HOUSE BILL NO. 273 "An Act relating to the transfer of the title to a vehicle, including certain manufactured homes and trailers, on the death of the owner; and providing for an effective date." 8:49:50 AM MARTY RUTHERFORD, ACTING COMMISSIONER, DEPARTMENT OF NATURAL RESOURCES, indicated she would be providing a brief overview of the proposed sale of the state's royalty oil to Tesoro. Commissioner Rutherford relayed that she would discuss the process and the criteria for royalty-in-kind (RIK) sales. She would also discuss the specific contract terms of the Tesoro RIK contract. She would also be mentioning another royalty oil contract the state was in the mist of negotiating. Commissioner Rutherford began with slide 2: "Royalty In- Kind versus Royalty In-Value": The State has a choice to take its royalty in-kind (RIK) or in-value (RIV) · When the State takes its royalty as RIV, the lessees who produce the oil also market the State's share along with their own production and pays the State the value of its royalty share. · When SOA takes its royalty share as RIK, the SOA assumes ownership of the oil, and the DNR Commissioner disposes of it through the sale procedures prescribed by AS 38.05.183. · Currently, the SOA receives all royalties as RIV; historically, the SOA has regularly taken royalties as RIK. Commissioner Rutherford advanced to slide 3: "Non- Competitive RIK Sale Process": · Before taking RIK, the DNR Commissioner must find it is in the State's best interest. · DNR must decide whether to sell RIK pursuant to a competitive auction or a non-competitive, negotiated sale. · Solicitation of Interest issued January 2015 to prospective purchasers to gauge market interest. · DNR determined that there was not competition allowing for a competitive sale, and proposes to enter into the negotiated 5 year contract with Tesoro. Commissioner Rutherford continued to slide 4: "Commissioner's Decision Criteria": AS 38.05.183(e) states that the commissioner must sell the State's royalty oil to the buyer who offers "maximum benefits to the citizens of the state." In making this determination, the commissioner must consider: 1. The cash value offered 2. The projected effects of the sale on the economy of the state 3. The projected benefits of refining or processing the oil in state 4. The ability of the prospective buyer to provide refined products for distribution and sale in the state with price or supply benefits to the citizens of the state 5. The eight criteria listed in AS 38.06.070(a), as reviewed by the Royalty Board Commissioner Rutherford noted that she would be talking about the eight criteria in greater detail in another slide. Commissioner Rutherford turned to slide 5: "Approval Process for the RIK Sale": · DNR must make a Best Interest Finding (BIF) in support of the sale · Preliminary BIF issued February 2016; final BIF issued in March 2016. · DNR presented the sale to the Royalty Board on March 15, 2016; the Board reviewed the BIF and the contract, and unanimously voted to recommend the Legislature approve the sale to Tesoro. · Prior to finalizing the RIK contract, the Legislature must pass a bill ratifying the contract with Tesoro (HB 373; SB 205). 8:54:44 AM Commissioner Rutherford discussed slide 6: "Royalty Board's Decision Criteria": AS 38.06.070(a) states that the Alaska Royalty Oil and Gas Development Advisory Board must 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; 3. The desirability of localized capital investment, increased payroll, secondary development and other possible effects of the sale; 4. The projected social impacts of the transaction; and 5. The projected additional costs and responsibilities which could be imposed upon the state and affected political subdivisions by development related to the transactions. Commissioner Rutherford stated that number 3 was not applicable because the state was selling to an existing refinery that had been using alternative privately purchased supplies. She also relayed that number 5 was not applicable because the state had an established refinery. Commissioner Rutherford turned to slide 7: "Royalty Board's Decision Criteria Cont.": AS 38.06.070(a) states that the Alaska Royalty Oil and Gas Development Advisory Board must consider: 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 or negative environmental effects related to the transactions; and 8. The projected effects of the proposed transaction upon existing private commercial enterprise and patterns of investment. Commissioner Rutherford added that the royalty board reviewed the final best interest finding and the associated Tesoro contract. They voted unanimously to recommend that the legislature approve the sale. Commissioner Rutherford spoke on slide 8: "Tesoro RIK Contract Terms": · 5 year contract for 20,000 to 25,000 barrels per day. · The RIK sales price uses a netback formula and provides higher revenue to State compared to RIV. · If Tesoro nominates zero barrels for 3 consecutive months, the contract terminates. · Security: Tesoro shall provide a letter of opinion from a financial analyst or a stand-by letter of credit equal in value to 90 days of ANS royalty oil (if rating falls below BBB- and Baa3). · In-state processing: Tesoro to use "commercially reasonable efforts" to manufacture refined products from the ANS royalty oil. · Employment of Alaska residents: no discrimination against AK companies and residents. Commissioner Rutherford highlighted that Tesoro had over 210 Alaskan employees and employed over 40 Alaskan contractors. The plant was located in Nikiski and had been in operation for several decades. 8:58:26 AM Commissioner Rutherford detailed slide 9: "RIK Contract Price": ANS Spot Price - $1.95 - Tariff Allowance +/- Quality Bank Adjustments - Line Loss · ANS Spot Price = Average US West Coast Price for Alaska North Slope oil (reported by industry trade publications Platts and Reuters) · $1.95 RIK Differential · Destination value minus marine costs so RIK > RIV. · Tariff Allowance = TAPS and Pipelines upstream of PS-1. · Quality Bank Adjustments = as reported by TAPS Quality Bank Administrator. · Line Loss (loss of volume between PS1 and the VMT). Commissioner Rutherford pointed to the price formula listed at the top of the slide in red. The Revenue In-Kind contract prices equaled the Arctic North Slope (ANS) spot price minus $1.95 minus a tariff allowance, adjusted for a quality bank - either up or down - minus line loss. She explained that ANS spot price was the destination value of ANS at the United States West Coast - determined by reports from the industry trade publications, Reuters and Platts. The next item deducted was a location differential. She reported that the amount of $1.95 was used in the solicitation of interest. She explained that starting with the ANS spot price the state deducted the marine transportation costs. When the state received RIV and looked to the working interest owners the shippers/producers charged the state between $3.30 and $3.70 for the cost of the marine transportation from the Valdez Marine Terminal to the West Coast. The state then deducted the tariff allowance, a combination of the Trans Alaska Pipeline tariff and the upstream pipelines. Following those deductions the state adjusted for a quality bank, determined by the TAPS quality bank administrator at the Federal Energy Regulatory Commission (FERC). Finally, the line loss was deducted, the loss of volume that occurred between Pump Station 1 and the Valdez Marine Terminal. The resulting figure equaled the value that the state of Alaska received. She explained that difference between RIK versus RIV was about $1.95 versus $3.50 - about $1.50 in the state's favor. The only distinction between calculating the RIK versus was RIV had to do with the amount being deducted. Commissioner Rutherford highlighted slide 10: "Contract is in the State's Best Interest": · DNR estimates the State will receive $45 to $56 million in additional revenue over taking RIV. · Producers deduct around $3.30 to $3.70 from the west coast value as a "transportation deduction" in arriving at the price for RIV. · The proposed Tesoro contract will deduct only $1.95 as a "location differential" from the west coast ANS value. · The proposed sale provides crude to Tesoro's refinery at Nikiski with associated economic and social benefits to Alaska's economy: · Tesoro employs approximately 210 Alaskans · Tesoro produces 59,000 bpd refined products at its Nikiski refinery · Tesoro refinery's estimated contribution to the local economy is $127mm 9:02:55 AM Commissioner Rutherford moved to slide 11: "Additional Royalty Oil Sales": •Additional royalty oil volumes are available for the other in-state refiner, Petro Star; helping maintain a competitive in-state refining industry. •DNR is currently negotiating sales with Petro Star of remaining royalty oil under similar contractual terms. •The proposed Tesoro contract and forthcoming Petro Star contract will allow for additional sale oil nominations to maximize royalty oil sales if the State has more royalty oil than is currently forecasted. Commissioner Rutherford added that if the volume fell the state would be pro-rationing both contracts down together. She concluded her presentation and made herself available for questions. Co-Chair Thompson asked about the quality bank adjustment. He asked her to elaborate on the subject. Commissioner Rutherford suggested Mr. Nouvakhov would be a better person to address Co-Chair Thompson's question. ALEX NOUVAKHOV, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES, responded that the quality adjustment in the netback evaluation equation looked at the crude which was being sold at the entry of the TAPS and compared it to the comingled stream at the Valdez point. If any residuals were frozen into the TAPS the payment or penalty would be borne by Petro Star rather than the sellers. The two contracts between the State and Tesoro and between the state and Petro Star would have the same quality adjustment. Commissioner Rutherford explained to Mr. Nouvakhov that because both Petro Star and Tesoro took their oil at the terminus the question was whether there was any quality bank adjustment involved in the formula for Tesoro. 9:06:30 AM Mr. Nouvakhov responded in the affirmative. He explained that there was because, depending on the nominating field, the state had an option as to which fields and crudes were nominated. For example, if the state nominated something for the crude oil field and then compared that to a commingled final crude in Valdez there might be a quality adjustment. Co-Chair Thompson was still unclear. He thought the quality bank had to do with the amount of product taken off by Petro Star in the Fairbanks area. They take out a part of the product and what was placed back in the line was of a lesser quality. Therefore, there was a quality bank change to Petro Star. He furthered that if Tesoro took it out in the same as it would go to the West Coast and did not put anything back in the line, he wondered if there would still be a quality bank adjustment. They did not put back a lesser quality product into any line. Mr. Nouvakhov responded that Co-Chair Thompson was correct that Tesoro did not put any product back into a line. He detailed that the crude the state sold at the point of delivery at Pump Station 1 could be of a different quality than the final commingled ANS crude which Tesoro took at the Valdez Terminal. Commissioner Rutherford furthered that the state received an average of 12.5 percent from certain fields. The state took delivery of its RIK from Pump Station 1. What was delivered downstream from that could be of lessor or greater quality. The quality bank used an adjustment to calculate either a deduction or an increase to the state's value to ensure the state would receive the pure molecular value for the units from which the state received its oil. Representative Wilson commented that Petro Star would be effected by the quality bank differently than Tesoro because of their location. She did not think how they [Tesoro] were effected had anything to do with their contracts because a certain portion was not in the contract. It was dealt with separately because of it being a federal government related transaction and certain information was unknown at the time. Commissioner Rutherford indicated she was correct. She relayed that it was an effort to ensure that where the state took its molecules and the composition of the particular molecules were accommodated so that when they were mixed with everything going into line the state received the appropriate value for the molecules. 9:10:03 AM Representative Wilson thanked Department of Natural Resources for making it possible for the state to keep its own oil in the state and using it for the in-state refinery. She hoped it would result in keeping the refinery more profitable and steady. She hoped the state had learned a lesson from what happened at Flint Hills and looked forward to the arrival of Petro Star. Representative Gara was fine with the bill. He was glad a rider was not in the bill like there had been two years previously. He commented that the more he looked at the legislation the unhappier he became about what the legislature did 2 years prior. He explained that legislation that passed granted up to $10 million per year of tax credits adding to the royalty renewal contract for three company owners of refineries. Tesoro had indicated they did not want them. He did not believe the state was in the kind of financial condition to continue that kind of legislating. He opined that in part the budget was very unfair to many people. He thought it would be unfair not to give the $10 million to Tesoro if the state was giving it to others. He would consider offering an amendment on the House Floor. Co-Chair Thompson indicated that the discussion would continue on the house floor. Representative Guttenberg had assumed that the quality bank calculation was zero. He realized that there were adjustments for quality per field. He queried if there was a daily calculation on flow rate. He wondered if the state was taking oil from its high volume fields. Commissioner Rutherford responded that she would ask Mr. Nouvakhov to speak to his question about flow. She responded that the State of Alaska received its royalty oil as it was produced by producers. The state could not over lift or under lift. When the producers produced from various fields the state received its royalty percentage from particular leases. If there was a variation of the royalty rate, it would very between leases. The state took it as it was produced by the various working interests by field and by lease. 9:13:54 AM Vice-Chair Saddler asked about the effects of the price indices rising substantially. He wondered if the contracts for the sale to Tesoro had any provisions for an escalated price. Commissioner Rutherford explained that the place where the state captured how the price was variable was at the ANS spot price. Vice-Chair Saddler asked Commissioner Rutherford to describe the negotiations that lead to the equalization of the pro-rata provisions in exchange for changed volume for Petro Star. Commissioner Rutherford detailed that when the department went out for the solicitation of interest the state received various responses. Two of the five parties that responded were North Slope Producers who had indicated that while they might be able to meet a price point of $195 they were intending to ship out of state for refining. The state had received a response from Flint Hills indicating they were closing down and not interested. The state also received a response from Petro Star that they were interested but were not willing to hit the price point. Tesoro expressed their interest and willingness to hit the price point. The state, then began its negotiations with Tesoro. As negotiations with Tesoro progressed Petro Star came back expressing their interest and the desired price point. The state was well into the negotiating process with Tesoro. As part of trying to accommodate Petro Star's desire for volume the state asked Tesoro if it was willing to give up some of its volume to accommodate Petro Star's interest. The state believed it was good to have a competitive environment for refining in Alaska. In exchange the state had looked at providing Tesoro with a preferential pro-rationing position. She furthered that as the negotiations continued a point was reached where all partners were relatively satisfied. In the end it was decided that neither party would have a pro-rationing decision. The state would pro-ration down equally between any contracts the state had in place. Co-Chair Thompson asked for further questions. 9:17:22 AM MATT GILL, EXTERNAL AFFAIRS, SENIOR MANAGER, TESORO, urged members support for the legislation. He read from a prepared statement: Tesoro Corporation is a Fortune 100 company and is an independent refiner and marketer of petroleum products. Tesoro's refining operations started Alaska with the purchase of the Kenai refinery back in 1969. Our Kenai refinery has the operational capacity to produce up to 72,000 barrels per day and is primarily focused on Jet and Diesel production followed by gasoline and gasoline blendstocks, heating oil and heavy fuel oils, propane and asphalt. We operate a 68- mile, common-carrier products pipeline that transports jet fuel, gasoline and diesel fuel to the Port of Anchorage and the Anchorage International Airport. The wholesale delivery of our products occurs through our terminals in Kenai, Anchorage, our Nikiski dock and the Port of Anchorage. In addition to being the largest taxpayer in the Kenai Peninsula Borough, Tesoro is also able to provide around 225 family wage jobs at the refinery, along with about 30 full-time contractors that are working in and around the refinery year round. We provide retail fuels at our company-owned Tesoro 2-Go retail outlets as well as at numerous branded and unbranded outlets. We employ operators who work at our terminals in the Port of Anchorage and in Nikiski. We are a major supporter of the Cook Inlet Regional Citizens Advisory Council (CIRCAC) and the largest member of the Cook Inlet Spill Prevention & Response team (CISPRI). We actively support a wide range of local events and programs - from employee fundraising for the United Way to youth sports programs. Each year we sponsor all of the 5th and 6th grade classes on the Kenai Peninsula to conduct a mission at the Kenai Challenger Learning Center and we are the Signature Sponsor of "Caring for the Kenai" program. Tesoro strongly urges you to support House Bill 373, "An Act approving and ratifying the sale of royalty oil by the State of Alaska to Tesoro Corporation and Tesoro Refining and Marketing Company LLC; and providing for an effective date." This legislation is the result of constructive dialog and productive negotiations between the Department of Natural Resources and the Tesoro Corporation. By all accounts, our company was very impressed with the State's ability to understand our issues and arrive at a mutually beneficial agreement that is truly a win- win for both parties as well as accommodating to the other refineries in the State. For the State, the DNR estimates that it will continue to receive a price for its Royalty-in-Kind oil that exceeds the price it would have receive if it elected to keep its Royalty Oil in Value. For Tesoro, this 5 year contract will provide us with a stable supply of ANS crude while also giving us the volumetric flexibility to help accommodate seasonal fluctuations in demand for refined products. The availability, flexibility and stability that this contract offers will have a positive impact on our ability to maintain our ongoing operations at our Kenai refinery. In order to accommodate the needs of the other in- state refiners, Tesoro and the State modified this contract to reduce volumes as well as eliminate a proration clause and a 5 year extension option. Tesoro believes in Alaska's future and is committed to being an active corporate citizen. We look forward to continuing to provide Alaskans with clean burning fuels to keep your homes warm and your cars, boats and snow machines traveling across this great state. I urge you to support House Bill 373. 9:21:20 AM Representative Pruitt reported regularly getting asked about pricing. He asked Mr. Gill how Tesoro saw the sales impacting the consumer. Mr. Gill clarified that Representative Pruitt was asking about gasoline prices versus oil prices. Representative Pruitt responded affirmatively. Mr. Gill relayed that the approval or denial of the contract before the committee would have no direct impact on street prices of gasoline and Tesoro's other oil products. It was strictly a commercial transaction between Tesoro and the State of Alaska, equivalent to a commercial seller. Vice-Chair Saddler queried about any other supply of crude oil that would replace the state RIK oil. He wondered about the current source of capacity assuming there would be no change in the refinery throughput. Mr. Gill reported that currently Tesoro took every drop of oil produced in Cook Inlet, the company's base supply. It supplemented the Cook Inlet oil with ANS crude either through state royalty contracts or through contracts with other North Slope producers. On rare occasion the company had to import crude oil from out of state to fill its' needs. Currently, Tesoro's royalty oil contract, which expired in January 2016, left the company with a gap until the new contract was in effect in August 2016. It was his understanding that the company had to purchase some Russian crude to bring into the refinery. 9:23:37 AM Co-Chair Thompson OPENED public testimony. Co-Chair Thompson CLOSED public testimony. Co-Chair Thompson asked Vice-Chair Saddler to review the fiscal note. Vice-Chair Saddler reviewed one indeterminate fiscal note from DNR, Division of Oil and Gas, Office of Management and Budget, component number 439. The fiscal note was dated March 23, 2016. Co-Chair Neuman MOVED to report HB 373 out of Committee with individual recommendations and the accompanying indeterminate fiscal note. There being NO OBJECTION, it was so ordered. HB 373 was REPORTED out of committee with a "do pass" recommendation and with one previously published indeterminate fiscal note: FN1 (DNR). 9:25:01 AM AT EASE 9:29:05 AM RECONVENED