Legislature(2015 - 2016)BARNES 124
02/16/2015 01:00 PM House RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| Presentation(s): How Lng Affects Local Markets and Marketing Alaska's Gas | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
ALASKA STATE LEGISLATURE
HOUSE RESOURCES STANDING COMMITTEE
February 16, 2015
1:03 p.m.
MEMBERS PRESENT
Representative David Talerico, Co-Chair
Representative Mike Hawker, Vice Chair
Representative Kurt Olson
Representative Paul Seaton
Representative Andy Josephson
Representative Geran Tarr
MEMBERS ABSENT
Representative Benjamin Nageak, Co-Chair
Representative Bob Herron
Representative Craig Johnson
COMMITTEE CALENDAR
PRESENTATION(S): HOW LNG AFFECTS LOCAL MARKETS AND MARKETING
ALASKA'S GAS
- HEARD
PREVIOUS COMMITTEE ACTION
No previous action to record
WITNESS REGISTER
JANAK MAYER, Partner, Energy Consultant
enalytica
Washington, DC
POSITION STATEMENT: As consultant to the Alaska State
Legislature, discussed how liquefied natural gas (LNG) affects
local markets and marketing Alaska's gas.
NIKOS TSAFOS, Partner, Energy Consultant
enalytica
Washington, DC
POSITION STATEMENT: As consultant to the Alaska State
Legislature, discussed how liquefied natural gas (LNG) affects
local markets and marketing Alaska's gas.
ACTION NARRATIVE
1:03:41 PM
CO-CHAIR DAVID TALERICO called the House Resources Standing
Committee meeting to order at 1:03 p.m. Representatives Seaton,
Josephson, Tarr, Hawker, Olson, and Talerico were present at the
call to order.
^PRESENTATION(S): How LNG Affects Local Markets and Marketing
Alaska's Gas
PRESENTATION(S): How LNG Affects Local Markets and Marketing
Alaska's Gas
1:04:42 PM
CO-CHAIR TALERICO announced that the only order of business is a
refresher presentation and question and answer session with the
legislature's natural gas project consultant, enalytica.
1:04:58 PM
JANAK MAYER, Partner, Energy Consultant, enalytica, noted he has
advised the committee for the last four years - two years of
providing advice and testimony on oil taxation and two years on
issues around the gasline and liquefied natural gas (LNG)
project. When last before the committee on 1/28/15, he and his
partner Nikos Tsafos provided a PowerPoint presentation ["Alaska
LNG [AK LNG]: Project Overview and Update"], which is the same
presentation he has today. This presentation provided an update
on the Alaska LNG Project (AK LNG) regarding what needs to
happen this year to keep the project moving forward, addressed
the question of how to best manage a domestic gas market given
the presence of a large LNG project, and looked at options to
consider for how the state disposes of its share of LNG assuming
it takes the LNG in-kind. He explained that today he and Mr.
Tsafos will focus on the latter two topics.
1:06:45 PM
NIKOS TSAFOS, Partner, Energy Consultant, enalytica, stated he
has spent 10 years as a consultant to the oil and gas industry,
the majority of that time in natural gas helping companies buy
or sell gas or figure out what is going on in the world.
Turning to slide 5, he addressed enalytica's paper ["Marketing
Alaska's Gas From AK LNG: Key Issues"], explaining enalytica
put the paper together because one prospect envisioned by Senate
Bill 138 [28th Alaska State Legislature] was that the State of
Alaska would take control/possession of gas and therefore the
state must figure out what to do with that gas. This being a
new role for the state, especially in terms of natural gas,
enalytica has laid out some ground rules and some ways to think
about how the state might dispose of this gas. The four
principles listed on slide 5 are a distillation of the lessons
that can be drawn upon from other sovereigns that have
participated in LNG projects. Those propositions are very, very
big picture items - the yardsticks through which legislators can
judge information, agreements for ratification, and direction
that legislators may wish to convey to the administration in
terms of how the administration should be negotiating agreements
for the disposition of the state's gas.
1:09:14 PM
MR. TSAFOS said the first of the four principles, "Focus on
performance over time," is a wise investment decision in general
but particularly true in the case of LNG because of the long-
term nature of the investment. All going well, he said, AK LNG
will be on line for possibly 30 years or longer. The temptation
over such a long period of time is to check on how the state is
doing on a given day. In general this is very counterproductive
because lots of things are happening at the same time, and over
short periods of time the market sometimes changes a little bit
and sometimes dramatically. A good way to think about this is
to step back at any given point and look at how the money being
made from this gas, and the risk being taken, is performing over
a period of time. If one to four years go by and the state
feels it has a bad deal, then yes something must be done. He
cautioned, however, about the state thinking it has a bad deal
and wanting to renegotiate if, for example, it discovers that
one country is selling its gas in Japan for $13 and someone else
is selling it for $14. If that kind of conversation gets
started, he warned, it can get really counterproductive very
quickly; rather, an eye needs to be kept on the ball in the big
picture.
1:11:24 PM
MR. TSAFOS addressed the second principle listed on slide 5,
"Focus on risk not the highest price." The key word is risk,
not price, he said, and definitely not the highest price. Every
seller likes to get the highest price the same way that a buyer
always likes to get the lowest price. However, there are things
about the LNG market that make it difficult to know what the
highest price is. It is not a very liquid or a very transparent
market. For example, the price of gas in Asia cannot be looked
up in the Wall Street Journal in the same way that the price of
oil in international markets or the Lower 48 can be looked up.
This second principle is important because many times a price
may be quoted, but that price is being traded in a completely
different market than is another price. An example is a long-
term contract versus a spot sale; or, put in different terms, it
is the difference between having a five-year renter on a
property versus something that can be booked for a weekend. Not
only are prices nontransparent and difficult to understand, the
highest price today may not be the highest price tomorrow due to
the way the pricing system works. This is because the standard
practice in LNG is what he calls an S-curve. In a straight-line
relationship, the price of gas is linked to oil - if oil goes
up, gas goes up. An S-curve, however, has a floor and a
ceiling. If the price of oil goes up, the price of gas doesn't
always go up at the same rate. So, if [Alaska's] gas is on an
S-curve, it may be earning a lower price than someone else,
which [the state] may feel is unfair. But if prices go down,
[the state] will be earning a higher price than someone who
doesn't have a floor and a ceiling, which is why what really
matters is risk; and, related to the first principle,
performance over time, rather than how [the state] is doing at
any given point.
1:14:19 PM
MR. TSAFOS drew attention to the third principle, "Don't
outsource your risk profile." As envisioned by the Heads of
Agreement (HOA) and Senate Bill 138, he said, the state has
contemplated the option of selling its gas through its partners.
The partners would take the state's gas, sell it, and then push
back to the state whatever the partners get for their gas. That
perfectly legitimate way to sell gas has pros and cons. A pro
is that these companies really know what they're doing. A con
is that [the state] ultimately would be adopting the risk
tolerance of the other companies. As an example he posed a
scenario in which he has someone at a hedge fund invest his
savings for him. While the hedge fund person knows the market,
the hedge fund person is probably willing to take risks that he
is not willing to take with his savings. He said his point is
not that the state shouldn't sell its gas to its partners, but
rather that the state should assess the offer to sell gas based
on what it does for the state's risk tolerance. Just because it
works for Exxon, BP, or Conoco doesn't mean it works for the
state. That doesn't mean that if it works for them it doesn't
work for the state, it could work for the state, but that is the
base upon which to evaluate any offers that these companies will
make to market the state's gas together with their gas.
1:16:34 PM
MR. TSAFOS turned to the fourth principle, "Build in-house
expertise." To explain this principle he noted the oil market
is so deep and liquid the state could be a passive investor and
still do okay. Being an active marketer of oil may add 50 cents
or a dollar to the state's sales price. So, there is a benefit
in having active marketing and knowing how to place the state's
gas, but the forgone revenue of not doing so is not that high.
For gas on the other hand, the market is fragmented and there is
no one price that everyone gets, so it all depends on how the
state sells its gas. Something enalytica has seen is that, in
general, those sovereigns choosing to take a backseat in selling
their gas and just letting the foreign company do it on their
behalf many times come back and try to retake control over the
marketing. This was seen in Atlantic LNG in Trinidad where the
government had some tax-as-gas equivalent and was letting one of
the partners sell that gas. A few years into the project
Trinidad said it did not think the partner was trying to
maximize the gas the same way that Trinidad would like to
maximize the gas, so it tried to take that gas back and sell the
gas on its own. Qatar invested heavily in building significant
gas marketing capabilities within the state-owned enterprise,
not because it didn't have good partners, but because Qatar
recognized that its risk profile, risk tolerance, and interest
may not be the same as its private partners. So, in general, it
is hard to think of many countries that are involved in an LNG
project as an owner that have taken a backseat to the marketing
and felt very happy about it. In general, the trend of the last
10 years is to hear of sovereigns that realize five years later
that their gas is being marketed in a way that seems suboptimal
and they've tried to change the terms. No one really wants to
change terms halfway through the project, so enalytica submits
to the committee that the best thing is to think about building
that capability up front so that at the moment [the legislature]
makes a decision it is known exactly what [the state] is getting
into.
1:20:05 PM
MR. TSAFOS moved to slide 8 of the presentation. Referring to
enalytica's paper, "How LNG Affects Local Markets? Lessons for
Alaska from Western Australia from Western Australia, he said
the point of departure is that when a state or country starts
exporting gas in large quantities there will be an impact on the
already existing local market. This is inevitable and has
happened in pretty much every jurisdiction where there has been
LNG exports. The question is how to think about the impact that
this megaproject is going to have on the domestic market in
Alaska. In the Lower 48, as well as in Queensland in Eastern
Australia, there have been either forecasts or facts of gas
prices rising because of or in anticipation of LNG exports.
Queensland has had a huge amount of development to export
natural gas and gas consumers there complain that they can no
longer get gas at the affordable rates of five years ago. As
part of the effort in the Lower 48 to approve export projects,
the U.S. Department of Energy (DOE) has issued a number of
studies examining the impact of exports on gas prices in the
U.S. The general consensus is that exports will raise prices.
The question and subject of debate is whether exports will raise
gas prices by a little or a lot. As a jurisdiction looking to
export gas, [the state] will want to know whether some of those
lessons from the Lower 48 or Eastern Australia are going to
apply to [Alaska].
1:22:27 PM
MR. TSAFOS specified that in the Lower 48 everything is driven
by a model, by what an economics textbook says should happen.
In Eastern Australia the fuss about rising prices happened
before any exports actually occurred; LNG exports effectively
started in December [2014] with startup of the first [of three]
projects. Neither of those two cases provided enalytica with
enough confidence that a case could be studied and a generally
complete picture be offered of the dynamic effects that happen
with the passage of time. Prices today may be high, but the
question is whether over a longer period of time people reinvest
and prices come down. Therefore, enalytica chose to do a case
study on Western Australia, which has many similarities to
Alaska. Western Australia has a domestic market and exports
that have been running since 1989, which provides a fairly long
history for figuring out what really happened in this
jurisdiction. Western Australia has a select number of big
companies that are gas producers, similar to Alaska. Western
Australia also has a specific policy that LNG projects must
supply the domestic market by 50 percent of the gas that they
have. While Alaska doesn't have that, part of the negotiations
for AK LNG effectively include a question about whether to have
a version of that - whether to have some kind of obligation for
all of the producers to meet local demand.
1:24:15 PM
MR. TSAFOS discussed the three lessons from Western Australia
that, in enalytica's opinion, fit Alaska's own experience. The
first lesson, he said, is that domestic prices sometimes
correlate with exports and sometimes not. This lesson is a
major conclusion because it shows the benefit of studying an
actual case rather than doing an economic textbook model that
tells how they should work. History actually showed there
wasn't a given correlation between export and domestic prices -
sometimes they moved together and sometimes they did not.
MR. TSAFOS said the aforementioned leads to the second lesson,
which is that what really matters is the local market, not the
export price. This can be seen in the Cook Inlet where the
export and local market prices have correlated for some periods
of time and other times not. Right now prices are lower in the
Cook Inlet even though prices in Japan have gone up. This is
partly because Alaska is exporting much less and at times
nothing, partly because Alaska has changed the way it prices the
gas, and more importantly because Alaska has a lot more gas.
However, none of these things would have been possible without
the turnaround in gas supply in the Cook Inlet. That, more than
anything else, is what allows Alaska to keep prices lower even
though prices in Japan are very high.
MR. TSAFOS addressed the third lesson, noting Western Australia
was concerned that if it started exporting LNG everyone would
want only to export LNG and no one would care about the local
market. However, he said, that didn't happen; instead companies
came in that were interested in the local market. The reason
for this is that LNG is a very specific type of beast. Not
every company likes to do LNG because it exposes the company to
a ton of risks that it may or may not want to take, something
that is currently being learned in Alaska. In enalytica's
opinion, he said, this experience in Western Australia also fits
the experience of the Cook Inlet where there are companies that
are quite happy to find and produce gas for the local market.
1:27:15 PM
MR. TSAFOS spoke to the path forward for Alaska as outlined on
slide 8, explaining that enalytica arrived at two takeaways,
both a bit counterintuitive, after teasing out the implications
of the Western Australia case study. The first takeaway is the
temptation to ensure that every single molecule of gas demand in
the state is met before the project goes forward, as was done in
Western Australia. During the process of developing its LNG,
Western Australia authorized local market development first to
meet all demand. This resulted in prices crashing - there was
so much gas that no one came to invest because there was no
demand to meet. Market conditions matter, however, so this is
not to say that if Alaska does the same thing prices are going
to crash. But, it is important to consider what happens, the
repercussions, if all the gas demand must be met by the AK LNG
partners. It means that anyone having smaller amounts of gas on
the North Slope has no outlet for their gas because the market
has already been taken up. This leads to the second, and most
important, takeaway. When starting this paper the initial
question that enalytica began to answer was, How will LNG impact
domestic gas in Alaska and how can the state manage and mitigate
those impacts? However, by the end of the paper, enalytica
discovered that that wasn't the right question. Rather, the
right question was, How to ensure a well-functioning market
given there is now this big player joining in? In answering
that question, a broader toolkit must be thought about. Not
everything that is done needs to be done with AK LNG. Other
things can be done that will just incentivize more players to
come into the market, more transparency, more liquidity. Much
of the policy of dealing with AK LNG may have nothing to do with
AK LNG; it will have to do with how to set the pieces around AK
LNG in a way that ensures that AK LNG doesn't disrupt the
market.
MR. TSAFOS concluded his presentation by pointing out that the
aforementioned is enalytica's attempt to provide a very broad
conceptual framework through which [legislators/the state] can
process the information to assess proposals and plans. The
aforementioned is the question to ask any time somebody comes
forth asking whether to do this or do that. Once AK LNG is
added to the picture, the question to ask is whether this is a
well-functioning market or are distortions being introduced that
[the state] may come to regret later on.
1:31:10 PM
REPRESENTATIVE HAWKER stated that enalytica's 1/28/15 PowerPoint
presentation was the committee's overview and update of the
Alaska LNG Project (AK LNG). He observed that slide 2 revisits
the anticipated schedule of the project. Today, he related, the
committee's colleagues "across the way" laid out some very
specific detailed benchmarks for the project. He requested that
enalytica comment on the difference between the major benchmarks
and the ancillary benchmarks on the way to those. For example,
the major benchmarks are going into pre-front-end engineering
and design (Pre-FEED), then front-end engineering and design
(FEED), then final investment decision (FID), and ultimately the
project being on line. He inquired whether enalytica thinks
there is room for the ancillary benchmarks to slip without
impacting the major benchmark timelines.
MR. MAYER replied the biggest major benchmark coming up is the
question of moving from the current Pre-FEED stage to FEED. The
timeline laid out last year was that that would happen in 2016.
A lot needs to be done to reach that very important milestone.
For that to occur, a very broad range of agreements needs to be
negotiated between now and then. Much of what those hinge
around is getting to the point that the state can say with
comfort yes or no to taking tax and royalty in-kind rather than
in-value. To get to a point of comfort in making that decision,
a very broad range of things needs to be pretty firmly nailed
down for gas offtake, how the state will market its LNG, how all
these pieces will fit together, and how that works with the
partnership with TransCanada and agreements that are signed on
that front. In terms of minor milestones, 12/31/15 is the date
that's currently in agreements with TransCanada for signing the
next round of agreements. All of those things need to come
together to get to the point that the project can proceed to
FEED, which is a very ambitious schedule for this year. That
said, he advised, it's incredibly important that major projects
like this not be primarily schedule driven. It is much, much
more important to negotiate well and to sign good agreements
that serve the state's interest than to say that "because this
needs to happen by this date we'll live with it." Be very aware
of just how much under this schedule is supposed to happen this
year. But more than anything else, he stressed, care about the
quality of negotiations and the fact that agreements take the
time that they take and good agreements are wanted more than
anything else.
1:35:05 PM
REPRESENTATIVE JOSEPHSON said it seems fundamental that a
contract doesn't need to be adjusted if both parties don't want
to adjust it, unless that is laid out in the terms of the
contract itself in some way. He recalled that about a decade
ago under a previous governor there was the issue of the tax
rate being established and the question about whether future
legislatures can be bound. In regard to price, he inquired what
power the state would have as a sovereign to say that the price
is bad and so the state wants to renegotiate.
MR. TSAFOS, in regard to the price question, responded that the
state will most likely sign long-term contracts for its gas, and
those long-term contracts are likely to include a price formula
rather than a price. A price formula is how in a given month
the price will be determined. Within that contract is a sales
and purchase agreement (SPA) under which there are likely to be
two provisions for potentially revisiting the price. One fairly
common way is for contracts to have a price review clause.
Price review basically happens periodically; for example, every
three, four, or five years the parties agree to sit down and re-
look at the price. Depending on how the contract is written,
this could be a complete free-for-all or it could be very
narrowly and tightly written; for example, he knows of LNG
contracts with boundaries that say the price review may not
allow the price to change by more than 10, 15, or 20 percent.
Also within those contracts are provisions for what happens if
the parties disagree. Usually arbitration is tried. Europe is
now in the golden age of arbitration lawyers because of the
changes that have happened in the gas market there. Pretty much
every contract is being renegotiated by going to arbitration
because the two parties agree that the market has changed but
disagree about what needs to happen. So, the aforementioned is
the simplest way in which a contract can be revisited: the
parties agree about how often and under what conditions and with
what boundaries the revisiting of price may happen. Mr. Tsafos
said a second provision that may or may not be included in a
sales and purchase agreement is a once-in-a-contract review out
of the cycle. In this provision, each party has the opportunity
once in the life of the contract to revisit the contract. Both
of these two provisions might be in a contract, or only one of
them, or a combination of them. These two provisions are pre-
established ways for the two parties to come together. When
signing a 20-year contract, he advised, it is impossible that
both parties will be happy with this contract every single day
for 20 years. However, the point is performance over time -
Does it broadly work?
MR. TSAFOS continued his answer, noting that enalytica has seen
contracts that don't have the aforementioned kind of provisions,
particularly with sovereigns. In these cases the option is
pretty simple. Either the sovereign says, "hey tough luck,
we're just gonna have to live with it" or the sovereign pounds
the table until someone pays attention and negotiates. In
general, when sovereigns have serious issues with things
happening in their jurisdiction, private companies pay
attention. Of course the companies can also hold the sovereign
to account, saying it is liable and responsible, if there are
signed contracts. In general, there are enough normal legal
avenues for the state to revisit the price that it worked in the
beginning of the contract, and, if something extraordinary
happens that is not provided by the contract, there is still a
possibility to sit down and find a new agreement.
1:41:16 PM
REPRESENTATIVE SEATON noted that 20-25 percent of the Alaska LNG
Project cost is on a gas treatment plant to remove the CO from
2
the natural gas going down the pipeline to be liquefied, while
gas out of Cook Inlet may be more pipeline ready. He inquired
whether there is enough of a difference in the quality of Cook
Inlet gas versus North Slope gas to create a price sensitivity
between those two supplies in both the local and export markets.
MR. TSAFOS answered he is unsure, but that he knows the Cook
Inlet gas that is exported as LNG is very lean, meaning it has
very few impurities. He said he doesn't know what specification
the Alaska LNG Project's gas will be. However, Asian markets
generally prefer "hot" gas, which is methane with other things
in it like ethane, propane, or butane. He said he is unclear
whether AK LNG will try to create a gas quality that meets a
specification of the buyers or whether the project has even
settled on this yet.
1:43:44 PM
CO-CHAIR TALERICO offered his appreciation for enalytica's
advice, especially regarding the fluctuation of the markets. He
asked whether, historically, gas prices have risen or fallen
faster than have oil prices.
MR. TSAFOS replied the broadest principle to remember for gas is
that there is no such thing as a global gas price. The most
important answer to the question is that it depends on where
[State of Alaska] wants to look. Each place being looked at may
have specific trends or relationships between gas and other
fuels that can be identified. For example, there may be a place
where gas has been 50 cents for the last 15 years and another
place where gas prices have tumbled up and down. In addition to
the broad principle, there are a few things that generally
happen. One is that on energy equivalency, how much energy is
needed from oil and gas to get the same outcome, gas trades at a
discount to oil. For one-to-one energy, gas is cheaper than oil
and this has generally held true across many geographies and
many different periods of time. The reason for this is because
if it doesn't, people switch back to oil, which creates a sort
of cap on natural gas. Secondly, in many places of the world,
certainly in Asia and parts of Europe, the price of gas is
contractually linked to oil. So, in a place like Japan, oil and
gas prices generally move together. There are exceptions from
time to time, such as when the Japanese are buying a lot of spot
LNG. Also, the volatility is much greater in oil than in gas
and that is purely contractual. The way it works is the price
today is based on an average of three, four, or six months
beforehand and because of that average some of the volatility is
smoothed out.
1:47:46 PM
MR. TSAFOS, continuing his answer, noted that a definitive
statement cannot be said for markets where the price of gas is
set by supply and demand, like the Lower 48 or Northwest Europe.
Before the 2008 crisis, gas prices in the U.S. had gone up to
$12 per million British thermal units (mmBtu). Multiplying $12
mmBtu by 6 equals $72 per barrel of oil equivalent. In the
summer of 2008 oil had gone up to $146 or $147 and gas topped
out in the Lower 48 at $72, showing that gas never quite fetches
as much. However, gas is a lot more expensive to transport and
is priced lower, which is why most companies like to find oil
rather than gas. Especially after 2009, there is no systematic
correlation between oil and gas in the Lower 48. So, the answer
is that it really depends on how price is set and where in the
world it is being looked at. The broad implication of this for
the State of Alaska is that at any given time there are dozens
and dozens of wildly varying prices of gas. For example, in
just the one country of Japan in 2013 the most expensive gas
stream was twice as expensive as the cheapest gas stream. The
price at which "Kenai" sold gas in Japan was much different than
the price at which Oman sold gas in Japan. At times that price
was 2:1, so Alaska was selling gas into Japan for twice the
price that Oman was. This was because of renegotiation and
before that it was not that, which is why these things are very
dynamic. So there isn't really a very clear answer and that is
why even speaking of averages or the Asian price or the Japanese
price can be very misleading because those averages conceal a
huge amount of variations. Another example is China, in which
the cheapest gas is an old contract signed in the early 2000s
that comes in from Australia for $3.15. But in a Qatari
contract that China signed in 2008 when oil was at $110, the gas
comes in at about $18. The supplier that gets $3 was really
happy when it signed the contract because there was no other
buyer in the early 2000s. It all depends on the circumstances.
1:50:56 PM
MR. TSAFOS, responding to Co-Chair Talerico, said enalytica will
be providing an informational overview tonight about where the
Alaska LNG Project is at and why the state decided to become an
investor in the project and why the state brought in
TransCanada. Referring to slide 2, he said that if all goes
well the state will have gas in another eight or nine years.
So, it will be a long process and a lot of things are going to
change in there interim.
1:51:50 PM
REPRESENTATIVE TARR inquired whether domestic gas means
comparing North Slope gas versus Cook Inlet gas, or Alaska gas
compared to Lower 48 gas, or both.
MR. TSAFOS replied the simple answer is to think just of Alaska.
But, he qualified, there is a regime connection to the Lower 48.
If Alaska decided to price its gas in Anchorage based on Henry
Hub, then by definition Alaska is connected to the Lower 48, but
Alaska's ability to sustain that price depends on supply and
demand conditions in Alaska. Overwhelmingly the price will be
determined by supply and demand conditions in Alaska, but there
may be periods of time where the way Alaska sets prices could
link it to the Lower 48 or could link it to Asia. For example,
Alaska could have a system that says the price of gas in Place X
is linked to the price of gas in Asia minus $5, $10, or some
other amount. He said he thinks of Alaska as connected to the
Lower 48 mostly because of a regulatory and commercial decision
to be tied to the Lower 48, not because there is any physical
linkage that affects the market in Alaska.
1:53:53 PM
REPRESENTATIVE SEATON observed the last sentence on slide 5
states, "The LNG market is highly fragmented, and expertise
makes a difference; an autopilot approach will not serve the
state's interests over the long term." He asked how that works
when talking about a sales agreement with a price formula and S-
curve and re-openers. He expressed his concern over how the
state would fluctuate and the changes that could take place if
the state doesn't have a robust, self-correcting autopilot
system. He requested Mr. Tsafos to explain why enalytica thinks
an autopilot approach with self-correcting mechanisms is not
best for the state.
MR. TSAFOS responded that "passive approach" would have been a
better term to have used than "autopilot" because what enalytica
was meaning by autopilot is that the state cannot make an
agreement in 2017 and then step back saying that it isn't going
to look at this again for another 20 years. The reason for
enalytica not liking that approach is because things are going
to change. Prices will change. Customers may come and say they
cannot take all of the gas they signed up for and they need to
renegotiate. Or, a customer that agreed to take anywhere from
"five to ten" now only wants to take five, leaving an extra five
that the state must try to dispose of. He said he understands
Representative Seaton's concern that the state could have a team
that on any given day fluctuates wildly in terms of what it
wants to do. However, he submitted, that is not building in-
house expertise because by definition an expert is someone who
is able to separate the signal from the noise and is able to
understand in what conditions the state needs to change its
approach. The overarching principle is the need to have a core
group of people working for the state who can be trusted and who
know what they are doing so that [legislators] can feel
comfortable that Alaska's gas is being marketed in the best way
possible, comfortable with the amount of risk being taken, and
comfortable that any changes in the market are being responded
to in the proper way. It would be unacceptable, for example, if
the moment comes that someone says "oh, the price is X and we're
selling it for Y and at that point your answer is, 'well,
ExxonMobil says it's okay.'" If Alaska has a team of people
with expertise that know this market, it's all about trusting
them rather than trusting someone whose risk profile may be
different than the state's.
1:57:31 PM
REPRESENTATIVE SEATON said he sees autopilot as being that [the
state's] gas is marketed by the producers rather than a robust
autopilot in which there is a built-in framework of a price
formula with review clauses and such. Because legislators are
elected every two years he wants to ensure suggestions are made
for building in robust changes that can be considered at one
time instead of coming back and reanalyzing every so often. He
requested further elaboration from enalytica.
MR. MAYER reminded members that enalytica has also discussed
focusing on risk rather than price and not outsourcing the
state's risk profile. The best way to think about this is the
different components of risk, such as price risk, country risk,
what the markets are that the state is selling into, whether it
is only one market or many markets, or future things that happen
in a market. Counter-party risk is particularly relevant and
important to everything being talked about here. The state
could sign a deal and say, "because the state isn't well
equipped to handle these things it should sign one contract that
it's happy with and have, let's say, a major producer, whether
one involved in the project or outside, handle all of its LNG
sales." Such a contract might look good on day one. The time
at which a contract is signed is probably the time that the
state has maximum negotiating leverage to get good terms. But
if the state has no capability itself as an alternative in the
future, then as market conditions change over time and as that
counter-party decides its priorities are different, the state
has progressively less leverage to say that this isn't a great
deal because what is the state going to do as an alternative.
The way that the state best manages counter-party risk is by
having other options in terms of counter-parties. If one
follows that logic, it leads one to say that the best way to
manage many of the state's risks is to have the best in-house
team possible, the best capability possible, because then the
state always has other options.
2:00:33 PM
REPRESENTATIVE SEATON said he understands developing a system
with checks and balances and reopeners. But, he continued, he
doesn't see how the state having in-house expertise will provide
stability because that sounds like the state will be going to
spot sales so it can make changes on all these different factors
and will have short-term contracts to be able to make changes
with counter-parties. He asked for an explanation of what is
being proposed, what autopilot means or doesn't mean, and what a
self-correcting robust system means.
MR. TSAFOS answered by relating the term "autopilot" to flying a
plane. While autopilot is great, he said, there still needs to
be someone who knows when to take it out of autopilot and fly
the plane. Even if all of the state's gas is sold in long-term
contracts with one re-opener every four years, [the state] won't
know what to do with that re-opener unless it has people who are
monitoring the market, who know whether that re-opener makes
sense, and how to negotiate that re-opening. Having in-house
expertise, having people who know what they are doing, doesn't
mean [the state] will be changing things all of the time. Many
times the answer will be to not do anything. He submitted that
[legislators] will find it incredibly difficult to understand
whether the [state's] system of sales is working if [the state]
doesn't have people in-house who understand it and can explain
it to [legislators]. For example, if [legislators] decide they
want 80 percent of [the state's] gas to be at really predictable
prices and 20 percent at spot sale, then [the state] needs to
have people who can carry out that directive. If [legislators]
decide there is too much volatility and they want less
volatility, there needs to be someone who can implement that.
What enalytica is getting at here is that this is all about
contrasting with oil. In oil, not much more needs to be done
than reading the price on the cover of a journal and every six
months the Department of Revenue does a long-term forecast. No
more than that needs to be done because at the end of the day
nothing can be done about it - the oil market is going to be
what it is going to be and [legislators] will accept whatever
price is set in global markets. However, that is not going to
be the case in natural gas. Knowing how to set the autopilot
requires expertise. Understanding the boundaries, the clauses,
and the state's risk tolerance requires expertise. A sales and
purchase agreement, one of many documents the state will have to
enter into, will have a hundred pages. Understanding exactly
the risk that [the state] is taking is huge.
2:04:49 PM
MR. TSAFOS, continuing his answer, noted that another big risk
[the state] will take is counter-party risk, which is volume
risk. Contracts typically have a plus or minus to them, he
explained. So, if the state is in a contract for 4 million tons
with a 20 percent flexibility, the buyer will be obligated to
buy, say, 3.2 million tons rather than 4. If, for example, [the
purchaser] has a regime change, the state could find itself -
without any violation of contract terms - with an extra 800,000
tons of LNG that it needs to sell. Who is going to do that for
[the state]? Those kinds of things come up all the time, things
change. [The state] needs to protect its interest, and
enalytica is putting that up front because [the state] can
prepare itself over time. It is not being suggested that a
skyscraper of LNG staff be built, but rather a team of 5-10
people who manage an LNG portfolio - [the state] needs people
who know what they are doing.
REPRESENTATIVE HAWKER surmised Mr. Tsafos is saying that a
hands-off approach will not serve [the state's] interest best
over time.
MR. TSAFOS thanked Representative Hawker.
2:07:02 PM
REPRESENTATIVE TARR offered her belief that the state is
following enalytica's suggestion given the experienced staff
being brought in for the Alaska Gasline Development Corporation
(AGDC). She asked whether enalytica thinks this is sufficient
for building the suggested expertise or whether the state should
be putting together another team since AGDC is a corporation
separate from the state.
MR. MAYER replied that the people brought on at AGDC are largely
under contract to the Department of Natural Resources rather
than specifically within AGDC. He said this is an excellent
first start in what enalytica is talking about for bringing on
serious in-house expertise. If it gets to the point of where
the state says yes to taking tax and royalty in-kind, it is
enalytica's view that there needs to be a team of people, not
just one expert, charged with marketing the state's LNG.
2:09:31 PM
REPRESENTATIVE HAWKER commented that Representative Tarr's
question seems to be drawing a distinction between AGDC and the
state. He pointed out that AGDC is the State of Alaska and that
AGDC was created to be an entity of the State of Alaska to
represent the interests of the people of Alaska in this process.
He said he is wondering whether Representative Tarr's question
is really about the difference between the regulatory agencies
of the Department of Natural Resources and the Department of
Revenue versus the actual state gasline entity which is AGDC.
REPRESENTATIVE TARR responded that her question was to tease out
that difference. At a fall [2014] meeting, she related,
legislative members were introduced to several people that had
been brought on and it was her mistake in recalling that those
individuals had been hired by AGDC if they are contract
individuals with the state. She said she is wondering more
broadly whether enalytica has been following those type of
people given enalytica had recommended to the committee last
year that the state start to staff up. She asked whether
enalytica thinks the state is heading in the right direction in
this regard.
MR. TSAFOS responded yes, [the state] is definitely heading in
the right direction. These are the kind of people [the state]
wants, he said, and will want more of them. In terms of drawing
lines between where these people sit and what the governance
relationship is between state agencies and state corporations is
another conversation to have. He clarified that enalytica is
advising to build in-house expertise, not necessarily where to
put that expertise. The type of people the state wants are
people who know the market on both the technical and commercial
sides. If the state decides to take possession of the gas, he
sees that team growing over time.
2:11:45 PM
REPRESENTATIVE HAWKER announced that at 5:00 p.m. this evening
in the Senate finance chambers, enalytica will be presenting an
educational/refresher seminar for the entire legislature.
2:12:57 PM
ADJOURNMENT
There being no further business before the committee, the House
Resources Standing Committee meeting was adjourned at 2:13 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| enalytica Special Report How LNG Affects Local Markets Jan 2015.pdf |
HRES 2/16/2015 1:00:00 PM |
How LNG Affects local Markets? Lessons for Alaska from Western Australia |
| enalytica Special Report Marketing Alaska's Gas from AK LNG - Key Issues Jan 2015.pdf |
HRES 2/16/2015 1:00:00 PM |
Marketing Alaska’s Gas from AK LNG: Key Issues |
| enalytica HRES AK LNG Project Update January 2015.pdf |
HRES 2/16/2015 1:00:00 PM |
enalytica AK LNG Project Update |