Legislature(2009 - 2010)BUTROVICH 205

03/17/2010 03:30 PM Senate RESOURCES

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03:39:38 PM Start
03:40:33 PM Overview: Sb 143-railbelt Energy & Transmission Corp.
04:05:13 PM SB301
04:09:37 PM Update: Agia Regulations by the Dnr
05:24:24 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Joint w/ (S) Energy (Below Bill Only)
+ Overview: Railbelt Integrated Resource TELECONFERENCED
+ AGIA Regulations Presentation from TELECONFERENCED
Dept of Natural Resources
+ Bills Previously Heard/Scheduled TELECONFERENCED
Moved SB 301 Out of Committee
                    ALASKA STATE LEGISLATURE                                                                                  
                         JOINT MEETING                                                                                        
              SENATE RESOURCES STANDING COMMITTEE                                                                             
               SENATE SPECIAL COMMITTEE ON ENERGY                                                                             
                         March 17, 2010                                                                                         
                           3:39 p.m.                                                                                            
MEMBERS PRESENT                                                                                                               
SENATE RESOURCES                                                                                                                
 Senator Lesil McGuire, Co-Chair                                                                                                
 Senator Bill Wielechowski, Co-Chair                                                                                            
 Senator Charlie Huggins, Vice Chair                                                                                            
 Senator Hollis French                                                                                                          
 Senator Bert Stedman                                                                                                           
 Senator Gary Stevens                                                                                                           
 Senator Thomas Wagoner                                                                                                         
SENATE SPECIAL COMMITTEE ON ENERGY                                                                                              
 Senator Lesil McGuire, Chair                                                                                                   
 Senator Bert Stedman                                                                                                           
 Senator Bill Wielechowski                                                                                                      
MEMBERS ABSENT                                                                                                                
SENATE RESOURCES                                                                                                                
 All members present                                                                                                            
SENATE SPECIAL COMMITTEE ON ENERGY                                                                                              
 Senator Lyman Hoffman                                                                                                          
 Senator Albert Kookesh                                                                                                         
COMMITTEE CALENDAR                                                                                                            
OVERVIEW: SB 143 - RAILBELT ENERGY & TRANSMISSION CORP                                                                          
     - HEARD                                                                                                                    
SENATE BILL NO. 301                                                                                                             
"An  Act relating  to  the power  project  fund; authorizing  the                                                               
Alaska Energy  Authority to charge  and collect fees  relating to                                                               
the power  project fund; authorizing the  Alaska Energy Authority                                                               
to  sell and  authorizing the  Alaska Industrial  Development and                                                               
Export Authority  to purchase  loans of  the power  project fund;                                                               
providing  legislative  approval for  the  sale  and purchase  of                                                               
loans  of  the  power  project   fund  under  the  memorandum  of                                                               
understanding  dated  February 17,  2010;  and  providing for  an                                                               
effective date."                                                                                                                
     - MOVED SB 301 OUT OF COMMITTEE                                                                                            
AGIA Regulations presented by the Department of Natural                                                                         
     - HEARD                                                                                                                    
PREVIOUS COMMITTEE ACTION                                                                                                     
BILL: SB 301                                                                                                                  
SHORT TITLE: POWER PROJECT FUND                                                                                                 
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR                                                                                    
02/26/10       (S)       READ THE FIRST TIME - REFERRALS                                                                        
02/26/10       (S)       RES, FIN                                                                                               
03/15/10       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
03/15/10       (S)       Heard & Held                                                                                           
03/15/10       (S)       MINUTE(RES)                                                                                            
03/17/10       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
WITNESS REGISTER                                                                                                              
JAMES STRANDBERG, P.E., Project Manager                                                                                         
Alaska Energy Authority (AEA)                                                                                                   
Anchorage, AK                                                                                                                   
POSITION STATEMENT: Supported SB 143.                                                                                         
ANTHONY SCOTT, Commercial Analyst                                                                                               
Division of Oil and Gas                                                                                                         
Department of Natural Resources (DNR)                                                                                           
Anchorage, AK                                                                                                                   
POSITION STATEMENT: Presented AGIA regulations for the DNR.                                                                   
MARTY RUTHERFORD, Deputy Commissioner                                                                                           
Department of Natural Resources (DNR)                                                                                           
Anchorage, AK                                                                                                                   
POSITION STATEMENT: Presented AGIA regulations for the DNR.                                                                   
FRED HAGEMEYER                                                                                                                  
Black & Veatch, Corporation consultant                                                                                          
POSITION STATEMENT: Presented AGIA regulations for the DNR.                                                                   
DEEPA PODUVAL                                                                                                                   
Black & Veatch consultant                                                                                                       
POSITION STATEMENT: Presented AGIA regulations for the DNR.                                                                   
ACTION NARRATIVE                                                                                                              
3:39:38 PM                                                                                                                    
CO-CHAIR  WIELECHOWSKI called  the  joint meeting  of the  Senate                                                             
Special  Committee on  Energy and  the Senate  Resources Standing                                                               
Committee to  order at  3:39 p.m.  Present at  the call  to order                                                               
were  Senators   Huggins,  Stedman,  Wagoner,   Stevens,  French,                                                               
McGuire, and Wielechowski.                                                                                                      
     ^Overview: SB 143-RAILBELT ENERGY & TRANSMISSION CORP.                                                               
CO-CHAIR  WIELECHOWSKI  announced  the first  order  of  business                                                               
would be  an overview  of SB  143, also known  as the  GRETC bill                                                               
(Greater Railbelt Energy Transmission Corporation).                                                                             
3:40:33 PM                                                                                                                    
JAMES STRANDBERG, P.E., Project  Manager, Alaska Energy Authority                                                               
(AEA), said he had 11 power point  slides that he hoped to use to                                                               
summarize  the work  the administration  in cooperation  with the                                                               
Railbelt  utilities  has  done  to date  with  the  Railbelt  G&T                                                               
(generation  & transmission)  restructuring effort  and what  the                                                               
new  corporation  is all  about  including  its initial  tasks  -                                                               
should this bill pass.                                                                                                          
He said last  year he appeared before them with  a very different                                                               
GRETC bill. At the end of that  session the bill was held in this                                                               
committee at  the request of  the Railbelt utilities  that wanted                                                               
to take  a year and involve  all the boards of  directors for the                                                               
utilities in  a task force  to make  the plan more  responsive to                                                               
their needs. They came up with  a committee substitute (CS) to SB
143  that  has  major  support within  this  utility  group.  His                                                               
agency, the AEA, working with  the Governor's office participated                                                               
in the  majority of these task  force meetings and acted  as both                                                               
advisor and observer  as the work on the  bill progressed through                                                               
the   summer.   The   Attorney  General's   Office   provided   a                                                               
representative  as well  to  assist in  drafting  changes to  the                                                               
legislation. They are awaiting the CS from the drafters.                                                                        
He said  the fiscal note  will be reduced generally  because they                                                               
have  taken a  hard  look  at the  requirements  for forming  the                                                               
business  and with  the new  framework there  is a  lesser fiscal                                                               
requirement. That is also forthcoming.                                                                                          
MR.  STRANDBERG said  that  AEA accomplished  the  REGA Study  to                                                               
understand the economics of regional  G&T organizations, and that                                                               
study  found  that  forming  a   GRETC-like  company  could  save                                                               
ratepayers significant money through  reduced rates over the long                                                               
term. AEA  also completed a  regional plan for  future generation                                                               
transmission projects  (RIRP) in  the late fall,  which indicated                                                               
several  things that  add to  the urgency  of forming  a regional                                                               
entity  such as  GRETC. First  this study  defined critical  near                                                               
term  projects that  a unified  G&T company  should take  on from                                                               
critical fuel supply projects to  near term transmission projects                                                               
to  needed generation  additions. It  also identified  a critical                                                               
capital  shortfall where  the cumulative  capital  needs for  the                                                               
region  are  much  larger  than the  abilities  of  the  Railbelt                                                               
utilities  to raise  capital for  projects defined  in the  RIRP.                                                               
This  plan   concluded  that  a  GRETC   or  GRETC-like  unifying                                                               
organization with  state financial  backing is the  best approach                                                               
to achieve a future of  reliable and affordable electric service.                                                               
It would  save the ratepayers  a lot of  money over the  long run                                                               
and forming  that entity will give  them the ability to  meet the                                                               
capital needs of  the future. Without that they will  have a very                                                               
hard time raising money.                                                                                                        
3:46:13 PM                                                                                                                    
He said  he would next explain  how the CS is  different from the                                                               
original  bill. He  developed  four topics  in  his summary:  the                                                               
governance of  the new  company, the  powers of  the corporation,                                                               
external controls  for the corporate activities  and a discussion                                                               
of the initial tasks for GRETC.                                                                                                 
The key points of the Board of Directors make up are:                                                                           
   · The corporation is a private not-for-profit entity (not a                                                                  
     state corporation).                                                                                                        
   · Each of the six Railbelt utilities regardless of size,                                                                     
     generating capacity or transmission line ownership, will                                                                   
     have two board members and two votes.                                                                                      
   · GRETC has 6 public utility members and 12 board members; it                                                                
     has  one public  member that  is appointed  by the  Governor                                                               
     from  a list  of  three candidates  supplied  by the  public                                                               
     utility members.  Public utility  members do not  have terms                                                               
     of service, but the public  member has a four-year term. The                                                               
     board  will  be  required  to designate  a  chief  executive                                                               
3:47:40 PM                                                                                                                    
Types of business GRETC can undertake:                                                                                          
   · Providing wholesale power to its Railbelt customers (one of                                                                
     the distribution utilities that would buy wholesale power.)                                                                
     No retail customer relationship.                                                                                           
   · Providing wholesale power is at the center of the                                                                          
     corporation's   purpose   and    GRETC   can   undertake   a                                                               
     considerable  number  of  tasks  to generate  and  sell  its                                                               
     wholesale power that  are allowed under the  new language in                                                               
     the bill.                                                                                                                  
3:48:27 PM                                                                                                                    
MR.  STRANDBERG  said  GRETC  is  now  a  voluntary  organization                                                               
similar to  the JAA effort that  was made several years  ago, but                                                               
there are significant differences in approach now (slide 8).                                                                    
CO-CHAIR WIELECHOWSKI  asked why  it is in  the best  interest of                                                               
consumers to have an all volunteer corporation.                                                                                 
MR. STRANDBERG answered to get to  the goal of becoming a unified                                                               
operation   their   studies   have   indicated   companies   need                                                               
significant flexibility  to make mid-term agreements  so that two                                                               
utilities  can have  agreements but  still participate  in GRETC.                                                               
They believe through state funding  they will have the ability to                                                               
channel the  organization more towards the  unified organization.                                                               
Extensive conversations with the  utilities on these matters have                                                               
revealed an understanding  that they need the  flexibility now to                                                               
really take up the  issues in the Railbelt, as well  as a need to                                                               
focus over the long run into a tighter integration.                                                                             
3:52:19 PM                                                                                                                    
MR.  STRANDBERG said  that GRETC  is  now much  more flexible  so                                                               
utilities can  act to  meet the future  wholesale power  needs of                                                               
their regions.  One point  is that  utilities under  this statute                                                               
really  can  undertake their  own  projects,  approach GRETC  for                                                               
power  supply or  do  any number  of  arrangements for  providing                                                               
wholesale  power.  A  critical difference  is  that  the  earlier                                                               
bill's intent was that the  company would evolve towards being an                                                               
all-requirements provider  for wholesale  power in  the Railbelt.                                                               
That language  has been left out  of the CS that  rather provides                                                               
the flexibility to make different arrangements.                                                                                 
Another difference is that GRETC  now has the Railbelt Integrated                                                               
Resource  Plan  (RIRP), last  year  it  didn't. Another  critical                                                               
difference is  that four utilities  now must agree to  join GRETC                                                               
before it can actually form.                                                                                                    
SENATOR  WAGONER  asked  if  Homer Electric  were  to  join  this                                                               
organization, would  its administration would  have to go  to the                                                               
annual meeting.                                                                                                                 
MR.  STRANDBERG answered  yes; the  commitment would  have to  be                                                               
approved by their board.                                                                                                        
SENATOR WAGONER said  "Good luck," because he  knows the politics                                                               
of the situation in his area.                                                                                                   
MR. STRANDBERG  said participating with boards'  members has been                                                               
a very interesting and positive  process over the past year. This                                                               
flexible platform  is what all  the groups  as a whole  saw would                                                               
allow them to get through  their board processes and really begin                                                               
unifying over the long haul.                                                                                                    
CO-CHAIR WIELECHOWSKI  said he understood that  all the utilities                                                               
support the CS.                                                                                                                 
MR. STRANDBERG said that is correct.                                                                                            
3:55:05 PM                                                                                                                    
He  went to  the External  Controls in  slide 9  saying a  lot of                                                               
people have talked about rate  regulation and the RCA issues. AEA                                                               
sees a  definite need  for oversight  for consumer  protection as                                                               
well as financial oversight to  make sure the company is managing                                                               
money correctly,  particularly if the  state is going to  back it                                                               
in some way.  The third thing is to make  sure the corporation is                                                               
actually doing its job.                                                                                                         
The significant protections in the  CS include: RCA economic rate                                                               
regulations which  would sunset at  the end of five  years unless                                                               
the  legislature   took  further  action.  Also   included  is  a                                                               
requirement for  a management audit  done in accordance  with the                                                               
National Association of  Regulatory Utility Commissioners (NARUC)                                                               
3:56:59 PM                                                                                                                    
The  near  term tasks  for  GRETC  (slide  10) are:  forming  the                                                               
company, getting  the legal  documentation together,  and hitting                                                               
the  ground  running and  actually  starting  the work.  AEA  has                                                               
accomplished the RIRP which is  being provided to the utility for                                                               
GRETC for its  consideration as it starts up  its operations. The                                                               
plan  has a  priority list  of projects,  business functions  and                                                               
contractual agreements that need to  be accomplished. The AEA has                                                               
spent a  lot of time over  the last three years  working with the                                                               
utilities with this  plan, and clearly utilities  take issue with                                                               
things like  committed units. So,  their expectation and  hope is                                                               
that utilities will take the plan to heart.                                                                                     
Finally,  the  CS  has  the requirements  to  develop  a  capital                                                               
improvements plan  and a financial  management plan.  Last, there                                                               
is a critical  need to begin generation  of transmission projects                                                               
in the Railbelt.                                                                                                                
3:59:02 PM                                                                                                                    
SENATOR HUGGINS  said he implied  phases, but he didn't  see that                                                               
broken  down anywhere  and asked  if  he had  that somewhere.  He                                                               
thought Mr.  Strandberg was expecting  this to change  over time;                                                               
and that is  implied in the sense  that the RCA goes  away at the                                                               
end of year five.                                                                                                               
MR. STRANDBERG said  the first five years will  be very critical.                                                               
They need to induce the  utilities to provide their board members                                                               
to come  to the table and  actually meet and create  bylaws. They                                                               
will  have to  hire  a CEO,  and certainly,  if  there are  major                                                               
projects and the  utilities actually come to the  table and begin                                                               
to do  major projects with this  company and the state  begins to                                                               
pour money into that, they are  going to need to get the external                                                               
controls  going  right  away.  A major  amount  of  oversight  is                                                               
necessary in  these formation  phases of  the company  and likely                                                               
there will be a need for  agency involvement "to make sure public                                                               
benefit flows."                                                                                                                 
SENATOR HUGGINS said  he had discussed four big  debate points so                                                               
far and asked if any are remaining.                                                                                             
MR.  STRANDBERG  said  the  RCA   was  a  major  sticking  point.                                                               
Utilities  wanted  to  be  able  to  continue  making  near  term                                                               
arrangements  for  power.  There  was  concern  that  if  utility                                                               
operations were  consolidated, one group of  ratepayers could end                                                               
up  paying more  when another  group was  paying less.  There was                                                               
concern that  the evolution to  an all requirements  provider was                                                               
too  constraining  and  it  didn't really  reflect  some  of  the                                                               
arrangements that would be need to be made in the near term.                                                                    
SENATOR HUGGINS  said it  appears the business  of being  able to                                                               
develop projects  outside of  GRETC by  one of  the members  is a                                                               
fracture waiting to happen.                                                                                                     
MR.  STRANDBERG said  that is  always a  possibility. If  all the                                                               
utilities can't  see an economic incentive  to unified operations                                                               
under  this arrangement  it is  likely  that bilateral  contracts                                                               
will  continue.  This  corporation  will  be  a  success  if  the                                                               
utilities  can see  economically that  it's to  their benefit  to                                                               
CO-CHAIR WIELECHOWSKI  said it's an interesting  balance they are                                                               
trying  to achieve.  Finding no  further questions  he ended  the                                                               
Senate Energy  portion of  the hearing and  announced an  at ease                                                               
from 4:04-4:05 p.m.                                                                                                             
                   SB 301-POWER PROJECT FUND                                                                                
4:05:13 PM                                                                                                                    
CO-CHAIR WIELECHOWSKI called the  Senate Resources portion of the                                                               
meeting to order  at 4:05 p.m. He  announced SB 301 to  be up for                                                               
consideration saying it's a good bill  and he had held it over to                                                               
give members the opportunity to review it over the weekend.                                                                     
CO-CHAIR  MCGUIRE moved  to  report SB  301  from committee  with                                                               
individual  recommendations  and  attached zero  fiscal  note(s).                                                               
There were no objections and it was so ordered.                                                                                 
4:07:40 PM                                                                                                                    
at ease (projector difficulties)                                                                                                
4:08:49 PM                                                                                                                    
              ^Update: AGIA Regulations by the DNR                                                                          
CO-CHAIR WIELECHOWSKI  called the meeting  back to order  at 4:08                                                               
p.m. and  said the next order  of business would be  an update on                                                               
AGIA regulations by the DNR.                                                                                                    
ANTHONY SCOTT,  Division of  Oil and  Gas, Department  of Natural                                                               
Resources (DNR), said  the first part of the  presentation is the                                                               
valuation principles of  natural gas. He would  then step through                                                               
an example  of how  they would actually  value royalty  gas under                                                               
the regulations  - a  little more  complicated process  than what                                                               
they  saw last  week with  the  Department of  Revenue (DOR).  He                                                               
would also talk a little  bit about the RIV/RIK switching problem                                                               
for the state's  producers under the lease and  the solution they                                                               
are  proposing  in the  regs.  Finally,  Deepa Poduval,  Black  &                                                               
Veatch consultant, will give them a  sense of the range of values                                                               
that  are  provided to  the  qualifying  lessees (producers)  who                                                               
choose to amend their leases under the regs.                                                                                    
MR.  SCOTT said  that the  public comment  period would  close on                                                               
March 22, so  he has to be sensitive to  honoring that process in                                                               
treating everyone fairly.                                                                                                       
4:09:37 PM                                                                                                                    
He said  that gas is  complicated because  how it will  be valued                                                               
has to  be clarified and then  existing lease terms will  have to                                                               
be  modified to  eliminate  initial  shipper exposure  associated                                                               
with the  cost of  transportation on  the mainline.  An important                                                               
difference in  these regulations compared to  the DOR regulations                                                               
is that if  a lessee qualifies, he may chose  to amend his leases                                                               
and have  his gas valued  under these regulations. If  he doesn't                                                               
like this  framework, he doesn't have  to have his gas  valued in                                                               
this  way. This  is not  something  they can  impose on  lessees.                                                               
Similarly, they  cannot impose  the royalty  switching provisions                                                               
on lessees; that is something they  have to elect. They can elect                                                               
the valuation provision, the switching provision or both.                                                                       
CO-CHAIR  WIELECHOWSKI  asked  him   to  describe  a  lessee  who                                                               
qualifies for royalty inducement.                                                                                               
MR.  SCOTT  replied   a  lessee  must  commit   to  acquire  firm                                                               
transportation  (FT)  in the  initial  open  season of  the  AGIA                                                               
licensed project to have his  gas valued under these regulations.                                                               
The  qualification language  is exactly  the same  to get  in the                                                               
door between both DOR and DNR.                                                                                                  
4:14:03 PM                                                                                                                    
He   said  Valuation   regulations  (slide   4)  must:   minimize                                                               
retroactive adjustments  in royalty value, establish  fair market                                                               
value (FMV)  based on reliable  trade publications,  allow actual                                                               
and  reasonable  deductions  for transportation  and  processing,                                                               
allow  reasonable share  of  unused capacity.  So  if an  initial                                                               
shipper acquires  capacity and he doesn't  have enough production                                                               
to fully  fill it the state  would pick up a  reasonable share of                                                               
that empty capacity  and allow deductions under  the 1980 royalty                                                               
settlement agreement.                                                                                                           
MR.   SCOTT  said   crafting  regulations   to  meet   all  these                                                               
requirements  is not  as easy  as they  first thought.  There are                                                               
complications like  trying to  protect the  state and  the lessee                                                               
while minimizing  retroactive adjustments  while first gas  is 10                                                               
years in  the future. So they  came up with basing  royalty value                                                               
on reliable  trade publications as  opposed to looking  to actual                                                               
sales. Trade  publications are public;  you can look them  up and                                                               
know what  your royalty  value will be.  However where  the sales                                                               
are  occurring can't  be traced;  so there  is uncertainty  about                                                               
exactly where gas was marketed and  how it should be valued given                                                               
they can't be sure what they  might have received for it and what                                                               
they  might have  received for  it may  come apart,  importantly,                                                               
from what the trade publications are.                                                                                           
4:16:03 PM                                                                                                                    
He  said  that  allowing  reasonable and  actual  deductions  for                                                               
transportation  and processing  is quite  a complication.  One of                                                               
the reasons is because it means  they can't simply deem one price                                                               
as the  basis for determining all  value by assuming all  the gas                                                               
will go to  the Alberta (ACCO) market, for  instance. The problem                                                               
is that Alaska gas may never  enter into the ACCO market, but may                                                               
interconnect with,  for example,  the Alliance pipeline  and move                                                               
on  into Chicago.  Because the  statute  says that  you get  your                                                               
actual and reasonable cost of  transportation, the lessee gets to                                                               
deduct  their actual  and reasonable  cost  of transportation  to                                                               
Chicago. So, you  wouldn't want to value gas in  Albert but allow                                                               
a transportation deduction all the way to Chicago.                                                                              
Allowing a reasonable share of  unused capacity? Define standards                                                               
for what  is reasonable,  he said.  They have  done that  in what                                                               
they think is  a fair manner, but  there were a lot  of things to                                                               
sort through to get there.                                                                                                      
4:16:50 PM                                                                                                                    
MR. SCOTT  said gas  markets are  inherently more  complicated in                                                               
terms of valuing  ANS hydrocarbons than oil,  which is relatively                                                               
straight forward.  It gets produced  on the North Slope,  it goes                                                               
down TAPS,  it's loaded on to  tankers that are dedicated  to the                                                               
ANS trade, and they go to  refineries on the West Coast. You know                                                               
where  the  oil  is  going  to  a  considerably  high  degree  of                                                               
certainty. And you know where your markets are.                                                                                 
In the case of gas that's not  true. First of all they don't know                                                               
exactly what  the infrastructure  will end  up being.  They don't                                                               
know what  will get  built. So, clearly  they don't  know exactly                                                               
where it  will go  - not to  mention that first  gas is  10 years                                                               
out.  Even then,  gas may  directly flow  from this  project into                                                               
Alberta,  into Sumas,  Washington,  and go  down  the West  Coast                                                               
pipeline  and bypass  the ACCO  market.  ANS gas  may bypass  the                                                               
Alberta  market  and  go  into  Chicago.  Further  they  have  to                                                               
recognize that  individual molecules of  ANS gas may  be consumed                                                               
in  Oregon  or  New  York  City, because  North  America  has  an                                                               
interconnected pipeline  grid where molecules are  comingled. So,                                                               
you have  to come up  with standards  and rules about  how you're                                                               
going to cut  that process off for valuation  while also allowing                                                               
actual and reasonable costs.                                                                                                    
MR.  SCOTT  said that  meanwhile  the  gas business  is  dynamic.                                                               
Twenty-five years  ago natural gas  prices were regulated  at the                                                               
wellhead. The  transportation infrastructure was  regulated quite                                                               
differently.  The markets  were dominated  by large  transmission                                                               
pipelines that purchased  the gas at the wellhead and  sold it to                                                               
consumers. Today it's  very different, but the point  is that was                                                               
only 25  years ago  and they  are trying  to develop  a framework                                                               
that will be robust for a very long time.                                                                                       
4:19:07 PM                                                                                                                    
An additional complication is that  the North Slope gas will vary                                                               
by quality  from one  property to  the next (slides  5 &  6). The                                                               
composition  of the  gas at  Prudhoe  Bay is  different than  the                                                               
composition of  the gas at  Pt. Thomson.  But not only  are those                                                               
streams  being  comingled,  streams  from  other  systems,  quite                                                               
possibly from  the British  Columbia and Alberta  - all  of which                                                               
has  different   compositions  -  will  be   comingled,  and  the                                                               
composition of the  gas has value. The gas that  comes out of the                                                               
ground will  have a different value  for the lessee based  on its                                                               
composition. So,  if the lessee receives  differential value, the                                                               
statute directs the state to try to obtain that value as well.                                                                  
Finally, allocating processing costs  is complicated. The statute                                                               
says you get  processing costs, but in this  particular slide (6)                                                               
you  may  well  have  multiple   processing  plants  in  a  given                                                               
location, and  how do you  allocate the costs of  those different                                                               
processing plants to Alaska gas  which is also comingled with gas                                                               
from many  other sources?  These are  the kinds  of complications                                                               
they faced  in putting these  regulations together in a  way that                                                               
treats all parties fairly.                                                                                                      
MR. SCOTT said the legislature was  wise when it passed AGIA that                                                               
directed  them to  promulgate these  regulations; the  state does                                                               
not have valuation  regulations for gas outside of  AGIA. He said                                                               
that real  money is  at stake based  on the  particular molecular                                                               
composition of  the gas that comes  out of the ground  (slide 7).                                                               
No party  wants to  be deprived  of the  opportunity to  get what                                                               
their due is either  as a royalty lessor or as  a lessee. He then                                                               
turned the discussion over to Marty Rutherford.                                                                                 
4:22:52 PM                                                                                                                    
MARTY  RUTHERFORD,  Deputy  Commissioner, Department  of  Natural                                                               
Resources (DNR), said  she would speak to  the overarching policy                                                               
principles  some of  which are  embedded in  these draft  royalty                                                               
regulations: (slide 8)                                                                                                          
Overarching Principles:                                                                                                         
1. Reduce lessee uncertainty                                                                                                    
2. Maintain state's full royalty value (in statute)                                                                             
3. Incorporate natural gas industry  practices to the extent that                                                               
doing so is consistent with (1) and (2)                                                                                         
4:24:21 PM                                                                                                                    
She explained that  the first two goals especially  have a degree                                                               
of tension. They want to  provide as much administrative ease and                                                               
clarity as  they can while  also ensuring that the  state doesn't                                                               
make any assumptions that turn out  to be very wrong and cost the                                                               
state substantially down the road;  it has happened. (One example                                                               
will be discussed later on how  the 1980 field cost settlement at                                                               
Prudhoe  Bay will  actually affect  the cost  of the  gas to  the                                                               
state.) She  noted that  not completely  locking a  royalty value                                                               
scheme  can also  benefit  the lessees.  The  requirement of  the                                                               
statute is to maintain fair market  value and they think the regs                                                               
have done that.                                                                                                                 
The  effort  to  incorporate gas  industry  standards  themselves                                                               
stems from  a desire to  map the  valuation scheme to  the extent                                                               
they can on  how it will be necessary for  the lessees to account                                                               
and manage their gas flows. The  department's goal is for them to                                                               
be  able  to use  their  existing  gas marketing  and  accounting                                                               
systems  to the  extent possible  while also  complying with  the                                                               
AGIA royalty valuation provisions -  and frankly they are hopeful                                                               
that   having  normal   industry   practices   embedded  in   the                                                               
regulations will also reduce room for future disputes.                                                                          
4:24:59 PM                                                                                                                    
SENATOR FRENCH asked how the  department measures and keeps track                                                               
of all the  gas streams coming into some inlet  header to the new                                                               
gas treatment plant (GTP). Is  that taking place upstream of that                                                               
MS.  RUTHERFORD answered  yes; it  is done  from the  unit as  it                                                               
enters into the GTP.                                                                                                            
4:26:23 PM                                                                                                                    
She said  the overarching  principle addressed in  slide 9  is to                                                               
reduce uncertainty by:                                                                                                          
   1. Eliminating "higher-of" lease valuation terms                                                                             
   2. Establishing value based on published prices                                                                              
   3. Minimizing or eliminate retroactive adjustments                                                                           
   4. Allocating volumes pro rata to increase clarity of gas                                                                    
     value and costs of transportation and processing                                                                           
This does not mean that the  lessees will know what they will pay                                                               
in  royalty  30 years  from  now.  Trying  to  do that  would  be                                                               
ridiculous because of the differences  in regulation, markets and                                                               
knowing that regulations change over  time. But what it does mean                                                               
is that  in any given  month the lessee  and the state  will know                                                               
what the royalty  value will be for that month  and what needs to                                                               
be paid.  Some of the details  for how that is  done will follow,                                                               
but achieving this  principle is not trivial whatsoever.  It is a                                                               
substantial change  from where they  are today, she said,  and it                                                               
promises also  to reduce litigation  that has been a  constant so                                                               
far on gas issues.                                                                                                              
CHAIR WIELECHOWSKI  asked her to explain  what "eliminate higher-                                                               
of lease valuation terms" means.                                                                                                
She explained that  the current leases require lessees  to pay on                                                               
the highest value  of three different measures.  In practice that                                                               
means that  a lessee doesn't know  what it should pay  in a given                                                               
month because  that is a  function of what other  lessees receive                                                               
in  value as  well. In  other words,  of three  different lessees                                                               
getting value  for the same  oil, whichever lessee gets  the most                                                               
money, that  is the  basis for the  lessees paying  their royalty                                                               
value. It's a retroactive calculation.                                                                                          
CO-CHAIR WIELECHOWSKI asked for an example.                                                                                     
MS. RUTHERFORD  explained for instance the  three major producers                                                               
are producing oil  from the same unit; they go  to the market. BP                                                               
has  an exceptionally  good marketing  strategy;  they receive  a                                                               
higher value for  their oil or for their gas.  And in the current                                                               
lease  structure the  state  bases its  royalty  returns on  that                                                               
higher value,  which means that  everybody will make  an estimate                                                               
or maybe  use their  own returns  as the  basis for  paying their                                                               
royalty  in a  given  month, and  once  they go  back  and do  an                                                               
accounting of  it and audit the  other firms, they will  owe some                                                               
additional monies to basically bring  the into alignment with the                                                               
highest amount of value received.                                                                                               
CO-CHAIR WIELECHOWSKI asked if the proposed regs eliminate that.                                                                
MS. RUTHERFORD answered  yes, in fact they go  beyond the minimum                                                               
requirements of the statute by  eliminating the "higher-of" value                                                               
and they replace it with a  system that allows the lessee to know                                                               
by  very  transparent and  objective  measures  what its  royalty                                                               
obligations for the  current month are.  Under  the current lease                                                               
contracts, it could be several  years before all the lessees know                                                               
through audit  what their royalty  obligation was  previously and                                                               
they would have retroactive payments to make.                                                                                   
CO-CHAIR WIELECHOWSKI asked if this  is being eliminating for gas                                                               
only or both oil and gas.                                                                                                       
MS. RUTHERFORD replied this would be for gas.                                                                                   
CO-CHAIR  WIELECHOWSKI asked  if she  had any  estimates of  what                                                               
sort of loss this will be to the state.                                                                                         
MS.  RUTHERFORD  answered yes;  Deepa  Poduval  would talk  later                                                               
about the  values they believe  are being conveyed  through these                                                               
regulations to  lessees who choose  to accept this  valuation and                                                               
royalty switching methodology.                                                                                                  
4:29:18 PM                                                                                                                    
CO-CHAIR WIELECHOWSKI asked if this  is an option they are giving                                                               
to the producers.                                                                                                               
MS.  RUTHERFORD  answered yes.  Because  the  state's leases  are                                                               
contracts, they  cannot impose this upon  them and at the  end of                                                               
the  day  they   can  choose  whether  or  not   they  like  this                                                               
methodology  - valuation  of transportation  costs and  switching                                                               
higher-of - better than their existing contract requirements.                                                                   
4:30:00 PM                                                                                                                    
She said they also established  the value based on public prices.                                                               
The  regulations  propose relying  only  on  published prices  to                                                               
establish  a  destination  value.   These  published  prices  are                                                               
knowable  by  both the  lessee  and  the  state. They  have  also                                                               
recognized  that published  prices  evolve over  time and  expect                                                               
that will continue  in the future years.  The regulations contain                                                               
a  provision  to  insure  that   as  the  publications  or  their                                                               
reliability  change the  regulations can  be amended,  but in  no                                                               
instances  will there  be retroactive  adjustments to  the prices                                                               
once that is established by designated publication.                                                                             
CO-CHAIR WIELECHOWSKI  asked if  these regulations apply  for the                                                               
entire duration  of the  gas pipeline  or do  some of  them apply                                                               
only to the 10 years under AGIA.                                                                                                
MS.  RUTHERFORD  replied that  they  apply  to  the gas  that  is                                                               
committed in  the initial open season  - for the duration  of how                                                               
long that throughput occurs.                                                                                                    
CO-CHAIR  WIELECHOWSKI asked  again  for  clarification if  these                                                               
regulations apply to gas from the initial open season.                                                                          
MS.  RUTHERFORD  said  these regulations  apply  for  the  entire                                                               
duration.  "As long  as that  gas that  qualifies in  the initial                                                               
open  season continues  to flow  through the  AGIA pipeline  then                                                               
they  will have  the  benefit of  these alternative  regulations,                                                               
should they choose them."                                                                                                       
4:31:56 PM                                                                                                                    
SENATOR STEDMAN  asked if a  company answers the  initial binding                                                               
open season and  has a 20-year commitment, is it  normal for them                                                               
to  have extensions  beyond 20  years or  would this  arrangement                                                               
last for 20 years plus any extensions.                                                                                          
MR. SCOTT  said the  regulations would apply  to the  initial 20-                                                               
year  contract  period.  The  open   season  offering  right  now                                                               
contains options for extension. So a  shipper could sign up for a                                                               
20-year  contract  with  a  5-year  option  to  extend,  but  the                                                               
regulations would  apply only to  the 20  years. If they  sign up                                                               
for  a   25-year  contract,  the  regulations   would  apply  for                                                               
valuation for that  25 years. Options to extend  are not included                                                               
within the scope of the valuation regulations.                                                                                  
CO-CHAIR  WIELECHOWSKI   asked  if  they  are   still  trying  to                                                               
encourage producers  to come  in at the  initial open  season and                                                               
bid gas for the duration of the pipeline.                                                                                       
MS. RUTHERFORD replied yes. These  were the inducements that were                                                               
embedded into  AGIA - the tax  inducement on gas and  the royalty                                                               
inducements. These regulations flesh out  what that looks like in                                                               
MR. SCOTT  explained that  it is  fair to  say that  their burden                                                               
isn't that  they want  people to sign  up for  exceptionally long                                                               
contracts, but rather in exchange  for making a commitment in the                                                               
initial  binding open  season they  get some  benefits. Once  the                                                               
project  is launched,  then the  need  for the  state to  provide                                                               
inducements for  extensions is different. It  basically preserves                                                               
some options for the state  to renegotiate whatever deal it wants                                                               
MS. RUTHERFORD  said the assumption  is that the project  will be                                                               
capitalized based  upon that initial  throughput, so  there won't                                                               
be the same  requirements for the state to provide  as much value                                                               
exchange at a later open season.                                                                                                
4:34:38 PM                                                                                                                    
They  tried  to carry  the  principle  of minimizing  retroactive                                                               
adjustments  through and  making  revisions to  the key  concepts                                                               
underlying royalty  value. For example, if  a publication changes                                                               
or if  an appropriate location  or quality  differential changes,                                                               
they don't go back and  recalculate royalty. The regulations have                                                               
a strong  emphasis on identifying forward-looking  values instead                                                               
of retroactive.                                                                                                                 
4:35:17 PM                                                                                                                    
She  said there  is no  way to  identify the  molecules that  are                                                               
moving through the  pipeline in terms of  allocating volumes. So,                                                               
they  have established  pro-rata  allocations  to prevent  either                                                               
party, the  state or the lessees,  from gaming this issue  and to                                                               
ensure that both  are treated fairly. This means that  there is a                                                               
recognition that North Slope qualifying  gas will only be part of                                                               
the total gas  stream that reaches the market. The  value will go                                                               
in  various  directions,  and rather  than  attempting  to  trace                                                               
molecules which is impossible or  worse, have the state really do                                                               
what  it  is  currently  doing -  determine  that  one  company's                                                               
marketing strategy is better than  another's, they have landed on                                                               
a policy  where on a pro  rata basis an individual's  quantity of                                                               
gas is proportionately  spread across all the  markets they might                                                               
utilize.  This is  only for  the purposes  of royalty  valuation.                                                               
These rules  are very clear and  minimize the scope of  dispute -                                                               
hopefully limiting litigation going forward.                                                                                    
SENATOR FRENCH asked how they do that if gas goes to tidewater.                                                                 
MS.  RUTHERFORD  said  they  are  not  speaking  here  about  LNG                                                               
valuation  and have  given  themselves  a bye  in  it within  the                                                               
regulations because  there aren't any clear  market indicators to                                                               
use at this time.                                                                                                               
MR.  SCOTT  added  that today  some  trade  publications  publish                                                               
prices that give  some indication, but nothing  reliable that are                                                               
indicative  of LNG  values landed  in Japan.  The market  for LNG                                                               
isn't  as mature  as the  North American  market. But  that said,                                                               
they didn't  completely throw  up their hands.  If there  were an                                                               
LNG cargo shipped today that went  to Japan they have an approach                                                               
for valuation, but  it doesn't honor all of  the same principles.                                                               
They wouldn't rely on industry  trade publications, for instance.                                                               
They will if they can, but it  will depend on where the gas goes.                                                               
If the  cargo goes  to Baja,  they could  establish value  on the                                                               
basis of reliable trade publications  in Southern California with                                                               
an appropriate location  differential. If the cargo  was going to                                                               
Japan they  would have to  do something different.  Provisions in                                                               
the regulations address that.                                                                                                   
4:39:10 PM                                                                                                                    
SENATOR STEDMAN  said the  state loses  flexibility after  May 1,                                                               
the date  of the initial  open season. Assuming someone  comes in                                                               
and  fully subscribes  to a  project that  takes it  to tidewater                                                               
with the intent  of LNG exports to China or  somewhere that could                                                               
handle the  capacity (Baja is  not one  of them), and  asked what                                                               
position is  the state in after  May 1 to deal  in the regulatory                                                               
environment with the flexibility restrictions.                                                                                  
MR.   SCOTT  answered   that   statute   provides  for   changing                                                               
regulations  subject  to  market  conditions  to  achieving  fair                                                               
market  value.  In  fact  the  statute  actually  says  that  the                                                               
commissioner has  an obligation to revisit  the regulations every                                                               
two years  to ensure that  they are achieving fair  market value.                                                               
So, a  lessee who intended to  ship their gas to  China would not                                                               
have the  same degree of flanged  up clarity in terms  of how the                                                               
state would approach their problem,  because it's not mature yet.                                                               
If  it were  going to  China, they  would probably  eliminate the                                                               
"higher-of"  but they  would base  royalty on  their arms  length                                                               
sales in China. So there would  be one measure of value under the                                                               
lease  and it  would be  their arms  length sales,  because there                                                               
aren't  widely available  industry trade  publications. If  those                                                               
evolve and they  were able to get there then  they would have the                                                               
opportunity no less than every two years to address that.                                                                       
4:41:36 PM                                                                                                                    
SENATOR STEDMAN asked for a 30-second  blast on where they are in                                                               
the  regulations  dealing  with  a large  export  possibility.  A                                                               
couple  of years  ago it  seemed  rather unlikely,  but today  it                                                               
seems less unlikely.                                                                                                            
MS. RUTHERFORD  replied that the  regulations provide  for either                                                               
option  equally. Should  the project  move  to an  LNG line  into                                                               
Valdez, one  alternative in the  AGIA licensee  project proposal,                                                               
then  the regulations  have adequate  coverage to  allow them  to                                                               
value  the royalties  during the  two years  that will  begin the                                                               
process  of establishing  a viable  market to  whatever locations                                                               
they  take the  gas.  And  the state  has  the responsibility  to                                                               
determine  whether their  regulations are  capturing fair  market                                                               
value  every two  years. She  said the  Canadian market  has more                                                               
data available to  use for valuation, but  either alternative can                                                               
be accommodated through the regulations.                                                                                        
MR.  SCOTT added  that a  number  of aspects  of the  regulations                                                               
apply  equally  to   both  -  in  terms   of  how  transportation                                                               
deductions and unused capacity commitments  are handled, how non-                                                               
arms length costs of various  plants - and either liquifaction or                                                               
re-gas  facilities if  those are  owned  within the  chain -  are                                                               
handled. The destination  value piece is a little  harder for LNG                                                               
in   terms   of   widely  available   reliable   industry   trade                                                               
publications, but  other than  that piece  they are  "pretty well                                                               
flanged up."                                                                                                                    
4:44:36 PM                                                                                                                    
SENATOR  HUGGINS  recalled  they  have "watered  down"  the  term                                                               
"maximize the  benefit of  the resources" in  AGIA by  adding the                                                               
term "reasonably" and  it appears to him that this  is one of the                                                               
reasons. It  is an interesting  concept if  constitutionally they                                                               
are   supposed   to   "maximize"  but   now   we're   "reasonably                                                               
maximizing," which lowers the value.                                                                                            
MR. SCOTT said  he didn't recall language  around "maximize," but                                                               
there  certainly   is  language   around  "reasonable   share  of                                                               
transportation deduction."                                                                                                      
SENATOR HUGGINS commented that they debated that extensively.                                                                   
MS. RUTHERFORD stated that the  constitution provides to maximize                                                               
consistent  with the  public need,  and  what they  have done  is                                                               
within those parameters,  because they still have  to obtain fair                                                               
market  value. Existing  lease contracts  provide  that when  one                                                               
competitor does better than another  the State of Alaska benefits                                                               
from  that improved  marketing situation  through its  royalties.                                                               
She  didn't think  there was  a constitutional  issue as  long as                                                               
they are still within the fair market parameters.                                                                               
4:46:14 PM                                                                                                                    
She said slide 11 illustrates the  full value under the lease. To                                                               
comply  with AGIA  these regulations  move away  from the  actual                                                               
sales, which  is the current  valuation methodology,  and instead                                                               
they look  to published  prices to  establish value  for distinct                                                               
components of  the gas stream  including the residue gas  and the                                                               
natural   gas  liquids.   The  working   assumption  within   the                                                               
regulations is  that on  average a published  price in  a healthy                                                               
well  functioning  market  will closely  approximate  a  lessee's                                                               
received value in that market.                                                                                                  
She said  they also have no  way of knowing into  which markets a                                                               
lessee will market their gas.  Given that they simply assume that                                                               
on average  "reasonably optimal  decisions" will  be made  by the                                                               
companies, and  that is what  these companies do. She  said there                                                               
are  other  complications beyond  not  being  able to  track  the                                                               
molecules;   for  instance,   they  don't   know  how   long  the                                                               
publications  will be  in  print or  for how  long  they will  be                                                               
reliable. Also,  there gas  value has to  be established  in some                                                               
markets that don't have published  reliable prices and LNG is one                                                               
of those.  Because of  these various  complexities they  tried to                                                               
develop some  mechanisms to  ensure that  the state  doesn't lock                                                               
itself in  to some decisions  today that  may be very  wrong over                                                               
time. They believe that protects both the lessee and the state.                                                                 
4:47:39 PM                                                                                                                    
MS. RUTHERFORD pointed out that  a further clarification in these                                                               
regulations says  there will be  no negative royalty.  This means                                                               
that the  netbacks on gas  components cannot go below  zero. They                                                               
believe this is already the  current status within their contract                                                               
structure, but that is getting  clarified within the regulations.                                                               
It hasn't been  tested on oil, but it is  a point of disagreement                                                               
between the state and some lessees.                                                                                             
SENATOR STEDMAN asked her to amplify on that issue.                                                                             
MS.  RUTHERFORD responded  that basically  they are  saying in  a                                                               
calculation, should  the cost of transportation  should go higher                                                               
than eventually  where their marketing goes,  the state's royalty                                                               
can't go lower than zero.                                                                                                       
SENATOR STEDMAN tried  to clarify further and  said the severance                                                               
or the production sharing arrangement  would be gone, the royalty                                                               
value could go to zero, and that  is as far south as it would go.                                                               
It  can't be  offset by  some other  direction into  oil, because                                                               
that's the only value left.                                                                                                     
MS.  RUTHERFORD replied,  importantly, it  is currently  arguable                                                               
that if  transportation costs exceeded the  valuation received at                                                               
the other  end, the state would  be placed in a  negative royalty                                                               
position  where it  would  actually owe  the  lessees money.  The                                                               
department  does  not believe  the  state's  oil and  gas  leases                                                               
provide for that,  but that has been a question  in some people's                                                               
minds.  So within  this set  of regulations  they are  clarifying                                                               
that zero  is as low  as it can go.   That situation  exists with                                                               
oil  now;  but  arguably  under  oil  where  it  has  never  been                                                               
clarified it could go below zero.                                                                                               
CO-CHAIR WIELECHOWSKI  noted that  these regs don't  address oil,                                                               
and asked if  the state could be in a  position of losing royalty                                                               
value there. Does oil need regs?                                                                                                
MS. RUTHERFORD replied that the  state doesn't have regs in place                                                               
on oil  and it hasn't been  tested. If they got  into a situation                                                               
where the  value of oil  fell significantly, it is  possible that                                                               
someone  might bring  that argument  forward and  take it  to the                                                               
court. But they  do feel the lease contract is  strong enough for                                                               
the state to make its case if that should come up.                                                                              
4:52:05 PM                                                                                                                    
MS. RUTHERFORD  said incorporating gas industry  practices (slide                                                               
11) in determining the cost  of transportation is very difficult.                                                               
For instance,  the original TAPS  tariff dispute raged  for eight                                                               
years  and the  question  of the  transportation methodology  was                                                               
never  settled.   The  intent  within   the  draft  regs   is  to                                                               
incorporate  generally well  established industry  practices. One                                                               
of these  was to use the  FERC methodology to determine  the cost                                                               
of  transportation for  gas pipelines.  They incorporated  FERC's                                                               
approach in  order to be  consistent with how they  will approach                                                               
thinking  about   transportation  and  transportation   costs  in                                                               
marketing the state's North Slope gas.  As well for the main line                                                               
they substantially  relied on the public  offering by TransCanada                                                               
to  establish  a  backstop  for  non-arms  length  transportation                                                               
costs. She said  they are not just relying on  FERC practice, but                                                               
on  industry  commercial practices  as  well  - as  indicated  by                                                               
TransCanada and ExxonMobil's proposal to the FERC.                                                                              
Additionally,   in   crafting   the  regulation   language,   Ms.                                                               
Rutherford said  they used the  Mineral Management  Service (MMS)                                                               
royalty  value regulations  as a  template. All  the North  Slope                                                               
producers are familiar  with the MMS regulations  for their Lower                                                               
48  gas production.  Some  MMS  regs were  modified  in order  to                                                               
comply  with AGIA.  For example,  the MMS  regulations are  built                                                               
around a gross  proceeds measure of value,  whereas AGIA requires                                                               
the   department  to   use   widely   available  industry   trade                                                               
publications.  That   said,  they  have  retained   a  number  of                                                               
approaches to  try to ensure  it is  well understood and  that it                                                               
limits opportunities for dispute.                                                                                               
4:54:12 PM                                                                                                                    
FRED HAGEMEYER,  Black & Veatch  Corporation consultant,  said he                                                               
would talk about five of the key valuation concepts:                                                                            
  1. Destination where gas is valued                                                                                            
  2. Publishing value at destination                                                                                            
  3. Backstop measure of FMV for residue gas                                                                                    
  4. Actual and reasonable transportation and processing costs                                                                  
  5. Appropriate deductions for unused capacity                                                                                 
4:56:24 PM                                                                                                                    
A lessee's gas is valued for  royalty at destination, he said. In                                                               
determining  destination a  lessee's qualified  gas is  generally                                                               
considered to be at destination when it first:                                                                                  
  1. enters a first destination market (defined in regulation)                                                                  
   2. has been sold in a arm's length transactions; or                                                                          
   3. has been processed to extract residue gas and gas plant                                                                   
     product (this gas will have a lot of NGLs so there will be                                                                 
     a lot of processing).                                                                                                      
MR. HAGEMEYER  said the key  around first destination  markets is                                                               
that they  are looking  for is  something the  state can  rely on                                                               
that has a lot of liquidity,  an area where they believe that ANS                                                               
gas is  physically transported,  and where it  can be  bought and                                                               
sold,  there is  processing  and where  they  can find  published                                                               
indices available.  As an  example the  Alberta market,  which is                                                               
referenced often, is clearly a first destination market.                                                                        
4:58:32 PM                                                                                                                    
He said  one of the  things that is  key throughout parts  of the                                                               
regulations is being able to put  on the DNR website elements and                                                               
information prior to  the royalty reporting period  so the lessee                                                               
can value royalty during the  month in question, and locations of                                                               
the first  destination markets is  a key concept. They  will have                                                               
all the  elements to value the  gas even if gas  goes beyond that                                                               
   · The name of the source of the published price for residue                                                                  
    gas, gas plant products at the first destination market                                                                     
   · Appropriate location or quality differentials to establish                                                                 
     FMV with reference to first destination market                                                                             
   · Reasonable gas treatment, processing, or re-gasification                                                                   
     cost allowances.                                                                                                           
5:00:23 PM                                                                                                                    
Alternative  Destination  Value for  residue  gas  (slide 15)  is                                                               
found  using  a  basket  of  published  indices  to  calculate  a                                                               
backstop  fair   market  value  to  published   index  prices  at                                                               
destination   markets   -   published  ahead   of   time.   These                                                               
publications will provide the range  of fair market value in that                                                               
market. A number of market  centers have interconnectivity to ANS                                                               
gas that could go off into  different areas after or before being                                                               
processed. Each  one would have  publications that  would qualify                                                               
under  the criteria  of publication.  A weighted  average of  the                                                               
volume on the basket would be  compared to the price at ACCO (for                                                               
instance)  and a  5-percent buffer  accounts for  month to  month                                                               
fluctuations. The basket  is relied upon only  when the published                                                               
price at a destination market is less than 95 percent.                                                                          
Another  transportation concept  is  around  the non-arms  length                                                               
transportation cost.  A unique thing  about these  regulations is                                                               
that they  have had the luxury  of knowing what has  been offered                                                               
in  the  TransCanada  ExxonMobil  open season  offering  so  they                                                               
suggest  that they  provide a  watermark for  reasonable non-arms                                                               
length  transportation  costs. During  the  process  of the  open                                                               
season they  will see if  a shipper  can negotiate a  better rate                                                               
than can  be calculated from the  basic terms in it  now, and the                                                               
state would take the lower rate.  As a general principle they are                                                               
going    with     FERC-based    methodologies     to    calculate                                                               
"reasonableness,"   even   though    other   pipelines   segments                                                               
particularly  out of  the Alaska/Canada  main pipeline  will have                                                               
cost deductions.                                                                                                                
5:03:18 PM                                                                                                                    
The  last point  he  wanted to  make about  something  that is  a                                                               
reasonable and  actual cost has  to do with processing  costs and                                                               
in  this case  they have  used the  template of  what the  MMS is                                                               
allowing; typically those plants are not regulated.                                                                             
5:04:38 PM                                                                                                                    
MR. HAGEMEYER said  the last major bullet in this  area is around                                                               
unused transportation  capacity which is designed  to balance the                                                               
need and mitigate the producers'  risk associated with taking out                                                               
that capacity as  well as help protect the  state from unintended                                                               
costs associated  with that. A  detailed example of how  it would                                                               
work was on slide 18.                                                                                                           
5:08:05 PM                                                                                                                    
MR.  HAGEMEYER went  to slide  19 on  the royalty  in kind  (RIK)                                                               
royalty in value  (RIV) switching issue. He  explained that under                                                               
the  lease, the  state  has the  option of  taking  its share  of                                                               
royalty either in RIK or RIV. This  can in the case of taking out                                                               
firm capacity (FT) in the open  season create a risk for shippers                                                               
along the lines of if the state  takes its RIK during a period of                                                               
time  when  the  shippers  may  have  excess  capacity  and  that                                                               
capacity could be fairly expensive  (for the shipper). But if the                                                               
state were in RIK for a period  of time and wanted to switch back                                                               
to RIV  and now the timing  is fairly short (maybe  90 days) then                                                               
the shipper may not have capacity  to take that back in, and they                                                               
would have  to acquire capacity  somewhere or do  something else.                                                               
In addition, producer marketers will  put elements in place, some                                                               
short term  some long term, over  the course of the  volumes they                                                               
are moving (no matter which market  it may be); so there needs to                                                               
be some  time to adjust those  volumes if the royalty  portion is                                                               
not there.  Given that, they have  tried to work through  ways of                                                               
mitigating that risk while protecting the state.                                                                                
SENATOR WAGONER  said he thought if  the state would take  RIK it                                                               
would be for  a specific length of time and  a specific amount by                                                               
MR. HAGEMERYER  replied it can  do that,  but it is  not required                                                               
right now according to the lease.                                                                                               
SENATOR WAGONER  stated that it's  at the state's option  not the                                                               
producers' then.                                                                                                                
5:09:02 PM                                                                                                                    
MR. HAGEMEYER said  in switching from RIV to  RIK, the regulation                                                               
is set up  so that the state would be  obligated to seek capacity                                                               
corresponding to  the state's RIK  share from the producers  in a                                                               
prearranged deal.  This means the  state would take  the released                                                               
capacity  that they  acquired at  original contract  rate and  in                                                               
doing that,  the state  risks foregoing  a potential  better deal                                                               
that  could be  negotiated. The  state would  be taking  capacity                                                               
from the  shipper sort  of like  the capacity  is going  with the                                                               
gas.  If the  gas went  to  the state  the capacity  goes to  the                                                               
state,  too;  if  capacity  is  switched from  RIK  to  RIV  that                                                               
capacity goes  to the producer.  They felt it was  reasonable for                                                               
both sides to  do this, and he mentioned both  sides wanted it to                                                               
SENATOR WAGONER  asked what if  the producer in the  meantime has                                                               
filled that capacity with other gas.                                                                                            
MR. HAGEMEYER  responded that when  a shipper takes  capacity and                                                               
that capacity is  released to another party, it  goes through the                                                               
carrier to  the third  party. So  now the  state would  have that                                                               
capacity. The producer  doesn't have the capacity  to refill, but                                                               
it  doesn't mean  they  can't acquire  other  capacity for  other                                                               
5:11:45 PM                                                                                                                    
One  of the  tools  to do  this  is having  a  contract rate,  so                                                               
whatever rate  they have is  what is transferred over.  The state                                                               
requested a  waiver from  FERC in November  (approved by  FERC in                                                               
January) that  essentially allows for  this transfer to  occur at                                                               
that contract  rate. The regulations  increase the  notice period                                                               
trying to allow  more time to arrange  other marketing situations                                                               
for that  royalty gas  that may  be taken.  If it's  over 200,000                                                               
Mmbtu/day it would be 180 days notice.                                                                                          
5:12:38 PM                                                                                                                    
DEEPA PODUVAL,  Black &  Veatch consultant,  said she  would walk                                                               
the  committee estimates  of what  quantitative values  are being                                                               
provided  to the  producers through  these proposed  AGIA royalty                                                               
regulations (slide 21).                                                                                                         
She said one of the aims  of the regulations was to provide value                                                               
to the producers while protecting  the state's interest. In going                                                               
through  the process  of developing  the regulations  one of  the                                                               
exercises  they  did  was  to  find  how  much  value  was  being                                                               
transferred in  some of the  key provisions; they looked  at four                                                               
main provisions:                                                                                                                
   · Valuation - moving away from the higher-of provision                                                                       
   · Transportation - adopting a FERC-like approach for non-arms                                                                
     length transportation deductions rather than the MMS-like                                                                  
     approach, and allowing deductions for unused capacity                                                                      
   · RIK/RIV switching - FERC waiver allows capacity transfer                                                                   
     deal at contract rates                                                                                                     
5:15:19 PM                                                                                                                    
MS.  PODUVAL  said  one  of   the  challenges  in  quantitatively                                                               
analyzing the value to the  producers is the level of uncertainty                                                               
about certain  factors that influence the  project going forward:                                                               
prices, project  costs, volumes that  may be found,  reserves and                                                               
uncertainties  related  to  RIK/RIV  switching.  So  rather  than                                                               
attempting to create  base line assumptions on how  some of these                                                               
uncertainties  may evolve  they  made  aggressive assumptions  to                                                               
establish an upper bound on what  the value to producers could be                                                               
(slide 22). In other words they  looked for the highest value the                                                               
producers could  get, but the  actual value they would  get would                                                               
be something lower  than that depending on  how the uncertainties                                                               
evolved. Some of the assumptions they made were:                                                                                
   · Methane valuation - Assumed impact of moving away from the                                                                 
     higher-of provision is not offset by market basket concept.                                                                
   · Transportation deduction for non-arm's length transactions                                                                 
     Assumed that alternative was MMS methodology.                                                                              
     Two  key  provisions  were related  to  MMS  that  were                                                                    
     different  in the  proposed regulations.  The first  is                                                                    
     that MMS  does not  recognize taxes as  a valid  way of                                                                    
     determining  cost when  creating  the  cost of  service                                                                    
     methodology and  second that the return  on equity that                                                                    
     MMS allows  on pipeline is calculated  taking 1.3 times                                                                    
     the Bbb bond rating.  The proposed regulations allow 12                                                                    
       percent. Based on recent data the MMS methodology                                                                        
     would allow a little less than 7 percent.                                                                                  
   · Unused capacity deductions - they assumed a worst case                                                                     
     scenario where the only gas  that flows through the pipeline                                                               
     are  from the  proven reserves,  essentially no  yet-to-find                                                               
     gas  is found,  and  so  there is  a  significant amount  of                                                               
     unused capacity on  the pipeline and the state  does not pay                                                               
     for any  of it. Essentially  the producers bear  100 percent                                                               
     of the  cost of commitments  they have made related  to that                                                               
5:18:46 PM                                                                                                                    
   · RIKRIV switching - Assumed that the state takes its entire                                                                 
     royalty volume  in-kind for the entire  25-year period. They                                                               
     further assumed  that the producers  are unable to  take any                                                               
     mitigating actions to  offset the cost of  the capacity they                                                               
     are now  stuck with (they  don't try  to acquire gas  from a                                                               
     third party to flow through that capacity).                                                                                
  · They looked at what the value to the producers is from the                                                                  
     1980 royalty settlement agreement (slide 23).                                                                              
5:19:57 PM                                                                                                                    
She estimated  the quantitative  value from  different provisions                                                               
that could potentially  be given to the producers as  a result of                                                               
the proposed regulations. The biggest  contributor comes from the                                                               
FERC waiver that  mitigates the capacity risk  that the producers                                                               
have from  the state's option  of switching between RIK  and RIV.                                                               
It can range anywhere from zero  dollars if the state never takes                                                               
RIK to  up to $17 billion  if the state  takes all of its  gas in                                                               
RIK and the  producers are unable to offset  their capacity costs                                                               
in  any  way. The  second  largest  component  is from  the  1980                                                               
royalty  settlement agreement  where  three different  components                                                               
were considered:  field cost allowances, GTP  cost allowances and                                                               
the central  compression plant allowance.  That amounts  to about                                                               
$6 billion of value for the producers.                                                                                          
MS.  PODUVAL  said  the  unused  capacity  is  the  next  biggest                                                               
contributor of  value to the producers.  It is a range  from zero                                                               
if there isn't  any unused capacity and yet-to-find  gas is found                                                               
and keeps the  pipeline full to the other extreme;  if no yet-to-                                                               
find  gas is  found and  there  is significant  amount of  unused                                                               
capacity  on the  pipeline  this could  be worth  as  much as  $3                                                               
billion to the producers.                                                                                                       
Transportation   deductions,  the   proposed   cost  of   service                                                               
methodology  related  to  non-arms length  transactions  provides                                                               
about $2.8  billion of value  to the producers. This  is relative                                                               
to a  benchmark where  the state could  have adopted  an MMS-like                                                               
methodology that  is used for  federal royalty purposes  and been                                                               
much less generous  in what cost components are  included as well                                                               
as what is allowed for return on equity.                                                                                        
The last value  component is from moving away  from the higher-of                                                               
provisions and  is a range  of zero up  to $1.4 billion.  The low                                                               
end is theoretically  possible if all the producers  get the same                                                               
value  in each  market  and  the state  wouldn't  be making  that                                                               
higher-of comparison.                                                                                                           
In   conclusion,   Ms.   Poduval   said   significant   potential                                                               
quantitative value is provided to  the producers from the various                                                               
provisions of  the proposed  AGIA royalty  regulations and  it is                                                               
good  to keep  in mind  that  they would  be in  addition to  the                                                               
qualitative  benefits of  improving  their certainty  as well  as                                                               
5:23:21 PM                                                                                                                    
CO-CHAIR WIELECHOWSKI asked if these  values were calculated over                                                               
the course of the pipeline.                                                                                                     
MS. PODUVAL said it is dollars of the day over a 25-year period.                                                                
5:24:24 PM                                                                                                                    
CO-CHAIR WIELECHOWSKI said this is  an important slide that shows                                                               
some pretty  significant sweeteners being added  to encourage the                                                               
producers to have  an open season. He calculated  $8.8 billion to                                                               
$21.4 billion of  incentives. He thanked everyone  for their work                                                               
on this issue and adjourned the meeting at 5:24 p.m.                                                                            

Document Name Date/Time Subjects
GRETC-Senate Resources slides 3-17-10 (2).pdf SRES 3/17/2010 3:30:00 PM
SRES DNR AGIA Final - 03-17-10.pdf SRES 3/17/2010 3:30:00 PM