                                                               
where  the  obligation  is  found   to  exist.    It  allows  the                                                               
legislature  to voice  its opinion  on  a level  of profit  above                                                               
which the  legislature expects the  oil and gas lessees  who have                                                               
signed a contract giving them  the exclusive right to develop and                                                               
market  gas from  state  lands are  expected to  do  just that  -                                                               
develop and  market the gas, even  if they would prefer  to defer                                                               
their investment in Alaska until a later day.                                                                                   
How does the legislation interpret  "reasonably profitable?"  The                                                               
short answer is  a minimum of a 14 percent  return on capital for                                                               
production  and  processing  operations, and  the  FERC-regulated                                                               
rate for pipeline  operations.  But let us also  discuss the long                                                               
answer. The  legislation does  not use  the figure  "14 percent."                                                               
Instead, it  allows the administration  to select a  sample group                                                               
of oil and  gas companies and use a simple  average of the sample                                                               
group's most recent ten-year average  return on capital employed.                                                               
The   administration  has   the   discretion   in  selecting   an                                                               
appropriate  sample group  for the  project under  consideration,                                                               
but  for  purposes  of  discussion  today,  we  assume  that  the                                                               
administration  chooses to  use a  group consisting  of the  four                                                               
largest international  petroleum companies and the  three largest                                                               
Alaskan oil and  gas companies.  For this sample  group, the most                                                               
recent ten-year simple average of  returns on capital employed is                                                               
14 percent, as the following exhibit shows:                                                                                     
3:45:45 PM                                                                                                                    
     [Insert  Excel Spreadsheet  on ExxonMobil,  Royal Dutch                                                                    
     Shell, BP, Chevron  Texaco, ConocoPhillips. The returns                                                                    
     on capital  employed for each  of these  companies from                                                                    
     1995 to  2004 appear by  year and are averaged  over 10                                                                    
     years  individually  by   company  and  averaged  again                                                                    
     across  companies.   The  average  return   on  capital                                                                    
     employed is 14 percent.]                                                                                                   
But what does a  14 percent return on capital mean?   It does not                                                               
mean 14 percent  return on shareholders' equity  unless the North                                                               
Slope  producers  choose to  finance  their  operations with  100                                                               
percent equity  - the most expensive  form of capital.   It means                                                               
some  rate higher  than 14  percent and  possibly as  high as  46                                                               
percent (even  higher), in  light of  the federal  loan guarantee                                                               
available on  up to 80  percent of the  debt used to  finance not                                                               
only a gas  pipeline, but also North  Slope production operations                                                               
and a  new gas treatment  plant to be built  at Prudhoe Bay.   We                                                               
turn to another  graphic to demonstrate what a  14 percent return                                                               
on capital may mean for an Alaska natural gas pipeline project:                                                                 
How Are Investments Made?                                                                                                   
               X%  Debt (cheap)                                                                                                 
          +    Y%  Equity (expensive)                                                                                         
                    =    100% Capital                                                                                       
If Capital Earns 14%, How Much Does Equity Earn?                                                                              
Debt Is Repaid At Cost                                                                                                        
               0%   Debt                                                                                                        
          +    100% Equity                                                                                                    
          =    14% Return on Equity                                                                                           
               50% Debt at 6%                                                                                                   
          +    50% Equity                                                                                                     
          =    22% Return on Equity                                                                                           
               80% Debt at 6%                                                                                                   
          +    20% Equity                                                                                                     
                     =   46% Return on Equity                                                                               
We are accustomed to hearing  that an Alaska natural gas pipeline                                                               
project  is a  high-risk  project,  entitled to  a  high rate  of                                                               
return, but some may argue that  the rate of return allowed under                                                               
this  legislation  is  too  rich.    Why?    First,  the  federal                                                               
government has significantly  reduced the risks and  costs of the                                                               
project.   The  federal government  will provide  loan guarantees                                                               
for the  project, allow accelerated depreciation  of the pipeline                                                               
over  seven  years rather  than  fifteen  years, and  extend  tax                                                               
credits for  the new gas treatment  plant to be built  at Prudhoe                                                               
Second, the majority of gas  filling this pipeline will come from                                                               
the  proven  reserves at  Prudhoe  Bay.    Prudhoe gas  has  been                                                               
explored for  (and found),  developed, and  is being  produced at                                                               
the rate  of 8 billion cubic  feet per day (bcf)  though that gas                                                               
is now being  reinjected into the ground.   Production at Prudhoe                                                               
Bay should not  be considered high-risk when compared  to many of                                                               
the risks voluntarily undertaken by  large oil and gas companies.                                                               
Yet the  reward - the  return -  included in this  legislation is                                                               
based on  average returns  earned by  companies that  among other                                                               
things  invest  in  exploration   or  wildcat  operations  -  and                                                               
sometimes lose  it all, not just  the return on capital,  but the                                                               
capital itself.                                                                                                                 
In fairness,  it must  be said  that the  rate of  return allowed                                                               
under  this   legislation  may  encompass   not  only   the  high                                                               
exploration  risk  faced  by vertically-integrated  oil  and  gas                                                               
companies, but  the relatively low  returns those  same companies                                                               
earn  on  certain downstream  operations.    Still, we  think  it                                                               
strikes the  right balance, and, in  fact, will be viewed  as too                                                               
generous by some when they  recognize that the Administration may                                                               
be  limited  in its  ability  to  enforce  the lessees'  duty  to                                                               
develop and  market gas where the  return on equity is  less than                                                               
46 percent.                                                                                                                     
For those  who see  the returns discussed  today as  not generous                                                               
enough, remember that the administration  will have discretion in                                                               
selecting  the  sample  group  of oil  and  gas  companies  whose                                                               
returns are included in the simple  average of returns and it may                                                               
choose  to  use  only  upstream  companies,  or  only  production                                                               
companies, or  any other grouping of  companies - as long  as the                                                               
companies are  oil and gas companies  - in getting to  a fair and                                                               
equitable result under the particular facts then at hand.                                                                       
3:51:05 PM                                                                                                                    
Some  will also  argue  that  the uncertainty  as  to future  gas                                                               
prices imposes a level of  risk not adequately compensated for by                                                               
the  returns built  into this  legislation.   Their argument  may                                                               
have been well founded in prior  times.  In prior times, abundant                                                               
supply and  slack demand  made for modest  commodity prices.   In                                                               
prior times - in fact, in  1998 when the Stranded Gas Development                                                               
Act first became law, the only  project then envisioned was a LNG                                                               
project,  without a  possible Jones  Act  exemption, and  without                                                               
possible benefits  of tax exempt  status.  In prior  times, there                                                               
was  no  federal  loan guarantee  for  the  project,  accelerated                                                               
depreciation  for the  pipeline, or  tax  credits for  a new  gas                                                               
treatment plant at Prudhoe Bay.                                                                                                 
But let us look at the  current risk that future commodity prices                                                               
will  not cover  the estimated  costs for  an Alaska  natural gas                                                               
pipeline  project  including  a   regulated  rate  of  return  on                                                               
regulated assets and  an adequate return at the  wellhead for the                                                               
lessees'   gas.   We   could   examine  this   risk   using   the                                                               
administration's economic model developed  under the Stranded Gas                                                               
Act.  That  model has been built at significant  expense with the                                                               
assistance  of  outside expertise.    It  is tailor-made  for  an                                                               
Alaska natural gas pipeline project  and accounts for the volumes                                                               
of gas at  issue here, the market impacts  of introducing Alaskan                                                               
gas, the  estimated costs  of the project,  the effect  of future                                                               
supply  and demand  on commodity  prices, and  the time  value of                                                               
money, among  other things.  Unfortunately,  the administration's                                                               
model is  confidential at  this time and  neither its  inputs nor                                                               
outputs  can be  disclosed in  this hearing.   However,  publicly                                                               
available data can provide a rough  sense of whether the range of                                                               
uncertainty surrounding future gas  prices makes the minimum rate                                                               
of return included in this legislation inadequate.                                                                              
First, let's look  at publicly available forecasts  of future gas                                                               
prices.    We  mention  here   two  sets  of  forecasts,  one  by                                                               
government, one by industry.   The government forecasts come from                                                               
the  federal  Energy Information  Administration,  or  EIA.   The                                                               
industry forecasts come from the  American Gas Foundation.  There                                                               
are  limitations on  comparing these  forecasts to  the costs  we                                                               
will discuss  in a moment -  imperfect matches on the  time value                                                               
of money  and the location of  gas sales, among others  - but the                                                               
comparison will allow you to get  a rough sense of the difference                                                               
between projected  revenues and  projected costs on  average over                                                               
time. A single page from  the American Gas Foundation forecast is                                                               
included here,  and additional  materials from  both the  EIA and                                                               
American  Gas  Foundation  are  included  at  the  end  of  these                                                               
prepared remarks:                                                                                                               
3:53:41 PM                                                                                                                    
[Insert AGF graph of actual and projected natural gas prices]                                                                   
As you  can see,  gas prices are  expected to  exceed $4.50/mmbtu                                                               
under any scenario.                                                                                                             
Next,  we turn  to data  the  three largest  North Slope  lessees                                                               
released on costs, which include  - if memory serves correctly, a                                                               
12  percent return  on equity  invested in  the pipeline  itself.                                                               
After these  North Slope  lessees spent  $125 million  studying a                                                               
gas pipeline  project, their best  estimate was that  the average                                                               
toll covering a new gas treatment  plant at Prudhoe Bay, new pipe                                                               
not only to  Alberta, but all the way to  Chicago, and extraction                                                               
facilities for  the removal of  valuable gas liquids  would total                                                               
$2.39/mcf. With the  +/- 20 percent uncertainty  modeled by these                                                               
lessees, $2.39/mcf became a range  of $1.90 - $2.85/mcf, as shown                                                               
in the attached exhibit:                                                                                                        
     [Insert exhibit on estimated costs]                                                                                        
In looking at  this exhibit, bear in mind that  $1.90 - $2.85/mcf                                                               
is not the  same as $1.90 - $2.85/mmbtu, and  mmbtu's are how gas                                                               
is sold.   Prudhoe Bay  and Pt. Thomson  gas is rich  in liquids,                                                               
and contains  more than  1,000 btus  per cubic foot.   We  do not                                                               
know exactly how  much more. That information is  not public, but                                                               
at  1,070  btus/cf,  the  range   for  tolls  drops  to  $1.78  -                                                               
$2.66/mmbtu.   At  1,120 btus/cf,  the range  for tolls  drops to                                                               
$1.70 - $2.54/mmbtu.  And, to  repeat, that range covers a +/- 20                                                               
percent  uncertainty and  already includes  profit on  the lion's                                                               
share of project costs.                                                                                                         
Is  $1.70  -  $2.54/mmbtu  or  $1.78 -  $2.66/mmbtu  or  $1.90  -                                                               
$2.85/mcf the right range for project  costs?  We cannot tell you                                                               
in  total,  in   public.    But  we  can  tell   you  that  those                                                               
calculations were made by the  lessees before tax credits for the                                                               
gas  treatment plant,  federal loan  guarantees, and  accelerated                                                               
depreciation  on the  pipeline  became available,  and the  range                                                               
should drop  on that account.   The calculations also  assume new                                                               
pipe would  be built all the  way to Chicago. Yet  more probably,                                                               
Alaska gas will  travel from Alberta to the Lower  48 in existing                                                               
pipelines  and  expansions  of   existing  pipelines,  a  cheaper                                                               
In fairness,  we mention that these  cost-savings undoubtedly are                                                               
offset to  some degree by  increased steel prices.   But remember                                                               
the cost  range given for  tolls already  includes a return  - or                                                               
profit  - for  the  pipeline, facilities  for  the extraction  of                                                               
NGLs, and  the new gas treatment  plant at Prudhoe Bay.   You may                                                               
want to  ask one of the  lessees here today, but  my recollection                                                               
is that  their figures included repayment  of debt at cost  - and                                                               
that would be a higher cost  than available with the federal loan                                                               
guarantees -  and a return on  equity for regulated assets  at 12                                                               
percent per year.                                                                                                               
So what  is the bottom line?   Prices are expected  to average in                                                               
excess of  $4.50/mmbtu on  costs of less  than $3.00/mmbtu.   And                                                               
the  difference  between  prices   and  costs  is  indicative  of                                                               
wellhead value.   Again, we caution you this is  very rough math.                                                               
The real math  we must keep confidential, but we  are not here to                                                               
mislead you today.                                                                                                              
One criticism  that has been  levied at the  proposed legislation                                                               
is that it is based on  forecasts and estimates and that is true;                                                               
we  cannot  know the  future  in  advance  of  the future.    The                                                               
legislation   is  similar   in  this   regard  to   the  analysis                                                               
contemplated under  the Stranded  Gas Development Act,  AS 43.82,                                                               
and  the   analysis  performed  by  the   Department  of  Natural                                                               
Resources  when  examining  applications  for  royalty  reduction                                                               
under AS  38.05.180(j).   Oil and gas  companies also  base their                                                               
business  decisions   on  commodity  price  forecasts   and  cost                                                               
estimates for future  projects.  Forecasts and  estimates are the                                                               
way business is done by both industry and government.                                                                           
A second and related criticism is  that the state rather than the                                                               
lessees forecasts  prices and estimates costs  under the proposed                                                               
legislation.   However, the lessees have  repeatedly indicated in                                                               
other contexts  that they  will not  share their  price forecasts                                                               
with the state  or with each other and they  will not share their                                                               
gasline  economic   models  either.     They  have   shared  cost                                                               
information from  their $125 million  study and  that information                                                               
is reflected in the administration's gasline economic model.                                                                    
This legislation allows the administration,  if it so chooses, to                                                               
recognize lessees'  reticence to  share certain  information, not                                                               
force that  issue, but still  enforce the lessees'  obligation to                                                               
develop    and   market    gas   when    reasonably   profitable.                                                               
Additionally, the  Administration is already the  arbiter of when                                                               
the Prudhoe  Bay and Pt.  Thomson lessees must produce  gas. Both                                                               
the Prudhoe  Bay and Pt.  Thomson unit agreements state  that the                                                               
director of  the Division of  Lands -  that is the  Department of                                                               
Natural Resources, "is  vested with authority to  alter or modify                                                               
from time to  time the quantity and  rate of production...limited                                                               
to alteration or modification in the public interest...."                                                                       
3:59:39 PM                                                                                                                    
Otherwise stated, DNR  is the decision-maker now  and remains the                                                               
decision-maker  under this  legislation (subject,  of course,  to                                                               
reversal  by  the court  system  for  abuse of  discretion).  The                                                               
lessees may  not appreciate that  DNR rather than the  lessees or                                                               
the  court  system  is vested  with  primary  responsibility  for                                                               
decision-making  on  this  issue,  but   they  granted  DNR  that                                                               
authority  decades  ago when  they  signed  the unit  agreements.                                                               
This legislation does nothing to  alter the original bargain over                                                               
the party vested with control.                                                                                                  
Speaking  of  the court  system,  some  argue that  the  proposed                                                               
legislation  promotes litigation.   It  does not.   Understanding                                                               
exactly how this legislation works  should ease concerns.  First,                                                               
it lets the administration determine  whether it thinks there is,                                                               
in fact, a preexisting duty under  the State's oil and gas leases                                                               
and unit  agreements for  the lessees to  develop and  market gas                                                               
when  reasonably profitable.    If  the administration  concludes                                                               
such a  duty exists, it  can choose to  enforce that duty  or not                                                               
now  or later.   If,  say,  negotiations under  the Stranded  Gas                                                               
Development Act  reach an impasse, the  administration may choose                                                               
to  enforce  the  duty,  subject,  of  course,  to  finding  that                                                               
production  and marketing  of the  lessees' gas  would return  at                                                               
least a  reasonable profit to  the lessees.   The administration,                                                               
because of the Stranded Gas  Act negotiations, is already sitting                                                               
on  a  large  body  of  information  from  which  it  could  draw                                                               
conclusions  about  whether  a  gas  pipeline  project  would  be                                                               
"reasonably  profitable."   However, before  drawing conclusions,                                                               
it  is  apt to  wait  until  the  next  annual deadline  for  the                                                               
lessees'  submission of  their proposed  plan of  development for                                                               
the Prudhoe Bay unit.  Same thing for the Pt. Thomson unit.                                                                     
However, I'll continue  with the Prudhoe Bay unit  as my example.                                                               
So, to  repeat, before  drawing conclusions, DNR  is apt  to wait                                                               
until the  next annual  deadline for  the lessees'  submission of                                                               
their proposed plan of development for  the Prudhoe Bay unit.  Or                                                               
maybe  DNR would  immediately send  a letter  to the  Prudhoe Bay                                                               
lessees,  advising them  that when  their next  proposed plan  of                                                               
development   is  up   for  review,   DNR  intends   to  make   a                                                               
determination  on whether  development and  marketing of  Prudhoe                                                               
Bay gas  would be  reasonably profitable.   In either  case, when                                                               
the   lessees  submit   their  next   annual  proposed   plan  of                                                               
development,   that  proposed   plan  together   with  supporting                                                               
documentation and other information  within the possession of DNR                                                               
or  requested  from  the  lessees   by  DNR  would  be  reviewed,                                                               
analyzed, and evaluated.  Assuming  the lessees' proposed plan of                                                               
development  did not  commit  to produce  and  market gas  within                                                               
seven  years, DNR's  decision  on the  proposed  plan would  most                                                               
likely  condition  approval  of  the  proposed  plan  on  a  firm                                                               
commitment to  develop and  market the  gas in  specified minimum                                                               
quantities by  a certain  date.  The  lessees could  accept DNR's                                                               
conditions and  proceed to develop  and market their gas  or they                                                               
could  reject the  conditions.   If  the  lessees rejected  DNR's                                                               
conditions,  their  current  plan  of  development  would  expire                                                               
putting the  unit in  default for  operating without  an approved                                                               
plan.   At this stage, litigation  is likely, but no  more likely                                                               
because reasonably profitable has been  defined as a minimum of a                                                               
14 percent  return on  capital than  because some  other standard                                                               
was  used by  DNR in  determining what  constitutes a  reasonable                                                               
4:03:17 PM                                                                                                                    
If there is litigation, the  lessees have suggested that they may                                                               
claim that  the legislation is  unconstitutional when  applied to                                                               
Prudhoe  Bay  and  Pt. Thomson  because  it  changes  preexisting                                                               
contract terms.  Again, we  think the legislation does not change                                                               
preexisting  contract   terms  and  will  be   constitutional  as                                                               
applied. As previously mentioned,  the legislation simply defines                                                               
in  a  reasonable way  terms  that  are currently  undefined.  It                                                               
provides guidance to DNR on what reasonably profitable means.                                                                   
But  I will  not, as  I sit  here today,  guarantee you  that the                                                               
Alaska Supreme  Court will find this  legislation constitutional.                                                               
Still,  we believe  that  the  legislation can  be  applied in  a                                                               
constitutional  manner, and  in any  case,  it is  a vehicle  for                                                               
sharing  with the  administration the  Legislature's thoughts  on                                                               
what constitutes reasonably profitable  and the time frame within                                                               
which a gas pipeline should be built.                                                                                           
On  a related  note, the  legislation's definition  of reasonably                                                               
profitable  is intended  to rise  and fall  independently of  the                                                               
seven-year  clock contained  in the  legislation.   Thus, on  the                                                               
chance  a  court  strikes  down  the  definition  of  "reasonably                                                               
profitable" provided  in this legislation  and instead  uses some                                                               
other  definition that  is nonetheless  met by  the facts  of the                                                               
case, the  seven year  clock still  runs from  the date  of DNR's                                                               
initial determination.   Hence,  lessees are encouraged  to spend                                                               
their time  after issuance  of DNR's  determination working  on a                                                               
gas  pipeline project  rather  than  litigating, particularly  if                                                               
those  lessees  estimate  project  profits that  would  meet  any                                                               
court-imposed standard of "reasonably profitable."                                                                              
Before closing,  the seven-year  clock should  be discussed  in a                                                               
little more detail.   Seven years is the period  two of the three                                                               
gasline  project proponents  tell  us they  need  to bring  North                                                               
Slope gas to  market.  A longer time period  could be included in                                                               
this  legislation  to  encompass  the preferences  of  the  third                                                               
project  proponent. However,  time is  money  - a  lot of  money.                                                               
Every  year's  delay  costs  the  State  and  its  municipalities                                                               
hundreds of  millions of  dollars per  dollar of  wellhead value.                                                               
At current gas prices, the cost  of each year's delay will exceed                                                               
$1 billion and could exceed $2 billion.                                                                                         
What  happens then,  if the  lessees  use their  best efforts  to                                                               
develop and  market the gas in  seven years, but for  some reason                                                               
all  of us  can  sympathize with,  it takes  them  eight or  nine                                                               
years?  First, the state  and municipalities are out the hundreds                                                               
of millions or billions of  dollars regardless of good intent and                                                               
unforeseeable circumstances.   Second,  the state can  choose not                                                               
to pursue  remedies that  might otherwise  be available.   Third,                                                               
the lessees are  sure to argue force majeure or  "Acts of God," a                                                               
term that  is already  defined under  existing agreements  and in                                                               
the unit regulations.                                                                                                           
In summary, this legislation does  not create a new obligation if                                                               
one does not already exist.   It does not create new remedies for                                                               
breach  of existing  obligations.   It  simply defines  undefined                                                               
terms  in  both  old  and  new   oil  and  gas  leases  and  unit                                                               
agreements,  rather  than  leaving  those  definitions  to  other                                                               
branches of government.  It  gives the administration guidance on                                                               
a tool  it already has  and can choose to  use or not  in getting                                                               
North Slope  gas to market.   And if and when  the Administration                                                               
chooses to use  that tool, it sets a seven-year  clock on getting                                                               
gas  to market.   We  believe the  legislation is  reasonable and                                                               
appropriate for the current circumstances.                                                                                      
4:06:58 PM                                                                                                                    
CHAIR WAGONER asked if HB 71 changes the commissioner's duties.                                                                 
MS.  ROBSON   replied  no.  The  commissioner   already  has  the                                                               
authority  to modify  or  alter from  time to  time  the rate  of                                                               
production from both  the Prudhoe Bay and unit  agreement. He can                                                               
do that  through annual  plans of  development submitted  for the                                                               
two  units.  He  would  now   have  a  standard  for  "reasonable                                                               
profitability" to follow.                                                                                                       
4:08:21 PM                                                                                                                    
SENATOR GUESS asked how she decided  the best approach to use was                                                               
a 10-year simple average.                                                                                                       
MS.  ROBSON replied  that  she  has been  working  with Econ  One                                                               
Research,  Inc. on  a  number  of gas  pipeline  matters and  the                                                               
decision was that a period of  time should be used to reflect the                                                               
highs and  lows that oil  and gas  companies experience to  get a                                                               
representation  of  the  returns   on  capital  that  they  would                                                               
typically earn.  Also, she looked  at the definition  of stranded                                                               
gas at  the very  end of the  Stranded Gas Act  and it  refers to                                                               
using prevailing costs  and prices. It is an average  over a long                                                               
enough period  of time to  accurately reflect typical  returns on                                                               
capital  for  the  largest  and   most  profitable  oil  and  gas                                                               
companies in the world.                                                                                                         
4:09:49 PM                                                                                                                    
SENATOR GUESS said  the way page 4 is written,  if you don't have                                                               
a large  enough sample  size, your average  could be  skewed. She                                                               
asked Ms. Robson  if she had a reason for  using a minimum number                                                               
of companies.                                                                                                                   
MS. ROBSON replied  that the commissioner of DNR  was vested with                                                               
the  discretion  to come  up  with  a  methodology he  felt  best                                                               
reflects the appropriate measure for profitability at any time.                                                                 
4:10:51 PM                                                                                                                    
SENATOR GUESS  asked her  to explain  the thought  process behind                                                               
overall companies'  return on capital  versus specific  return on                                                               
gas capital.                                                                                                                    
MS. ROBSON  replied the she looked  for a standard that  could be                                                               
ascertained from publicly  available information. Many vertically                                                               
integrated  oil  and gas  companies  do  not  have that  kind  of                                                               
breakdown  and  that  information  is  not  necessarily  publicly                                                               
4:12:03 PM                                                                                                                    
SENATOR ELTON  said Spencer Hosie  talked about access  the state                                                               
has to risk/reward  scenarios that are held by  the producers and                                                               
asked what information she is able to get from producers.                                                                       
MS. ROBSON  replied that there  may be a difference  between what                                                               
you  can obtain  legally  and practically.  The lease  agreements                                                               
have  existing  language  that   entitles  the  state  to  obtain                                                               
information. It's  well recognized that  the lessees do  not want                                                               
to  provide  that information  and  at  various times,  different                                                               
administrations  have  been reticent  to  ask  for it.  So,  this                                                               
legislation   allows  the   administration  to   proceed  without                                                               
information and an incentive is  created for the lessees to share                                                               
certain  information  with the  administration  if  it feels  its                                                               
internal documents will paint a different picture.                                                                              
4:13:41 PM                                                                                                                    
SENATOR ELTON said  it still sounds like she  is saying producers                                                               
can share  their information as  long as it supports  their case,                                                               
but  they  may not  be  required  to share  if  it  would not  be                                                               
beneficial to their interests.                                                                                                  
4:13:55 PM                                                                                                                    
MS.  ROBSON replied  that  she wanted  to  distinguish the  legal                                                               
obligation, which authority she  believes the administration has,                                                               
to  assert,  because she  has  been  involved in  enough  royalty                                                               
litigation to know that it is  not always easy to get information                                                               
from oil and gas companies.                                                                                                     
4:14:52 PM                                                                                                                    
SENATOR  DYSON asked  what  remedy investors  have  if the  state                                                               
forced them into a deal and it "went south."                                                                                    
4:15:53 PM                                                                                                                    
MS.  ROBSON replied  there is  a recognition  that a  party other                                                               
than  the  lessees must  make  the  decision  about the  duty  to                                                               
develop and  market, because otherwise  the obligation  could not                                                               
be  enforced and  effectively does  not exist.  Potential parties                                                               
that  could   be  the  decision-maker  are   the  administration,                                                               
judiciary  and  the legislature.  However,  she  believes DNR  is                                                               
already the one.                                                                                                                
4:17:02 PM                                                                                                                    
SENATOR DYSON  asked what the  current definition  of "reasonably                                                               
profitable" is without this bill.                                                                                               
MS. ROBSON  replied that that would  be left to DNR  to determine                                                               
on  a  case-by-case  basis.  Lessees   have  to  annually  submit                                                               
proposed  plans for  development and  if DNR  chose to  press the                                                               
issue of  a failure to  include development and marketing  of the                                                               
gas  within a  reasonable  timeframe, it  could evaluate  whether                                                               
production  and  marketing  would be  reasonable  profitable.  It                                                               
would   then   look   for  an   appropriate   standard   in   the                                                               
circumstances. Since that process has  not been gone through, she                                                               
could not  tell them what  standard would be used.  She suggested                                                               
that the DNR  or the Department of Law perform  that analysis and                                                               
independently see what they think  is the appropriate standard to                                                               
exercise in  trying to enforce a  duty to develop and  market. If                                                               
the Legislature passes this bill,  it has guidelines and lets the                                                               
administration  know that  it is  interested in  seeing the  duty                                                               
enforced and what  it thinks is a reasonable rate  of return. She                                                               
also  suggested  that the  administration  look  at a  number  of                                                               
different standards  and write an  opinion that covers  all those                                                               
4:20:10 PM                                                                                                                    
CHAIR WAGONER  said a  lot of  people have  been talking  about a                                                               
reserves  tax to  force development  and asked  what affect  this                                                               
legislation would have on the option of levying a reserves tax.                                                                 
MS. ROBSON  replied that this wouldn't  impact continuing efforts                                                               
either by  the legislature or  by voter initiative to  go forward                                                               
with a gas reserves tax. Typically  a gas reserves tax is thought                                                               
of as a property tax and  typically property can only be taxed if                                                               
it has value.                                                                                                                   
     If  gas  is valueless  on  the  North Slope,  then  the                                                                    
     property tax  on something that  is valueless  might be                                                                    
     zero. This might be used  as an indicator of whether or                                                                    
     not there  is, in  fact, value to  the North  Slope gas                                                                    
     reserve,  but, again,  it does  not directly  relate to                                                                    
     and has not  been intended to either  advance or thwart                                                                    
     any effort for those  parties interested in progressing                                                                    
     a reserves tax to go forward with their efforts.                                                                           
4:21:28 PM                                                                                                                    
SENATOR  STEDMAN asked  why the  return on  capital was  selected                                                               
versus some other measure.                                                                                                      
MS.  ROBSON  replied that  oil  and  gas  lessees have  told  her                                                               
frequently that  they examine and compare  potential projects for                                                               
investment based on  a return on capital or an  assumption of 100                                                               
percent equity.                                                                                                                 
     It  is not  how they  actually invest  and make  money.                                                                    
     They will  typically use at least  some percentage debt                                                                    
     and so  their return on  equity rises above  the return                                                                    
     on capital used in  making decisions on investment. So,                                                                    
     this was done  in recognition of some  of the practices                                                                    
     employed by oil and  gas companies in making investment                                                                    
     However,  in  that  regard  I  need  to  note  that  if                                                                    
     companies do,  in fact, choose  to compare  projects or                                                                    
     potential  projects  based  on the  assumption  of  100                                                                    
     percent  equity, that  assumption may  or may  not have                                                                    
     been appropriate as of September  2004. But by November                                                                    
     of  2004  the  United   States  government  had  passed                                                                    
     legislation  providing   up  to  an  80   percent  loan                                                                    
     guarantee  to the  tune  of $18  billion  to make  this                                                                    
     project possible.  And with  80 percent  debt available                                                                    
     for  this  project,  one  has  to  ask  whether  it  is                                                                    
     appropriate for a decision to  be made on whether to go                                                                    
     forward  with this  project on  the  assumption of  100                                                                    
     percent equity  when that's the most  expensive form of                                                                    
4:24:11 PM                                                                                                                    
SENATOR STEDMAN  asked if her  chart on capital returns  for each                                                               
company was for the entire company or just the gas division.                                                                    
MS. ROBSON replied that they are company-wide overall returns.                                                                  
4:24:46 PM                                                                                                                    
SENATOR  STEDMAN  asked if  the  ACRS  is  factored in  with  the                                                               
department's  analysis   along  with  the  lower   interest  rate                                                               
assumption on debt for each of the companies.                                                                                   
MS.  ROBSON  replied  that  the numbers  she  used  are  publicly                                                               
reported return on  capital employed. "There was no  effort to go                                                               
in and manipulate these numbers.  I believe they are as published                                                               
in 'Value Line.'"                                                                                                               
SENATOR STEDMAN asked if she just  used the average tax rates for                                                               
MS. ROBSON  replied that the  economic modeling would be  used to                                                               
determine  the rates  of profitability  for specific  projects to                                                               
compare  them  to the  simple  average  of companies'  return  on                                                               
capital employed.                                                                                                               
     If I  understand that correctly,  at least  with regard                                                                    
     to  the  modeling  that  has   been  done  now  by  the                                                                    
     administration for a gas pipeline,  I believe there has                                                                    
     been extensive  efforts to make  sure that  tax burdens                                                                    
     and  tax  benefits  are accurately  reflected  in  that                                                                    
CHAIR WAGONER thanked  Ms. Robson for her  comments and announced                                                               
that he would take public comments next.                                                                                        
4:26:45 PM                                                                                                                    
TADD  OWENS,  Executive  Director, Alaska  Resources  Development                                                               
Council (RDC), said he has  serious concerns with CSHB 71(FIN)am,                                                               
which was  radically altered  on the House  floor last  week. New                                                               
language requiring standards for  interpreting existing state oil                                                               
and gas leases and unit agreements  signifies to him that a major                                                               
policy  decision was  made on  House  floor after  10 minutes  of                                                               
debate and with no committee  hearing. Neither the public nor the                                                               
directly  impacted  stakeholders  were given  an  opportunity  to                                                               
comment. RDC  fears that  the decisions may  change the  terms of                                                               
existing state oil and gas leases and unit agreements.                                                                          
     If one concedes that this  argument is even a debatable                                                                    
     point, then  one must also  concede the bill  is likely                                                                    
     to  have a  detrimental effect  on the  state's ongoing                                                                    
     negotiations  with   those  parties  that   have  filed                                                                    
     applications under the Stranded Gas Development Act.                                                                       
If  a  lessee questions  the  constitutionality  of the  bill  or                                                               
disagrees   with  the   state's  interpretation   of  "reasonable                                                               
profitability" or  other terms, litigation could  follow and that                                                               
does not bring  Alaska closer to commercializing  its natural gas                                                               
MR. OWENS  said this bill  is inconsistent with the  state's goal                                                               
of   identifying   and   encouraging  the   best   possible   gas                                                               
commercialization project  and in the end  may create uncertainty                                                               
rather than establishing certainty.                                                                                             
4:30:01 PM                                                                                                                    
LARRY HOULE, Alaska Support Industry  Alliance, said the Alliance                                                               
supported the  bill until it was  amended on the House  floor and                                                               
stressed that it must be entirely removed.                                                                                      
Most apparent is  that the language is  totally inconsistent with                                                               
and contrary  to free market  principles. He asked  the committee                                                               
to  examine  whether it  is  the  proper  role of  government  to                                                               
dictate  to  any  industry  when  a  market  exists  and  what  a                                                               
reasonable rate  of return should  be. No other  state government                                                               
exercises that latitude and this would set precedent.                                                                           
MR. HOULE said:                                                                                                                 
     You  need  to  know  that  the  construction  community                                                                    
     represented  by the  Alliance  membership is  extremely                                                                    
     concerned  with  this   increasing  amount  of  adverse                                                                    
     legislation   that  appears   to   be  coming   through                                                                    
     administrative orders and out  of Juneau these days. We                                                                    
     are concerned  because we continue to  see every effort                                                                    
     to single  out the State of  Alaska's largest industry,                                                                    
     an industry  that employs the  bulk of  our membership.                                                                    
     Even   today    several   Alliance    contractors   are                                                                    
     experiencing incredible slow-downs  specifically in the                                                                    
     area  of  engineering  -  all  due  to  the  Governor's                                                                    
     aggregation of  the Prudhoe  Bay satellites.  This type                                                                    
     of legislation before us in  HB 71 is nothing more than                                                                    
     an add-on.                                                                                                                 
4:34:41 PM                                                                                                                    
KEN CONRAD,  Senior Vice President,  BP Alaska,  strongly opposed                                                               
Amendment 1 to  HB 71, but liked  the rest of the  bill and would                                                               
support it if  the amendment were to be deleted.  He related that                                                               
the amendment  was passed without  prior discussion  or committee                                                               
work and  sets an ugly precedent  for gas and oil  development in                                                               
Alaska - and for business in  general. It seeks to alter existing                                                               
contracts entered  between the state  and leaseholders  and would                                                               
make the  DNR the  all-powerful decision-maker  regarding project                                                               
development,   determining  what   level   of  profitability   is                                                               
acceptable regardless of the risks involved.                                                                                    
     It  suggests  that   government  and  government  alone                                                                    
     should be able to  force investors into a multi-billion                                                                    
     dollar project that  is by all accounts  a project with                                                                    
     significant  risk. Of  course, the  amendment does  not                                                                    
     suggest  compensating investors  when the  government's                                                                    
     assumptions  in  its  all-knowing  economic  model  are                                                                    
     wrong.  The  amendment  hands  the  critical  roles  of                                                                    
     investment evaluation and  field regulation directly to                                                                    
     the   commissioner  of   the   Department  of   Natural                                                                    
     Resources in an entirely one-sided process....                                                                             
     The HB  71 amendment  violates basic state  and federal                                                                    
     constitutional    prohibitions   against    legislative                                                                    
     impairment   of  contracts.   This  is   a  fundamental                                                                    
     principle intended to insure  the sanctity of contracts                                                                    
     and is a cornerstone of the U.S. economic system....                                                                       
     The amendment seeks to strip  away the lessee's ability                                                                    
     to evaluate  and act on investment  decisions. Changing                                                                    
     the rights  and obligations of the  lessees years after                                                                    
     the  contract   was  entered  fails  this   most  basic                                                                    
     constitutional  premise.  This  legislative  effort  to                                                                    
     alter contracts after the fact  sends a chilling signal                                                                    
     to  industry  at the  very  point  in time  when  we're                                                                    
     looking  for clarity  and durability  through a  fiscal                                                                    
     contract for gas development.                                                                                              
     The  amendment  also  violates  fundamental  government                                                                    
     separation  of power  principles by  infringing on  the                                                                    
     role  of courts  in  adjudicating  contracts. We  would                                                                    
     suggest the chairman request  a balanced and thoughtful                                                                    
     legal evaluation  of this bill  from the  Department of                                                                    
     Given  the clear  constitutional issues  raised, it  is                                                                    
     safe to assume  that any effort to  actually invoke the                                                                    
     amendment to  challenge existing lease  contracts would                                                                    
     spark a  marathon of litigation.  As a matter  of fact,                                                                    
     some have suggested this bill  be renamed "The Lifetime                                                                    
     Employment For Lawyers Act...."                                                                                            
MR.  KONRAD   explained  that   there  would   be  constitutional                                                               
challenges through state courts,  then more litigation as similar                                                               
issues are  addressed through a  variety of federal  courts. "And                                                               
while  the  lawyers are  doing  fine,  the gas  project,  itself,                                                               
4:41:33 PM                                                                                                                    
He  said the  amendment is  in stark  contrast to  the sound  and                                                               
thoughtful  approach   that  was  previously  developed   by  the                                                               
Legislature  and supported  by  industry under  which in  January                                                               
2004,  BP,  ConocoPhillips  and ExxonMobil  submitted  the  first                                                               
Stranded Gas Act application received by the state.                                                                             
     Just two months after the  U.S. Congress passed the gas                                                                    
     pipeline    legislation,    BP,   ConocoPhillips    and                                                                    
     ExxonMobil  submitted  a   detailed  and  comprehensive                                                                    
     proposal to  the state that  would allow a  gas project                                                                    
     to advance to the next  phase of activity. The proposal                                                                    
     embraced  the   Governor's  desire  for   direct  state                                                                    
     participation in  the project. The opportunity  for gas                                                                    
     commercialization   is   at  our   doorstep.   Detailed                                                                    
     discussions with the state are,  of course, ongoing. It                                                                    
     should be  clear that  we are  doing exactly  what that                                                                    
     legislation intended  - exactly. Negotiating  towards a                                                                    
     clear  and durable  fiscal contract  that enhances  the                                                                    
     prospects   for  a   commercially  viable   Alaska  gas                                                                    
     pipeline project....                                                                                                       
     In  the  short  period  of time  since  this  amendment                                                                    
     crawled out  of the shadows  on April 28, we've  had an                                                                    
     opportunity to discuss with  many legislators what this                                                                    
     amendment  actually means.  It  has  become very  clear                                                                    
     that  few members  in the  House  appreciated the  full                                                                    
     meaning  or   the  wide-ranging  consequences   of  the                                                                    
     amendment when the vote was  held. This is not entirely                                                                    
     surprising  given that  there was  no prior  debate, no                                                                    
     prior discussion,  no prior  committee work  in advance                                                                    
     of the very sudden House floor vote....                                                                                    
     Mr. Chairman,  members of the committee,  the amendment                                                                    
     to HB 71 is  an unworkable, unhelpful, unconstitutional                                                                    
     approach that will  at best set the stage  for years of                                                                    
     litigation.   It   creates   an   immensely   dangerous                                                                    
     precedent  that has  implications for  all leases,  all                                                                    
     contracts,   including   the  gas   pipeline   contract                                                                    
     currently   under  negotiation.   For  all   of  Alaska                                                                    
     industry, the bill casts serious  doubt on the sanctity                                                                    
     of any contract  at any time. I urge  this committee to                                                                    
     strip this amendment from the otherwise sound bill....                                                                     
4:46:27 PM                                                                                                                    
SENATOR ELTON thanked him for  his testimony and remarked that as                                                               
a former newspaper editor, a  couple of things bothered him about                                                               
his  language  - "Are  we  still  in  America? Ugly  amendment  -                                                               
cavalier,  shortsighted, an  amendment  that crawled  out of  the                                                               
He referred to the last paragraph on page 1 of Mr. Konrad's                                                                     
testimony and suggested the following rewrite:                                                                                  
     It  would  make  the  resource   owner  a  partner  and                                                                    
     decision-maker   regarding   project   development   by                                                                    
     allowing  the resource  owner  to  help determine  what                                                                    
     level of  profitability is  acceptable given  the risks                                                                    
SENATOR ELTON asked Mr. Konrad if he would agree with that.                                                                     
MR. KONRAD replied that he didn't agree with the rewrite. He                                                                    
wanted to go back to the terms of the existing contracts.                                                                       
4:49:00 PM                                                                                                                    
SENATOR ELTON said when he reads the leases, he interprets them                                                                 
to give the state certain rights as a resource owner and asked                                                                  
how he thought the bill contravened that.                                                                                       
4:49:37 PM                                                                                                                    
MR. KONRAD clarified:                                                                                                           
     We have a contract. We  have mutually agreed over 25 to                                                                    
     30 years that  those contracts are being  met and we're                                                                    
     saying let's not change  the contract. The commissioner                                                                    
     of Natural Resources currently has  the ability to make                                                                    
     his  own   judgments  around  that.  The   courts  will                                                                    
     adjudicate whose  opinions around  the contract  may be                                                                    
     right  or  wrong,  but  to   date  there  has  been  no                                                                    
     conflict. If there ever is  a conflict, we would see it                                                                    
     as the  role of the  judiciary to settle  that dispute,                                                                    
     not the  role of the  Legislature to presuppose  that a                                                                    
     dispute is  actually going  to occur  or to  create the                                                                    
     probability for a dispute.                                                                                                 
4:50:40 PM                                                                                                                    
SENATOR ELTON observed that he and Mr. Konrad might                                                                             
fundamentally disagree:                                                                                                         
     But it seems clear that  there are obligations that the                                                                    
     leaseholder has  that the state may  not have exercised                                                                    
     as  a resource  owner in  the past.  But, I'm  not sure                                                                    
     that you help your argument  by using some of the terms                                                                    
     that  you  did  in  the course  of  your  presentation.                                                                    
     Because they were very loaded  words; they didn't speak                                                                    
     to the language  in the leases and it just  seems to me                                                                    
     that the  loaded words  may have  been designed  to not                                                                    
     talk  about policy,  but to  stigmatize lease  language                                                                    
     that you didn't....                                                                                                        
MR. KONRAD clarified that the language in the leases is fine.                                                                   
     I'm not suggesting  in any way shape or  form to change                                                                    
     that. What we're  proposing is that this  is a backdoor                                                                    
     way  to try  to  change  that at  the  very time  we're                                                                    
     contemplating  a 35-year  contract for  the development                                                                    
     of gas  to suggest that some  subsequent legislature in                                                                    
     5 years, 10  years, 20 years, 30 years can  come in and                                                                    
     seek to  reinterpret that contract is  problematic from                                                                    
     an  investor's  point of  view.  The  entirety of  what                                                                    
     we're  trying to  seek here  is clarity  and durability                                                                    
     and predictability.                                                                                                        
4:52:03 PM                                                                                                                    
SENATOR GUESS  asked him to  expand on how the  amendment changes                                                               
the contract.                                                                                                                   
4:52:48 PM                                                                                                                    
MR. KONRAD  replied that it  doesn't literally change  it; that's                                                               
not allowed, but it  is an indirect effort to tell  DNR to push a                                                               
button on  a model to say  whether the project should  go forward                                                               
or not and  that's not in the contract today.  The contract today                                                               
represents balanced and reasonable judgment.                                                                                    
4:53:48 PM                                                                                                                    
SENATOR SEEKINS said  they were now talking  about contracts that                                                               
were negotiated  some time ago  when he  wasn't around and  he is                                                               
assuming that they  were negotiated by both parties  and this was                                                               
not a take it or leave it contract.  He asked if the terms of the                                                               
lease negotiated openly between both parties.                                                                                   
MR.  KONRAD replied  that  he  wasn't here  then  either, but  he                                                               
believed the terms were set out and industry fit around them.                                                                   
4:54:31 PM                                                                                                                    
PATRICK COUGHLIN, Senior Counsel,  BP Alaska, responded that that                                                               
precise question was considered by  Judge Carpeneti in one of his                                                               
decisions regarding  the meaning of  this lease. Here's  what his                                                               
decision said:                                                                                                                  
     At the  outset it should  be noted that in  the typical                                                                    
     oil and gas lease, the  lessee dictates the terms. This                                                                    
     case is different  from the typical case as  was in the                                                                    
     case of Davis Oil. The lease  form is "take it or leave                                                                    
     it" for  oil companies who  do business with  the State                                                                    
     of Alaska. Moreover, the contract  is an elaborate one,                                                                    
     which undertakes  to define  the respective  rights and                                                                    
     duties  of the  parties where  contracting parties  are                                                                    
     sophisticated, represented by  highly competent counsel                                                                    
     and have demonstrated that they  are capable of dealing                                                                    
     in the written  word. A court should be  hesitant to go                                                                    
     outside the  written contract in  search of  an implied                                                                    
     relationship. Given its authority  under the lease, the                                                                    
     state  was hardly  at the  mercy  of its  lessee as  is                                                                    
     sometimes the case.                                                                                                        
4:56:12 PM                                                                                                                    
SENATOR  SEEKINS  summarized  that   the  lease  agreements  were                                                               
drafted by  the state on  a "take it or  leave it" basis  and the                                                               
producers did not have an opportunity to define the terms.                                                                      
MR. COUGHLIN replied that was right.                                                                                            
SENATOR SEEKINS said  if any clarification of  terms is necessary                                                               
it wasn't  because the producers, themselves,  had an opportunity                                                               
to define or redefine them.                                                                                                     
MR. COUGHLIN replied that is correct.                                                                                           
SENATOR  SEEKINS asked  if the  effect  of this  amendment is  to                                                               
provide a  definition to a  term that has already  been contained                                                               
in an adhesion contract.                                                                                                        
MR. COUGHLIN replied:                                                                                                           
     It's my  view that the  words are in this  contract and                                                                    
     the  state drafted  them. The  state wasn't  some poor,                                                                    
     innocent  little  farmer  in   Kansas  that  was  taken                                                                    
     advantage  of by  an oil  company. The  term is  in the                                                                    
     contract  and   the  proper  place  to   determine  the                                                                    
     meaning, if there is a  dispute about this provision is                                                                    
     in the  court system. It's  not for the  Legislature to                                                                    
     decide 25 or 30 years after the fact...                                                                                    
SENATOR SEEKINS interrupted to say  that he understands that, but                                                               
wanted  to  know  if  there  was  a  definition  section  in  the                                                               
MR. COUGHLIN replied yes.                                                                                                       
SENATOR SEEKINS asked if this definition was provided.                                                                          
MR. COUGHLIN replied that it wasn't.                                                                                            
4:58:33 PM                                                                                                                    
SENATOR STEDMAN  said he was  still struggling with  tying return                                                               
on capital into a rate that  would stimulate or motivate a global                                                               
company  who  is  subject to  currency  exchanges  and  different                                                               
governmental requirements.                                                                                                      
MR.  KONRAD  replied that  return  is  a  function of  risk.  The                                                               
rewards go up for riskier projects.  It's not a simple average as                                                               
was proposed.                                                                                                                   
     At the  end of the  day, people need to  make judgments                                                                    
     around  the  risks  and   rewards  of  this  particular                                                                    
     project and  hopefully that balance will  be right and,                                                                    
     I think,  we've tried to  send a message as  clearly as                                                                    
     possible. We  think we're on  the doorstep  of actually                                                                    
     doing  this. We're  working very  hard to  bring it  to                                                                    
     reality. And  if we can  get that balance  right, we're                                                                    
     in the business of producing oil and gas....                                                                               
5:01:36 PM                                                                                                                    
SENATOR STEDMAN  asked if  his company  operates anywhere  in the                                                               
world that has  something implemented like this  proposal - where                                                               
the government  can come in and  do a calculation and  tell it to                                                               
develop or not to develop.                                                                                                      
MR.  KONRAD  replied  that  it is  unprecedented  in  the  United                                                               
States. Globally,  he is not  personally aware of any  that would                                                               
attempt to  boil it down to  this simple equation. He  offered to                                                               
get back to him with an example if he could find one.                                                                           
SENATOR ELTON said that it sounds  like he is suggesting that the                                                               
risk/reward analysis  be done  by the people  who hold  the lease                                                               
despite the fact that the leases say:                                                                                           
     The  lessee is  granted  the exclusive  right to  state                                                                    
     lands for  the sole  and only purposes  of exploration,                                                                    
     development,  production, processing  and marketing  of                                                                    
     oil, gas  and associated substances  produced therewith                                                                    
     and  of installing  pipelines and  structures to  find,                                                                    
     produce, save,  store, treat, process,  transport, take                                                                    
     care of and market all such substances.                                                                                    
He  asked  why  the  risk/reward analysis  stays  just  with  the                                                               
resource holder and why the owner  of the resource doesn't have a                                                               
role in making those determinations.                                                                                            
MR. KONRAD replied that  the owner does have a role  - he has the                                                               
power  to challenge  the lessee,  but  that hasn't  been done  to                                                               
     People act like we don't  want to do this project. Yet,                                                                    
     we're actually busting  a gut to make it  happen and we                                                                    
     feel like we're  on the doorstep of  actually making it                                                                    
     happen with a concrete  proposal. People are frustrated                                                                    
     that  30  years ago  a  project  didn't go  ahead.  The                                                                    
     reason it didn't go ahead was  because it cost $4 to $5                                                                    
     to get gas to market and gas was selling for $2....                                                                        
     It didn't make people  happy necessarily that it didn't                                                                    
     go ahead,  but that  was the reality.  As for  when the                                                                    
     risk/reward picture comes into  balance, we're going to                                                                    
     want to do  it. If the Department  of Natural Resources                                                                    
     ever  feels that  we're not  doing that,  the contracts                                                                    
     are there and they actually  have more freedom to raise                                                                    
     an issue if they feel so inclined.                                                                                         
SENATOR ELTON countered:                                                                                                        
     You can  respond to this or  not, but it just  seems to                                                                    
     me that section 1 and section  2 of this bill gives the                                                                    
     owner of the  resource the right to  participate in the                                                                    
     risk/reward  analysis  and  that   right  seems  to  be                                                                    
     implicit in the leases that you hold.                                                                                      
MR. KONRAD  replied it looks  like a simplistic push  the button,                                                               
get the answer out of a model as opposed to using good judgment.                                                                
5:05:30 PM                                                                                                                    
CHAIR WAGONER  asked if the  commissioner doesn't have  the right                                                               
already to define  what is "reasonably profitable"  and this just                                                               
puts it in statute.                                                                                                             
MR.  COUGHLIN  replied  once  the state  enters  into  a  private                                                               
contract, if  there is a  dispute about  what a term  means, both                                                               
sides go to court to present  what they think it means. This bill                                                               
fundamentally  says  the commissioner  gets  to  decide what  the                                                               
standard is  and to decide whether  or not the producers  have to                                                               
build the pipeline.  It fundamentally changes the  balance in the                                                               
5:08:02 PM                                                                                                                    
SENATOR SEEKINS said he thinks  the state should enforce existing                                                               
     If it has powers within  an agreement to enforce it, it                                                                    
     should do  so with  the full  power of  that agreement.                                                                    
     However, if  I'm asked whether  or not I  would support                                                                    
     giving  even   greater  power   or  authority   to  the                                                                    
     administrative  branch,  which   is  already  the  most                                                                    
     powerful administrative branch in  terms of its balance                                                                    
     of  power  of any  state  in  the  nation, I  would  be                                                                    
     compelled to say I'm not willing to do that.                                                                               
     It  basically   comes  down  to   me  that  I   have  a                                                                    
     fundamental  objection, Mr.  Chairman, to  a party  who                                                                    
     has  presented a  'take  it or  leave  it' contract  to                                                                    
     after execution  of that contract attempting  to define                                                                    
     terms  within  the  contract  especially  when  there's                                                                    
     already a definition section  within that contract. The                                                                    
     entire advantage  here, legal  advantage, was  with the                                                                    
     state when  they authored the lease  and they presented                                                                    
     it  on  a 'take  it  or  leave  it'  basis to  the  oil                                                                    
     companies. In that case,  fundamentally, I would wanted                                                                    
     to be treated as a  contractor, and I believe we should                                                                    
     be treated  as a  party to a  contract, any  terms that                                                                    
     need to be  defined relating to the  performance of the                                                                    
     lessee  would  properly be  defined  in  court, not  by                                                                    
     subsequent legislation....                                                                                                 
5:10:10 PM                                                                                                                    
SENATOR   STEDMAN   said   the  amendment   might   be   creating                                                               
motivational leverage, but  it seems odd that  a relationship has                                                               
been  built up  and over  30 or  40 years  and the  producers are                                                               
already interested. The timing seems odd.                                                                                       
JUDY BRADY,  Executive Director,  Alaska Oil and  Gas Association                                                               
(AOGA), agreed  that there are  a couple  of things that  are odd                                                               
about the  amendment. This is  the biggest pipeline in  the world                                                               
and the state is in the middle of negotiations now.                                                                             
     I  can't  tell you  how  very  clear  it is  that  when                                                                    
     anything you say, anything  the Governor says, anything                                                                    
     the Legislature says is carried  in every big financial                                                                    
     insider reporter  in the  world. People  are interested                                                                    
     in this pipeline, because if  this pipeline goes, other                                                                    
     things  are not  going to  go. If  this pipeline  goes,                                                                    
     pipe from  Japan or Korea is  going to be a  huge deal.                                                                    
     This  has  international  interest. When  an  amendment                                                                    
     comes on with  this kind of affect and it  comes on the                                                                    
     way  it did  -  from friends,  from  people I  consider                                                                    
     bright people  - so I know  they were trying to  do the                                                                    
     right thing - comes on the  way it did with no hearings                                                                    
     and people still have a  lot of questions. People don't                                                                    
     know how the  system works now. A lot  of the questions                                                                    
     are how  does this system  work now under the  terms of                                                                    
     these leases....                                                                                                           
She related that if Governor Hickel could have done something                                                                   
like this, he would have done it at the time the leases were                                                                    
     There  have been  four  serious attempts  to  do a  gas                                                                    
     pipeline.  Every time  the people  who  wanted it  done                                                                    
     believed it  was economic  and believes  the companies,                                                                    
     whoever  they  were,  were   dragging  their  feet.  If                                                                    
     someone could have done this  in the past legally, they                                                                    
     would have tried it and  of course now we'd either have                                                                    
     bankrupt companies or a pipeline that was half built.                                                                      
     We're at  a time for the  first time that I  can see in                                                                    
     the history  of this  state where we  really do  have a                                                                    
     chance  for  a  pipeline.  The  MacKenzie  pipeline  is                                                                    
     imploding because  people can't  get along  and they're                                                                    
     acting like  a bunch  of amateurs.  If we  start acting                                                                    
     like amateurs,  we are  going to  lose this  pipeline -                                                                    
     and if  there are people  who believe that  the company                                                                    
     interests are not aligned with  the state interests, if                                                                    
     the companies  pieces of gas up  here is not as  big as                                                                    
     they are other places, which  is not true, that's where                                                                    
     the interests align, because it's  so important to them                                                                    
     and so  important to  us. Then I  don't know  what they                                                                    
     could look at,  but they shouldn't do it  like this. It                                                                    
     shouldn't  be something  that was  passed  at the  last                                                                    
     minute  with  people  kind  of  giggling  about,  'Boy,                                                                    
     there's something  coming that's  really going  to hurt                                                                    
     you guys.' What  is that about? Why would  you go there                                                                    
     for  a  pipeline  this  big?   This  is  not  a  little                                                                    
     something that  is not  going to  make a  difference in                                                                    
     the world.  This is something  that is going to  make a                                                                    
     difference to  us for the  next hundred years.  This is                                                                    
     too important  to be treating  like some kind  of throw                                                                    
     away  gambit. I'm  not very  often really  unhappy with                                                                    
     something, but  I'm really  unhappy with  this -  as an                                                                    
     Alaskan  and  everything  else.  If  people  have  real                                                                    
     concerns,  they need  to treat  it as  a real  concern.                                                                    
     There need to  be hearings, people need to  know how it                                                                    
     works now....                                                                                                              
     The  way it  works  now -  it  was put  in  for a  good                                                                    
     reason. It was  put in to protect the  interests of the                                                                    
     state. When there are issues, it does go to court.                                                                         
     5:17:12 PM                                                                                                               
     It was never  intended to try to  force a multi-billion                                                                    
     dollar pipeline that a financial  community also has to                                                                    
     agree  to.   Some  asked  about  risk.   The  financial                                                                    
     community has said over and  over again that because of                                                                    
     the  risk involved  here, the  internal rate  of return                                                                    
     has to  be at least in  the $20s and they  have said it                                                                    
     over and over and over again.                                                                                              
     And do you want to  talk about the federal government's                                                                    
     80  percent,   $18  million   grant?  It   hasn't  been                                                                    
     appropriated. The  money is not  there; the  promise is                                                                    
     there.  People  don't  know  how  to  put  the  package                                                                    
     together because it has never been done before.                                                                            
MS. BRADY said  further that this would have  the commissioner of                                                               
DNR pre-guess what FERC is going to do. She explained:                                                                          
     FERC has  a staff  of 400 people.  That's all  they do.                                                                    
     They spend their  time on pipelines and  we're going to                                                                    
     pre-guess what RCA does? We're  going to pre-guess what                                                                    
     a  return should  be and  that will  somehow -  I'm not                                                                    
     even talking  about the companies  - that  will somehow                                                                    
     force the  financial markets to  take some  action when                                                                    
     their shareholders  are going to say,  'Are you kidding                                                                    
     me?'  Do you  know what  a shareholder  would say  if a                                                                    
     company took a $20  billion risk because a commissioner                                                                    
     of Natural  Resources from  the State  of Alaska  ran a                                                                    
     model and  said yeah, there's  enough out there  for 30                                                                    
     years  from now?  You're going  to make  money. Do  you                                                                    
     know what would happen with their stock?...                                                                                
5:19:36 PM                                                                                                                    
She said  she liked the original  bill and advised them  to start                                                               
with the  way the process works  now. She said the  original bill                                                               
does some important things in terms of incentive.                                                                               
5:20:52 PM                                                                                                                    
SENATOR STEDMAN  said she mentioned  a 20 percent rate  of return                                                               
and  he has  heard  of different  expectations -  that  18 to  20                                                               
percent is in the venture capital range.                                                                                        
5:22:42 PM                                                                                                                    
MS.  BRADY responded  that some  venture capital  people say  the                                                               
risk of building this pipeline is  too high because if gas prices                                                               
fall, the project would have to  be finished anyhow. Some of them                                                               
didn't  believe it  could  ever  be done  anyway.  She said  that                                                               
Alaska  hears  a   lot  of  positive  things,  but   at  big  gas                                                               
conferences in other places, you hear other things.                                                                             
5:23:37 PM                                                                                                                    
SENATOR ELTON  said he agreed with  her on one issue  and that is                                                               
that the  amendment was  a surprise. There  could have  been more                                                               
discussion of the policy implications.                                                                                          
5:24:32 PM                                                                                                                    
SENATOR  SEEKINS  agreed,  but   denied  that  sneaking  anything                                                               
through could happen  here where finding out which  rumor is true                                                               
is the problem.                                                                                                                 
5:26:45 PM                                                                                                                    
JOE FERRELL, Managing Attorney,  ConocoPhillips, urged the Senate                                                               
to  reject the  last-minute changes  to HB  71, because  they are                                                               
ill-conceived  and   not  needed.   He  said  the   Stranded  Gas                                                               
Development Act (SGDA) is working as it is.                                                                                     
     My testimony will address the following points:                                                                            
                  1. The interpretation of lease obligations                                                                    
                    is a judicial function.                                                                                     
                  2. The substantive provisions of the                                                                          
                    amendment  are  not   supported  by  the                                                                    
                    terms of  the lease  or general  oil and                                                                    
                    gas law.                                                                                                    
                  3. The substantive standards created in                                                                       
                    the  legislation  are inappropriate  for                                                                    
                    judging  the commercial  viability of  a                                                                    
                    pipeline project.                                                                                           
                  4. Finally, the bill is not needed. The                                                                       
                    Stranded Gas Act  is working as intended                                                                    
                    and  ConocoPhillips is  working hard  in                                                                    
                    negotiations  with  the  state  team  to                                                                    
                    make the Alaska gas pipeline a reality.                                                                     
     The first point is that the  changes to HB 71 are not a                                                                    
     proper    subject   for    legislative   action.    The                                                                    
     interpretation  of  lease  obligations  is  a  judicial                                                                    
     function. As  the Alaska Supreme Court  reaffirmed just                                                                    
     this  year, oil  and  gas leases  are contracts,  which                                                                    
     become  fixed  when  originally signed.  Moreover,  the                                                                    
     contracts  clause   of  both  the  federal   and  state                                                                    
     constitutions  prohibit  the  state from  passing  laws                                                                    
     impairing the  obligations of  contracts. As  a result,                                                                    
     the  state  legislature  is  simply  without  power  to                                                                    
     modify existing oil and gas  leases to the detriment of                                                                    
     the lessees  by imposing  any new  duties upon  them or                                                                    
     decreasing any of their right under those leases.                                                                          
     It   has  been   suggested  that   these  changes   are                                                                    
     authorized  because they  really only  restate existing                                                                    
     contract  terms under  existing law.  This leads  to my                                                                    
     second  point: that  the substantive  content of  these                                                                    
     changes are not supported by  the terms of the lease or                                                                    
     general oil  and gas  law. The  fundamental proposition                                                                    
     proposed by these changes is  that lessees must build a                                                                    
     pipeline project  based on the state's  estimate of the                                                                    
     rate of return  for the pipeline project,  based on the                                                                    
     state's  modeling  of   future  costs,  production  and                                                                    
     prices  exceeds   the  historical  return   on  capital                                                                    
     employed  (ROCE)  achieved  by  the  lessees  on  their                                                                    
     worldwide activities.                                                                                                      
     The fact is that there is  not a single lease term or a                                                                    
     case  that  has  been identified  by  those  testifying                                                                    
     before the  legislature and we  have been able  to find                                                                    
     none that support this astounding proposition.                                                                             
     Indeed, the  attorney for the Port  Authority confirmed                                                                    
     in  his  testimony that  no  court  has ever  found  an                                                                    
     implied  duty  under an  oil  and  gas lease  to  build                                                                    
     anything more than a short  connector pipeline. Nor has                                                                    
     any proponent  of this legislation shown  a single case                                                                    
     where  this  kind  of test  was  applied  to  determine                                                                    
     whether  a  lessee could  be  forced  into risking  its                                                                    
     money in an  investment for the benefit  of the lessor,                                                                    
     let  alone any  support for  the proposition  that this                                                                    
     mechanical,   but   highly  manipulable   approach   is                                                                    
     legitimate or  appropriate as a  general test  for when                                                                    
     investment duties are created.                                                                                             
     There  is a  good reason  for the  fact that  the tests                                                                    
     that appear in the revised bill  are not to be found in                                                                    
     the lease  itself or  in case law.  The reason  is that                                                                    
     the  tests put  forward are  not rare  and do  not make                                                                    
     economic  sense. There  is no  mathematical formula  or                                                                    
     model under the  lease or general oil and  gas law that                                                                    
     determines  when  a duty  arises.  It  is always  fact-                                                                    
     specific analysis and depends  on all pertinent factors                                                                    
     including risk.                                                                                                            
     This makes sense, since a  prudent lessee assesses each                                                                    
     project on  the basis  of its  particular circumstances                                                                    
     and  risks. In  that regard,  it is  critical that  the                                                                    
     Legislature  understand that  decisions  to develop  or                                                                    
     construct  projects cannot  be determined  by reference                                                                    
     to  a  single financial  parameter,  in  this case  the                                                                    
     historic Return on Capital Employed  (ROCE) for a group                                                                    
     of oil companies over the last 10 years.                                                                                   
     First, let's  address what  a company  ROCE represents.                                                                    
     Each company's ROCE  is the output or result  of a wide                                                                    
     variety of very separate  corporate decisions. The ROCE                                                                    
     for  any  given  year  reflects  the  results  of  past                                                                    
     decisions   over  the   course   of   many  years   and                                                                    
     comprehends   not  just   decisions  to   proceed  with                                                                    
     individual projects  based on their intended  return on                                                                    
     investment, (which  in any event, were  based upon each                                                                    
     project's  unique  factors,   in  particular  the  risk                                                                    
     associated with  each project),  but also  decisions on                                                                    
     exploration drilling  (which has  a high  likelihood of                                                                    
     failure), capital  projects implemented to  comply with                                                                    
     new environmental  laws or for  other reasons  that are                                                                    
     recognized   as   non-payout,   for   maintenance   and                                                                    
     accounting  treatment on  corporate mergers.  All these                                                                    
     end up blending into a  ROCE output that varies for any                                                                    
     given  year  and is  highly  dependent  on upon  actual                                                                    
     market prices.                                                                                                             
     Second, let's  address what  factors a  prudent company                                                                    
     must take into account  in making investment decisions.                                                                    
     Any   decision  to   invest   in   a  major   potential                                                                    
     development  project must  address  a  wide variety  of                                                                    
     risks  and uncertainties,  including  the potential  or                                                                    
     low  prices,  capital  cost  overruns,  regulatory  and                                                                    
     permitting  problems  and  schedule delay.  No  prudent                                                                    
     operator looks at a single  financial parameter such as                                                                    
     ROCE to decide to invest. And  as the cost and scale of                                                                    
     the  project increase,  the  risk associated  increases                                                                    
     and so  does the rigor to  address uncertainties, which                                                                    
     take higher priority.                                                                                                      
     The Alaska gas pipeline  project is currently estimated                                                                    
     to cost  $20 billion.  The size  alone, not  to mention                                                                    
     the governmental  regulatory, technical  and commercial                                                                    
     complexity, requires it to address  a massive number of                                                                    
     issues outside  of a single point  ROCE calculation. We                                                                    
     have had  to address the US  regulatory process through                                                                    
     congressional  acts to  pass the  enabling legislation.                                                                    
     To  help mitigate  some fiscal  issues,  we worked  for                                                                    
     passage of  the loan guarantee provisions,  credits for                                                                    
     the gas treatment plant similar  to those for other Co2                                                                    
     removal facilities and  depreciation provisions similar                                                                    
     to those  allowed for  gas pipeline  gathering systems.                                                                    
     To  address the  uncertainty related  to making  such a                                                                    
     long-term  and unprecedented  investment in  Alaska, we                                                                    
     have been  working with the administration  on a fiscal                                                                    
     contract  as  contemplated  by the  Stranded  Gas  Act.                                                                    
     These actions have all  been undertaken consistent with                                                                    
     analysis to address major risk  elements far outside of                                                                    
     any single economic data point.                                                                                            
     To summarize:                                                                                                              
     This  proposed  amendment  attempts to  quantify  which                                                                    
     projects  should  be  developed  based  on  what  would                                                                    
     appear to be sufficient in  the state's eyes to provide                                                                    
     "an adequate rate of return."                                                                                              
     The  project's projected  return  is  to be  calculated                                                                    
     based on  estimates made  by the  lessor, who  does not                                                                    
     have  to make  the required  investment. The  amendment                                                                    
     defines an "adequate return" be  referenced to a single                                                                    
     data point, an average historic ROCE.                                                                                      
     Reliance on this single financial  parameter is a gross                                                                    
     oversimplification  of   the  actual  process   that  a                                                                    
     prudent operator  would use to determine  to progress a                                                                    
     Given the  size of major projects  in Alaska, including                                                                    
     the Alaska gas  pipeline, such oversimplification could                                                                    
     do  nothing  but add  confusion  about  what is  really                                                                    
     necessary to progress the project.                                                                                         
     I  believe   that  what   was  intended   through  this                                                                    
     amendment was  an indication of the  desire to progress                                                                    
     the development  of Alaska's  resources. ConocoPhillips                                                                    
     shares  these  goals  and believes  that  they  can  be                                                                    
     accomplished    through    prudent   exploration    and                                                                    
     development   of   oil   resources  and   through   the                                                                    
     development  of the  gas  pipelines. ConocoPhillips  is                                                                    
     working hard  and will  continue to  work hard  to make                                                                    
     the  Alaska  gas  pipeline  a  reality.  However,  this                                                                    
     proposed  amendment will  only  create uncertainty  and                                                                    
     impede  progress toward  attainment  of  that goal.  We                                                                    
     respectfully urge that the  Senate eliminate sections 1                                                                    
     and 2 from HB 71. Thank you.                                                                                               
5:34:49 PM                                                                                                                    
SENATOR  DYSON said  earlier testimony  from producers  suggested                                                               
that if they don't agree on  the financial basis on which the DNR                                                               
commissioner reached  his conclusions,  they could  provide other                                                               
information  that would  impeach those  assumptions -  or provide                                                               
better  information. He  asked if  there  was a  reason why  that                                                               
might be impractical.                                                                                                           
MR.  FERRELL  replied  that  oil and  gas  leases  are  contracts                                                               
between the state  and the producers and  those contracts contain                                                               
rights and obligations on each of the parties.                                                                                  
     To interpret  what the parties' rights  and obligations                                                                    
     are  initially the  parties will  discuss those  things                                                                    
     just   as  they   would   in   any  other   contractual                                                                    
     relationship and  if they could  not agree,  after that                                                                    
     exchange of information, after  that exchange of views,                                                                    
     then  the proper  forum to  decide whether  the state's                                                                    
     interpretation or the  producers' interpretation of the                                                                    
     contract is correct would be through the courts....                                                                        
SENATOR DYSON clarified his question  and asked if another way to                                                               
solve the  situation would be  to give  the state better  data to                                                               
use in  its model. He  understood that  his answer is  that's not                                                               
the way it's done; you go to court.                                                                                             
MR. FERRELL  replied that the term  that has been defined  in the                                                               
bill is "reasonably  profitable" and he could not  find that term                                                               
in the DL1 lease form.                                                                                                          
SENATOR DYSON interrupted to say  that he is answering a question                                                               
he didn't ask  right now. He repeated his question,  which is, if                                                               
the state is using  a model that has bad data,  isn't part of the                                                               
way to solve that to give the state correct data.                                                                               
MR. FERRELL responded by saying again that:                                                                                     
     You discuss  it with your contract  counterpart.... You                                                                    
     try  to  reach  agreement  on what  the  words  of  the                                                                    
     contract  mean,  what  obligations  are  imposed,  what                                                                    
     rights you  have under the contract  and that's exactly                                                                    
     what we're doing.  We are working hard  to progress the                                                                    
     gas  pipeline   project  and  we're  trying   to  avoid                                                                    
SENATOR DYSON sought to clarify one more time asking:                                                                           
     Okay, but  my question was  couldn't you help to  get a                                                                    
     fair process  by giving  the best data  and I  hear you                                                                    
     saying that's - I haven't  heard you say, 'Yeah, that's                                                                    
     what  we should  do,' so  that all  the decision-makers                                                                    
     have  the  best  data.  At first  I  thought  you  were                                                                    
     saying,  'Well,  you  go  to court.'  Now  I  hear  you                                                                    
     saying, 'No, you get together and negotiate.'                                                                              
     But my question  was is there something  that keeps you                                                                    
     from giving  the state the  best data you have  so that                                                                    
     they can have  the best presuppositions on  which to go                                                                    
MR. FARRELL responded:                                                                                                          
     We   are  in   negotiations.  The   content  of   those                                                                    
     negotiations are confidential, but  we are working hard                                                                    
     to  address  the  enormous   risks  that  this  project                                                                    
     represents - to  try to make the Alaska  gas pipeline a                                                                    
     reality. And it's like any  other negotiation and it is                                                                    
     a long process and we're working very hard at it.                                                                          
5:41:07 PM                                                                                                                    
CHAIR WAGONER  said he wanted to  follow up on the  definition of                                                               
"reasonably profitable" and that the  state might be using faulty                                                               
data. He  asked if  that's the  case, why  don't the  majors come                                                               
forward with the  right data. The state has said  that 14 percent                                                               
return  on a  project is  reasonably  profitable to  it, but  the                                                               
producers can take  their funds they were going to  invest in the                                                               
pipeline and  go to Indonesia  or someplace that  has a 24  to 30                                                               
percent return on their investment.                                                                                             
     If  that  the  way  this is  going  to  be  determined?                                                                    
     Because if it  is, I have a problem  with that. Because                                                                    
     if the state  says according to our best  data, this is                                                                    
     reasonable profitable  at this time to  build a gasline                                                                    
     and  to produce  the gas,  we're entitled  to that  gas                                                                    
     being  produced and  the income  from it  that we  have                                                                    
     coming by lease agreement. Is there a flaw in my...                                                                        
MR.  FERRELL quickly  went back  to  the fundamental  proposition                                                               
that the producers have a  series of contracts that impose rights                                                               
and obligations on the parties.                                                                                                 
     The  question  would  be,   'What  do  those  contracts                                                                    
     require the  lessees to do.' Now  the words 'reasonably                                                                    
     profitable' don't appear in  those contracts. That's an                                                                    
     interpretation  of what  our obligations  are that  was                                                                    
     put forward by one side  in testimony before the Budget                                                                    
     and  Audit  Committee.  Now,   the  leases  do  provide                                                                    
     certain  grants of  rights to  the  producers. I  think                                                                    
     they were  enumerated earlier  to explore,  produce and                                                                    
     market.  It  also  imposes obligations  including  -  I                                                                    
     don't  really thinks  it's  appropriate  to go  through                                                                    
     that  right  now  because   that's  really  a  judicial                                                                    
     proceeding.  Basically, what  they do  is it  obligates                                                                    
     the producers  to drill wells  to prevent  drainage and                                                                    
     to drill  additional wells for if  a reasonably prudent                                                                    
     operator  would do  so in  all the  circumstances. What                                                                    
     you have to  do is you have to go  back and say, 'Well,                                                                    
     what  obligations are  actually under  the lease.'  Now                                                                    
     the proponent  of this  legislation has  suggested that                                                                    
     what this legislation does is  it takes away the normal                                                                    
     course of procedure for deciding  that question - which                                                                    
     would be  if there's  a disagreement after  the parties                                                                    
     to the contract  have discussed that, then  it would be                                                                    
     sent to court. And it  said, we want the Legislature to                                                                    
     decide that  question - not  only an  interpretation of                                                                    
     an undefined  term, but the  creation of a term  and an                                                                    
     interpretation of what the  obligations are rather than                                                                    
     leaving   that   definition   to  other   branches   of                                                                    
     That's  not the  way it  works. This  bill attempts  to                                                                    
     take a  contract dispute and  solve it in favor  of one                                                                    
     party  to the  contract.... That's  the effect  of this                                                                    
5:45:21 PM                                                                                                                    
SENATOR SEEKINS  asked him to  explain what he thought  section 2                                                               
MR.  FARRELL replied  that section  2 purports  to interpret  the                                                               
provisions of  the existing contracts  between the state  and the                                                               
producers  in a  one-sided  way without  an  opportunity for  the                                                               
other party  to the  contract to  present its  views in  a proper                                                               
forum.  The  Supreme  Court  has  recently  reaffirmed  they  are                                                               
5:46:47 PM                                                                                                                    
SENATOR  SEEKINS asked  if  the  contracts ConocoPhillips  signed                                                               
were "take it or leave it" contracts.                                                                                           
MR. FARRELL replied yes.                                                                                                        
SENATOR  SEEKINS  asked if  the  oil  companies were  allowed  to                                                               
negotiate  the terms  or were  they  just allowed  to accept  the                                                               
terms that were already in the contract.                                                                                        
MR. FARRELL  replied to his knowledge  it was a take  it or leave                                                               
it contract.                                                                                                                    
SENATOR  SEEKINS  asked if  that  is  still  a standard  form  of                                                               
contract between the state and someone else.                                                                                    
MR. FARRELL replied yes.                                                                                                        
5:47:59 PM                                                                                                                    
SENATOR BEN STEVENS  said that it's fair to  say the negotiations                                                               
are taking  place and  that there are  three separate  models for                                                               
each applicant  being constructed  right now -  the Legislature's                                                               
under Econ One  Research, Inc., the Department of  Revenue or the                                                               
Stranded Gas application team, and the applicants.                                                                              
5:49:57 PM                                                                                                                    
He observed that  "Standard and Poor's" has  different reports on                                                               
equity on  global positions than  "Value Line" and there  will be                                                               
different  outputs and  different  interpretations regardless  of                                                               
who does the models.                                                                                                            
     The question in my mind  is does this amendment have an                                                                    
     impact  on   who  makes  the  determination   of  those                                                                    
     results? Is  it the free  market? Is it  the applicant?                                                                    
     Or,  in fact,  is it  the commissioner?  So, if  that's                                                                    
     what  we're  contemplating, the  variables  circulating                                                                    
     around this  process are yet  to be  fully comprehended                                                                    
     by me.... I think we need  to think about the impact of                                                                    
     what this does and fully  digest it before - personally                                                                    
     before I can make a full determination on it.                                                                              
5:51:41 PM                                                                                                                    
CHAIR WAGONER asked which is the more conservative.                                                                             
5:51:54 PM                                                                                                                    
SENATOR  BEN  STEVENS  replied  that  "Standard  and  Poor's"  is                                                               
considered to be more conservative than "Value Line."                                                                           
5:52:39 PM                                                                                                                    
SENATOR ELTON said  testimony has indicated that  the benefits of                                                               
the  loan  guarantees  are  more  ephemeral  than  he  originally                                                               
thought and asked Mr. Farrell how comfortable he was with them.                                                                 
MR. FARRELL responded that he  wasn't prepared to testify on that                                                               
issue,  but he  was  prepared  to talk  about  how  the bill  was                                                               
fundamentally flawed and  would do nothing to  advance the Alaska                                                               
gas project.                                                                                                                    
5:54:16 PM                                                                                                                    
SENATOR  ELTON countered  that Mr.  Farrell brought  up the  fact                                                               
that the guarantee provisions may not  be as solid as assumed and                                                               
before  the  next hearing,  he  wanted  an understanding  of  how                                                               
comfortable ConocoPhillips is with that provision.                                                                              
MR. FARRELL said he would follow up on that for him.                                                                            
5:5:48 PM                                                                                                                     
VICE CHAIR SEEKINS thanked Mr. Farrell for his testimony.                                                                       
5:54:59 PM                                                                                                                    
KEVIN TABLER,  Land and Government Affairs  Manager, Unocal, said                                                               
that Unocal  is the predominant  operator in the Cook  Inlet, but                                                               
it  also has  some  small interests  on the  North  Slope in  the                                                               
Kuparek and Endicott  fields and in TAPS. He  related that Unocal                                                               
and  other producers  participated in  a Joint  Senate and  House                                                               
Resources  meeting in  Kenai  to discuss  the  need for  enhanced                                                               
exploration and  development within  Cook Inlet and  other areas.                                                               
The  intent  was  to  provide  incentives  to  encourage  earlier                                                               
exploration  of the  state's oil  and gas  resources. The  bill's                                                               
original  intent provided  incentives to  explore in  the Bristol                                                               
Bay  area.  Other bills  involved  incentives  as well  and  were                                                               
rolled into one - HB 71.                                                                                                        
     The  amendment   that  was   attached  last   week  has                                                                    
     absolutely  nothing  to  do with  the  intent  of  that                                                                    
     original  legislation. The  unintended consequences  of                                                                    
     this amendment  are unknown. Due to  the hasty creation                                                                    
     of  the amendment  and  the lack  of  input from  those                                                                    
     directly affected by  it, we really don't  know all the                                                                    
     consequences intended  or unintended.  We do  know that                                                                    
     it  does  create  an uncertain  investment  environment                                                                    
     after the investments have already been made.                                                                              
     It  appears that  the  amendment  is targeting  certain                                                                    
     leases.  The  fact is  this  amendment  applies to  all                                                                    
     leases statewide.  The amendment  is not clear  that it                                                                    
     excludes  oil.  It speaks  to  oil  and gas  throughout                                                                    
     sections 1 and 2, in particular  page 3, line 17 at the                                                                    
     end refers to 'at a  minimum.' That language would lead                                                                    
     us to  believe that  the DNR  would have  the unlimited                                                                    
     authority to create their own standards.                                                                                   
     This amendment was put on  without any input from those                                                                    
     that it  will directly affect. We  question the state's                                                                    
     authority   to  unilaterally   amend  the   contractual                                                                    
     obligations   with  existing   leases  through   either                                                                    
     manipulation   and/or   interpretation  of   the   unit                                                                    
     agreements  and their  corresponding administration  of                                                                    
     the plan of development.  By imposing an interpretation                                                                    
     after the  fact to address current  legislative desires                                                                    
     could be  perceived as a  constitutional taking  by the                                                                    
     state.  One  party  to  a  contract  cannot  impose  an                                                                    
     interpretation  on  that  contract  when  the  contract                                                                    
     specifically  provides  for  consent as  does  the  DL1                                                                    
     lease form.                                                                                                                
     The  implied covenant  to explore  is  part and  parcel                                                                    
     under  the state's  oil  and gas  lease  and all  other                                                                    
     leases and  is further offset  by the payment  of delay                                                                    
     rentals. The  right of  the state  to dictate  the rate                                                                    
     and timing of development,  production and marketing is                                                                    
     less  well-defined.  It  is not  the  state's  absolute                                                                    
     right  to dictate  these parameters.  If  the state  is                                                                    
     unhappy with  the proposed  future plans  and agreement                                                                    
     cannot be  reached between the  lessor and  the lessee,                                                                    
     it  is  the  courts  that will  ultimately  decide  the                                                                    
     appropriate  rate,  timing   and  marketing  parameters                                                                    
     after hearing both sides of the discussion.                                                                                
     As written,  HB 71  has producers  taking all  the risk                                                                    
     while using someone else's  forecast. The oil companies                                                                    
     make  a   living  making  forecasts.  I   question  how                                                                    
     accurate  has the  state been  at forecasting  price of                                                                    
     oil and  gas futures.  We question the  state's ability                                                                    
     to forecast these futures better than the producers.                                                                       
     What happens  when the state's  forecast is  wrong? Who                                                                    
     assumes  liability then?  Will the  state offer  up its                                                                    
     royalty  share  to  cover  the  downside  of  a  faulty                                                                    
MR. TABLER said that the  amendment raises more questions than it                                                               
provides  answers. With  the  amendment this  bill  is no  longer                                                               
incentive  legislation, but  disincentive  to future  exploration                                                               
and investment in Alaska and Unocal no longer supports it.                                                                      
6:00:31 PM                                                                                                                    
SENATOR ELTON asked  if his concerns would be  mitigated if there                                                               
were  a   process  in  which   the  state's  forecast   could  be                                                               
arbitrated. Otherwise they  would be in a situation  in which any                                                               
other  producer can,  in effect,  make a  "no decision"  based on                                                               
some information that they keep internal.                                                                                       
MR. TABLER replied that is correct.                                                                                             
SENATOR ELTON stated he thought  that was fundamentally unfair to                                                               
the resource owner.                                                                                                             
6:02:57 PM                                                                                                                    
MR.  TABLER replied  that it  also  seems unfair  when the  lease                                                               
requires consent  of the  lessee or the  lessor to  establish the                                                               
criteria  that   will  force  the  lessee   to  make  significant                                                               
investments at  the threat of  taking the lease back.  He related                                                               
that even  the working interest  owners sometimes don't  agree to                                                               
economic models that are used  in their investment profiles. They                                                               
have different  market constraints  and different  contracts they                                                               
have to produce to. He  thought an arbitration process might work                                                               
if all the  parties could agree on that  approach beforehand, but                                                               
reminded the committee that the lessee is the risk taker.                                                                       
6:04:24 PM                                                                                                                    
SENATOR GUESS  asked if  this bill doesn't  pass, would  the Cook                                                               
Inlet tax  credits still  be in  place, but  the Bristol  Bay tax                                                               
credits wouldn't because they were new.                                                                                         
MR. TABLER replied:                                                                                                             
     No,  my  understanding  is that  the  Bristol  Bay  tax                                                                    
     credits will be new, but  the existing tax credits that                                                                    
     are in place under statute  now would be in place. This                                                                    
     augments and changes and creates  a true incentive that                                                                    
     we didn't  have when  SB 185 two  years ago  was rolled                                                                    
     out, when it was originally  a Cook Inlet bill and then                                                                    
     turned into a statewide North Slope bill. Some of the                                                                      
      provisions we tried to get in that bill we're trying                                                                      
     to get back in through these credits here.                                                                                 
CHAIR WAGONER thanked Mr. Tabler for his testimony and closed                                                                   
the public hearing. With that, he adjourned the meeting at                                                                      
6:06:18 PM.                                                                                                                   

Document Name Date/Time Subjects