HOUSE BILL NO. 423 An Act relating to the Alaska Railroad; authorizing the Alaska Railroad Corporation to provide financing for the acquisition, construction, improvement, maintenance, equipping, or operation of facilities for the transportation of natural gas resources within and outside the state by others; authorizing the Alaska Railroad Corporation to issue bonds to finance such facilities; and providing for an effective date. NEIL SLOTNICK, DEPUTY COMMISSIONER, DEPARTMENT OF REVENUE, spoke in support of the legislation. He observed that the initial review indicated that public financing could not be used for private activity. There are some exceptions to that rule, with a private activity cap for $225 million dollars, which the State does have access to. That cap is almost always fully subscribed to because Alaska Housing and Finance Corporation (AHFC) use it for some of THEIR housing finance needs. None of the exceptions fit into something as large as a gas pipeline. Mr. Slotnick pointed out that there was one other exception and that there could be a "special congressional" exception to the requirement. Mr. Slotnick noted that is where is was left when some outside advisors, bond counsel and the investment bank, Goldman and Saks, came to the Department of Revenue and informed the State of a special State exception that already exists in federal law, the Railroad Transfer Act. He pointed out that a copy of that statute had been included in member's packets, USC Title 45, Chapter 21, the Railroad Transfer Act, Section 12.07.A6A. (Copy on File). The exception allows the railroad to borrow money on a tax- exempt basis for purposes, which would include the financing of a transportation project of a natural gas pipeline. In addition, the Railroad would not have to take ownership of the pipeline. Mr. Slotnick explained that would be termed "conduit" financing. He referred to Page 4 of the handout and the financing of the marine terminal by the City of Valdez. That City, using its tax-exempt financing status, did the financing but Valdez did not have to undertake the ownership of the marine terminal. They did not have to use their own credit-at-risk to issue bonds. The bonds are guaranteed by the credit of the underlying companies. The State is using the same analogy to explain what can be done for the gas pipeline. The law in the Railroad Transfer Act is a unique, special exception that does not have the same limitations of other practices trying to do private activity financing. Mr. Slotnick explained how the financing would move forward in the market. He referred to the Canadian gas pipeline. That project was 70% debt and 30% equity, which is about the most debt that the market would allow the State of Alaska to undertake. The market wants to guarantee that there is a principal behind the financing that has its own capital at risk. Tax-exempt financing runs at about 20% - 25% less than taxable financing. Mr. Slotnick referenced the "Alaska Gas Pipeline Financing Alternatives" handout. (Copy on File). He noted Page 12, "Taxable versus Tax-Exempt: Gross Interest Cost". He commented that the best way to determine the savings is by preparing a present value analysis. There would be approximately a $1 billion dollar savings if the producers had access to tax exempt financing through the Railroad. He reviewed some of the assumptions used in preparing the analysis: · The credit would be backed by companies through a ship or pay contract. · If project financing was used, it was assumed that there would be approximately an 8.5% interest rate with 6.5% tax exempt; · Four year construction period; and · Twenty-five year bond issue. Mr. Slotnick explained why the State legislation was necessary even with the federal authorization. The feds gave the authority, but when the State purchased the Railroad, it did not give authority to issue bonds for a gas pipeline transportation project. The legislation authorizes the sale of bonds in the market for a project that is backed by contracts with the producers. JEFF BROWN, (TESTIFIED VIA TELECONFERENCE), GOLDMAN AND SACKS, spoke in support of the legislation. He observed that there would be a 20-year amortization on the debt. The Governor's number of $1 billion dollars could be larger given more aggressive assumptions. He complimented the Alaska State Department of Revenue for their detailed work. In response to a question by Vice-Chair Bunde, Mr. Slotnick noted that producers do not feel that there is enough incentive. The Department's assumptions were based on a $17 billion dollar project and a $3 barrel of gas would have led the State to the same conclusion. Vice-Chair Bunde estimated that a substantial return on the investment would be needed. Mr. Slotnick did not know what the hurdle rate would be for the producers. Representative Davies observed that there are concerns regarding the application of the Railroad Act. Mr. Slotnick noted that the IRS has not been consulted on the issue. ERIC WOHLFORTH, (TESTIFIED VIA TELECONFERENCE), ECONOMIST, ANCHORAGE, explained that it was adequate and complete for the Railroad to undertake tax exempt financing of the gas line when the Legislature authorizes that project. The Railroad lacks the power to issue bonds; consequently, the bill is needed. Once the bill passes, the Railroad would be legally able to move forward with the pipeline-financing project. Representative Davies asked about the issues around the IRS re-authorization. Mr. Wohlforth explained that the federal authorization path cleared without conflicts or ambiguities. It was clarified that there could not be specific exemptions. There is no doubt that there is clear authority to undertake the project. Representative Hudson asked about the problem between the Railroad and the pipeline and the restrictions upon the Railroad's use of the tax-free borrowing capacity. Mr. Wohlforth advised that the financing of a gas pipeline is within the charter authority of the Railroad and the Railroad was authorized to undertake financing for that purpose. It would be used for transportation. Representative Hudson asked who would own the $1 billion dollar asset. Mr. Wohlforth explained that the gas pipeline would remain within the ownership as if no public financing had taken place and would be a pass through, non-recourse financing. It would be a financing not involving the change of ownership. There would be legal support of the bonds, but it would not allow any transfer of ownership. Representative Hudson asked clarification that the State would no longer have the asset value of $1 billion dollars if the Railroad secures the tax-free funds. Mr. Wohlforth agreed and added that the State would not have ownership in the gas pipeline were financed. Representative Croft asked if it was assumed was that the producers would own it. Mr. Wohlforth thought that question should be left to Department of Revenue. Mr. Brown added that the shippers for the oil companies would own the pipeline and that they would be able to take the depreciation benefits on the pipeline. He explained that was important because: · The ownership is a huge economic issue; and · The Governor's Pipeline Counsel recommended that the State not own the pipeline. Representative Croft asked if the "shippers" were the people who own the right to the oil. Mr. Brown commented that the shippers could either be those who own the oil or the "ultimate" customers. Representative Croft understood that the more financially secure the entity, the less advantage they get from the status. He asked if it was correct that a corporation as solvent as Exxon, would receive less of a benefit than an independent pipeline company. Mr. Brown agreed that was a "fair assumption". With most big projects, there is an advantage to the user of the pipeline in order for it to be project financed. That minimizes the expensive equity put in. Different companies will look at it differently. Initially, only a few companies were registered but as it became a success, twenty or thirty companies came on board. That is why companies appreciate doing their own balancing rather than using a project balance sheet. Representative Croft asked the different models created between a company owned by an independent versus the producer. Mr. Brown noted that if an AAA oil company were financing it long term and using relatively less debt, versus a BBB pipeline company, the benefit would be very different. Representative Whitaker asked if the mid-point savings would be $1 billion dollars over a twenty-year time period and if it would be weighted equally over the course of the twenty years. Mr. Slotnick stated that was not accurate as that is not the manner in which the municipal bond market works. The full advantage of the tax exemption is not yet provided. Bondholders do not like to take long-term tax risk. The $1 billion dollars value is the present value and in actuality, it would be more like $5 billion dollars real terms. Mr. Brown noted that the raw numbers amounted to nearly $100 million dollars per year. Representative Whitaker thought that the $100 million present dollar per year value added to an expected return, by the State's assumption would not get the project "over the hurdle". He claimed that the producers were seeking another number. Mr. Slotnick advised that the economists had plugged in various assumptions over the years. He did not know what was a reasonable projection. Representative Whitaker referenced the $163 million dollar FY05 fiscal note projection, a contractual expense to be paid by bond proceeds. He questioned what the $163 million dollars would be used for. Mr. Slotnick advised that would be used for the expense of issuing bonds. It would be paid to bond counsel, underwriters and financial advisors. The decision would be left up to the Railroad, as they would be the contracting entity. Mr. Slotnick suggested that future questioning be directed to the Railroad. He advised that he had spoken with the Railroad to help develop the procedures for going to market. The agencies involved are Alaska Housing Finance Corporation (AHFC), Alaska Industrial Export & Development Authority (AIDEA), and the Department of Revenue. Vice-Chair Bunde asked who would pay the cost. Mr. Slotnick explained that the cost would be paid by the Railroad and would be reimbursed through the proceeds of the bond sale. The eventual payer would be the owner of the pipeline. Representative Whitaker commented that the cost would be reflected in the tariff. He assumed that the State of Alaska would essentially be paying the $160 million dollar cost. Mr. Slotnick acknowledged that the cost of issuance of the bonds would be reflected in the tariff, even if it were taxable through taxable bonds or through tax-exempt bonds. DAN FAUSKE, (TESTIFIED VIA TELECONFERENCE), EXECUTIVE DIRECTOR, ALASKA HOUSING FINANCE CORPORATION, DEPARTMENT OF REVENUE, WASHINGTON D.C., stated that there are a lot of questions that need to be answered in reference to the IRS. He noted that those concerns are beyond the control of AHFC and the legislators. He commented that the proposed legislation was a very "do-able" deal. However, the IRS agents or U.S. Congress could question the deal. He stated that it is important that the State put itself in a position to act on the proposed deal. He believed that would send a strong message to Congress about Alaska's preparedness to undertake the deal. Additionally, it would send a message to the oil and gas industry that the project is do-able and in the case of dollars, tax exempt financing would be a step in the right direction to make the project viable. Mr. Fauske referenced the fiscal note and the underwriting costs. The costs are built in on how to price that bond. Mr. Fauske did not know how those costs would be paid. JOHN BITNEY, LEGISLATIVE LIAISON, ALASKA HOUSING FINANCE CORPORATION, DEPARTMENT OF REVENUE, referenced the handout distributed, "Presentation to the House Finance Committee by Alaska Housing Finance Corporation, April 9, 2002". (Copy on File). He noted that the information in the handout is a replica of what AHFC provided to the Alaska Railroad for preparing the tax-exempt finance bond. JOE DUBLER, CHIEF FINANCAL OFFICIER, ALASKA HOUSING FINANCE CORPORATION, DEPARTMENT OF REVENUE, introduced the team of participants with AHFC and financial advisors that were on line. Mr. Dubler spoke to the assumed a 30-year term. He claimed that AHFC's proposed numbers were more aggressive. He referenced the booklet and the tax-exempt bond issuance: · Selecting appropriate professionals such as the financial, tax, legal, and financing specific experts; · Performing feasibility analysis such as tax, financial, and project analysis; · Developing optimal finance structure such as coordination with users of project; · Generating local support; · Providing information to the public; and · Responding to rating agency concerns and obtaining a rating.   TAPE HFC 02 - 78, Side B  · Marketing the bonds with the institutional and the retail investors; and · Providing continuing disclosure. Representative Whitaker thought that there should be more than one approach to the bond issue. Mr. Bitney explained that AHFC was hoping that based upon their experience in providing the "lion's share" of tax financing to the State, they would show the types of things that are necessary to undertake that type of financing. HB 423 would authorize the Alaska Railroad for the federal tax exemption. The passage of the bill would be financing under the auspicious of the Alaska Railroad. At that point, it would be the obligation of that agency to conduct the financing. Representative Whitaker asked if there would be an opportunity for the State to gain some of that portion back. Mr. Wohlforth explained that in 1974, the City of Valdez was part of the first financing. The City charged 1% and has continued to charge that fee for recent refinancing, extending the term to 2031. With the 1% increased aid fee the City has charged, they now have a permanent fund in the order of approximately $55 million dollars. That could be a consideration for the Railroad. Representative Whitaker questioned if the AHFC approach was different from the approach put forward by the Department of Revenue. Mr. Bitney responded that there have been no decisions regarding the specific approach of how to address the concern. AHFC is providing a series of necessary steps in order that it can happen. The key rests with the selection of the people involved in structuring the financing. Representative Whitaker asked if the State was on the correct financing course. Mr. Bitney did not know of any problems at this point. It is a process that needs to be driven by the Railroad. Representative Whitaker commented on the nature of the transaction and the value it could have for serving the State of Alaska. He suggested that if AHFC should become aware of something in the process that was "non- competitive", they would come forward and warn the Administration. Mr. Dubler explained that to the extend that AHFC was involved in any transaction, they will take steps to insure the process. Representative Whitaker asked who would insure that the process was procedurally competitive and in compliance with how the public process is conducted. Mr. Bitney advised that at this point in the process, AHFC is not in charge of the financing, pointing out that right now, AHFC is only addressing the process needed to get the procedure started. Mr. Dubler explained that the meeting presentation had been encouraged by Alaska Railroad and was not intended to be a secondary or alternate approach. Representative Whitaker asked who is in charge. Mr. Dubler explained that the Railroad is in charge. Mr. Fauske noted that AHFC was asked to prepare advice based on their experience. There are a couple of agencies involved that have extensive experience in financing. These agencies stand on the position that offering assistance would help show the way for the transaction to happen. Alaska Railroad will be issuing the bonds and they have no experience in doing that. With a model in place, AFHC, AIDEA and the State would be the best and most effective tax models. Mr. Fauske mentioned that with a "deal" this large, it is important to get as many outside firms as possible involved to help market it. It is imperative that the Alaska Railroad authority will reside with that entity and that the Railroad has absolute control over the financing. He advised that there have been no discussions other than how to approach the issue with the underwriters. Mr. Fauske urged that the idea move forward as it would mean a great deal for the State and to the Nation. MICHAEL HURLEY, PHILLIPS ALASKA, ANCHORAGE, spoke in support of HB 423. He noted that Phillips Alaska has reviewed the concept embodied in the bill. Conduit financing does have the potential to benefit the gas pipeline project. Additional clarity in several areas will be needed. He added that Phillips Alaska is continuing to evaluate the impacts more fully. At this time, Phillips Alaska supports passage of the legislation, which would provide the authorization necessary if the project were to become a viable alternative. Representative Whitaker asked who Mr. Hurley previously represented. Mr. Hurley noted that in the past, he had represented three companies, Exxon Mobil, British Petroleum and Phillips Alaska. JERRY MCCUTHEON, (TESTIFIED VIA TELECONFERENCE), ANCHORAGE, claimed that there will not be a gas pipeline out of Alaska in our lifetime. He spoke to concerns regarding the C2's and C3's. The project would need about five trains a day. He commented that it could be done, if the State was willing to pay for the track. Amtrak is requesting billions of dollars. Amtrak and the Alaska Railroad are the two eligible entities for those billions for which Amtrak desperately needs. He said that the current system of putting the gas liquids in a hot oil line is wasteful. Vice-Chair Bunde suggested that there should be opportunities for future legislators to "weigh-in" or review the procedures. He warned about the size of the project and the amount of oversight that it will need. PAUL FUHS, YUKON PACIFIC CORPORATION, spoke in support of the proposed legislation. He noted that when it was first proposed, it could only be used for a pipeline through Canada. The Oil and Gas Committee did amend the bill to allow other options including the pipelines to tide water in Alaska. Mr. Fuhs pointed out that the State is attempting to make an economic model of a project available to the Oil and Gas Committee in contrast to other projects. Mr. Fuhs noted that there have been rates of returns indicated in the range proposed by Vice-Chair Bunde. If the railroad model could improve the financing, those rates would improve more. He claimed that there is a huge fight regarding who will get the value added for the project. At this time, there are 18 alternative proposals. He stated that he would make the handout about the alternative mean proposals available to the Committee. (Copy on File). Two tests need to be used to determine whether the project is feasible: · The first is the economic amount being put forward and whether the market would be buying that gas; and · Whether the bonds can be sold. People will need to believe in the economics of the project. Co-Chair Williams noted that HB 423 would be HELD in Committee for further consideration.