HB 393 - DEVELOP STRANDED GAS RESOURCES CHAIRMAN HODGINS stated that the committee would now hear HB 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." He asked Commissioner Condon to give his presentation. Number 0167 WILSON CONDON, Commissioner, Department of Revenue, stated that he was the chairman of the gas commercialization team, created by HB 250. He stated that HB 393 was introduced by the Governor and if enacted, would be called the Alaska Stranded Gas Development Act. He stated that he wanted to talk about the objective of the bill, the development of stranded gas in Alaska. He stated that Commissioner Shively and himself would testify about some provisions in the bill and then he would address the following seven policy issues: Alaska hire, gas supplies for local communities, municipal sharing in project revenue, confidentiality of information, Legislative approval, the question of whether one legislature can bind future legislatures with respect to the project's fiscal system and the delegation of tax and power. Number 0295 COMMISSIONER CONDON stated that a lot of gas has been discovered on the North Slope. He stated that in the Prudhoe Bay Reservoir, one- quarter of the recoverable energy that is available is in the form of gas. There has also been a big gas discovery on the North Slope, he asserted that the question that needs to be asked is why can't these resources be developed like oil and why do they appear to be stranded today. He explained that the reason is because it takes a lot more plumbing and more expense to haul an equivalent unit of energy in the form of gas to market then it does for a unit of energy in the form of oil. Number 0366 COMMISSIONER CONDON referred to the proposed project to take North Slope gas as liquefied natural gas (LNG) to Asia. The facilities for that project would include a conditioning plant, a pipeline, a liquefaction plant and ships. This project will cost about the same in nominal dollars as the oil pipeline in hauling the North Slope oil to market. Yet the proposed North Slope Gas Project will carry an energy equivalent of about 400,000 barrels of oil a day to market. He pointed out that it is one-third or less in energy equivalents of the oil stream that is going to market. Therefore, the situation is that there is the same dollar cost spread over one-third the amount of energy. Number 0436 COMMISSIONER CONDON stated that currently there are two possibilities for commercializing the North Slope Gas Resource: the above-mentioned LNG project, pipelining gas to tide water, liquefying it there and then transporting the LNG to Asian markets, or a gas-to-liquids (GTL) project. This project would convert North Slope Gas to liquids that could be transported through taps. It is the state's belief that the proposed LNG project has the best chance of commercial success. He pointed out that it would be helpful to review the alphabet soup of LNG, natural gas liquids (NGL) and GTL's. He stated that the liquids in each of them are quite different. He held up a model of a methane molecule which has one carbon molecule and four hydrogen molecules at the center. In order to make LNG, it is a physical process and this is what makes up the gas, it makes up 90 percent of the "good stuff". This "stuff" would be pipelined from the North Slope to Valdez or Prince William Sound to a liquefaction plant and then it would be cooled to minus 260 degrees Fahrenheit, and in doing so it becomes a liquid. The liquid is then hauled to Asia where it would be re- gasified and distributed through a pipeline system to a power plant and a town gas delivery system. Number 0639 COMMISSION CONDON stated that he wanted to talk about NGL'S, a substance which is present in natural gas but can be liquefied and sold as propane, butane and others. Currently, these gases are recovered out of the gas stream on the North Slope. Propane is made up of three carbon molecules and eight hydrogen molecules. He explained that it is one of the substances that comes out of the gas stream of Prudhoe Bay and used as miscible injectant to increase the recovery of oil in the reservoir. He stated that butane consists of four carbon and four hydrogen molecules. It is also recovered in the central gas facility of Prudhoe Bay and is blended with the crude oil and sent to market. He stated that substances which were generally thought of as gas are marketed from the North Slope as part of the crude oil springs. Number 0802 COMMISSIONER CONDON stated that he would talk about the chemical conversion of the substance methane into another chemical substance. This molecule is taken apart to achieve the conversion, the molecules are then put into another chemical process and constructed into another substance. He stated that the desired result is the molecule decane, which consists of 10 carbon molecules and 22 hydrogen molecules. He explained that what often happens is a molecule that had 20 carbon molecules and 42 hydrogens molecules which is wax. This cannot be prevented, therefore, there needs to be a facility in the project that will take that apart again to result in the two decane molecules. Number 0965 COMMISSIONER CONDON explained that a year and a half ago the department retained a Dr. Pedro van Meurs, a consultant that talks to governments around the world that are trying to structure their fiscal systems to develop resources. Dr. van Meurs was retained to see if there was something that the state could do to improve the economic viability of a North Slope Gas Project. His recommendations were that in order to be able to compete against other political entities, restructuring of the state and local fiscal regime should be considered to make it competitive with the fiscal terms that are being offered in respect to other grass roots projects around the Pacific Basin. Specifically, modify the front -end loaded fiscal system to one which is a back-end loaded and modify it in a way that it would be more progressive. This could be risking some of revenue that may be received in the event of low energy prices in exchange for receiving a higher share, if energy prices turn out to be high. He recommended increasing the fiscal certainty of the arrangements that are put in place, by embodying them in a contract. He also recommended that federal decision makers be engaged and that there is a succinct modification of federal fiscal terms so that they would also facilitate the project. Number 1118 COMMISSION CONDON stated that both state and local fiscal systems are just part of what is needed to come together before a North Slope gas project is going to be viable. There needs to be significant reductions in the cost and there needs to be favorable market conditions in order to have a successful resource to market. House Bill 393 would provide for payment, in lieu of taxes, for sponsors of a stranded gas project. He explained that existing taxes including production, property and corporate income taxes could be replaced by a single periodic payment that is more closely related to the projects profitability. And gives state and local governments more of a share of the projects economic grant later on in the life of the project. He stated that the provisions in the bill that lays out the above mentioned proposition is in AS 43.82.020 and AS 43.82.210(a) Number 1205 COMMISSIONER CONDON explained that stranded gas is gas that the commissioner determines to be uneconomic or uncompetitive to develop under prevailing economic or competitive conditions. He stated that the definitions are listed in AS 43.82.900(10). He stated that if the fiscal regime is embodied by a contract that is negotiated by the state, it will enhance the viability of a project for two reasons: First, it increases certainty regarding the return investors can expect because it decreases the possibility that the government's portion will rise unexpectably in the future. Secondly, it will increase certainty regarding the return investors can expect and therefore reduce the financial risks taken by the investors. He stated that it means that they will require a lower rate of return to compensate them for investing in a project. He stated that the department believes that is a sound justification for tailoring a fiscal system for a stranded gas project on a project by project basis to a fiscal contract. Number 1325 COMMISSIONER CONDON stated that under the proposed bill the potential project sponsors come to the commissioner with a proposal for development. The proposed AS 43.82.110 would require that a qualified sponsor or a sponsor group must intend to own an equity interest in the project or commit gas to the project. In addition, they must either own 10 percent of the gas that the project proposes to market, hold the necessary permits to construct the project or have a sufficient network or borrowing capacity to get the project moving. Number 1370 COMMISSIONER CONDON stated that a qualified project must be a proposal to develop 500 billion cubic feet or more of uncompetitive gas within 20 years from the project's commencement and it must be capable of satisfying local and state demand within the proximity of the project. These requirements are listed in AS 43.82.100. He explained that a qualified sponsor must also come in with a qualified plan and present that plan in the application, this is found in the bill under AS 43.82.120(b). A qualified client must have a proposal which reflects anticipated diligent development, it can not conflict with pertinent oil and gas lease terms and it has to be satisfactory for making gas available for instate demand within the proximity of the project. He stated that if there is a qualified project, qualified plan and qualified sponsor, the bill provides a review process to determine whether it is possible to go on and negotiate a contract. He stated that in respect to whether the applicant and the project are qualified, it is a determination made by the commissioner of revenue. Whether a project plan is satisfactory it would be made jointly by the commissioners of revenue and natural resources. This is stated in AS 43.82.120-150. Number 1518 COMMISSIONER CONDON stated that if the prospective sponsor was qualified in all respects then the application would be initially approved and the negotiation process would begin. He stated that the contract negotiations process is covered by AS 43.82, Sections 200 to 270, pages 10-17. The important point being that the fiscal terms are to be tailored to the particular economic conditions faced by the project. They are to be developed by the commissioner of revenue after reviewing the pertinent technical and market data. The commissioner of revenue may employ an independent consultant with the cost to be reimbursed by the applicant. The commissioner of natural resources may negotiate terms to be included in the contract that deal with certain aspects of the royalty. He stated that once a proposed contract is in place there is a period for public comment and legislative review. He stated that the provisions that deal with that aspect of the bill are AS 43.82.400-420 pages 19-21. Number 1611 COMMISSIONER CONDON stated that once a tentative contract has been negotiated, the commissioner of revenue is required to present the contract along with preliminary findings and a determination that the contract is in the long term fiscal interests of the state. He stated that the bill provides for legislative review but not legislative approval. After the opportunity for the general public and the legislature to review what the commissioner proposes to do, the commissioner may then enter into the contract and can change the terms of the contract provided that the long term fiscal interest of the state remains protected. Number 1654 COMMISSIONER CONDON stated that there are eight basis principles of contract development that are set forth in the proposed bill under AS 43.82.210(b), pages 10-11. He explained that in negotiating the contract the commissioner of revenue would be obligated to (1) improve the competitiveness of the proposed gas project, (2) develop a contract that was fair to both the state and to the projects sponsors under a wide range of economic circumstances, (3) provide fiscal terms that were progressive; state and local governments could take more if the economics turned out to be rich, (4) back-end loaded fiscal terms, (5) fiscal terms which recognize the sponsors need for a share of the up-side potential, (6) state and local governments should take a significant share of the proposed project economic grant, (7) clear and unambiguous terms and (8) the use of cost formulas for administrative certainty and efficiency were appropriate. He deferred to Commissioner Shively for some comments on the royalty provisions on the bill. Number 1755 JOHN SHIVELY, Commissioner, Department of Natural Resources, stated that AS 43.82.220 contains the royalty provisions. He explained that the department has not suggested a change in royalty rate, it would stay the same. The issue that could be negotiated on, is the timing of how they take in-kind versus in-value gas. Currently, they are operating under the royalty oil contracts and can change the amount of royalty oil or gas that is taken on a monthly basis, as long as six months notice is given. This causes potential problems for any project sponsor that is involved in long-term contracts. He pointed out that is an area that may require some negotiation during the review of the project proposal. He stated that the second thing to look at is how the royalty is determined. He stated that in the past there has been a number of disagreements regarding the evaluation methodology with the industry. Number 1839 COMMISSIONER CONDON stated that he would run throughout the seven policy issues. He explained that on the issue of Alaska hire, both the U.S. and Alaska Constitution limit the legislature's ability to impose local hire obligations in terms of exercising the legislature's police powers. He continued that the state does have more flexibility to achieve local hire objectives when it enters into contracts but it does run into problems, however, when the legislature mandates that it must be put into contracts. He stated that it is a difficult area and one which has to be approached with some delicacy. He stated that the local hire provisions are all found in the proposed AS 43.82.230, pages 13 to 15. He stated that the department would like to recommend a change to the definition of an Alaska resident. The definition in the bill is a person who has received a permanent fund dividend or any two of the following, a drivers license, a hunting fishing or trappers license, voter registration or motor vehicle registration. He stated that the drivers license and motor vehicle registration provision should be deleted so that it would be a permanent fund dividend or a hunting, fishing and trapping license and voter registration. In order to make those changes on page 15, line 5, an "and" would need to be added at the end of the line and strike the language on lines 8 and 9. Number 1967 COMMISSIONER CONDON addressed the issue of gas to communities. He stated that requiring project sponsors to subsidize local gas consumption would increase the project costs and have a dependency of pushing project economics in the wrong direction. He stated that they are trying to increase the likelihood that the project is going to come into being. He stated that they are going to be requiring a reasonable provision of gas to communities and they need to figure out ways to reduce the uncertainty regarding the quantity of gas that the project is going to be required to deliver to local users. This is so that requiring Alaska deliveries is not a disincentive to the project. Number 2016 COMMISSIONER CONDON stated that the third area is municipal revenue sharing. Clearly, the single step that both state and local governments can take to improve economics of this project is to relieve the project of the tax burden of a local property tax before the project goes into operation. He stated that the state and local governments will feel the largest negative impact from the project in terms of providing social services and the social disruption that occurs with a large project. He pointed out that the question is whether or not it is worth it. He stated that there is the question of how municipalities should share in the revenues generated by a fiscal contract. Whether municipal governments should be at the table, is a question that the legislature needs to address. He pointed out that the bill does not provide for that now and it if it were made to include them, negotiations would be more cumbersome. Number 2107 COMMISSIONER CONDON addressed the area of confidentiality, trade secrets would be held in confidence by the state. That information would be shared among the pertinent executive branch agencies and the legislature, but would be kept confidential as long as they truly were trade secrets. The memorandum and documents generated during the negotiation process would remain confidential during the negotiation process but would be entirely open and available for review once the review of the contract began. He stated that it is stated in AS 43.82.310(f). Number 2171 COMMISSIONER CONDON addressed the issue of legislative approval of the contract. Formal legislative approval of any fiscal contract involving the taxation of stranded gas is important for both policy and legal reasons. The Governor strongly supports formal legislative approval and has pledged to require it even if a legislature enacts legislation without legislatively inserting that requirement. He stated that the bill did not include this requirement because he was advised against it due to technical constitutional reasons. Number 2276 COMMISSIONER CONDON stated that the final issue is, can one legislature bind future legislatures with respect to the tax liability of a project. He stated that the Department of Law has concluded that it is not possible to bind future legislatures. He stated that it could be done with a properly written fiscal contract which raises the issue of if the legislature wants to test that authority. The considerations are what the legislature believes its power ought to be and what effect litigation would have on this project. He stated that he thought it would be wiser to avoid litigation and the exploration of the issue of what the extent of legislative power is. Number 2372 CHAIRMAN HODGINS stated that he would like to have a presentation by the producers and that the majority of the work be done in this committee. Number 2417 REPRESENTATIVE JOE RYAN stated that the bill requires a deep leap of faith on the part of the legislature. He stated that it is time to get to the serious negotiations of what the resources are worth to state of Alaska and how far Alaska is willing to go to sell the project. He stated that there has not been any testimony as to the potential of the project. TAPE 98-11, SIDE B Number 0033 REPRESENTATIVE RYAN stated that the commissioner of revenue through the bill is given a lot of power and he questioned if that was wise. CHAIRMAN HODGINS stated that at a earlier meeting Dr. Pedro van Meurs' testified that he thought there was approximately $150 billion worth of revenues. He stated that Dr. van Meurs would be back at a later date to answer those questions. Number 0064 REPRESENTATIVE KEMPLEN asked that on page 7, line 5 "proximity of the project" if the definition could be nailed down better than as stated. He questioned if it was just within 10 miles or does it extend to a pipeline that goes out to Southcentral Alaska. Number 0099 CHAIRMAN HODGINS stated that it is his hope that committee members will pick the bill apart and make sure that there are no unanswered questions. He stated that HB 393 will be held over for further consideration.