SB 208-DNR STUDY ON NATURAL GAS  3:36:40 PM CO-CHAIR WIELECHOWSKI announced SB 208 to be up for consideration. MICHELLE SYDEMAN, staff to Senator Wielechowski, sponsor of SB 208, explained that many share a growing concern over the dwindling reserves of natural gas in Cook Inlet. Last year the committee heard testimony on this topic from Kevin Banks, Director, Division of Oil and Gas, and Bob Swenson, Director, Division of Geological and Geophysical Survey, both with the DNR. They were all shown a chart that is in their packets today that is known as "The Waterfall Chart," which depicts declining production from Cook Inlet wells. Unless there is additional exploration and identification of new reserves by 2012 the possibility exists of homes and businesses in Southcentral Alaska not having sufficient gas. She said that earlier this year the DNR completed a new assessment of known possible and probable reserves in Cook Inlet. The review concluded that if sufficient investing in the Inlet were made, supplies could last a great deal longer, certainly into the next decade. This would be especially good for the local economy since gas produced locally would not be subject to expensive tariffs or other transportation costs. MS. SYDEMAN said the challenge still remains of deciding what actions the state should take if any at all to encourage more natural gas exploration and production in the Inlet. 3:37:34 PM SENATOR HUGGINS joined the committee. 3:37:43 PM MS. SYDEMAN remembered the June 4 meeting in Anchorage when producers from Cook Inlet were asked what could be done to help them feel more comfortable investing there. So, she said, this bill examines which incentives are most likely to work and which would simply transfer precious state dollars from the state treasury to companies that otherwise might have sufficient incentive to invest in the Inlet if proper market conditions exist. It asks if the state can take steps other than lowering tax rates or increasing credits that might have a greater effect on private sector behavior. This question is particularly compelling in light of the very modest tax rates and generous tax credits the producers in the Inlet already enjoy, and the fact that the Legislature has gone to lengths to encourage more gas production in the Inlet. It asks to what extent those incentives are working, because that is not exactly known now. Before the state leaps to offer additional incentives, Ms. Sydeman stated, this bill seeks to answer questions like what other jurisdictions are doing to promote more investment. If the small size of the market in Alaska is an impediment to new exploration and production, which they all heard last June, are can the state take steps to enhance the market to ensure that producers see a return on their investment in a reasonable time frame? Could it commit to buying proven reserves upfront so investors don't have to wait years to realize their investment, for instance? MS. SYDEMAN said last week they heard testimony that the state already reimburses companies for roughly 45-65 percent of their exploration costs. Given this fact, how can the state partner more effectively with industry to ensure that the needs of Alaskans for a long-term, affordable and reliable source of gas are met? Would it be worthwhile to consider establishment of a state entity like ANGDA to partner with the private sector to explore in areas where a critical need for gas exists? She said this bill calls for a speedy analysis of these questions before new incentives are enacted. It asks Department of Natural Resources (DNR) and the Department of Revenue (DOR)to assess the effectiveness of existing incentives, propose new incentives they believe will be useful and then look more broadly at what other strategies the state might employ to make sure Alaskans don't tumble down the cliff depicted in the waterfall chart. Most importantly, it calls for this work to be done expeditiously - by November 1 of this year, so the legislature can act swiftly next year once the foundation for more informed decisions has been laid. 3:41:39 PM KEVIN BANKS, Director, Division of Oil and Gas, Department of Natural Resources (DNR), said he was available to answer questions on SB 208. SENATOR WAGONER said he wanted Mr. Banks to talk about how important the market is versus the incentive to explore. He thought they had already incentivized gas exploration in Cook Inlet as much as possible some years ago. 3:42:45 PM MR. BANKS responded that was a good point and that the waterfall chart is as much a function of decline in demand in the marketplace as it is a decline in production. The real challenge in the Cook Inlet market is that it has essentially three large sellers of gas and three or so consumers of gas in the form of the electric utilities and the local distribution company, EnStar. As a consequence, the marketplace has few players. So he likes to say, "The market is free, but it's not necessarily competitive." 3:44:10 PM Furthermore, he remarked, it's challenged because the contracting arrangements among all of the parties don't always come due at the same time. So, one contract will expire and it may be the only time that buyers and sellers are interacting in the marketplace until another contract is negotiated. There are very few indicators of what the market price is or should be, and it's difficult to know what market incentives exist to encourage new production in the kind of "surplus production" that the Inlet has enjoyed for so long - the lack of which is creating some anxiety about future supplies. 3:44:59 PM SENATOR STEDMAN asked if he has seen any changes since the PPT was passed and if they need to review that work. MR. BANKS answered that at the moment, the tax rate that applies to gas in the Cook Inlet is only about $17.07/mcf, and as prices for gas change in time, that number will remain the same under the current tax regime. Tax credits can be used in Cook Inlet, but he didn't know how the credits and tax rate interact with each other; DNR might better respond to that. It was his impression that the tax and royalty provisions that apply in the Cook Inlet exert kind of a light touch on production there. Several fields have only a 5-percent royalty as result of legislation that was done 10 years ago. He mentioned that Armstrong is developing the North Fork Unit - one of those 5- percent royalty fields. So in a sense, a lot of the stimulus in terms of tax and royalty incentives is already in place. Then to follow on from Senator Wagoner's point, it would behoove legislators to try to get a better understanding of how the market interacts, so they might considering doing something to expand it. CO-CHAIR WIELECHOWSKI said this is one of the first things he looked into when elected over three years ago and they still don't have an answer. Some of the lowest tax and royalty rates in the nation are in Cook Inlet; so that looks like the incentives that are in place are not working and his thought is to step back and get some experts to evaluate how exploration can be spurred. 3:48:40 PM SENATOR WAGONER said no one will explore and drill for gas without a market or a place to put it. Right now there is no place to put it; the only outlet is the LNG plant. Has any producer other than ConocoPhillips or Marathon put any gas into the LNG plant? MR. BANKS said he didn't know. 3:49:48 PM JOHN IVERSON, Director, Tax Division, Department of Revenue (DOR), said that exploration in Cook Inlet is very heavily incentivized from a tax credit perspective. SENATOR HUGGINS stated that it appears that this area is a victim of a lack of effort and the subject gets just probed whenever it comes up. He has listened to the department talk about all the gas there and he has seen the charts and all we have to do is go get it. The two jack-up rigs the Murkowski administration talked about "just went away." Right now the state has an in-state gas coordinator that is supposed to be working on things like this. Enstar and ANGDA have been working on it, the Railbelt consolidation is going on, and then there's the RCA that no matter what solution they come up with, they tend to be able "to just screw it up" because long term contracts can't be used. He asked Mr. Banks if he was "Mr. Cook Inlet," programmatically, what three things would he do in Cook Inlet? 3:53:19 PM MR. BANKS answered that he looks at the problem from different perspectives. Number one, the size of the market is pretty small; number two, the Cook Inlet region has enjoyed relatively low gas prices because it had a surplus of productive capability - people looking for oil found large gas fields. It was actually cheaper to just drill another producing well than to do anything else. If we want to go back to the time where we had this kind of surplus productive capacity, then that tends to mean there are different kinds of problems to solve. First of all, the market must be bigger. It has to have some kind of support either in exports or some other kind of demand. The issue, then, is if gas can be found for prices that are attractive for those kinds of projects. 3:55:21 PM MR. BANKS said he is convinced that Cook Inlet has a fair amount of gas in the ground, and the trigger to get it to market is not just a matter of price, although that is important. A place to put it is also needed; and this requires increasing costly investments. He said the he would look for ways to expand the market, ways to export, and create situations within the market today that will solve some of the more critical problems. For instance, the supply on an annual basis as indicated in the supply studies is part of the problem, but gas supply is also needed in the winter when it's cold and consumption rates are high. Storage will be needed for that. They also need to make sure that the infrastructure for supplying gas to homes will not break down - so reliability is another factor. Also some kind of mechanism should be considered so that a lessee or a producer doesn't have to strand his supply of gas in order to give the state peace of mind knowing that it has a sufficient supply of gas - whatever that means. 3:56:46 PM SENATOR HUGGINS said effort are going on right now to work LNG imports and he characterizes that as - okay we can't solve our problems, so we'll buy somebody else's product and invest in their jobs. He hangs his head when he thinks about it. He asked Mr. Banks if he was aware of those efforts. MR. BANKS answered no. SENATOR HUGGINS remarked, "Call the Railbelt Consolidation guys, because they're doing it." MR. BANKS asked if he was referring to the integrated resource development plan. SENATOR HUGGINS said that is part of it. CO-CHAIR WIELECHOWSKI agreed with him and said that all these groups have been studying these problems for years, but no comprehensive plan has been developed for it. 3:58:22 PM SENATOR STEDMAN asked Mr. Banks to clarify what he means by expanding and "unstranding" the Cook Inlet area. MR. BANKS replied that he means if the goal is to be where we used to be with excess gas supply, the only way to have that is to have a larger market. But the industrial LNG market was created to take up excess supply. When consumers needed the gas, there was an opportunity to direct production into the local market. To the extent that the reserves on the graph are "stranded" it means that people are not drilling for these kinds of supplies of gas because they know that unless they can enter into some kind of agreement with a local utility, there is no point in drilling today. So, a producer will wait until it has a supply contract with certain supply requirements that must be met and then make the drilling commitments to satisfy those requirements. It seemed to him that a broader market with more players would create conditions for more production. 4:00:27 PM SENATOR STEDMAN asked what part the long term pricing contracts play into this and how do they incentivize producers to drill if they aren't able to get a long term contract to make it worth their while to go drill. MR. BANKS replied that he was hitting on all the issues that surround the problems with getting more production out of the Cook Inlet, and he didn't disagree with anything he said. Even the possibility of LNG exports from Cook Inlet in the future, a new industrial use, or the reestablishment of Agrium's plant will truly depend on the price of gas. How the marketplace with so few players gets to that price is a real challenge. He said he shares everyone's frustration that he has heard here today about how the market itself doesn't seem to be taking care of what residents' expectations are for that region - that new supplies will be produced there. So, something else needs to be examined as a possibility. A structure like ANGDA should be explored and that is what that kind of study is doing. 4:02:49 PM SENATOR WAGONER suggested the he discuss the Armstrong re- drilling on the North Fork of the Anchor River and talk about the history of that gas field where oil was explored in the early '70s, but gas was found. The wells were capped, because there was no market or transportation for it. MR. BANKS explained that North Fork and several other fields that are now under way in the last several years are an example of fields that had been discovered very early on in the search for oil, but because of the lack of transportation and the technology that existed in those days the gas wasn't produced. Now Armstrong is bringing in different technologies that weren't even available when the gas was discovered and they have a commitment to sell 10 bcf to Enstar. Presumably the price will be satisfactory to Armstrong to encourage their development, and those are a bit higher than what the weighted average cost of gas is today in the Cook Inlet. 4:05:25 PM SENATOR HUGGINS recalled that the state has one lease for gas storage. MR. BANKS answered that three gas storage facilities exist now in the Cook Inlet - one is on federal land at Swanson River and two are on state land. SENATOR HUGGINS said one is proposed by ANR, a subsidiary of TransCanada, and it appears that it has been put in limbo by the Regulatory Commission of Alaska (RCA) and their connotation that there potentially has to be legislation before it will go forward. MR. BANKS said he wouldn't say that judging by the level of activities his division is entering into and that the department is involved with in terms of permitting the project and developing the storage lease. It is correct that the RCA ruled that it regarded its jurisdiction as muddled over the question of whether or not they would regulate storage there, but he wasn't sure to what extent that is going to hold up a project that still has an 18-month timeframe before production goes into it. 4:07:31 PM SENATOR HUGGINS said if modifications have to happen legislatively, would he be correct in assuming the administration would bring forward some legislation. Does there have to be a fix? MR. BANKS replied that he didn't know what the administration is planning on doing on that issue, but he knew some discussions were going on in the other body with the chairman of the RCA now. SENATOR HUGGINS said he is supportive of his efforts to get some things done. Lawmakers need some answers, because they can't just "dilly dally on the sidelines" while people end up without any gas. CO-CHAIR MCGUIRE asked what kind of outreach his division does or how it interfaces with potential commercial consumers in the Cook Inlet. For instance, she said, Alberta has an active portion of its department looking for those industrial anchors that will be a part of developing these basins and trying to match them up with potential explorers. 4:09:05 PM MR. BANKS replied that the department doesn't have a specific outreach to that kind of consumer, but it does spend a lot time with the potential producers and potential new producers. It was an attempt of theirs in licensing the LNG plant where exports are now occurring to encourage the operators of the plant to offer the services of the LNG plant to other suppliers as part of an RFP that they were to publish just prior to the export license period to begin. They did that without much success. When the opportunity arises the department steps up, but it doesn't do that kind of advertising and promoting that she is thinking about. 4:11:04 PM CO-CHAIR MCGUIRE asked who is leading the charge in developing Cook Inlet, and said perhaps the administration is the better branch of government to do this. She remembered last year that no one was interested in gas storage in the Interim and then she started hearing rumors that TransCanada had been in conversations with the department and is on the fast track to a storage facility. How is the department participating in those negotiations? 4:12:54 PM MR. BANKS thanked her for the encouragement to develop new markets for the state's gas. He said that he went to China in December and met with petrochemical companies along with Harold Heinze and some legislators as part of his "ongoing duties as assigned" in trying to find potential gas markets in general. With respect to the TransCanada project, they are thought of as the applicant for the AGIA pipeline, but their subsidiary, ANR, has a lot of storage capacity in facilities in the Midwest, particularly in Michigan. So becoming a potential sponsor of a storage facility whose role it is only to provide the warehousing of the gas and pumping it out when it is needed hasn't been done yet in the state of Alaska. ANR came to the department about six months ago and they are working through a process to gain the appropriate permits and the land they will need for the surface operations, and the DNR is helping them prepare the lease agreements that will make it possible for them to operate a storage facility on the state's mineral estate. That company and the current lessee have agreements; some of those discussions are ongoing and confidential so he couldn't say too much. He related that the department has had other sporadic conversations with other sponsors in the Cook Inlet region; he has gotten the sense that the sponsors have gone back to do some more homework and he full expects them back as time goes on. He said, "There are more than just the TransCanada ANR proposal that may come to fore here in the next couple of years." CO-CHAIR MCGUIRE said a second example occurred to her - the first one being AGIA - of when the government decides to really fast track and put together a series of permits, advice, authority, and bring suppliers together. She would like to see Alaskan companies coming forward and maybe the department could come up with a process to get more information out to them about the opportunities. SENATOR STEDMAN went to page 3, line 1, that said, "identify, evaluate and recommend additional incentives that may be enacted by the legislature for increasing exploration and development of gas" and suggested softening it to "that may be enacted by the legislature" because they are really trying to come up with a solution. He went to a similar item on line 4 says, "determine the cost, feasibility, and a proposed organizational structure for a new state entity". He said some are a little gun shy about continually creating new state entities; Cook Inlet already has too many entities running around. This issue has been going on for several years and it seemed more like a long-term price issue to him. 4:19:08 PM MR. BANKS said on that last point, their supply study had an observation that bringing in the new resources will cost more than in the past and that the right kind of price signal will have to be available to producers to do it. He agreed that an "organizational structure" might be a "long reach" and that they should look at all possibilities. However, he thought this bill intended to look for a more active role by the state to achieve some new supply. SENATOR STEDMAN said he still thought that until the long-term price issue is solved, they can do everything including paying an explorer directly to explore and even that wouldn't solve the problem. He said lowering the tax rate in Cook Inlet three years ago didn't produce the results they were hoping for then and he did not want to create another state bureaucracy that would not lead to a solution. CO-CHAIR WIELECHOWSKI said Cook Inlet has some of the lowest taxes in the country and very low royalty rates, but it's not getting exploration. If the producers who have the leases are not willing to develop the leases they have, he said, let's do it ourselves. 4:22:55 PM SENATOR WAGONER said if they really want the "free market" to work, they should have a five year sunset and keep RCA from having oversight on gas contracts. Basically that gas has one major user, Enstar, and with the RCA controlling the market, they won't see much exploration in Cook Inlet other than what can be put under contract. Taking RCA out of the picture would stimulate some exploration and production. CO-CHAIR MCGUIRE said she and Senator Wielechowski diverged philosophically on this particular method of solving the problem, but they don't diverge on the need for it. That sense of frustration is pretty unanimous, but the need in Cook Inlet is "dire." She thought in a state that depends so much on this resource someone should be tasked with bringing people to the table to chat with other folks - like the tourism and fisheries industries do. SENATOR STEDMAN said he supported the concept of the bill, but they need to look back at what incentives they have already done in Cook Inlet over the last decade - reducing taxes, increasing credits, and ring-fencing Cook Inlet - that were supposed to address this issue. CO-CHAIR WIELECHOWSKI said that is a good point and he also thought they should look at what has been done in the past and not repeat themselves on something that isn't working. 4:29:31 PM JERRY MCCUTCHEON, representing himself, Anchorage, Alaska, said this is a Kevin Banks problem. They don't need to encourage further Cook Inlet gas production with tax breaks or whatever; they need to enforce the leases in Alaska's constitution. 4:31:12 PM CO-CHAIR WIELECHOWSKI announced a recess. 4:31:17 PM CO-CHAIR WIELECHOWSKI called the meeting back to order at 4:31. He closed public testimony and announced that SB 208 would be set aside for further work.