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." 9:03:38 AM JIM SHINE, COMMERCIAL MANAGER, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES, discussed the presentation, "Proposed Sale of the State's Royalty Oil to Petro Star: Senate Bill 30; Senate Finance Committee" (copy on file). Co-Chair MacKinnon stated that Mr. Chapadose was online for questions. Mr. Shine looked at 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 pay 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. The SOA has regularly taken royalties of ANS oil as RIK (starting in 1979). The State will receive between $29 to $37 million in additional revenue over what the state would receive if the contracted volumes were taken RIV. Petro Star contract has been through public review and Royalty Board processes. Mr. Shine addressed 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 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. Co-Chair MacKinnon acknowledged Senator Micciche. 9:08:44 AM Senator Olson looked at slide 2. He queried the period that the increase of $29 million to $37 million took place. Mr. Shine replied that it included the current one-year contract and the four-year contract contained in the legislation. The one-year contract did not need legislative approval. The $29 million to $37 million included the one- year and four-year contracts through calendar year 2021. Senator Dunleavy stressed that the proceeds were deposited into the Permanent Fund. Mr. Shine agreed. Co-Chair MacKinnon noted that 50 percent of revenue was deposited into the Permanent Fund; 45 percent went to the general fund; and 5 percent went to the Public School Trust Fund. Mr. Shine agreed. Mr. Shine looked at 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; 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 highlighted slide 5, "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 addressed 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; 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. Senator Dunleavy looked at number 7, and wondered who oversaw that criteria. Mr. Shine replied that the Division of Oil and Gas oversaw that criteria, but he did not know how much consultation was done with other state agencies. He stated that the report indicated that there would be no negative environmental impacts. He stated that it was existing status quo operations for Petro Star. 9:13:46 AM Mr. Shine discussed slide 7, "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 percent of the total ANS royalty oil if the nominations from all RIK buyers is greater than the 95 percent 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 percent 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. 9:19:01 AM Mr. Shine addressed slide 8, "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 Plattsand 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. Senator Micciche queried the range of ANS spot prices for the calculation. Mr. Shine replied that the actual spot price was not included. He remarked that the local in-state differential gave the approximate $1.50 per barrel benefit over RIV. He stated that the starting point was the same regardless of the price of oil. Co-Chair MacKinnon wondered if it was fair to consider the revenue from the one-year contract. Mr. Shine replied that the one-year contract did not require legislative approval, so it was not included in the fiscal note. The $29 million to $37 million did include the benefit that the state would receive with the four-year contract and one-year contract. Senator Olson noted the volatility of the oil price market, and queried the advantage of a four-year contract versus a year-to-year contract. Mr. Shine replied that the benefit the state received was that it was not subject to a $3.50 per barrel deduction for marine transportation from the Valdez Marine Terminal to its west coast destination. Senator Olson announced that the price did not matter. Mr. Shine agreed. Mr. Shine continued to discuss slide 8: 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 percent of the amount resulting from the formula above, excluding "Line Loss." Senator Micciche noted that the differential between $29 million and $37 million was the transportation difference between the take-or-pay quantity and the max-quantity of the contract. Mr. Shine agreed. He stated that the $29 million would represent the benefit to the state if the minimum volumes were nominated in each contract month, versus the $37 million the state would receive if the maximum volume was nominated each month. 9:24:37 AM Mr. Shine looked at 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 percent-30 percent will be refined products. Petro Star refineries' estimated contribution to the local economy in 2014 was $25mm Vice-Chair Bishop felt that the four-year contract was a national security issue. He wanted comments on his concern. 9:25:54 AM DOUG CHAPADOSE, PRESIDENT AND CEO, PETRO STAR, ANCHORAGE (via teleconference), stated that Petro Star was the largest supplier of fuel to the Defense Logistics Agency, which was the federal agency responsible for supplying energy in all forms to the Department of Defense (DOD). He stated that the fuel supplied by Petro Star was essential to the war-fighting capabilities of the Pacific forces located in Alaska. He stressed that it was a large factor in determination to base the F-35 fighters at Eielson Air Force Base. Senator von Imhof noted that Golden Valley Electrical Association felt that the contract would provide a 10 percent or more reduction for the cost of power for approximately 35,000 Interior Alaska residence, because of the new fuel blend. Mr. Shine agreed. He acknowledged the letter of support in the bill packet. Senator von Imhof queried plans to expand beyond 35,000 customers. Mr. Shine deferred to Mr. Chapadose. Co-Chair MacKinnon shared that the public testimony portion of the meeting might address that concern. Co-Chair MacKinnon stressed it a contract which the state had made with Petro Star. She noted that the bill mentioned the Arctic Slope Regional Corporation, and queried the relationship and its inclusion in the statutory bill. Mr. Shine replied that Arctic Slope Regional Corporation was the parent wholly-owned subsidiary was Petro Star Refining. Mr. Chapadose thanked the efforts in drafting the contract. He stated that it was a long period to come to a resolution, and felt that it was a rewarding period. He was pleased with the contracts. 9:30:33 AM Senator von Imhof noted that Golden Valley Electrical Association (GVA) had entered into a contract with Petro Star to provide NAPTHA fuel costs, which resulted in a 10 percent decrease in costs. She remarked that GVA provided power to approximately 35,000 Interior Alaska members. She wondered if there were further plans for Petro Star to expand their footprint to provide natural gas to more residents. Mr. Chapadose responded that the 35,000 referenced the number of account holders of Golden Valley Electrical Association. Those individuals would receive the benefit of the new contract; therefore, the lower cost fuel was passed onto the consumers. He could not speak to expanding the GVA membership. Senator Micciche wondered why the availability of royalty oil to the refineries was not only beneficial to the parent company of the refinery. He queried its importance to the overall economy in Alaska. Mr. Chapadose replied that Petro Star operated the only refinery in the interior. The Flint Hills refinery was currently being demolished. He stressed that Petro Star was the only source of refined products within the interior region, including Valdez. The oil from the Trans-Alaska Pipeline System (TAPS) was the only oil available to refine. He stressed that the ability to source crude was critical to the Petro Star operation. He remarked that acquiring crude from producers was becoming more difficult, as production had decreased on the North Slope. He stated that the source of crude from the state was essential to remain in business. 9:35:09 AM Co-Chair MacKinnon CLOSED public testimony. 9:35:09 AM AT EASE 9:36:38 AM RECONVENED 9:36:40 AM Vice-Chair Bishop detailed the fiscal note. 9:37:05 AM AT EASE 9:37:16 AM RECONVENED Vice-Chair Bishop readdressed the fiscal note. SB 30 was HEARD and HELD in committee for further consideration. 9:38:25 AM AT EASE 9:40:00 AM RECONVENED