HOUSE BILL NO. 393 "An Act relating to contracts with the state establishing payments in lieu of other taxes by a qualified sponsor or qualified sponsor group for projects to develop stranded gas resources in the state; providing for the inclusion in such contracts of terms making certain adjustments regarding royalty value and the timing and notice of the state's right to take royalty in kind or in value from such projects; relating to the effect of such contracts on municipal taxation; and providing for an effective date." REPRESENTATIVE MARK HODGINS emphasized that HB 393 is enabling legislation. He noted that there were two areas of concern. The first was gas to liquids. This provision was taken out, put back in, taken out, and is currently out of the legislation. He acknowledged the importance of gas to liquids technology, but maintained that the technology would not be hurt by its absence in the bill. Some members felt that gas to liquid should be reviewed separately and have its own tax policy. A provision to ratify contracts by the legislature was added. The affect on communities was reviewed. There would be a community advisory group. He maintained that mayors and municipalities will have the ability to express concerns. He stressed that most of the pipeline communities are very excited about the legislation. In response to a question by Co-Chair Therriault, Representative Hodgins clarified that the advisory group would be on municipal taxation. The group would be put together if there is a contract or proposal. Representative Martin questioned if there would be a guarantee to invest in pipeline equity. Representative Hodgins stressed that contracts would be in place. Purchasing countries generally want to be involved in equity. Contracts for natural gas would be for several years. The project would not go forward without contracts. Representative Martin emphasized that purchases should also be partners in the investment of the pipeline. He also noted the value of recycled gas. (Tape Change, HFC 98 -93, Side 1) Representative Hodgins emphasized that a taxation figures would be developed to determine the actual and true cost of the pipeline. He stressed that the pipeline would not be built for the current projected cost. The intent is to lower the cost to approximately $12 billion dollars. The current general analysis is $15 billion dollars. In response to a question by Representative Davies, Representative Hodgins reviewed incentives in the legislation. A municipal taxation exemption would be one incentive. Tax revenue is anticipated at $12.6 billion dollars. He suggested that it would be appropriate to give up as much as two percent of that amount. This would be approximately $160 million dollars. There would be a negative impact to communities in the form of infrastructure. More schools could be required due to employment expansions. Communities have indicated that they can manage operational costs but not capital expenditures. Communities might receive natural gas as a result of their proximity to the pipeline. The federal government would receive approximately $26 billion dollars over the course of the project. Federal relief would help the cash flow portion of the project. He did not anticipate any allowance for decreased taxes once the revenue is flowing. The legislation is an incentive program to indicate that the State wants to do business. Representative Martin expressed concern that oil companies are not threatened by the implementation of taxes. JOHN T. SHIVELY, COMMISSIONER, DEPARTMENT OF NATURAL RESOURCES provided members with a flow chart of HB 393 (copy on file). Stranded gas is gas that is uneconomic or not competitive to develop. A qualified project would be identified and a qualified sponsor would come forward. The project would have to establish that: 1. Own some or all of the stranded gas; or 2. Have a right to purchase some of the stranded gas; or 3. Have the financial strength to construct the project. Once a qualified project by a qualified sponsor brings a project to the commissioner of the Department of Natural Resources, the commissioner would have to determine if: 1. The gas is stranded; 2. Qualified sponsors requirements are met; 3. The proposed project is a Qualified Project; and 4. There is a Project Plan that reflects a proposal for diligent development of the gas, and includes reasonable provisions for providing gas to local communities. If all the conditions are affirmed than the commissioner of the Department of Natural Resources may begin to negotiate an agreement. The commissioner would look at the following principles: 1. Improve the competitiveness of the Alaska project; 2. Function effectively under a wide range of economic and market conditions; 3. Link the State's share to project profitability (make tax "progressive"); 4. Make State's share "backend loaded"-lower tax rates in earlier years, higher rates in later years; 5. Allow Sponsor a share of the project's return commensurate with the Sponsor's assumed risk; 6. Have the State's share increase under favorable price and cost conditions; 7. Be clear and unambiguous; and 8. Base payment terms on actual costs if possible. In addition to fiscal terms, the contract would also: 1. Provide for Alaska Hire within the limits of Constitutional restrictions; 2. Provide gas for Alaska communities; 3. Provide for a fair and reasonable sharing of revenue with affected communities; Development of municipal revenue sharing terms would be based on the following: i. The size of the tax base that would be exempted; ii. The anticipated economic and social burdens imposed on a municipality from a project; iii. The need for stable and predictable payments; and iv. The eight fiscal principles outlined above. Commissioner Shively emphasized that how the State deals with affected communities is one of the challenges it faces. Property tax is the most regressive. Assuming that there is an agreement, the commissioner of Department of Natural Resources has the ability to negotiate a couple of issues. The commissioner can provide for a method for valuing the gas for royalty purposes. He observed that there have been disagreements about the system of valuing gas. The amount of the royalty would not be changed. The method of figuring the royalty could change. The commissioner may also modify the rights of the State to take royalty in-kind rather than in-value. Currently, the amount of oil the State takes can be changed on a monthly basis. Project sponsors will not want the State to be able to take up to 12 and a half percent of the gas at anytime during the project. They will need to know, up front, how much royalty gas will be taken. Commissioner Shively observed that once the commissioners or the Department of Revenue and the Department of Natural Resources are in agreement it goes out to contract. The commissioner of Department of Revenue listens to the public and a final agreement is reached. Then the contract would go to the governor. The governor would submit the contract to the legislature. If the legislature authorizes the contract the commissioner of Department of Revenue signs the contract within 60 days. In response to a question by Representative Martin, Commissioner Shively noted that companies have to make a case for confidentiality. Trade secrets, things that affect the applicants competitive position, information that has commercial value that could be significantly diminished by public disclosure, or public exposure that is not in the long term interest of the state of Alaska would be standards for confidentiality. The legislature could still review information under executive session. The major portion of the contract would be under public debate. Representative Martin questioned qualifications for Alaska hire. He noted that Alaskans would have to be trained for some skilled positions. Commissioner Shively stated that a year or more residency would be required. He stressed that Alaska's work force is more qualified than it was during the mid 1970's. If the workforce is a large as it was for the pipeline there will probably be some outside hire. The companies would be pressured to prove that they exhausted efforts to hire Alaskans. JIM SYKES, OILWATCH ALASKA, ANCHORAGE stated that the legislation is moving in a good direction, but cautioned that there are some areas that need to be improved. He emphasized that the project cannot be made profitable if it is not profitable. He asserted that the state of Alaska cannot afford to give away valuable resources. He noted four areas of concern: - Payment schemes for payment in lieu of taxes; - No legal assurance that a negotiated contract by the Administration will fully compensate the people of Alaska for the public owned resource or other public cost; - There has been no discussion about the downside risks and the effect of the project on the State; and - How can a competitive environment be assured? Mr. Sykes observed that cash starved nations maybe willing to grant greater concessions to get gas extraction activity started at almost any price. This could hurt Alaska's competitive position. It is possible that gas from other nations could flood the nation after the project is on line. He observed that the system of identifying impacted communities is based on the question of whether periodic payments to communities will adequately compensate for the real cost of providing schools, public safety and other services during construction. There is no insurance that there will be money available when the municipalities need the money the most. He maintained that something more concrete is needed to assure that municipal needs are met. He stressed that the only way to assure that those that are working in Alaska are supporting the benefits they require is to have them pay an income tax. He observed that the upside benefits have been addressed but that until the downside is fully examined the Department of Natural Resources should not negotiate a contract. He emphasized that the state of Alaska needs to make sure that there is a competitive environment to prevent antitrust cases. DAVID BROOKS, MANAGER ALASKA GAS, BP EXPLORATION ALASKA INCORPORATED stated that they have prove in Prudhoe Bay approximately 25 trillion cubic feet of gas. There is approximately 5 trillion cubic feet of gas in Point Thompson and the US geological survey suggests that there could be in excess of another 100 trillion cubic feet yet to be found on the North Slope. He emphasized the value for the resource owners and the State if economic ways of transporting the gas to market could be found. He assured the Committee that BP is taking the issue of the commercialization of these gas resources very seriously and continues to dedicate resources to exploring routes to commercialize it. Mr. Brooks observed that over the past year BP has worked with the legislature, the state administration, other gas owners and interested parties on the commercialization of the North Slope gas. The Gas Commercialization Report published in January of this year was an outcome of that work. He highlighted two issues that BP believes ought to be considered. He emphasized that a key option today is gas to liquids technology. Although the technology is currently uneconomic many companies including BP have extensive work programs in progress to drive down the costs of the process and make it competitive. The gas to liquids technology would convert the gas on the North Slope to a liquid hydrocarbon such as diesel. That diesel could be transported in the TAPS oil pipeline and sold out of Valdez in the normal way. Although this would not require the development of a gas line it would have other significant benefits. First, a gas to liquids plant on the North Slope would increase the flow of oil through the TAPS line, which would help to keep down transportation costs. This could help facilitate the production of crude oil from some of the smaller accumulations on the North Slope. Secondly, enhanced flows down TAPS would prolong the useful life of TAPS and ensure that refineries and communities along the pipeline continue to have access to energy derived from North Slope reserves. Mr. Brooks added that the options of LNG and Gas to liquids are not mutually exclusive. The vast quantities of gas already proven on the North Slope means that BP could do both a LNG project and a gas to liquids project. Mr. Brooks urged that the scope of the legislation be widened to include all options for gas commercialization, in particular the options of LNG and gas to liquids technology. Mr. Brooks noted that BP's second area of concern is the sunset clause on page 10 of the Bill. The clause limits the applicability of the legislation to projects making an application before the end of June 2001. He stressed that this would close off options for the future. Mr. Brooks stressed that BP cannot control the development of technology or markets for the gas. He felt that a cut off date would reduce options and gives a negative message to the potential developers of technology and stranded gas resources. He recommended that the sunset clause be deleted. Mr. Brooks emphasized that the HB 393 is enabling legislation that does not commit the State. He maintained that the legislation provides a positive signal to industry and to developers of stranded gas that the State is open for business. Representative Davies asked for a summary of work by BP to commercialize stranded gas through a reduction in transportation costs. Mr. Brooks noted that BP has worked with Arco and Exxon to look at reducing costs by sharing infrastructure. He stated that the cost of the project is between $12 and $15 billion dollars. He expressed confidence that the project could be built for $12 billion dollars. He maintained that the project is not competitive at either $15 or $12 billion dollars. The next stage of their work program tries to find innovative ways to reduce costs, particularly the pipeline. A workshop with experts in building and operating a pipeline in harsh conditions was held two weeks ago with other companies. Plans to bring a pipeline from the North Slope to Cook Inlet are being addressed. Representative Mulder asked if they would be concerned about the applicability of gas to liquid still warranted. Mr. Brook stated that there are people discussing gas to liquid plants. The issue is site specific. The technology is present. He emphasized that the legislation is enabling legislation. Removal of the sunset clause would allow work to progress. The clause would potentially remove options from the State for discussions of ways to develop stranded gas at a later date. Representative Martin asked how much investment would be needed to liquid gas, would the same pipeline be used, and where is the market. Mr. Brooks stressed that the cost is unknown. The gas could be sent down the pipeline, blended into the crude oil. It would increase the value of the crude oil. This would increase the value of Alaskan oil. JIM JOHNSON, DEVELOPMENT MANAGER, ALASKA REGION, PHILLIPS PETROLEUM COMPANY observed that the Alaska Region in Phillips includes North Slope assets operated by other companies, and the Tyonek Platform in the North Cook Inlet. Gas from the North Cook Inlet Unit goes to the Kenai LNG plant for processing and shipment as LNG to Asia. He observed that Phillips has looked at the implementation of a North Slope gas project, and believes that it has the potential to be economic, although with current conditions it is not economic. He observed elements that will be key in determining the ultimate economic viability of such a project: 1. The project costs (pipeline, plants, LNG tankers); 2. The market for LNG sales overseas; and 3. The regulatory and tax structure. He stressed that Phillips believes that timely definition of a project structure, including potential improvements in all three of these elements, is important for such a project to ultimately come to fruition. As companies work toward addressing project costs and marketing arrangements, it will be important to be able to define any improvements in the tax structure that will be available to bring the project into being. MICHAEL HURLEY, SENIOR TAX ADVISOR, ARCO ALASKA, ANCHORAGE testified in support of HB 393, The Alaska Stranded Gas Development Act. He pointed out that ARCO has been aggressively pursuing the development of North Slope gas resources for some time now. As one of the major gas interest owners on the slope, these resources represent one of Arco's most significant undeveloped assets. Finding a way to commercialize them is an important priority. Mr. Hurley stated that their most encouraging work to-data has been in the development of plans to commercialize the gas as LNG sold into Far East markets. While this project is not yet economically viable, ARCO has been working on four key areas which, if successfully addressed, could lead to an economically viable project: 1) Reduction in the cost of the project; 2) Development of a viable project structure; 3) Development of a viable market; and 4) Pursuit of federal and state fiscal & commercial regulatory matters. He stated that ARCO believes HB 393 represents an important, indeed a vital, component of their plan to develop a viable economic project. (Tape Change, HFC 98 - 93, Side 2) Mr. Hurley observed that while they have been pursuing their plan for an LNG project to commercialize these gas resources, alternative plans to commercialize the gas have been and continue to be studied. Over the last twenty years several serious efforts were initiated to move the gas in conventional gas pipelines through Canada to lower-48 markets. Unfortunately, none of those efforts achieved economic viability. Other, more technologically challenging, alternatives for commercializing the gas continue to be researched, including gas to liquids technology. Mr. Hurley maintained that HB 393 is important because it puts in place a process and structure within which sponsors or sponsor groups may work with the administration to develop alternative fiscal regimes more appropriate to the kind and structure of project. These alternative fiscal regimes would then be open to public comment, and would ultimately return to the legislature, in the form of contracts. In response to a question by Representative Davies, Mr. Johnson observed that the legislation accepts several kinds of project structures. The bill is flexible enough to take care of different kinds of structures. He stressed that the legislation should be broad in the sense of time. BEVERLY MENTZER, ALASKA GAS COMMERCIALIZATION MANAGER, EXXON COMPANY U.S.A.'S observed ways that the legislation would facilitate the commercialization of Alaska's gas and highlighted key areas of interest during the prior hearings. She assured the Committee that Exxon continues to have a keen interest in commercializing Alaska's North Slope gas, which represents over one-half of Exxon U.S.A.'s gas resources. Since discovery of Prudhoe Bay, Exxon has devoted a significant amount of their technical and financial resources searching for a way to commercialize the gas. They have spent in excess of $100 million dollars on these efforts. Ms. Mentzer emphasized that this work has demonstrated that it will take a combination of fiscal and regulatory modifications and certainty, favorable market terms and significant cost reductions for a North Slope gas project to be economic. She observed that the State's fiscal consultant, Pedro Van Meurs said that, "In order to make the Alaska North Slope LNG project economic, three objectives have to be achieved: 1. The costs of the project have to be reduced substantially. 2. The profitability of the project has to be improved through a fiscal package in which federal, state and local governments cooperate, and 3. The risks of the project have to be considerably reduced." Ms. Mentzer noted that risks include such things as gas price, cost overruns, fiscal stability and market access. To help reduce fiscal risk, the legislation provides reasonable guidelines and boundaries for development of a fiscal contract. It includes the opportunity for input from the legislature, local municipalities and the public during the contract development stage. It also appropriately requires legislative review and authorization of any fiscal contract. Ms. Mentzer pointed out that a key objective of the bill is to keep options open for the state of Alaska, so that it can maximize the value of its gas resources. She noted that the bill is not field-specific, but keeps options open by defining criteria for a qualified project. She observed that there are only criteria to judge the intent and financial strength of potential qualified sponsors. She added that there are only guiding principles for future negotiations, and options for taxes to be considered and that there are only three years to apply for a fiscal contract. Ms. Mentzer asserted that following recent removal of the gas-to-liquids language, it is debatable whether Alaska wants to keep the door open today to encourage the valuation of new technology which may expedite commercialization of Alaska's gas. Ms. Mentzer explained the options and issues surrounding gas-to-liquids conversion. She noted that the most frequently asked question is whether gas-to-liquids conversion is really an option worthy of Alaska's serious consideration today. From Exxon's perspective the answer is "yes." Exxon has spent over $300 million dollars on technology development and acquired 1500 patents worldwide. They have completed a feasibility study with the Qatar General Petroleum Company and are currently in negotiations with them on commercial terms for a possible project. She stressed that the issue is not whether the technology is ready, but whether or not the technology is economic. The site-specific economics will be determined by such factors as product price, construction, operating and transportation cost and fiscal terms. A Department of Energy report, which compared the economics of similar size LNG and GTL projects for Alaska, concluded that "both options are economically promising and warrant consideration in industry and government decision making." Ms. Mentzer concluded that the passage of House Bill 393 is a necessary step in the process of developing appropriate fiscal terms that could be specified for the life of the project. Such a fiscal contract could increase the competitiveness of an Alaska gas project, while meeting the long-term fiscal interests of the state. Representative Mulder asked if there are any successful gas to liquid projects. Ms. Mentzer observed that there are three operating plants in the world. They are not economic. Co-Chair Therriault pointed out that the economics are different. He was not supportive of adding gas to liquid back into the legislation. Ms. Mentzer stressed that HB 393 is a general framework. The criteria in HB 393 would be applicable to any major resource development project. She pointed out that LNG and gas to liquid are both uneconomic, they face some of the same hurdles. The issue is whether the door will remain open. In response to a question by Co-Chair Therriault, Ms. Mentzer clarified that the gas to liquid process is about 60 to 65 percent energy efficient. It is a heat intense process and requires a lot of fuel. The BTU potential can be more valuable than LNG. The energy lost in the process is not regained directly in the product. However, heat can be used for electric power generation or waste heat based on site-specific opportunities. The third step of the gas to liquid process can result in a range of high quality products. In response to a questions by Representative Davis, Ms. Mentzer explained that some products could be used in the community without additional processing. The climate is not a significant detriment to the processing. Arctic conditions, in general, raise operation costs. She emphasized that they do not know when the Asian economy is going to recover and take increasing amounts of LNG from Alaska. She spoke against the sunset provision. In response to a question by Representative Martin, Ms. Mentzer interpreted the removal of the gas to liquid option to indicate that it is not the intent of the legislature to consider the option. Representative Davies observed that communities are concerned that fiscal terms not prohibit an appropriate return to the community at some place and time. They are also concerned about having input into contracts. WILSON CONDON, COMMISSIONER, DEPARTMENT OF REVENUE stated that communities have several opportunities to voice concerns. The bill creates a municipal advisory group that would be consulted throughout the negotiation of the contract. The commissioner of Revenue is directed to consult with and seek the advice of the municipal advisory group. There is a period of public comment. The commissioner must consult with municipalities and others during the public comment period. The contract can be amended to address concerns before legislation is presented. Legislation can also be amended. The proposing group would be consulted on amendments. Representative Mulder MOVED to report CSHB 393 (RES) out of Committee with the accompanying fiscal notes. There being NO OBJECTION, it was so ordered. CSHB 393 (RES) was REPORTED out of Committee with "no recommendation" and with two fiscal impact notes, one by the Department of Revenue and one by the Department of Natural Resources, both dated 2/11/98.