CS FOR SENATE BILL NO. 138(FIN) am "An Act relating to the purposes, powers, and duties of the Alaska Gasline Development Corporation; relating to an in-state natural gas pipeline, an Alaska liquefied natural gas project, and associated funds; requiring state agencies and other entities to expedite reviews and actions related to natural gas pipelines and projects; relating to the authorities and duties of the commissioner of natural resources relating to a North Slope natural gas project, oil and gas and gas only leases, and royalty gas and other gas received by the state including gas received as payment for the production tax on gas; relating to the tax on oil and gas production, on oil production, and on gas production; relating to the duties of the commissioner of revenue relating to a North Slope natural gas project and gas received as payment for tax; relating to confidential information and public record status of information provided to or in the custody of the Department of Natural Resources and the Department of Revenue; relating to apportionment factors of the Alaska Net Income Tax Act; amending the definition of gross value at the 'point of production' for gas for purposes of the oil and gas production tax; clarifying that the exploration incentive credit, the oil or gas producer education credit, and the film production tax credit may not be taken against the gas production tax paid in gas; relating to the oil or gas producer education credit; requesting the governor to establish an interim advisory board to advise the governor on municipal involvement in a North Slope natural gas project; relating to the development of a plan by the Alaska Energy Authority for developing infrastructure to deliver affordable energy to areas of the state that will not have direct access to a North Slope natural gas pipeline and a recommendation of a funding source for energy infrastructure development; establishing the Alaska affordable energy fund; requiring the commissioner of revenue to develop a plan and suggest legislation for municipalities, regional corporations, and residents of the state to acquire ownership interests in a North Slope natural gas pipeline project; making conforming amendments; and providing for an effective date." 1:59:06 PM MICHAEL PAWLOWSKI, DEPUTY COMMISSIONER, STRATEGIC FINANCE, DEPARTMENT OF REVENUE, continued to address questions on the legislation. He recapped that earlier in the day the administration had discussed the affordable energy aspects and the ability to move and look at infrastructure and to move benefits of the project across the state. Representative Gara referred to a request for information about where Alaska ranked in terms of its potential government take on the project. He stated that Roger Marks [Legislative Consultant, Legislative Budget and Audit Committee] estimated the state's share at approximately 60 percent, which he deemed to be lower than other jurisdictions taking similar risks. Mr. Pawlowski replied that the royalty study was available on the Department of Natural Resources website and provided a broad range of government takes across different types of projects. He noted that he would work to provide excerpts from the study. He relayed that the consulting firm Black and Veatch was updating the study to put the information on one page. Representative Gara wondered if the information would be available prior to the amendment process. Mr. Pawlowski replied that the consultants were working on the information as fast as possible. Representative Costello communicated that her primary concern about the current project was the state's relationship with TransCanada. She asked about all of the opportunities the legislature would have the ability to alter its relationship with TransCanada. Mr. Pawlowski pointed to page 8, Exhibit C of the Memorandum of Understanding (MOU) related to termination events (copy on file). The section described the rights that the state and TransCanada had to reevaluate the relationship and choose to terminate. The initial and pre- FEED [Front End Engineering and Design] stages were estimated to conclude around the end of 2015; at that point contracts with a longer duration would be ratified. He detailed that the state had the right at any time (provided that 90-day notice was given to TransCanada) to reevaluate and/or terminate the relationship prior to the ratification of the contract in 2015. He relayed that the firm transportation services agreement decision would be required to be brought to the legislature and be made public 90 days prior to the effective date; the MOU specified the date would be 90 days before the end of 2015. The legislature would have an opportunity to determine if it wanted to continue moving forward with its partner TransCanada. Mr. Pawlowski communicated that after the contract had been approved, the FEED stage would be entered; during the FEED stage through to the final investment decision (FID), the legislature and the state would retain an ability to terminate the relationship with TransCanada for a couple of reasons. Including, if within 60 days from the date, one or more of the producers or the transporter withdraws from the project or at any time the shipper was unable to sign agreements to sell all of its royalty or tax gas on terms acceptable to the shipper. He relayed that the legislature would play a role in the FID (most likely through appropriation powers). The state would have another opportunity to reevaluate its relationship with TransCanada at the FID stage; however, during the FEED and FID stages there was a provision that would provide TransCanada an option to participate in an alternative similar project advanced by the state. The opportunity was based on the MOU terms (75 percent debt and 25 percent equity); however, the cost of debt and return on equity were open to negotiation based on conditions at the time. He summarized that there would be multiple occurrences when the state had the opportunity to weigh advancement with TransCanada; the legislature would make the next decision on the terms towards the end of 2015. 2:06:57 PM Representative Costello asked whether the state's buyback option was always open or limited. Mr. Pawlowski replied that the buyback option was only applicable in the ratification of the firm transportation services agreement. The provision would be in effect from the end of 2015 forward. Representative Costello referred to testimony from the Department of Transportation and Public Facilities. She had been surprised by the testimony related to the department's lack of awareness about logistical needs. She wondered whether the logistics would be provided to the state at a certain point or if the conversation would improve with time. Mr. Pawlowski answered that the needs of the project broadly and specifically related to transportation were issues developed during the pre-FEED period. The phase moved from a conceptual idea to a conceptual design. He elaborated that the size of the pipe was developed during the time period; all of the decisions impacted the boom and trench sizes in addition to other logistics. The development of due diligence conducted during the pre-FEED time period, which was also important for the Federal Energy Regulatory Commission (FERC) environmental impact statement (EIS) requirements related to social impacts. He noted that the department would provide the list of resource reports to the committee. He summarized that during the next project stage the detailed work would begin and the items would be developed in order for the involved parties to decide whether it was desirable to move forward. 2:09:38 PM Co-Chair Stoltze handed the gavel to Vice-Chair Neuman. Mr. Pawlowski followed up on his response to Representative Costello. He added that Black and Veatch was currently updating the government take to include implied state expenditures for infrastructure; the information would be provided to the committee. Vice-Chair Neuman referred to a 5 percent return on equity (ROE) related to SB 21 [oil tax legislation that passed in 2013]. He discussed a 5 percent per barrel of oil exclusion on ROE in the Black and Veatch proposal. Mr. Pawlowski asked for verification that Vice-Chair Neuman was speaking about the Black and Veatch fiscal analysis. Vice-Chair Neuman replied in the affirmative. Mr. Pawlowski explained that under SB 21 there was a credit for the production of each barrel of oil. One of the items Black and Veatch had looked at was a similar credit for each million British thermal unit (btu) or million cubic feet (mcf) of gas produced. The goal had been to determine a modification that would create the same system. The $5.00 had been divided by the energy equivalent, which created a fixed credit per unit of gas. He believed it had been $5.00 divided by 6 per mcf. Vice-Chair Neuman asked for detail on off ramps [i.e. termination options]. Mr. Pawlowski pointed to page 8 of Exhibit C of the MOU. He explained that the section was broken up into circumstances under which the shipper could terminate, the transporters could terminate, and cases where either the shipper or transporter could terminate. He addressed the right to terminate prior to the FEED stage; notice could be given by the shipper (State of Alaska) any time provided that a 90- day notice was given to the transporter (TransCanada). From the beginning of FEED through FID the shipper could terminate within 60 days from the date one or more North Slope producers or transporter withdrew from the Alaska LNG Project. Secondly, the shipper could terminate at any time if it was unable to sign agreements to sell all of its royalty or tax gas on terms acceptable to the shipper. Additionally, the shipper could choose to terminate for any reason at FID. Mr. Pawlowski addressed that the transporter could choose to terminate if the legislature failed to provide statutory authority to the Department of Natural Resources (DNR) or the Department of Revenue (DOR) to enter into the precedent agreement by June 30, 2014. He referred to additional reasons listed in the MOU (Exhibit C): · Shipper fails to execute the PA within the specified time. · Shipper fails to execute the FTSA by December 31, 2015. · Shipper fails to maintain the standard of Creditworthiness Requirements. Transporter shall provide notice to Shipper of a failure to meet such standards, and Shipper shall have a reasonable period to cure. · At FID, if all Transporter corporate/Board approvals have not been obtained. · Within 3 months from FID, if debt financing has not been secured on terms and conditions satisfactory to Transporter in its sole discretion. Mr. Pawlowski noted that the term sheet was a conceptual document. The precedent agreement would begin with the concepts and would add detail. The firm transportation services agreement would add a more thorough level of detail. 2:14:36 PM Representative Guttenberg referred to DOR's earlier testimony that Black and Veatch was working on a new report on government take. He believed it had been in the context of the state's obligation to expand and build infrastructure. He was concerned about the issue because of a report from the Department of Transportation and Public Facilities. He wondered if there were things like deductions for existing North Slope infrastructure, expansion, and how it would affect the existing oil tax rate. Mr. Pawlowski responded that the deductibility of lease expenditures had been included in every model developed on the project since the beginning. He noted that the deductions were often listed in Black and Veatch models as a separate part of the negative calculation for the early years. He clarified that the prior evening the department had received a request by the committee chair's office for an update on the government take. Also requested was that the state choose some numbers that it would be spending on infrastructure. He believed it had been a specific request to assume $1 billion or another amount was spent by the state on infrastructure. He explained that providing the information required the models to be rerun; the models were not based on anything other than a guess. He relayed that the royalty report included government take information. Representative Guttenberg asked if there was one scenario being run that included $1 billion as the infrastructure needs. Mr. Pawlowski replied that the scenarios would include $1 billion, $2 billion, and $500 million. He provided a disclaimer that the numbers were arbitrary. Representative Gara noted that a contract under former Governor Murkowski had fallen apart when the legislature had realized the governor could move forward without legislative approval. He asked for the meaning of FID. Mr. Pawlowski replied that FID stood for Final Investment Decision. Representative Gara referred to department testimony that the state's authority would be determined [at FID] when the governor came forward with a contract and the legislature could decide whether appropriate the money. He asked if his understanding was accurate. Mr. Pawlowski replied that he was hesitant to contemplate what would be necessary for the FID. His reference to appropriations had been used based on his assumption that appropriations would be necessary given the scale of the FID and construction step. He communicated that any contract with a duration exceeding five years would require a legislative vote. He did not currently know how many contracts would be necessary for the FID to take place. Representative Gara wanted to ensure that it was in writing that at FID the legislature had the right to say no to a contract. He did not want the legislature to be in a situation where it was held liable for damages if it chose not to appropriate money. 2:19:33 PM Mr. Pawlowski answered that the actual body of work that would go into the FID was not currently known. To his knowledge there was nothing specific in the legislation that drove one single decision. The department had worked to break the concept apart from previous efforts, that one contractor or one execution would actually lead to a project. There were multiple contracts and agreements. He detailed that part of the path was designing what would occur in the pre-FEED stage. As the different work needed was identified, it would become clearer what would need to be done in the FEED and FID stages. There were many potential decision points leading up to FID, but they were unknown at present. Co-Chair Austerman noted that enalytica was available for questions. Representative Wilson wondered how to determine the project was the best deal for the state's residents. She wondered why the consultants believed the current project was the best way to go or if there were other options it should consider. 2:22:28 PM JANAK MAYER, PARTNER, ENALYTICA, asked for clarification on the question. He wondered if the question was primarily focused on potential future gas prices for constituents along the pipeline route. Representative Wilson agreed. She believed the state would ensure the constituents were taken care of. She relayed that the Fairbanks area was primarily on heating oil. She wondered how gas would be different from heating oil for Fairbanks and other areas. NIKOS TSAFOS, PARTNER, ENALYTICA, responded with advice on thinking about the issue at the 40,000-foot level. He highlighted that the state would sell gas in Asia. Once the process began the state would realize that consumers were using gas or fuel oil. He spoke to the competitiveness of Alaska's gas in the Asian market; it would need to be less expensive than fuel oil. When oil prices had collapsed in 2008 and 2009 there had been a short period of time where oil was cheaper than gas. He stated that during the time the Korea Electric Power Corporation had switched from LNG to oil. He reasoned that if gas was taken earlier it would be able to compete with fuel oil if the delivery price of gas had to be lower than the fuel oil in Asia. He could not think of many cases worldwide where gas traded at a continuous premium to fuel oil. He detailed that in most locations gas gained market share by being more competitive than fuel oil, which was one reason gas prices in Asia and Europe were linked to fuel oil. Distribution price was not yet known. He characterized his response as the highest level observation that could provide any comfort that the energy delivered to Alaskans would be more competitive than what they currently paid (especially locations that relied heavily on oil-based energy). 2:27:05 PM Representative Wilson wondered if it came down to contracts. She asked how the state would make sure it would have sufficient gas for instate use. She remarked on meeting demand and making sure Alaska was not only receiving a leftover amount of gas. Mr. Tsafos replied that the issue could be thought of in two different ways. He remarked that the concern was not unique to Alaska; any sovereign developing LNG considered to obtain competitive energy. He believed there were two parts that would require management. First, when using gas for heating it was difficult to know how much would be used because it depended on the weather. He stated that the limitation was well understood and would require working through contracts. He explained that sales contracts typically had upward or downward quantity provisions. For example, if 4 million tons were sold there was usually flexibility to go 10 percent higher or lower. Additionally, there was a planned out monthly delivery schedule. He suspected that in Alaska it would be assumed that the state needed more gas in the winter; therefore, it would deliver less during that period. He noted that it would also depend on the state's ability to produce more. He communicated that the state could produce at a flat amount and alter the distribution between domestic sales and exports or it could produce more when more was needed and vice versa. Second, the broader concern was what would happen if the state underestimated its need. He relayed that there were a number of ways to manage the issue including studying what the number would be. He referred to prior testimony that AGDC would work to determine the most reliable number possible. He discussed the importance of understanding what the contingencies and spare capacities of infrastructure would be. He referred to committee discussions on surplus infrastructure and spare capacity in order to enable other producers to meet the demand. Additionally, it was important to have a contractual access regime that would allow third-parties to supply the gas; the absence of a well laid plan could be problematic. He stated that the optimal solution was not yet known. Sovereigns that failed to do the proper due diligence had seen exports decline because they had diverted gas to the domestic market; some had paid penalties as a result. He detailed that there were ways to mitigate the problem such as choosing to commit 80 to 90 percent of sales to long-term contracts in order to provide more flexibility and avoid penalties. He noted that the state may want to consider marketing its gas in different ways than producers. Perhaps the state would want to keep more of its gas for the open market in order to retain gas for the "what if's." The commercial and technical aspects would be worked through during the pre- FEED and FEED stages. He reiterated that the concerns were fairly common facing all LNG producers. He thought the best thing to do was to look at how various concerns were addressed in each stage of the agreements. 2:32:52 PM Representative Wilson believed the state was looking for answers that were not yet known. She noted that the answers were desired before the start of the project, but the legislature was being told the project needed to start before the answers could be obtained. She remarked that AGDC and the administration would direct the project on the state's behalf. Currently TransCanada was the state's partner and the three producers would each have 25 percent. She believed most of the gas would be takin in-kind versus in-value. She believed the tax structure was being set somewhat. She remarked on the pre-FEED and FEED stages. She wondered if she was missing any pieces. She understood that a contract would not be set at present. Mr. Mayer answered that there were a number of key items occurring at present. He discussed that the state was acknowledging a vision that addressed whether all requirements could be met for taking in-kind and having an equity share. The legislature was giving the administration the authority to negotiate the key points. He remarked that the basic structure of a state gas share and direct participation in the project provided significant flexibility for the state to solve the problem of obtaining affordable gas prices in the state. The options would be better understood as the process evolved. He relayed that the state could decide to solve the problem by using its own share of the gas to provide for the domestic demand; the price would have an impact on the economics received by the state. The state could decide that it was a uniform obligation across all project participants; if the other partners believed the terms were not in their best interest there may be negotiations. There were a wide range of items that could be considered including meeting in-state demand not primarily with gas from the project but from other sources such as Cook Inlet or from other producers on the North Slope (gas that was essentially stranded at present). There were many different mechanisms the state could use that would determine the ultimate delivery price. Representative Wilson asked what the state would be required to approve next and when. Mr. Tsafos deferred the question to the administration. 2:38:16 PM Representative Wilson wondered if the consultants believed the state would need to be able to meet the deadline for the Asian market needs. There were other competitors working to get the market as well. She wondered if 2022 was the "drop dead" deadline. Mr. Tsafos cautioned that it was dangerous to speak about closing windows of opportunity. He stated that because of the time the project would take, the farther out the project went the better it looked because there were fewer projects planned in the future. He discussed that currently entities selling gas were aiming for delivery dates in 2018 through 2021. Alaska was looking at a later market that was not as saturated by competition. He acknowledged that as time went by, later future dates would become saturated as well. He stated that trying to capture a specific window was the wrong way to move forward. He believed the primary reason to keep moving forward was due to the length of time the process took. He noted that everything was interrelated and one piece could not be moved without the other. It was not possible to talk about marketing until conducting the financing study; likewise it was not possible to know how much gas there would be before conducting the engineering study. Although the state would get to FID that included financial, marketing, technical studies, the items would become more final throughout the process. He concluded that it was not possible to wait for everything to be done before moving to the subsequent step because everything would become obsolete if too much time passed. 2:42:16 PM Co-Chair Austerman believed that what the legislature approved in the current session would mean a two-year timeframe on most contracts. He surmised that if contracts were not signed within the two years they would become null and void; the contracts would be required to come before the legislature in order to move to the next step. Mr. Mayer answered in the affirmative. The contracts the legislature was empowering the administration to negotiate without coming back before the legislature would govern the pre-FEED phase. Contracts governing the project beyond pre- FEED would come back to the legislature for approval (especially large contracts such as the joint-venture agreements and firm transportation services agreements). Mr. Tsafos communicated that the fiscal notes only covered the pre-feasibility study. The FEED stage would cost hundreds of millions of dollars. Co-Chair Austerman surmised that by the time the state got to the FEED stage there would be a special session in late 2015 to discuss the issue. Mr. Tsafos replied that it sounded reasonable, but he deferred the question to the administration. Representative Gara was interested in the ability to get extra gas in the pipeline. He discussed expanding by compression up to 1 billion cubic feet; expansion beyond the amount would become difficult without help from other parties. He referred to a provision in the HOA that represented risk for the state, but reward for the other companies. He elaborated that if the state wanted to expand the pipeline, as long as it and a new shipper came in and expanded, the state had to share the benefits with Exxon, Conoco, and BP. Once the expansion got the state back to the cost of the initial shipping rate the state would be required to bare all of the cost. He remarked that if the cost of expansion increased the tariff up to the original rate, the state and shipper would be required to pay the cost. He wondered why the provision was fair. 2:46:37 PM Mr. Mayer replied that there were two important items to distinguish pertaining to Representative Gara's question. The first item pertained to the parties involved in an expansion and who bore the direct capital cost. The second item related to the total per unit capital costs for the entire pipeline, whether the costs were higher or lower than previously, and whether there was a benefit or cost to the expansion in terms of the implied tariff. He stated that among the parties to the HOA there were active explorers who may have additional gas in the future that they would like to see an expansion for (that the state may or may not want to participate in). He noted that the agreement allowed a party that wanted to expand to do so unilaterally without being held back by the other parties. He mentioned that under the HOA any benefits of an expansion would go to all parties; however, when costs rose they were borne by the parties executing the expansion. He agreed that greater symmetry from the state's perspective was preferable. However, he noted that reasonable people could disagree on the subject. He had heard testimony that the tradeoff was that the initial investment enabled the expansion; therefore, the initial investors should benefit in some way. However, when looking solely at the state's interest, it would be reasonable to say that only expanding parties bore costs and benefits or that if benefits were shared that costs would also be shared. He stated that in negotiations if one party was adamant about unilateral expansion, sharing the costs may be given up. 2:50:29 PM Mr. Tsafos referred to discussions about the importance of initial design and how to build a pipeline that was as expandable as possible as cheaply as possible. He reasoned that if the state wanted its partners, which would be baring 75 percent of the cost, to put down 75 percent on a slightly larger or more expandable pipeline, one way to encourage the partners towards the option would be to provide them with a benefit. He noted that the tradeoff could be important. Representative Gara believed the state had the most interest in bringing in new parties. He opined that the producers did not care about the ability to bring in new parties. He stressed that the state cared how much more of the North Slope was developed. He hoped the state would be actively seeking new partners; however, he reasoned the partners would not develop unless they could get their gas in the pipeline. He commented on the state giving producers the benefit of reduced shipping rates if there was an expansion. Co-Chair Austerman asked Representative Gara to avoid making statements about how producers would act in response to certain things. Representative Gara agreed. He wondered why it would not be fair for producers to share in costs. He asked about the fairness of allowing the state to bring the cost back up to the original rate in order to expand. Mr. Mayer answered in terms of the implied pipeline tariff, the arrangement seemed to be a fair and equitable. He could not say whether the arrangement would ensure the state with the right of unilateral expansion that was provided in the current contract. 2:54:10 PM Representative Guttenberg wondered if the consultants could answer a question related to the midterm service agreement in the MOU, Exhibit C. Mr. Mayer replied that he would try to answer the question. Representative Guttenberg looked at the document and observed that TransCanada would have the ability to write off its property taxes against the capital expenditures, which was 100 percent recovered through tolls. He surmised that Anchorage and Fairbanks would charge property taxes and they would charge the taxes to the state. He observed that the money moved in a circle. Mr. Mayer answered that there were a series of costs incurred in the development of a project. The costs with allowances for the return on debt and equity would be recovered by the project builder over the lifespan of the project. The costs included the upfront capital, maintenance, operating, and those associated with taxes such as federal, state, and property taxes etc.; the costs were all built into the model determining the tariff. Representative Guttenberg observed that it was money moving in a circle. 2:56:41 PM Co-Chair Austerman asked for verification that the consultants were under contract with the Legislative Affairs Agency. Mr. Mayer replied in the affirmative (specifically under the Legislative Budget and Audit Committee). Co-Chair Austerman asked when the contract expired. Mr. Mayer replied that it expired on January 31 of the following year. Co-Chair Austerman asked for verification that the consultants would be available over the upcoming interim. Mr. Mayer agreed. Co-Chair Austerman relayed that amendments on the bill were due at 4:00 p.m. that day. CSSB 138(FIN)am was HEARD and HELD in committee for further consideration. 2:58:07 PM AT EASE 3:04:49 PM RECONVENED