HOUSE SPECIAL COMMITTEE ON OIL AND GAS April 4, 2000 5:25 p.m. MEMBERS PRESENT Representative Jim Whitaker, Chairman Representative Fred Dyson Representative Joe Green Representative John Harris Representative Allen Kemplen MEMBERS ABSENT Representative Gail Phillips Representative Brian Porter Representative Tom Brice Representative Hal Smalley COMMITTEE CALENDAR HOUSE BILL NO. 399 "An Act levying and collecting an ad valorem tax on North Slope natural gas in place; and providing for an effective date." - HEARD AND HELD PREVIOUS ACTION BILL: HB 399 SHORT TITLE: AK NATURAL GAS PIPELINE INCENTIVE ACT Jrn-Date Jrn-Page Action 2/16/00 2218 (H) READ THE FIRST TIME - REFERRALS 2/16/00 2218 (H) O&G, RES, FIN 2/16/00 2218 (H) REFERRED TO O&G 3/30/00 2797 (H) COSPONSOR(S): WHITAKER 4/04/00 (H) O&G AT 5:00 PM CAPITOL 17 WITNESS REGISTER REPRESENTATIVE ERIC CROFT Alaska State Legislature Capitol Building, Room 400 Juneau, Alaska 99801 POSITION STATEMENT: Sponsor of HB 399. JEFF LOWENFELS, President Yukon Pacific Corporation 1049 West Ninth Avenue Anchorage, Alaska 99513 POSITION STATEMENT: Testified on HB 399. WILLIAM M. WALKER, General Counsel Alaska Gasline Port Authority Walker, Walker, Wendlandt and Osowski 550 West Seventh Avenue, Suite 1850 Anchorage, Alaska 99501 POSITION STATEMENT: Testified on HB 399. ACTION NARRATIVE TAPE 00-21, SIDE A Number 0001 CHAIRMAN JIM WHITAKER called the House Special Committee on Oil and Gas meeting to order at 5:25 p.m. Members present at the call to order were Representatives Whitaker, Dyson, Green, Harris and Kemplen. Chairman Whitaker expressed displeasure with those who had chosen not to attend. HB 399-AK NATURAL GAS PIPELINE INCENTIVE ACT Number 0098 CHAIRMAN WHITAKER announced that the purpose of the meeting was to discuss HOUSE BILL NO. 399, "An Act levying and collecting an ad valorem tax on North Slope natural gas in place; and providing for an effective date." CHAIRMAN WHITAKER read a letter received earlier in the day from former Governor Walter J. Hickel: I would like to congratulate you and the committee for giving serious consideration to additional incentives the State of Alaska can offer its leaseholders to commercialize Alaska North Slope Natural Gas. As I see it, the state has three major options as an owner: It can work with the producers and pipeline companies to promote gas sales. It should do this by continuing the state offices abroad, supporting the property tax exemption proposed by the Mayors' group, and otherwise working to improve project economics and market interest. It can take back the gas interest if it determines the gas producers are not fulfilling their leasehold commitment. I considered this option as Governor with the Point Thomson leases, but as far as I know, the option has not been used with any of our major untapped gas fields at present. It can charge a tax on gas reserves that are not produced, reflecting the argument that gas is more valuable "in the ground" than "in the market" in competition with supplies leaseholders sell from other areas. Your bill, HB 399, puts the third option in place and strengthens the second option. I hope a reserve tax never needs to be used, but it is high time - given the fact gas was discovered over 30 years ago - that the option is there. Other nations have much stronger "disincentives" to a lack of production, and I believe that is part of the reason producers put us off as an option for the Asia marketplace. CHAIRMAN WHITAKER thanked Governor Hickel for his support and echoed many of the things he had said. Number 0307 REPRESENTATIVE CROFT, prime sponsor of HB 399, presented the bill. He said he thinks that if this legislation were to pass, it could be one of the most significant steps toward the most significant construction project, economic opportunity, and resource development opportunity for the state seen in the past 30 years or likely to be seen in the next 30 years. REPRESENTATIVE CROFT offered a 1955 quotation of Senator Bob Bartlett before the Alaska Constitutional Convention. Senator Bartlett believed that the future of Alaska for a long time was going to be dependent upon mineral development. Representative Croft noted that this was before any significant discoveries on the North Slope, but that Senator Bartlett's points are as true for oil resources now as they were for mineral development in that day. He read: The financial welfare of the future state and the well- being of its present and unborn citizens depend on the wise administration and oversight of these developmental activities. Two very real dangers are present. The first, and most obvious danger, is that of exploitation under the thin disguise of development. The taking of Alaska's mineral resources without leaving some reasonable return for the support of Alaska governmental services and the use of all the people of Alaska will mean a betrayal in the administration of the people's wealth. The second danger is that Outside interests determined to stifle any development in Alaska which might compete with their activities elsewhere, will attempt to acquire great areas of Alaska's public lands in order not to develop them until such time as they, in their omnipotence and the pursuance of their own interests, see fit. If large areas of Alaska's patrimony are turned over to such corporations, the people of Alaska may be even more the losers than if the lands had been exploited. REPRESENTATIVE CROFT emphasized the words of Senator Bartlett about the second of the two dangers. He expressed concern about getting a fair return for the people of Alaska, and asked if the resources of the state are being developed in a timely manner by those who have contractual rights to develop them. REPRESENTATIVE CROFT said one way to answer that question might be to look at indicators including the following: Is it a small or a large deposit? Is there an established market for the product? Is that market anywhere on the Pacific Rim, which is our natural trading partner? Is it a valuable commodity, sought world-wide. Is it likely to be in demand in the future? Has there been any export of it from the state in the past? Is there an existing transportation path? Is the project do-able, both technologically and economically? He concluded that the natural gas deposit owned by the people of Alaska and for whom legislators are trustees meets those criteria. Number 0766 REPRESENTATIVE CROFT highlighted a difference between what he and some of the producers mean by "economical." He means, "Can it show a profit to do it?" What a company sometimes means is, "Is it more profitable than other competing, worldwide projects?" The latter "is not what we [of Alaska] mean," he said, "and it is not what we should demand from the people who have contractual rights to develop our resource." Number 0823 REPRESENTATIVE CROFT noted that there are significant other natural gas projects being developed around the world by some of the same multinational corporations that are reluctant to develop Alaska's resources. He called attention to the Prudhoe Bay operating agreement and changes that would occur in it, if there were a major gas sale. These changes are significant, they affect the players differently, and they may have provide disincentives for one or more players to allow a major gas sale, he said. REPRESENTATIVE CROFT reminded listeners that Alaska's constitution, unlike those of other states, preserves all of the mineral, oil and gas resources for the people of the state. Legislators have an obligation to look after Alaska's interests and are trustees for the people in disposing of their resources. Although some leaseholders sometimes refer to it as "their" oil, he said, "it is more accurately ours, and they have a contractual right and duty to develop it. He stated that it is important to look to Alaska's interests in terms of the revenue and jobs that can be created. It is in Alaska's interest to have the cheap energy and the economic engines of development that this gas line can provide. Number 0972 REPRESENTATIVE CROFT concluded by quoting former President Theodore Roosevelt, "Speak softly and carry big stick." Representative Croft proposed that Alaska continue to speak softly with the people who have leasehold interests in the state's oil, [and] "that we continue to push ... to build this gas line and bring this gas to market," he said, adding: But, in HB 399, I propose that we take a very big stick [to the] table. If this gas line is a doable project, there is very little excuse for the delay, and no excuse that is justifiable to us as the trustees. REPRESENTATIVE CROFT suggested it is appropriate for this legislature to determine whether North Slope gas is, in effect, being warehoused; if so, the legislature has an obligation to fix it. Number 1132 CHAIRMAN WHITAKER asked Representative Croft whether the intent of HB 399 is to tax. REPRESENTATIVE CROFT said there is clearly a tax in the bill, but he hopes never to collect it. He hopes it is enough of an incentive that this legislation is passed. He noted that the bill defines reasonable benchmarks, and if they are met, the tax never will go into effect. Number 1193 JEFF LOWENFELS, President, Yukon Pacific Corporation, applauded the legislature for introducing HB 399. He testified that Yukon Pacific has an economic project and is ready, willing and able to work with any producer who has gas on the North Slope to ensure that they never have to pay the tax under HB 399. He said Yukon Pacific is convinced that the market is there. There are no technological barriers to the gas line project. Yukon Pacific has secured the major permits. "Frankly, we think it is time for people to put down studies and start working on a project," he said. MR. LOWENFELS said there are a lot of issues involving the Prudhoe Bay Unit Agreement, some of which are beginning to be discussed publicly. Yukon Pacific believes it is not necessary for a North Slope producer to invest in the gas line project. What the producers have to do is make gas available, and they are going to be paid for that gas. Number 1333 CHAIRMAN WHITAKER said, "Assuming that the gas is purchased from the producers, there is a logical conclusion that it would be profitable for them to sell it or they would not sell it. Would you agree?" MR. LOWENFELS agreed and went one step further. He said: We have always said that a liquified natural gas [LNG] project, because of the duration of the contracts - long-term contracts - has to be a marriage, a non- divorce marriage. And that means everybody in the marriage has to be happy, including the buyer and the seller of the gas. Number 1358 CHAIRMAN WHITAKER asked about the economics inherent in Yukon Pacific's new cost model. MR. LOWENFELS said the project would be phased, starting as small as possible, at about 9 million metric tons, with about 7.5 million tons of that going to markets outside of Alaska. Pipeline and compressor stations will cost about $5 billion, the North Slope conditioning plant about $1 billion, the ships (which do not necessarily have to be included in the capital costs)about $1.8 billion, "so you could get a 9 million metric ton project up for $8.16 billion." He added: The rule of thumb in the LNG business, around the world, is that if you have a project that can come in under $1 million per metric ton a year, then you have an economic project. Our 9 million metric ton project comes in at $8 billion a year. When we expand up to 13.5 billion metric tons a year, we are at $10.5 billion. If you expand to 18, we are at $12-13 billion. MR. LOWENFELS concluded by saying that all of these numbers tell him that this project is economic. Number 1440 CHAIRMAN WHITAKER asked if that estimate is bankable. MR. LOWENFELS replied: Our estimate is very close to bankable. For about $10- 15 billion, we will be at a bankable cost estimate, in my opinion. That is a staggering statement I'm making because it shows how much work we have done at Yukon Pacific. It shows how accurate and detailed this latest cost estimate is. MR. LOWENFELS added that he thinks that with cooperation from North Slope producers, the project could be up and running by the first quarter of 2007. Number 1489 CHAIRMAN WHITAKER asked how much Yukon Pacific has spent. MR. LOWENFELS said more than $100 million. Number 1513 REPRESENTATIVE KEMPLEN asked if Yukon Pacific could work within the parameters of HB 399. MR. LOWENFELS replied, "Absolutely." REPRESENTATIVE KEMPLEN followed with, "You do not consider this piece of legislation to be an onerous burden?" MR. LOWENFELS said it shouldn't be an onerous burden on the producers, since all they have to do is make the gas available. "The burden is on our shoulders, and it is a burden we are willing to take," he added. Number 1587 REPRESENTATIVE GREEN reported that when he was in Japan last summer and talked with several of the gas-importing companies there, he heard that they did not want to depend more than 20-25 percent on any single source for their gas. He asked: Would 9 million metric tons of gas be far more than they can utilize? MR. LOWENFELS said if Alaska were dealing only with Japan, that might be true. However, the plan is to sell to Korea and China, too, so gas would be distributed among those three countries. He pointed out that the Middle East now supplies 80 percent of the oil and 70 percent of the LNG that goes to Japan. Buying from Alaska would provide Japan with desirable diversification. REPRESENTATIVE GREEN said he was just quoting what they told him. MR. LOWENFELS responded that he has gone to Japan 59 times, is well acquainted with those buyers, and has never been told they were worried about too high a percentage of natural gas coming from the United States. REPRESENTATIVE GREEN volunteered to give him the names of those with whom he had talked. MR. LOWENFELS said he is not questioning the accuracy of Representative Green's reporting, but the ability of those buyers to speak for all of Japan. Number 1800 WILLIAM M. WALKER, General Counsel, Alaska Gas Pipeline Port Authority, testified on behalf of the port authority that they, too, believe that an LNG pipe line project in Alaska is economic. That is based on the past year's work. MR. WALKER said that they have closely followed Dr. Pedro Van Meurs' study, and have exceeded what he said needed to be accomplished for Alaska's gas to compete on the world market. Mr. Walker said in addition, the port authority has obtained an Internal Revenue Service (IRS) ruling, which was not suggested or even contemplated in the 1997 study. Two weeks ago, Mr. Walker spent some time with Dr. Van Meurs, and they went over the IRS ruling. Dr. Van Meurs, he said, estimated that the IRS ruling brought $10-$20 billion economic benefit to the project. MR. WALKER said the port authority has nine representatives in the Far East, and they are reporting, as did Mr. Lowenfels, that there is great interest in Alaska's gas. He said the port authority has retained the best financial advisers that money can buy to assist in the modeling to confirm the economics of the project. Number 1983 MR. WALKER further explained that Dr. Van Meurs, in his 1987 report, had made about six different recommendations which he thought were going to be necessary in order to make Alaska gas competitive. The only one involving the federal government was a suggestion that they might provide an accelerated depreciation schedule for the assets of the owner of the gas line. When he compared those economic projections with having no federal tax obligation whatsoever, Dr. Van Meurs had said the impact is "absolutely huge, monumental to the economics." Number 2038 CHAIRMAN WHITAKER asked Mr. Walker if he thought a bill of this nature would serve as an incentive to have meaningful discussions with the producers in Alaska. MR. WALKER echoed the previous speakers' hopes that the tax would never be imposed, but he anticipated that gas lease holders would be most interested in engaging with a project which has no risk to them, as described by both Yukon Pacific and the port authority. "So, yes, I believe it would," he concluded. Number 2080 CHAIRMAN WHITAKER called attention to the proposed amendments in the bill packet. Number 2113 REPRESENTATIVE HARRIS moved to adopt the proposed committee substitute (CS) for HB 399, Version I [1-LS1474\I, Chenoweth, 3/29/00] as the working document before the committee. CHAIRMAN WHITAKER explained the intent of Amendment 1 [1- LS1474\I.1, Chenoweth, 4/4/00]. He said it is to allow the lessees the option of surrendering their rights in the land held under the lease if they choose not to contract for sale or deliver gas. In other words, if they do not wish to pay the tax, they may simply surrender their leases to the state. Amendment 1 read: Page 1, line 1, following "on": Insert "certain" Page 8, following line 19: Insert a new bill section to read: "* Sec. 5. The uncodified law of the State of Alaska is amended by adding a new section to read: LESSEE AUTHORIZED TO SURRENDER LEASE. To avoid liability under AS 43.58, added by sec. 4 of this Act, for payment of the tax on certain proven North Slope gas reserves, a lessee who owns gas subject to the provisions of AS 43.58 may, consistent with the regulations adopted by the Department of Natural Resources under authority of AS 38.05.020 relating to surrenders of rights in land held under lease, surrender the lessee's rights under the lease to the Department of Natural Resources if the lessee surrenders the rights no later than December 31, 2002, and complies with all applicable requirements of the department's regulations and of the lease that relate to surrender of the lessee's rights in it." Renumber the following bill sections accordingly. Page 8, line 23: Delete "sec. 9" Insert "sec. 10" Page 9, line 4: Delete "sec. 10" Insert "sec. 11" Page 9, line 5: Delete "sec. 5" Insert "sec. 6" Page 9, line 10: Delete "sec. 5" Insert "sec. 6" Page 9, line 14: Delete "SECS. 5 AND 6" Insert "SECS. 6 AND 7" Page 9, line 27: Delete "sec. 5" Insert "sec. 6" Page 9, line 29: Delete "sec. 6" Insert "sec. 7" Number 2158 REPRESENTATIVE GREEN asked whether, in those cases where a lease covers both oil and gas deposits, the lessees would be surrendering their oil rights, too. CHAIRMAN WHITAKER said they would not surrender any oil rights, that this was exclusively related to gas. If that is not clear in the amendment as proposed, it would be revised to make it clear. Number 2197 CHAIRMAN WHITAKER explained that Amendment 2 [1-LS1474\I.2, Chenoweth, 4/4/00] creates an exemption from the provisions of HB 399 for gas that is needed for re-injection to enhance recovery operations. Amendment 2 read: Page 1, line 1, following "on": Insert "certain" Page 4, line 18, following "reserves": Insert "except gas from a lease that before, on, or after the effective date of this section is determined to be necessary for reinjection into a reservoir in the course of enhanced recovery operations ordered or approved by the Alaska Oil and Gas Conservation Commission in accordance with AS 31.05.030 and regulations adopted under authority of that section" REPRESENTATIVE GREEN noted that both in Cook Inlet and on the North Slope there is gas from one field being injected for enhanced recovery in another field. He asked: Would this gas that is transferred from one field to another be subject to this [taxation under HB 399] once it is injected in the other reservoir? CHAIRMAN WHITAKER said that is a good question to which he did not have an answer, and he indicated it would be appropriate to include. Number 2257 CHAIRMAN WHITAKER turned to Amendment 3 [1-LS1474\I.3, Chenoweth, 4/4/00], which creates an exemption from the provisions of HB 399 for gas that is necessary for in-field operations, use and consumption, that is, for electrical generation and other reasonable use. Amendment 3 read: Page 1, line 1, following "on": Insert "certain" Page 4, line 18, following "reserves": Insert "except gas from a lease that before, on, or after the effective date of this section is determined to be necessary for consumption or use in production operations for the lease or that is to be sold or otherwise transferred by the lessee to another producer for consumption or use in production operations involving North Slope oil and gas production facilities" CHAIRMAN WHITAKER explained that Amendment 4 [1-LS1474\I.4, Chenoweth, 4/4/00] deletes references to "stranded gas" and provides a definition for the condition in which gas must be sold. Amendment 4 read: Page 1, line 4: Delete "stranded gas" Page 3, line 12: Delete "stranded gas, as that term is defined in  AS 43.82.900," Insert "produced from the lease and delivered, in  good and merchantable condition and pipeline quality,  on the lease or at another mutually agreed location" Page 3, line 18: Delete "stranded gas, as that term is defined in  AS 43.82.900," Insert "produced from the lease and delivered, in  good and merchantable condition and pipeline quality,  on the lease or at another mutually agreed location" Page 4, line 8: Delete "stranded" Number 2288 CHAIRMAN WHITAKER explained that the final proposed amendment was Amendment 5 [1-LS1474\I.5, Chenoweth, 4/4/00]. It deletes language that specifically prohibits "arms length" and related party transactions from the sale of gas. It also changes references from "producer" to "lessee." That essentially allows the producers to do their project. Amendment 5 read: Page 4, line 2: Delete "an arms-length" Insert "a" Page 4, line 3: Delete "producer or producers if the agreement or  agreements do not constitute a related party  transaction under generally accepted accounting  principles" Insert "lessee or lessees" Number 2328 CHAIRMAN WHITAKER said he hoped the committee would give serious consideration to what had been presented. It is obviously a "very, very touchy subject," he said. "We know that, and it is not done lightly." He emphasized that HB 399 was not a disincentive, not a tax, but was put forward as an incentive. He said he "would go with Bartlett and Hickel any day." Number 2345 REPRESENTATIVE CROFT urged members and all interested Alaskans to consider their interests in North Slope gas. He reiterated that the project is economic and questioned why, then, it is not being done. He noted that the lead article in a recent issue of World Gas Intelligence was about British Petroleum's joint venture with Petro China. Those plans include a trans-China pipeline about three times as along as the Alaska pipe line would be. The amount of gas to be tapped there is about half of what Alaska's reserves are estimated to be. There are major projects being undertaken in other places. He asked: If this project is economical, why is it not being undertaken here? Number 2432 REPRESENTATIVE KEMPLEN asked about Mr. Hickel's reference to the Point Thomson leases. As he recalled, Exxon Mobil Corporation (Exxon) is the major holder of those leases. He said he understands that this legislation is not directed at Exxon, but "isn't it the case that Exxon filed suit against the Phillips [Petroleum]/BP Amoco agreement because they felt Phillips will develop the gas... [ends midspeech because of tape change]. TAPE 00-21, SIDE B REPRESENTATIVE CROFT replied, "We have high hopes for Phillips coming in." They are a company with experience in natural gas, he said, and have been doing it here for a long time. He said he and many other legislators were very disappointed to see Exxon's suit, and that under the Prudhoe Bay Operating Agreement, Exxon is the one that has the biggest disincentive for a major gas sale. Number 2432 REPRESENTATIVE GREEN posed a hypothetical question: "I have a significant amount of gas on the North Slope, and I finally agree to Yukon Pacific and say, 'OK, I'll make that gas available to you.' And Yukon Pacific says, 'Great,' and they start out working on a gas pipeline, but they don't get it done by 2008. Is my gas then subject to tax under this bill?" REPRESENTATIVE CROFT answered that if they had not [finished the pipeline] by December 31, 2008, the tax would come into effect. However, if it looked as if the pipeline would be completed by 2009 or 2010, he didn't think there would be much of a problem amending to accommodate. REPRESENTATIVE CROFT said he worries that there are a lot of other places that negotiate on a far different plane than Alaska does. He mentioned China, where one's involvement in the country is conditioned on doing some very specific things, where the threat of nationalization is not theoretically possible but has been done in the past. He said, "In natural gas, a lot of the world plays hardball, and we just haven't been. So we can still play hardball and change the rules a little later, if you want." Number 2342 REPRESENTATIVE GREEN said he had several questions, and asked whether they should be submitted in writing or held until the committee hears the bill again. CHAIRMAN WHITAKER replied that if they are detailed questions that will require research to answer, he would very much appreciate having them in writing. He indicated that he hoped the bill could be heard again Thursday, April 6. He said he thought the support for HB 399 was "realistic despite the lobbying effort that has been put against it over the last few days." He urged all members of the legislature to stand firm. [HB 399 was held over.] ADJOURNMENT There being no further business before the committee, the House Special Committee on Oil and Gas meeting was adjourned at 6:12 p.m.