Legislature(2001 - 2002)

02/13/2002 03:39 PM NGP

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
                        ALASKA LEGISLATURE                                                                                    
             JOINT COMMITTEE ON NATURAL GAS PIPELINES                                                                         
                         February 13, 2002                                                                                      
                             3:39 p.m.                                                                                          
SENATE MEMBERS PRESENT                                                                                                        
Senator John Torgerson, Chair                                                                                                   
Senator Pete Kelly                                                                                                              
Senator Johnny Ellis                                                                                                            
SENATE MEMBERS ABSENT                                                                                                         
Senator Rick Halford                                                                                                            
HOUSE MEMBERS PRESENT                                                                                                         
Representative Joe Green, Vice Chair                                                                                            
Representative Brian Porter                                                                                                     
Representative Scott Ogan                                                                                                       
HOUSE MEMBERS ABSENT                                                                                                          
Representative John Davies                                                                                                      
OTHER LEGISLATORS PRESENT                                                                                                     
Senator Kim Elton                                                                                                               
Senator Gary Wilken                                                                                                             
Senator Ben Stevens                                                                                                             
Senator Georgianna Lincoln                                                                                                      
Senator Robin Taylor                                                                                                            
Representative Beth Kerttula                                                                                                    
Representative Eric Croft                                                                                                       
COMMITTEE CALENDAR                                                                                                            
Department of Revenue - Financial Participation in AK Natural Gas                                                               
Pipeline Study                                                                                                                  
     Deputy Commissioner Larry Persily                                                                                          
     Bill Garner, Investment Banking Firm of Petrie Parkman & Co.                                                               
     Kevin Banks, Petroleum Analyst, Department of Natural                                                                      
     William Nebesky, Division of Oil and Gas, DNR                                                                              
Department of Natural Resources - Gas Supply and Demand: Natural                                                                
Gas and NGL Value                                                                                                               
ACTION NARRATIVE                                                                                                              
TAPE 02-2, SIDE A                                                                                                             
Number 001                                                                                                                      
CHAIRMAN JOHN  TORGERSON called the  Joint Committee on Natural  Gas                                                          
Pipelines meeting to order  at 3:39 p.m. and announced the committee                                                            
would  hear  comments  from  the  Department   of  Revenue  and  its                                                            
consultants on  an ownership study of state financial  participation                                                            
in the natural gas pipeline,  something that was directed in SB 158.                                                            
MR.  LARRY  PERSILY,  Deputy  Commissioner,  Department  of  Revenue                                                            
(DOR), thanked the committee  for its confidence in the department's                                                            
abilities to assist  them in this work. The department  believes the                                                            
report  it  gave the  committee  a  couple  of weeks  ago  on  state                                                            
financial  participation  in an  Alaska natural  gas  pipeline is  a                                                            
thorough desk reference  on the history of gas line plans in Alaska,                                                            
the latest potential gas  line projects, the potential sponsors, the                                                            
participants' financing,  the investment risks and possible benefits                                                            
to the state.                                                                                                                   
MR.  PERSILY briefed  the  committee  on the  conclusions  regarding                                                            
direct state  ownership, one of the  key questions in the  report by                                                            
     First, as  an owner, not as an investor and buying  shares                                                                 
     in a corporation  or as a financing authority,  regardless                                                                 
     of  the percentage  of  ownership,  we believe  the  state                                                                 
     would  need to  come up  with a  30% down  payment and  we                                                                 
     couldn't find  any examples where you could get  away with                                                                 
     borrowing anything more  than 70% of your investment as an                                                                 
     owner  in  a  gas  line  venture.  Even   if the  state's                                                                  
     ownership stake was at 12.5%,  which would be equal to the                                                                 
     royalty  share of North Slope  natural gas, that 30%  down                                                                 
     payment would be $0.5 billion  or so and we just don't see                                                                 
     where the  state has that kind of cash sitting  around and                                                                 
     available  for appropriation  - unless you wanted to  take                                                                 
     it from  the Permanent  Fund, which  would mean taking  it                                                                 
     from the principal or taking  it from the earnings reserve                                                                 
     account,  which would jeopardize  inflation proofing,  the                                                                 
     dividends and the available  of earnings to pay for public                                                                 
     services  in the event the legislature  were to decide  to                                                                 
     use  some of  the Permanent  Fund  earnings  to close  the                                                                 
     budget gap.  As for where you would get the other  70%, we                                                                 
     believe  that could  conflict with all  the other demands                                                                  
     that  exist on  the state's  bonding capacity  unless  you                                                                 
     count  Permanent  Fund  earnings  as  available  for  debt                                                                 
     service. The state's available  bonding capacity is just a                                                                 
     few hundred million dollars  - assuming you want to remain                                                                 
     within  the same  guidelines  we've used  in  the past  to                                                                 
     maintain the state's high credit rating.                                                                                   
     The other  issue to consider  as an owner in the gas  line                                                                 
     business is what you would  get for the money, because you                                                                 
     can be taking the risk and  you're certainly going to be a                                                                 
     minority  partner. We  found the state  just wouldn't  get                                                                 
     much that  it could not otherwise obtain in its  role as a                                                                 
     landlord,  taxing  authority,  and  regulator of  the  gas                                                                 
     line.  As a minority partner,  the state would be sharing                                                                  
     in all of  the risks the same as the majority  owners, but                                                                 
     we would have  much shallower pockets than Exxon  or BP or                                                                 
     anyone else on the list  to cover problems that might come                                                                 
     up. We would have little  control over the operations as a                                                                 
     minority voice.                                                                                                            
     We believe  the state could better  influence the project                                                                  
     through statute, regulations,  and permitting than putting                                                                 
     up  cash  and  taking  our  chances.  And  as  a minority                                                                  
     partner,  we would  be in  the gas line  business. Again,                                                                  
     this  is as  a partner  at  the table  rather  than as  an                                                                 
     investor  in a corporation  with stocks  or as financing.                                                                  
     Being  in the  gas line business  is much  different  than                                                                 
     simply assisting in the  financing of the project. Just as                                                                 
     being  in  business  has  its rewards,  it  also  has  its                                                                 
     financial  risks, its demand  on capital and the need  for                                                                 
     expertise in running that business.                                                                                        
     Finally, I'd like to say  we could not see where the state                                                                 
     signing  on as a  partner would  in any way  help the  gas                                                                 
     line get built any sooner.  The market and the cost of the                                                                 
     project will determine when  it gets built and not whether                                                                 
     the  state  is  partner.  Again,  that  is  separate  from                                                                 
     whether the state could  help in financing the project for                                                                 
CHAIRMAN TORGERSON asked him who wrote the executive summary.                                                                   
MR. PERSILY said  he wrote the executive summary personally  and the                                                            
consultants  wrote the  conclusions at  the back  of the report.  He                                                            
maintained,  "We felt  the executive  summary should  come from  the                                                            
commissioner's  office  and the  conclusions  should  come from  the                                                            
consultants,  which  in addition  to  Petrie Parkman  included  CH2M                                                            
Hill, which  is a well known engineering  firm. They helped  us with                                                            
economic analysis and economic engineering on the project."                                                                     
MR. BILL GARNER said he was with the investment-banking firm of                                                                 
Petrie Parkman and Company in Houston and thanked members for the                                                               
opportunity to testify about the report. He told members:                                                                       
     I thought  I would supplement the Department of  Revenue's                                                                 
     testimony  this afternoon with comments on the  discussion                                                                 
     and  conclusions  within  the  sections  of [the]  SB  158                                                                 
     report  that I  worked upon.  To refresh  the committee's                                                                  
     recollection,  my firm, Petrie Parkman and Co.,  is a full                                                                 
     service  investment bank that  solely focuses on services                                                                  
     to the oil and gas industry.  The context of my remarks is                                                                 
     somewhat unique  in that not only do I provide  investment                                                                 
     banking  advisory  services  on behalf  of the  firm,  but                                                                 
     prior  to my  joining the  firm, I  spent 15  years as  an                                                                 
     attorney  and business  executive  with Kaen  Energy,  the                                                                 
     third largest  interstate natural gas pipeline  company in                                                                 
     North  America.  In my  years  with  Kaen, I  developed  a                                                                 
     strong appreciation  for the challenges and opportunities                                                                  
     associated  with  developing  new natural  gas pipelines.                                                                  
     Clearly,  the  construction   of  an Alaska   natural  gas                                                                 
     pipeline  is vital to both the  future economic growth  of                                                                 
     Alaska  and the security  of energy  supply to the United                                                                  
     States as  a whole. The problem today, as it has  been for                                                                 
     the  past 30 years,  is to  balance those  needs with  the                                                                 
     practical  realities of building  the largest natural  gas                                                                 
     pipeline  project  ever attempted  in North  America.  The                                                                 
     risks  for all stakeholders [are]  great. As you know,  as                                                                 
     part  of this report  last fall, we  interviewed the  then                                                                 
     known  commercial developers  of the gas pipeline project                                                                  
     to obtain  their assessments of the project risks  and how                                                                 
     these risks  could be mitigated. The developers  fell into                                                                 
     three  main   categories:  first,  the  three  major   oil                                                                 
     producers; second, the natural  gas pipeline group holding                                                                 
     the  ANGTS  certificate;  and  third, the  other  new  gas                                                                 
     producer entrants on the  North Slope such as Anadarko and                                                                 
     Alberta  Energy that wanted to  ensure access to whatever                                                                  
     gas line may be built.                                                                                                     
     We   learned   some  interesting   things   during   those                                                                 
     interviews.  In an effort to  mitigate risks, some of  the                                                                 
     companies   are   seeking   federal  assistance   through                                                                  
     legislative  action that would  provide economic benefits                                                                  
     or  accelerated  regulatory review,  among  other things.                                                                  
     With  respect  to  the  State  of  Alaska,  however,   the                                                                 
     companies were only in favor  of an indirect state role in                                                                 
     the  gas pipeline  by the  state providing,  for example,                                                                  
     clarity on  certain of the state's tax and royalty  fiscal                                                                 
     terms, acceleration  of state regulatory approvals  and/or                                                                 
     for  the state  to somehow  provide access  to tax exempt                                                                  
     financing.  They  did  not want  the  state as  an equity                                                                  
     partner  in  the gas  line project,  although  some  would                                                                 
     reluctantly  allow some form of minority participation  if                                                                 
     the state forced the issue.  They did not see state equity                                                                 
     involvement  as assisting the  project to get constructed                                                                  
     or  constructed  any  sooner  than  planned.  And several                                                                  
     companies  saw state involvement  as actually slowing  the                                                                 
     project  down.  Finally,  given the  condition  of global                                                                  
     financial  markets, we learned  that direct state funding                                                                  
     provided  from  taxable  funds  was  not necessary.   Many                                                                 
     companies  already have  sufficient funds  available  from                                                                 
     their  current cash  flow and  the others  saw no problem                                                                  
     with financing  a project at  favorable interest and  upon                                                                 
     favorable  terms that could be  obtained from traditional                                                                  
     banking sources.                                                                                                           
     Despite  the  private  companies'  thoughts   about  state                                                                 
     involvement,  the  ultimate  decision  as to  whether  the                                                                 
     state  should continue  to pursue an  equity stake in  the                                                                 
     pipeline project rests with  the executive and legislative                                                                 
     branches   of  the  government.   Some  of  the  numerous                                                                  
     practical   issues  the   state  must   wrestle  with   in                                                                 
     determining   whether  to  proceed  or  not included   the                                                                 
     following:  the source of funds, the amount of  investment                                                                 
     that  the state may  wish to make and  its motivation  for                                                                 
     doing  so,  which  may  not coincide  with  the  role  and                                                                 
     ownership  percentage that  may be offered  by any of  the                                                                 
     developer  groups.  Another  point is  the impact  of  the                                                                 
     amount  and  nature  of  the  state's  investment  on  the                                                                 
     state's  credit rating.  Another factor  is how the  state                                                                 
     would  weigh  its  legal  obligations  to  state citizens                                                                  
     through  regulatory oversight  and access  to information                                                                  
     with  the fiduciary  obligations the  state would have  to                                                                 
     its private  company equity partners  to keep proprietary                                                                  
     information  confidential  and  to act  in a  manner  best                                                                 
     suited  to  the  success  of  the  joint  venture.   These                                                                 
     responsibilities may be irreconcilable at times.                                                                           
     Finally,  another  example would  be how  the state  would                                                                 
     replace  expected amounts and  timing of revenue from  the                                                                 
     gas  line if  the project  were  not constructed,  it  was                                                                 
     delayed or  the project did not perform as forecasted  due                                                                 
     to  design defects  or market  conditions.  These and  the                                                                 
     other  practical issues raised  in sections 3, 5 and  8 of                                                                 
     the report are not easily answered.                                                                                        
     Let's  turn to  the sources of  state funds  if the  state                                                                 
     does  decide to proceed  with an investment  or financial                                                                  
     participation  in the gas line.  As you know, this report                                                                  
     went into  some detail regarding  the potential source  of                                                                 
     such  funds including  such sources as  the general  fund,                                                                 
     the Permanent  Fund, the Earnings  Reserve Account of  the                                                                 
     Permanent  Fund, the  CBRF, general  obligation bonds  and                                                                 
     various types of revenue  bonds. For various practical and                                                                 
     legal reasons,  some of those sources are foreclosed.  The                                                                 
     most viable  source of funding  probably would be through                                                                  
     the  issuance of  some form of  a revenue  bond through  a                                                                 
     conduit of a state authority.  The bonds probably could be                                                                 
     secured   by  shipper  pay  contracts.   The  difficulty,                                                                  
     however,  today  is  that  such  revenue  bonds  would  be                                                                 
     taxable  under the current  federal revenue  code and  the                                                                 
     companies  likely could issue debt at the same  or a lower                                                                 
     cost  than the  state. Nevertheless,  if  the state  could                                                                 
     assist with issuing tax-exempt  bonds, such issuance could                                                                 
     help  the project's  economic  feasibility.  I personally                                                                  
     have   not  been  part  of  the   Railroad  Transfer   Act                                                                 
     discussions,   so  I  can  offer  no  opinion  about   the                                                                 
     potential  use of the tax-exempt funding mechanism  within                                                                 
     that legislation.                                                                                                          
     If,   however,   tax-exempt   financing  could   be   made                                                                 
     available,  there might be a  strong interest by at  least                                                                 
     some of the  company developers in having access  to these                                                                 
     funds.  The interest  rates on tax-exempt  bonds would  be                                                                 
     about  25%  less  than  conventional   taxable  rates  and                                                                 
     assuming  the  tax  benefits  were  passed  through,   the                                                                 
     pipeline tariff could be  lowered by perhaps 10%. Needless                                                                 
     to say,  the availability of  tax-exempt financing raises                                                                  
     complex  tax securities  and  fiscal issues  that will  be                                                                 
     fact-specific  to the  particular financing  plans of  the                                                                 
     developers.   If   tax-exempt   financing  can   be   made                                                                 
     available,  detailed discussions with the developers  will                                                                 
     be required  to gauge their interest and to determine  how                                                                 
     it fits within their overall development scheme.                                                                           
     In summary,  the financial and practical risks  to all the                                                                 
     stakeholders  in  this project  are material.  Should  the                                                                 
     state wish  to pursue participation in the project,  there                                                                 
     are practical and financial  hurdles it must overcome, but                                                                 
     they are not  necessarily insurmountable, just  difficult.                                                                 
3:55 p.m.                                                                                                                       
CHAIRMAN TORGERSON asked  if, in his expert opinion, would the state                                                            
involvement  in ownership  of  the pipeline  enhance  the  project's                                                            
feasibility  since his statement  said that  tax-exempt bonds  would                                                            
move the  project along,  but he also stated  that there is  nothing                                                            
they can do to move the project along.                                                                                          
MR. PERSILY replied  that they believe the state participation  as a                                                            
part owner  would do  nothing to  move the project  along, but  tax-                                                            
exempt financing  would lower  the rate the  borrower has to  pay on                                                            
the funds,  which would  lower the  tariff and  might help move  the                                                            
project over the hurdle so someone would be willing to build it.                                                                
CHAIRMAN  TORGERSON  asked  how  much  work  they did  on  the  port                                                            
authority issue.                                                                                                                
MR.  PERSILY  replied  that   they  spent  a  fair  amount  of  time                                                            
discussing  it,  but  didn't  think it  would  make  an appreciable                                                             
difference.  There  is a  constitutional  issue  of whether  a  port                                                            
authority  could exist as  a political subdivision.  He noted,  "The                                                            
Alaska  Constitution  spells out  what  is a  political subdivision                                                             
explicitly and it does not list port authorities."                                                                              
CHAIRMAN  TORGERSON  said he  didn't think  the port  authority  was                                                            
being  organized  as a  municipality  and  asked  how he  made  that                                                            
MR. PERSILY replied, "Because  it is not a municipality; it is not a                                                            
political subdivision, which…"                                                                                                  
CHAIRMAN  TORGESRON responded  that  it's owned  by a municipality.                                                             
"So,  it theoretically  is  a quasi-government  arm  of those  three                                                            
entities that are creating it."                                                                                                 
MR.  PERSILY   replied  that  argument   could  be  made,   but  the                                                            
Constitution says "municipalities,"  it doesn't say port authorities                                                            
or transit  authorities or airport  authorities. Someone  could make                                                            
the argument  that  it's formed  by municipalities  and  it was  the                                                            
intent of the Constitution, so it should be allowed.                                                                            
CHAIRMAN TORGERSON  said he thought the higher test  was that it had                                                            
to have  a public  purpose,  but it  concerned distribution  of  the                                                            
profits  back to the  local governments.  He asked  if they  had any                                                            
discussions with the IRS on the port authority idea.                                                                            
MR. PERSILY replied that they hadn't.                                                                                           
CHAIRMAN  TORGERSON asked if  they had an  opinion as to whether  or                                                            
not the port authority's income was tax-exempt.                                                                                 
MR. PERSILY replied they  relied on the opinion that the IRS gave to                                                            
the port authority,  but there are some questions  as to whether the                                                            
IRS had all the facts.                                                                                                          
CHAIRMAN  TORGERSON said he  thought the  department had an  opinion                                                            
saying the state couldn't issue G.O. bonds.                                                                                     
MR. PERSILY said that they  don't believe the state could issue G.O.                                                            
debt and if they could, it would be an intolerable risk.                                                                        
MR. GARNER  pointed out that  the state would  be pledging  the full                                                            
faith  and  credit  of  the  state  behind   that  sort  of  funding                                                            
CHAIRMAN  TORGERSON asked if  he was part  of the discussion  on the                                                            
railroad tax-exempt bonds.                                                                                                      
MR. GARNER replied that  he thought the state would have to overcome                                                            
many hurdles  to issue  tax-exempt financing  absent, but using  the                                                            
Railroad Transfer Act is a whole other situation.                                                                               
CHAIRMAN TORGERSON  quoted page 5  through line 10 saying  and read,                                                            
"The state  would  face formidable  legal and  practical hurdles  to                                                            
financing  a significant  portion  of  the project  with  tax-exempt                                                            
He said  that their statements  don't necessarily  fit with  some of                                                            
the other statements they are hearing today.                                                                                    
MR. GARNER  said he  hadn't heard  about the  railroad possibility,                                                             
which might  provide a clear exception  to the existing federal  tax                                                            
laws. It would be difficult to do without that.                                                                                 
CHAIRMAN  TORGERSON  asked  Mr.  Persily  if  it  would  be  a  good                                                            
investment  for   the  Permanent  Fund  (not  talking   about  large                                                            
withdrawals,  but  investing)  and  would such  a  large  investment                                                            
violate the prudent investor oath.                                                                                              
MR. PERSILY asked  if he meant as an active business  partner rather                                                            
than just buying shares in a corporation.                                                                                       
CHAIRMAN TORGERSON said it would be targeted to the actual line.                                                                
MR. PERSILY  replied that  they believe investing  a large  sum from                                                            
the Permanent Fund would  violate the prudent investor rule. He told                                                            
members,  "For example, if  we're 12.5% ownership  of the line  with                                                            
30% equity,  that's $0.5  billion and would  be 2% of the  Permanent                                                            
Fund's  market value  and they  don't have  2% invested  in any  one                                                            
CHAIRMAN TORGERSON  asked if the producers sign on  the dotted line,                                                            
which would happen no matter  what happens if the state loans money,                                                            
aren't [they] the ones on the hook.                                                                                             
MR. PERSILY replied  that they are on the hook, but  there are risks                                                            
that the project  would be delayed and there might  be cost overruns                                                            
or a catastrophe that would stop the revenue flow.                                                                              
CHAIRMAN  TORGERSON  asked if  the  risk wasn't  borne  more by  the                                                            
producers than by the investors.                                                                                                
MR. PERSILY  replied,  "They [the  producers] might  as well  own it                                                            
themselves, if they're going to take all the risks."                                                                            
CHAIRMAN TORGERSON  said he was integrating recent  legislation that                                                            
puts the state in that  position. He said, "Either the state's going                                                            
to do it through  the railroad and it's a good thing  and there's no                                                            
risk and if  the state wants to do  it somewhere over here,  there's                                                            
high risk."                                                                                                                     
MR. PERSILY replied  that the difference is that the  state would be                                                            
an owner of part  of the line as opposed to the railroad  just being                                                            
a conduit.  He explained,  "Their name  would be  on the top  of the                                                            
prospectus, but they would  not be liable in any way for that debt."                                                            
SENATOR LINCOLN  said she  was flipping back  and forth between  the                                                            
conclusion  and  the  summary  to  see if  there  were  any  glaring                                                            
differences between  the two or if there were any  disagreements the                                                            
department might have had with the conclusions.                                                                                 
MR. PERSILY  said he wasn't aware  of any glaring conflicts  between                                                            
MR. GARNER said he didn't recall any either.                                                                                    
CHAIRMAN TORGERSON  said, if risk  is a known factor, isn't  it true                                                            
that  the more  investors  there  are the  less  risk  there is  per                                                            
investor. He questioned, "Why wouldn't it lower the risk?"                                                                      
MR.  GARNER replied  that  it lowers  the  risk for  the  individual                                                            
investors,  but they are still putting  forth their money  and there                                                            
is a risk of the project functioning as forecasted.                                                                             
MR. PERSILY said:                                                                                                               
     In terms  of return on your investment,  my understanding                                                                  
     of the way  FERC sets rates is that investors  are allowed                                                                 
     a  return on  their equity  portion.  So, I  guess you're                                                                  
     saying  you're  guaranteed  a  profit of  return  on  your                                                                 
     equity  investment. All FERC  will allow you on your  debt                                                                 
     investment   is a  return  adequate   to  cover  the  debt                                                                 
     service. Bill,  correct me if I'm wrong, but if  the state                                                                 
     borrows  70% of  the money  they need  to invest  in  this                                                                 
     project, FERC  will allow us enough to cover the  interest                                                                 
     on the debt,  but no profit or extra return to  the state.                                                                 
     The only return we would  get would be on the cash we take                                                                 
     out of our pockets.                                                                                                        
MR. GARNER  said that was  correct, but FERC  would allow the  state                                                            
the opportunity to earn  that amount of money so long as the project                                                            
functions  as it was forecasted.  He added,  "If there is a  problem                                                            
with the way the project  works, you may not be allowed to earn that                                                            
rate of return as a practical matter."                                                                                          
MR. PERSILY clarified,  "So, if you're looking for  a return, you're                                                            
only going to  get a return on the cash you take out  of your pocket                                                            
to  invest  money you  borrow.  You  just  get enough  to  make  the                                                            
mortgage payment."                                                                                                              
MR. GARNER agreed.                                                                                                              
SENATOR  LINCOLN  said  what  pops out  at  her  is that  the  state                                                            
participation  would  do nothing  to eliminate  the  risk, that  the                                                            
potential companies simply  do not need the state's money to build a                                                            
She asked if they had the  Alaska railroad bill before them prior to                                                            
writing  the report,  would the  conclusion be  different than  what                                                            
they have today.                                                                                                                
MR. PERSILY  replied if producers,  or whoever decides to  build the                                                            
pipeline, used  the railroad's tax-exempt financing  that lowers the                                                            
cost of funds,  which reduces the  tariff they have to charge.  This                                                            
means  the project  might pass  their economic  test.  This risk  is                                                            
certainly an issue. He explained:                                                                                               
     If you're  going to  risk $15 billion,  you want a higher                                                                  
     rate of return  than if you're just risking $1  billion on                                                                 
     a  smaller  project  somewhere   else.  The  market  is  a                                                                 
     question.  Four billion cubic feet per day or  six billion                                                                 
     cubic  feet per day is  a lot of gas  to bring into  North                                                                 
     America  regardless  of projections.  When  that much  gas                                                                 
     hits  the  market…You  really can't  ramp  up a  gas  line                                                                 
     slowly as you would an oil  line. When that much gas comes                                                                 
     into  the market,  depending  on the market  situation  in                                                                 
     2008  or 2009,  it could very  well depress  the price  of                                                                 
     natural gas across the country.                                                                                            
He said it could  very well lower the price on not  just the Alaskan                                                            
gas, but of all the gas that a company is selling.                                                                              
MR.  GARNER added  that  there is  no doubt  in anyone's  mind  that                                                            
Alaska gas is needed in  the Lower 48 in one form or the other. That                                                            
is an  absolute  given, but  the problem  is the  timing. The  other                                                            
factor is  that this  project is going  to take  a long time  to get                                                            
built - a minimum of four years.  He stated,                                                                                    
     Hopefully,  we won't  wait too long  to get this pipeline                                                                  
     built when  the Lower 48 is going to be demanding  the gas                                                                 
     for two years before it  actually arrives. We'll just have                                                                 
     to  see what  people  are forecasting  when  they put  the                                                                 
     first shovel in the ground.                                                                                                
SENATOR  WILKEN  noted  that  item  5  on  page  10  says  that  the                                                            
Constitution  does not  allow general  obligation  bonds to  finance                                                            
state participation  of joint  business ventures.  He asked  if that                                                            
was a severely limiting  constitutional prohibition and is it common                                                            
to see it in state constitutions.                                                                                               
MR. PERSILY  answered that  it would certainly  prohibit G.O.  bonds                                                            
and tax-exempt  revenue bonds. Since Exxon, BP, Phillips  and others                                                            
can obtain  debt at  a very  low rate, if  they can  find debt  at a                                                            
lower price, there is a  value to having the state involved. Since a                                                            
G.O. bond is a  full faith credit of the state, it  makes sense that                                                            
there  would  be a  constitutional  prohibition  against  the  state                                                            
pledging them for joint  ventures with business since joint ventures                                                            
have not always returned good profit."                                                                                          
MR. GARNER said that many  states prohibit the state government from                                                            
getting  involved in private  business except  for certain  economic                                                            
development projects. Some  states are more severe than the State of                                                            
Alaska and some  are less. Some states, for example,  do not require                                                            
a vote of the  citizens to issue G.O.  bonds and other states,  like                                                            
Alaska, do.                                                                                                                     
REPRESENTATIVE  FATE  asked if  the state  had an  ownership (as  in                                                            
partnership) position, would there be a reduction in the tariff.                                                                
MR. PERSILY said he didn't think so.                                                                                            
MR. GARNER  responded  that FERC  sets  the tariff  for the  project                                                            
irrespective  of the investors. He  added that tax-exempt  financing                                                            
would result  in a lowering of the  debt cost and assuming  that was                                                            
passed through, that would affect the tariff.                                                                                   
CHAIRMAN TORGERSON  thanked them for joining the committee  and said                                                            
the discussion was not over yet.                                                                                                
MR. KEVIN BANKS, Petroleum  Analyst, Department of Natural Resources                                                            
(DNR), said  he would talk  first about their  value study  and used                                                            
projected  slides. The purpose  of it was  to encapsulate what  they                                                            
understand  about the  markets  in the Lower  48 and  what kinds  of                                                            
drivers exist  that will  influence how the  state should value  its                                                            
royalty  gas when  it's  produced. Page  3 shows  a  picture of  the                                                            
natural  gas  suppliers  in  the  U.S.  He said  that  most  of  the                                                            
production occurs in the  western Canadian sedimentary basin and the                                                            
Rockies. New supplies of  gas will come from the Gulf of Mexico, the                                                            
Mackenzie Delta and the  North Slope. There is room for new supplies                                                            
of gas,  but in every  instance  those supplies  come in only  after                                                            
significant  investment.  He  said  that  current  supply  from  the                                                            
Rockies and Canada are in a decline.                                                                                            
The next slide  shows consumption,  which pretty much happens  where                                                            
the gas is produced. He  noted a large network of pipelines wherever                                                            
the  gas  is produced  and  significant  storage  areas  around  the                                                            
country  in both the  consuming and  producing areas.  This makes  a                                                            
very  active  and  flexible  marketplace  for  gas,  which  produces                                                            
TAPE 02-2, SIDE B                                                                                                             
MR.  BANKS said  that  NGL  market is  different  than  the dry  gas                                                            
market.  They  recognize  that  gas  shipped  from  Alaska  will  be                                                            
enriched  with ethane and  other gas liquids.  The market for  those                                                            
other  liquids  is significantly   different  from the  natural  gas                                                            
market. He informed  them that the gas liquids are  processed out of                                                            
natural gas  fairly near the wellhead  and can't be moved  to market                                                            
until they are removed.                                                                                                         
The processing  plants will distribute these liquids  either blended                                                            
or fractionated into component  parts to just basically three market                                                            
centers - Alberta,  Conway and Mont Bellvieu. This  means that there                                                            
is  a large  market  of purchasers  of  processing  facilities.  The                                                            
processors sell  into a fairly restricted market.  The folks who buy                                                            
those  products   are  refineries  and  petrochemical   plants  that                                                            
represent an even  smaller number of purchasers. The  market funnels                                                            
down to fewer  and fewer players. Figure 8 shows that  one component                                                            
of NGLs is more  valuable most of the time than the  energy content.                                                            
This suggests that when  valuing our royalty, we better make sure we                                                            
pay attention to this uplift.  He noted, "It is perfectly reasonable                                                            
for the state  in evaluating its royalty to try and  capture some of                                                            
that value."                                                                                                                    
MR.  BANKS told  members the  chart  on page  10 shows  some of  the                                                            
problems about where they choose to calculate royalty:                                                                          
     Because of the royalty settlement  agreements we now have,                                                                 
     because  of the way  we have interpreted  them, our  lease                                                                 
     contacts are  calculated as a netback. That means  what is                                                                 
     the destination  value of the  gas in this instance  minus                                                                 
     the transportation  and that  should give us the value  of                                                                 
     our gas on the North Slope  at the wellhead. A lot depends                                                                 
     on where you make that destination value calculation.                                                                      
He explained that  sometimes the value of natural  gas in Chicago is                                                            
higher than the value of  it in Alberta and that is because, if it's                                                            
difficult  to get  it into  Chicago, there  would be  a response  in                                                            
Alberta to drive the price down.                                                                                                
If they choose  to value the gas at Alberta, it could  be a mistake,                                                            
because  they have collected  in an  area that  could get backed  up                                                            
behind transportation constraints  into the Lower 48. It may be that                                                            
there are transportation  constraints  for many of the participants                                                             
in that market,  but not necessarily the Alaska producers.  They may                                                            
find alternative routes  or make commitments on transportation going                                                            
to Lower  48 markets either  by building a  bullet pipeline  all the                                                            
way to Chicago  or by buying substantially in existing  pipelines or                                                            
by securing shipping on existing pipeline space.                                                                                
MR. BANKS said the summary on pages 12 and 13 says:                                                                             
     As we move forward there  is certainly compelling argument                                                                 
     that  the state  should  try  to arrive  at some  kind  of                                                                 
     valuation  agreement with producers  to avoid the kind  of                                                                 
     task   that  we  had  litigating   oil  for  value.   That                                                                 
     discussion and that negotiation  certainly require that we                                                                 
     have a considerable amount  of information and experience.                                                                 
The  producers need  some  time to  get  some experience  with  this                                                            
market place as well.                                                                                                           
CHAIRMAN  TORGERSON  asked  if he  meant  that  gas is  always  more                                                            
expensive in Chicago  than Alberta because of transportation  costs.                                                            
MR. BANKS replied that would be the case.                                                                                       
CHAIRMAN  TORGERSON  asked  what  he thought  the  tariff  was  from                                                            
Alberta to Chicago.                                                                                                             
MR. BANKS replied that he thought it was $0.80 - $1.00.                                                                         
CHAIRMAN TORGERSON asked if everything above the $1.00 would be                                                                 
the benefit we'd be losing if we chose the Alberta Hub.                                                                         
MR. BANKS said that would be right.                                                                                             
CHAIRMAN TORGERSON thanked Mr. Banks for his comments.                                                                          
MR. WILLIAM NEBESKY,  Division of Oil and Gas, DNR,  recognized that                                                            
one of  the principal  authors of  the Alaska  Natural Gas  In-State                                                            
Demand Study  was David Dismukes with  the research firm,  Econ One,                                                            
and he was also  on the faculty of the Center for  Energy Studies at                                                            
Louisiana State University. He noted:                                                                                           
     Basically,  the purpose of the  study was to evaluate  the                                                                 
     possibility  for  meeting Alaska's  energy  needs through                                                                  
     Alaska North  Slope gas and that question is divided  into                                                                 
     two parts: one is the potential  in-state demand out there                                                                 
     today and  in the future that a gas source from  the North                                                                 
     Slope  could  serve -  and  then, secondly,  what  is  the                                                                 
      ability of Alaska North Slope gas to meet that demand.                                                                    
He said that  looking at the demand  was done two ways. First,  they                                                            
looked at the existing baseline demand for gas in the state and                                                                 
extrapolated how that demand would grow in the various segments                                                                 
that make up  that demand, which includes  residential, commercial,                                                             
industrial and electric power generation.                                                                                       
     The study  used standard statistical  extrapolation  tools                                                                 
     to explore how baseline  demand would grow based primarily                                                                 
     on assumptions that are  consistent with the idea that the                                                                 
     past  five  years of  growth  and expansion  will  be  the                                                                 
     underlying  assumptions driving  future demand. The  study                                                                 
     looked at  specific applications that would go  beyond the                                                                 
     baseline and  those include expanding residential  service                                                                 
     into areas that are currently  not served by natural gas -                                                                 
     looking also  at our existing industrial applications  and                                                                 
     what is  the potential for those  applications to expand.                                                                  
     Two final areas deal with  electric power generation - one                                                                 
     called fuel switching and the other gas by wire.                                                                           
He gave  the  committee a  handout,  which illustrated  the  overall                                                            
picture of  the statistics.  The first bar  shows in the year  2000,                                                            
total in-state  demand for gas was about 230 billion  cubic feet per                                                            
year. It  shows that demand  would grow to  about 360 billion  cubic                                                            
feet  of  demand  by  the  year  2020.  So,  there  is  roughly  the                                                            
opportunity for  a 60% increase in the current level  of demand with                                                            
all the applications  that were explored in the study.  The State of                                                            
Alaska  demand  is  about 1%  of  existing  North  American  demand.                                                            
Existing usage  of gas in Alaska is  roughly about one-sixth  of the                                                            
volume of  gas that  would flow through  the gas  line at a  4 bcf/d                                                            
MR. NEBESKY  highlighted another  bar graph  that shows most  of the                                                            
current in-state  demand centered  in Southcentral Alaska  and about                                                            
65%  of the  current in-state  demand  was generated  by  industrial                                                            
uses, consisting  mostly of the Phillips Marathon  LNG plant and the                                                            
Agrium Ammonia Urea plant,  both in Kenai. Electric power uses about                                                            
15% and commercial and residential together use about 20%.                                                                      
The potential for baseline  growth from about 233 bcf is to increase                                                            
by about  another 27  bcf across  all the sectors,  a fairly  modest                                                            
potential for existing baseline usage to expand.                                                                                
Page  3 of the  study  shows a  map of  the State  of Alaska,  which                                                            
identifies  the local distribution  utility  companies that  provide                                                            
gas service in  various locations and the 340 settlements  that make                                                            
up  the state's  population.  There  are  five natural  gas  service                                                            
providers in  the state. Right now  three out of four households  in                                                            
the state receive  gas service. The potential to expand  is into the                                                            
last 25%. He  pointed out, "So, you  could say on a statewide  basis                                                            
right now, natural gas penetration rate is about 75% statewide."                                                                
MR. NEBESKY  said that nine  out of ten  communities do not  receive                                                            
gas service  in the state.  That illustrates  there is only  so much                                                            
potential  to   expand  and  most  of  the  gas  in   the  state  is                                                            
concentrated in Southcentral.                                                                                                   
To show the  potential to expand into  the residential sector,  they                                                            
used a kind of geographic  analysis called the Residential Proximity                                                            
Analysis,  which explored  geographically  occupied households  that                                                            
currently don't have access  to gas service, but are relatively near                                                            
existing local  distribution companies that do provide  that service                                                            
and near where  the Alaska Highway route would fall.  They found (on                                                            
page 6) that there  is potential in both the Interior  region, which                                                            
increases from  5,000 - 8,000 households within a  20-mile zone that                                                            
could  be potential  customers  for gas  service.  Similarly in  the                                                            
Southcentral  region,  there's  about  11,000  occupied   households                                                            
within 20-miles  of existing  facilities. This  is about 10%  of the                                                            
existing 105,000 Enstar customers now.                                                                                          
The  chart on  page  7 shows  an area  graph  of the  various  major                                                            
segments of gas usage in  the state over time. Even the small amount                                                            
of residential usage has  potential for a gas line to supply it. The                                                            
charts on the  next two pages continue  to illustrate potential  for                                                            
expansion  in  the   different  segments.  A  large  facility   like                                                            
Netricity would use about  400 mcf/y of gas to generate the power to                                                            
run computers.  This is close to the size of a small  electric power                                                            
generation  plant for a  small community.  That application  doesn't                                                            
imply  a lot  of additional  use of  gas in  the  overall scheme  of                                                            
things, but it is one to  consider. They considered the gas usage of                                                            
a petrochemical  facility similar  to the proposal that Williams  is                                                            
in the process of studying now.                                                                                                 
MR.  NEBESKY   explained   that  on=page  9   they  looked   at  two                                                            
applications that  involved electric power generation.  The first is                                                            
fuel  switching  where they  compare  the  new applications  to  the                                                            
existing  baseline  usage.  This  application  involves   converting                                                            
existing  coal and diesel  driven power  generation facilities  into                                                            
natural  gas power generating  facilities.  They have identified  20                                                            
power utilities  in eight  communities in  the Interior region  that                                                            
might have some proximity  to the pipeline. Finally, the gas by wire                                                            
application  is  an idea  where there  is  a central  power  station                                                            
located near  the pipeline  in a community  like Fairbanks  which is                                                            
gas-fired   electric  power  generation   and  then  the   power  is                                                            
distributed  by wire into communities.  That was the demand  side of                                                            
the study.                                                                                                                      
The supply side  of the study explores the potential  for a gas line                                                            
to serve these kinds of  demands. The chart on page 10 estimates the                                                            
cost of delivering  natural gas to a residential or  commercial user                                                            
in the  Interior region  (the greater  Fairbanks  area) taking  into                                                            
account  all of  the  transportation,  all  of the  step-down  meter                                                            
station  costs in  connecting to  the gas line,  depressurizing  and                                                            
extracting  liquids possibly,  also the  local distribution  charges                                                            
for a local  distribution  gas line into the  community, as  well as                                                            
commodity cost  for the gas itself.  A couple key assumptions  are a                                                            
tariff  of $1  to get  the gas  from the  North Slope  to the  meter                                                            
station in Fairbanks where  it's taken off the gas line and used for                                                            
some local distribution  application. A portion of the tariff on the                                                            
whole gas line  is applied for that first 400-mile  segment from the                                                            
North Slope to Fairbanks.  The other key assumption is the commodity                                                            
costs of $1.91,  which reflects the  prevailing value of  gas in the                                                            
Cook Inlet Basin  that produces the gas to sell to  electric and gas                                                            
service utilities.                                                                                                              
MR.  NEBESKY said  they  found that  even  in the  case  of a  small                                                            
application  to maybe  8,000 households  that  currently don't  have                                                            
access to gas, but are  within 20-miles of an existing local service                                                            
provider and  the highway route, the  study shows that gas  could be                                                            
delivered  to those  retail users  for about $5.87.  This result  is                                                            
somewhat encouraging  because the  graph on page 11 shows  delivered                                                            
cost and penetration rates.                                                                                                     
     If  80%  of the  households  hook  up and  all  the  other                                                                 
     assumptions  built into the cost side are satisfied,  then                                                                 
     that indicates  the delivered  cost. But as we move  down,                                                                 
     in  terms of  the proportion  of households  that hook  up                                                                 
     (penetration  rate), we see that the delivered  cost rises                                                                 
     more   steeply  as   we  move   toward   lower  rates   of                                                                 
Fairbanks Natural  Gas Utility serves  400 customers or about  1% of                                                            
the occupied households  in the greater Fairbanks  area. It provides                                                            
gas to its  customers at  about $8 mcf. This  gas is shipped  in the                                                            
Enstar system  and liquefied  at a small  facility at Pt.  Mackenzie                                                            
and trucked up the Parks  Highway to Fairbanks. Tapping the gas line                                                            
and providing  gas  by that mechanism,  if penetration  rates  could                                                            
exceed 30%, that  system could compete with the existing  shipage of                                                            
gas from Southcentral.                                                                                                          
Most Interior  residents heat  with heating  fuel and by  comparison                                                            
the mcf  equivalent cost  of heating  your home  in the Interior  at                                                            
$1.23  per gallon  is $10  - $12  mcf. It  wouldn't  take very  much                                                            
penetration  into  those occupied  households  to compete  with  the                                                            
heating fuel alternative.                                                                                                       
MR. NEBESKY said the chart  on page 13 looks at prices in Cook Inlet                                                            
Basin, which  has enjoyed  a long history  of excess supply  of gas.                                                            
Both industrial  and residential gas has had relatively  inexpensive                                                            
costs. Today Anchorage  residents pay about $4.27  mcf. The forecast                                                            
going  forward  into  the  future  is based  on  the  Department  of                                                            
Energy's most recent forecast  of gas prices with adjustments to the                                                            
Henry Hub. He explained:                                                                                                        
     Pricing in  the Cook Inlet Basin as evidenced  by this new                                                                 
     Unocal  Enstar   contract,  which  will  provide  service                                                                  
     beginning  in 2004 are going up. There's some  recognition                                                                 
     in the  market place to the looming  potential demand  and                                                                 
     supply in the Cook Inlet Basin.                                                                                            
Another  chart shows  that in  2005 there  is an  imbalance  between                                                            
demand  and supply.  This  makes the  assumption  the energy  prices                                                            
remain the  same as  they have been  in recent  history. They  see a                                                            
shortfall in the supply and a steady gradual increase in demand.                                                                
MR. NEBESKY  said assuming  an additional 1  tcf of reserves  coming                                                            
into  service  around  2004  in  the Cook  Inlet  Basin  is  a  very                                                            
reasonable  assumption   considering  the  stepped  up  exploration                                                             
activity  and the  studies that  explored reserves  in great  detail                                                            
(connected with  the last go-round for the LNG plant  export license                                                            
extension  in 1996 and  1997). Therefore,  the imbalance is  delayed                                                            
until  the year  2009 or  2010. But,  it doesn't  go  away with  the                                                            
addition  of 1  tcf of  gas. If  the LNG  plant does  not receive  a                                                            
renewal  for continued  LNG exports  beyond 2009,  when the  current                                                            
license expires,  there will be a  significant reduction  in demand,                                                            
but even then  the imbalance between demand and supply  isn't erased                                                            
entirely. It's just further out in time.                                                                                        
The study  also explored  to what  extent gas  from the North  Slope                                                            
could interface  with the  demand supply balance  in the Cook  Inlet                                                            
Basin. The results were  somewhat encouraging. For example, on a 16-                                                            
inch pipeline,  the unit cost would fall from $3 mcf  at 10 bcf/y to                                                            
less than $1 once there is more than 40 bcf/y.                                                                                  
MR. NEBESKY  said a number  of assumptions  were behind the  capital                                                            
cost  for  the  lateral  spur  line  that  connects   Fairbanks  and                                                            
Anchorage drawing heavily  from a study by Stone and Webster Co. (in                                                            
connection with  the Susitna Hydro project in 1989).  They gave it a                                                            
25-year  life, assumed  a 10%  regulated  rate of  return, which  is                                                            
consistent  with the rules  of thumb that  experts use in  designing                                                            
pipelines.  It might  not answer  all of  the Cook  Inlet  imbalance                                                            
questions,  but for a lateral  line to meet  the cost that  meets an                                                            
economic  curve that might  convince an investor  to invest  in this                                                            
line, you  would need  to get 30  - 40 bcf/y.  All the applications                                                             
they  looked at  and studied  would  not be  enough  to bring  those                                                            
volumes up to 30 - 40 bcf/y.  If there is not sufficient replacement                                                            
to cover all  the imbalance, that  might speak well for the  lateral                                                            
spur line coming out of Fairbanks sometime in the next decade.                                                                  
CHAIRMAN TORGERSON asked if his assumptions were identified.                                                                    
MR. NEBESKY said they were.                                                                                                     
CHAIRMAN  TORGERSON  asked  who developed  the  assumptions  on  the                                                            
capital costs for Fairbanks.                                                                                                    
MR. NEBESKY  said he had help from  Williams and Econ One  Research.                                                            
He said  they used a high-pressure  dense  phase gas line,  stepping                                                            
that down into some kind of local system.                                                                                       
REPRESENTATIVE GREEN asked,  regarding the slide on page 17, how far                                                            
out would a  bigger line have to go  to achieve economies  of scale.                                                            
He  thought that  should  happen somewhere  in  the  future or  they                                                            
should be building a smaller line.                                                                                              
MR. NEBESKY replied that  was a good question and the answer is that                                                            
the volumes on the graph don't go far enough to the right. A 16-                                                                
inch pipeline is more than capable of handling 40 - 100 bcf.                                                                    
TAPE 02-3, SIDE A                                                                                                             
MR. NEBESKY  said if the charts went  more to the right,  they would                                                            
begin to curve  up at different rates. The green curve  representing                                                            
the 24-inch  pipeline would probably  continue to decline  while the                                                            
blue and red curves started to turn up steeply.                                                                                 
CHAIRMAN TORGERSON thanked everyone for their presentations and                                                                 
adjourned the meeting at 5:18 p.m.                                                                                              

Document Name Date/Time Subjects