SENATE BILL NO. 30 "An Act approving and ratifying the sale of royalty oil by the State of Alaska to Petro Star Inc.; and providing for an effective date." 1:51:09 PM JIM SHINE, COMMERCIAL MANAGER, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES, provided a PowerPoint presentation titled "Proposed Sale of the State's Royalty Oil to Petro Star: Senate Bill 30" dated March 13, 2017 (copy on file). He relayed that the proposed sale was the result of a lengthy commercial negotiation and public review process. He began on 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). lessees who produce the oil also market the State's share along with their own production and pay the State the value of its royalty share. SOA assumes ownership of the oil, and the DNR Commissioner disposes of it through the sale procedures prescribed by AS 38.05.183. oil as RIK (starting in 1979). million in additional revenue over what the state would receive if the contracted volumes were taken RIV. review and Royalty Board processes. Mr. Shine related that the state was currently selling oil to Petro Star under a one-year contract, which had not required legislative approval. Contracts over one year required legislative ratification. Mr. Shine addressed slide 3 titled "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 proposed to enter into two negotiated contracts with Petro Star. The first contract, in effect for the period January - December 2017, did not need legislative approval under AS 38.06.055(a) and (b)(1), received recommendation of the Royalty Board and was entered into in August 2016. The second contract, effective for the period January 2018 -December 2021, received the recommendation of the Royalty Board, but requires Legislative approval. Mr. Shine detailed that the Department of Natural Resources (DNR) sent the solicitation of interest to five instate refineries: Petro Star, Tesoro, Flint Hills, BP, and ConocoPhillips. The state choose to enter into negotiated sales with Tesoro and Petro Star. In 2016, the legislature ratified a 5-year contract with Tesoro under HB 373 Approval of Sale of Royalty Oil to Tesoro [Chapter 3 SLA 16/ - 04/21/2016]. The department prepared a best interest finding and determined that the 4-year Petro Star contract was in the state's best interest. In addition, DNR issued a 30-day public comment review where no public comments had been received. Subsequently, DNR presented the contract to the Alaska Oil and Gas Royalty Development Advisory Board (Royalty Board) on August 31, 2016, which unanimously approved the contract and recommended it for legislative approval. He noted that the "Report to the Alaska Legislature" (copy on file) and the Approval Resolution [Resolution 2016-2 (copy on file)] were included in the committee member's packets. 1:55:38 PM Co-Chair Foster noted Representative Wilson had joined the meeting. Vice-Chair Gara relayed that he had never had a problem with the oil royalty contracts. He spoke to RIK versus RIV and noted that the state stood to gain more taking RIK. He asked whether the RIK "net positive" accounted for the amount of oil used to pay the pipeline tariff. Mr. Shine answered that Petro Star had already received its "feed stock" from other producers. The state was maximizing the value of it royalty by selling the oil to Petro Star. He elaborated that Petro Star refined roughly 25 to 30 percent of each barrel of oil and returned the remaining percentage of the barrel back into Trans-Alaska Pipeline System (TAPS) in the comingled stream. He noted that the same volume of oil would be shipped upstream and downstream from the refinery. Representative Guttenberg referenced the Quality Bank allowance calculation and a related court case. He asked what the state would lose in the Quality Bank allowances versus if there was no sale. He thought that the Quality Bank cost the state and buyer money. He asked whether there was a calculation for the expense. Mr. Shine deemed that the case Representative Guttenberg referred to concerned the valuation of the residual portion of a barrel of oil and was a Quality Bank administrative mandated federal program. The value was determined by a Quality Bank administrator contracted through the TAPS owners. He delineated that the Quality Bank payment was a deduction on the netback formula, determined by the Quality Bank administrator. He noted the formula was the same if the state chose RIV. Representative Guttenberg relayed that the court determined that the state had no standing in the Quality Bank allowance situation. He was under the impression the state lost money because "the calculation was higher than it should be." He asked if the state looked at the Quality Bank costs and how it impacted the sale of oil. Mr. Shine replied in the affirmative. He reiterated that the number was the same whether the state took its royalty in-value or in-kind. He explained that the Quality Bank was an economic leveling mechanism that ensured upstream producers were in the same economic position at the Valdez main terminal based on the value of oil they contributed into the comingled stream. He agreed that larger Quality Bank payments may impact the bank's deduction that was part of the state's netback formula. He surmised that the real value to the state taking RIK was not being subject to a marine transportation deduction. Representative Guttenberg requested a letter explaining how the in-kind and in-value worked out to be the same number. Mr. Shine agreed to follow up. 2:01:34 PM Representative Grenn referenced point number 4 on slide 4 and read: 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… Representative Grenn asked whether there was a breakdown of what Petro Star would do with its refined products. Mr. Shine answered that the items were covered in the best interest finding included in the member's packets ["Final Best Interest Finding and Determination for the Sale of Alaska North Slope Royalty Oil to Petro Star Inc." Division of Oil and Gas, Alaska Department of Natural Resources, September 15, 2016 (copy on file)]. Co-Chair Seaton spoke to refineries tax credits that were not "transparent." He asked if the department was opposed to the suggestion of adding transparency language regarding the credits to the bill. Mr. Shine did not believe the department would have a problem with increasing transparency. Representative Wilson asked whether the bill was the appropriate vehicle to discuss the refinery tax credits. Mr. Shine replied that the contract was not subject to amendment. He believed that DNR preferred the legislature address the issue in standalone legislation. Mr. Shine moved to slide 4 titled "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; and 5. The eight criteria listed in AS 38.06.070(a), as reviewed by the Royalty Board. In considering these criteria, the commissioner will state which criteria apply to the proposed disposition and discuss the weight given to the applicable criteria in determining the maximum benefits to the state. Mr. Shine noted that Petro Star had two refineries: North Slope and Valdez. The refined products provided jet fuel, home heating, and ultralow sulfur diesel fuel for Alaskan's use. Mr. Shine advanced to slide 5 titled "Approval Process for the RIK sale": DNR must make a Best Interest Finding (BIF) in support of the sale. Preliminary BIF issued July 2016. Final BIF issued in September 2016. DNR presented the proposed sale to the Royalty Board on August 31, 2016. The Board reviewed the Preliminary BIF and the proposed contracts, and unanimously voted to recommend the Legislature approve the sale of ANS royalty oil to Petro Star. The Board issued a Report to the Alaska Legislature and Resolution 2016-2 stating that the proposed disposition of ANS royalty oil to Petro Star meets the requirements of AS 38.06.070. Prior to finalizing the RIK contract, the Legislature must pass a bill ratifying the contract with Petro Star (HB 70; SB 30). Mr. Shine turned to slide 6 titled "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; 5. The projected additional costs and responsibilities which could be imposed upon the state and affected political subdivisions by development related to the transactions; 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 patters of investment. Mr. Shine notified the committee that the Royalty Board addressed the criteria in its report. 2:05:48 PM Mr. Shine addressed slide 7 titled "Petro Star RIK Contract Terms": Quantity 1-year contract: from 18,800 bpd to 23,500 bpd for Jan. 2017 -Dec. 2017 4-year contract: from 16,400 bpd to 20,500 bpd for Jan. 2018 -Dec. 2018 from 13,200 bpd to 16,500 bpd for Jan. 2019 -Dec. 2019 from 10,800 bpd to 13,500 bpd for Jan. 2020 -Dec. 2020 from 8,400 bpd to 10,500 bpd for Jan. 2021 -Dec. 2021 Price: the contracts use a netback formula and provides higher revenue to State compared to RIV. Quantity flexibility Petro Star may nominate zero barrels up to 3 consecutive months if "turnaround clause" is used, otherwise the contract terminates. The State can cap its delivery amounts to 95% of the total ANS royalty oil if the nominations from all RIK buyers is greater than the 95% threshold. Provided that the supply of ANS royalty oil exceeds demand from both RIK buyers, the State can sell Additional Sale Oil as long as the total deliveries are not greater than the 95% threshold. Security Petro Star's guarantor (ASRC) shall provide a letter of opinion from a financial analyst or a stand-by letter of credit or surety bond equal in value to 50 days of delivery. If guarantor's credit rating falls below investment grade level, then guarantor shall provide a stand-by letter of credit or surety bond described previously. In-state processing: Petro Star to use "commercially reasonable efforts" to manufacture refined products in-state from the ANS royalty oil. Employment of Alaska residents: no discrimination against AK companies and residents. Mr. Shine reported that the decline in the nomination values was reflective of the state's anticipated royalty barrels. The numbers were based on 2015 Fall Production Forecast using only currently producing assets. He indicated that the state expected to receive 50 thousand to 55 thousand barrels of oil per day in 2017 and from 2018 through 2021 the state anticipated receiving 36 thousand to 50 thousand barrels of oil per day. The Tesoro contract (HB 373 from the previous year) was based on 20 thousand to 25 thousand barrels per day during the same time period. The total accounted for approximately 95 percent of the state's royalty oil in the next five years. Representative Thompson referenced slide 7 and interpreted that the state could sell an increased amount of royalty oil up to the 95 percent threshold if supply was greater due to increased production. He asked whether the statement was correct. He noted that current oil production was over 550,000 barrels per day but the fall forecast predicted under 500,000/bbl. Mr. Shine replied in the affirmative. He pointed to the third bullet point on slide 7 under "Quantity Flexibility" and reported that if more royalty oil was available during the contract period the state could provide the excess barrels based on the contracts. He restated that the contract was based on 2015 currently producing assets. 2:09:08 PM Mr. Shine spoke to the security provisions. He reported that the state negotiated a surety bond with the Arctic Slope Regional Corporation; Petro Stars parent company, for $46 million that would ensure the state was reimbursed at the same level in case of default. He elaborated that there were two default risks: - if barrels were delivered and the company was unable to meet its obligation or a denomination risk. He explained that the state employed a nomination process to receive its royalty oil. One hundred days prior to the delivery of royalty oil, the state received the nomination volumes information from Petro Star. The state then had 10 days to notify upstream producers how many barrels it was taking in-kind. The purpose of the security provision and the bond was to ensure the state was "kept whole" if either default occurred. He indicated that Petro Star employed over 300 Alaskans. Mr. Shine offered that the following slide contained the netback formula for the contract. He discussed slide 8 titled "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 This is a deduction used to calculate the price of ANS oil sold in Alaska. The deduction is applied to the price of ANS oil at its most common destination market (the U.S. West Coast). It resembles the deduction used in sales of ANS oil in Alaska between North Slope producers and between North Slope producers and in-state refineries. In contrast, for the ANS royalty oil that is sold outside of Alaska and that is taken in-value, producers use a deduction that approximates the marine transportation cost. Since deduction that represents the marine transportation cost is generally higher than the value of the RIK differential, the State has the potential to obtain a higher price for its ANS royalty oil by taking it in-kind and selling it in Alaska. Tariff Allowance = Tariffs for TAPS and pipelines upstream of Pump Station 1 (PS-1). Quality Bank Adjustments = adjustments reported by TAPS Quality Bank Administrator. Line Loss = loss or mismeasurement of volume between PS-1 and the Valdez Marine Terminal (VMT). It is calculated as 0.09% of the amount resulting from the formula above, excluding "Line Loss." Mr. Shine summarized that the main difference between the RIK and the RIV netback formula was the difference in the marine transportation deduction versus the RIK differential. He delineated that the RIK differential was $1.95 /bbl. in both contracts and the marine transportation deduction was expected between $3.30/bbl. and $3.70bbl. The RIK differential represented the value of oil sold within the state. He referenced the $29 million to $37 million over 5 years increase in excess of a RIV contract was the delta between no marine transportation deduction and an RIK differential at approximately $1.50bbl. 2:13:09 PM Representative Guttenberg asked who performed the marine transportation calculation. Mr. Shine replied that the calculation on fields that were covered under RSAs (Reimbursable Service Agreements) was an average subtracted from the netback formula for the RIV. Mr. Shine instructed that the line loss was an industry standard deduction in netback formulas for pipeline transportation that accounted for the difference in flow meters. He moved to slide 9: CONTRACT IS IN THE STATE'S BEST INTEREST The State will receive between $29 to $37 million in additional revenue over what the state would receive if the volume of ANS royalty oil the contracts is taken in-value. 1-year contract (Jan. -Dec. 2017): from $7.6 to $9.5 million 4-year contract (Jan. 2018 - Dec. 2021): from $22.3 to $27.9 million On average, producers selling ANS royalty oil outside Alaska for the 5-year period of the proposed RIK contracts with Petro Star are expected to deduct from $3.37 to $3.70 per barrel as a "marine transportation cost" in arriving at the price for RIV. This is the deduction used to adjust the price of ANS oil from the U.S. West Coast to Alaska. The proposed contracts with Petro Star will deduct only $1.95 as a "location differential" from the west coast ANS value. The proposed sale provides crude to Petro Star's refineries at North Pole and Valdez with the associated economic and social benefits to Alaska's economy: Petro Star employs approximately 44 people in its refining operations. Maximum throughput capacity North Pole refinery: 22,000 barrels per day (bpd). Valdez refinery: 60,000 bpd. Of the throughput amounts, approximately 25%-30% will be refined products. Petro Star refineries' estimated contribution to the local economy in 2014 was $25mm Mr. Shine commented that the total of the two current contracts and another previously approved Tesoro contract brought the state $75 million to $95 million more over the next five years than available under RIV contracts. 2:15:40 PM Mr. Shine addressed slide 10 titled "Comparison of RIK Contracts." The slide contained charts summarizing the breakdown in the difference between the volumes in the Tesoro and Petro Star contracts. He mentioned that there was a positive fiscal note accompanying the bill reflecting the value of the four-year contract taken in RIK versus RIV. Representative Guttenberg spoke to the tariff allowance on slide 10. He read the following from a box titled "Tariff Allowance": …If royalty comes from fields upstream of PS No 1, then RIK contracts consider tariffs filed with FERD for shipment of royalty oil upstream of PS No 1. Representative Guttenberg asked where the tariffs were filed and who set the rates. He asked whether the state was paying twice for shipments and if the upstream costs were regulated. Mr. Shine responded that if the state nominated royalty barrels from Prudhoe Bay the netback formula was only subject to a TAPS deduction, which represented the transportation costs from Prudhoe Bay to Valdez. However, if the state was nominating royalty barrels from other locations like Pt. Thompson, additional tariff adjustments were made for moving the oil from the point of production to the comingled stream at Pump Station number 1. He was not certain whether the costs were regulated. He would follow up. 2:18:25 PM Representative Guttenberg was concerned that in the past some of the tariff allowances on TAPS were disputed because, in his view, owners were overcharging themselves and lowering the costs at the wellhead and getting a better deal from themselves for shipping costs. He wondered what happened upstream with TAPS owners and independent producers and asked for a follow up. Mr. Shine agreed to follow up. Co-Chair Seaton asked whether there was any interaction with the gross value reduction (GVR) for new oil or the 10 percent GVR for those with royalty shares above 12.25 percent. Mr. Shine answered in the negative. Representative Wilson thanked the department for negotiating the deal, which she believed was long overdue. She asked about the difference between the Tesoro contract and the Petro Star contract in how much more the state received. Mr. Shine replied that the prior Tesoro contract was $56 million more over 5 years and in the two current contracts between $29 million to $37 million more or the difference between the minimum nomination volumes versus the high-end volumes. Representative Wilson spoke to the best interest of the state. She asked if the department believed the contract was in the state's best interest. Mr. Shine replied in the affirmative. Representative Grenn asked for clarification of the fiscal note (FN 2 (DNR). He noted that according to the analysis on page two the proposed contract is expected to generate between $22 million and $27 million in revenues. He asked about the difference. 2:21:22 PM Mr. Shine responded that SB 30 was based on a four-year contract. He cited sub-bullets on slide 9 that reported the range for a four year contract similar to the fiscal note at $22.3 million to $27.9 million the minimum versus the maximum nomination range. DOUG CHAPADOS, CHIEF EXECUTIVE OFFICER AND PRESIDENT, PETRO STAR, thanked DNR for its work on the contract and felt that the contract was equitable. Representative Thompson asked whether Mr. Chapados was in favor of the contract. Mr. Chapados replied in the affirmative. He added that crude oil for his refineries was essential to remain in business and stated that it was becoming harder to source with the decline in throughput. The royalty oil served as the basis of his supply. Co-Chair Seaton agreed the contract was in the state's best interest. He asked if the company had any opposition to transparency regarding refinery credits. Mr. Chapados answered that Petro Star was happy to provide a level of transparency, but he believed it was more appropriate to have the issue attached to a tax bill. Co-Chair Seaton replied that he was not planning to add any language to the current bill. 2:25:09 PM Representative Wilson thanked Mr. Chapados for taking up the "gap" that had been left in Fairbanks by Flint Hills. Mr. Chapados answered that Petro Star was happy to still be in business and was happy to fill the gap left by the closure of Flint Hills. The company utilized the refinery credits that enabled Petro Star to fill the void. He reported that the company invested in an asphalt project and produced a low-cost fuel for use by Golden Valley Electric Association due to the credits. Representative Thompson stated that the company was currently holding about $15 million in tax credits. He asked if the company had been paid anything. Mr. Chapados replied that Petro Star submitted $5 million in tax credits generated in 2015 and would apply for $10 million in tax credits generated in 2016. 2:27:17 PM Co-Chair Foster OPENED and CLOSED public testimony. He relayed that the bill would be heard on Friday. SB 30 was HEARD and HELD in committee for further consideration.