Legislature(2003 - 2004)
03/26/2003 03:37 PM Senate RES
| Audio | Topic |
|---|
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
ALASKA STATE LEGISLATURE
SENATE RESOURCES STANDING COMMITTEE
March 26, 2003
3:37 p.m.
MEMBERS PRESENT
Senator Scott Ogan, Chair
Senator Thomas Wagoner, Vice Chair
Senator Fred Dyson
Senator Ralph Seekins
Senator Ben Stevens
Senator Kim Elton
MEMBERS ABSENT
Senator Georgianna Lincoln
COMMITTEE CALENDAR
SENATE BILL NO. 50
"An Act amending the manner of determining the royalty received
by the state on gas production as it relates to the manufacture
of certain value-added products."
HEARD AND HELD
PREVIOUS ACTION
SB 50 - No previous action to record.
WITNESS REGISTER
Ms. Mary Jackson
Staff to Senator Wagoner
Alaska State Capitol
Juneau, AK 99801-1182
POSITION STATEMENT: Presented SB 50 for the sponsor
Mr. Gary Carlson
Forest Oil Corporation
1600 Broadway, Suite 2200
Denver, CO 80202
POSITION STATEMENT: Supports SB 50
Ms. Lisa Parker
Agrium
PO Box 575
Kenai, AK 99611
POSITION STATEMENT: Answered questions about CSSB 50(RES)
Mr. Bill Popp
Kenai Peninsula Borough
144 North Binkley St.
Soldotna, AK 99669
POSITION STATEMENT: Supports CSSB 50(RES)
Mr. Mike Nugent
Agrium
PO Box 575
Kenai, AK 99611
POSITION STATEMENT: Stated support for CSSB 50(RES)
Mr. Eric McDowell
The McDowell Group
Juneau, AK
POSITION STATEMENT: Answered questions related to CSSB 50(RES)
Mr. Mark Myers
Division of Oil and Gas
Department of Natural Resources
550 W 7th Ave.
Anchorage, AK 99501
POSITION STATEMENT: Supports CSSB 50(RES)
ACTION NARRATIVE
TAPE 03-17, SIDE A
Number 0001
CHAIR SCOTT OGAN called the Senate Resources Standing Committee
meeting to order at 3:37 p.m. All members were present except
Senator Lincoln, who was excused. The committee took up SB 50.
SB 50-ROYALTY GAS CONTRACTS
CHAIR OGAN noted the sponsor prepared a proposed committee
substitute, labeled Version H.
SENATOR BEN STEVENS moved to adopt Version H as the working
document before the committee.
CHAIR OGAN objected for the purpose of discussion.
MS. MARY JACKSON, staff to Senator Tom Wagoner, sponsor of SB
50, told members that Version H now conforms to HB 57, companion
legislation that was heard yesterday in the House Finance
Committee. She referred to a handout comparing SB 50 to Version
H and provided the following explanation of Version H.
On page 1, lines 10-12, language was inserted that specifies
that the contract will be used to accept a price for gas on or
after the effective date of this particular act. In addition, it
further defines a manufacturer as a manufacturer of agricultural
chemicals. That is the predominant change in Version H.
On page 2, lines 10-11 and lines 30-31, and on page 3, line 7,
language was again added to specify a manufacturer of
agricultural chemicals.
On page 3, lines 8-12, the definition was expanded to reflect
"manufacturer of agricultural chemicals."
On page 3, lines 13-18, new language was added so that
applicability occurs on the date of passage of this act.
MS. JACKSON said the House's intent in making the above
revisions was to clarify what a manufacturer is. House members
had considerable discussion about the appropriate verbiage.
CHAIR OGAN removed his objection to the adoption of Version H;
therefore Version H was the working document before the
committee.
MS. JACKSON told members that the sponsor statement for SB 50
still applies. The intent of the bill is to provide certainty of
the cost of the royalty gas to a manufacturing entity. That
would be accomplished by allowing the commissioner to enter into
an agreement with a manufacturing entity, similar to the
agreements made with utility companies. She noted that
representatives from the manufacturing company this bill applies
to are present to answer questions about the fiscal
implications.
CHAIR OGAN stated for the record that it is not his intention to
move this bill out of committee today.
SENATOR SEEKINS referred to the language on page 1, line 8, that
reads, "the commissioner shall enter into an agreement with the
lessee to use or accept the price," and asked how the state can
compel someone to agree on a lease price within 90 days.
MS. JACKSON said she doesn't know that the state could compel
anyone, however the bill requires the commissioner to act within
certain parameters set out on page 2, lines 28 and 29. It also
requires the commissioner to enter an agreement when certain
findings are in place.
SENATOR SEEKINS said the word "shall" indicates that the
commissioner has no choice but to enter into an agreement within
90 days regardless of where the parties are in the stages of
negotiation. He asked if that is common language.
MS. JACKSON said that is the existing statutory language so the
commissioner is required to enter into an agreement with the
utilities now. This bill inserts agricultural chemical
manufacturers into the existing statutes.
CHAIR OGAN suggested discussing that point with the commissioner
to see if that language has been problematic in the past.
SENATOR SEEKINS said whenever he enters into a lease agreement
with a customer, both parties have to come to an agreement and
no "shall" is involved.
SENATOR ELTON asked if the committee would be hearing from a
department representative.
CHAIR OGAN said that Mr. Myers was available.
SENATOR SEEKINS suggested that the language on page 2, line 23,
"unless the contract price is unreasonably low," might be the
caveat. He said it appears that the commissioner must negotiate
if a request is made and, as long as the price is not
unreasonably low, the commissioner is compelled to enter into a
lease agreement.
MS. JACKSON said that is exactly the point; the commissioner
does not have the luxury of dragging his or her feet. The
commissioner is required to go forward if DNR finds the
agreement is in the best interest of the state.
CHAIR OGAN asked if the bill contains a provision that allows
the negotiations to be reopened if the economics suddenly
change.
MS. JACKSON said not that she is aware of, but that does not
mean a provision could not be inserted into a contract.
CHAIR OGAN said he is sympathetic to Agrium's need to know what
its cost of gas will be and there will be a cost to the state to
provide that. He said part of the problem is the market for
Agrium's product is soft, but if the market suddenly improves
and the state is taking a loss, he would like to provide a way
for the state to reconsider.
MS. JACKSON asked Chair Ogan if his intent is that the state
should share the risk with the manufacturer, but it should also
share any windfalls.
CHAIR OGAN said that is correct. He said that is a concept the
committee can work on and talk to the manufacturer about. He
then took public testimony.
MR. GARY CARLSON, Senior Vice President of Forest Oil
Corporation, an upstream producer that concentrates mainly in
Cook Inlet, said the focus of his testimony will be to provide
the viewpoint of an upstream producer that may be entering into
an arms length contract with Agrium for a future gas discovery.
He made the following statement.
Gas exploration is only a recent focus in the Cook
Inlet outside the companies that controlled the
market. You now have companies like Aurora, Evergreen
and Forest Oil beginning to invest in gas exploration
and development with the anticipation of supply gaps
in future markets. There is a small, but expanding
demand by the utilities, and an anticipated large gap
in the amount of gas committed to keep the Agrium
plant at capacity. Forest Oil is actively investing in
gas prospects in part due to this anticipated market.
Field size distribution analysis suggests that there
are 100 BCF to 500 BCF accumulations yet to be
discovered in the Inlet. The current annual production
rate of 200 BCF can be broken down into service to
various markets. A rough estimate would be 35 percent
LNG, 25 percent fertilizer feedstock, 30 percent
utilities and 10 percent fuel in oil and gas
facilities.
Field size distribution analysis suggests that there
are 100 BCF to 500 BCF accumulations yet to be
discovered in the Inlet. The current annual production
rate of 200 BCF can be broken down into service to
various markets. A rough estimate would be 35 percent
LNG, 25 percent fertilizer feedstock, 30 percent
utilities and 10 percent fuel in oil and gas
facilities.
The commerciality of the projects is tied to capital
required, rate that the asset can produce, and price.
As an industry, we are working hard to drive down the
costs using new technology and innovative utilization
of current infrastructure. The gap in supply for the
fertilizer plant is a key driver for the anticipated
market. I will not try to address the price Agrium can
afford to pay for its feedstock except to say that it
ranges from $1.50 to $2.00 MCF depending upon
fertilizer prices.
Under current law, these low product prices coupled
with the potential of a 20 percent royalty burden
would limit the number of small or moderate gas
development projects that could be considered
commercial. The other threat facing potential upstream
investors in gas potential is the partial idling or
shutting in of the fertilizer plant for Cook Inlet
gas, thus eliminating the near term market.
The timeframe from exploration to first production can
exceed 5 years; therefore, some degree of certainty is
essential to encourage investment. Currently, the
state has the ability and willingness to negotiate an
equitable royalty settlement and that is a possible
solution to this critical problem; however, there
still remains a degree of uncertainty in the process.
As an upstream investor in the Cook Inlet, Forest Oil
supports SB 50. I would be happy to answer any
questions.
CHAIR OGAN asked Mr. Carlson how much gas Forest Oil supplies.
MR. CARLSON said all of Forest Oil's current gas is being
consumed in lifting the oil production. He said Forest Oil has
gas prospects and some excess gas production that it is trying
to bring to the market. Right now, the only substantial demand
is the Agrium plant.
CHAIR OGAN asked if it is fair to say the stability of that
market drives Forest Oil's investment decisions in Cook Inlet.
MR. CARLSON said that is a good description. Forest Oil is
counting on that market being available. It could make
substantial investments today but if the market disappears it
would be a difficult problem for the industry so certainty will
help. In response to a statement by Chair Ogan, he offered to
host committee members and show them the Osprey platform and its
facilities. He said after investing $200 million in the state,
it has been good to see some return. Forest Oil began production
in December.
CHAIR OGAN asked if Forest Oil has oil and gas reserves booked
at this point.
MR. CARLSON said Forest Oil has reserves booked based on its
ownership in the other fields and, when it purchased Marathon's
oil fields, it had reserves booked in a small field that it
bought from Stewart Petroleum. It has just booked reserves at
Redoubt. Forest Oil's position is that it hopes the reserves
wind up between 50 and 100 million barrels but it has only been
in production a couple of months.
CHAIR OGAN asked what Forest Oil's output will be.
MR. CARLSON said it is producing around 3,000 barrels a day from
two wells and it has another well ready to produce. The
challenge is drilling wells two to three miles away from the
platform; therefore Forest Oil can only drill three or four
wells per year. Forest Oil hopes to build its production to
10,000 barrels per day but that will take time.
CHAIR OGAN again asked the amount of gas Forest Oil produces.
MR. CARLSON said the Redoubt Shoal development, which he was
referring to, is primarily oil. The amount of gas is
insufficient to lift the oil so Forest Oil is taking gas from
the Westmoreland field to power the equipment needed to lift the
oil. Forest Oil's anticipated sales in the future would be from
new prospects that have yet to be drilled.
CHAIR OGAN thanked Mr. Carlson.
MS. LISA PARKER and MR. MIKE NUGENT of Agrium, AND MR. ERIC
MCDOWELL of the McDowell Group, introduced themselves to
members.
MR. NUGENT provided the following written testimony.
Mr. Chairman, members of the committee, thank you for
the opportunity to testify before you this afternoon.
My name is Mike Nugent and I am the General Manager of
Agrium's Kenai Nitrogen Operations based in Kenai,
Alaska. With me today is Lisa Parker, Government &
Community Relations Advisor for Agrium U.S. and Eric
McDowell from the McDowell Group. I am here today to
speak in favor of the bill before you - SB 50.
As I view this legislation, it is just one piece of
the pie, which could provide producers in Cook Inlet
with stability, and Agrium with certainty of what the
costs are to manufacture the products we sell. The
major raw material we use to manufacture our products
is natural gas.
Agrium's Kenai Nitrogen Operations is one of Alaska's
few major value-added manufacturing operations. The
Kenai plant is the second largest producer of nitrogen
products in the United States, with the largest
facility being in Louisiana. From Kenai, we
manufacture 6% of the total nitrogen products in North
America.
While we are located in Kenai, the majority of our
product is exported to Pacific Rim countries,
including Korea, Taiwan, Mexico, Thailand, and
Australia, to name a few. In total, we exported
product to fifteen different countries and in 2001 the
gross sale value of our product was $210 million (this
is total sales). Kenai has been able to be
competitive in world markets
á because of its location-close to Pacific Rim Markets,
á because there is a skilled workforce, and
á because there is a stable government.
Countries that compete with Kenai to sell fertilizer
products - Russia, Indonesia, Saudi Arabia, and
Venezuela - do not have these same attributes,
particularly a stable government. However, what they
do have are extremely low natural gas prices, which
puts Kenai at a disadvantage in marketing our product.
This disadvantage is in part due to current provisions
in state contracts, which require the State of Alaska
to receive the highest prevailing price for the
State's royalty gas.
The bill before you, SB 50, could help in that it
would allow the commissioner to accept, as the price
being paid to the state for its gas, the price that
has been negotiated between Agrium and the producer.
Over the past few weeks there [have] been some
questions with respect to the fiscal impact of this
bill. With respect to the fiscal implications, I
would like to offer the following comments:
1. The Department of Natural Resources has supplied
you with a fiscal note. It does not consider the
other economic impacts such as wages, purchases
of goods and services, taxes, and new
developments, to the State of Alaska; it only
considers the impact of natural gas value.
2. This analysis is based on forecasts and these
forecasts involve several variables such as
volume, price, ownership, etc., all of which are
very difficult to accurately predict. This
analysis also assumes we are operating at full
capacity or, in other words, consuming maximum
volumes of natural gas.
3. As opposed to forecasting the future, the reality
of today is Agrium's Kenai operation is currently
curtailed due to the inability of suppliers to
deliver adequate natural gas supplies. Our plant
is operating on average at 75% capacity so there
is currently a real revenue reduction to the
state, Agrium, and the local economies,
regardless of which price forecast is used.
4. Unless we are able to find a producer who can
provide us with a large quantity of natural gas
at a competitive price, and in the very near
future, this curtailment will last for several
years or could even result in our shutdown. We
have had repeated discussions with the current
and future producers in Cook Inlet and one of the
primary areas of concern is the additional
royalty the producer is currently subject to. To
quote one of the producers in a letter sent
recently to the City of Kenai:
As a producer looking to market our natural gas, there
is great hesitation to enter into a gas sales
agreement with a purchaser such as Agrium because it
adds yet another layer of risk to the producer. A
producer selling gas to Agrium runs the risk, in fact
the probability, that several years after selling its
gas to Agrium, the State will assert a claim that
royalty needs to be paid on a value higher than the
arms length negotiated contract price. This additional
royalty, plus interest accrued at a higher-than-market
rate, would have to be borne by the producer and/or by
the purchaser. It is for this reason that Aurora Power
and its natural gas marketing affiliate strongly
endorse [SB 50] and the concept that royalty should be
paid on the basis of arms length negotiated contract
price.
1. As noted above, the development of new natural
gas reserves is more difficult because of the
risk of unknown state royalty gas values.
2. The risk is associated with the value or price
being set by others in a process we have not
participated in.
3. If we are not successful in developing additional
competitive gas reserves, we will not survive as
a business. As a result, the revenues to the
State from royalty gas sales and the added value
our business brings to the local economies will
be zero.
4. Natural gas will have a different value to
different consumers. One price does and will not
fit all.
5. The overall economic benefits that different
natural gas consumers bring to the local
economies will be different. So, don't just
focus on the value of the gas, look at the whole
economic picture.
Eric McDowell from The McDowell Group is here to
answer any questions you might have with respect to
the economic benefits as well as the economic impacts
this facility has in Alaska. In the study the
McDowell Group undertook last year, they concluded "By
Alaskan economic standards, the Agrium operation is
exceptional for its combination of high pay levels,
amount and concentration of expenditures in the local
area, and the degree of value-added manufacturing that
occurs in Alaska prior to export. The result is a
high multiplier impact.
Mr. Chairman and members of the committee, again,
thank you for the opportunity to speak before you. We
would be happy to answer any questions.
SENATOR DYSON asked if Agrium's international product tends to
track natural gas prices.
MR. NUGENT said it does, to some degree, within the North
American market, which Agrium does not participate in. He
stated:
Fertilizer prices closely track the value of natural
gas on an international market so the North American
market does have some influence on the international
market, but on the international market the prices
tend to not track the value of natural gas. And the
main reason for that is most of the other
manufacturers or producers of fertilizers on the
international market - the other countries I mentioned
- Russia, Indonesia, Saudi Arabia - they tend to fix
the value of their natural gas and they fix it at a
very low level. They do not - gas in their countries
[does] not compete in a free market.
SENATOR DYSON said he has seen a couple of reports that indicate
that as early as five or six years from now, the price of gas
may be $6 per BTU on an international level. He asked if Alaska
got its stranded gas to an advantageous market on the West Coast
or the Great Lakes and it had that kind of value for heating and
power generation, whether Forest Oil would have a competitive
advantage.
MR. NUGENT said it could. If the value of natural gas in Cook
Inlet was tied to a bigger market and driven higher by that
market, then Agrium would have to make adjustments to either
compete in that market or not continue as a business.
CHAIR OGAN commented that the value of Cook Inlet gas varies
depending on whom it is sold to. He said if it is sold to the
Enstar system, it is more or less tied to the Henry Hub by a
formula. He asked if Agrium's long-term contract is quite a bit
lower than the Enstar price.
MR. NUGENT said that is correct.
CHAIR OGAN asked if that puts Agrium at a disadvantage with the
law of supply and demand so that if there is more demand for gas
than is currently in production, the price of gas is likely to
go up. However, Agrium needs the lowest price gas in the Inlet
to be competitive with Indonesian gas.
MR. NUGENT said that is correct but within the marketplace,
several other variables bring value to producers, one being that
Agrium is a steady consumer of natural gas throughout the year,
whereas the utilities demand a lot of gas in the winter and
almost none in the summer. He said different consumers and
producers within Cook Inlet will value gas differently and that
is where the risk comes in if another producer and consumer
strike a contract for a larger value that can have an effect on
Agrium's business in that the state's portion of that gas can be
hired at that higher value.
MS. PARKER said Agrium's current contract with its gas supplier
through June of 2009 is not affected by this legislation. This
legislation would apply to any future contracts that are entered
into if this legislation is enacted.
CHAIR OGAN noted that is due to a change in the bill and he
appreciates Agrium's consideration of it as that change made the
fiscal note much more palatable. He then pointed out that Agrium
is involved in litigation about reserves when Agrium bought the
business. He asked if this bill would be in existence if Agrium
believed the reserves it was buying were the reserves it got.
MR. NUGENT said he believes Agrium would be before the committee
today but not with the same amount of urgency. Agrium's view of
the reserves it was going to get from its supplier one year ago
took Agrium further into the future than what the reserves are
now predicted to be. This legislation has importance for the
development of natural gas in Cook Inlet in the future by making
it easier for the developers.
MS. PARKER explained that Agrium began discussions with the
Division of Oil and Gas over 1 1/2 years ago to try to find a
mechanism to provide stability for the state's royalty rate.
Agrium was not in litigation with Unocal at the time; that
litigation has nothing to do with SB 50. Agrium is trying to
provide stability and reliability in gas pricing for value-added
manufacturers in Alaska.
CHAIR OGAN asked for an explanation of how Agrium's current
rates vary and current problems with those rates.
MR. NUGENT said in Agrium's contract with its main supplier,
Unocal, the price is based upon the value of Agrium's products.
CHAIR OGAN asked if the amount of royalty paid to the state
varies depending on certain factors so Agrium does not really
know what it will pay at the end of the day.
MR. NUGENT said that is correct so, on a day-to-day basis, the
state receives the same value for the gas that Agrium pays the
producer. As time goes on, the state will monitor and compare
that to the prevailing value for that Cook Inlet gas and can
seek additional payment for the state's portion of that gas.
CHAIR OGAN commented the problem is that Agrium would not
necessarily have that money budgeted.
SENATOR BEN STEVENS said Mr. Carlson gave a breakdown of total
Inlet production at 35 percent LNG, 25 percent fertilizer
feedstock, 30 percent utilities, and 10 percent for extraction
at oil and gas facilities. He asked if the 25 percent fertilizer
feedstock is at capacity.
MR. NUGENT said it is.
SENATOR BEN STEVENS asked if Agrium sees any growth in its
consumption in the future.
MR. NUGENT said as a first step, Agrium would like to encourage
and develop arrangements with other producers to produce enough
gas in Cook Inlet to get Agrium back to capacity. Hopefully, if
additional reserves are discovered, that additional gas could
either be available to Agrium or other manufacturers.
SENATOR BEN STEVENS asked if Mr. Carlson's rough estimate is
Agrium's consumption at capacity.
MR. NUGENT said yes, and in volume numbers, the consumption
within Cook Inlet on an annual basis is about 200 BCF per year.
Agrium consumes about 55 BCF, the Phillips LNG consumes about 80
BCF and the utility system and the oil companies consume the
balance.
SENATOR BEN STEVENS asked if Agrium buys its consumption from
Unocal who pays the royalty.
MR. NUGENT said that is correct.
SENATOR BEN STEVENS asked if it is based on the value of
Agrium's product.
MR. NUGENT replied, "The price that we pay our supplier, Unocal,
is based on the value of our product."
MS. PARKER told members the draft contracts that Agrium is
discussing with the producers have an upside. They contain a set
a base price so if the price of ammonia goes up and Agrium is
making money, the price that Agrium pays the producer for gas
would also increase.
SENATOR BEN STEVENS asked if Mr. Nugent said the commissioner is
required to negotiate for the highest price available.
MR. NUGENT verified that he did.
SENATOR BEN STEVENS referred to Section 1(B) on page 2, line 9,
and asked if that gives the commissioner the latitude to look
into other justifications for price negotiations and to take the
price generated from Agrium's product.
MR. NUGENT said there could be. In Agrium's existing contract,
the value of the gas is based on the value of Agrium's product.
He noted that as Agrium makes agreements with other producers in
the future, that would be one way to price gas with a producer.
There would be several ways to price that gas other than a set
dollar amount per volume for a set period of time.
TAPE 03-17, SIDE B
SENATOR BEN STEVENS asked if Section B gives the commissioner
the latitude to accept prices other than the highest price.
MS. PARKER said it does. Section B will allow the commissioner
to accept the contract that's been negotiated between the
producer and Agrium, as opposed to using the higher one.
SENATOR BEN STEVENS referred to language on page 2, line 29 that
reads, "or other tangible benefits to the state;" and asked how
the commissioner would quantify those tangible benefits.
MR. ERIC McDOWELL told members in the McDowell Group's study on
the economic impacts of Agrium, the group looked at about 200
economic entities in Alaska over the years. He stated:
Of all of them, this seemed to come out - most
beneficial in terms of other benefits to the state,
first, in terms you're earning royalties off of this
operation. Secondly, the stable year-round resident
payroll has wages comparable to the North Slope, which
is not all resident, but the average wage is $84,000,
it's year-round, it's stable. Taxes that might -
otherwise the state would bear - are generated
privately $2.5 million per year to the Borough alone,
just on that plant, $50 million in payroll, housing
taxes, so on and so forth.
So, we find that the multiplier effect to 300 jobs of
this kind of that pay scale that are all resident
through both - through all the multiple impacts,
generate another 700. In this day and age, where we're
measuring economic progress in Alaska in terms of
MacDonald's jobs, to have this situation here that can
be stabilized and enhanced by policies you can make is
certainly an opportunity in favor of the kind of
value-added manufacturing you would like to see a lot
of in Alaska.
So, while the report is full of various numbers about
the economic impacts of what we can say, it certainly
is an operation that generates a lot of money from the
private sector that goes to pay for public services
and so forth.
A second comment I'd like to make - not directly part
of our study but in looking at the fiscal note and in
doing some analysis of our own, you have a peculiar
market situation in there. You essentially have three
buyers, and they're buyers for different purposes -
utilities, LNG and fertilizer. What he's saying is
there are different prices for each of those uses and
they're consuming - they're kind of like a COSTCO -
they're consuming 25 percent of the production of the
Inlet. If that buyer drops out, what happens to the
pricing structure of the state's royalties overall? It
goes down to zero and the whole pricing structure,
based on the way the state does it, sort of collapses.
And, so, what they're asking for, as I'm hearing it
is, rather than a subsidy, is stability. By supporting
this particular situation before you, where you're
looking where you can continue an exceptional economic
situation that has these other benefits that the
commissioner is required to consider that we've
quantified in this study, guarantees that you'll have
continued royalty payments from a quarter of the gas
produced in the Inlet plus encourage other production.
So, there seems to be a lot of benefits to the state.
The risk, on the other side, is either decreased or no
production by Agrium, in which case there are less
royalties to the state and when, in the future, you
might find another buyer for some other purpose you
would have that gap of perhaps years of no revenue -
royalties from that.... So, from an economic
standpoint, I'll conclude my comments, and that is
that there are some very substantial and positive
economic benefits, especially in this time with the
burden you have of considering the economy in Alaska.
A major private operation is contributing
substantially in lieu of money the state would
otherwise have to contribute to support that region.
Secondly, recognizing that this is kind of a unique
market - very limited consumers and that it probably
is appropriate state policy to arrange it so that you
can insure both revenue directly to the state and also
the bigger issue of the economic benefits that are
currently accruing and we hope would continue to
accrue.
CHAIR OGAN noted that Senator Stevens zeroed in on the heart of
the issue, that being that the state would give the same deal to
a private company that it gives to the utilities: accepting the
contract price as the royalty calculation. The justification for
the utilities is that the break will trickle down to the
customers who actually own the public utilities. Therefore, a
little less money goes into the state treasury, but the money
from a public resource is going back to the public. He noted the
justification of SB 50 is that the legislature will adopt that
same policy for a private company so the state will receive a
smaller royalty in exchange for employment opportunities or
other tangible benefits. He felt that the committee must decide
whether this is a good public purpose for a public resource and
justifies less money to the state treasury.
SENATOR BEN STEVENS noted the difference between Sections A and
B, in terms of affiliation, and asked why an affiliated interest
is defined as substantial influence of a family interest or
common stock interest.
MS. JACKSON said the House was attempting to grasp a numerical
value, which is the reason for the 10 percent factor. Beyond
that, the parties become affiliated and could be gaining the
interest.
SENATOR SEEKINS thought the intent appears to be that a
manufacturer cannot buy gas at an advantageous price to
wholesale it to itself. He commented [that addresses] the
threshold of a relationship in which a company could get a good
price from the state to wholesale it to itself to make a profit
in another market.
SENATOR BEN STEVENS questioned why the two sections have
different definitions but said he would research that question
himself.
SENATOR ELTON said the relationship is defined on page 2, lines
9-21, which says it cannot be over 10 percent of the
manufacturer's value-added product. He then referred to the
existing language on lines 30-31, that says, "(C) the lessee and
the utility are related in management, ownership, or other
aspect; and." He asked if this legislation sets up two different
standards, one that seems to allow the commissioner to find that
any relationship is a reason to make a written finding denying
the royalty provision, yet the earlier language defines it by 10
percent.
MS. JACKSON said she sees that as a double-edged sword because
there would be two ways for the commissioner to deny a contract
using either the 10 percent provision or because of a
relationship to the management/ownership.
SENATOR ELTON responded, "Or, you could set up a situation in
which it's 8 percent, which would be allowed under (B), but may
not be allowed under (C)."
MS. JACKSON said that would be correct because the commissioner
would have to make a written finding if it was under 10 percent
but there was management ownership and "other."
SENATOR ELTON noted that Mr. Carlson outlined the percentage of
gas that was going to the three different uses. He said the
legislature has created this benefit for the utilities and this
legislation extends that benefit to the fertilizer feed stock
industry. He asked what effect that will have on the component
of gas that is going into the LNG market and whether it will be
disadvantaged because the legislature has created opportunities
for two of the customers and not for the third.
MS. JACKSON said that is a good question.
CHAIR OGAN suggested asking a representative of the Division of
Oil and Gas.
MS. JACKSON said regarding Senator Stevens' question about other
tangible benefits, the one that has always come to her mind as a
resident of the Kenai Peninsula is the 20-mil cap for oil and
gas properties. The Kenai Peninsula is not at the 20-mil cap so
the State of Alaska gets the difference right now. That can
amount to 8 to 12 mils, which is a substantial amount of money.
MS. PARKER asked to clarify that the purpose of the language in
Section 1(B) is to make sure the transaction is an arms-length
one between the producer and the consumer, in this case the
agricultural chemical manufacturer. She then said with respect
to Senator Elton's question about disadvantaging the LNG
component, the LNG plant is also in the exploration and
production business. It supplies its own product as the Tyonek
platform is dedicated strictly to the LNG plant. The negotiated
settlement between the State of Alaska and Conoco-Phillips over
the royalty share will provide benefit to Conoco-Phillips.
MR. BILL POPP, Oil and Gas Liaison for the Kenai Peninsula
Borough, gave the following testimony.
The Kenai Peninsula Borough supports in principle the
passage of SB 50 and views this legislation as an
important step towards providing a stable business
environment for the value-added manufacturing industry
in the Cook Inlet basin.
Agrium is a key component of our economy of the Kenai
Peninsula Borough. It's the third largest local
employer. It generates nearly 300 direct high paying
jobs and several hundred additional jobs within the
local support industry and it does account for nearly
$25 million in direct payroll in our communities. The
Agrium facility generates nearly $2.5 million in
property taxes to the Kenai Peninsula Borough, which
equates to approximately 9 percent of the total
property taxes collected by the Borough in 2001. That
number is holding true again this year.
SB 50 addresses the issues of price certainty and
planning stability for Agrium by providing a
consistent and reliable price structure for any
royalty natural gas purchased by the plant for
conversion into fertilizer or ammonia, products that
compete for buyers in a highly competitive world
market with razor thin margins at times. While SB 50
will not solve all the issues that face Agrium as it
moves forward to compete for sales in the future, it
does eliminate a significant uncertainty factor from
its future business planning.
The Kenai Peninsula Borough supports the passage of SB
50 and has stated that support through the Kenai
Peninsula Borough resolution 2003-024. So, on behalf
of the Kenai Peninsula Borough, I do ask the Senate
Resources Committee to support passage of this bill
and I thank you for the opportunity to testify in
support of SB 50.
SENATOR ELTON said it would be helpful to learn about the other
incentives the state may offer for exploration and production in
the Cook Inlet fields to put this legislation in context.
CHAIR OGAN suggested the committee get an overview of the oil
and gas situation in Cook Inlet. He then asked Mr. Myers if he
wished to comment on SB 50 today.
MR. MARK MYERS, Director of the Division of Oil and Gas,
Department of Natural Resources, said he could clear up some
questions about the criteria and how the negotiations would take
place. He said the first misconception is that actual
negotiations occur. Basically, in an AS 38.05.180(aa) treatment
[hereafter referred to as (aa) treatment], the state accepts the
contract price that the lessee has with the buyer. There is no
negotiation involved, therefore the 90 days provides plenty of
time. The state has no mechanism of negotiation; the state
accepts whatever the parties negotiate external to the state.
Regarding the criteria, the statute is rather unusual in the
sense that (B)(2) lists the criteria the commissioner must
consider as follows:
(A) Is the contract price is unreasonably low?
(B) Will increased employment opportunities or other
tangible benefits result?
(C) Is the relationship an arms length one? and
(D) Is it in the best interests of the state?
He said it is important to note that line 29 contains the word
"and." Therefore, all four of the criteria must exist for the
commissioner to deny a contract, which makes it almost
impossible for the commissioner to do so. He pointed out that
language provides an automatic grant under almost anything but
the most unusual circumstances.
MR. MYERS then clarified that the word "and" is on page 3, line
1 of the committee substitute.
CHAIR OGAN asked Mr. Myers if he would recommend using the word
"or" instead.
MR. MYERS said he would if the committee's intent is to
disqualify an applicant for any one of those conditions. He
repeated that the standard is that the contract must be an arms-
length contract. One reason the state uses the market value
approach is that it is very difficult to demonstrate arms-length
contracts. Almost all royalty contracts use market value rather
than just the contract price. That is true of the state-federal
leases in Cook Inlet. That provides additional value to the
state, but it also provides confidence that the contract is not
an arms-length one. He said the third thing to note is that the
certainty goes to the lessee, not to the buyer of the gas under
the contract. The state is not subject to the negotiations
between a Cook Inlet producer and a buyer. Whether or not that
benefit is passed on to the purchaser is purely due to that
contract. Therefore, it is quite possible an Inlet producer
might keep all of the value under the (aa) treatment and
legitimately so. That is not for the state to judge. Mr. Myers
said that the (aa) treatments are a bit unusual because the
relief does not go to the intended party. However, it is passed
on in utility cases but that would not necessarily be the case
in a private manufacturing contract.
MR. MYERS said DNR feels comfortable with the fiscal note. It
does not look at the upside potential of the plant remaining in
existence, but that is not allowable in a fiscal note. The
fiscal note contains some assumptions but outcomes were derived
from various scenarios, which all have less royalty value to the
state. That is simply because the state would have kept the
contract price if, in fact, it was higher. There are no cases in
which this will provide more royalty value other than the plant
either taking less gas from the state or the plant shutting
down. He noted DNR's economist spent a lot of time working on
this fiscal note with Agrium to do a solid analysis.
MR. MYERS said DNR is aware of the importance of the Agrium
plant and a value added industry, however it does recognize that
the value here, approximately $2 million annually, has the
equivalent effect of lowering their gas price by about 3.6 cents
per MCF on Agrium's total gas take. He offered to answer
questions.
CHAIR OGAN commented that he suggested the bill should contain a
provision for a negotiation reopener if there is an upside to
the market and Agrium's response was the price it pays is based
on the price it gets for its goods. He asked Mr. Myers if he
concurs that an upside is already built in.
MR. MYERS said it all depends on the contract Agrium has with
the producer. Agrium can enter into a long-term, fixed price
contract where compensation for adjustments in price value could
be compensation other than gas price. Agrium could enter into a
contract where it is directly proportional to the gas price and
the gas price does go up. On the other hand, Agrium could enter
into a contract price based on spot or market value in the Inlet
or Henry Hub. Therefore, it would be fairly speculative to say
how the state would benefit from that and, again, DNR is not a
party to that contract.
MR. MYERS said his last point is on the question of how the
state deals with the value of gas for the LNG facility. The
state reached a settlement with the producer so it gets about
half of the value of the gas delivered in Japan. In that case,
the state recognized that it is dealing with a different market
and different conditions. Other mechanisms could be used, as Mr.
Carlson suggested, and some of those mechanisms could capture
the upside. He repeated that the (aa) treatment was never meant
to capture the upside. It was meant to provide a stable, lower
price of gas, which passes on the benefit to the user of the
gas.
CHAIR OGAN asked Mr. Myers if he sees any potential liabilities
in the future due to this legislation setting a precedent for
others.
MR. MYERS said that is a good question and certainly other
value-added uses for natural gas exist. One of the issues is the
higher value has brought in significantly more revenue. A
rolling of that contract, under the lease form, will have a
large-scale economic impact if applied to other users. He said
this is a policy call, sort of an insurance policy that
increases value to the gas producers selling to Agrium. That
amount will vary depending on the contract price versus the
market value. Similar treatment would provide additional
economic value to any lessee.
CHAIR OGAN said the construction of a natural gas pipeline is a
possibility so the legislature needs to be mindful that there
will be other value added industries when it decides on this
policy. There being no further questions, CHAIR OGAN adjourned
the meeting at 5:00 p.m.
| Document Name | Date/Time | Subjects |
|---|