SENATE BILL NO. 86 "An Act approving and ratifying the sale of royalty oil by the State of Alaska to Flint Hills Resources Alaska, LLC; and providing for an effective date." 10:20:20 AM JOE BALASH, DEPUTY COMMISSIONER, DEPARTMENT OF NATURAL RESOURCES, stated that the bill would grant legislative approval for the sale of royalty oil to Flint Hills Resources by the Department of Natural Resources (DNR). He began with Slide 2 of the presentation, "Royalty In-Kind Sale to Flint Hills Resources" (copy on file): The state has a choice to take its royalty in-value (RIV) or in-kind (RIK). •When the State takes its royalty as RIV, the lessees who produce the oil also market the State's share along with their own production and pay the State the value of its royalty share. •When the State takes its royalty share as RIK, the State assumes ownership of the oil, and the commissioner disposes of it through the sale procedures prescribed by AS 38.05.183. 10:22:13 AM Mr. Balash spoke to Slide 3, "Non-Competitive RIK Sale Process": •Statute presumes State's Best Interest is met by -Taking royalty in-kind-AS 38.05.182(a) -With sale to in-state buyer-AS 38.05.183(d) -Accomplished through a competitive process-AS 30.05.183(a) •August 13, 2012 Informal Solicitation of Interest sent to: -North Slope Producers -In-state Refiners -Industry specific & general media 10:24:04 AM Mr. Balash addressed Slide 4, "RIK Contract Terms": •Proposed 2013 contract is similar to 2004 contract •Proposed 2013 contract, like 2004 contract, does not directly reference RIV valuation in RIK price calculations •Key Contract provisions -Price -Quantity -Term -Special Commitments -In-State Processing and Local Hire 10:24:59 AM Mr. Balash discussed Slide 5, "RIK Contract Price": ANS Spot Price - $2.15 - Tariff Allowance ± Quality Bank Adjustment - Line Loss •ANS Spot Price = Average US West Coast Price for Alaska North Slope oil. -Reported by industry trade publications: Platts, Telerate, Reuters •$2.15 = RIK Differential -Destination Value - Marine Costs so RIK •5,9 -Subject to a one-time adjustment of no more than ± $0.15 per barrel. -This amount = $1.65 per barrel in the current 2004 contract. •Tariff Allowance = TAPS and Pipelines Upstream of PS- 1. •Quality Bank Adjustment = as reported by the TAPS Quality Bank Administrator •Line Loss = 0.0009 times the netback price 10:25:53 AM Mr. Balash pointed to Slide 6, "RIK Contract Quality": •Initial Quantity Range -18,000 - 30,000 barrels per day -May be adjusted after 12 months, with Commissioner approval •Termination of Contract -No or zero nomination for 3 months terminates contract -Contract terms comparable to the private market •Refinery Turnaround -Contract allows FHR the flexibility to cease royalty oil purchases during maintenance •Guarantees, reserves and proration clauses included -24,000 barrels per day with 15 percent reserves for other RIV or RIK interests 10:27:31 AM Mr. Balash addressed Slide 7, "2013 RIK Contract Term": •FHR initially sought a ten-year contract -Creates supply and price risk -Increases counterparty risk -Limits the State's ability to supply other RIK buyers •DNR negotiated a five year term -April 1, 2014 to March 31, 2019 -Possible extension condition for: •Large capital improvement at the North Pole Refinery •Binding support for a North Slope natural gas transportation system 10:29:47 AM Mr. Balash discussed Slide 8, "2013 RIK Contract Quantity", which was a bar graph that illustrated the total expected royalty oil and liquid natural gas volume and the expected share committed to Flint Hills Resources. 10:30:54 AM Mr. Balash spoke to Slide 9, "Commissioner's Decision Criteria": AS 38.05.183(e) states that the commissioner must sell the State's royalty oil to the buyer who offers "maximum benefits to the citizens of the state." In making this determination the commissioner must consider: 1)The cash value offered 2)The projected effects of the sale on the economy of the state 3)The projected benefits of refining or processing the oil in state 4)The ability of the prospective buyer to provide refined products for distribution and sale in the state with price or supply benefits to the citizens of the state 5)The eight criteria listed in AS38.06.070(a), as reviewed by the Royalty Board Mr. Balash addressed Slide 10, "Royalty Board's Decision Criteria": AS 38.06.070(a) states that the Alaska Royalty Oil and Gas Development Advisory Board must consider: 1)The revenue needs and projected fiscal condition of the state 2)The existence and extent of present and projected local and regional needs for oil and gas products 3)The desirability of localized capital investment, increased payroll, secondary development and other possible effect of the sale 4)The projected social impacts of the transaction 5)The projected additional costs and responsibilities which could be imposed upon the state and affected political subdivisions by development related to the transactions 10:32:09 AM Mr. Balash continued with Slide 11, "Royalty Board's Decision Criteria": AS 38.06.070(a) states that the Alaska Royalty Oil and Gas Development Advisory Board must consider: 6)The existence of specific local or regional labor or consumption markets or both which should be met by the transaction 7)The projected positive or negative environmental effects related to the transactions 8)The projected effects of the proposed transaction upon existing private commercial enterprise and patterns of investment 10:32:32 AM Mr. Balash addressed Slide 12, "Royalty In-Kind Sales." He noted that it was difficult to read. He relayed that over the course of the last 30 years the state had been engaged in the continuous sale of royalty oil. He noted that there were a variety of sales in the early 1980s and that there had been a lot more oil during that time. He said that the price crash of 1986 had caused the department to reconsider how royalty oil was sold and to limit the number and variety of sales. 10:33:58 AM Mr. Balash spoke to Slide 13, "Best Interest of the State Served by the RIK Contract with Flint Hills Resources (FHR) ": •Cash Value Offered with Contract -Cash value of $3.5-5.9 Billion over 5 years •Analyzed for Consistent value between RIK and RIV •Volume weighted average of current reported netback price (11 AAC 03.026(b)) -Anticipated increases in marine transportation allowance will favor RIK contract •Positive effect on the State -Maintain stability in in-state refining and distribution of refined products. -Support jobs and economy of Fairbanks North Star Borough 10:35:00 AM Mr. Balash addressed Slide 14, "FHR's North Pole Refinery": •Strategically located on TAPS •Current throughput of 82,000-84,000 barrels per day of ANS crude •Producing approximately 22,000-25,000 barrels of refined product •All crude and constituents that are not transformed into refined product are injected back into TAPS (with a penalty paid) 10:35:44 AM Mr. Balash continued to Slide 15, "FHR's North Pole Refinery": •FHR produces approximately -672,000 gallons of jet fuel per day -143,000 gallons of gasoline per day -41,000 gallons of home heating fuel per day -68,000 to 194,000 gallons per day of product consisting of HAGO, LAGO, naphtha, asphalt, refining fuel, and a small volume of high-sulfur diesel •680,000 gallons per day shipped to Anchorage via the Alaska Railroad •230,000 gallons of ultra-low sulfur diesel and gasoline on the backhaul to Fairbanks •FHR owns 50 million gallons of storage facilities -30.7 million in Anchorage and 19.3 million in Fairbanks 10:36:42 AM Mr. Balash addressed Slide 16, "Proposed Contract Benefits": •Proposed contract is expected to: -Maintain status quo of in-state refining behavior -Produce 330 million gallons of refined product or 18% of gasoline and 26% of jet fuel consumed in Alaska -Provide approximately $140 million per year in gross regional product sales for the Fairbanks North Star Borough (FNSB) -Support 1,300 direct and indirect jobs in the FNSB -Sustain $100 million in annual earnings in FNSB -Provide socio-economic stability against energy costs 10:37:53 AM Mr. Balash discussed Slide 17, "Projected Impacts if not Approved": •If FHR stops refining, anticipated effects include: -Loss of approximately 1,300 direct and indirect jobs in the Fairbanks North Star Borough -State could experience increased utilization of the social safety net -Possibility of population redistribution -Increased and decreased infrastructure utilization and maintenance with population shift -Impact to the fuel supply for the Fairbanks and Anchorage airports, affecting trade and tourism and the Alaska Railroad -Loss of heat source for warming low flow in TAPS 10:39:14 AM Senator Hoffman pointed to Slide 9. He requested further explanation of bullet four: 4)The ability of the prospective buyer to provide refined products for distribution and sale in the state with price or supply benefits to the citizens of the state Mr. Balash responded that the criteria had been examined during the evaluation. He said that FHR distribution patterns had been examined. He said that FHR had been able to sell locally, in the interior at the refinery, as well as the Port of Anchorage area. He stated that there was a special contract commitment provision relative to the pricing of gasoline in the Fairbanks market that help to provide price discipline for the transportation segment of the business line in the interior. 10:41:23 AM Senator Hoffman wondered how that equated to "the citizens of the state" versus "the citizens of Fairbanks." Mr. Balash responded that that question encompassed the tension that was embedded throughout the body of the statue and regulations. He said it would be one thing if DNR were to sell royalty oil at a steep discount to any refinery in that region of the state that resulted in a lower price for consumers of the region. He said that DNR worked to ensure that one community was not benefitting at the expense of others by getting at least royalty and value equivalent for the price offered in the sale of the royalty oil itself. He said that the price available in Fairbanks was a wholesale price that was being offered to the retail outlets in the area. 10:43:12 AM Senator Olson asked what were the possibly penalties to the state for not honoring the guarantees provided to FHR. Mr. Balash turned to Slide 6. He said that the steepest penalty could be grounds for termination of the contract itself. He said that the refinery was required to maintain a letter of credit in good standing. He said that the credit quality of the parent company would be scrutinized as well. 10:44:34 AM Senator Olson restated the question. Mr. Balash responded that he did not think there were any specific penalties to the state. He said that the contract itself would obligate the state to no more than 85 percent of the total royalty volume. He assured the committee that the state was protected to a certain degree. 10:45:24 AM Senator Olson queried the future of the refinery in the North Pole area that had been in decline. Mr. Balash responded that both the refineries in North Pole served distinct markets. He said that FHR was in the business of making jet fuel for sale at Ted Stevens International Airport; however, some products were sold in the interior. He shared that the other refinery largely supplied fuel to military installations and home heating fuel in the residential market. He thought that if the refineries could fire their plants with a cheaper fuel product than was currently being used, overall business would improve. 10:47:57 AM JEFF COOK, REGIONAL DIRECTOR, EXTERNAL AFFAIRS, KOCH INDUSTRIES PUBLIC SECTOR, FLINT HILLS RESOURCES, spoke in support of SB 86. 10:53:46 AM Senator Bishop inquired whether the bill could bring about growth opportunities in jet fuel. Mr. Cook responded in the affirmative. 10:54:52 AM Senator Dunleavy requested a hard copy of the public testimony. 10:55:07 AM Co-Chair Meyer CLOSED public testimony. SB 86 was HEARD and HELD in committee for further consideration. SB 59 was SCHEDULED but not HEARD. 10:55:27 AM