Legislature(1999 - 2000)
05/06/1999 05:09 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
HOUSE SPECIAL COMMITTEE ON OIL AND GAS
May 6,1999
5:09 p.m.
MEMBERS PRESENT
Representative Jim Whitaker, Chairman
Representative Fred Dyson
Representative Scott Ogan
Representative John Harris
Representative Allen Kemplen
Representative Tom Brice
Representative Harold Smalley
MEMBERS ABSENT
Representative Gail Phillips
Representative Brian Porter
COMMITTEE CALENDAR
HOUSE BILL NO. 170
"An Act establishing the Alaska Gas Corporation, a public
corporation, and providing for its structure, management,
responsibilities, and operation."
- HEARD AND HELD
(* First public hearing)
PREVIOUS ACTION
BILL: HB 170
SHORT TITLE: ALASKA GAS CORPORATION
SPONSOR(S): SPECIAL COMMITTEE ON OIL & GAS
Jrn-Date Jrn-Page Action
3/31/99 625 (H) READ THE FIRST TIME - REFERRAL(S)
3/31/99 625 (H) O&G, RES, FIN
4/22/99 (H) O&G AT 5:00 PM CAPITOL 17
4/22/99 (H) <BILL POSTPONED TO 4/29>
4/29/99 (H) O&G AT 5:00 PM CAPITOL 17
4/29/99 (H) HEARD AND HELD
5/06/99 (H) O&G AT 5:00 PM CAPITOL 17
WITNESS REGISTER
WILSON CONDON, Commissioner
Department of Revenue
PO Box 110400
Juneau, Alaska 99811-0400
Telephone: (907) 465-2300
POSITION STATEMENT: Discussed the economics of HB 170.
ROGER MARKS, Petroleum Economist
Department of Revenue
Anchorage, Alaska
Telephone: (907) 343-9257
POSITION STATEMENT: Discussed his analysis of the Alaska Gas
Corporation as established under HB 170.
KEN VASSAR, Attorney
Wohlforth, Vassar, Johnson & Brecht
900 West 5th Avenue, Suite 600
Anchorage, Alaska 99501
Telephone: (907) 276-6401
POSITION STATEMENT: Discussed the bonding and financing aspects of
HB 170.
BRIAN ANDREWS, Financial Consultant
Merrill Lynch
One Sealaska Plaza, Suite 301
Juneau, Alaska 99801
Telephone: (907) 586-4102
POSITION STATEMENT: Discussed the "five C's."
MARK PRUSSING, CPA
Public Finance
Seattle-Northwest Securities Corporation
1000 Southwest Broadway, Suite 1800
Portland, Oregon 97205
Telephone: (503) 275-8309
POSITION STATEMENT: Discussed the bonding and financing aspects of
HB 170.
ACTION NARRATIVE
TAPE 99-16, SIDE A
Number 0001
CHAIRMAN JIM WHITAKER called the House Special Committee on Oil and
Gas meeting to order at 5:09 p.m. Members present at the call to
order were Representatives Whitaker, Dyson, Ogan, Harris, Kemplen
and Smalley. Representative Brice arrived at 5:19 p.m.
Representatives Phillips and Porter were excused.
HB 170-ALASKA GAS CORPORATION
CHAIRMAN WHITAKER announced that the only order of business before
the committee would be HOUSE BILL NO. 170, "An Act establishing the
Alaska Gas Corporation, a public corporation, and providing for its
structure, management, responsibilities, and operation."
CHAIRMAN WHITAKER reviewed the April 29, 1999 meeting which mainly
discussed the revenue sharing aspect of HB 170. He noted that now
it must be established that indeed there is revenue to share.
Chairman Whitaker directed the committee's attention to an Alaskan
map which was utilized in the discussion of up-line processing in
Prudhoe Bay, energy distribution, down-line processing and the
possibility of petro-chemical industries. He commented that a spur
line to Anchorage will clearly be needed.
Number 0447
WILSON CONDON, Commissioner, Department of Revenue, indicated that
policy makers will wish to explore and pursue the question of the
bill providing a vehicle to restructure the fiscal system in a
manner making the project economic. Of the total costs the owners
and operators of the project would pay over the life of the
project, 40 percent of those costs are taxes of which 80 percent
would be federal taxes. He noted such would occur under the
current fiscal system, if that fiscal system was applied to a
privately owned and financed project. Commissioner Condon stated
that under the bill as proposed, as a state-owned project, that may
be achieved such that the project is exempt from federal tax.
Therefore, the economics of the project would change enormously.
Furthermore, avoiding federal taxes might just be enough to improve
the project enough to make the project economically feasible.
COMMISSIONER CONDON emphasized that there is one basic issue to
which he did not know the answer, that is being tax exempt. The
entity owning the project needs to be a lot like state government.
Therefore, he believed that an entity must be established with
close ties to the state in order to placate tax people. On the
other hand, investors in bonds who would pay for the project would
insist on a sound, independent entity that makes its decisions
based upon good business, not on politics. Establishing such an
institution is the challenge. Commissioner Condon informed the
committee that investors might have pause with the project's
requirement that the project terminate in Prince William Sound. In
summary, Commissioner Condon explained that the issue is whether
there is a suitable institutional arrangement that is both eligible
for federal tax exemption and independent enough of the political
process to satisfy investors. Commissioner Condon acknowledged
that over the years, there have been a series of legislative steps
to commercialize North Slope gas which led to the enactment of HB
393 and the current sponsor group. He urged that if HB 170 moves
forward that it be crafted in such a manner to take advantage of
the work done by the sponsor group.
CHAIRMAN WHITAKER commented that nothing is being done to preclude
the sponsor group from participating. In fact, the sponsor group
is encouraged to participate.
Number 1012
REPRESENTATIVE OGAN referred to page 14, line 30 of HB 170 which
refers to "Credit of the state not pledged." He inquired as to how
it could be made to look like a state entity, if the state does not
have any obligation for the debt.
COMMISSIONER CONDON stated that a number of state entities have
been established which are clearly state entities that borrow money
and whose obligations are not obligations of the state. A few such
entities are the Alaska Student Loan Corporation, Alaska Housing
Finance Corporation (AHFC), the Alaska Industrial Development and
Export Authority (AIDEA), the Municipal Bond Bank, and the Alaska
Energy Authority. Commissioner Condon was quite certain that the
general credit of the state would not be desired to be pledged.
REPRESENTATIVE OGAN asked if there is enough of a state entity that
the bonds would be considered tax free by the Internal Revenue
Service (IRS).
COMMISSIONER CONDON said that he did not know. In further response
to Representative Ogan, Commissioner Condon noted that the Alaska
Railroad Corporation (ARRC) is tax exempt. He indicated that the
ARRC is tax exempt, perhaps, because the Congress specifically
granted an exemption. He pointed out that the memo from Legal
Research and Services provided the committee with an example of the
liquor store owned by the City of Bethel which was not found tax
exempt.
REPRESENTATIVE OGAN surmised then that a gray area exists with
regard to whether the corporation established under HB 170 is tax
exempt or not. Perhaps, an act of Congress would be required.
Number 1334
COMMISSIONER CONDON discussed Norwegian Statoil as an example of
the type of entity that would be desirable. Norwegian Statoil is
owned by the government, but is run like a private business. "If
you set up a business that operated that way and you simply had a
board and it could choose to pay dividends or not, that even though
that was state owned, that an entity like that is going to be a
taxable entity." He posed another scenario in which the project
would be run under the Department of Transportation in the same
manner in which Alaska's international airport system is run as an
enterprise. Under such a situation, Commissioner Condon indicated
the enterprise would be tax exempt. He said that investors would
probably not like to see an enterprise this large run as is
Alaska's international airports.
REPRESENTATIVE KEMPLEN said that he was intrigued by the notion of
a hybrid corporation which evoked thoughts of the Permanent Fund
Corporation. It seems possible to create a quasi-governmental
entity that is managed by a sponsor group, which is paid a fee for
management, and has incentives for dividends to be paid to the
state. He asked if that would fall between the two examples given
by Commissioner Condon.
COMMISSIONER CONDON agreed that Representative Kemplen's scenario
would fall between the two examples already discussed. He
commented that the permanent fund is different than what is
encompassed in HB 170. The permanent fund is managing assets that
are clearly state assets. Furthermore, the permanent fund is not
an enterprise in the sense of buying or selling something.
REPRESENTATIVE KEMPLEN asked if an entity managed by a private
sector team would fall within the model of a tax exempt entity.
Could it be possible for the state to engage in a contract with the
sponsor group to serve as managers of the Alaska Gas Corporation,
if the sponsor group could illustrate that they are capable of
managing the project.
COMMISSIONER CONDON imagined that could occur, but he was reluctant
to speculate about what may or may not work. He informed the
committee that he was not present to offer a suggestion to the
resolution. With regards to management, private people can be
hired for a variety of services which may or may not be called
management. "The question of how the entity fits into the state
institutionally maybe goes beyond what we normally think of as the
decision to paint the facility red or green next year."
Commissioner Condon emphasized that lenders will want assurances
that the enterprise will be run in a manner to get the money lent
back. If the lenders think the enterprise will be micro-managed by
the governor or the legislature in an inappropriate manner, the
lenders will be concerned about getting their money back.
Therefore, the question is to determine how to establish an
institution that will run in a business-like manner giving the
investors confidence.
REPRESENTATIVE KEMPLEN inquired as to how the committee could
receive models of how such an entity would work.
COMMISSIONER CONDON said that other examples from around the
country could be utilized, however he did not believe there was
anything that resembled what is proposed here. Commissioner Condon
noted the possibility that the legislation, as drafted, may be
adequate.
CHAIRMAN WHITAKER concluded then that this project would have to
provide for the satisfaction of the IRS and the investment
community; the overlapping of the two must be discovered.
Furthermore, he surmised that there is not an exact model that
could be followed, although the goal is worthy of the time to make
it work.
COMMISSIONER CONDON agreed.
Number 1943
ROGER MARKS, Petroleum Economist, Department of Revenue, noted that
he was present to discuss the results of his analysis of the Alaska
Gas Corporation as established under HB 170. He reiterated the two
main aspects of state ownership which are the tax-free financing
and the state being exempt from federal income taxes on the
profits. With regard to tax-free financing, Mr. Marks pointed out
that tax-free financing does not always mean that the interest rate
will be low. The interest rate is related to the risk an investor
associates with a particular project. Mr. Marks said, "The
question why would tax-free financing, to the extent it's available
and the extent interest rates are low and why would exemption from
federal income taxes be important? If you look at the common
picture that most folks have of this LNG (liquefied natural gas)
project, that is the sale of 2 billion cubic feet a day or 14
million tons a year of gas to Asia at a cost of roughly $12 billion
by the private sector. In our judgement, that probably is not
economic at this time or won't be economic for awhile." He cited
two main reasons why the project is not economically feasible.
Firstly, the pipeline is very expensive and it would require much
gas to be marketed in order to decrease the per unit cost to a
competitive level. The sponsor group has been working to reduce
the cost or utilize a smaller project that would not require the
sale of as much gas to start. Secondly, the project is also
economically challenged because the competition is cutthroat with
other competing jurisdictions containing lots of gas who would like
to sell under the same finite market. Mr. Marks echoed
Commissioner Condon's comments that the large portion of taxes
under the status quo is huge. If that could be removed, that would
economically be the same as cutting the cost $3.5 billion from the
capital outlay. Therefore, it would be a large economic advantage
to eliminate the taxes.
MR. MARKS directed the committee to his series of spreadsheets
which illustrate the possible numbers under this proposal. He said
that the spreadsheet labeled 1 would be utilized as a
representative case. Spreadsheet 1 represents state ownership of
the facilities which would include, per Chairman Whitaker's
instructions, the conditioning plant, the pipeline, and the
liquefaction facilities. He noted that the state ownership would
not include the ships. Also there would be no taxes on the profits
of the sale of the gas as well as tax-free financing for the
conditioning plant, the pipeline, and the liquefaction plant. The
ships would be financed privately. He explained that Spreadsheet
1 illustrates the state's revenue stream, cost stream, and the
difference which is the net revenue to the state. The revenue
stream would be the sale of gas in the Far East. Spreadsheet 1
utilizes the price of $3.50 per million Btu which represents
approximately $17 ANS in energy market prices. He noted that
Spreadsheet 1 keeps the $3.50 constant in real terms, or inflated
at a three percent rate of inflation. Historically, forecasting
energy prices has not been a real success of economists and
therefore, would be a risk to be considered for those financing the
project. He pointed out that the first three columns illustrate
the gross revenue realized by the state; volume multiplied by the
price results in the gross revenue.
Number 2223
MR. MARKS continued with the next set of six columns which
illustrate the state's cost. Mr. Marks assumed that the state
would pay a third party to operate the project which is illustrated
under the heading of "total operating cost." The next heading,
"total principal + interest to pay off $9 billion capital cost"
represents the pay off of the principal and interest on the
conditioning plant, pipeline, and liquefaction facilities.
Currently, it is estimated that the state will finance $9 billion
of the $12 billion total project. He noted that $3 billion of the
$12 billion is ships. In this case, the interest rate was assumed
to be six percent which a normal rate of inflation. Mr. Marks
explained, "As I have structured it, the state does not begin to
pay off the bonds, the principal and interest, until gas sales
commence in 2007 and they pay them off over 30 years. And what
I've done is set this up what we call levelized payments where you
look at on a per mcf (million cubic feet) basis, you start at a
certain rate and those payments increase at the rate of inflation
such that the bond holder, at the end of the day, has earned six
percent on their bonds." He commented that this is different than
a home mortgage under which you would pay the same each year. This
would utilize a low amount that would increase with the rate of
inflation such that the net effect would be the same as a mortgage.
The next column illustrates the financing of the ships in the
private market at an interest rate of 10 percent. He noted that
the 10 percent interest rate was suggested by Dr. Pedro Van Meurs'
report suggested. The final set of costs for the state would be
the purchase of the gas from the working interest owners at Prudhoe
Bay. Per Chairman Whitaker's instructions, the purchase was
started at $0.50 per mcf which is increased with inflation. He
pointed out that the price would ultimately result from the
negotiated price between the state and the working interest owners.
Therefore, summing the operating cost, the sate's capital, the
ship's capital, and the purchase price of the gas result in the
total cost.
MR. MARKS stated that the difference is called the state's net
revenue. Under this scenario, this really represents the state's
cushion to remain competitive. If the state had difficulties
entering the market, the state could reduce the selling cost of the
gas in the Far East or utilize a smaller project that would cost
more on a per unit basis. He recognized that there could be many
sensitivities a few of which he reviewed. If the price of gas
received in Asia was 20 percent less, the state revenues would be
reduced by half. If there was a 40 percent cost over-run, the
state revenues would be reduced by half. If the financing cost was
10 percent rather than six percent, the state revenues would be
reduced by half. Mr. Marks informed the committee that Spreadsheet
2 is identical to Spreadsheet 1, except Spreadsheet 2 utilizes a
starting price of $2.50 in 2007 which could be considered a low
price scenario. A $2.50 starting price represents $12.00 oil.
Spreadsheet 3 is identical to Spreadsheet 1, except Spreadsheet 3
utilizes a starting price of $4.50. A $4.50 starting price
represents $22.00 oil.
TAPE 99-16, SIDE B
MR. MARKS continued discussion regarding Spreadsheets 4, 5, and 6
which are predicated on the idea that there are a number of surplus
LNG tankers. If there were enough LNG tankers, only the operating
costs would have to be paid. The figures with that scenario are
provided by Spreadsheets 4, 5, and 6. He said that it is currently
unknown if there are enough surplus LNG tankers. He offered to
entertain any questions.
Number 2441
CHAIRMAN WHITAKER asked Mr. Marks to describe an S-curve contract
as it relates to historical LNG sales.
MR. MARKS commented that LNG is a very capital expensive endeavor
and most will not undergo the risk of spending such capital without
a secure contract in place. However, consuming countries have
other sources of energy besides natural gas heating oil. In order
to protect consumers, the consuming countries do not want to pay on
a Btu basis more for energy than the competing price of energy. He
informed the committee that generally, the energy market moves with
oil prices. In general, the price received with LNG contracts
varies with the amount of oil, however to protect the consumers and
the producers there is the S-curve. The S-curve places a ceiling
and a floor on the price, within the ceiling and the floor the
price of LNG varies with respect to oil.
CHAIRMAN WHITAKER asked if the range in gas prices from $2.50 to
$4.50 would be reasonable to construct a S-curve.
MR. MARKS noted that traditionally S-curves have been the way
contracts have been structured. Generally, the S-curve has an
inflation component, although it does not accommodate inflation 100
percent. Therefore, if oil prices were flat for 30 years, very
little of the gas price, maybe a quarter, would increase with
inflation. Mr. Marks informed the committee that in the past few
years the Katarese(ph) have become very active in the LNG market,
particularly in Korea. The Korean government has been fairly
cutthroat in contract negotiations and have refused to negotiate a
price floor. Mr. Marks said that in the last five years, prices
have been set without floors or ceilings. He agreed with Chairman
Whitaker that in those contracts the market is at work.
Number 2293
REPRESENTATIVE BRICE expressed the need to have discussion
regarding the rationale behind the $0.50 per mcf purchase price.
He inquired as to how Mr. Marks adjusted for state royalty.
MR. MARKS informed the committee that he assumed that it would be
passed through in the price, if royalties and severance taxes
stayed in place. He felt it made sense that if the state purchases
the gas, the royalties and severance taxes would be passed through.
Therefore, under this type project it would make sense to remove
royalties and severance taxes from the scene.
REPRESENTATIVE KEMPLEN asked if the $9 billion capital cost
included local property taxes.
MR. MARKS clarified that local property taxes were also removed
from the scene. In further response to Representative Kemplen, Mr.
Marks said that the pipeline would amount to between $4.5 and $5
billion of the capital cost. He explained that the model utilized
was one which was developed by the Administration's gas
commercialization team that provided a report to the governor in
1998. That model was developed in conjunction with the three major
working interest owners at Prudhoe Bay and Yukon Pacific. The
original cost of the pipeline was determined, almost 10 years ago,
to be $15 billion. The working interest owners were optimistic
that the price could be reduced to about $12 billion including
everything. The notion was that if the price could not be reduced
to $12 billion, there would be no project anyway.
REPRESENTATIVE KEMPLEN inquired as to how one could best achieve a
sense of the sensitivity for this capital cost if there was a
desire to integrate advances in pipeline construction technology.
MR. MARKS suggested waiting until the middle of next year when the
sponsor group reports on just such questions. Mr. Marks understood
that the sponsor group would complete its report in a little over
a year from now.
CHAIRMAN WHITAKER summarized that Mr. Marks' model is based on the
Van Meurs study, significant industry input, and state
assimilation. Chairman Whitaker indicated that the committee
should have copies of the January 1998 report to the governor.
REPRESENTATIVE BRICE inquired as to where the $0.50 per mcf was
derived.
CHAIRMAN WHITAKER said that he chose an astronomically high number
which the producers could not turn down in order to start
negotiations. He commented that negotiation is under the purview
of the administration. Chairman Whitaker announced that the
committee would now turn its attention to the legality of the
bonding and financing of this.
Number 1970
KEN VASSAR, Attorney of Wohlforth, Vassar, Johnson & Brecht,
informed the committee that his career began with four years,
1976-1980, of drafting legislation for the legislature. During
that time he was the drafter responsible for all the legislation
related to state lending and bonding activities, including the
legislation which laid the foundation for the current programs of
AHFC, AIDEA and the Alaska Municipal Bond Bank Authority. After
that time, Mr. Vassar was in the Attorney General's office for two
years during Commissioner Condon's tenure as the Attorney General.
For the past 17 years, he has been in the aforementioned firm
working as bond counsel for the same agencies for which he drafted
legislation.
MR. VASSAR echoed Commissioner Condon's comment regarding the
dynamic tension between maintaining the essential governmental
function of this entity versus providing this entity with the
financial independence and powers to attract interest in the bond
market. He identified the two separate, but related issues of
whether the income earned would be taxable, which he noted was not
his expertise, and tax exempt bond financing. The financing
proposed has certain challenges because the project would
necessarily involve the sale of gas to private companies or at
least to non-governmental entities as referred to by the IRS code.
The code describes governmental entities as being state governments
and municipal governments, anything else is a non-governmental
entity. Such a situation presumes that it is an area involving
private activity bonds rather than governmental obligations.
"Governmental obligations are the kinds of bonds that people
typically think of that municipal bonds are issued for." Such
bonds finance roads, schools, and state and municipal office
buildings. He pointed out that governmental obligations begin with
the presumption of being tax exempt. When private parties are
involved, the presumption is that the bonds are taxable. He noted
that the IRS code does create exceptions that allow certain types
of bonds to be tax exempt, although the bonds are private activity
bonds.
MR. VASSAR said that the challenge in this project is to determine
which portions of this financing would be categorized as
governmental obligations. For those portions that are private
activity bonds, the challenge would be whether those bonds would be
eligible for one of the exemptions allowed by the IRS code to
maintain being tax exempt. Mr. Vassar commented that at this point
there seem to be many questions with fewer answers for this
project. For example, docks and wharves can be financed with tax
exempt funds in the private activity bond category. Perhaps, that
will be a part of this project. He pointed out that facilities for
the local furnishing of gas and electricity could be financed. He
understood that a portion of the gas in this proposed pipeline
would be diverted to local governmental use. In all likelihood, a
percentage of the overall facility can be taken based upon the
percentage that would be used by local governments to qualify for
the local furnishing exception. He noted that there are a couple
of other financing possibilities and there should be time to review
those. Mr. Vassar related that there is a better possibility of
taking advantage of available exemptions under the IRS code as well
as the best possible financing structure to the extent that
flexibility can be maintained in the underlying enabling
legislation for the responsible financing entity. Therefore, he
suggested that any legislation created to pursue this financing
needs to provide flexibility while keeping in mind that this is a
state project.
MR. VASSAR referred to Representative Ogan's earlier question
regarding the state's pledge to disclaim liability for the bonds.
He emphasized that no indebtedness should be created through this
mechanism that anyone could mistake for a general obligation of
indebtedness for the state. If that occurred, the indebtedness
would be invalid. It is a common practice for governmental
entities to issue debt that is secured by something less than the
governmental entity's full faith and credit general obligation.
That merely makes the security for that debt come from a particular
source. Similarly, Representative Kemplen mentioned questions
about the management team to which the same types of considerations
apply. If there are private management teams, one must take care
that the essential governmental characteristic is maintained. The
regulations of the IRS code provide specific rules for management
teams. However, the IRS recognizes the ability of states to create
private corporations to accomplish financing of governmental
purposes. Therefore, the existence of private managers does not
eliminate the governmental aspect of the function being served.
Mr. Vassar concluded by saying that this is an excellent
opportunity to review a number of options available to accomplish
this financing function.
Number 1312
REPRESENTATIVE KEMPLEN noted that Mr. Vassar mentioned that it is
easy to publicly finance ports, harbors, and electrical
distribution facilities. Are there examples of quasi-public
entities financing pipelines or similar infrastructure?
MR. VASSAR said there are not examples in Alaska, but there are in
other parts of the country. He cited the New Jersey turnpike as an
example. In further response to Representative Kemplen, Mr. Vassar
explained that a nonprofit corporation can be created that would
own the facilities. He noted that this is all premised on the
initial determination that all of this is an essential governmental
function. The nonprofit corporation can be established to own the
facilities and can be given the power to issue bonds itself on the
state's behalf. The proceeds of those bonds could finance the
construction and acquisition of the facilities and then lease the
facilities to the state with the lease payments utilized to repay
the debt. At the end of the debt term, the facilities would
automatically become state property and the 501C4 corporation would
be eliminated. That is basically the IRS code 6320 approach. Mr.
Vassar informed the committee that there is also an allowance for
the issuance of tax exempt bonds to finance the activities of 501C3
corporations. In this case, the state agency would issue the bond
and make a loan to a 501C3 nonprofit corporation. The finance
structure would be similar to that described above. Mr. Vassar
pointed out that the difficulty is that in both of these
situations, the corporation would be performing an essential
governmental function. He noted that a presentation must be made
to the IRS who would determine whether the project would be
eligible for one of the aforementioned corporations to perform.
REPRESENTATIVE KEMPLEN commented that he was interested in more
information in the essential governmental function. What type of
criteria is utilized to determine if a project or entity qualifies
for such a designation? Would the construction of a pipeline to
move a public resource from the North Slope qualify as an essential
governmental function?
MR. VASSAR said that there is a spectrum of financing, ownership,
and leasing arrangements. He commented that he liked the
introductory portion of this legislation which walks through the
state constitutional provisions which mandate the utilization of
the state's natural resources for the benefit of the people of the
state. Such statements present the state's case and is helpful in
that way.
Number 0932
REPRESENTATIVE BRICE inquired as to the benefits and drawbacks to
the two approaches mentioned by Mr. Vassar, assuming the IRS sees
this as an essential governmental function.
MR. VASSAR clarified that the 6320 and the 501C3 are similar in
that both involve a private corporation performing what the state
might do for itself. When a private corporation is involved, a
certain amount of the possible liability of the state is taken
away. At the same time, that introduces another entity controlling
an essential governmental function. He pointed out that is why
many of Alaska's bond-issuing entities as well as this legislation,
include language creating the entity as public corporations of the
state with separate and independent legal status. He explained
that the notion is that if the debt of these corporations is not
paid, the people who purchased the bonds know they cannot come to
the state expecting to be paid back.
REPRESENTATIVE OGAN acknowledged that there is a gray area with
this project, but how can the pitfalls be avoided?
MR. VASSAR said that part of the art of developing any bond
issuance is to work with a financing team of experts with a
significant background in preparing such financing. Such would
include underwriters, financial advisers, counsel to the
underwriters, and trustees. The working group would meet to make
the best determination possible and often there is a way of doing
things which is well within the state IRS code, regulations, and
rulings. Unfortunately, there are many gray areas. If that point
is reached and satisfaction that the project is well within the
financing spectrum cannot be obtained, the financing group is
incumbent to say to the issuer that the IRS must first make a
ruling. Mr. Vassar noted that the IRS has procedures regarding
formal responses to questions about bond financing. He likened the
procedures to an administrative appeal. The IRS also gives out
private letter rulings to issuers with questions. Those private
letter rulings have precedential value and are applicable only to
the particular project. In further response to Representative
Ogan, Mr. Vassar explained that there is an appeal process. One
could request that the Department of Treasury overturn an IRS
ruling. In response to Representative Kemplen, Mr. Vassar said
that the process usually takes about six months. However, the
timing depends upon the complexity of the issue and how busy the
IRS is. He noted that the IRS never provides a time specific.
Number 0412
BRIAN ANDREWS, Financial Consultant, Merrill Lynch, informed the
committee that all credit transactions are evaluated on what he
called the "five C's." The "five C's" are as follows: capacity -
ability of debtor to repay the creditor; collateral - value of
assets that secure a loan in case of default; credit - historical
indication of how a debtor has handled prior obligations;
character; and coverage - diversification of capacity and
collateral risk to a third party such as an insurance company. If
those can be satisfactorily negotiated between a creditor and a
debtor, a transaction can be struck. He acknowledged that what is
being discussed here is a sizable credit transaction and would peak
the interest of the global banking and investment community.
However, he felt it important to note that AT&T just successfully
raised $42 billion for its Media One bid. In Mr. Andrews opinion,
if the "five C's" can be satisfied such a financing could be
accomplished.
Number 0279
MARK PRUSSING, CPA, Public Finance, Seattle-Northwest Securities
Corporation, informed the committee that he had been a resident of
Alaska since 1974 until his move to Portland last year. Prior to
his move he served in the Department of Revenue. He said that he
understood the impact of oil revenues and royalties on state
finances as well as the importance of such a project for the
state's future. He pointed out that the Public Finance portion of
Seattle-Northwest Securities Corporation specializes in the
issuance of bonds as an underwriter and in a financial advisory
capacity. The financial advisory position would be similar to what
would be performed in this case. He noted that Seattle-Northwest
Securities is the number one underwriter of municipal bonds in the
Northwest in 1998 as well as a number of years prior. He also
noted that he currently serves as the financial advisor to the City
of Seattle on all of its municipal bond transactions. Mr. Prussing
commented that he has a personal and professional interest in
Alaska.
MR. PRUSSING stated that the team that would be desired for this
project would be include someone like Mr. Vassar's bond counsel; a
financial advisor to act in the state's interest in order to sort
the proposals from various underwriting firms. With a project of
this size, the underwriting firms would be those such as Merrill
Lynch, Goldman Sax, Solomon Smith Barney, et cetera. He explained
that typically, he would help select the underwriting team for the
State of Washington. He indicated that the project would be better
with more flexibility.
TAPE 99-17, SIDE A
Number 0044
MR. PRUSSING commented that a project of this nature should not
rely on the nature of the taxability of its debt to make the
project feasible. If the project cannot be achieved on its own
merits, Mr. Prussing indicated that the project would not be a good
candidate for issuing bonds. The tax exempt status simply enhances
the profitability of such a project. He noted that this relates to
the ability to borrow in the municipal bond market versus the
taxable bond market. In such a project, it is likely that there
will be a combination of tax exempt and taxable bonds. There are
many investing and financing vehicles available and the goal is to
find the best mix to meet the requirements of the project.
MR. PRUSSING provided the committee with the following point of
reference regarding how the tax exempt status of debt figures into
the profitability for the state's purposes. He explained that he
ran some numbers assuming a differential in taxable versus tax
exempt rates. He predicted that it would represent between $125 to
$200 million annually if the bonds are tax exempt. That is in debt
service cost. According to Mr. Marks' spreadsheet for the year
2015, if the income were subject to federal income tax that would
amount to almost $554 million. That illustrates the magnitude of
the two issues. The tax exempt status of the bonds is important
and although it will make the project more feasible, it will not
drive whether the project will work or not. He reiterated the
likelihood of portions of the project being taxable and others
being tax exempt. Mr. Marks commented that the ability to not pay
federal taxes on income is an order of magnitude greater than the
tax exempt financing. This would be considered a revenue backed
financing which is common.
MR. PRUSSING acknowledged that there are many challenges ahead for
this project. If this is a project that proves to be feasible
economically, the capital markets will come and meet the need of
the financing. In closing, Mr. Prussing encouraged the committee
to explore, identify, and seek solutions to the challenges of this
project.
Number 0431
REPRESENTATIVE BRICE inquired as to what would result if the state
up-front capitalized a portion of the project with maybe the $3.5
billion from the capital budget reserve and would only need to bond
for $8.5 billion.
MR. ANDREWS noted that any credit transaction is a negotiated
process. Therefore anytime additional collateral value can be
added or the risk reduced, the stronger the credit and the lower
the rate can be negotiated. In other words, the better the deal.
MR. PRUSSING agreed with Mr. Andrews and likened it to borrowing
money to purchase a house. If the home buyer puts down money, the
bank will probably give a better interest rate. It is a credit
rating question.
REPRESENTATIVE OGAN utilized a triangle to illustrate the
components necessary for this project. There is gas, financing,
and the market. He noted that those present dealt with the
financing aspects which would have to have some comfort with the
market. Representative Ogan indicated the need to hear about the
market at some point beyond mere speculation.
MR. PRUSSING agreed with Representative Ogan that the state would
have to demonstrate that there is a market for the gas to make
investors more comfortable to meet the debt service. Typically,
the projected revenues would be reviewed with regard to what
percentage the projected revenues would be of the debt service.
MR. ANDREWS commented that of the elements he mentioned, the
capacity to repay the debt probably carries the most weight. That
is the element the creditors will strip down. The creditors will
want to ensure that those purchasing the gas have the capacity to
continue with that obligation.
REPRESENTATIVE OGAN requested that Mr. Andrews expand on the
character and coverage elements of his "five C's."
Number 0767
MR. ANDREWS explained that coverage is the element of shifting
risk, typically to a third party. Usually in a municipal bond or
tax exempt financing, an insurance company will come in with its
credit worthiness and assets to protect the underlying creditors to
the obligation. It is a credit enhancement situation. He noted
that another way to view coverage is to obtain an assuridity, a
third party that may not put up assets, but would sign for the
obligation. Mr. Andrews explained that character is an intangible
concept to some extent and it folds into credit. Is the debtor
capable of making the debt whole? He pointed out that sometimes
tax exempt financing carries with it moral obligation which may or
may not be worth anything and would necessitate returning to the
character of the issuer.
MR. PRUSSING commented that another way to view coverage is to
review the projected revenues and how well does that cover debt
service. How many times over does it cover the debt service? With
regard to the moral obligation of the state, some issuers rely upon
that, but that would not be an assumption. He believed that Mr.
Vassar would agree that it would not be appropriate to have people
believe that the state is morally obligated. Therefore, this would
have to stand alone and the coverage would be from a third party
guarantee or generally stand alone with regard to how the projected
revenues compare to projected debt service.
REPRESENTATIVE KEMPLEN recalled that there was mention that the
legislation's language should be broader to ensure flexibility in
financing. He guessed the reference was in regard to Article 2 of
the legislation. He asked if the language was restrictive.
Number 0953
MR. PRUSSING replied no. He clarified that his comments were
directed to underscore Mr. Vassar's comments. To have flexibility
in establishing the entity, as the borrower, will provide more
flexibility in the future. "As far as the instruments that are
authorized under the legislation, I just made the assumption that
as we get further down the road we'll refine that and make sure
that any options we would want to explore would be covered in
there." He reiterated that it does not appear to be restrictive.
CHAIRMAN WHITAKER commented that the instruments are all subject to
change. He echoed his comments at the previous hearing that this
legislation is an idea in search of a better idea. Chairman
Whitaker announced that there will be other hearings and that there
will be the need for two subcommittees, one to examine financing
options and mix and the other to examine the tax status of income.
He indicated the need for those interested to come forward.
ADJOURNMENT
There being no further business before the committee, the House
Special Committee on Oil & Gas meeting was adjourned at 6:55 p.m.
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