Legislature(2013 - 2014)Anch Temporary LIO
12/02/2014 01:00 PM House LEGISLATIVE BUDGET & AUDIT
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| Audio | Topic |
|---|---|
| Start | |
| Overview(s): Caelus Energy Royalty Rate Modification Application | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
ALASKA STATE LEGISLATURE
LEGISLATIVE BUDGET AND AUDIT COMMITTEE
December 2, 2014
1:03 p.m.
MEMBERS PRESENT
Senator Anna MacKinnon, Chair
Senator Click Bishop
Senator Cathy Giessel
Representative Andy Josephson
Senator Mike Dunleavy (via teleconference)(alternate)
MEMBERS ABSENT
Representative Mike Hawker, Vice Chair
Senator Kevin Meyer
Senator Donald Olson
Representative Alan Austerman
Representative Bob Herron
Representative Kurt Olson
Representative Scott Kawasaki (alternate)
Representative Bill Stoltze (alternate)
OTHER LEGISLATORS PRESENT
Representative Les Gara
COMMITTEE CALENDAR
OVERVIEW(S) CAELUS ENERGY ROYALTY RATE MODIFICATION
- HEARD
PREVIOUS COMMITTEE ACTION
No previous action to record
WITNESS REGISTER
J. PATRICK FOLEY, Senior Vice President
Caelus Energy
Alaska Operations
Anchorage, Alaska
POSITION STATEMENT: Testified and answered questions regarding
the background of Caelus Energy and development plans within the
Oooguruk Unit.
WILLIAM BARRON, Director
Central Office
Division of Oil & Gas
Department of Natural Resources (DNR)
Anchorage, Alaska
POSITION STATEMENT: Testified and answered questions regarding
DNR's background and royalty rate modification calculations and
negotiations with Caelus Energy.
ACTION NARRATIVE
1:03:51 PM
CHAIR ANNA MACKINNON called the Legislative Budget and Audit
Committee meeting to order at 1:01 p.m. Senators Bishop,
Giessel, and MacKinnon, Representative Josephson, and Senator
Dunleavy (alternate)(via teleconference) were present at the
call to order. Representative Les Gara was also present.
^OVERVIEW(S): CAELUS ENERGY ROYALTY RATE MODIFICATION
APPLICATION
1:04:16 PM
CHAIR MACKINNON announced that the only order of business would
be an overview of the recent preliminary determination by the
Department of Natural Resources (DNR) regarding the royalty rate
modification application by Caelus Energy (Caelus). She
continued that the committee would hear an overview of the
project from Caelus followed by an overview of the process by
DNR.
1:04:57 PM
J. PATRICK FOLEY, Senior Vice President, Caelus Energy, Alaska
Operations, began by discussing the application for royalty
modification within the Oooguruk Unit on the Torok Interval,
Nuna Development Project (Nuna). Mr. Foley informed the
committee he has had extensive experience working in Alaska, had
assisted in starting up the Pioneer Natural Resources Company in
Alaska (Pioneer), and when he left after 10-years was president
of the Alaska organization. He introduced Matt Musselman (via
teleconference) as vice president of Caelus Energy and advised
Mr. Musselman manages the business development group and was
closely involved in the royalty modification application.
1:07:25 PM
MR. FOLEY stated that Caelus Energy is a privately held
exploration and production company established in 2011 by Jim
Musselman and in April 2014, Caelus acquired all of Pioneer
Alaska's assets via a stock purchase. He pointed out that
Caelus employs 80 Alaska resident employees and seasonally
employs contract workers. Although, he explained, this season
due to shooting two seismic 3D programs Nuna will employ over
500 contract employees. In Alaska, Pioneer spent $2 billion in
capital and expenses and made payments to the state in the form
of royalty and ad valorem taxes of approximately $100 million.
1:09:33 PM
MR. FOLEY noted that funding in Caelus is unique in that it has
a large private equity funder, Apollo Global Management that has
pledged $1 billion in capital to assist in developing the
Oooguruk Drill Site (ODS), which includes Nuna and other
exploration opportunities. Currently, he explained, Caelus has
a $300 million second lien loan and additional credit facility
is available if more money is necessary. He expressed that the
2015 Oooguruk capital budget is approximately $500 million and
is split fifty-fifty between the ODS development project and the
subject project, Nuna. He assured the committee that Caelus
will be careful stewards of the environment and resources while
at the same time "pace is everything" and it will move forward
in a responsible manner. The Pioneer Oooguruk project, from
first lease to first oil was six-years which, he expressed, is
unprecedented and he expects from Caelus's April [2014]
acquisition until first oil will be a little more than two-
years.
1:12:22 PM
MR. FOLEY agreed with Senator Bishop that Pioneer had an
excellent relationship with the Native community on the North
Slope and that the relationship did transfer over as the same
Pioneer employees transferred to Caelus.
1:12:40 PM
REPRESENTATIVE GARA commented that in 2010 Pioneer began working
on exploration and development wells under Alaska's Clear and
Equitable Share (ACES). In November 2013, Caelus purchased the
lease and, he noted that a statement was made that it expected
to begin work immediately without royalty relief. He questioned
why Caelus is currently requesting royalty relief for a field it
purchased and had expected to begin work immediately.
1:13:17 PM
MR. FOLEY responded that in 2002 Pioneer began its business in
the state. He remarked that the Nuna project was in 2010 and
during that period of time Pioneer had lost enthusiasm in Alaska
as it found tremendous success in the Lower 48 and was focusing
100 percent of its capital on developing those assets. In the
summer of 2013 Pioneer began the process of selling its assets
to Caelus and closed on April 15, 2014, he explained.
Approximately December [2013] and January [2014] Caelus began
preliminary conversations with the state regarding "if" it buys
this asset and "if" it develops Nuna what could be done to
improve the economic terms, he remarked.
1:14:53 PM
MR. FOLEY answered in the affirmative to Representative Gara's
question that no one had promised royalty relief when Caelus
purchased the field.
SENATOR DUNLEAVY asked if the $1 billion commitment regarding
Apollo Global Management (Apollo) is contingent upon a royalty
discussion or modification.
MR. FOLEY answered that the financial commitment Apollo made is
specifically for the Nuna project. He explained that Caelus
obtained contingent sanction approval and Apollo will fund the
project subject to the finalization of royalty modification.
1:15:59 PM
CHAIR MACKINNON requested Mr. Foley to depict the information
Caelus had at the time of acquisition and the status of what was
known about the find itself.
1:16:20 PM
MR. FOLEY asked that he be allowed to proceed through the
overview in order that the answer to Chair MacKinnon's question
may become clear.
1:16:30 PM
MR. FOLEY referred to slide 3 of his handout "Caelus Energy
Alaska, Legislative Budget and Audit, Nuna Development & Royalty
Modification and Overview." He advised it demonstrates that
Caelus and many other companies are the type of companies the
state would like to continue to do business in Alaska. He noted
that approximately two weeks ago, Caelus was the apparent high
bidder on 323,000 acres of leasehold and assumed all of the
leases would be issued. He explained the map represents 126
tracks and the total lease bonus that will be paid by Caelus for
these blocks is $15 million. He highlighted that prior to the
lease sale, Caelus made a commitment to a 3D geophysical company
to acquire a new high resolution 3D seismic program which will
be shot this winter within the area depicted on the map.
1:18:02 PM
MR. FOLEY turned to slide 4 and advised the black outline
represents leases owned by Caelus within the Oooguruk Unit which
has two separate developments: the existing off-shore [Oooguruk
Drill Site] island, and the subject project, Nuna. Phase 1 is
shown by the area outlined in brown where there are two drill
sites that ultimately may be associated with the Nuna project.
The Oooguruk Drill Site (ODS) makes production from the Nuiqsut,
Kuparuk River Unit (Kuparuk) and Torok with the estimated
recoverable reserves from the ODS island being roughly 100
million barrels. He stated his working interest partner at
Oooguruk is Eni with a 30 percent interest and Caelus has the
remaining 70 percent. He pointed out that for Nuna, Eni has
gone non-consent so all of the working interest and all of the
monies are spent exclusively by Caelus. He advised that ODS
currently produces approximately 13,000 barrels per day of gross
production with a 2015 capital budget of approximately $250
million. He noted that the island has 48 well slots with 36
slots used, leaving 12 wells yet to be drilled. He noted there
is the possibility of a project to expand the island by adding a
few acres of gravel to grow the well bay thereby allowing for 12
additional wells, with a potential of 24 new wells from ODS.
1:20:21 PM
MR. FOLEY addressed the Nuna Project and reiterated it is within
the Oooguruk Unit and exclusively focused on the Torok Interval.
He explained that Phase 1 has a single drill site (NDS1), with
road system to put in place connecting back to the Kuparuk River
Unit Palm 3S drill site, and flow lines connecting back to the
Oooguruk tie-in pad (OTP). He pointed out that Caelus has no
processing in its unit and therefore made contractual
arrangements with the Kuparuk River Unit (KRU) owners to process
on its behalf. Mr. Foley said that Caelus is the sole true
third-party facility sharing arrangement anywhere on the North
Slope, and that arrangement will continue for Nuna. He
explained that Nuna started by drilling three wells from the ODS
Island, two producers and one injector, which did demonstrate
that Caelus could have a successful water flood. Subsequently,
it drilled two appraiser wells, NDS1 and NDS2, which were
fracture stimulated, production tested, and flowed at
approximately 2500 barrels of oil per day. He estimates that
the Nuna resource has recoverable reserves in the range of 50
million to 100 million barrels and described Phase 1 as 30
development wells.
1:22:26 PM
MR. FOLEY referred to slide 5 and described it as roadside
geology demonstrating a laminated reservoir, of which Nuna is
very similar. He explained that slide 6 is a core photograph
from the 1998 ARCO Kalubik #2 well, wherein the yellow area
represents oil sections, with the black areas being shale. He
added that the challenge with Nuna, unlike the Kuparuk and
Ivishak, is that there are laminated layers of small portions of
sand, shale, sand, shale which continues for as much as 250
feet. The reservoir has low permeability and low porosity and
the only process to remove the oil is by fracture stimulation
treatments and, he remarked, Caelus intends to fracture both the
producer and injection wells which is a technique no other
reservoir on the North Slope has had to employ.
1:25:08 PM
MR. FOLEY referred to slide 7 and noted that on July 1, 2014,
Caelus submitted a final, formal, and complete application. In
October 2014, DNR issued its preliminary finding and
determination which is now in a period of public comment, he
said. He explained that Caelus requested a modification of
royalty at five percent, which is the statutory floor the state
can grant but the [preliminary finding and] determination
maintained base royalties at five percent until a gross revenue
target of $1.25 billion is received. He stated that a
significant amount of jobs will be created and additional
revenue would flow to the state later in the project's life.
Mr. Foley said that another of the state's criteria when
considering any modification is the concept that if the state
helps on the front end, how will the parties share on the up
side. He stated that 75 percent of leases in the Nuna
development are burdened by a one-eighth [royalty] plus a 30
percent net profit share. Consequently, he offered, when this
project goes forward and reaches economic payout over and above
all of the other typical fiscal benefits to the state, the state
will also have a 30 percent net profit share interest in
approximately 75 percent of the Nuna resources. Absent royalty
modification, he remarked, there is no doubt this project may
still go forward but it will be delayed an unknown amount of
time.
1:28:40 PM
REPRESENTATIVE GARA quiered that when a state lease is bid,
whether the lease terms include 12 percent royalty plus 30
percent lease profit.
MR. FOLEY responded in the affirmative.
1:29:08 PM
MR. FOLEY offered that the state concluded in its preliminary
finding that the cost of a project delay of several years
exceeds the loss or diminishment in revenue the state forgoes as
a result of the royalty modification.
1:29:37 PM
SENATOR DUNLEAVY remarked that the issues were known when Caelus
bid upon the lease and questioned the thinking behind that
action as now Caelus is requesting royalty modification.
MR. FOLEY responded that he believes that the leases burdened by
one-eighth [royalty] and 30 percent net profit were originally
issued to a group of companies in the early 1980's, and
ConocoPhillips Alaska and other parties attempted development
and determined those leases were not worthy of their investment.
In 2004, those companies made a deal assigning the leases to
Pioneer that had procured them subject to the existing lease
terms, he remarked.
SENATOR DUNLEAVY surmised that [Pioneer] understood the
conditions of the lease.
MR. FOLEY agreed, and then pointed out that when Pioneer
developed Oooguruk it was granted royalty modification on the
Kuparuk and Nuiqsut Formation within the Oooguruk Unit.
1:31:42 PM
MR. FOLEY brought to the committee's attention the state's
crafted decision holding Caelus's feet to the "fire" as far as
development obligation and, he noted that the state could agree
to a royalty modification with a commitment of diligent
development. The required terms include: a firm and final
sanctioning decision by December 31, 2014; a spend calendar
requirement that Caelus must begin its capital investment of
building the facilities by March 31, 2017; and sustained
commercial production from Nuna by March 2017, he advised.
1:32:42 PM
MR. FOLEY described slide 8 as Nuna's pictorial timeline. He
explained that assuming there is an ultimate favorable royalty
modification determination, Caelus will proceed "full speed
ahead" to install gravel for a road system in a single drill
site pad and vertical support members (VSMs) installed in
February 2015. He further explained that during the winter of
2016, Caelus will install all surface facilities and flow lines,
and a drilling rig moved onto location with development
beginning later in 2016. He noted that Caelus is targeting
first oil in the third quarter of 2016 and anticipates that
initial production rates will be in the 5,000 to 10,000 barrel a
day range with its peak at 15,000 to 20,000 plus barrels a day
range and, he anticipates the project will flow until
approximately 2045. For the purposes of this analysis, assuming
oil prices are similar to today, and the rate profile is similar
to what Caelus believes, the project should reach the $1.25
billion net revenue target in approximately 2020, he submitted.
1:34:50 PM
MR. FOLEY responded to Representative Gara that [slide] 8
represents the life of the project extending to 2045.
REPRESENTATIVE GARA noted that roughly $1.4 billion in royalties
paid by Nuna is less than $50 million per year.
MR. FOLEY assumed Representative Gara's calculations were
correct.
1:35:28 PM
MR. FOLEY described slide 9 as depicting benefits the state will
receive in exchange for a modification of royalty and in
ensuring the project moves forward. He remarked that hundreds
of jobs will be created, with production of approximately 50
million to 100 million barrels of oil, and a capital investment
of $1.3 billion in Phase 1. He further remarked that when
Caelus reviews its economic model forecast of the ultimate money
flowing to the state in the form of royalties, production tax,
ad valorem tax, and net profit share leases it is approximately
$1 billion to $1.7 billion over the entire life of the project.
At the end of the development [phase] Caelus has agreed to share
any findings regarding its costs, development scheme, geology,
all of the techniques employed to maximize production, and
lessons learned with the state, the industry, and other North
Slope developers, he stated.
1:37:44 PM
REPRESENTATIVE GARA noted that Pioneer moved forward with
development wells and exploration wells in 2011, believing this
was a producible project under Alaska's Clear and Equitable
Share (ACES) Act and further noted that this field was purchased
before any promise of royalty modification. He stated that
according to Dr. Scott Goldsmith, fields like Nuna that qualify
for the lower Gross Value Reduction (GVR) tax rate produce for
the state somewhere between a near zero or negative net present
value just for the production tax under SB 21. Yet currently,
he reiterated, the legislature is reviewing a royalty relief
request of over 70 percent for at least a portion of the
project. He summarized that the company committed to buy [the
leases] before it received royalty relief, Pioneer advertised it
as a project it would move forward, and performed development
and exploration wells. He said that Caelus is paying very
little production tax, something worth a near zero or negative
present value to the state, and in addition is requesting a
royalty reduction of over 70 percent. Representative Gara
questioned how those facts made a compelling case for [royalty
modification].
1:39:41 PM
MR. FOLEY responded that the royalty reduction would be at 70
percent up until the $1.25 billion Gross Revenue Value [GRT] is
achieved and it then reverts back to the existing rates. He
offered that Pioneer had a water flood project at the island to
demonstrate that oil could flow from the Torok and could inject
water into the Torok reservoir. With that information, Pioneer
made the decision to drill two exploration wells, Nuna1 and
Nuna2, which represented approximately $100 million in total
capital for the drilling of the two wells. Subsequently,
Pioneer came to the conclusion that development might be
possible but determined not to continue its business in Alaska
and sold all of its assets to Caelus. Therefore, when Caelus
acquired all of Pioneer's assets it acquired a piece of which is
the Nuna project. He reiterated that Nuna, with royalty
modification, will be sanctioned and will go forward in the time
table previously discussed.
1:41:48 PM
REPRESENTATIVE GARA remarked that the state has a tax structure
wherein the state pays back credits and offers deductions. He
questioned the total amount of dollars the state has paid to
Pioneer and Caelus in terms of tax credits and deductions to
help move this field forward.
MR. FOLEY replied that he did not have the numbers with him but
would provide them to the committee.
1:42:24 PM
CHAIR MACKINNON reminded the committee that this is a
preliminary finding and Governor Bill Walker will make the final
determination on this project.
1:43:06 PM
REPRESENTATIVE JOSEPHSON requested a brief description of the
process Caelus performed with DNR to evaluate, as required by
the royalty modification statute, the reasonable profits that
comparable fields should receive and why this deal may be
underneath that threshold.
MR. FOLEY responded that the description may be answered within
DNR's overview.
1:44:04 PM
SENATOR DUNLEAVY quiered whether the 30 percent net profits tax
remains in full force throughout the duration of the project,
and to confirm it is not part of the modification.
MR. FOLEY responded that the lease terms remain in full force
and effect for so long as the lease remains in effect, and
further responded that "No," the net profit share interest is
not affected in any way shape or form by the granting of the
royalty modification.
1:44:57 PM
WILLIAM BARRON, Director, Central Office, Division of Oil & Gas,
Department of Natural Resources, noted the transfer of assets
from Pioneer to Caelus started in October 2013, with the
transferred assets being finalized in June 2014. He described
the Nuna development as an onshore development and that the
current offshore development (ODS) is an island with the process
being through the Kuparuk field. He stated that prior to
submission of a formal application most of the discussions,
economic reviews and analysis of Caelus and Pioneer, from
October 2013 to date, were associated with the acquisition of
Pioneer's assets by Caelus. He stated that relative to economic
modeling and understanding the estimated cost of abandonment and
dismantling, removal, and restoration (DR&R) obligations, a
sinking fund and bonding mechanism was established relative to
that function which has now been employed at the transfer. He
explained that due to DNR's history with Pioneer and ODS the
parties were able to move quickly on the Caelus July 1, [2014]
application and consequently on October 28, 2014, DNR issued its
preliminary finding. On November 7, 2014, DNR issued the
official announcement through the public information office
which triggered the 30-day public comment period. He determined
that due to an error the citizens of Alaska received
approximately 10 extra days to look at the document as it was
first posted on the web site of the Division of Oil & Gas.
1:49:36 PM
REPRESENTATIVE GARA noted that the press release did not mention
the Nuna Development in its title or within its first seven to
eight paragraphs, but was mentioned at the end of the page and
slipped by "all of us."
MR. BARRON characterized it as a general press release which
discussed positive oil and gas activities associated with
several independent operators, and HilCorp and Caelus were
mentioned.
1:50:26 PM
MR. BARRON explained [since 1996] DNR received approximately six
royalty modification applications [slide 3] with some withdrawn
or denied, and the Pioneer Oooguruk Drill Site application being
approved in 2005. Currently, under [DNR's] preliminary findings
the Nuna Torok development would be granted a royalty
[modification] down to five percent until the $1.25 billion
gross revenue target is accomplished. He described gross
production as measured from the lease and a fixed well head
deduction of six percent based on the back-out payment for
processing the product through Kuparuk. He noted it is one of
the operating costs DNR allowed in terms of the net back
pricing. The goal of the Division of Oil & Gas (O&G) was to
structure this as straight up gross revenue and almost straight
value of the product, he explained. Caelus does not have
influence over world product price with some influence over rate
but, he pointed out that is more of a reservoir issue than a
completion issue and described completion technologies and high
dollar costs as "interesting." The Department of Natural
Resources desired the development to move forward but, he
remarked, this was not an open ended royalty modification in
that there had to be clear authorizations of expenditures with a
timeline depicting that both the installation of the facilities
being well on its way and production starting in 2017. He added
that these are hard timelines offering the state protection
because in the event these benchmarks are not met the royalty
modification is rescinded. He opined this puts the burden of
operatorship and responsible development on a timeline to the
company and removes the obligation from the state.
1:54:08 PM
He referred to the technology sharing piece Mr. Foley mentioned
and reiterated that within 24 months of initial production
Caelus is required to issue Society of Petroleum Engineering
(SPE) standard technical documents and publications discussing
and demonstrating Caelus's performance. These documents include
[but are not limited to]: cost structure, the size and type of
fracture technologies employed, drilling techniques, and full
open support of all technology transferred to the [public] in an
accelerated manner for the other players. He offered that it
takes time, energy, and money to "crack the nut" on how to get
some of the reservoirs producing and stated this is a critical
piece in DNR's proposal and negotiations.
1:55:55 PM
SENATOR GIESSEL questioned how Mr. Barron decided that $1.25
billion was the threshold for going back to full royalty.
MR. BARRON responded that the question would be answered [within
his overview].
MR. BARRON responded to Senator Giessel in the affirmative that
the idea of sharing technology is a new concept that has not
been included in other royalty relief.
1:56:25 PM
MR. BARRON pointed out that Caelus's original request was a five
percent royalty until its activities associated with the Torok
at ODS and Nuna had paid out, and subsequent to that payout
there would be a slight increase in royalties over a three-year
timeframe and on the fourth anniversary full royalty would be in
place for all areas. The Department of Natural Resources had
the opportunity to ask the company a great deal of questions
that typically companies do not like to answer when asking for
royalty modification, he said. He mentioned a discussion
regarding sharing the information included in the royalty
modification application with the general public and stated much
of that information is inter-twined with economic and geologic
information which is sensitive and confidential to Caelus. He
advised he is statutorily obligated to keep the information
confidential.
1:58:41 PM
MR. BARRON expressed that it was necessary DNR understood how
the company could determine that this was an uneconomic project
or that the project probably would not go forward without
royalty modification. Subsequent to a review, DNR recognized
that the company was looking at only proven reserves, better
known in the industry as one "P," basically a 90 percent chance
more reserves would be recovered, he stated. Caelus determined
a 10 percent slice of recovery of reserves, which is a
conservative prospective and also possibly fair in attempting to
strike a balance between analysis and critique, he remarked. He
characterized the structure of the Torok as difficult to produce
and reasoned that those calculations were fair due to the
ability to drill horizontally and fracture a producer being one
thing, yet having to do that with injectors is unique and
costly. Plus, he noted, it is unknown if there will be pressure
maintenance and sweep from a water flood in this type of
formation. The efficiency of that sweep and the pressure
support resulting from the water is yet to be determined which
clouds the two "P" and three "P" reserves, he explained. He
noted that the company had a price structure that floated for
the first couple of years and then was fixed for all years out
at the same price. At the time, DNR believed it was
conservative but currently (after a few months) believes it is
radically high, he stated.
2:00:50 PM
MR. BARRON remarked that the company had a fixed opex and fixed
capex. At the time DNR believed it was a conservative
deterministic model with the results of the company's economics
being a low rate of return before federal income tax. He
pointed out that DNR does not use deterministic values so it
"leaned" into Caelus and requested its two "P" and three "P."
He advised that in the engineering world for reservoir
management, reservoir reserves are usually described in log
normal distribution which means it is not a normal curve, it is
a log normal [curve]. Caelus provided the company's internal
and third party consultant documents and DNR established a log
normal distribution for reserves and advised that some risk was
added given the type of reservoir it was and the unknown
characteristics the company may encounter. The Department of
Natural Resources did the same thing with oil price and costs.
He remarked that DNR advised the company that it had given DNR a
fixed cost for capital and a fixed cost for operating expenses,
and to now provide a range. Subsequently, DNR backtracked and
validated some of the numbers in terms of highs and lows and
built distributions around those figures as well. He noted that
the statute is for the prolonged life of the Torok so DNR
reviewed the Nuna plus the ODS, and the ODS only, and calculated
a subtraction of the two to determine the value of the Nuna
portion of the Torok. He explained that DRN calculates its
economics after federal income tax (AFIT) and ran this model
numerous times.
2:03:41 PM
MR. BARRON responded to Senator Dunleavy that the SPCE standard
of the three "P" is that "one P is proven reserves, two P are
probable reserves, and three P is possible reserves." He
explained that as the number of the "P" gets bigger, the
confidence there will be a recovery of the reserves is
diminished.
2:04:28 PM
MR. BARRON referred to slide 8 and described it as a price
forecast and an example of the division's distribution. He
advised that when running the models at the time of the analysis
DNR ranged it from $50-$130 per barrel and built a normal
distribution around those figures with a mean at that time being
$90 [per barrel].
2:05:12 PM
MR. BARRON responded to Representative Gara that the red area on
slide 8 is dollar per barrel. He explained it is a distribution
curve to recognize the frequency of events at a certain product
price and slide 8 depicts the highest point as $90 per barrel
which is where most of the distribution landed.
2:05:39 PM
MR. BARRON referred to slide 9 and stated that DNR ran the
stochastic model, Monte Carlo technique, "tens of thousands" of
times and let the computer generate possible results. He opined
that this is an important aspect to understand as there is an
unknown as to what the product price will be at any given point
in time, or production rate, or capital costs, or the opex which
is why distribution models are built. He noted that any of
these events can take place against each other at any point in
time which is why DNR performs a Monte Carlo analysis to obtain
a range of results. Slide 9 is a probability distribution of
results, and this is roughly a tipping point project. Fifty
percent of the cases came out to be positive at a fifteen
percent rate of return and fifty percent of the cases were not
profitable. He advised it was an interesting dilemma to work
through in terms of whether it was the correct model to be using
as DNR should look at the type of company it was dealing with.
He stated that DNR recognized the company has a higher cost of
capital in that it is receiving private equity funding.
Historically, he offered, DNR has reviewed companies such as
ConocoPhillips Alaska, Inc., BP, Chevron Oil and Gas Exploration
and Development, which are internationally diversified portfolio
companies with worldwide standards and Caelus is basically a
single asset startup company which must go to the private equity
market to receive funding for these projects. He highlighted
that it is a limited pool that can provide $1 billion for
activities in Alaska. In striving to be fair, DNR communicated
with the Permanent Fund Investment Group and inquired as to what
rate of return it would consider if it invested in this type of
project and the answer was somewhere between 17-25 percent.
2:10:02 PM
MR. BARRON turned to slide 12 and stated it depicts the results
of DNR rerunning the economics at 17.5 percent. Sixty-five
percent of the cases were not positive as when elevating the
requirement for rate of return the failure rate increased, which
was expected but not as far as it went, he expressed. The mean
case was a negative expected monetary value with only a few
cases positive, he noted. He indicated that when DNR reviewed
the results it considered that it was a private equity company,
with the project at the tipping point at 17.5 percent. He noted
that DNR recognized that [Torok] is a reservoir that is risky
and more so than the conventional plays of Prudhoe Bay and
Kuparuk. He advised that DNR desired an opportunity to promote
new drill techniques, and for the state to determine if the
techniques could work, how well, and how the technology could be
transferred. It is the intention of DNR to encourage the
development of this type of resource and, he noted, this is also
the sort of play as Badami, Meltwater [Participation Area], and
Tarn [Field]. He explained there are several plays like this
that have not been robustly positive and the companies have
struggled with them. He stated DNR wanted to focus on a single
formation from the new development site and that the Caelus
application requested the Torok from ODS and Nuna. The
Department of Natural Resources concentrated on limiting it to
the new development area and establishing clear milestones the
company would be held to. It was not the intention of DNR to
adversely affect the Alaska Net Profit Share Lease (NPSL) System
benefits and DNR recognized that production, recovery and
product price were critical factors and, except for production,
recovery and product price are completely out of the control of
the operator. He advised that the parties participated in
lengthy discussions in terms of options and alternatives,
ratcheting down and up on product price, sliding scales and
clean curves on product price in an attempt to take issues the
operator was not in complete control of but were drivers of the
economics, and they discussed a gross revenue product. He
opined that regarding a gross revenue product, DNR recognized
that if the company was technically successful the state did not
want to diminish the state's ability to recover product if it
had high rates at low price. In essence, he noted, if the state
only gave the company a product price royalty modification the
company could enjoy low price robust production and gain the
royalty modification. He stated that DNR structured [an
agreement] that if the company's technology worked and
production was high the state would also benefit as it would
truncate the time of which the company was under royalty
modification. He further stated that DNR wanted to blend the
balance of benefiting the state with elevated production and
risk product price, which is how DNR determined the proposal of
the gross revenue target.
2:14:21 PM
MR. BARRON stated that with regard to Senator Giessel's earlier
question concerning how DNR arrived at the $1.25 billion figure,
he referred the committee to slide 14 and described it as the
expected monetary value at 17.5 percent and a $1.25 billion
gross revenue target. He pointed out that the mean is negative
$7.05 which denotes the project on a mean basis is negative;
however, statistically it might as well be zero. He explained
that DNR worked its way back from 2.5, 3.5 and worked backwards
down the scale to a gross revenue target at 17.5 percent which
was at a tipping point of value to the company. He opined that
the project is at a mean of negative $7.05, essentially zero and
any less than negative $7.05 and the project would be more
negative, and any higher the state would leave too much on the
table. The cost is essentially that the state forgo $44 million
in royalty to move the project forward, he surmise and remarked
that DNR expects to receive anywhere from $1 billion to $1.7
billion value to the state in revenue taxes, etcetera. He
offered DNR's belief that as a privately equity funded company
the project would either not go forward or would be
significantly delayed without royalty modification and noted
that caused DNR concern as it desires this sort of project move
forward yet protect the state as robustly as possible.
2:17:02 PM
MR. BARRON remarked that everything was on an economic basis so
DNR tried to find the tipping point of the project in terms of
the gross revenue target. He referred to slide 16 and advised
it represents net present value to the state in its decision
making abilities. He presented the question that assuming the
project did not go forward or was delayed without royalty
modification what would be the value to the state. He pointed
to the red bar on the axis which represents $44 million the
state would forgo under the current proposal, and the blue curve
represents no royalty modification with a one- to five-year
delay. He summarized that by not taking action today it would
cost the state more money in net present value than if the
project was delayed a year with the state losing approximately
$79 million. He surmised that on one hand the state is risking
$44 million but accelerating the development of the asset,
gaining and requiring hard milestones for the company, and
requiring information transfer. On the other hand, the state
could delay a year with no royalty modification and lose more
money than by granting the royalty modification, he further
surmised.
2:18:56 PM
REPRESENTATIVE JOSEPHSON noted he had previously reviewed a
figure of lost royalty of $75 million and quiered how that
figure was determined.
MR. BARRON responded that in the preliminary finding there was a
reduction of $75 million in royalty but with additional taxes
rolled onto that figure the state's total revenue loss is $44
million.
2:19:36 PM
REPRESENTATIVE GARA asked if the state will receive $1.3 billion
in state revenue or whether it would be reduced by tax credits
and tax deductions.
MR. BARRON stated that [$1.3 billion] net is the amount the
state expects to receive at the end of the day.
2:20:29 PM
SENATOR DUNLEAVY questioned if it is possible to recover the
[$44 million] at the back end after the $1.25 billion gross
revenue is met.
MR. BARRON responded to Senator Dunleavy's question by stating
that within robust negotiations DNR did not require [$44
million] but it reduced the gross revenue target, which was
originally higher, and pushed it back to $1.25 billion. He
reiterated that DNR compensated by pushing the gross revenue
target down to provide the state compensation and accelerate the
time in which the state would regain its full royalty.
SENATOR DUNLEAVY surmised that [$44 million] never was recouped
[in the negotiations].
MR. BARRON answered in the affirmative.
2:22:15 PM
MR. BARRON referred to slide 17 and opined that the royalty
modification is in the best interests of the state and is a
well-crafted royalty modification to jump start a project. It
offers the state immediate development into new reserves as
delays cost the state more money and the [royalty modification]
is focused on the scope of a single formation from the new
development, he remarked. He said there are clear milestones
and acknowledged that the legislature has an issue with how to
ascertain companies are performing as the legislature asked them
to perform thereby holding the companies to a fine line. He
noted it does not adversely affect the NPSLs so the benefit of
net profit leases do trigger in when reaching payout. He
further noted that the state gains $1.3 billion net present
value 3 percent discount which targets an "elusive" reservoir on
the North Slope and automatically triggers that 24 months after
first production will be the transfer of technology to the
industry [and public].
2:23:56 PM
REPRESENTATIVE JOSEPHSON questioned if net profit share leases
are unique to this unit, how it came to be, and remarked that it
suggests the unit should have been a more profitable place to do
business.
MR. BARRON answered that net profit leases are not unique to
this unit as there are several throughout the state, mostly in
the North Slope. He offered that the idea first came about in
federal leases with the idea there is a base royalty but once a
payout is reached the company pays more back to the state. He
explained there was a balancing act between the state or the
royalty owner and companies in terms of the uniqueness of NPSL
leases. He explained that the leases are used federally, and
several states use them, and Alaska has performed a few lease
sales with those terms in them. He further explained that the
terms are not often used and this [unit] happens to have some
NPSLs.
2:25:38 PM
MR. BARRON responded to Representative Josephson that the
[preliminary determination and finding] is in the public review
period. Subsequent to gathering comments and, barring a comment
or missed issue that must be addressed in the language of the
agreement, a final finding will be written for the DNR
commissioner's signature, and upon signature that agreement is
completed. He added that DNR will offer background information
to the new administration as it goes through a transition
process.
2:27:18 PM
REPRESENTATIVE GARA noted that most state leases are bid at 12.5
percent royalty, with some at 16 percent, and this lease at 12.5
percent plus 30 percent profit share. He surmised that the
state uses the higher rate when it feels [the lease] is
potentially more productive.
MR. BARRON answered that historically 12.5 percent royalty was
common throughout all domestic regimes and explained that many
years ago the state recognized there were higher potential areas
on the North Slope and designated a line that above which the
royalties were 16.67 [percent]. He noted that those areas are
still 16.67 [percent] and all other areas are 12.5 percent. In
a couple of the lease sales the idea was propagated and the
lease terms included the net profit sharing component and, he
offered, in the last four lease sales and a few years prior to
that the state moved away from the idea. He remarked that
current leases commonly do not include a net profit share
because they are complicated to administer. He pointed out that
Caelus's recent purchase of approximately 320,000 acres is the
third largest lease sale in terms of value in the state's
history for the North Slope. Caelus now must gather data, shoot
seismic, and review the analysis before it determines where to
put in its first exploration well which could be a dry hole. He
offered that exploration wells can cost over $80 million to
drill which is a large investment on a company for a dry hole,
even though they do obtain data. He stated that DNR offers
competitive lease sales but not with an understanding that it is
trying to impose where DNR believes there will be greater
production. When a company purchases a lease it may not have a
lot of information and, he said that the legislature created
royalty modification statutes to assist companies, having
obtained additional information, an opportunity to request
assistance from the state. The structure of this agreement is
sound in its approach to address many issues that bring benefits
to the state, he opined.
2:31:24 PM
REPRESENTATIVE GARA quiered whether it was a reflection of the
state's view that a field is more promising when there is more
than a 12.5 percent royalty.
2:31:35 PM
MR. BARRON reiterated that DNR issues leases without knowledge
of a field being there or not and that the state drew a
demarcation line on the North Slope map stating that north of
that line is 16.67 [percent], and south is 12.5 percent royalty
with no idea of whether anything will be discovered at the time
of the lease sale.
2:32:06 PM
SENATOR BISHOP questioned whether the 320,000 acres were at 12.5
percent or 16.67 percent.
MR. FOLEY advised he believed all of the subject leases Caelus
purchased are at 16.67 percent royalty, other than a single
digit amount being one-eighth royalty.
MR. BARRON confirmed that Mr. Foley was correct.
2:33:26 PM
MR. BARRON replied to Chair MacKinnon that public comment cutoff
is December 12, 2014.
2:33:53 PM
CHAIR MACKINNON paraphrased AS 38.05.180(j)(1)(B) as follows:
"Modification is necessary to prolong economic life of an oil or
gas field or pool because without modification future production
is not economically feasible, and royalty modification must be
in the best interests of the state."
MR. BARRON agreed with both Chair MacKinnon's characterizations
[of the statute] and that his testimony is DNR's effort to
explain to the general public and the legislature the steps
taken to protect the state's interests.
2:34:37 PM
REPRESENTATIVE GARA advised that on November 27, [2014], Page 2,
Commissioner Balash was quoted in the Alaska Dispatch News as
saying "What I found, they are expecting some pretty significant
returns on the investments they make and so ultimately that was
one of the things I took into account." Representative Gara
questioned why he should be comforted that Commissioner Balash
was looking at something that would produce significant returns
for [Caelus].
2:35:52 PM
MR. BARRON noted that he could only answer Representative Gara's
question in that this will be the first private equity funded
project on the North Slope and possibly in Alaska for oil and
gas. In the event an arrangement can be structured for royalty
modification that will allow these kinds of private equity
projects to come into the state, he noted, it would be a
positive step forward. He further noted that it is important
for the people of Alaska to grasp the nature of the companies
now coming into the state, such as: Caelus, Hilcorp, Brooks
Range, 70 & 148 LLC, Armstrong, Royals, Furie, BlueCrest, Eni
and Repsol, with the last two companies to a different degree.
He described companies that require private equity funding as
not "wildly" diversified corporations. In structuring an
agreement that does not onerously diminish value to the state
yet, he remarked, demonstrates to the industry and private
equity sector that the state looking at these projects
positively could play into large dividends for the state and for
future players to develop its projects through private equity.
He explained that private equity players hold a great deal of
acreage in the state for exploration activities and surmised it
is important these companies are successful so the state can
continue the development of its natural resources.
2:38:12 PM
REPRESENTATIVE GARA asked if Mr. Barron disagreed with Dr.
Goldsmith's analysis that fields like Nuna post-2002 production
units will generate in production taxes a negative or near zero
net present value to the state.
MR. BARRON advised he has no opinion.
2:38:54 PM
MR. BARRON agreed that Chair MacKinnon's depiction of slide 15
was fair in that it depicts that a delay would be more costly to
the state as compared to the impact of the royalty modification,
and that it would shorten the overall economic life of the
project.
2:39:35 PM
CHAIR MACKINNON requested verification that Mr. Barron has tried
through negotiations to ascertain that Alaska receive production
timely by requiring the start of the installation of the
facilities by 12/31/15, and production must have started by no
later than 3/31/17.
MR. BARRON answered that Chair MacKinnon was correct.
2:40:13 PM
SENATOR BISHOP surmised that from the state's standpoint there
would be a $1.3 billion net profit back to the state with a $44
million investment.
MR. BARRON agreed with Senator Bishop.
MR.BARRON agreed with Senator Bishop that it is a rounding
"error" to get to $1.3 billion.
2:41:20 PM
The committee took a brief at-ease.
2:42:07 PM
ADJOURNMENT
There being no further business before the committee, the
Legislative Budget and Audit Committee meeting was adjourned at
2:42 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| NUNA_Royalty Modification Backgrounder FINAL.pdf |
JBUD 12/2/2014 1:00:00 PM |
|
| NunaLBA 2 Dec 14 Final For Distribution Non Conf [Read-Only].pdf |
JBUD 12/2/2014 1:00:00 PM |
|
| LB&A Nuna Development Overview.pdf |
JBUD 12/2/2014 1:00:00 PM |