Legislature(2005 - 2006)BUTROVICH 205
05/01/2006 03:30 PM Senate RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| HB304 | |
| SB314 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | SB 314 | TELECONFERENCED | |
| + | HB 304 | TELECONFERENCED | |
| + | TELECONFERENCED |
SB 314-RETROACTIVE ADJUSTMENTS IN OIL PRICES
CHAIR THOMAS WAGONER announced SB 314 to be up for
consideration.
3:51:15 PM
SENATOR KOOKESH arrived.
BRIAN HOVE, staff to Senator Seekins, presented SB 314 on behalf
of the sponsor. He read the following sponsor statement into the
record. [Original punctuation is provided.]
This legislation corrects the unintended consequence
resulting from the State's filing of a protest with the
Federal Energy Regulatory Commission (FERC) regarding
interstate tariff rates on the Trans Alaska Pipeline
System (TAPS). SB 314 amends AS 38.05.183(f) so as to
disallow retroactive adjustments in the sale price of
royalty oil where a TAPS transportation rate change has
occurred.
The effect of the State's filing (from January 1, 2005
forward) is to create a potential retroactive payment for
any in-state refinery purchasing State royalty oil until
the FERC case is settled. This could be as late as August
of 2009. Though the State is a signer to both the ten
year royalty oil contract with Flint Hills Resources
Alaska (effective April 1, 2004) and the TAPS Settlement
Methodology (TSM) which governs TAPS rates through 2009,
the State chose to challenge TSM prior to 2009 thus
creating retroactivity potential for Flint Hills
Resources Alaska (Flint Hills).
The negative impact on Flint Hills and other entities has
been real and immediate. FHR must reserve for this
potential liability up to $50 million per year. With up
to five years to settle the case with FERC, accumulated
retroactive liability could reach $200 million or more.
This has caused Flint Hills to cancel a $175 million
clean fuels project and a $91 million naphtha stabilizer
project.
In addition, low margin products such as naphtha have
been discontinued in 2006 and Flint Hills is purchasing
10,000 barrels less per day of State royalty oil, for
which a premium is paid. This has also resulted in the
loss of approximately $7 million in shipping revenue for
the Alaska Railroad and $1 million in fuel flowage fees
for the Port of Anchorage. FHRA is also not able to
provide long term contracts to fuel customers such as
Golden Valley Electric Association because of the
uncertainty caused by potential retroactivity.
Senate Bill 314 eliminates the uncertainty for buyers of
State royalty oil and encourages investment and product
production decisions to be based on genuine market
factors rather than the prospect of tariff retroactivity.
It also restores fairness in terms of avoiding
retroactivity with respect to raw materials that have
long since been manufactured and sold into the
marketplace.
3:54:24 PM
JEFF COOK, Director, External Affairs, Flint Hills Resources
Alaska, "Flint Hills", outlined the company's business in
Alaska. He said that Flint Hills has worked with the Department
of Natural Resources (DNR) on this issue for over a year and has
provided as much information as possible. However, due to
proprietary issues and anti trust considerations, it has not
been possible to provide the detailed pricing and contract
information that DNR has requested.
Fortunately, Mr. Cook said, that information is not needed to
understand that tariff retroactivity is mutually harmful to the
Flint Hills refinery, to its customers, and to the State of
Alaska. Tariff retroactivity was addressed in the royalty oil
contract with the state and Flint Hills considered the issue in
its purchase economics of the refinery. However, it did not
expect the state to protest the agreement prior to its
expiration at the end of 2009.
3:57:10 PM
MR. COOK said that beginning in March 2005 Flint Hills
approached DNR to suggest possible options, but there was no
agreement. As a result, Flint Hills has cancelled over $260
million in projects for clean fuels and naphtha stabilizer. This
has resulted in lost jobs, smaller purchases of crude oil from
the state, lost revenue to the Alaska Railroad, and lost revenue
to the Port of Anchorage. Furthermore, Golden Valley Electric
Association would like a five-year contract for naphtha for its
new turbines at North Pole, but that's not possible unless the
long-term price for naphtha is known. Not only does this hurt
Flint Hills, it also hurts GVEA and its customer base, he said.
Also, asphalt prices for the 2006 construction season and beyond
are uncertain and that impacts road construction and upgrades in
Interior Alaska.
Historically the Flint Hills refinery has been profitable
because of its cost advantage over the West Coast price for ANS
crude, but that advantage would be eliminated with
retroactivity. He offered the information that refineries that
don't grow don't tend to survive.
MR. COOK stated that SB 314 puts the state at a crossroads. It
can support and pass the legislation, which would be mutually
advantageous to a host of beneficiaries, or it can continue on
the path of tariff retroactivity thereby perpetuating the
negative results outlined above. He asserted that when the total
impact of retroactivity is considered it is clear that the long-
term losses are far greater than any windfall retroactive
payment the state might receive in the future.
SB 314 provides equity, fairness and certainty for any purchaser
of state royalty oil. It will encourage production decisions
based on legitimate market factors, he concluded.
4:02:24 PM
SENATOR FRED DYSON asked for a summary of pipeline tariffs and
questioned why the shipper would owe retroactively if FERC
decided that a pipeline owner had over charged for shipping.
MR. COOK deferred to Mr. Sementelli.
TONY SEMENTELLI, Chief Financial Officer, Flint Hills Resources,
explained that the tariff calculation starts with a published
West Coast price for ANS crude. Deductions are applied for
marine freight and the pipeline tariff to arrive at a Prudhoe
Bay value. In the next step Flint Hills moves the barrels to the
Flint Hills refinery at the intrastate rate. He said the lower
the tariff, the more Flint Hills pays for crude at Prudhoe Bay.
SENATOR DYSON indicated that his question was not answered.
MR. SEMENTELLI used the following example. The published ANS
price in California is $60. To arrive at an Alaska price you
would deduct marine transportation and the tariff. The agreement
with the state is that the marine transportation deduction is
$1.55. For simple math consider the tariff to be $4.00.
Basically, the price Flint Hills pays the State of Alaska is $60
less $1.55 less $4. If the tariff were reduced to $2, the
deduction from the West Coast is lower and therefore Flint Hills
would owe the state more for the crude oil.
4:05:43 PM
SENATOR DYSON again asked why his company has to pay as opposed
to pipeline owners who were overcharging.
MR. SEMENTELLI replied because Flint Hills has indexed its crude
oil contract to the published tariffs so the pricing term is
used as a proxy to get a value to pay the state.
SENATOR DYSON questioned why the pipeline company wouldn't be
required to pay back the overcharge instead of Flint Hills.
MR. SEMENTELLI replied they would if they actually shipped
barrels interstate, but they don't. The rate is just use for
pricing terms.
SENATOR DYSON mused that the cost of shipping the barrels to the
refinery at North Pole is not in contention here.
MR. SEMENTELLI replied that is correct.
4:07:58 PM
SENATOR KIM ELTON commented on the DNR fiscal note and said he
would agree with the analysis. No one should have been caught by
surprise because the RCA had already determined that the tariff
valuation method was flawed. He asked Mr. Cook to respond.
MR. COOK said it may or may not be flawed, but the state was a
signatory to TSM so Flint Hills did not expect the state to
oppose the contract prior to the expiration at the end of 2009.
MR. SEMENTELLI said the point is that the RCA has no
jurisdiction on interstate rates. The RCA decision is still on
appeal so Flint Hills could get a decision in 06 or 07 saying
that the RCA was not correct in that particular rule.
MR. SEMENTELLI added that running the refinery five years in
arrears is not a good way to run a business and that policy has
caused Flint Hills to seek ways to avoid retroactive payments.
First they have worked proactively to address the concerns Mr.
Cook expressed and second they have reduced production so that
fewer barrels are at risk of retroactivity. He noted that
refining is a very capital-intensive business that requires
continuous reinvestment, but the current policy is for minimum
investment until there is cost certainty. This could take years
longer than 2009, he concluded.
4:11:56 PM
SENATOR ELTON followed up saying the fiscal note is based on the
premise that the potential liability is up to $50 million per
year so if a potential decision is far into the future, the
potential impact to the state could be well over $100 million.
MR. SEMENTELLI agreed. It could go on for years such that the
retroactivity bill could potentially be larger than the cost of
the refinery. Clearly, he said, it is not possible to run a
business with a potential liability that is larger than the
actual physical cost of the asset.
SENATOR ELTON asked if other refineries are buying product on
the open market rather than from the state and whether that is
more competitive.
MR. SEMENTELLI replied Flint Hills is very competitive with the
Kenai refinery, but if Flint Hills were put on parity with
Valdez then it would be at a competitive disadvantage because it
would have to pay the higher price and the railroad costs.
4:15:09 PM
KEVIN BANKS, Petroleum Market Analyst, Division of Oil and Gas,
Department of Natural Resources (DNR), explained the
department's perspective. When the state chose to sell oil to
Flint Hills, the decision was to take oil that would normally be
paid for by the lessees in-value. Those contracts include
retroactive provisions. When the lessees ship oil to the Lower
48, they pay an interstate tariff. When the tariff is adjusted
downward and the FERC rules that it should be paid
retroactively, the companies do get a refund from the pipeline
company and then the refund is passed on to the state.
That is where the basis for the decision to sell oil to Flint
Hills begins, he said. When the state is negotiating contracts
with potential RIK buyers, it may not sell the royalty for less
than what it receives for it in-value. The state tried to make a
contract with Flint Hills that has as few moving parts as
possible, but the tariff allowance and the quality bank
allowance were left with retroactive provisions.
4:18:34 PM
Although there may be discussion about what was said when the
deal was struck, the state has always recognized that in
insisting on a retroactive provision items were traded away. One
such example is interest. Under normal circumstances interest
begins to accrue once the payment is due. However, should a
retroactive payment be required, Flint Hills will enjoy an
interest break from today up to the point that the state issues
an invoice.
To put it into context, he said the state last year received 56
percent or $1.2 billion of its royalty revenue from Flint Hills,
which makes it the largest royalty payer in the state. It is by
far larger than the royalty-in-value lessee payers. Over time
Flint Hill's percentage is expected to increase, so by the end
of the contract it could take nearly 80 percent of state's
royalty oil. Although Flint Hills says it anticipates buying
less oil from the state to avoid the potential retroactive
liability, the current contract does allow it to take as much as
77,000 barrels a day so the state cannot sell that oil to anyone
else.
4:21:01 PM
Historically the state has had retroactive provisions in its
contracts and that has been an issue for other purchasers. If SB
314 were to pass a question of fairness would arise because the
state would be offering new contracts to new purchasers, but it
would only have a limited amount of oil to sell.
4:21:28 PM
SENATOR DYSON asked if he said that if SB 314 were to pass new
companies would not be subject to retroactivity, but Flint Hills
still would be.
MR. BANKS said no. He said that SB 314 would require that the
state sell oil without a retroactive provision. That would be
attractive to other potential purchasers, but there is not a
large quantity of royalty oil available to sell. When the
contract with Flint Hills was negotiated, a finding was that
there was not competition for the crude oil. But now, because of
the current contract, the state couldn't meet other refineries'
needs.
4:22:44 PM
SENATOR DYSON asked if this legislation would make the current
Flint Hills contract significantly more attractive than the
original bargain.
MR. BANKS replied yes, because the company would no longer be
subject to the potential $50 million lump sum payment.
SENATOR DYSON asked if the original contract had a lump sum
provision.
MR. BANKS said technically there was no bidding process. The
contract was based on a negotiated price and there was no lump
sum provision.
SENATOR ELTON restated his understanding of the previous answer.
Passing SB 314 would negate the retroactive provision and compel
the state to sell royalty-in-kind to others without
retroactivity. However, because of the Flint Hills contract,
there may not be much royalty -in-kind oil to sell to others.
MR. BANKS replied that is basically true.
4:25:57 PM
SENATOR ELTON said that would suggest that the sweeter deal is
already locked in at 77,000 barrels. Companies buying on the
open market may want to get back in if retroactivity is gone,
but there may not be enough oil available.
MR. BANKS said there's another problem with the concept of the
77,000-barrel reservation. Nominations are made each month based
on a range of 56,000-barrels to 77,000-barrel per day. Although
current projections indicate that 44 percent of royalty oil is
available to sell to someone else, that might not always be the
situation during the summer when North Slope production falls
and Flint Hills' demand for product rises.
4:27:20 PM
MR. BANKS noted that Article VIII, Section 2, says that the
maximum benefit of the people rule would apply when disposing of
royalties. He related that in 1980 Judge Compton ruled on the
ANS Royalty Litigation and created a bright line when he
indicated that in that particular case RIK could not be sold for
less than RIV.
If attorneys were to argue on behalf of a less bright line, they
would need to demonstrate that in return for selling RIK for
less than RIV the state would receive a measurable benefit -
such as jobs. Flint Hills would have to make a definite
commitment to provide that measurable benefit such that it
sufficiently balances what the state gives up and therefore is
not found unconstitutional. The issue is whether or not Judge
Compton's view of what RIK can be sold for in the state allows
the state to sell it for less than RIV.
4:30:06 PM
SENATOR ELTON asked if he agrees with the previous speaker that
the decision could be pushed well into the future in which case
the fiscal note would be significantly understated.
MR. BANKS said given the past performance of the FERC it is
reasonable to assume that the wait could be lengthy. He outlined
that a hearing is scheduled for early 2007 and a decision is due
by the end of April 2007. However, it will be subject to
judicial appeal so the process could go on for some time.
SENATOR DYSON mused that a prudent company negotiating to buy
royalty oil might figure this sort of perfect storm situation
into its business plan and set the money aside to address that
potential.
4:32:28 PM
MR. BANKS replied a prudent company would make sure it had the
money it needed if the FERC lowered the tariff and required
retroactive adjustment. It's a reserve against owner equity and
not available for spending anywhere.
There is more here than just retroactivity, he added. Flint
Hills had to make adjustments to meet the Environmental
Protection Agency (EPA) low-sulphur diesel requirements and to
do that they elected to join with Tesoro, which was a less
costly option than retooling the North Pole refinery.
Furthermore, Flint Hills's ability to supply naphtha to the
local and export markets has been affected by the treatment of
naphtha as a cut in the quality bank. Previously naphtha was
relatively less expensive and it was possible to remove it from
the oil stream and export it to Asia. With the new quality bank
naphtha will cost Flint Hills much more.
He concluded that retroactivity undoubtedly is important because
$50 million a year comes right out of Flint Hill's pocket. The
issue that DNR struggles with is whether the $50 million will be
returned to the economy of the state or go to the Lower 48.
4:35:49 PM
SENATOR DYSON questioned whether it's fair to impose such a
significant uncertainty factor on Foot Hills when it didn't have
a watchman or any control on the process.
MR. BANKS disagreed with the portrayal of the issue and noted
Flint Hills is a subsidiary of Koch Industries and that company
owns a portion of the pipeline so they too are involved in the
dispute with the FERC to keep the tariff high. Clearly, the
intrastate tariff is lower so transportation between Pump
Station 1 and North Pole is based on a lower tariff methodology
that the RCA imposed. So a distance-adjusted tariff on the
interstate would be a higher price. The reason royalty oil is
sold to Foot Hills based on the interstate tariff is because
that's where the oil goes if it doesn't stay in the state so the
opportunity for the state is to either go to the West Coast and
sell the oil in-value or sell it in state to someone else. Mr.
Banks emphasized that the interstate deduction for tariff is an
appropriate deduction. The difficulty is that the tariff is
being adjudicated by the FERC.
4:38:43 PM
GOVERNOR BILL SHEFFIELD, Chair, Alaska Railroad Corporation
(ARC), Director, Port of Anchorage, presented the railroad's
perspective on the issue. He explained that hauling petroleum
from the North Pole refinery accounts for $45 million in revenue
or 48 percent of the railroad's revenue freight business.
Because Flint Hill's business is down about 15 percent this
year, the railroad will make $7 million less revenue, which is
essentially the profit.
He related that the railroad must prepare this year for the
anticipated further decline in Flint Hills business and to that
end ARC management expects to lay off 200 to 208 people from the
United Transportation Union. To emphasize what that means
Governor Sheffield told the committee that a March 2005 study
indicated that the Alaska Railroad supports nearly 1,900 Alaska
jobs and about $83 million in payroll. He calculated that with
the expected drop in business about $21.5 million in payroll
would disappear.
Governor Sheffield continued to outline expected cuts to the
$108 million in capital operating programs and resulting payroll
losses to further demonstrate the potential impact this issue
has on the railroad and the ripple affect that it would have on
the Port of Anchorage and other Alaskan businesses. He estimated
that it would take five years to develop an industry that would
create the kind of jobs that would be lost if this issue isn't
resolved.
4:46:58 PM
MERRICK PIERCE, Fairbanks, described SB 314 as horrible
legislation and corporate welfare. He related that Flint Hills
Resources is a subsidiary of Koch Industries Inc., which is the
largest privately held corporation in the U.S. with over $80
billion in annual revenue. The principle owners of Koch
Industries Inc. are among the 50 wealthiest people in the U.S.
and although he doesn't disagree with their political leanings
he does take issue with the apparent hypocrisy when it comes to
self-interest. They support the elimination of social welfare
programs claiming that they result in undue government control
being exerted over individual lives. Perhaps they'd like to give
a straight-faced explanation of why welfare for the poor is bad
while corporate welfare for billionaires is okay, he said.
MR. PIERCE referenced page 9 of the 2004 contract between Flint
Hills Resources and the State of Alaska and said it clearly
states that the tariff allowance is subject to retroactive
adjustment so Flint Hills knew it should establish a contingency
fund for when the tariff was revised. Furthermore, it's
important to note Flint Hill's parent company is one of the
owners of the Trans Alaska Pipeline and as such it is acutely
aware of the tariff issue.
In closing he stated the belief that it would be better to get
Alaska roads in decent shape before giving hundreds of millions
of dollars to billionaires living in Minnesota.
4:50:33 PM
LADD McBRIDE, Fairbanks, reported that he is not sympathetic
with Flint Hills Resources because the tariff adjustment was a
known expense item when the contract was signed. He expressed
the view that Alaskans should not "eat" the potential $200
million. Flint Hills certainly has not given Alaska customers a
break, he said. In fact, up until recently the locally refined
gas came at a premium. Furthermore, Flint Hills has not met any
of the obligations or contract requirements concerning
manufacture of low sulphur fuel and that is costing everyone in
Alaska money.
MR. McBRIDE urged the committee to look at the maximum benefit
to Alaskans when considering how to handle SB 314.
CHAIR WAGONER held SB 314 in committee.
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