HOUSE SPECIAL COMMITTEE ON OIL AND GAS April 15, 1997 8:04 a.m. MEMBERS PRESENT Representative Mark Hodgins, Chairman Representative Scott Ogan Representative Joe Ryan Representative J. Allen Kemplen MEMBERS ABSENT Representative Norman Rokeberg Representative Con Bunde Representative Tom Brice COMMITTEE CALENDAR Trans-Alaska Gas Line Participants Van Meurs Report - Suggested Legislative Action PREVIOUS ACTION Continued from April 10, 1997 WITNESS REGISTER BEVERLY MENTZER, Manager Business Development Natural Gas Department Exxon Company, U.S.A. P.O. Box 2180 Houston, Texas 77252-2180 Telephone: (713) 656-6145 POSITION STATEMENT: Gave presentation on behalf of Exxon Company, U.S.A. JIM JOHNSON, Onshore Manager Partnership Operations North America Production Division Phillips Petroleum Company P.O. Box 1967 Houston, Texas 77251-1967 Telephone: (713) 669-2968 POSITION STATEMENT: Gave presentation on behalf of Phillips Petroleum Company. GEORGE FINDLING, Public Affairs Advisor Gas Commercialization and Marketing Team ARCO Alaska, Incorporated P.O. Box 100360 Anchorage, Alaska 99501 Telephone: (907) 263-4174 POSITION STATEMENT: Gave presentation on behalf of ARCO Alaska, Incorporated. DR. EDWARD M. ("Ned") PATTON, Section Manager Southwest Research Institute P.O. Drawer 28510 San Antonio, Texas 78228 Telephone: (210) 522-3442 POSITION STATEMENT: Gave presentation on behalf of the Southwest Research Institute. ACTION NARRATIVE TAPE 97-18, SIDE A Number 0001 CHAIRMAN MARK HODGINS called the House Special Committee on Oil and Gas meeting to order at 8:04 a.m. Present at the call to order were Representatives Hodgins, Ogan and Kemplen. Representative Ryan arrived at 8:17 a.m. Sites on teleconference included Anchorage, Kenai, Houston, San Antonio and Calgary. Trans-Alaska Gas Line Participants Van Meurs Report - Suggested Legislative Action Number 0083 CHAIRMAN HODGINS announced the hearing was a continuation from the April 10, 1997, meeting on suggested legislative action regarding the Trans-Alaska Gas System line. He offered a brief synopsis of the previous hearing, saying, "Commissioner Condon from the Department of Revenue gave us a work plan from the Administration and proposals to legislative action. This is based on the Van Meurs report, and we're looking at some continuing strategy. We also received a report from Yukon Pacific Corporation, and in a nutshell, they offered permits and offered to be a portion of the pipeline and to finance their percentage into work towards the pipeline." CHAIRMAN HODGINS noted that they had been in the middle of testimony from Mark Bendersky regarding a statement made by Richard Campbell when the previous meeting concluded. When he invited Mr. Bendersky to continue, Mr. Bendersky offered to answer other questions but did not testify. After requesting that Mr. Bendersky remain on teleconference, he called on Beverly Mentzer. Number 0251 BEVERLY MENTZER, Manager, Business Development, Natural Gas Department, Exxon Company, U.S.A., testified via teleconference from Houston, Texas. She specified that she is responsible for commercialization of the Alaska gas reserves. She indicated she would focus on one aspect of the work needed to potentially make a liquefied natural gas (LNG) export project commercially viable, which is the need to improve the state's fiscal and regulatory system that would be applicable to an LNG project. "We will also share our view on the plans proposed for the joint work with the state that was presented by Commissioner Condon," she added. MS. MENTZER said, "The state's consultant, Dr. Van Meurs, has recently concluded that the current state fiscal system that would be applied to a project does not favor an LNG project due to the system's regressive nature. And he also concluded that an LNG project requires that the fiscal system be stable throughout the project's life. Exxon agrees with these conclusions, and we agree that addressing these problems is an important and logical next step in seeking to make an LNG project economic." MS. MENTZER continued, "Looking ahead, developing a long-term, appropriate and stable fiscal and regulatory environment for an LNG project will be both a complex and time-consuming process. Both the MOU [memorandum of understanding] and HCR 1 provide for the state Administration and the producers to develop a proposal and then bring that proposal forward to the legislature for its consideration." Number 0382 MS. MENTZER continued, "Exxon has worked with the state to identify steps to develop a comprehensive fiscal and regulatory proposal that addresses all the issues that were included in HCR 1. We agree with Commissioner Condon and believe that the time schedule presented by the state is aggressive and perhaps optimistic, given the complexities of fiscal and regulatory issues to be considered. Nevertheless, we are willing to work hard to progress these issues." MS. MENTZER continued, "We believe a process needs to be put in place and that the state and producers jointly and efficiently develop an appropriate proposal for the legislature's consideration. And in that regard, Exxon supports the legislation that was recently introduced by the Administration because it will provide for such a process." MS. MENTZER continued, "In conclusion, it's important that we all keep in mind that an LNG export project is not commercially viable today and that fiscal changes alone cannot make this project succeed, but that substantial cost reductions and favorable market conditions will also be needed." She offered to answer questions. Number 0488 REPRESENTATIVE J. ALLEN KEMPLEN recalled that at the previous meeting, the presentation by Yukon Pacific Corporation indicated a key item is a project structure that really develops an understanding among the private sector principals as to responsibilities. He requested an update on the project structure. MS. MENTZER replied, "I guess I have to back up a little bit to answer your question, particularly as it relates to YP's testimony. You've heard - many people have testified, including the state, some legislators, Pedro van Meurs and the producers - that an LNG export project is currently uneconomic, and only YP has testified differently. And based on their testimony on Thursday, which is really all the discussion we have at this time, it's apparent that the Yukon Pacific assessment of the project's commercial viability is very different from Exxon's view, as well as the view of others." MS. MENTZER continued, "So, in looking at the question of project structure, we're really focused that the logical next step is the development of stable and appropriate fiscal and regulatory terms and that a project structure as they described it, i.e., a new limited partnership, is not needed to do that. Clearly, as the producers are working together, you know, we've developed an informal structure, you might call it, to coordinate our activities, coordinate discussions with the market, and that's the framework we'll continue to work under as we move forward." Number 0636 REPRESENTATIVE KEMPLEN asked when Ms. Mentzer thinks it would be appropriate for a project structure to be established. MS. MENTZER replied, "That may be more appropriate after you know you've got an economic project." Number 0662 REPRESENTATIVE KEMPLEN asked, "Beverly, given the time line that was set out by Commissioner Condon at the last meeting, when do you think that the determination of an economic project would be arrived at?" MS. MENTZER responded, "Well, 1998 will be a really important year for doing the assessment to evaluate commercial viability at the next phase, and I say that because we have a full year of technical work outlined where we're focusing on our cost reduction efforts; so you'll have the results of that technical work and then you'll also have the vast majority of the results of all of the work that was on the schedule that Commissioner Condon presented. So when you look at those two pieces - you can say primary fiscal, technical, also some regulatory issues; you'll have those fiscal terms and fiscal certainty issues - and then you lay that down and look at the market, that then you can do another good kind of assessment of the commercial viability. But the outcome of that decision depends on our success in the work efforts throughout the next year." Number 0757 REPRESENTATIVE SCOTT OGAN said, "Beverly, you mentioned all the work that has to be done the next year, yet our ... trade representatives that we consult with in the market countries tell us that we need to be at least speaking with a unified voice this year. They stressed how important it was, said the market views us as dysfunctional. They are getting mixed signals, and they don't have confidence in our ability, our working together. Do you care to comment on that? I mean, we're talking about all this work to do in the next year, and before we decide whether or not we're even going to talk, is there any reason why we can't speak with one voice on this, I mean, even [if] it's, `Yeah, we're assessing it but we're all here working together'? ... I just don't think the market perceives that there's a real true spirit of cooperation going on, and I certainly don't." Number 0848 MS. MENTZER responded, "There are several different issues around what you're asking, and let me try to address all of them. One, on the unified message, the major gas owners are unified in their assessment of the project economics and the forward plan to increase the project's chance of success. And we fully understand what is meant by the comments from the state's Japanese trade representative, and we believe that producers who have gas to sell are the appropriate parties to talk to the market to avoid confusion." MS. MENTZER continued, "And another issue that comes up around that question is the question of, `When do you make a proposal to the market?' And that's a little different than just talking to the market and keeping them apprised of your progress, letting them know ... how you're moving in regards to the project. With the current project cost and fiscal terms, the project cannot be developed that satisfies both the market needs and the returns that would be expected from necessary investors or financial lenders. And if you look at it on the flip side, if you say, `Well, at competitive LNG prices, what can we do,' then the economics are too weak to attract the needed investors. So, at attractive investment rates, the LNG prices are not competitive; so you're kind of in a Catch-22 situation here. You can't satisfy ... all the parties in the chain." MS. MENTZER continued, "And just an aside: It was interesting when I was over in Japan, on the trip in November with the Governor, that one potential buyer had told us that they had reviewed the CS Boston (ph) report and thought that the pricing assumptions in there were too optimistic. So what we're struggling with is we know the market wants competitive prices. They're not willing to pay a premium. They would like Alaska gas, but they don't want to pay a penny more than they have to for it; so we know what they would consider an acceptable proposal. And until we have our costs and fiscal terms and economics together where we can make that acceptable proposal, that's really what we need to work on before we make a formal proposal to the market." Number 1003 REPRESENTATIVE OGAN asked whether Ms. Mentzer was confident that by the time everything was done to make the project competitive, it would not be too late for the "infamous market window." MS. MENTZER replied, "We are comfortable that we will not be too late because we do not believe there is a market window that closes. The demand projections in the Far East continue to grow. 2005 is when the opportunity -- that a gap between supply and demand develops, and it continues to expand through 2010-2015, as you see economic growth in Japan, Korea, Taiwan, China and some of the other Far East countries. So the key is making sure that we get to the market with a proposal that meets the gap that they need to fill, ... to meet their demand, but that it's also at competitive prices." CHAIRMAN HODGINS noted that Representative Ryan had joined the meeting. Number 1084 REPRESENTATIVE OGAN stated, "Beverly, you said the important next step is working on the fiscal certainty. Is that correct?" MS. MENTZER responded, "Well, working on everything that's on the state's schedule there, as outlined, the combination of fiscal terms, fiscal certainty and regulatory issues." Number 1131 REPRESENTATIVE OGAN asked, "And can you suggest what would be the best approach for that? ... Should we get some legislation out on the table for discussion purposes this year, have meetings over the interim and be ready to act early next year on it?" MS. MENTZER replied, "I feel like the appropriate approach is consistent with what the state has outlined. There is a lot of complex work to do when you look at defining a fiscal system. It's not just setting, for example, the tax rates or the terms, but how is the LNG valued? How are net-backs determined? How do you write that into a contract that ... is agreed to by all the parties and to bring back some really substantial legislation that has the concurrence of all potential stakeholders? Working on that, to bring forward proposed legislation in the '98 session, I think, will be very challenging." Number 1191 REPRESENTATIVE OGAN asked, "Who do we negotiate the contract terms with, as a state?" MS. MENTZER replied, "That's an interesting question. I guess the way we have viewed HCR 1, and the direction to the Administration there, is that the producers and other stakeholders that ... the state may work with are kind of acting as proxies for potential project investors. Some of them we may know about now - people who are already in the state - but there may be others who invest in the project who are not currently a part of this process. So in working with us and others that the state chooses, we need to at the same time be thinking that what they're developing might also be ... used by other parties who will be investors, that aren't yet identified." Number 1251 REPRESENTATIVE OGAN responded, "You hit on kind of an important note there. We're negotiating contract terms with maybe unspecified players in the contract, and ... they might not like the terms when they get there or might cause some other renegotiation. It's a kind of difficult thing to do, is it not?" MS. MENTZER said, "Correct. We almost view it as maybe it ends up that there is some overall legislation that's enabling legislation that the contract is consistent with, but it could be, you know, there are separate contracts signed with different parties at different times as they join into the project. But that's just one approach we've hypothesized." Number 1299 REPRESENTATIVE OGAN asked who the proxies are that Ms. Mentzer can envision. MS. MENTZER replied, "Well, the proxies that we envision now are, I guess, the same ones y'all have invited to your hearing, basically." Number 1324 REPRESENTATIVE KEMPLEN said, "Beverly, you've mentioned about the administrative work schedule and the fiscal regime, and I guess I'd like to explore another aspect, which is the technical side of this project. ... At the last meeting, we had a presentation by the chief engineer for Yukon Pacific, and he gave an explanation of the long lead times that were involved in the engineering and ... ordering some of the more complex pieces of the infrastructure for the pipeline itself. ... One of the points that was brought up was the amount of money that would be needed to really invest in preliminary engineering for this project in order to get a better sense of what the costs are. Is Exxon committing any resources, in-house or on a contract basis, to the determination of those engineering costs? Are you doing any preliminary engineering, or are you participating in any preliminary engineering for this project?" MS. MENTZER replied, "We are definitely doing work technically, in- house and with contractors. Right now, we have a total of over about 40 people working on the project. I guess the combined technical team between Exxon, ARCO and BP is about 35 people, plus about half a dozen contractors right now who are looking at all phases of the project from the slope ... on through shipping." MS. MENTZER continued, "I'd like to clarify, though, there are a lot of different terms of types of engineering that are being talked about when you say `preliminary engineering.' We see our engineering as the very early phase of screening, trying to drive costs down, identify opportunity, which is different than -- preliminary engineering is when you say, `This project is a go; it's economic; I've got it funded; we're moving ahead; you know, let's start ordering long-lead-time equipment.' So, it's kind of putting the cart before the horse, we feel like, to be talking about things like that now, when you don't have an economic project." Number 1469 REPRESENTATIVE KEMPLEN said, "I'm to understand, then, that from your statement, that ... the resources to do preliminary engineering would be committed once the project is determined economic. Is that correct?" MS. MENTZER replied, "That's correct, Representative. That would be the normal progression of a project. You go from screening engineering to - we kind of call another phase - conceptual engineering and then into preliminary engineering, then into detailed engineering and construction and start-up." Number 1504 REPRESENTATIVE JOE RYAN apologizing for missing part of the presentation, then stated, "What I've surmised so far - perhaps you can tell me if I'm correct - is that we're just in an exploratory stage now, and if we pencil this thing out, it doesn't make economic sense, the profit isn't there. Is that an accurate summary?" MS. MENTZER replied, "I would say that's a good assessment. I liked your characterization of an exploratory stage, that we're really working hard to try to make it economic, and if our efforts this year aren't successful, we'll keep looking at ... what do we need to do to make it successful." Number 1545 REPRESENTATIVE RYAN said, "Okay. There's a couple of things of which I have some concerns. The players in here, whether it be the producers or whomever, how much of this will they capitalize personally, and how much will they go to capital markets? Have you any idea yet what that would be?" MS. MENTZER asked whether he was referring to financing versus putting in companies's individual equity. Number 1565 REPRESENTATIVE RYAN replied, "Well, both, actually. How much money will the actual producers put up for the project, percentage-wise, versus how much will they have to go to capital markets to get? Because capital markets being what they are, they're very competitive worldwide. I'm just wondering how you're going to get a commitment on the money, at what rate of return." MS. MENTZER responded, "Right now, at the phase of the project we're at, we have not addressed that question; and until you know how good your project is and how the risks and rewards of the project are allocated among the various elements of the chain, the company can't really make a decision on ... what part they want to be in and for how much equity or interest there. And then the financing aspect would come along, kind of like preliminary engineering; when you know you are moving forward, then you really work the financial markets hard to optimize that financing, determine ... what sort of debt you might to take on for the project and how that would be developed with the lender." Number 1623 REPRESENTATIVE RYAN recalled a presentation by foreign trade representatives a couple of weeks before and said the people from Japan and Korea seemed interested but not a lot. He stated, "I was very much impressed with the report from the people from Taiwan. They seem to have an undetermined, growing energy need but one that ... seems to be a lot greater than Japan and Korea. ... As you're exploring this for customers in the market, how much have you folks looked at Taiwan?" MS. MENTZER replied, "We have looked at Taiwan, as we've looked at other countries also. You're correct in your assessment that they have a very strong, growing demand for LNG that's forecast. Relative to our project, though, while they might increase their LNG imports fivefold, the quantity is still relatively small, going from, like, I think it was, like, 2 to 10 million tons per year between, like, now and ... 2010, whereas Korea, while the percentage increase is not as high, the absolute volume is higher." Number 1694 CHAIRMAN HODGINS requested a synopsis of the structure of the steering committee and clarification about who the "proxy folks" are. MS. MENTZER explained, "I would consider the steering committee a subset of the total proxy group ... that the state would work with. But then focusing on that, I would say that the structure is such that Exxon and ARCO and BP have all agreed to bear the costs on an equal basis for the work that we do. We develop joint work plans. We follow up on those together. As you know, we've made some joint trips to the market; we're not committed to only traveling jointly. And ... it's not the formation of a new consortium or an entity, but you could say it's, some ways, similar to joint operations on the slope where there are still three separate owners but they're working jointly for a common objective." Number 1758 CHAIRMAN HODGINS asked, "Then the structure of the steering committee, who is actually taking the lead on that at this point? Or is it just a committee of the whole, just visiting about what might happen?" MS. MENTZER replied, "It's a shared leadership committee. It's myself and Mark Bendersky with BP and David Lawrence with ARCO, and we make joint decisions as to our forward direction. And then quite frequently, one company might take the lead to help progress a certain aspect of the work, but still it's brought back for a consensus, a decision or analysis, basically saying, we kind of divide up the administrative responsibilities and take turns leading from an administrative perspective. There is no one company that has more of a leadership role in the decision-making than any other company." Number 1805 CHAIRMAN HODGINS asked, "And then if I might, when would you possibly see that three-tiered steering committee, or that three- member steering committee, expanding to something a little bit larger?" MS. MENTZER replied, "Mr. Chairman, as far as it expanding larger, well, first of all it gets back to ... is the project economic and are we moving forward and are we increasing in our engineering activities and things like that. We've said all along that ... in a project this size, there is certainly room for more participants. And we expect there will be more, but exactly where and how that evolves, I really am not certain at this moment. It kind of depends on how much money other potential participants want to put at risk in the early phases of a project." Number 1853 CHAIRMAN HODGINS asked, "The results of what comes out of the steering committee and ... the informal negotiations that are going on now between the producers, does the state of Alaska, being a 12- 1/2 percent royalty owner, have the opportunity of visiting - and I would assume that would be through Commissioner Condon - some of the decisions and some of the process that's going on?" MS. MENTZER replied that they inform the commissioner and various other Administration representatives on a regular basis as to what work is going on and what activities or studies are being undertaken. She emphasized that it is not so much negotiations as it is work. For example, areas requiring further investigation, such as cost-reduction work, are coordinated through the steering team; they assign responsibilities, get the job done and gather information needed to continue to assess the project's viability and help move it forward. Number 1912 CHAIRMAN HODGINS stated, "Thank you for that clarification. And if I could sum up, then, this steering committee will continue on with their scope of work as they define it at this time. And from what you said, if somebody wants to join that committee, they need to come up with dollars or a commitment ... for this project. Is that a correct assessment?" MS. MENTZER indicated that is essentially correct. Number 1930 CHAIRMAN HODGINS said, "In keeping the Administration informed, then, I assume that there'll be times when this committee will be informed as to what is going on with the steering committee and how we might be able to assist legislatively. ... Are there plans for that in the near future?" MS. MENTZER replied, "Yes, Chairman. We had prepared at your request kind of a first-quarter activity report that we're prepared to share with you and your committee at any time so that you can see the overall activities that are going on. A lot of it parallels what the state had talked about in their schedule, focusing on some of the same issues. Then there is the technical aspect of it and some other aspects that aren't directly on that schedule that we'd be glad to provide an update on. As to legislatively, how can you help: I think the key focus legislatively is in the fiscal arena. That's really ... your responsibility and a very, very important part of the project. So anything that can be done to help provide long-term, appropriate, stable fiscal terms will be very beneficial to the project. And then I also expect that as we work through the plan for the year that there will be regulatory issues that may also require legislation to help reduce the risk in the project and help bring it along." CHAIRMAN HODGINS thanked Ms. Mentzer and said, "We will look forward to scheduling that meeting and finding out a little bit deeper as to how we can assist in the structure ... and the progress of the steering committee." Number 2019 REPRESENTATIVE RYAN said, "Since you have delineated how very much we're in the bare preliminary stages, the Van Meurs report talks about different means of royalty taxes and so forth, the back- ending instead of front-ending. Don't you think it's a little ... premature for us at this time to start even considering these things, since we don't have very much information, actual information, on how the project will go forward, or if it will, or when it will? ... I am not against some concessions to make the project possible and successful, but I think it's a little premature at this time to start discussing those things. What are your thoughts on that?" MS. MENTZER replied, "I think it's human nature to not want to move forward when there are a lot of uncertainties surrounding the project. Unfortunately, from a competitive perspective, with all the other projects that are competing out there for the same supply/demand gap in the market, we can't wait. Most of the foreign governments, as you know from the Pedro van Meurs report, establish fiscal terms, contracts, and that's even when companies are coming in in the exploration phase of projects. And they've established them for several of the LNG projects already that are competing in our same time slot, that have some of the same uncertainties that we have. So while we might like to wait, the competition won't let us wait." Number 2097 REPRESENTATIVE OGAN said he was hearing a bit of inconsistency and stated, "I personally would like to get something that we can work on over the interim, yet we're told, `Wait 'til we get things figured out,' and then you just said, `We can't wait.' Could you clarify, please?" MS. MENTZER replied, "I'll try to do my best here. I don't feel like bringing something forward in the ['98, misstated as '88] session is waiting. There is an extreme amount of work to be done to develop a fiscal package of the caliber needed to provide credibility and appropriate fiscal terms for the project. It's not a quick-fix kind of deal. The contracts are very complex. There will be a lot of different terms and conditions. Hopefully, we won't have the same complexities as the oil fiscal regime has had over time, but some of the same issues we would like to address for LNG, such as ... how do you value it when you pay your taxes, have been debated in the state for years and years. And for us to say we want to get that all figured out ... in the next ... eight months or before February is a very aggressive task. So, the feeling that because we're not bringing something forward right now or in the next two months - two or three months - over the interim means that we're waiting, I really am sorry you have that impression because it's not waiting. It's working extremely fast to meet a very aggressive deadline." Number 2182 REPRESENTATIVE OGAN said he understood that. However, he was concerned that "if you guys show up in February, according to the Governor's bill as proposed, and say this is what you want," there would be only March through May to get something of this magnitude through both bodies of the legislature. He stated, "And I'm concerned with that short amount of time - coupled with the fact that's just one of many issues that we deal with - that we might do a poor job if we have all the stuff laid on the table in February sometime, instead of working on it over the interim as the issues get more clearly defined with the working group ... that's going to be putting this together, and then we start dealing with those legislatively at least in a rough-draft form and get the discussions ongoing through the interim, when we are ... quite a bit less distracted and maybe do a more responsible job. That's my concern." MS. MENTZER replied, "Okay. Well, we may be consistent in that perspective, then, because as you notice on the state's schedule, it says discussions with legislature ... throughout the process. So the idea is not that you'll get something you've never seen before in February and then have to digest it, understand it and decide what you want to do with it ... all in that time period, but that you will have seen it coming and been aware of the issues and had some input. Because clearly if we work in a vacuum and then there's something you don't like, that's not in anybody's best interest. So we want to try to flesh those things out along the way so that when it comes into the legislature in February, we have a reasonable expectation that it's something the legislature would be supportive of." Number 2265 REPRESENTATIVE RYAN commented, "My problem right now is in cutting a bargain when someone comes to the table and cannot tell me anything about even the feasibility of the project and yet wants me to make a commitment on a value and a tax and a royalty; that's kind of like getting a bride because she's just a little bit pregnant. It makes it very difficult. I saw some original negotiations with the oil. I've seen what happens in other countries in the royalty percentage and so forth. I'm afraid I'd need a lot more information before I'd want to sit down at the table and put a value on anything. I'm just being a little cautious. I'd rather err on the side of caution." CHAIRMAN HODGINS asked whether Ms. Mentzer had concluding remarks and requested that she remain on teleconference. He then called on Jim Johnson. Number 2312 JIM JOHNSON, Onshore Manager, Partnership Operations, North America Production Division, Phillips Petroleum Company, testified via teleconference from Houston. He specified that he has responsibility within his group for the properties that contain Phillips' North Slope gas reserve, such as Prudhoe Bay Unit and Point Thomson Unit. MR. JOHNSON stated, "Phillips Petroleum's interest and involvement with the North Slope gas project would come about in several ways. First, we are an interest owner in North Slope gas. We have an interest in Prudhoe Bay Unit, where along with our 1.88 percent interest in the oil rim, we have a 0.26 percent interest in the gas cap. We do have a much larger interest, approximately 12 percent, in the Point Thomson Unit. And as you may know, Phillips is a majority owner and operator of the Kenai, Alaska, LNG facilities. This is the first LNG project to export LNG into Asia and North America's first and only existing base-load LNG operation. The Kenai, Alaska, facilities were the first to achieve 27 years of reliable, uninterrupted LNG deliveries into Asia, and it brought significant benefits to the state in ... jobs and revenues." MR. JOHNSON continued, "Phillips is supportive of the efforts to facilitate the North Slope LNG project. Consequently, Phillips would be interested in evaluating opportunities to participate in the Trans-Alaska gas line project, as well as opportunities related to potential participation in the LNG liquefaction facilities and shipping elements. Phillips has examined North Slope gas production, and based on current information, we believe that the potential exists for this to be economic. Further refinements, decisions and actions will be needed on several items to bring about a final conclusion in this regard. This includes studies of North Slope gas deliverability and costs; the cost of the required pipeline and other facilities; the tax and regulatory structure; and the marketing arrangements and prices for the LNG." MR. JOHNSON continued, "With our interest in Point Thomson and our past experience in LNG, we'd be in a position to study a number of aspects of these with a good perspective. I'd like to comment further on what we feel are some key items here. In the Point Thomson Unit, Phillips has been actively participating, along with the operator, Exxon, and other interest owners, in studies to better define the reserve's producibility and development scenarios of that field. Results on studies currently underway have been encouraging in indicating that potential reserves and production from this field may be better than previously indicated, although it is too early at this point to define specific numbers." Number 2417 MR. JOHNSON continued, "Phillips believes that the Point Thomson gas condensate field could play a pivotal roll in facilitating the North Slope LNG project. Point Thomson gas reserves could give the North Slope pipeline project considerable additional flexibility and viability. It could supply early gas supplies needed to accelerate the potential start-up date for the project to coincide with the earliest market opportunities. Point Thomson could be developed to supply significant gas volumes in plenty of time to be ready for the pipeline. This would allow you to have both early start-up of the project, to capture market opportunities, as well as allowing high recycling of Prudhoe Bay gas to continue for a longer time to benefit oil recovery there. Also, Point Thomson could augment Prudhoe Bay gas deliverability in the longer course of the project. Point Thomson, along with any other gas-producing fields on the North Slope, could provide the synergy that should yield better economics for everyone." MR. JOHNSON continued, "Finally, having had 27 years' experience in marketing LNG into Asia, Phillips concurs that a market window for the North Slope LNG project could open as early as 2005 and that competition among supply projects for these markets is and will be fierce. This being the case, Phillips supports the House Oil & Gas Committee efforts to facilitate timely definition of the project structure .... [Cut off mid-speech by end of tape] TAPE 97-18, SIDE B Number 0006 REPRESENTATIVE OGAN asked, "Do you concur with the view that the market will continue to open in 2010-2015, or do you feel that the competition - the projects that are already competing and maybe quite a bit further ahead in development - will fill that market and put our project at a disadvantage?" MR. JOHNSON replied, "We feel that there will be some continuing opening of the market beyond 2005. We feel that a good opportunity exists for projects that will be ready by 2005 and that if you are able to meet that particular window, you would be in the best situation." Number 0046 REPRESENTATIVE OGAN asked whether there is somewhat of a diminishing return after 2005. He noted that they are talking about a large project compared to many that would be competing. MR. JOHNSON responded, "From what we see right now, there would be some diminishment in returns after 2005." Number 0065 REPRESENTATIVE OGAN asked, "Enough to knock us out of the market?" MR. JOHNSON replied, "I would not be prepared to say that. It would not necessarily knock you out of the market." Number 0080 CHAIRMAN HODGINS said, "We heard a presentation earlier that the Point Thomson gas unit has a high-pressure gas situation that might preclude it from becoming a part of this project. Possibly you could comment on that or what you see would be a time line that maybe the technical aspect of a high-pressure gas situation in Point Thomson might be solved." MR. JOHNSON replied, "We see the high pressure in Point Thomson as something which can be addressed technically. We do not see that it presents any hurdle in the development of that field where it would be producible prior to a pipeline being available in 2005. The high pressure means that you would have additional considerations in terms of the facilities and equipment. The high pressure, of course, yields higher deliverability, and that is good in many aspects for the project. But these are technical things which we certainly feel can be addressed and does not cause any real problem for the Point Thomson field development." Number 0128 CHAIRMAN HODGINS said, "And, in fact, your statement about fierce competition after 2005, one of the things that the Oil and Gas Committee is looking at, and I'd like to refer to Article VIII of the constitution as far as natural resources, Section 2, General Authority: `The legislature shall provide for the utilization, development, and conservation of all natural resources belonging to the State, including land and waters, for the maximum benefit of its people.' And that is why this committee is trying to facilitate this project, understanding that there is a difference of opinion between when this window will be open and how long the window is going to go." CHAIRMAN HODGINS continued, "It is this committee's chairman's feeling that we need to expedite this in a very reasonable manner, and we do understand and thank your input into what needs to be done in order to sell this gas. And ... it's important for us to go through this process to try to find out who the players are, who will be involved with this, and to continue along the line of getting the most aggressive people that are involved with this project and helping them to see ... their aims, and that is to deliver gas and get this pipeline built as soon as possible. And that will be the structure that this committee will have as long as I'm chairman and as long as we have a viable project in front of us. And I do thank you, Mr. Johnson, very much for your insight." CHAIRMAN HODGINS next called on George Findling. Number 0201 GEORGE FINDLING, Public Affairs Advisor, Gas Commercialization and Marketing Team, ARCO Alaska, Incorporated, came forward to testify, saying, "I am here to indicate ARCO's support of the state's forward plan, sort of taking us back to the original presentation by the Administration last week. And let me expand a little bit, briefly, on this." MR. FINDLING continued, "This work that the Administration is proposing, along with other steps, will help to advance the Alaska North Slope gas project. This plan is consistent with both HCR 1, which calls for the leaseholders and Administration to work together to identify a stable and appropriate fiscal regime, and is consistent with the MOU framework. This plan is also consistent with the Pedro van Meurs report. Now, our analysis of that report suggests that a competitive state fiscal system will need to be progressive, back-end loaded for the state take, unchanging, predictable and likely relief-providing for the sponsors. Now, while we understand these general requirements, we think that the Administration's work plan is needed to resolve the actual details. And I would quickly point out that ARCO plans to provide people and resources for our part of this effort." MR. FINDLING continued, "We do believe that the discussions between the state and leaseholders will be facilitated by a process that allows free exchange of sensitive data and discussions of innovative options. We would also support prescribed public and legislative briefings along the way to maintain public awareness of the discussions. We see the state fiscal system work moving in parallel with other activities essential to project viability: cost reductions, commercial structure development, market development, federal fiscal incentives and the definition of economic regulation. Progress is required in all these areas because improvements in the state fiscal system alone will not make this project commercially viable. Also, we all need to recognize that despite everyone's best efforts, economic viability may be very elusive. For example, Pedro's report shows that Alaska ranks fifth of nine green field projects on a ROR [rate of return] basis compared to hurdle rates. And that's at an undemonstrated $12 billion cost." Number 0303 MR. FINDLING continued, "Let me put the '97 fiscal work in context. Prior to project sanction, all fiscal and regulatory issues must be resolved and finalized. Focusing on the state fiscal system, we believe that we need a fiscal framework completed during the '98 session. And to do that, we believe that the substantial work laid in the "State and Local Fiscal Modifications" and "Fiscal Certainty" headings on the Administration's plan is needed before there will be enough information to introduce the needed framework legislation." MR. FINDLING concluded, "Mr. Chairman, in closing, let me thank you for the opportunity to testify and to restate our intent to try to move this project to commercial viability and our support of the state's proposed plan." Number 0332 REPRESENTATIVE RYAN said, "I still have this feeling that I don't have enough information to make a commitment to a tax and to a royalty. I feel that I'm being asked up-front to make these concessions, to establish a policy, and yet I don't have any information from the other side. I do have some knowledge. Are you familiar with the Arctic coal study report? It was done about three years ago for the potential of the coal in the North Slope Borough's grandiose plan; they want to build a railroad ...." MR. FINDLING replied, "No, I'm sorry." Number 0357 REPRESENTATIVE RYAN stated, "Well, part of the portion showed the energy needs in the Pacific Rim, and that seemed to be some original work and some good stuff. And it showed from coal, from 100 million tons a year to 300 in 20 years. I assume that a lot of that same energy need could be met by LNG. So, the market seems to be out there, and other people have recognized the market is there. But we keep getting told about a very narrow window, that a lot of things depend upon stable policies and deliveries and so forth. I understand those. I know how markets work, especially commodity markets. But I'm not getting any other factual information. How can I put a value on something when I haven't the slightest idea of what it's going to sell for in the market? How can I establish a tax policy and establish a royalty share on this end when I have no information on the other end? ... As an elected official, I have to be responsible to the state and to the people of Alaska and the people in my district to ensure that they get a fair share of the deal. I don't know how I'm going to do this unless I get some more information." Number 0400 MR. FINDLING replied, "I think we see the situation the same as you, and that lack of information is precisely why this work that we have visualized with the Administration in the coming months is so critical as to develop the kind of information that we would then have to understand what is the appropriate state fiscal system that should be in place. ... And we have that same feeling that you do that ... there's a tremendous amount of information that needs to be developed, and that's why this is going to take time. And there's a comment I've heard; it's, `Real work takes real time.' And this is one of those cases where we need to develop real information that's going to give some indication of what state fiscal system is needed." REPRESENTATIVE RYAN replied, "Thank you. That's a little more reassuring that we will receive some more information before we're asked to make a decision." Number 0433 CHAIRMAN HODGINS stated, "Part of the problem - and Representative Ryan, I think, hit it pretty close - was the uncertainty with the legislature as to, `We're kind of in a fog as to what is going on,' and that's obviously because you're still at the very early planning stages of trying to figure out what direction and what needs to be done. And I understand the enormity of this project; $12-15 billion is something that takes quite a bit of time to massage and to figure out all the `ins and outs' because a 10 percent reduction in that, or a 15 percent reduction, is quite a lot of change. So you can kind of understand our frustration in trying to come forward with real, hard, viable facts. And I guess we have to be a little patient with your understanding that ... those facts are not readily available. However, that will not change our demeanor at all in keeping everybody on a progressive schedule to accomplish what needs to be accomplished, whether it's a `yes' or a `no' or whatever. We will be diligent in continuing on that." MR. FINDLING responded, "I often do hear a notion that since we've had an awareness of this gas for so many years, that surely the producers must understand exactly what is required. And I guess I'm complimented by the sense that we have that much insight. But the fact is, we don't know exactly what's required, particularly on this state fiscal system. And that's maybe a point I was trying to make in my testimony when I said that we understand the general characteristics - the back-end loading, the progressive nature, potentially relief-providing, the certainty, all of that - but we don't know the next level of, `How do we actually accomplish that?' And, again, ... I wish we could say we did have exactly the answer, could just lay it out, but we don't. And that's why we need to do the substantial work that we have visualized here." Number 0527 CHAIRMAN HODGINS responded, "Let me ask you a question, going back earlier. We've had several businesses come forward and say that they would like to be involved, that they would like to be a part of this. And obviously the old adage is, `You put up or you sit down and you be quiet.' ... I guess one of the frustrations we have is who's actually in charge. Who's going to assign the franchise? Who is going to decide who the players are? Is it just something where they come up and put down their expertise and a pile of money and say, `Here, I want to be a player'? How does the structure go forward from here?" MR. FINDLING replied, "I don't want to sound like a broken record, Mr. Chairman, but I think the economics are in charge here. And what you want to do is have an economic project. And ... people will beat a path to our door if we have an economic project, in concept, so that I think the idea is to try to develop an economic project. ARCO has ... basically seen that the way we would like to do that is through a gas owner/producer-driven sponsor project development. And ... there's a lot of elements that go into that. And we've talked about the four working elements in the past of cost reduction and so forth; I won't belabor those. But basically, keep working on those and try to migrate this project to something that's economic, and then -- that we'll have something that people want a part of." Number 0605 REPRESENTATIVE OGAN said if they were a jury and had to find beyond a reasonable doubt that there was a 100 percent good-faith effort on everybody's part, with all parties `pedal to the metal' on this project, he could not make that determination. He suggested reducing skepticism on the part of the legislature by including it more in the loop, as much as possible, acknowledging some information is proprietary, for example. He stated, "I know myself and possibly Representative Hodgins or some other people could be actually involved in some of the working group meetings on a sit-in basis, do a little bit of an overview of maybe the executive summaries of what's been determined so far. And I know I would be willing to - more than willing to - do that over the interim. Because I think what I'm hearing here is just, we sit here in this hearing process, you guys come here and tell us what we're doing, what you're doing, and we ask a lot of questions, and you guys go away, and we go do our thing, and then we come back. And you're right, it's starting to sound like a broken record." REPRESENTATIVE OGAN continued, "Also I'd think it's important that this group that works over the interim with the Administration, that legislative representation is included in that as well. I think it would facilitate a lot less skepticism. And next year, ... hopefully we'll be getting hard at work moving forward with legislative initiatives. That's just what I'm suggesting, and I'm suggesting that to all the producers that that happen. And I'm available anytime to do that, and I think it would be helpful for me to just sit in on this steering committee, maybe a steering committee meeting sometime if it's appropriate, so we can hear what the discussion is going on amongst producers, not just in this forum but in real time, real life." Number 0732 MR. FINDLING responded, "Just a quick comment, Representative Ogan. I take your comments. I'm not certainly going to be in control of all the decisions on legislative involvement and whatnot, but we have two guiding principles at ARCO on this matter. The first is that the thing we don't want to have happen is that come early session '98, when we're ready to present results, that it's a big surprise to legislators. ... And that's the second point, is that we really support something where legislators can be informed along the way. What form that takes, I don't know." Number 0767 CHAIRMAN HODGINS advised, "Basically, we're going to be having a steering committee report, and I'm going to schedule that as soon as possible to bring us up to speed. You know, there's a lot of questions that need to come forward, and hopefully that will clear some of the fog. You know, we talk about economic and uneconomic, and in some instances that's a different meaning to different companies. Something that's uneconomic for one company might prove to be more economic for another. So there's a lot of determinations that need to go. I will schedule the steering committee report that Ms. Mentzer had mentioned - that they would be glad to give one - and I think that will be the next big step towards informing the legislature and the public ... as to where we're sitting and what we're actually doing." Number 0805 REPRESENTATIVE RYAN said, "It's still not clear in my mind from listening to the Van Meurs report, looking at the field, the unitization and so forth; what I basically see is Exxon and your company have a great share in this gas and would like to sell it because it's profitable. BP, on the other hand, stands to lose 400 million barrels of oil, which they have in their hand and which they know what the value is going to be or can sell a forward contract. And commodity markets being what they are, and forward contracts being what they are, a lot of people have lost their shirt and other people have made a lot of money. It appears on the surface that it's really the share of gas that BP has, as compared to 400 million barrels of oil, is not a good deal for BP. The gas for Exxon and ARCO is a good deal because their share of the oil is proportionately less. Has that been resolved, or is that still on the table? ... I understand the problem, but I haven't heard a solution." MR. FINDLING responded, "First of all, I think you have to ask BP what their situation is. I think the best answer I've seen is what was presented to this committee - I don't remember the date - when Roger Marks (ph) came up and basically gave a presentation on the unit economics. What I can say is that the discussions within the steering team have focused on how to advance this project ... in those four areas. And ... these issues that you're talking about have not been part of that, sort of part of that effort. So I feel like we're sort of moving forward on those areas." Number 0891 REPRESENTATIVE RYAN said, "Having run a small business, a large business is an order of magnitude more. It's still - the basic thing is - you have something to sell for which you can make a profit. You're sure you have that, and then you're speculating on something else. And markets being what they are, most people would go with what they have in hand versus what may happen." He said he would like to hear the final decision on that. MR. FINDLING replied, "We'll certainly put together some more information for you on that." CHAIRMAN HODGINS thanked Mr. Findling and called on Ed Patton to address a technological aspect of the pipeline. Number 0926 DR. EDWARD M. ("Ned") PATTON, Section Manager, Southwest Research Institute, testified via teleconference from San Antonio, Texas. He stated, "I'm testifying today on behalf of a project team that's being formed by the Gas Research Institute to develop and commercialize composite material and steel hybrid pipe technology that we believe has the potential to make the Trans-Alaska Gas System project an economic success. This technology has a 20-year development history, with several successful commercial applications in high-pressure gas cylinders. However, it has never been commercially applied in a high-pressure natural gas pipeline." DR. PATTON continued, "Our project team will include a technologically advanced ... steel pipe manufacturer, a worldwide manufacturer of structural composite fibers and a leading resin manufacturer, as well as an oversight committee representing the natural gas pipeline industry and the appropriate regulatory bodies. This team is now evaluating project requirements and market opportunities, and we believe that we would be ready to deliver pipe to meet the needs of the Trans-Alaska Gas System project." DR. PATTON continued, "The potential represented by the composite steel hybrid pipe technology, we believe, can yield a 20 percent reduction in TAGS' project costs through a number of fundamental economies. First, the `leak before burst' character of the hybrid pipe will allow the gas line to be placed much closer to the oil line than a high-strength steel line, saving substantial sums in right-of-way development and construction." DR. PATTON continued, "Second, the high strength of hybrid pipe allows the safe transmission of dense-space gas at up to 3,500 psi, reducing pipe size and weight relative to lower-pressure systems. These savings will allow significant reductions in the amount of energy and labor required to construct the pipeline." Number 1024 DR. PATTON continued, "Third, by the use of hybrid pipe, the steel wall thickness is reduced by approximately half, relative to competing all-steel designs, thereby saving 75 percent of the required weld material in an all-steel design." DR. PATTON continued, "Fourth, the steel liner of the hybrid pipe will use conventional pipeline steels, allowing the use of well accepted construction techniques by the pipeline industry and saving costs relative to high-strength steel designs that use materials that are difficult to fabricate." DR. PATTON concluded, "There are other advantages to the concept, but these few examples illustrate the substantial potential that this concept holds for the TAGS project. The project team represented by the pipe manufacturers, Southwest Research and ... the Gas Research Institute would like to meet with other players in the TAGS project to develop a basis for working together to make this project an economic success. We're available at your convenience for further discussion and, again, thank you for your time and attention." Number 1090 REPRESENTATIVE RYAN stated, "If I remember correctly, Dr. Patton was up here and gave a presentation and it seemed intriguing. Doctor, have you had an opportunity to contact the potential buyers of this pipe? Have they shown any interest?" DR. PATTON asked for clarification. REPRESENTATIVE RYAN said, "The people who may want to put in a pipeline. Have you had an opportunity to discuss the advantages of what you're talking about with them?" DR. PATTON stated, "We have left information with all of the people that are involved in the Trans-Alaska Gas System line, and we also have talked to several of the major `pipeliners' and have letters from them in support of our project." Number 1132 REPRESENTATIVE OGAN said, "Dr. Patton, you said you have letters of support from the `pipeliners.' Could you be a little bit more specific who that is?" DR. PATTON replied, "There are four organizations that run pipelines in the states. I have that information someplace here in my office. But they are large pipeline operators in the United States, down in the Lower 48." Number 1160 REPRESENTATIVE OGAN stated, "But you said that this ... hasn't been tested or actually isn't in place; it's a technology that you're proposing." DR. PATTON responded, "There is one piece of this pipe that has been put in the ground in Jamesville, Wisconsin, that's been in operation as a gas line since, I believe, the late 80s. There was 300 feet of the line that was put in the ground, and sections of it have been removed. ... That was done as a demonstration of both the fabrication technology and the ability of the fiberglass to withstand being in soils. And so far, there hasn't been any degradation of the pipe whatsoever." Number 1200 REPRESENTATIVE OGAN said, "This pipeline, ... that's two separate things. There's a 300-foot piece and then there's another one somewhere else that's actually in use, and that's under high pressure. Is that correct?" DR. PATTON replied, "There are no high-pressure pieces of this in use yet." Number 1220 REPRESENTATIVE OGAN expressed some concern and said, "Any of us that have been on the slope know that even steel breaks, and things just break at 70 below. Being a boat builder, and having worked with epoxy resins and fiberglass and whatnot, that ... gets pretty brittle when it's cold as well. Has there been Arctic testing done?" DR. PATTON replied, "We haven't done testing of the pipe itself. We had a meeting ... of the project team last week in Chicago, and those issues were addressed with the resin manufacturer. And ... it's common amongst our project team now -- we understand that we have to have a very flexible resin that's able to stay flexible down to about 100 below. So, those issues are all going to have to be addressed in the development program for this pipe before it is made into a ... commercially available and commercially viable product." Number 1280 REPRESENTATIVE OGAN suggested if they were not already doing so, it would probably be worthwhile to test some of that material on the slope or another extremely cold place because pipelines expand and contract and the temperatures are extreme. Number 1317 CHAIRMAN HODGINS said, "I would hope that you would keep us informed, Dr. Patton, on your progress. And we would be glad to share that with the public as you bring it forward to us." DR. PATTON responded, "We'll definitely keep you informed." CHAIRMAN HODGINS asked whether committee members had questions of any of the speakers. Number 1356 REPRESENTATIVE OGAN requested that all the producers get back with him at some time in the future about the level of involvement that legislators could have in the whole process. Number 1375 CHAIRMAN HODGINS offered a recap, saying it is important for this committee, this legislature and this Administration to push forward in an appropriate and expeditious time frame, so as not to lose the market availability for Alaska's natural gas. He stated, "We've heard somewhat conflicting windows of opportunity. We feel that the pipeline cannot be built until the year 2005, maybe a little bit later, maybe a little bit earlier if we can get some breaks, which I am not too optimistic about." CHAIRMAN HODGINS said it is important that the committee and the Administration continue forward with necessary legislation. They must work in concert with the federal government in its taxing ability and with local municipal governments that will be impacted. He believes it is extremely important that they work with the producers and, especially, the potential customers. CHAIRMAN HODGINS stated, "If we can start coming forward with one protocol, with one message, I think that this project will be further enhanced. I think that ... while it may be premature at this time to anticipate that we can come forward with one message, that will be one of the goals of this committee is to try to prompt the players, once we identify them, into a single message for our customers in the Orient around the Pacific Rim. And I think it's extremely important to continue to hold everybody's feet to the fire, to make sure that we are moving as promptly and as quickly as possible." Number 1486 CHAIRMAN HODGINS continued, "I will maintain that this committee will become a referee in that respect as far as keeping folks on target and continually pushing. We will have as many hearings as need be, to facilitate communication and ... to keep the various parties energized and to keep them on target. We will be meeting several times during the interim. We will be looking at legislation that comes forward and we'll be making recommendations. The legislation that's come forward from the Administration, there [is] probably going to be quite a bit of work done to that. There is a feeling in the legislature from some of my colleagues that we probably don't need all of that legislation. We'll have to have hearings to determine that. There is a feeling that the quicker that we get our work done, the quicker that this pipeline is ... going to be constructed. And so with that, I will reiterate one more time that it is going to be the quest of this committee to move this project along in a very expeditious manner. Would there be any further discussion?" Number 1586 REPRESENTATIVE RYAN commented, "We all want to see this. We've known the bumper stickers we've seen about `please, Lord, give me one more pipeline' and so forth. Let's not be so precipitous in our actions on the euphoria of a new economic development that we're not cautious enough to make sure we've taken the necessary things for the people of Alaska and to make sure that we cut a deal that's good for the state and for the people. We need to be a little more sagacious, I think, and not rush headlong into something." Number 1622 CHAIRMAN HODGINS said, "That is part of the equation, is to make this thing profitable not only for the producers but for the people of the state of Alaska, both individually as job opportunity and investments in the state and also the revenues that would be generated through the state for operations and capital improvements." ADJOURNMENT Number 1645 CHAIRMAN HODGINS adjourned the meeting of the Special Committee on Oil and Gas at 9:27 a.m.