Legislature(2003 - 2004)
02/25/2003 03:22 PM House O&G
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HB 57-ROYALTY GAS CONTRACTS CHAIR KOHRING announced that the final order of business would be 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." Number 2003 REPRESENTATIVE ROKEBERG moved to adopt the proposed committee substitute (CS), Version 23-LS0303\I, Chenoweth, 2/25/03, as a work draft. There being no objection, Version I was before the committee. Number 1987 REPRESENTATIVE CHENAULT, sponsor of HB 57, reminded members that questions had arisen at the previous hearing; those relating to the fiscal note prepared by the Division of Oil & Gas, Department of Natural Resources (DNR), required answers from Mark Myers, who was on teleconference. [The original fiscal note was dated 2/4/03; a new fiscal note with a more extensive analysis, dated 2/11/03, had been provided by the division for the original bill version, but copies weren't yet available to members.] Also available to answer questions was Mike Nugent, the general manager of Agrium Kenai Nitrogen Operations, which would be [assisted] by this legislation. Number 1860 REPRESENTATIVE CHENAULT, in response to a request from Representative Rokeberg, addressed changes in Version I. Page 1, line 10, further defines "manufacturer" to say "manufacturer of agricultural chemicals". The word "increased" on page 2, line 26 [of the original bill, line 27 of Version I] is deleted. Page 2, line 28, of the original bill, which is line 29 of Version I, adds [after "manufacturer", the words "of agricultural chemicals"]; page 3, line 3 [of the original bill, which is line 5 of Version I], does the same. And [page 3, line 8 of Version I] defines "manufacturer of agricultural chemicals" [whereas the original bill, beginning at line 6, defined "manufacturer"]. Number 1790 REPRESENTATIVE ROKEBERG requested corroboration that the concerns expressed by him and Representative Kerttula at the previous meeting were addressed by the more restrictive change from "manufacturer" to "manufacturer of agricultural chemicals". Number 1682 MARK MYERS, Director, Division of Oil & Gas, Department of Natural Resources (DNR), offered his belief that the definition has been significantly narrowed to address the agricultural chemical issue. He said the concern about the broader definition of ["manufacturer"] no longer remains. For further clarification, he deferred to Virginia Ragle of the Department of Law, who he said had looked at this extensively as well. Number 1639 VIRGINIA RAGLE, Assistant Attorney General; Oil, Gas & Mining Section; Civil Division (Juneau); Department of Law, noted that she reviews issues on behalf of DNR. She told members, "We did look over the definitions proposed by Agrium to narrow this, and they feel that this ... would be one way to narrow down the range of applicants ... DNR would be getting to seek relief under this bill." [She was given a copy of Version I at this point.] REPRESENTATIVE ROKEBERG referred to page 3, line 10, and asked whether the definition of "manufacturer of agricultural chemicals", which mentions "similar chemicals", is narrow enough. MS. RAGLE replied that it differs somewhat from the language proposed [by Agrium] for the definition, which she'd reviewed on behalf of DNR a couple of weeks ago. She said it didn't appear to differ in a "significant legal way," but pointed out that she'd just looked at [Version I] briefly. Number 1373 REPRESENTATIVE ROKEBERG asked, "As an attorney, are you comfortable defending the language or pursuing somebody who's trying to breach it?" MS. RAGLE offered the possibility that it was written by the legislative drafters to conform to (indisc.--papers over microphone) requirements. CHAIR KOHRING suggested that because Version I has a narrower definition, there should be a change in the fiscal note. The committee took an at-ease from 4:50 p.m. to 4:54 p.m. Number 1298 CHAIR KOHRING, indicating copies of the division's 2/11/03 fiscal note were being made, asked Mr. Myers to comment on it. MR. MYERS acknowledged its complexity and apologized for not being present to explain [the previous version] at the earlier hearing. He then told members it basically is about a $33- million fiscal note over about a seven-year period. The contract price - the contract value - is based on a negotiated contract between Agrium and Unocal [Union Oil Company of California]; Unocal actually owns the gas, and so basically [the state's] royalty commitment is through Unocal. Mr. Myers said there is a contract value for the gas, a known volume of gas being produced from the leases under that contract, and a differential between the actual market value - the prevailing value - of that gas and the contract value under the contract. Number 1209 MR. MYERS advised members that the negotiated contract with Unocal has provisions that complicate part of the analysis. [Agrium] essentially negotiated a lower contract price or contract value at the time of sale of the plant, basically buying both the gas supply and the plant for a single price. He offered his understanding that, as part of the contract, any lowering of royalty below market value is shared 50-50 between Unocal and Agrium. Expressing confidence that the fiscal effect to the state of $33 million is fairly accurate, he pointed out that approximately 50 percent - not the entire amount - of the benefit would go to Agrium. MR. MYERS explained that the [fiscal note] analysis recognizes that the amount of gas under that contract is decreasing over time. And there are other scenarios wherein additional gas is bought off other state lease sales. Therefore, the final page of the fiscal note addresses sensitivity analyses. For example, if the plant is only producing gas at about 75 percent of capacity and the amount of gas under the Unocal contract declines rapidly, [Agrium] will pick up more gas off other state leases and the differential could be a little less, around $23 million. Number 1098 MR. MYERS, mentioning that the division had run a bunch of scenarios, pointed out that the fiscal note strictly looks at Agrium and doesn't refer to any other people taking the benefit of what he called the "double-A" treatment [because this bill amends subsection (aa) of AS 38.05.180]. He explained: We put, in the earlier pages, a back-casting of what it would have cost in previous years; that's not actual costs of the bill, but it just shows you a good illustration ... that the numbers are, in fact, reasonable. We went through the fiscal analysis with Agrium as well, and, ... my understanding is, we have a pretty good concurrence ... on the numbers in the fiscal note with Lisa Parker ... and the folks at Agrium. So, again, we believe this is a good, actual calculation, ... with the sensitivity analysis in here for various scenarios. MR. MYERS pointed out that also complicating the fiscal note is that the contract price is arm's length - the state isn't privy to that data. That is one of the issues that makes calculating additional fiscal effects on other leases more difficult, because the state isn't a party to the contract between the two parties. Other considerations often come into that, he added, "which is one of the reasons you always keep a market value - a prevailing value - option in your lease form." He informed members that Ms. Ragle is very knowledgeable about both the contract between the companies and some of the history with the "double A" [subsection (aa)] and why it was done. Number 0972 REPRESENTATIVE CRAWFORD said he understands the worth and need of doing this for Agrium, but asked whether the bill would open up the possibility of big breaks with regard to taxes or royalties down the road. MR. MYERS replied that he believed it would, but only for other manufacturers of agricultural chemicals. If there were a lot of North Slope gas available, for example, and someone else wanted to do a large-scale agricultural project, it would certainly qualify for it. It would be for similar-type industrial activity, limited, to his belief, by that definition of ["manufacturer of agricultural chemicals"]. He also offered his belief that another company doing a similar type of value-added business would suffer the same competitive issues that Agrium would, and thus it would be reasonable that such a company would receive similar treatment. He suggested that if the desire is to limit potential revenue implications, there could be a sunset placed on the bill; he indicated he wasn't recommending that, but just thinking of possibilities. REPRESENTATIVE CRAWFORD thanked Mr. Myers and said it was what he'd wanted to hear. Number 0832 REPRESENTATIVE ROKEBERG asked Mr. Myers whether he'd looked at any model of economic alternatives weighing foregone royalties that would be lost to the state if the company were to shut down because of an inability to have affordable feedstock. MR. MYERS clarified that the division isn't taking a position on the bill on its merits. He added, "We understand the jobs and the importance of the Agrium plant, and that it is a truly value-added industry." He said the fiscal note just looks at the factual production base over the next seven years. Calling the "what ifs" a two-edged sword, Mr. Myers pointed out that the royalty gas is less than 7 percent of the gas going into the plant now. Only about half [Agrium's] gas currently is from state royalty leases; the other half is from federal and other lessees. He remarked: So, ... we only affect about 7 percent, and if half the value's going to another producer, you're only affecting, effectively, about 3.5 percent of their gas or less in giving them a lower break. Now, that could well help them stay in business, but there is no economic test in the bill, one way or the other, to say whether this is really helping them or not. And I'm not advocating that ... it wouldn't help them. I'm just saying, you can't really quantify, on that small quantity of gas, how it's going to affect their long-term marketability in the [Cook] Inlet. I think you can say, in converse, though: without a reasonable price for gas, you don't get future exploration ... and development. So ... there's a needed certain level of pricing in the inlet to establish that additional supply, to keep ... them healthy. And I think always, as ... the person paying the lowest value for gas, they're always going to be the lower end of the supply chain. But that lower-end price has to be enough to encourage that exploration [and] development. Number 0621 MR. MYERS suggested the market value and cost structure should [equilibrate] eventually. He added: I don't know, again, if there's a whole lot we can do about it, since the gas we supply in the royalty share's a relatively small ... portion of the gas. So you ask a really complicated question and, again, there is no position [on the bill]. We understand the value that Agrium brings, and I'm not suggesting that this bill is appropriate or not appropriate. We're just actually physically analyzing the percentage of the royalty gas - what the fiscal effect's going to be. Number 0575 REPRESENTATIVE ROKEBERG referred to one of the tables in the fiscal note analysis, specifying that he was looking at the royalties paid versus royalty foregone; using Agrium's figures based on the McDowell Group document [signed by Jim Calvin and included in packets], he said the company would be paying $41.5 million and that foregone royalty would be $24 million or so. He asked, if Agrium shut down, whether the product would be lost or would find its way into other markets. MR. MYERS surmised that the sale of the gas might be deferred, but that ultimately the gas would go into the LNG or utility market, in which case it would get a higher price. He mentioned the question of the loss of the industry and the jobs. Number 0467 CHAIR KOHRING said that's assuming there would be other takers for the gas, which isn't certain. He offered that if the plant shuts down, ultimately there will be less in royalty [payments] to the state because there will be less need for gas. He specified that he supports the legislation, and emphasized the need to weigh the economic benefits as well as the royalty consequences to the state. He said this is an effort to keep [Agrium] from closing. Number 0362 REPRESENTATIVE ROKEBERG asked Mr. Myers what kind of rate is being used for discounting the value and the present value basis on the fiscal note. MR. MYERS answered, "We're using 8 percent." Number 0331 REPRESENTATIVE CRAWFORD requested to hear verification from Agrium that 50 percent [of the benefit] would go to Agrium and 50 percent would be to Unocal. Number 0270 MIKE NUGENT, General Manager, Agrium Kenai Nitrogen Operations, responded, "Under the arrangement we have made with Unocal, right now we would share in any additional royalties to the State of Alaska. However, they are not our sole supplier of gas right now." REPRESENTATIVE CRAWFORD said, "According to your figures, over the next seven years there'd be about $24 or $25 million worth of total benefit. Half of that would go towards Unocal. Is that approximately right?" MR. NUGENT offered his understanding that all the figures assume that Agrium is running at full [capacity] and that all the gas is coming from Unocal. If that were the case, the figures would be correct, but that isn't the situation today or what is foreseen for the future. REPRESENTATIVE CRAWFORD responded that the figures provided by Agrium said $24 million, whereas the Division of Oil & Gas estimated approximately $33 million, based on uncertain figures. He said he wants to ensure that Agrium exists for generations to come. He asked whether a way needs to be found to direct that total $24 million to Agrium, instead of half to Agrium and half to Unocal. MR. NUGENT replied that splitting it with Unocal is an agreement his company made with Unocal on the gas it supplies. Number 0030 REPRESENTATIVE McGUIRE asked what percentage of its gas Agrium receives now from Unocal. TAPE 03-10, SIDE A Number 0001 MR. NUGENT said the company is operating at 75 percent of capacity, and approximately two-thirds of that gas is from Unocal. For the other one-third of the 75 percent, the company has made arrangements with other suppliers over the winter months to supply that gas. Number 0063 REPRESENTATIVE McGUIRE offered her understanding that the contracts with Unocal specify that any royalty adjustments - either up or down - are shared or apportioned equally. She asked whether the term is for a set amount of gas for a set period or is adjustable. She said it has been suggested that Agrium might benefit more if there were other suppliers in Cook Inlet so that the supply would be spread out. She acknowledged that she might be requesting proprietary information. MR. NUGENT answered: We had a contract with Unocal to be our sole supplier of gas through 2009. And Unocal has been unable to deliver that full quantity of gas. So, to answer your question, we are in the process, over the short term, to try to develop additional supplies from other producers, and it's out intention, ... going forward, to develop enough relationships with other producers to get our facility back to capacity. Number 0197 REPRESENTATIVE ROKEBERG asked whether the contract provides for a further [price] break because of Unocal's failure to deliver [the necessary amount of] Agrium's feedstock and because of the necessity to seek other sources of supply. MR. NUGENT replied that the contract is a subject of litigation at this point. There are provisions in the contract such that if Unocal cannot supply the full amounts, it is liable for some liquidated damages, but Mr. Nugent said those are "relatively minor in the shortfall that we're presently experiencing." Number 0287 REPRESENTATIVE ROKEBERG referred to Mr. Myers' testimony that the amount of royalty gas is a relatively small amount of Agrium's needed gas. He requested clarification, noting that Mr. Nugent had said Unocal is supplying about two-thirds of the current feedstock but that Mr. Myers had mentioned [3.5] percent for the royalty gas. He asked whether he'd misunderstood. MR. NUGENT answered, "This gets fairly complicated because it depends on where the gas comes as to what percentage ownership the state may or may not have in a particular property." REPRESENTATIVE ROKEBERG asked whether the [3.5] percent Mr. Myers had mentioned was in-kind royalty. He referred to the charts in the fiscal note that talk about the amount of foregone royalty because of the bill. Referring to the McDowell Group document in packets, he observed that it says part of Agrium's feedstock comes from federal leases, "of which the state gets 90 percent." He asked whether those types of revenue-sharing provisions come into play under this bill or would be insulated from the legislation. MR. NUGENT replied that this bill is designed to address [leases] in which the state has an ownership position in the gas. REPRESENTATIVE ROKEBERG referred to the McDowell Group document and noted that it refers to approximately 25 million Mcf [thousand cubic feet] and a royalty share of $3.4 million, with $3 million in royalty foregone. MR. NUGENT noted that in the table, the state leases assume that Agrium is operating at capacity, which isn't the case; that half the gas it receives comes from state leases; and that of that portion, one-eighth or 12.5 percent would be state royalty gas. He remarked that because the company isn't able to operate at capacity, there is an impact on the royalty paid. There is a real revenue loss taking place right now, he added. Number 0593 REPRESENTATIVE ROKEBERG said he was trying to figure out the other sources and where this particular royalty would come into play, since the bill affects only a portion of Agrium's feedstock. MR. NUGENT reiterated that the bill would have an impact on only those leases in which the state has an ownership position. REPRESENTATIVE ROKEBERG asked about federal ones or ones where Native corporations have subsurface rights. MR. NUGENT said those would not [be affected by the bill]. REPRESENTATIVE ROKEBERG asked whether that is part of where Agrium gets its feedstock now. [No answer was discernible.] Observing that the figures project to 2009 and that many assumptions are made in the fiscal note about where Agrium will get its gas, he expressed concern about that. MR. NUGENT said these forecasts were made on the assumption that the distribution would be the same as it was when [the plant] was at capacity, which was last summer. He said it is hard to predict where gas will be found in the future. In response to a question from Representative Rokeberg, he said there isn't another consumer standing there today to purchase the gas that Agrium wouldn't be consuming if it shut down. He suggested it would be a direct revenue hit to the state, to Agrium, and to the local economies. REPRESENTATIVE ROKEBERG requested elucidation about the McDowell Group study. Number 0862 JIM CALVIN, Economist and Partner, McDowell Group, noting that the McDowell Group is a research and consulting firm with offices in Anchorage and Juneau, told members Agrium had requested that his firm look at the economic impacts of its operations on the economies of Alaska and the Kenai Peninsula Borough. The analysis found that the facility directly employs just under 300 people, with an annual payroll of about $25 million; that averages about $83,000 per job, 2.5 times the Kenai Peninsula and Alaska annual average wage. "These are tremendous jobs that really are only found in this kind of value-added manufacturing activity," he remarked. MR. CALVIN further reported that the Agrium operation purchases gas and a variety of goods and services from Kenai Peninsula businesses, Anchorage businesses, and others; that spending activity, as well as the spending activity of its employees, generates about 1,000 jobs in the Kenai Peninsula area and about $50 million in total payroll - about 5 percent of the Kenai Peninsula employment base. Thus the company has a huge economic presence in the area, with about 250 businesses that enjoy some level of spending activity from Agrium. The borough itself receives more than $2 million in property tax from the plant, which is a big part of its property tax base. Number 1023 MR. CALVIN, describing "output" as the total value of all the goods and services produced as a result of the company's operation, said output for Agrium is about $300 million a year. He likened the operation to an economic-development director's dream: it creates year-round, high-paying jobs for residents, since he said there is virtually no nonresident participation in the workforce; it creates a high level of spending in the local economy in support of the operations, resulting in "great multiplier effects"; and it requires a high level of capitalization, which means it generates property tax revenues to help local government. Noting that the state spends millions of dollars on economic development kind of activities, he described this as "the kind of economic activity ... we all strive for," remarkable in the breadth and depth of its economic impact on the borough and state as well. CHAIR KOHRING indicated at some point he'd mentioned a billion- dollar effect to the economy, and said he stood corrected. He thanked Mr. Calvin for the information. Number 1123 REPRESENTATIVE ROKEBERG cited a figure in the McDowell Group analysis about payroll impacts of $383 million. He requested a definition of "payroll impacts." MR. CALVIN answered that it is the total payroll over the 2003- 2009 period addressed in the various fiscal notes. He explained that the McDowell Group had tried to total what is at stake. He added that it had been [adjusted for inflation] a little. REPRESENTATIVE ROKEBERG referred to the gross figures for foregone royalty [to the state] and an indication in the company's document that the foregone royalty, in terms of [Agrium's] costs, had gone from 1 percent of the plant's total economic output, or less than 6 percent of its $50-million-a- year payroll. He asked about that. MR. CALVIN responded that rather than focusing specifically on the impacts to the state's coffers, the McDowell Group had broadened it, looking at what is at stake. He said although there is $3 million a year or so of foregone revenue, there is $300 million worth of economic activity that stems in part from that. He described it as a "give a little, get a lot" picture that his company is trying to present. Number 1268 REPRESENTATIVE ROKEBERG asked Mr. Calvin whether he believes the legislation would be significant in helping the economic health of [Agrium] so it can continue to operate. MR. CALVIN replied that he wasn't familiar with the margins under which Agrium operates, but that there is no doubt the bill would significantly improve its likelihood of remaining in business. Number 1308 CHAIR KOHRING acknowledged that the fiscal note is complicated and difficult to comprehend, but said his comfort about it is greater than at the previous hearing. He offered his belief that the economic benefits far outweigh the modest amount that the state would forego if this legislation went into effect. Number 1370 REPRESENTATIVE FATE moved to report [CSHB 57, Version 23- LS0303\I, Chenoweth, 2/25/03] out of committee with individual recommendations and the accompanying fiscal notes. There being no objection, CSHB 57(O&G) was reported from the House Special Committee on Oil and Gas.
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