Legislature(2003 - 2004)
05/06/2003 09:01 AM Senate FIN
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
CS FOR HOUSE BILL NO. 57(FIN)
"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."
This was the first hearing for this bill in the Senate Finance
Committee.
Co-Chair Wilken stated this bill "allows the Department of Natural
Resources commissioner to adjust the value of the State's royalty
share for gas used by a manufacturer for agricultural chemicals."
He noted a proposed committee substitute "Version C" was submitted
to the Committee by the sponsor. He requested a presentation of the
bill and a comparison of "Version C" to the House Finance committee
substitute [referred to as "Version X"].
REPRESENTATIVE MIKE CHENAULT, Sponsor, explained this bill "adds
certainty to in-State value-added manufacturing". Currently, he
informed, royalty prices are calculated in four different ways
which causes problems for manufacturers because the price of gas is
uncertain, as well as the royalty owed on that gas. He explained
that four years after the sale of product, an audit could determine
that the price was considerably higher, costing the manufacturer $4
to $5 million in additional royalties. He stated this legislation
would permit manufacturers to negotiate the price of the gas to
allow the manufacturers to sell it at a price that allows for a
profit.
SENATOR TOM WAGONER clarified this legislation pertains to the
"price of the State royalty share of gas".
Senator Bunde commented that residents of the Kenai Peninsula
oppose the level of State spending; however, this legislation
proposes increased State funding. He understood the need to support
viable industry. He asked the estimated cost to the State.
Representative Chenault cited the fiscal note, which predicts the
cost to be between zero and $11,5 million in lost royalty payments.
He listed the factors, including the negotiations reached by the
commissioner, employment opportunities and tangible benefits to the
communities.
Senator Taylor asked the version the sponsor supports.
Representative Chenault responded that the proposed committee
substitute, Version "C" mirrors Senate companion legislation and
reflects a compromise agreed upon by the Senate.
Senator Wagoner reiterated Version "C" is the preferred version.
Senator Taylor moved for adoption of CS HB 57, 23-LS0303\C as a
working draft.
Without objection the committee substitute was ADOPTED as a working
draft.
Senator Taylor revisited the potential cost to the State.
Senator Wagoner clarified the maximum $11.5 million predicted loss
of royalty revenues would occur over a period of several years.
Senator Taylor asked if this estimate is based on the provisions of
committee substitute Version "C" or the House Finance committee
substitute.
Representative Chenault replied Version "C".
Co-Chair Wilken noted a draft fiscal note, dated 5/5/03, addresses
the provisions in Version "C".
Senator Hoffman expressed concern that chemical fertilizing plants
nationwide are currently failing because the methane gas used in
stock feed is worth more than the finished product. He questioned
therefore the benefits of this legislation to provide jobs.
Representative Chenault could not speak to businesses elsewhere
failing, but stressed the economic impact the loss of jobs on the
Kenai Peninsula that would occur if the local facility failed. He
informed that personnel layoffs are currently under consideration,
although he attributed this to new ownership and because the plant
is operating at 70 percent of capacity.
Senator Hoffman asked if the sponsor would consider a shorter time
period for a negotiated price to minimize the loss of royalty
revenues.
Representative Chenault indicated he would have to give the matter
consideration before offering support.
Co-Chair Wilken referenced page 2 of the draft fiscal note, which
details the potential loss of royalties over the five-year period.
Co-Chair Wilken asked for an explanation of the current process and
why the royalty rate changes. He also asked for additional
information on the impact on the State general fund.
Representative Chenault remarked that this bill would not affect
current contracts for gas supplies. He explained the existing
process whereby the State and the producer negotiate a royalty
amount without input of the manufacturer. He stated that upon
review after four years, the State could determine that the
negotiated royalty was not a "fair price".
Co-Chair Wilken asked for an example of the producers in this
context.
Representative Chenault exampled Unocal and Marathon, noting that
all gas producers are involved in the royalty negotiation.
Co-Chair Wilken clarified the producer negotiates a long-term
contract for the "price of that feed stock" with the State.
Senator Wagoner told the Committee that the previous owner of the
manufacturing plant also discovered and produced the gas.
Currently, he said, Union Oil produces the gas, and Agrium operates
as the manufacturer.
Co-Chair Wilken next clarified the States receives 12.5 percent in
royalty from Unocal, the producer, which sells that gas to Agrium.
Representative Chenault affirmed and continued that the State could
conduct an audit of the royalty price negotiated with Unocal and
subsequently could determine that Unocal paid less than the worth
of the gas.
Co-Chair Wilken understood an agreement of the price was
negotiated.
Representative Chenault reiterated the existence of four different
methods to calculate the royalty amount. As a result, he stated the
State could determine additional payment is required, at which
point, Unocal would collect the funds from Agrium.
SFC 03 # 78, Side A 10:36 AM
Co-Chair Wilken asked if retroactive price adjustments are a
condition of the agreements between Unocal and Agrium.
Representative Chenault affirmed.
Representative Chenault reiterated this legislation would not
impact current contracts, however in future contract negotiations
Agrium, i.e. the manufacturer, would participate in negotiations
and the royalty price would remain at the negotiated amount for the
term of the contract.
Co-Chair Wilken asked if Unocal were able to receive a higher price
from the sale of gas to a buyer other than Agrium, whether the
difference would be assessed to Agrium.
Senator Wagoner told of the contract providing that Unocal would
supply gas to Agrium at a negotiated price. He noted one exception
is increased utility demand during winter months.
Representative Chenault emphasized this legislation would provide
assurances that under the terms of future contracts, the
manufacturer would pay the negotiated royalty price.
Co-Chair Wilken asked if new contracts would be implemented in FY
05 and FY 06.
Representative Chenault informed that one long-term contract is in
effect currently and that the remainder of the gas purchases are
subject to "spot market". He stated that the manufacture is
attempting to purchase an adequate supply of gas to operate the
facility.
Senator Wagoner furthered this legislation allows the commissioner
to negotiate profit sharing with Agrium if determined to be in the
best interest of the State.
KEVIN BANKS, Division of Oil and Gas, Department of Natural
Resources, testified via teleconference from an offnet location,
that leases negotiated since statehood are market-value leases. He
explained that the royalty value is subject to an evaluation using
four different measures to determine the market value of the
royalty. He noted that some leases in other states are gross
proceeds leases, which provides that the royalty paid by the lessee
is equal to the amount that the lessee sold the gas. He stated the
sale price of the gas is one of the four measurements utilized for
determining market value of royalty in Alaska and that the State is
allowed to consider the price between the lessee and its customers
compared to the market value as measured by other mechanisms.
Therefore, he pointed out, the sale price and the royalty price
could differ under the provisions of the lease agreement if the
market value is higher.
Mr. Banks stated that determinations of higher royalty amounts are
often made after an audit and after the initial royalties have been
paid. In these instances, he said, the lessee is required to pay
additional royalty amounts two or more years later.
Mr. Banks pointed out that gas supply contracts commonly allow the
lessee and its customer to agree to an "excess royalties" term. He
exampled contracts between gas producers operating in Cook Inlet
and utility companies include this provision.
Mr. Banks outlined the fiscal note estimates the amount of gas that
would be sold to Agrium and other entities, such as utilities, in
the future, not including gas currently under contract. He stated
the fiscal note assumes that a royalty contract would provide for
the State to collect additional royalties in the event the market
value is determined higher.
Co-Chair Wilken asked if an audit calculates the price of gas if it
were sold to a utility company, compared to the price charged
Agrium, and collects the difference from Agrium. He asked if this
legislation eliminates this review and stipulates that the value of
gas sold to utility companies has no bearing on the royalty amount
due from Agrium.
Mr. Banks affirmed.
Co-Chair Wilken clarified that this bill establishes a procedure by
which the royalty price is determined through negotiation, and
asked which parties are involved in these negotiations.
Mr. Banks replied the suppliers and Agrium negotiate and that the
State has no involvement.
Co-Chair Wilken asked if the State is therefore relinquishing the
utility value, or alternative customer value of gas sold to Agrium,
and for the benefit of fertilizer production on the Kenai
Peninsula.
Mr. Banks affirmed. He pointed out that Version "C" provides that
the commissioner has the discretion to set a royalty price for
between $2 and $2.43, as exampled in the draft fiscal note. He
stated that under normal circumstances the value is $2.43 and the
contract value is $2.00.
Co-Chair Wilken asked how the commissioner would determine the
actual amount.
Mr. Banks replied the commissioner must ensure that the contract
price is not unreasonable low, and that the prospective reduction
in royalty receipts would be balanced by employment opportunities
in the fertilizer manufacturing plant.
Senator Hoffman asked how often during six-year term of the
contract would the commissioner make a determination of the royalty
amount, once or more often.
Mr. Banks explained the process, whereby each lessee would submit
an application to commissioner and provide the terms of a contract
with Agrium listing the negotiated prices. He said this information
would be used in calculating the royalty and would occur only once
in the life of the contract.
Co-Chair Wilken announced the bill would no report from the
Committee during this hearing.
MIKE NUGENT, General Manager, Kenai Nitrogen Operations, Agrium,
testified via teleconference from an offnet location that this
legislation is "one piece of a pie, which could provide producers
in Cook Inlet with stability, and Agrium with certainty of what the
are to manufacture the products we sell." He informed that natural
gas is the major raw material used to develop products.
Mr. Nugent asserted the nitrogen facility is one of few major
value-added manufacturing operations in Alaska, is the second
largest producer of nitrogen products in the United States, and
that six-percent of the total nitrogen products are produced in
North America. He listed the Pacific Rim countries that import
Agrium products, including Korea, Taiwan, Mexico, and Thailand, and
the need to be competitive in world markets. He remarked that the
company currently is competitive because of the facility's location
close to markets, the highly skilled workforce and the stable
political climate; unlike the competitors located in Russia,
Indonesia, Saudi Arabia and Venezuela. However, he pointed out
these countries enjoy "extremely low" natural gas prices, which
puts Agrium at a disadvantage. He stated this legislation would
lessen the disadvantage.
Mr. Nugent informed that this bill would allow the commissioner to
accept the price negotiated by the producer and the manufacturer,
Agrium, as the amount by which royalties would be calculated.
Mr. Nugent pointed out the fiscal note does not reflect economic
impacts provided by Agrium, including wages, purchase of goods and
services, taxes and new development to Alaska, and instead only
considers the price of natural gas. He stated that the analysis is
based on forecasts, which involve several variables that are
difficult to predict, such as volume, price and ownership. He
furthered that the analysis assumes that the facility is operated
at full capacity.
Mr. Nugent shared that the facility is not operating at full
capacity because Cook Inlet suppliers are unable to deliver
adequate natural gas supplies. He stated the plant is currently
operating at 75 percent of capacity, which results in lower revenue
for the State of approximately $2 million if 2003. He warned that
unless able to fund producer to supply a large quality of natural
gas at a competitive price, Agrium could eventually fail as a
business and the State and local communities would receive no
revenues from the operation.
Mr. Nugent told of repeated discussions with producers in Cook
Inlet in which the primary concerns were the additional royalty
charges the producer is subject to. He cited a letter to the City
of Kenai from Aurora Power Resources, Inc. dated February 11, 2003,
which reads as follows [copy on file].
Aurora Gas, LLC is aggressively pursuing the development of
natural gas producing properties, primarily on the West side
of Cook Inlet. Oil and gas exploration and development is a
high cost, high-risk endeavor. As a producer looking for to
market our natural gas there is a great hesitation to enter
into a gas sales agreement with a purchaser, such as Agrium,
because it adds yet another layer of risk to a producer. A
producer selling gas to Agrium runs the risk, in fact the
probability, that certain years after selling its gas to
Agrium, the State will assert a claim that royalty needs to be
paid on a higher value than the arms length negotiated
contract price. This additional royalty, plus interest accrued
at a higher-than-market rate, would have to be born by the
producer and/or by the purchaser.
It is for this reason that Aurora Gas, LLC and its natural gas
marketing affiliate, Aurora Power Resources, Inc. strongly
endorse this legislation and the concept that royalty should
be paid on the basis of arms length negotiated contract
prices. Accordingly, we salute and support the draft
resolution in support of HB 57 and urge the Kenai City Council
to adopt same.
Mr. Nugent spoke of the increased difficulty of development of
natural gas reserves caused by the unknown State royalty values.
Senator Taylor noted he was absent during portions of the testimony
asked why the chair intended to hold the bill in Committee.
Co-Chair Wilken indicated questions related to the fiscal note.
Senator Bunde referenced Mr. Nugent's testimony asserting that the
fiscal note does not take into account taxes collected from Agrium
in determining the cost of this legislation. He requested further
information on this matter, specifically what taxes.
Co-Chair Wilken instructed the sponsor to provide a detailed
sponsor statement explaining the bill.
Co-Chair Wilken ordered the bill HELD in Committee.
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