05/02/2005 03:30 PM Senate RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| HB71 | |
| Adjourn |
+ teleconferenced
= bill was previously heard/scheduled
| = | HB 71 | ||
ALASKA STATE LEGISLATURE
SENATE RESOURCES STANDING COMMITTEE
May 2, 2005
3:39 p.m.
MEMBERS PRESENT
Senator Thomas Wagoner, Chair
Senator Ralph Seekins, Vice Chair
Senator Ben Stevens
Senator Fred Dyson
Senator Bert Stedman
Senator Kim Elton
Senator Gretchen Guess
MEMBERS ABSENT
All members present
COMMITTEE CALENDAR
CS FOR HOUSE BILL NO. 71(FIN) am
"An Act providing standards for the interpretation of certain
terms in state oil and gas leases and unit agreements, requiring
development, production, processing, and marketing of gas that
is determined to meet those standards, and setting a maximum
time limit on that activity; extending and amending the
requirements applicable to the credit that may be claimed for
certain oil and gas exploration expenses incurred in Cook Inlet
against oil and gas properties production (severance) taxes, and
amending the credit against those taxes for certain exploration
expenditures from leases or properties in the state; and
providing for an effective date."
HEARD AND HELD
PREVIOUS COMMITTEE ACTION
BILL: HB 71
SHORT TITLE: OIL& GAS EXPLORATION CREDIT & LEASE TERMS
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR
01/12/05 (H) READ THE FIRST TIME - REFERRALS
01/12/05 (H) W&M, O&G, RES, FIN
02/11/05 (H) W&M AT 8:30 AM CAPITOL 106
02/11/05 (H) Moved CSHB 71(W&M) Out of Committee
02/11/05 (H) MINUTE(W&M)
02/14/05 (H) W&M RPT CS(W&M) NT 3DP 1AM
02/14/05 (H) DP: MOSES, GRUENBERG, WEYHRAUCH;
02/14/05 (H) AM: WILSON
02/17/05 (H) O&G AT 5:00 PM CAPITOL 124
02/17/05 (H) Heard & Held
02/17/05 (H) MINUTE(O&G)
03/15/05 (H) O&G AT 5:00 PM CAPITOL 124
03/15/05 (H) Moved CSHB 71(O&G) Out of Committee
03/15/05 (H) MINUTE(O&G)
03/18/05 (H) O&G RPT CS(O&G) NT 1DP 5NR
03/18/05 (H) DP: KOHRING;
03/18/05 (H) NR: SAMUELS, GARDNER, KERTTULA,
DAHLSTROM, ROKEBERG
04/01/05 (H) RES AT 1:00 PM CAPITOL 124
04/01/05 (H) Scheduled But Not Heard
04/04/05 (H) RES AT 1:00 PM CAPITOL 124
04/04/05 (H) Moved CSHB 71(RES) Out of Committee
04/04/05 (H) MINUTE(RES)
04/05/05 (H) RES RPT CS(RES) NT 3DP 5NR
04/05/05 (H) DP: ELKINS, RAMRAS, SAMUELS;
04/05/05 (H) NR: OLSON, GATTO, CRAWFORD, SEATON,
LEDOUX
04/11/05 (H) FIN AT 1:30 PM HOUSE FINANCE 519
04/11/05 (H) Heard & Held
04/11/05 (H) MINUTE(FIN)
04/14/05 (H) FIN AT 1:30 PM HOUSE FINANCE 519
04/14/05 (H) Bill Postponed To 4/15
04/15/05 (H) FIN AT 1:30 PM HOUSE FINANCE 519
04/15/05 (H) Moved CSHB 71(FIN) Out of Committee
04/15/05 (H) MINUTE(FIN)
04/18/05 (H) FIN RPT CS(FIN) NT 5DP 2NR
04/18/05 (H) DP: HAWKER, CROFT, FOSTER, MEYER,
CHENAULT;
04/18/05 (H) NR: WEYHRAUCH, KELLY
04/27/05 (S) RES AT 3:30 PM BUTROVICH 205
04/27/05 (S) Scheduled But Not Heard
04/28/05 (H) TRANSMITTED TO (S)
04/28/05 (H) VERSION: CSHB 71(FIN) AM
04/29/05 (S) RES AT 3:30 PM BUTROVICH 205
04/29/05 (S) <Pending Referral>
05/01/05 (S) READ THE FIRST TIME - REFERRALS
05/01/05 (S) RES, FIN
05/02/05 (S) RES AT 3:30 PM BUTROVICH 205
WITNESS REGISTER
BONNIE ROBSON
Consultant on Oil and Gas Issues
Legislative Budget and Audit Committee
Alaska State Capitol
Juneau, AK 99801-1182
POSITION STATEMENT: Supported CSHB 71(FIN)am.
TADD OWENS, Executive Director
Alaska Resource Development Council
121 W. Fireweed, Suite 250
Anchorage AK 99503-2035
POSITION STATEMENT: Opposed CSHB 71(FIN)am.
LARRY HOULE
Alaska Support Industry Alliance
360 W. Benson Blvd., Suite 200
Anchorage AK 99503
POSITION STATEMENT: Opposed CSHB 71(FIN)am.
KEN CONRAD, Senior Vice President
BP Alaska
PO Box 196812
Anchorage AK 99519
POSITION STATEMENT: Opposed CSHB 71(FIN)am.
PATRICK COUGHLIN, Senior Counsel
BP Alaska
PO Box 196812
Anchorage AK 99519
POSITION STATEMENT: Opposed CSHB 71(FIN)am.
JUDY BRADY, Executive Director
Alaska Oil and Gas Association (AOGA)
121 W. Fireweed Lane, Suite 207
Anchorage AK 99503-2035
POSITION STATEMENT: Opposed CSHB 71(FIN)am.
JOE FERRELL, Counsel
ConocoPhillips Alaska, Inc.
Anchorage AK
POSITION STATEMENT: Opposed CSHB 71(FIN)am.
KEVIN TABLER
Land and Government Affairs Manager
Unocal
Anchorage AK
POSITION STATEMENT: Opposed CSHB 71(FIN)am.
ACTION NARRATIVE
CHAIR THOMAS WAGONER called the Senate Resources Standing
Committee meeting to order at 3:39:11 PM. Present were Senators
Guess, Elton, Dyson and Chair Wagoner. Senators Seekins and
Stedman arrived at 3:40:15 PM.
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 &
Audit,
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
th
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
agreement:
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.
4.2)
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
Bay.
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
alternative.
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
profit.
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
available.
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
standards.
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
decisions.
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
capital.
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
comparison.
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
modeling.
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
resources.
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
Law.
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,
languishes."
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
shadows."
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
involved.
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
contract.
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
date.
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
leases.
5:08:02 PM
SENATOR SEEKINS said he thinks the state should enforce existing
agreements.
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
negotiated.
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
project.
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
litigation....
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
forward.
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
government.
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
legislation.
5:45:21 PM
SENATOR SEEKINS asked him to explain what he thought section 2
does.
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
contracts.
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
analysis?
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 |
|---|