HOUSE BILL NO. 194 "An Act approving and ratifying the sale of royalty oil by the State of Alaska to Marathon Petroleum Supply and Trading Company LLC; and providing for an effective date." 2:53:44 PM JOHN CROWTHER, DEPUTY COMMISSIONER, DEPARTMENT OF NATURAL RESOURCES, explained that the bill sought legislative approval for a "royalty in kind" contract, which was how the state disposed its share of royalty oil. It was a longstanding process and resulted in a small premium to the state versus the average value of royalty, supported the state's refineries, and ensured fuel security. He asked for the committee's support for the bill. RYAN FITZPATRICK, COMMERCIAL MANAGER, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES, provided a PowerPoint presentation titled "House Bill 194: Approve Marathon Petro Royalty Oil Sale," dated May 1, 2025 (copy on file). He began on slide 2 titled "What is "Royalty In-Kind": Oil and gas leases issued by the State reserve a "royalty share" to the State a portion of production that the State receives as owner of the resource. The State has the option to take its royalty oil and gas in-value (RIV) or in-kind (RIK). • RIV: Lessees market the royalty oil or gas alongside their own production; the State receives the proceeds from the sale of its royalty oil, subject to fair market value • RIK: Lessees provide royalty oil or gas of sales quality to the State; the State is responsible for marketing its royalty oil or gas. Department of Natural Resources (DNR) has statutory processes for receiving royalty: • Alaska Statute (AS) 38.05.182 requires DNR to make best interest findings for RIV and RIK determinations, and requires the commissioner report annually to the Legislature about these elections • AS 38.05.183 guides DNR in the sales of RIK and requires that contracts meet a number of statutory criteria and, in certain cases, receive legislative approval before being entered into • AS 38.06 establishes the Alaska Royalty Oil and Gas Development Advisory Board, which reviews royalty-in- kind actions by DNR Mr. Fitzpatrick expounded that the state's royalty share ranged from 12.5 percent to approximately 16.7 percent. The state's share was free of production costs but paid transportation costs. The state had the option to take the royalty in two ways as described on the slide. Mr. Fitzpatrick moved to slide 3 titled "Royalty A Core Lease Term." That depicted a snapshot of royalty provisions and the agreement. He turned to slide 4 titled "Sources of North Slope Royalty," which showed an overview map of the North Slope. The shaded units were state oil and gas units where the state received its share of production in royalty-in-kind, which were almost exclusively derived from North Slope leases. 2:58:30 PM Mr. Fitzpatrick turned to slide 5 titled "Royalty In-Kind Contract History • The State has historically selected to receive royalty oil both in-kind and in-value • About 97 percent of the State's royalty oil in-kind selections have been North Slope oil The amount of RIK oil that the State sells varies and depends on many factors: • Alaska North Slope (ANS) oil production from state-owned lands • Royalty rates for State oil and gas leases • State's selection of the fields from which to choose RIK oil • Quantity of crude oil sought by in-state refineries or other potential buyers • Competitiveness of ANS royalty oil versus other sources of crude oil for instate refineries or other potential buyers Mr. Fitzpatrick explained that that the state had taken royalty in-kind since 1980. The slide portrayed a chart containing its historical contract history of in-kind (green) versus in-value royalties (black). He pointed out that the amount of in-kind royalty varied considerably over the years. He reported that historically the barrels were completely marketed, often out-of-state. Recent statutes required the department to support in-state refining creating a preference for in-state refineries or other in- state purchasers before it could be marketed out-of-state. He elaborated that part of DNR's process was to release a public notice on potential royalty sales to gauge market demand. Over the last decade, there were no firm out-of- state contracts for the purchase of royalty oil and over the last two decades the royalty oil was exclusively sold to in-state refiners. 3:00:34 PM Mr. Fitzpatrick continued to discuss slide 6 titled Royalty In-Kind Contract History • Almost all the nearly one billion barrels sold to date have been sold via non-competitive sales • Less than 5 percent has been sold via competitive sales • The large majority of RIK oil sold to date has been to in-state entities, with a few historical cases where RIK oil was sold for export outside of Alaska Mr. Fitzpatrick indicated that the slide also depicted the history of the different royalty in-kind contracts. He noted the several long-term contracts existed for many years. He pointed to the recent Petro Star and Tesoro/Marathon contracts. He briefly discussed slide 7 titled "Processes And Legislative Approval RIK contract development and execution involves several significant steps: • DNR commissioner follows a statutory process to negotiate a proposed sale; then DNR publishes a proposed finding describing the terms and reasons for the sale • DNR must brief the Alaska Royalty Oil and Gas Development Advisory Board (AS 38.06) (Royalty Board) on the proposed sale and receive the Board's review and approval • After receiving public comment on the proposed findings, DNR publishes a final best interest finding AS 38.06.055 requires authorization by the Legislature before a contract can be Executed There are limited exceptions to this process, such contracts to relieve storage or market conditions with a duration of one year or less, and contracts for sales of 400 barrels per day or less. These exceptions do not apply to the Marathon contract now under consideration. Mr. Fitzpatrick emphasized that before the contract was submitted to the legislature for approval, the proposed contract went through an extensive public process. He reported that DNR did not receive any public comment on this contract. Representative Hannan cited the last sentence on the slide regarding the exceptions not applying to the current Marathon contract and asked for clarity. Mr. Fitzpatrick responded that the public process was for sales contracts such as the Marathon sale currently before the committee. He furthered that the department had separate statutory authority in certain contracts and was not required to be submitted to the legislature. The contracts went through public comment and published a best interest finding and were usually for the short-term of one year or less and for contracts considered di minimus, subject to a limited number of barrels or mcf (one thousand cubic feet) of gas per day. 3:04:50 PM Mr. Fitzpatrick examined slide 8 titled "Royalty Board Review:" AS 38.06.050 requires the Alaska Royalty Oil and Gas Development Advisory Board: • To provide a written recommendation of the board on the proposed sale, submitted to the Legislature at the time a bill approving the proposed sale is introduced, and • To provide a report on the criteria used to evaluate the proposed sale. Mr. Fitzpatrick indicated that the slide also depicted portions of the board's resolution and report to the legislature. He turned to slide 9 titled "Royalty Board Review Criteria:" Sec. 38.06.070. Criteria. (a) In the exercise of its powers under AS 38.06.040(a) and 38.06.050 the board shall consider (1) the revenue needs and projected fiscal condition of the state; (2) the existence and extent of present and projected local and regional needs for oil and gas products and by-products, the effect of state or federal commodity allocation requirements which might be applicable to those products and by-products, and the priorities among competing needs; (3) the desirability of localized capital investment, increased payroll, secondary development and other possible effects of the sale, exchange, or other disposition of oil and gas or both; (4) the projected social impacts of the transaction; (5) the projected additional costs and responsibilities which could be imposed upon the state and affected political subdivisions by development related to the transaction; (6) the existence of specific local or regional labor or consumption markets or both which should be met by the transaction; (7) the projected positive and negative environmental effects related to the transaction; and (8) the projected effects of the proposed transaction upon existing private commercial enterprise and patterns of investments. (b) When it is economically feasible and in the public interest, the board may recommend to the commissioner of natural resources, as a condition of the sale of oil or gas obtained by the state as royalty, that (1) the oil or gas be refined or processed in the state; (2) the purchaser be a refiner who supplies products to the Alaska market with price or supply benefits to state citizens; or (3) the purchaser construct a processing or refining facility in the state. The board shall make a full report to the legislature on each criterion specified in (a) or (b) of this section for any disposition of royalty oil or gas that requires legislative approval. The board's report shall be submitted for legislative review at the time a bill for legislative approval of a proposed disposition of royalty oil or gas is introduced in the legislature. 3:06:21 PM Mr. Fitzpatrick reported that DNR worked extensively with the royalty board regarding the Marathon contract and passed a resolution in support of the contract. He discussed slide 10 titled "Recent RIK Contracts:" The chart portrayed several of the more recent contracts. The proposed Marathon contract showed a royalty volume range (nomination range) from 10,000 to 15,000 barrels per day, which could vary between the range. He disclosed that Marathon only negotiated a three-year contract in its prior contract. Currently, Marathon started with a primary term of 3 years with an option of 7 years of annual extensions. The options were exercised one year at a time. Either party maintained the option to terminate the contract in three years or at the end of each subsequent year. In addition, if both parties were satisfied, they had the option to continue the contract. Representative Hannan asked about the mutual consent contract extension. She asked who was responsible for agreeing to the extension concerning the state's interest. Mr. Fitzpatrick answered that the decision on renewals was undertaken by the department. Functionally, the decision was made by the commissioner, but the decisions were run through the Division of Oil and Gas and managed by the Commercial Section. Representative Hannan asked if the annual extension required a specific time period. She thought a one year extension seemed short. She wondered whether the state could initiate the request to extend. Mr. Fitzpatrick answered that there was a notice period prior to the end of each subsequent one year term and the agreement had to be made prior to the end of each term. He furthered that the requirement lasted 30 or 60 days and the decision had to be made before the contract lapsed. The department had a certain window when the producers had to be notified that the state was electing royalty in-kind and the stated needed certainty that the contract would be renewed prior to the nomination window, therefore the actual time-period to renew or lapse was several months before the end of the other time periods. 3:11:37 PM Representative Galvin deduced that the chart showed all of the contracts that had been approved since 2016. Mr. Fitzpatrick replied affirmatively. Representative Galvin thought that the current Marathon contract was a standout due to the seven year optional potential. She wondered if there was any inherent reason for it to be designed so differently than other past contracts. Mr. Fitzpatrick answered that the chart depicted "adjustments to the contracts" versus brand new contracts. The extensions were a method to extend the contract on a basis both parties understood. He characterized it as a modification versus a wholesale change in terms. In addition, longer-term contracts were a positive thing for the state and important part of energy security. 3:13:51 PM Representative Galvin believed that it appeared positive that the producers were looking to have a longer term commitment. She thought it locked in the number of barrels. She asked if there was any reason for the state to hesitate to lock in for a longer period of time. Mr. Crowther responded that the pricing term had also been adjusted slightly to lock in the premium but also float year to year with an adjustment rather than being fixed for the entire term of the contract. He indicated that prior contracts had a fixed model. The more flexible the contract with a guaranteed premium and option to extend worked in the state's favor. Representative Galvin deemed that it could be very helpful for the company to have a fixed price because it would know what its profits looked like in the future. She wanted to determine whether the state had done its best to capture the most revenue possible. Mr. Crowther answered that the contract did not expose the state to underpricing due to the contract's price terms associated with an index that changes with the market. 3:16:26 PM Representative Galvin inquired whether the legislature had ever rejected a royalty in-kind contract and if so, why. Mr. Crowther replied in the negative. He believed that it was in part, due to the robust public process. Mr. Fitzpatrick turned to slide 11 titled "Competitive Vs. Non-Competitive Sales:" • AS 38.05.183 requires the sale of royalty oil be by competitive bid, unless determined that the best interest of the State does not require it, or no competition exists • A non-competitive sale requires a written finding by DNR; for the Marathon contract, a Final Best Interest Finding was published on April 14, 2025 • How does DNR decide between a competitive and non- competitive sale? • DNR publishes a "Solicitation of Interest" letter with the goal of gauging the interest of the market • In this letter, DNR establishes its preferred method of sale (i.e., competitive disposition) with non- binding parameters for such sale • Interested parties are invited to comment on their willingness to buy RIK oil and their preferred terms • DNR analyzes those responses and makes a written determination of the method of sale that is in the best interest of the State When awarding a royalty sale the commissioner shall consider: • The cash value offered; • The projected effects of the sale, exchange, or other disposal on the economy of the state; • The projected benefits of refining or processing the oil or gas in the state; • The ability of the prospective buyer to provide refined products or by-products for distribution and sale in the state with price or supply benefits to the citizens of the state; and • The criteria listed in AS 38.06.070(a) There have been very limited competitive sales in the past: • Competitive sales of RIK oil only occurred in 1981, 1985, and 1986 • Less than 5 percent of RIK oil (46 million barrels of approximately one billion overall barrels) sold to date has been via competitive sales Mr. Fitzpatrick communicated that when DNR only dealt with a single purchaser it was viewed as potentially problematic from a competitive standpoint. The bidder lacked a competitive environment and lacked the incentive to bid over the minimum of the bid. The state would then engage in non-competitive sales and enter into direct negotiations with the producer to increase the premium the state received. 3:18:51 PM Mr. Fitzpatrick addressed slide 12 titled "Royalty-in-Kind In-State Priority DNR is statutorily directed to give a priority to in- state RIK sales: Sec. 38.05.183. Sale of royalty. d) Oil or gas taken in kind by the state as its royalty share, or gas delivered to the state under AS 43.55.014(b) may not be sold or otherwise disposed of for export from the state until the commissioner determines that the oil or gas is surplus to the present and projected intrastate domestic and industrial needs Mr. Fitzpatrick reiterated that no out of state interest had resulted in an in-kind purchase in many years. 3:19:28 PM Mr. Fitzpatrick moved to slide 13 titled "The Historical Premium for RIK Sales • 11 Alaska Administrative Code 03.026(b) states that the RIK price should be at least equal to the RIV price • From 2008 - 2023 the average RIK price was $1.25/bbl. higher than that RIV price • The State sold over 173 million barrels of royalty oil during this period • RIK sales proceeds were $12.99 billion • The State made over $188 million in revenue compared to taking the royalty barrels in-value Mr. Fitzpatrick cited the slide's graph that depicted the premium of RIK price over RIV price for ANS royalty oil from January 2008 through November 2024. He pointed out that the zero dollar mark demarked the break even between the RIK and RIV sales. He indicated in almost every month the state managed to secure a premium for in-kind sales of over $1 to $3 relative to RIV sales excluding a few periods of market instability. The in-kind sales garnered additional revenue for the state. Mr. Fitzpatrick turned to slide 14 titled RIK Process Overview." He briefly reported that the slide contained a flow chart of the Royalty In-Kind process, which he already discussed in detail. 3:21:39 PM Mr. Fitzpatrick advanced to slide 15 titled "Recent RIK Contract Key Terms: Netback Pricing DNR sells its royalty oil at the field or "wellhead" and bases the price on market sales price indices with various costs backed out. Thus, the price of royalty oil is calculated by "netting back" the price of ANS oil from the U.S. West Coast to the field. RIK price = ANS price at the U.S. West Coast - RIK Differential - Pipeline transportation cost +/- Quality bank adjustment - Line loss Mr. Fitzpatrick explained that the chart was similar to slide 10 with the same contracts exemplified and related to Representative Galvin's questions regarding price terms and the potential for longer term contracts. He pointed to the far right hand column titled "RIK Differential." He explained that it showed the pricing term for the contracts. The RIK differential along with another "location differential contract" was an equivalent of the marine transportation costs when comparing the United States (US) west coast price using the market price indices for the sales and backed the price into the state of Alaska. The negotiated price did not have to match Alaska's actual marine cost and was less than the total marine cost. He revealed that there was a built in premium for sales that occurred in the state relative to West Coast sales. The chart portrayed the previous RIK differential was negotiated on a fixed dollar basis and was locked in at the prices shown on the chart. He noted that the price was a subtraction from what the state received from a barrel of oil. However, in the current year, instead of fixing a price, the department used DOR's location differential based on surveys of all of the oil sales contracts executed in the state over 12 months. The updates were published each year that contained the location differential for the Alaska market. The state used the location differential for its reference value and negotiated a discount off the location differential to establish a premium, which was $0.24 in the current year. It reduced the deduction against the state's value of oil in addition to the in-state premium. He expounded that because the state used a market value reference that was updated on an annual basis based on the market survey, it provided DNR the confidence to offer a potential longer term contract. He believed that it reduced the potential to diminish or eliminate the additional profit, and the model locked in the premium over the life of the contract. 3:26:26 PM Mr. Fitzpatrick addressed slide 16 titled "Why RIK?" He explained that the graphics showed the value chain for a barrel of oil in ANS in-value royalty and ANS in-kind royalty. He pointed out that both started at $80/bbl and detailed that the marine transportation allowance for in- value oil was $3.50 while the RIK differential was $2.25/bbl. There was a deduction on both of $6.00 for other transportation costs and adjustments. The resulting price per barrel for RIK oil was $71.75/bbl. and the RIV price was $70.50/bbl. He noted that the prices were hypothetical. 3:27:27 PM Mr. Fitzpatrick moved to slide 17 titled "RIK Pricing Formula The chart contained a formula representation of the RIK pricing calculation resulting in the Royalty In- Kind price explained in prior slides. He recounted that the department used the Reuters and Platts pricing agencies to determine the market indices for the west coast price. He noted that the tariff allowance was the actual transportation cost that also had two other components associated with it. The first was the Quality Bank adjustment that reflected the value of the field specific oil stream in Trans-Alaska Pipeline System (TAPS). The other was the Line Loss, which was the small variance in the metered volumes at Pump Station 1 and the Valdez Terminal. It was a small diminishment of a barrel when two crude streams were combined with different chemical conditions. 3:28:25 PM Mr. Fitzpatrick highlighted slide 18 titled "Contract Terms For Marathon Using the DOR Location Differential." Proposed RIK differential = DOR Location Differential minus 24 cents/bbl. • Difference between marine deduction and RIK differential largely drives RIK premium over RIV • New methodology allows for dynamic RIK differential deduction over contract term • DNR estimates $1.08/bbl. RIK premium • This would result in approximately $4.9 million incremental revenue per year of the contract over RIV if Marathon purchases an average of 12.5 thousand barrels of oil per day (mbopd). Mr. Fitzpatrick elucidated that the graph depicted the marine deduction and the RIK differential from 2007 to 2024. The information conveyed how the new pricing term would have performed relative to the fixed price differentials. He pointed out that the two tracked relatively closely with slight differences depending on the year. The purpose of moving to the market index pricing formula was not attempting to gain an additional premium, which was built into its current contracts. The main reason for the new mechanism was to reduce uncertainty over the term of the contract and to lock in the premium. He characterized it as a risk mitigation measure. 3:30:24 PM Mr. Fitzpatrick moved to slide 19 titled "Maximum Benefit to Alaskans As required by AS 38.05.183(e), the Marathon RIK contract maximizes the benefits to the State: • The sale results in royalty premiums to the State compared to the average RIV values • Incremental increase in State revenue by $4 to $6 million per year • In-state refining supports Alaskan jobs • Marathon provides 220 full-time positions at its Nikiski refinery, over 60 contracted positions and 40 positions at Anchorage and North Pole terminals • Producing refined products in Alaska reduces the costs to Alaskans Fuel security is economic security • Marathon's Kenai refinery produces 55,000 barrels of refined product per day • 30 percent is jet fuel supplied to Ted Stevens Anchorage International Airport nearly half the airport's demand • 27 percent is gasoline, which is consumed in state • 43 percent is a combination of liquid petroleum gas, fuel oil, asphalt and other products Co-Chair Foster asked for a review of the fiscal note. 3:32:02 PM Mr. Fitzpatrick reported that the published Department of Natural Resources zero fiscal note (FN1(DNR) had no cost for the department. The revenue was indeterminate for three years due to the variability in the amount up to 15,000 bbl. per day. However, the department did estimate between $4,000,000 and $6,000,000 in additional revenue. 3:32:51 PM Co-Chair Foster OPENED public testimony. CASEY SULLIVAN, GOVERNMENT AND PUBLIC AFFAIRS MANAGER, MARATHON PETROLEUM, ANCHORAGE (via teleconference), supported the bill. He believed that the contract provided stability, availably, and flexibility for the Kenai refinery. He shared that the Kenai facility had been one of the longest operating refineries in the state, opening in 1969. The plant was capable of producing up to 69,000 barrels per day and was focused on value added products like propane, diesel, and asphalt. They distributed products statewide and employed many Alaskans. He relayed that Marathon was committed to reliably producing quality fuels in Alaska for the long-term. He concluded that the contract would provide a positive shared value for all Alaskans and asked for members' support of HB 194. Co-Chair Foster thanked Mr. Sullivan. Co-Chair Foster CLOSED public testimony. 3:35:46 PM Co-Chair Foster noted the bill did not seem controversial. He wondered if there was an interest in moving the bill. Representative Galvin MOVED to REPORT HB 194 out of committee with individual recommendations and the accompanying fiscal note. There being NO OBJECTION, it was so ordered. HB 194 was REPORTED out of committee with eight "do pass" recommendations and with one previously published indeterminate fiscal note: FN1 (DNR). 3:37:36 PM Co-Chair Foster reviewed the schedule for the following day.