Legislature(2007 - 2008)BUTROVICH 205
02/12/2007 03:30 PM Senate RESOURCES
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| Overview: Cook Inlet Marketing Analysis by Division of Oil and Gas, Department of Natural Resources | |
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ALASKA STATE LEGISLATURE
SENATE RESOURCES STANDING COMMITTEE
February 12, 2007
3:34 p.m.
MEMBERS PRESENT
Senator Charlie Huggins, Chair
Senator Bert Stedman, Vice Chair
Senator Lyda Green
Senator Gary Stevens
Senator Bill Wielechowski
Senator Thomas Wagoner
MEMBERS ABSENT
Senator Lesil McGuire
COMMITTEE CALENDAR
Presentation: Market Analysis of Cook Inlet Gas
Division of Oil and Gas
Department of Natural Resources (DNR)
PREVIOUS COMMITTEE ACTION
No previous action to report.
WITNESS REGISTER
KEVIN BANKS, Acting Director
Division of Oil and Gas
Department of Natural Resources (DNR)
Anchorage, AK
POSITION STATEMENT: Presented market analysis of Cook Inlet Gas.
WILL NEBESKY, Commercial Analyst
Division of Oil and Gas
Department of Natural Resources (DNR)
Anchorage, AK
POSITION STATEMENT: Discussed the price of Cook Inlet gas.
ACTION NARRATIVE
CHAIR CHARLIE HUGGINS called the Senate Resources Standing
Committee meeting to order at 3:34:18 PM. Senators Wagoner,
Wielechowski, Stedman, Stevens, Green, and Huggins were present
at the call to order.
^Overview: Cook Inlet Marketing Analysis by Division of Oil and
Gas, Department of Natural Resources
CHAIR HUGGINS noted the committee's focus on Cook Inlet.
KEVIN BANKS, Acting Director, Division of Oil and Gas,
Department of Natural Resources (DNR), said there are concerns
about gas price, the viability of the Agrium fertilizer
business, and the extension of the LNG [liquefied natural gas]
export license beyond 2009. He speculated that if none of these
were a problem, he would not now be speaking to the committee.
The current marketplace is represented by the image of a funnel
feeding into a small tube: you can only force so much gas into
the marketplace at any given time because it is driven by how
much consumption can occur. The response to that demand is
entirely dependent on the price and the gas producers, he said.
3:38:25 PM
MR. BANKS referred to graph 3 showing a weighted average of the
price of gas paid by the electrical generation utilities. In the
last three to four years, prices have doubled at the wellhead
because many older contracts have terms tied to the price of oil
or to the Henry Hub marker. Increased oil and gas prices in the
lower 48 have driven up the weighted average price, he stated.
3:40:02 PM
MR. BANKS said the Cook Inlet market is following that of the
lower 48, which may be good because lower 48 markets compete for
new investments in Cook Inlet. The high prices are correlated
with new activity in the basin. Residential and commercial
amounts to less than one third of Cook Inlet gas usage, and two
thirds goes to industrial users, which include the LNG plant and
the fertilizer plant. The two industries are uniform consumers,
he explained, and were initially established by the gas
producers in order to monetize their reserves. The LNG plant is
still operated by ConocoPhillips and Marathon. Unocal built the
fertilizer plant and subsequently sold it to Agrium. Until
recently these users have provided the sole means of
backstopping peak demand days for the commercial and residential
users. On cold days, Agrium and LNG have redirected their gas to
Enstar to supply gas for heat.
3:42:38 PM
MR. BANKS said graph 5 shows daily gas demand. When it is cold,
the demand for gas goes up. Most of the contracts with the
utilities have incorporated full deliverability. The suppliers
have promised to deliver all the gas Enstar will need on a given
day, and embedded in the price is that service, he said. A
recent pricing mechanism tried to separate that out. There may
be more distinct peak load prices as time goes on.
MR. BANKS noted that today's proved, developed, and producing
reserves of gas are about 1.65 trillion cubic feet (tcf). This
is DNR's estimate of the amount of gas that is available from
existing fields without anymore investment, including drilling
or compression.
3:45:01 PM
MR. BANKS said that is about an eight-year supply of gas at
today's consumption rates, which is consistent with gas reserves
in the lower 48. "Yet to find gas represents undiscovered
gas…places where gas is not going to be found in stratigraphic
plays." Several gas fields are very small and a few are very
large, and there is a large gap in fields that are 200 to 500
billion cubic feet (bcf) in size, he explained. This suggests
that there is potential for very large new sources of
undiscovered gas that could come on line given the price and
consumption, and that gets back to the large funnel filling a
small tube, he said. It might be fairly easy to bring a 10-30
bcf field on line today and be able to squeeze the gas into the
market, but if 200-500 bcf are found, there will be gas that
sits in the funnel unless there are new marketing options.
3:47:34 PM
MR. BANKS spoke of when Unocal, ConocoPhillips, and Marathon had
to find and invent a new use for gas to keep it from being
stranded. Finding a half tcf of gas may be like drilling a dry
hole, he warned. In the Lower 48, gas from existing fields is
dropping similarly to Cook Inlet. He showed a graph of how
future gas supplies will require a lot of investment in new
conventional fields-"just plain looking through the geology,
finding prospects, and drilling them in areas where you have not
drilled before." And a portion of new gas in the lower 48 will
need to come from nonconventional fields-"this is tight gas and
coalbed methane mostly." He noted that the market place has
thousands of gas fields and tens of thousands of wells, so it is
a very liquid market with lots of producers and lots of buyers,
unlike Cook Inlet.
3:49:49 PM
MR. BANKS said graph 8, entitled Cook Inlet Historic and
Forecast Gas Production, 1958-2025, represents the cliff that
everyone worries about. In order to keep a steady supply,
something must happen, he stated. There will have to be
investment in existing fields, but drawing on gas from existing
fields has the potential consequence of watering out the well.
There could also be new discoveries. And, lastly, gas has to
come from unconventional sources like coalbed methane, a spur
from the North Slope, or imports of LNG.
MR. BANKS said the supply will depend on how the market responds
to the price today and whether or not, in five to ten years,
that market response will be demonstrated in new gas, he opined.
So far there has been a market response to rising prices (table
9). The graph assumes the offering of every available acre of
state land for oil and gas leasing each year "on a fairly
routine and regular basis so companies are able to evaluate the
land before they make their bids and have an opportunity to know
that in a predictable way that if they miss the bid this time,
they'll have another year hence to try again." The tracts sold
and the bids per acre have gone up, he added. The high bids have
been pretty good, and he referred to the appendix, page 16,
showing a bid of $45 per acre. There is a lot more competition
for the lease sales, he noted. Graph 10 shows that something is
happening in response to the increase in prices and a potential
for a new market: "a place in the market for new gas." Since
2000, there has been almost a doubling of exploration in Cook
Inlet, and 80 percent of the wells have been looking for gas.
3:54:35 PM
MR. BANKS said gas storage is another feature that is changing
in the gas marketplace, and it relates to seasonality, peak
demand, and deliverability. The producers have stepped up to the
plate, he noted, to manage deliverability in a way that they
haven't in the past. With huge gas fields, like Kenai and
Beluga, "where there was a lot of gas available by just opening
the valve and adding some more compression," now there is a
requirement to store gas in the summer for use in the winter.
There are four storage facilities, and two are on state land and
one is on federal land. There are operational challenges because
when gas goes into an exhausted gas field it is not all
recoverable. Some of the gas may fall into solution into oil, or
"watering out" may occur.
3:56:35 PM
CHAIR HUGGINS asked what percentage of gas gets lost.
MR. BANKS said he would find out. Graph 12 represents a "fairly
serious peak-day event" in 1999, and the amount of gas coming
out of the east side of Cook Inlet was about 183 million cubic
feet (mcf). The graph shows that it has dropped by about one
third, he explained. On the Kenai Peninsula in 1999, the gas
drawn was about 89 mcf, and it has now almost doubled. The other
factor, he said, was that in those days there was no storage.
The graph shows a storage draw of 55 mcf from the Swanson River
and Kenai gas fields, and it shows a storage draw of 8 mcf from
Pretty Creek. "So those storage facilities are actually
providing a service today…and supplying gas on those peak cold
days to make sure that consumers in the Enstar system are
getting the gas that they need." More of the gas is coming from
the east side of Cook Inlet now, he said, instead of the west
side like it was in the late 1990s. Enstar is making investments
to ensure that "the plumbing will facilitate that kind of
movement of that kind of production…into the Anchorage area."
3:59:23 PM
CHAIR HUGGINS asked about the location of Pretty Creek.
MR. BANKS said Pretty Creek is on the west side. He noted that
53 mcf of gas was drawn out of KKPL (Kenai Kachemak
Pipeline), which represents the consequence of new developments
on the east side of Cook Inlet. "We are seeing production from
places that hadn't been producing before," he noted. About 35
mcf of gas was diverted from the LNG plant during the event on
January 9, into the local market. That is the importance of
having industrial users on the system, he stated.
4:00:36 PM
MR. BANKS said the concerns about high prices are a fact of
life, because Alaska is competing for investments with the lower
48, where the price is high. The Agrium plant is shut down for
the winter, and 40 bcf of gas a year was being used by it. He
estimates that is will be down to 30 bcf because of the winter
shutdown. "So, demand [for gas] is falling off a little bit
because the industrial use is falling off and the
unavailability, basically, of a base-load supply for Agrium at
an economical price for them. Hence, their blue sky project
where they will try to develop coal gas as an alternative." He
said Alaska is faced with the question of how to respond to
ConocoPhillips and Marathon's application to extend the export
license through 2011.
4:02:00 PM
SENATOR STEDMAN asked about graph 6 showing the ratio of proved-
developed-producing reserves to production. He asked when the
number might become small enough to stimulate exploration versus
no interest when there is no market.
MR. BANKS noted the relationship of the table on page 6 with the
graph on page 10, which shows the number of wells that have been
drilled. In 1995 there was a growth in exploration, suggesting
that when the markets got close to an "R/P [Reserves/Production]
of 10 years, that the producers began searching for more gas."
The dramatic increase in price is having an effect. "It looks
like people want to start doing something in a hurry just
somewhere north of an R/P of 10 years."
4:04:06 PM
SENATOR STEDMAN asked if the access to credits from the PPT
[profits-based petroleum production tax of 2006] will stimulate
exploration in Cook Inlet.
MR. BANKS said access to credits will be important to Cook
Inlet. He said there are already several incentives that have
been offered to the producers there.
SENATOR WAGONER said there are other drilling incentives as
well, and Marathon is taking advantage of them.
4:04:55 PM
MR. BANKS said the PPT allows for deducting expenses not only
for exploration, so the PPT will be valuable to existing players
in Cook Inlet.
SENATOR STEDMAN asked if there is enough gas out there for the
industry to either find or produce. He asked if the bullet line
and the LNG are red herrings.
4:05:58 PM
MR. BANKS said if he were exploring he would be trying to figure
out how much those alternatives would cost the consumer and what
the competition would charge for gas and use that as an estimate
of his own economics. He surmised that the exploration in Cook
Inlet is fraught with a lot less headaches than the other two
alternatives, which are expensive alternatives, as well. "I
believe we have some cushion between what we see as today's
prices in the Cook Inlet and what the cost of those sources of
gas would be, and so if I can deliver gas for less than I think
a bullet line. I would start searching for gas in the Cook Inlet
to compete with it."
SENATOR WIELECHOWSKI noted the estimated 1.8 tcf of undiscovered
gas and asked if the correct analysis is to compare the cost of
finding and bringing it to market to the cost of building a
bullet line or spur line.
4:07:42 PM
MR. BANKS said it has to do with the expectation of price and
probability that the price would be yielded. Every explorer is
looking at the odds of finding gas and the probabilities of the
alternatives.
SENATOR WIELECHOWSKI asked for a rough estimate of drilling and
exploring versus the cost of a spur line from Glennallen.
MR. BANKS said he hasn't done that estimation.
CHAIR HUGGINS said there have been 320 holes drilled in Cook
Inlet, and that is a small number compared to like-size areas in
the lower 48. Should the state have a strategy to find someone
to "drill holes," because the gas is "out there and all we gotta
do is drill for it?" Last year the administration looked at
putting incentives on the table for Cook Inlet, he noted.
4:09:50 PM
MR. BANKS said more incentives are possibly needed. There is
also more information, "if more explorationists could have a
handle on that." But he is not sure what the state can do in
encouraging commercial arrangements among those incumbents who
have that data and those newcomers who need the data. He said he
would like to examine that to "see if there is some way to
leverage more data into the hands of those who are eager to
spend some money to find gas."
CHAIR HUGGINS asked if he will start working on that.
MR. BANKS said it will be one of his goals.
4:10:54 PM
CHAIR HUGGINS said storage has merit, and he asked if it is
based on industry initiative or if Alaska has a strategy to
promote it.
MR. BANKS said it is an alternative the producers have
entertained because it offers an alternative to more risky
investments in their own existing fields to improve
deliverability. Given the choice of expanding the deliverability
from existing fields or storing gas, storage is cheaper. It is a
natural consequence of the marketplace. The storage issue is
somewhat exciting because in every other market in the lower 48,
storage has a very important function, and it exists at both
ends of the market, he said. There is storage near the producing
regions and at the market place for peak demand days. Storage in
Cook Inlet has the same economical use, and it could facilitate
gas from a spur or bullet line.
4:12:51 PM
MR. BANKS said the LNG facility plays a similar function. The
Nikiski tanks could supply storage for future peak-day use.
SENATOR WIELECHOWSKI asked about state revenue from the Agrium
and LNG plants, and what they pay for gas in comparison to what
Southcentral consumers pay.
4:13:48 PM
WILL NEBESKY, Commercial Analyst, Division of Oil and Gas, DNR,
said page 35 in the packet shows the proceeds that the
fertilizer plant realizes from the sale of its product into its
market. The royalty value used to be tied to those fertilizer
prices but not since Agrium's purchase of the fertilizer plant.
He said he can tabulate the revenues from royalty dispositions
of gas to the fertilizer plant, and "they do tend to be, today,
at the lower end of the royalty revenue spectrum from the
standpoint of proceeds per unit of royalty gas disposition." He
noted the graph on page 33, illustrating the values received for
LNG disposition in Japan and compares them with the Henry Hub
spot price as well as the Department of Revenue's published
prevailing value. The line shows the destination value that was
received for LNG disposition and is not the same as Alaska's
royalty value. "Our royalty proceeds, in an important way, are
tied to the destination value, but we have different settlement
agreements with Marathon as well as with ConocoPhillips
regarding the royalty proceeds tied to their dispositions that
end up being LNG exports."
4:17:18 PM
MR. NEBESKY said the blue line that represents the Department of
Revenue prevailing value is very close to the weighted average
royalty value that the state receives for its combined royalty
proceeds from all the dispositions-both industrial and non-
industrial. He said he could compare the proceeds received from
industrial and non-industrial dispositions.
4:18:06 PM
SENATOR WIELECHOWSKI asked about the difference in gas price for
consumers and industrial users.
MR. NEBESKY said consumers are paying about $6 per mcf through
the Enstar system, and that is pretty close to the Department of
Energy estimate of prevailing value. "Those values probably are
in the neighborhood of, for example, the royalty value that the
state receives for LNG disposition." It varies, but today is
"closely matched with the netback value or royalty value
estimate for LNG disposition."
SENATOR WIELECHOWSKI said he is asking what ConocoPhillips pays
when buying LNG compared to what Enstar consumers pay.
4:19:55 PM
MR. BANKS rephrased the Senator's question. "What is the
wholesale price of natural gas when it's produced by Marathon
and by ConocoPhillips that is destined for LNG and eventually
sent to Japan?" The answer is difficult because the value Alaska
receives for royalty is determined by a royalty settlement
agreement that is many years old. It was intended to reflect
some measure of the value of gas when sold in Japan, minus the
cost of getting it there and transforming it into LNG and netted
back to the wellhead. ConocoPhillips' North Cook Inlet gas is
valued at about half of the price it receives for gas sold in
Japan, minus $0.10. It represents the best indicator for the net
back price for the LNG. He said that is about what the wholesale
price is for consumers. Agrium is paying less than consumers, on
average, and that is the reason that it can exist. It doesn't
have a peak demand, he said. The acquisition of gas at an
economical price is a problem for Agrium and why it shut down
this winter.
4:22:16 PM
CHAIR HUGGINS asked about methane in Alaska.
MR. BANKS said it represents a very widespread source of gas
throughout rural Alaska because coal and coalbed methane can be
found in a lot of places. The Red Dog mine has a license to
develop it. There is potential in Healy, but it is put on hold.
In the Mat-Su Valley, development was attempted in an Alaska
version of a residential area. The possibility could have been
achieved had the residents been more receptive. There are other
areas in the Cook Inlet that may contain sources of coalbed
methane, but the most inexpensive sources are near the road
system in the Mat-Su Valley, he opined.
4:24:23 PM
CHAIR HUGGINS said Harold Heinz said a spur line is important.
Enstar needs a continuous supply of gas. There is always a spike
in known reserves during an LNG application. He asked Mr. Banks
what Alaska should do to understand its natural gas destiny.
4:25:36 PM
MR. BANKS said Alaska needs to move gas from existing field
reserves into the "proved-developed-producing category, and we
need to find new gas in the Cook Inlet." The marketplace is
tightly balanced, but the market will respond to a growth in
demand and to rising prices as the supply tightens. Alaska needs
to make land and access available when pursuing plans of
development and exploration with its lessees and unitize these
prospects. He added that Alaska needs good, solid commitments
from its lessees to complete the work they say they would like
to do. Alaska formed three units last January that will require
a jack-up rig, and Mr. Banks hopes "that these lessees will
cooperate and bring in the equipment they need to start drilling
these prospects and do so very soon." If they fail to do that,
"we'll find explorers that will." He said he doesn't know how
the PPT will play out. Marathon has responded to the exploration
credits, he noted. There are several existing fields that are
known deposits of gas that have not yet been developed that
received a 5 percent royalty provision several years ago, and
some of that is now coming on line as a result of that. He said
those incentives work, and "we need to continue exploring the
efficacy of those kinds of credits and tax benefits."
4:28:17 PM
SENATOR WAGONER said Marathon was using credits that are
different from the PPT credits.
CHAIR HUGGINS asked the life of those credits.
SENATOR WAGONER said another 9 or 10 years.
CHAIR HUGGINS asked for a prediction from 2005 to 2015.
MR. BANKS said he predicts a lot more exploration in response to
the higher prices. He said there were about eight or nine wells
drilled per year and then less in the past two years. He thinks
it will increase. There are new players that are very active and
interested in putting together a land position to begin
drilling. He noted that Forest [Oil Corporation] has just
acquired a unit that was recently approved, but Forest's
position as the operator may be in question as it shifts assets.
But if it does sell, "let's hope that they find a customer who's
going to be eager to use that land." He said it will have to
meet the commitment to develop or explore the unit. Escopeta has
a unit that needs a jack-up rig, and once the rig arrives and if
it is sized right and others can use it, it may be here for
awhile, he said.
4:31:17 PM
CHAIR HUGGINS asked about the status of the beluga whale.
MR. BANKS said some tracts have been deferred because of "those
kinds of sensitivities." A listing of the Cook Inlet beluga
whale [under the Endangered Species Act] could have a future
impact on what areas will be open to oil and gas activities.
SENATOR WIELECHOWSKI asked if there are other uses besides
Agrium and LNG that Alaska could put more effort into. Is there
another demand or is the gas essentially stranded in Cook Inlet?
4:32:36 PM
MR. BANKS said being stranded was a more serious problem than it
is now. "You don't see R/P ratios of 20 years anymore, and we're
down to something more like what you'd expect to see in the
lower 48." If someone were to find half a tcf of gas, then
something would happen to expand the demand, he said. There is
room in the Agrium plant; it is running at half capacity when it
is running. There is some potential growth in LNG, but access to
the LNG is limited by the owners of the LNG plant. He noted that
years ago there was talk of iron ore reduction, but all that
demand requires a cheap price for gas. He questioned who would
look for the gas if the price is only going to be $2.00. It is a
chicken and egg problem, he surmised.
4:34:10 PM
CHAIR HUGGINS asked about bids received and tracts deferred.
MR. BANKS said he thinks tracts were deferred for whales, but
only four. In the one area where one could move eastward from
the shoreline, along the Sterling Highway, there is a fair
amount of activity, which should indicate that there is
potential for gas development in the wildlife refuge. The DNR is
beginning discussions with the federal government, he said.
4:36:22 PM
SENATOR WAGONER said Swanson River can be used for gas storage,
but to get that field opened up for gas storage was a
horrendous, several-year process, so it is hard to work with the
Kenai Wildlife Refuge. It was to use existing structures and
wells. It is a major problem to get access to anything out
there, he stated.
4:37:34 PM
CHAIR HUGGINS noted that the Regulatory Commission of Alaska
said there is a lot of the phone activity to keep gas in the
system for Enstar during peak periods. He asked if additional
storage areas should be considered.
4:38:25 PM
MR. BANKS said more storage will be needed, or better use should
be made of the storage available. The Swanson River field has
five times the capacity than is being used. He guessed that a
half of a tcf of gas could go in there. There are operational
challenges in getting the gas to come back out again. The market
and the facilities are at a crucial balance; there are enough
transmission lines, interconnects, and storage. In the very near
future, three to four years, a lot of that has to change. Enstar
will be updating interconnects around Nikiski and Soldotna,
there will be more storage on line, and hopefully more
deliverability out of the existing fields as a consequence of
meeting those requirements.
4:40:14 PM
CHAIR HUGGINS said in 2005 36 percent of the gas was used for
LNG, and during the peak demand periods, that is the reserve
that can be kicked in to make Enstar work.
MR. BANKS said he agrees. The gas that would normally be
consumed by the plant can be diverted to the Enstar system on
cold days--without substantial consequence for the LNG to supply
their contracts. It is an important service, he stated.
SENATOR WAGONER suggested hearing from the plant, because he has
been told that it has shipped LNG containers below capacity.
Every problem that is solved creates another one, he said.
4:41:52 PM
CHAIR HUGGINS said the future of Cook Inlet gas has huge
questions since half the population of the state depends on it.
The Senate Resources Standing Committee adjourned at 4:42:51 PM.
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