Legislature(2003 - 2004)
03/25/2003 01:41 PM House FIN
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* first hearing in first committee of referral
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+ teleconferenced
= bill was previously heard/scheduled
HOUSE BILL NO. 57
An Act amending the manner of determining the royalty
received by the state on gas production as it relates
to the manufacture of certain value-added products.
REPRESENTATIVE MIKE CHENAULT MOVED to ADOPT work draft #23-
LS0303\S, Chenoweth, 3/12/03, as the version of the bill
before the Committee.
Representative Croft OBJECTED in order to hear the changes
made to the previous bill.
Representative Chenault explained that changes had been made
to address concerns regarding a windfall/profit made for the
gas contract between the Agrium facility and Unocal.
Language was added to guarantee that the legislation would
not apply to Unocal.
Representative Croft noted that he would WITHDRAW his
OBJECTION to passage of the committee substitute. There
being NO further OBJECTION, the work draft was adopted.
Co-Chair Williams interjected that it was not his intent to
move the bill out of Committee at this time. He referenced
the draft fiscal note.
Representative Chenault stated that HB 57 would allow the
manufacturers and producers to know the basis upon which
royalty would be calculated before entering into a contract.
He believed it would help the acceleration of business for
oil and gas production companies. The companies currently
can be subject to audits as much as five years after the
sales have been completed. Adoption of the proposal could
promote development and would provide producers with the
knowledge that they would not have to pay additional
royalties at some point in the future. With a fixed royalty
rate, it would benefit the State of Alaska and its residents
by providing local manufacturing industries with a solid
foundation providing stable jobs, increased sales and a
greater investment in the local communities.
MIKE NUGENT, GENERAL MANAGER, AGRIUM KENAI NITROGEN
OPERATIONS, KENAI, spoke in favor of HB 57. He stated that
the legislation was a "piece of the pie", which would
provide producers in Cook Inlet with stability and Agrium
with certainty of what the costs are to manufacturer the
products. He stated natural gas is the major raw material
used by Agruim.
Mr. Nugent continued, Agrium's Kenai Nitrogen Operations is
one of Alaska's few major value added manufacturing
operations. The Kenai plant is the second largest producer
of nitrogen products in the United States. From Kenai, 6%
of the total nitrogen products in North America is
manufactured. The majority of the product is exported to
the Pacific Rim countries including Korea, Taiwan, Mexico,
Thailand, and Australia. He added that Kenai has been
competitive in the world markets because of its location and
the skilled workforce and stable government.
Mr. Nugent listed the countries that compete with Kenai to
sell fertilized products: Russia, Indonesia, Saudi Arabia,
and Venezuela; however, none have the same attributes, in
particular a stable government but they do have extremely
low natural gas prices. That situation puts Kenai at a
disadvantage in marketing their product. The disadvantage
is partly due to provisions in State contracts, which
require the State of Alaska to receive the highest
prevailing price for the State's royalty gas.
HB 57 could help in that it would allow the Department of
Environmental Conservation's Commissioner to accept a price
paid to the State for gas, a price negotiated between Agrium
and the producer. He noted that over the past few weeks,
there have been questions regarding the fiscal impact of the
bill. He offered the following comments:
· The Department of Natural Resources has
supplied a fiscal note. It does not consider
the other economic impacts such as wages,
purchases of goods and services, taxes, and
new developments, to the State of Alaska. It
only considers the impact of natural gas
value.
· The analysis is based on forecasts and the
forecasts involve several variables such as
volume, price, and ownership, all of which
are difficult to predict. The analysis also
assumes full capacity operations or
consumption of maximum volumes of natural
gas.
· As opposed to forecasting the future, the
reality is that Agrium's Kenai operation is
currently curtailed due to the inability of
suppliers to deliver adequate natural gas
supplies. The plant is operating on average
at 75% capacity making a revenue reduction to
the State, Agrium, and the local economies,
regardless of which price forecast is used.
· Unless the State can find a producer who can
provide a large quantity of natural gas at a
competitive price in the future, the
curtailment will last for several years
and/or could result in a shutdown. Agrium
has had repeated discussions with the
producers in Cook Inlet. The concern is the
additional royalties that the producer is
currently subject to.
· The development of new natural gas reserves
is more difficult because of the risk of
unknown State royalty gas values. The risk
is associated with the value or price being
set by others in a process not participated
in.
· If the State is not successful in developing
additional competitive gas reserves, Agrium
will not survive as a business. As a result,
revenues to the State from royalty gas sales
could be zero.
· Natural gas has a different value to
different consumers. One price does not fit
all.
Co-Chair Harris inquired how many employees did Agruim have
and what was their average salary. Mr. Nugent replied that
there were approximately 292 full time employees with an
average salary of $84,000 dollars a year. If the
legislation does not passed, the organization would not be
able to operate at capacity, raising the unit cost of the
product. If there are no additional reserves, then Agrium
cannot help other producers in the Cook Inlet area develop
their resources. He emphasized that Agrium could go out of
business without the requested reserves. He stated that HB
57 would help to reduce the risk that producers see as they
go to develop natural gas reserves in Cook Inlet.
Co-Chair Harris inquired how much can the State expect to
receive from gas royalties versus Agrium would going out of
business. The fiscal note assumes that the State should
receive a certain royalty; however, if the gas is not sold,
the State will loose much more revenue. He understood that
the fiscal note indicates that by FY 2009, the State might
loose up to $4.5 million dollars in revenue. He asked how
much gas that would represent. Mr. Nugent replied that the
gas stream would be approximately 34.4 billion cubic feet a
year.
Co-Chair Harris inquired the amount of revenue that Agrium
provides the Kenai Peninsula Borough. He stated that the
Committee was looking at benefits for a specific area versus
the benefits to the entire State.
Mr. Nugent responded that taking the total economic value of
the facility's impact on the economy, dividing it by the
billions of cubic feet of gas equals the economic impact at
approximately $6.28 dollars per cubic foot, which is
higher than what is paid for the gas.
ERIC MCDOWELL, PARTNER-McDOWELL GROUP, RESOURCE SOLUTIONS,
JUNEAU, commented that his company had analyzed many
entities across the State, noting that the situation is
unique in regard to value added and overall benefits. He
added that there are varying numbers regarding how this
would affect the Kenai economy.
Mr. McDowell referenced the fiscal note, pointing out that
the State would be gaining approximately $6-$7 million
dollars a year over a seven year period. Additionally, it
would be a good investment of the State's resources to have
the use of policy force stability and resources to enhance
the economy, keeping the costs private rather than going
public. He added that would not assure the State of a
revenue stream from the manufacturing operation of Agrium.
Mr. McDowell stressed, "Agrium more than carries its own
weight" and concluded that the stability policy assures
Alaska of revenue and economic benefit.
Representative Stoltze commented on how the loss of 300 jobs
would affect the Kenai community and economy. He hoped
there was someway to quantify the fiscal note.
Representative Croft inquired if the State was pricing the
royalty gas too high and questioned making statutory changes
that results in a loss of money. Mr. Nugent guaranteed that
the agreement between the producer and the user would be a
fair economic value for that gas. Representative Croft
pointed out that over a period of time, it could be a lower
price. Mr. Nugent interjected that there is a possibility
that over time, the value price could increase in value.
Representative Croft questioned why the market has not
operated to address this concern. Mr. Nugent responded that
Cook Inlet is in the stranded gas system with five producers
and three major consumers. Representative Croft mentioned
that there are seven other producers to buy from. Mr.
Nugent corrected that there are only five producers in Cook
Inlet.
LISA PARKER, GOVERNMENT & COMMUNITY RELATIONS ADVISOR FOR
AGRIUM U.S., KENAI, advised, currently, Alaska has
stipulated that the highest paying rate should be paid for
natural gas in Cook Inlet. The State has never received the
"higher-of" in any of the gas that they have sold. The
utilities right now have the ability to negotiate and get
between the price that they and the producer have
negotiated. The State could accept that as the price.
Currently, the State of Alaska, through their process,
negotiates settlement agreements with the company following
an audit years past to negotiate that price. The "higher
up" price has actually never been paid to the State of
Alaska in the Cook Inlet.
Representative Croft stated that the fiscal note indicates
that the State will loose some revenue on the arrangement.
He questioned if that was appropriate in order to protect
three hundred jobs, and asked why the State is not able to
buy from someone that is not inflating the price.
Mr. Nugent spoke to the fiscal note, claiming that it acts
as a forecast and that the nature of a forecast makes
assumptions. Predictability and stability are the goals.
Agrium believes that they will be able to strike a deal that
is fair to both Agrium and the State of Alaska.
Representative Croft questioned if it could be lower.
TAPE HFC 03 - 38, Side B
Mr. Nugent responded that compared to today's value, it
could be a lower price.
Co-Chair Williams recommended that Representative Croft get
together with the Agrium staff to discuss these concerns.
He recommended that the Committee could further discuss
these ideas at the next scheduled meeting.
Representative Croft asked why Agrium was not buying from
the other producers. Mr. Nugent responded that they do buy
gas from producers on property that does not have State
ownership. He noted that there are several private
individuals who would like to develop their natural gas
fields. Agrium would like to receive definition and
predictability around the wells and properties owned by the
State.
Representative Whitaker inquired about future production and
contracts. He asked about the royalty certainty on all
State leased lands regardless of the producer. Given
additional gas supply, he assumed that it would be probable
that production would increase. Mr. Nugent advised that in
the current situation, the gas in Cook Inlet has reached a
point where the demand exceeds supply. Currently, they are
at a 75% capacity. He stated that it would be difficult to
get back to capacity during the next two years.
Representative Whitaker asked if given the "feed stock",
could the market bear productivity increases. Mr. Nugent
thought it would. Representative Whitaker asked if it was
fair to assume that there would be an increased supply.
Representative Whitaker inquired how long after the fact
could an audit appear for royalty charges. Mr. Nugent
stated that it could take place four or five years after the
fact. Representative Whitaker advised that a company might
not know their full cost until after royalty charges, which
could be four or five years after the fact.
Co-Chair Williams inquired how the federal royalty system
works for Agrium. Ms. Parker explained that the manner in
which the State gets their royalty is based on the costs
which the producer and consumer have negotiated. That is
the manner in which royalties are calculated. She added
that the proposed legislation would establish that standard.
MARK MEYERS, (TESTIFIED VIA TELECONFERENCE), DIRECTOR,
DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES,
stated that the federal system was based on market value,
which is similar to the State's prevailing or market value.
Mr. Meyers commented that it is difficult to determine arms
length contracts with many factors involved and added that a
company could be audited up to six years. In most cases,
the audits are done to ensure proper royalties are paid
based on the allocation and that the transportation costs
are reasonable. He noted that due diligence was standard as
with any business.
Mr. Meyers recognized the value of the Agrium plant, which
adds value to the gas and the high paying jobs available.
No one wants to threaten that business or industry. He
voiced a concern regarding the effectiveness of the relief
provided. He pointed out the volatility of gas prices,
noting that in Cook Inlet, it rests in smaller amounts.
Mr. Meyer observed that one of the challenges is to
determine how to provide effective relief. To close down
the business would be value and economy lost to the State
for the short term. Additionally, he asked if shutting them
down would deter gas exploration throughout the State. All
explorers want the highest value contract. There are
natural market economics occurring in the market. He
suggested that the situation could be remedied if the
balance of gas in the Cook Inlet area would change. The
State does need more offshore exploration and ways to
stimulate it.
The legislation provides some certainty in terms of audit
cases. Mr. Meyer commented on the fiscal note, based on
creating many different scenarios at various capacities.
The fiscal note attempts to encompass all reasonable
outcomes. Clearly, if the plant were to close down, it
would be devastating to the local community and would defer
gas there. That consideration was not taken into account
when preparing the note.
Representative Croft inquired if the demand for Cook Inlet
gas exceeds the current supply. Mr. Meyers replied that it
is about even now. People are not willing to pay less for
the gas because of the problems getting it, which has
created a "squeeze" on those that cannot pay the high
utility market value. In previous years, there has been a
surplus. He noted that the gas price in general has a lot
of volatility. There are few long-term fix contracts
anymore based on a market value approach. Representative
Croft asked if that applied more broadly to Cook Inlet and
the risk to the North Slope's collateral value.
Mr. Meyers replied that it was limited to utilities that
manufacture the agricultural chemicals. He noted that the
original bill could have applied to any value added
manufacturer but the bill was amended to limit that to
manufacturers of agricultural chemicals.
BILL POPP, (TESTIFIED VIA TELECONFERENCE), KENAI PENINSULA
BOROUGH, OIL AND GAS LIAISON, KENAI, spoke in support of the
bill. He commented that the legislation would be a step in
providing a stable business environment for the value added
manufacturing industry in the Cook Inlet basin. There are
various value added industries located within that borough.
HB 57 address issues faced by the Agrium facility. Agrium
is a key component of the borough's economy as the third
largest local employer accounting for $25 million payroll
annual dollars. Agrium generates about $2.5 million dollars
in property taxes annually. Mr. Popp stated that the bill
addresses the issues of planning stability by providing for
a consistent and reliable price structure. He urged passage
of the bill.
Representative Stoltze asked what percent of royalty
payments were made for the Cook Inlet gas production going
to Anchorage. Mr. Meyer responded that he did not know at
that moment, the value of AA treatment for utilities. Vice
Chair Meyer inquired if that reference was to the one-third
ownership that the City of Anchorage has.
Representative Stoltze responded that there had been
legislation passed in the early nineties, which benefited
Anchorage consumers and royalty rate in terms of a "long-
term dependable" gas supply.
In response to Vice Chair Meyer's, Mr. Meyers explained that
they would qualify for AA treatment and would be receiving
that value on the royalty. The lessee would be receiving
the benefit and hopefully they would pass that on to their
contract, but they are not required to. Many utilities
value from 1991 to 1999 was about $6 million dollars. The
value of the incentive has declined because of the price
paid for gas, becomes prevailing value over time. Last
year's average was less than anticipated.
Representative Whitaker asked if AA treatment was determined
by a contract price between a producer and a gas or electric
utility. He commented that with the State involved, would
they be providing more value. He suggested that an
insertion that AA should not be a give away.
Representative Joule commented that there are always
accommodations made so that projects can have some validity.
He recommended another revenue generation discussion in the
Committee, determining when it becomes a "tradeoff". He
agreed that the bill would stimulate economy, however, it is
important to understand the State's need for revenue
generating capabilities.
Co-Chair Williams noted that work would be done on the
fiscal note during the following week. He voiced his
support for the bill.
HB 57 was HELD in Committee for further consideration.
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