HOUSE FINANCE COMMITTEE APRIL 30, 1996 1:55 P.M. TAPE HFC 96 - 150, Side 1, #000 - end. TAPE HFC 96 - 150, Side 2, #000 - end. TAPE HFC 96 - 151, Side 1, #000 - end. TAPE HFC 96 - 151, Side 2, #000 - #329. CALL TO ORDER Co-Chair Mark Hanley called the House Finance Committee meeting to order at 1:55 P.M. PRESENT Co-Chair Hanley Representative Martin Co-Chair Foster Representative Mulder Representative Brown Representative Navarre Representative Grussendorf Representative Parnell Representative Kelly Representative Therriault Representative Kohring ALSO PRESENT John Shively, Commissioner, Department of Natural Resources; Kenneth Boyd, Director, Division of Oil and Gas, Department of Natural Resources, Anchorage; Patrick Coughlin, Deputy Director, Division of Oil and Gas, Department of Natural Resources, Anchorage; Keith Burke, General Manager, Support Industry-Alaska Alliance Organization, Anchorage; Steve Conn, Executive Director, Alaska Public Interest Research Group, Anchorage; Eric Luttrell, Vice President for New Development, BP Exploration, Anchorage; Jerry McCutcheon, (Testified via teleconference), Anchorage; Mike Bruner, (Testified via teleconference), Anchorage. SUMMARY SB 89 An Act relating to the members of the board and staff of the Alaska Permanent Fund Corporation. SB 89 was postponed for a hearing at a later date. SB 98 An Act making changes related to the aid to families with dependent children program, the Medicaid program, the general relief assistance program, and the adult public assistance program; directing the Department of Health and Social Services to apply to the federal government for waivers to implement the changes where necessary; 1 relating to eligibility for permanent fund dividends of certain individuals who receive state assistance, to notice requirements applicable to the dividend program; and providing for an effective date. SB 98 was postponed for a hearing at a later date. SB 112 An Act establishing a discovery royalty credit for the lessees of state land drilling exploratory wells and making the first discovery of oil or gas in commercial quantities. SB 112 was rescheduled for May 1, 1996 A.M. meeting. SB 289 An Act relating to runaway minors and their families or legal custodians. SB 289 was postponed for a hearing at a later date. HB 500 An Act making capital and other appropriations; and providing for an effective date. HB 500 was postponed for a hearing at a later date. HB 548 An Act authorizing, approving, and ratifying the amendment of Northstar Unit oil and gas leases between the State of Alaska and BP Exploration (Alaska) Inc.; and providing for an effective date. CS HB 548 (WTR) was reported out of Committee with a "do pass" recommendation and with two fiscal notes by the Department of Natural Resources. HOUSE BILL 548 "An Act authorizing, approving, and ratifying the amendment of Northstar Unit oil and gas leases between the State of Alaska and BP Exploration (Alaska) Inc.; and providing for an effective date." JERRY MCCUTCHEON, (TESTIFIED VIA TELECONFERENCE), ANCHORAGE, stated that judging from what Governor Knowles and British Petroleum (BP) have said regarding legislative information, the down side, assuming the recovery was 105 million barrels, the contract would yield $28 million dollars more than the current contract. He emphasized that the proposal 2 put forth by the Administration was not a smart business move for the State. Mr. McCutcheon suggested that the Governor and BP were not supplying all the data on Northstar and Amerada-Hess. He insinuated that hearings were being held without public notice so as to move this "unfair" deal through the Legislature. Mr. McCutcheon spoke to Seal No. #1 and Northstar No. #1, two large wells. He continued, Seal No. not dry, it would greatly increase the size of the Northstar project. Seal No. #4 appears to be outside of the Amerada- Hess leases and on federal lands. Under a U.S. Supreme Court decision coming forth, Seal Island may extend State lands into what formerly was federal land. That move could enhance State revenues. Mr. McCutcheon continued, the "well step-outs" are approximately one mile, except Seal No. #3. The area served by the island with a mile step-out is 3.6 square miles, amounting to 6.3 square miles for Northstar and the Seal Islands. He asked why the leases cover 60 square miles for only 6.3 square miles indicated. Mr. McCutcheon claimed that BP has suggested that the field could produce 13 billion barrels of recoverable oil; he claimed that 17 billion barrels would be more accurate. He noted that his company found that the Northstar original oil in place (OOIP) is twice what BP claims. If the 45% rate BP claims recoverable, then 180 million barrels are recoverable with an OOIP of 400 million barrels. Crude oil is 42 degrees gravity oil with gas to use in recovery. The recoverable oil should approach 80% or better, 300 million barrels-plus which is about two and half times what the Knowles Administration and BP have told the Legislature. Mr. McCutcheon calculated that 130 million barrels vs. 320 million barrels is 190 million barrels more, and at $6 dollars a barrel that is a $1.1 billion dollar difference. He suggested that perhaps Seal Island No. #4 is not dry. That would be a loss to the State. Mr. McCutcheon summarized that OOIP is twice what BP suggests in relationship to the Amerada-Hess numbers, making it is a very high crude grade which could be twice as recoverable as BP claims. Speculation warrants concern that BP will not show the contract made with Amerada-Hess. Mr. McCutcheon suggested that BP had not purchased the leases but would receive a share to commensurate BP's ability to "beat down" the State. MIKE BRUNER, (TESTIFIED VIA TELECONFERENCE), ANCHORAGE, 3 testified in opposition to the renegotiation of the Northstar leases. He said that it was not constitutional. It is specified in statute that the Legislature "shall" develop the leases for the maximum benefit of the people. He indicated that "shall" does not mean "may". He suggested that there should be a mutuality of consideration. The State should not loose. He commented that BP would not be "pushing" the bill if they did not have a lot at stake to win. Mr. Bruner suggested that the proposed legislation was a "scandal" about to happen, stressing that the legislation is not in the best interest to the State. Representative Therriault commented that the estimated reserves have taken continual investment. That investment will be paid for by the State. ERIC LUTTRELL, VICE PRESIDENT FOR NEW DEVELOPMENTS, BP EXPLORATION, ANCHORAGE, provided back-ground information on BP Exploration. He suggested that BP's interest is in the development of new fields in Alaska. The agreement will unlock the potential of Northstar which has been blocked for seventeen years. The agreement reached with the State will fully align BP's interest and will provide a substantial benefit in terms of economic development and jobs. He added, when Northstar is developed, it will provide substantial revenues to the State of Alaska. BP acquired Northstar in 1994 from Amerada-Hess and purchased an additional piece of the field from Shell Oil in early, 1995. The purchase was made in a competitive process in hopes of reducing development costs. BP realized that net share profit (NSP) terms were on the leases. BP purchased Northstar anticipating that would not be a problem and that an agreement could be made with the State. To date, BP has invested $25 million dollars in Northstar. Mr. Luttrell explained that the agreement with the State is not an incentive or concession, but is an agreement by two parties to allow development of the field in a timely manner. The agreement does contain BP's commitment to Alaska hire and Alaska fabrication. The total benefits to the State will be near $1 billion dollars. Alaskan contractors will be working with BP. Mr. Luttrell spoke to the fabrication issue. BP, following examination of Alaskan capabilities, agreed that a considerable amount of the work will be performed within the State. The probable cost to BP using in-state hire will be $15 million dollars more. All design and engineering work will be done within Alaska and will result in substantial 4 new business opportunities for the State. He concluded that BP is excited about Northstar and the potential, noting that the project is critical to the State and to BP. If new oil fields are not developed, then BP would remove their business from the State. The proposed development will unlock a large potential for Alaska in off- shore and fabrication work. Representative Brown referenced Exhibit C in the renegotiated lease project schedule. She asked if the "obligation" would be affected by the "force majeure" clause as part of the lease. Mr. Luttrell noted that clause should cover the project schedule. He added that he did not know when they would invoke "force majeure", but the language does allow it. Representative Brown noted that Paragraph #41, which relates to employment of Alaska residents, was entirely being replaced. She suggested that BP had made purchasing decisions using commercial justification for taking business out of Alaska. Mr. Luttrell was not familiar with the language. Representative Brown informed him that language related to suppliers who were unhappy loosing BP's business. Representative Brown questioned the net profit share (NPS) being referred to as a "tax". Mr. Luttrell responded that "it" had been referred to in a variety of ways; as a tax and as a royalty. Representative Brown asserted that it should not be referred to as a tax. She referenced a handout previously distributed from Mr. Luttrell, dated 1/2/96, Initial Feedback from Discussion with the Legislature. [Copy on file]. She asked why there was a specific Northstar bill and not a policy "fix" of all net profit share lease (NPSL) terms. Mr. Luttrell replied that was a "rhetorical" question. Representative Brown asked why BP acquired the purchase from Amerada-Hess given the NPSL sale terms. Mr. Luttrell replied that BP acquired an "option" from Amerada-Hess, providing an economic possibility. Representative Brown questioned if BP recognized the responsibility to act upon the State's behalf with the leases held. Mr. Luttrell noted they did. Representative Brown inquired what would distinguish this lease. Mr. Luttrell replied that BP had a number of economic models from which to choose. BP came to the conclusion that to proceed, the interest of the State would be "different". The commercial interest would dictate something that would not be of benefit to the State. BP 5 made a decision not to develop the field. Representative Brown ascertained that the field appears to be very profitable with rates returned projected to be better than 20% and profits returned at $3.50 a barrel. She pointed out that the lease has been locked into a 20% return. She voiced caution that action would prematurely shut the field in. Mr. Luttrell commented that an early condition in negotiation with the Department of Natural Resources was to not seek relief under AS 207. Representative Brown asked if there had was ongoing discussion with the Department regarding the possibility of amending any other leases. Mr. Luttrell said no. Representative Brown asked if there has been discussion regarding the possibility of gas development. Mr. Luttrell replied no; adding that no written analysis had been prepared on other legal points. Representative Brown spoke to the size of the field and the downward readjustment of the parameters. Mr. Luttrell stated that he did not know the original estimates. He thought that the production rate should be around ten thousand barrel per day. Representative Brown stated that testimony on the record has indicated that it is common practice in industry that the growth rate be increased two or three times the original estimate of oil in place. She asked if that was true. Representative Brown discussed the State's interest and spoke on behalf of the State as the royalty owner. She spoke to the common experience regarding world expectation. Mr. Luttrell stated since his tenure at Northstar, there have been no downward revisions. Representative Brown requested information on BP's interest recently acquired in Venezuela and the terms involved with that purchase. Mr. Luttrell responded that those were not net profit terms, rather a tax and royalty system, similar to Alaska. That area was acquired at a generous deal to the company. The costs associated with activity in the well are substantially less than they are in Alaska. The agreement is "economic". Representative Brown pointed out that the per barrel profit in Alaska is much greater than that in Venezuela. Representative Brown asked how much BP had spent on advertising to convince Alaskans that the Northstar proposal would be in their best interest. Mr. Luttrell replied approximately $50 thousand dollars. (Tape Change, HFC 96-150, Side 2). 6 Representative Therriault asked for more information regarding the jobs which could flow to workers in Fairbanks. Mr. Luttrell replied that construction of modules could be built in Fairbanks. One of the bidders for that project will be the firm H.C. Price. He also understood that the gravel work would be done by an agency in Fairbanks. Representative Martin voiced support for Alaskan hire. Representative Brown asked if there was a significant difference in the capital costs of producing the modules in Alaska versus sharing with other facilities. Mr. Luttrell replied, the options have been cut. The amount of capital to proces on the island as opposed to on shore was modest. The decision has been made to do the processing on the island. Representative Therriault asked if that decision was irreversible. Mr. Luttrell could not imagine changing that decision. Mr. Luttrell spoke to the "economics" of the project. He spoke to the material added in the House Resources version of the legislation. Mr. Luttrell referenced the NORTHSTAR: Key Variables Affecting Economics. [Copy on file]. He provided an overview of the variables: * Oil reserves * Capital investment * Oil price * Operating costs * Production rate Mr. Luttrell spoke to the misalignments: * Lowering operating cost: Increase the revenue account and Accelerates initiation of Net Profit Share * Increasing flow rate: Increase near term revenues and Accelerates initiation of Net Profit Share Representative Brown spoke to BP's response to the Senate Resources Committee request dated 4/3/96, and asked if changes had been made to that request. Mr. Luttrell stated no changes had been made. He added that the number quoted for Shradder Bluff originated from a document presented by BP and Occidental to that Committee; he suggested it was an optimistic number. Representative Navarre inquired where an "optimistic number" would fall. Mr. Luttrell understood that $9.68 dollars was the actual cost of development at Trader Bluff. The cost of 7 development is not the only determinant of the value of the field. STEVEN CONN, EXECUTIVE DIRECTOR, ALASKA PUBLIC INTEREST RESEARCH GROUP, ANCHORAGE, spoke against passage of the proposed legislation. Mr. Conn referenced the keynote speech of E.L. Bartlett at the original Alaska State Constitutional Convention. The Department of Natural Resources has testified to BP's refusal to develop the Northstar unit lease. That represents the first occasion in which the State oil and gas lessee has confirmed they could develop an oil field, although, are unwilling to do so unless the State renegotiates the competitive bid terms of the lease. Mr. Conn noted the dangers indicated by delegate Bartlett, stressing that outside interests could stifle development in Alaska which would compete with activities elsewhere. That action has resulted in the terms of the renegotiated lease. He urged the Committee to take seriously their "responsibility" to be the stewards of the land and public resources. KEITH BURKE, GENERAL MANAGER, SUPPORT INDUSTRY-ALASKA ALLIANCE ORGANIZATION, ANCHORAGE, spoke in support of the proposed legislation. The legislation will put members of the Alliance and others to work. BP is willing to contract the activities in both Anchorage and Fairbanks. (Tape Change, HFC 96-151, Side 1). JOHN SHIVELY, COMMISSIONER, DEPARTMENT OF NATURAL RESOURCES, spoke to the 1993 Department of Energy study which addressed deterrents to development of the field and confirmation of the reserves. The reserves have not been confirmed. He pointed out that with the National Price Index (NPI) in place, it would not be an economic prospect for price cases. Commissioner Shively commented on the history of the case. In 1994, Amerada-Hess drilled one more well which was a "bust". They brought down the reserves and then decided not to proceed because of the high development costs. Department geologists confirmed that assessment. Resulting from was that information, the current assessment was arrived at. KENNETH BOYD, DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES, responded to Representative Therriault's query, pointing out that the Department has all the data available and access to information on fields to be drilled and seismic equipment to probe the ground. He 8 thought that 120 million barrels would be a "good" number. A range between 105 - 160 million barrels is the most which could be reached given the available information. Representative Mulder referenced the 79.59% NPS for Duck Island. Commissioner Shively stated that the NPS has not "kicked in" for Duck Island. The Department has not made that projection to date. That site has been in production for ten years. Representative Brown pointed out that the net profit "kicks in" late in the life of a well and is affected by price. She noted that the lease sales were efficient at capturing the rent for the State. Representative Brown suggested that it was premature to think that the leases would not be profitable under the terms in which they were bid. Representative Mulder commented on the change of approach assumed by the State, noting that leases currently, are not bid including the NPS. Representative Brown stated that actions are influenced by what is occurring economically at that time. Representative Brown asked if DNR staff had provided an analysis regarding the economic benefits, should there be a lawsuit stopping development. Commissioner Shively stated that a delay would be a benefit to the State. The net profit share declines as the supplemental royalty increases. Representative Brown asked if the benefit of the force majeure clause had been considered in negotiating the agreement. Commissioner Shively replied that it was the State's decision to allow BP to invoke the force majeure clause. If BP felt that the State was acting unreasonably, they could sue. The need for use of the force majeure had been discussed, speculating that a delay would benefit the State. Representative Brown understood Commissioner Shively meant that there would be benefits in attributing value to early development. Commissioner Shively agreed that there is value to early development, although, in this situation there is value to the Department in delaying. He suggested that delaying would encourage BP not to invoke the force majeure clause. Representative Brown pointed out that early development is not a certainty. Representative Brown asked if the losing bidders rights had been infringed upon with the change of terms. Commissioner Shively thought there was no indication of suits pending against the State resulting from the 1979 decision. 9 Representative Brown referenced a letter dated 4/23/96 to Governor Knowles from Jerry Van Kooten, Anchorage. [Copy on file]. Mr. Van Kooten is critical of the proposal, indicating the probable reserve growth at Northstar. Historically, fields that perform well are clastic reservoirs and Northstar is of that type. It is reasonable based on past experience for the Northstar reserves to increase over its life. That increase will be in the range of 2 or 3 times today's estimate. Mr. Van Kooten stressed that the State of Alaska would be giving up the most value in the current renegotiation and will lose much. Representative Brown agreed with his projection and asked why the Department was willing to sacrifice that possibility. Commissioner Shively referenced the letter including the suggestion "at the time of the first discovery". There have been a number of wells drilled and work has been done by the Department, all indicating the history of the field. The Department does not feel the field is capable of growing 2 to 3 times its current capacity. He indicated that DNR's staff has supported and directed the current decisions. Representative Brown advised that some of the "competent" and "professional" staff at DNR have concerns regarding the decisions being presented. Representative Brown referenced the second issue addressed by Mr. Van Kooten regarding the "level playing field" and the political pressure that comes with that. Commissioner Shively responded that there was "no price" of entry. There have been lease terms changed in the past. Representative Brown informed the Commissioner that Theus Island was the only lease in which the State's take had not been diminished. Commissioner Shively noted that there had been no public review of that case. Representative Brown asked if Amerada-Hess received any future production resulting from the transfer of leases from BP. Commissioner Shively stated that information was confidential. Representative Brown noted that the record shows several overriding royalty interests on one of the leases #355001, which was raised to 20%. Commissioner Shively was not aware of the ownership, although, there was a 2% overriding royalty on that lease. Representative Brown asked if there was an analysis of the allocations of oil within the Northstar unit. Mr. Boyd responded to Representative Brown, noting that BP would have to prove that there was oil on the lease as part of the plan 10 development. He added, the allocation was handled within the Division with a 98% interest. Representative Brown questioned if the Division's staff was analyzing the allocation to the individual leases. Mr. Boyd thought it had been done, although, did not know how much oil was on each track. Mr. McCutcheon asked which wells were being referenced. Mr. Boyd replied it was the well drilled on the southern track, Northstar III. Mr. McCutcheon questioned why the contract between BP and Amerada-Hess was not available. Commissioner Shively stated that the Department has asked that it be made public, although, Amerada-Hess will not release BP from their confidentiality. Mr. McCutcheon ascertained that the State does not really know if BP purchased the lease. Mr. Luttrell clarified that the leases have been filed with the State even though they are not public information. A document of transfer of ownership has been signed. Representative Brown asked if lessees were required to expose contingent liabilities on a lease, overriding royalties and shares of future production. Commissioner Shively assumed that would be required by the State at the time of production. Representative Kelly inquired if each unproductive lease would be revisited. Commissioner Shively noted that other committees have suggested a more "generic" approach for the future. Representative Brown spoke to the renegotiation of the lease term value provision. The lease appeared to be rewritten except for the provisions of associated substances. She quoted the Alaska North Slope (ANS) lease agreement exclusion. PATRICK COUGHLIN, DEPUTY DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES, explained that reference was to the ANS royalty oil settlement agreement which was reached between BP and the State in 1991. The point was to use that value as agreed by all the involved parties. Representative Brown asked if that agreement provided that leases not be included. Mr. Coughlin responded that BP did not own those leases at the time of settlement. Representative Navarre asked if a different value had been attributed when Amerada-Hess owned it. Mr. Coughlin stated that settlement agreement was with "BP" and not Amerada- Hess. He did not know if there had been any settlements 11 with Amerada-Hess prior to BP getting the leases that apply valuation to Northstar. Representative Brown pointed out that many of the old leases had been corrected with the new leases. She asked why the Division felt it was in the State's interest to agree to that settlement rather than incorporating "value" language. Mr. Coughlin said there has been no litigation on the new lease form, a request by BP. Representative Brown questioned if an evaluation had been provided of the projected losses by the lease form language. Mr. Coughlin replied that question assumes that value had been lost; the Department would not agree. (Tape Change, HFC 96-151, Side 2). Representative Brown interjected that the State had relinquished something significant by removing the minimum value determination provision. Commissioner Shively replied that decision had been made based on information of other leases on the slope producing to a similar extent. It resolved potential litigation between the State and development of the field. He added, there has been no litigation over that to date. Representative Brown asked if any value had been attributed to that provision in negotiations. Commissioner Shively stated it had not. Representative Kohring voiced support of the bill which will further enhance the oil industry and generate jobs. He added that BP has negotiated in "good faith" the local hire issue. Representative Therriault questioned the date of the court decision regarding the development account. Commissioner Shively noted that decision was made in 1985/1986. The total development costs to the State are estimated to be $260 million dollars. That figure does not include BP's expense in the amount of $50 million dollars. Representative Brown referenced a letter from Assistant Attorney General, James Baldwin. [Copy on file]. The letter concludes with a reference to the "mandate resident hire on module fabrication projects". Mr. Baldwin stated the probable constitutionality problems exist from inclusion of that language. Representative Brown advised that the language is not enforceable as currently drafted. She noted that an amendment has been requested to address that concern. 12 Mr Bruner provided Committee members a faxed copy of testimony. [Copy on file]. He spoke against the proposed legislation. Representative Martin MOVED to report CS HB 548 (WTR) out of Committee with individual recommendations and with the accompanying fiscal notes. Representative Brown stated that the amendment would be HELD for action on the floor. Representative Brown asked why the fiscal note did not indicate funds spent in FY97. Commissioner Shively pointed out that there were two fiscal notes, one of which indicates funds for FY97. Discussion followed regarding the two fiscal notes. Representative Martin noted that the letter from Mr. John Morgan, dated 4/29/96 would be MOVED with the two fiscal notes. There being NO OBJECTION, it was so ordered. CS HB 548 (WTR) was reported out of Committee with a "do pass" recommendation and with two fiscal notes by the Department of Natural Resources. ADJOURNMENT The meeting adjourned at 4:45 P.M. 13