HOUSE SPECIAL COMMITTEE ON OIL AND GAS April 11, 1995 9:11 a.m. MEMBERS PRESENT Representative Norman Rokeberg, Chairman Representative Gary Davis Representative Bill Williams Representative Bettye Davis MEMBERS ABSENT Representative Scott Ogan, Vice-Chair Representative Tom Brice Representative David Finkelstein OTHER MEMBERS PRESENT Representative Mike Navarre COMMITTEE CALENDAR Informational hearing on the oil royalty contract with Tesoro Alaska Petroleum Company. WITNESS REGISTER JOHN SHIVELY, Commissioner Department of Natural Resources 400 Willoughby Avenue Juneau, Alaska 99801 Telephone: (907) 465-2400 KEVIN BANKS, Economist Department of Natural Resources Division of Oil and Gas 400 Willoughby Avenue Juneau, Alaska 99801 Telephone: (907) 465-2400 BERNIE SMITH, Manager Alaska Government Affairs Tesoro Alaska Petroleum Company P.O. Box 3369 Kenai, Alaska 99611 Telephone: (907) 776-8191 JON TILLINGHAST Tesoro Alaska Petroleum Company One Sealaska Plaza, Suite 301 Juneau, Alaska 99801 Telephone: (907) 586-2890 ACTION NARRATIVE TAPE 95-18, SIDE A Number 000 CHAIRMAN NORMAN ROKEBERG called the House Special Committee on Oil and Gas to order at 9:11 a.m. Committee members present at the call to order were Chairman Rokeberg, Representative Bill Williams, and Representative Bettye Davis. He then stated Representative Mike Navarre was present to hear the testimony. He stated there was not a quorum present, but the committee would conduct an informational hearing, and hopefully other members would come in soon. CHAIRMAN ROKEBERG stated there would be an informational hearing on the oil royalty contract with the Tesoro Alaska Petroleum Company. He asked Commissioner Shively if he would like to begin his testimony. Number 030 JOHN SHIVELY, Commissioner, Department of Natural Resources (DNR), said with him is Kevin Banks, who is an economist in the Division of Oil and Gas. He is responsible for doing a lot of the work on this contract. COMMISSIONER SHIVELY explained he would like to give an overview of what the department is doing, and what the legislatures role is. Then you can either go on and take testimony from Tesoro, or we will be available to answer your questions. COMMISSIONER SHIVELY said first of all, it would be appropriate to apologize to the committee and to the legislature as to the timing of this action, as you know we do not yet have a bill in yet on this issue. He stated the bill would be presented to the legislature around April 24. The reason for this is a series of timing steps, when the new Administration took over, Tesoro was just about to begin a one year extension of a previous contract. He then stated the extension was granted by the previous commissioner, but there couldn't be more extensions of the contract without the contract coming before the legislature. COMMISSIONER SHIVELY continued by saying they thought they might put the oil up for competitive bid, but in review of this shortly after he became Commissioner, he felt there were good reasons to negotiate with Tesoro for this contract. He said he would get into some of those reasons in a minute. COMMISSIONER SHIVELY stated it took some time to negotiate the contract. Once the contract was agreed to, they had a thirty day comment period. He then mentioned the contract had to go in front of the Royalty Board as well as the legislature. At this time, he stated the Royalty Board unanimously agreed with the contract. He said once the public comment period is closed, which he believed was on the 22nd, they will review those comments, do a final best interest finding and get the members a piece of legislation. He then stated they do have a draft available if the members of the committee would like to review it. COMMISSIONER SHIVELY continued by stating Tesoro has had a series of contracts with the state of Alaska for royalty oil. The one which we are proposing to the legislature would be their seventh. The first contract was signed in 1980. We have one other existing contract on royalty oil right now with Mapco. That was a very long term agreement which ends in the year 2003. He then stated they are proposing to sell to Tesoro 40,000 barrels, per day, from the Prudhoe Bay unit which is about 30 percent of the oil, and would still leave us with 108,000 barrels of royalty oil, per day, to sell to other people, or to continue to have sold by BP who markets our oil at this time. The contract is for three years, it would begin January 1, 1996. COMMISSIONER SHIVELY then commented on price stating the price is basically equal to West Coast price. He continued stating they have several ways of establishing the price as a result of the various settlements. They have chosen to use the Exxon price for the royalty oil. In addition, we are requiring a seventy five day letter of credit to protect the state if Tesoro can not continue to pay for the oil. There is a provision stating the seventy five day letter of credit can be negotiated down to a sixty day letter of credit. COMMISSIONER SHIVELY then stated there are several reasons why we think it makes a lot of sense to proceed with this contract. He stated there is a long history of selling royalty oil to Tesoro. He also mentioned Tesoro is a major part of the economy on the Kenai Peninsula, but also an important part of the economy both in Southcentral and Fairbanks in terms of providing fuel. They have 189 people directly employed at the refinery, and they employ 552 people statewide. He then stated the impact is not just in the people, but by having several in state refiners, we really have made a difference in the pricing of petroleum products both for Southcentral and Fairbanks. This is because Tesoro does some refining for Mapco for their Anchorage sales, and Mapco does refining for Tesoro for their Fairbanks sales. So it impacts both Southcentral and Fairbanks and if you look recently at fuel prices here in Southeastern Alaska compared with those of Southcentral and Fairbanks, you'll see there is about a 30 percent difference in the prices. We believe this is a direct result of in state refining. COMMISSIONER SHIVELY stated the refinery is capable of processing 72,000 barrels, per day. They are presently processing about 50,000 barrels, per day. Another issue is the price re-opener which is in the agreement if the oil export ban is lifted because that could effect the value of the oil and also new marketing opportunities. I should also indicate, to the legislature, that two other companies have expressed some interest in royalty oil although we are not currently negotiating with either one of them. He then mentioned Petro Star has some interest for both their Valdez (indisc.) refining company out of California has expressed some interest for out of state refining. Neither of those requests would be before the legislature this year. He then stated he had reached the conclusion of his opening remarks. Number 181 CHAIRMAN ROKEBERG asked if there were any questions from the members of the committee. He then stated for the information of the Commissioner, he was in Washington D.C. last week and had the pleasure of meeting the President of Tosco Petroleum. He has been actively involved and one of the leading voices against lifting the export ban because of his ownership of a refinery in Ferndale, Washington, and also in California. Number 215 COMMISSIONER SHIVELY responded by stating this was an interesting piece of information. He then mentioned that selling to an out of state refiner would be breaking new ground. Whether or not we would even do that in a negotiated deal is unclear to me at this point, and what kind of premium we would expect is also unclear but we would get above what we would get in Alaska as a minimum because, other than us getting more money, there is no reason to sell to Tosco. We take a certain amount of risk every time we bring a new purchaser into the equation. I didn't try to indicate we were close to a deal with them, but I thought it was important the committee knows they had made a request. Number 235 CHAIRMAN ROKEBERG stated he was sure that Mr. Renquist, or somebody in Senator Murkowski's office would be happy to verify that. He then asked if Tosco is already refining North Slope crude. Number 238 COMMISSIONER SHIVELY stated they are buying it from British Petroleum (BP) since they are the biggest producer. Number 243 CHAIRMAN ROKEBERG stated to the commissioner that he had indicated there would be a premium; and apparently BP is selling approximately 100,000 barrels, per day, on the spot market, is that right? Commissioner Shively stated he did not know the answer to that. Chairman Rokeberg then asked if this is what he meant when he mentioned there was 100,000 barrels, per day, available for sale that is not committed to instate refineries. Number 252 COMMISSIONER SHIVELY stated they have, at this point, close to 200,000 barrels, per day, available to us in royalty oil. He then said about 18,000 barrels, per day, is set aside to pay for the fuel costs. Mapco has a long term contract for 35,000 barrels, per day. We are proposing another 40,000 barrels for Tesoro which is approximately what they are taking now. This leaves about 108,000 barrels which BP is presently marketing. I'm not sure they are marketing on the spot market, I didn't indicate that, they are just selling as they sell (indisc.). Number 267 CHAIRMAN ROKEBERG state that was his term, and he was curious about the selling on the spot market, and he asked the commissioner how this works. Number 265 COMMISSIONER SHIVELY stated this is a long term deal. One of the reasons we have the letter of credit with Tesoro, in order to ask BP to sell additional oil for us, we would have to give them at least a ninety day notice, or they can take a premium from us. He then stated this is a long term deal and not a spot market deal and they know well in advance how much oil they will have to market. Number 278 CHAIRMAN ROKEBERG then asked what the advantage of this arrangement is to the state. Number 280 COMMISSIONER SHIVELY stated they are acting as a broker. He then mentioned the last time the state went out to go out in a competitive sale ourselves, nobody showed up to bid, so somebody has to sell our royalty oil and we have chosen BP to do that. Number 282 KEVIN BANKS, Economist, Division of Oil and Gas, Department of Natural Resources, then stated as part of the BP (indisc.), Exxon and ARCO are also taking our oil and shipping it to the West Coast. He then stated the calculations for the spot price of that oil is the spot price of the Alaska North Slope (ANS) crude oil so we do capture the spot price of crude oil in California when the oil is shipped there on our behalf. Number 295 CHAIRMAN ROKEBERG asked if this was as opposed to a bargained for contractual price, as we have with Mapco, and now with Tesoro. Number 297 MR. BANKS responded by stating, in the Tesoro and the Mapco agreement, because the pricing mechanism is based on the same settlement agreements which we have with the North Slope producers, the element of a monthly calculated spot price is incorporated in these agreements. Number 302 CHAIRMAN ROKEBERG asked if Mr. Banks could refresh the committee members' memory on what the Exxon pricing basket was. Number 308 MR. BANKS stated the pricing basket is the same as the BP basket with a couple of differences. He said we start out with a basket of crude oils, which includes North Slope crude, a few California crude oils, and some crude oil which are traded internationally, there are spot prices reported for each of these crude oils and it is the average monthly price for each of these crude oils which are lumped into the basket to give us a destination value for royalty oil. He continued by stating from that number, we subtract a transportation computant, and in the Exxon case, that amounts to about $1.25, and then from that, the TAPS tariff, and other charges so that we price the oil for Tesoro at pump station one. We start at the destination, make a few deductions to come up with the pump station one price for Tesoro. That is the same number which our royalty value is established or lifted by BP, ARCO, or Exxon and the other producers on the North Slope. He then stated the only difference between the BP and Exxon West Coast value is that BP relies on an actual cost of the marine transportation component which is subject to readjustments over a long period of time, and is a rather uncertain number. Number 335 There being no further questions from the other members, CHAIRMAN ROKEBERG stated he wanted to follow up on two items. He stated, as he understood it, in the course of the protracted negotiations with the prior Administration and perhaps even with yourselves, two of the sticky points were the letter of credit, and the volume. He then asked how the commissioner was able to come to terms with those two items. Number 345 COMMISSIONER SHIVELY stated he did not know if there was ever a substantial disagreement about the volume. He then said what they did was because there was a situation with declining (indisc.) we did provide for an adjustment so Tesoro gets a percentage of what is available which, he said, was about 27 percent. Number 349 MR. BANKS then stated that is the current, but what we are proposing will be 30 percent. Number 350 COMMISSIONER SHIVELY then stated he did not think there was a lot of disagreement over that. The letter of credit did cause substantial disagreement, and they have yet to resolve that. He went on to say Tesoro prefers a 60 day letter of credit and, as you know, a letter of credit really does effect their ability to borrow. We previously had a 90 day letter of credit which was first established in an agreement with Petro Star. Continuing, he said we settled on 75 days in this contract with an agreement that if we could come to a future agreement assuring us there was transportation available to send the oil to the West Coast, we could bring the letter of credit down. Number 370 REPRESENTATIVE MIKE NAVARRE asked if Tesoro's history of royalty oil purchases since 1980, up until last year, had a letter of credit for 60 days. COMMISSIONER SHIVELY stated Representative Navarre was correct. REPRESENTATIVE NAVARRE then asked if they have ever failed to honor the contract. COMMISSIONER SHIVELY said, "No." REPRESENTATIVE NAVARRE then asked if any oil has ever been purchased under a 90 day letter of credit. MR. BANKS responded to the question stating (indisc.) the Petro Star agreement (indisc.). Number 379 REPRESENTATIVE NAVARRE referred to negotiating a 60 day letter of credit, versus a 75 or 90 day letter of credit, and asked is the outstanding Tesoro has to the state ever considered as a factor in this. Number 381 COMMISSIONER SHIVELY stated it was not. The outstanding liability they have to the state is secured by their refinery in Kenai. Number 387 REPRESENTATIVE NAVARRE asked if the value of the refinery in Kenai, and their ability to borrow under the 75 day letter of credit, doesn't that effect the ability of the refinery to continue economic operation. Number 395 COMMISSIONER SHIVELY stated he didn't know if it directly effects their ability to operate, but it does effect their economics. We may dispute what they think they need and what the state thinks they need. But clearly, it has an economic impact which is one of the reasons we left an ability to negotiate it back down to 60 days. Number 402 REPRESENTATIVE NAVARRE then stated his point is that they have been pretty good customers. Number 405 COMMISSIONER SHIVELY stated he agreed with that assessment. He then mentioned that people who do not believe the department does not know how to negotiate with the industry should read the booklet put out by Tesoro. He then stated the department did not take advantage of Tesoro even though Tesoro might see that in a different way. What this points out, he said, is the people in the Division of Oil and Gas are highly professional people who keep the state's best interest uppermost in their minds. He then said people sometimes concentrate on commissioners who come and go, and in this department there has been a rapid coming and going for the last eight years, but the real strength for the state in terms of what happens to our assets, is people like Kevin, Ken Boyd, and Patrick Coughlin. Those people do have a very good understanding of what the state's best interest is. Number 425 CHAIRMAN ROKEBERG asked about the Petro Star refinery in Valdez, and then asked where they were buying their oil if they are not buying it from instate. Number 430 COMMISSIONER SHIVELY stated they are buying their oil from the producers though he did not know which one. It is a commercial deal which they make with either one or more of the producers. Number 435 CHAIRMAN ROKEBERG asked if there was a reason why we are not selling to them in kind. Number 437 COMMISSIONER SHIVELY told the Chairman he would have to ask them that question. He then stated they had a deal with them, they never took any oil under that deal, and they have now come back to us stating they want to buy state royalty oil. He then mentioned they will be discussing that with them next year, and if we come to some agreement, it would be a contract which you would see in the next legislative session. He continued by stating, clearly the agreement which we had with them for royalty oil which we signed before the first refinery was built, helped them with their financing. They used it to show the lending institutions they had a supply of oil. Apparently, they were able to negotiate an equal or better deal with the producers. Number 450 REPRESENTATIVE NAVARRE stated he thinks part of that is related to the fact that they can buy directly since they are on the line without any risk of transportation liability which the producers, or at least one of the producers, indicated they were unwilling to risk sale to Tesoro. Number 455 COMMISSIONER SHIVELY stated that was a good point and he would like to follow up on it. He then said one of the other reasons we think this contract is in the state's best interest is because it is not clear, if we did not sell to Tesoro, whether they would be able to buy oil. One of the major producers has told Tesoro they would not sell oil form Valdez because they are afraid if there is an oil spill, the liability would go back to them. He then stated this is a major difference between Petro Star and Tesoro. He also mentioned that Tesoro pointed out in their review of the contract, this is one of the competitive disadvantages they have with Mapco and Petro Star. Number 465 CHAIRMAN ROKEBERG asked if there were any further questions from the members of the committee. Hearing none, he asked if Mr. Smith would like to come forward and present his testimony. Number 470 BERNIE SMITH, Manager, Alaska Government Affairs, Tesoro Alaska Petroleum Company, asked Jon Tillinghast to join him at the table. He stated that Commissioner Shively and Kevin Banks gave a pretty good overall view of Tesoro's situation. He then stated he would like to read a couple of paragraphs out of their summary to get it into the record. "The Department of Natural Resource is proposing the sale of 30 percent of the state royalty from Prudhoe Bay, or about 27 percent of the overall North Slope royalty oil to Tesoro Alaska Petroleum. Roughly 40,000 barrels, per day, would be available to Tesoro under this contract. The terms would be for three years and would require at least 80 percent of this production be processed at Tesoro's Nikiski refinery. The contract requires legislative approval under AS 38.06.055. Royalty oil has been, and remains the principal feed stock for Tesoro's refinery, and under the proposed contract delivers about 80 percent of the refineries crude supply. There are no other stable long term sources of crude for the refinery, and Tesoro's current one year contract with the state royalty expires December 31, 1995. As a result, if the legislature is unable to act on this proposed contract before it adjourns from the 1995 session, Tesoro would loose about 80 percent of its crude oil supply, and continued operations of the Nikiski refinery would be in peril. "Because the contract must be reviewed by the Alaska royalty oil, gas and development advisory board before being presented to the legislature, the contract would be introduced about April 24th. This is the reason have asked for these informational hearings, to review any information which the legislature may have prior to the actual committee hearings so we can get these questions answered. MR. SMITH then mentioned one thing he would like to talk about is the price. Tesoro is obligated, under the contract, to pay a substantial premium above the price the state receives from the North Slope producers and other in-state refineries. In the month of January, 1995, the premium would have been 19 cents per barrel, or about 2.7 million dollars, annually. He continued by stating he wanted to let the members know the state has definitely had the state's best interest in mind while negotiating this contract. In short, it is virtually at every turn the DNR has had a considerable bargaining advantage, and this will be as favorable a contract, from the states perspective, as any which has ever been delivered. Nonetheless, this contract does meet Tesoro need for a stable source of crude for three years, and the contract does deserve legislative approval. That ends my opening statement. Number 530 CHAIRMAN ROKEBERG Thanked Mr. Smith for his comments and asked if there are questions from the members of the committee. Number 534 REPRESENTATIVE NAVARRE stated he would like to thank Chairman Rokeberg for allowing these informational hearings to take place even though we do not have a bill to work with. Number 536 CHAIRMAN ROKEBERG thanked Representative Navarre and Mr. Smith for attending the meeting. He then stated he did have one question of Mr. Smith. He asked if he could explain the substantial premium, and why he thinks that was done. CHAIRMAN ROKEBERG then stated he did not want to embarrass Mr. Smith, and that he understood this was a difficult issue. Mr. Smith asked Mr. Tillinghast to address that issue. Number 550 JON TILLINGHAST, Tesoro Alaska Petroleum, said he would like the members to look at the copy of the a booklet entitled, "An Analysis of the Department of Natural Resources Proposed Three Year Contract for the Sale of Prudhoe Bay Royalty Oil to Tesoro Alaska Petroleum Company, March 29, 1995," which they provided. He requested the members look at the chart. He then stated the chart depicts prices based on January, 1995, reported prices. The first one is British Petroleum's reported prices, which I think is important to point out because those prices would include the spot market sales which the Chairman mentioned. The yellow board is the volume weighted average of all of the Prudhoe Bay sales to the West Coast and the Gulf Coast. This is the price which Mapco pays, and Petro Star would have paid had they taken deliveries under their 1992 contract. Lastly, is the Exxon price of $1.10, per barrel, which is what Tesoro is going to pay. If January, 1995, is representative of the way the next three years are going to go that's where you are looking at about a 19 cents per barrel, $2.7 million premium. MR. TILLINGHAST stated this is a premium because Exxon only sells on the West Coast and West Coast prices are higher than the Gulf Coast prices, and therefore, when you are paying on a West Coast only basis you are paying more than what the state is getting on average from the North Slope. He continued by stating it is the on average price which the state calls the royalty oil value. MR. TILLINGHAST said the Division of Oil and Gas' rationale for a premium has been, when you take royalty oils in kind and place it on the West Coast, of which Alaska is a part. This displaces some other West Coast companies, and in turn they send their oil to the Gulf Coast so they can get a lower price, and therefore, bring down your royalty values. This is called the displacement effect. He continued by stating what concerned Tesoro the last two times DNR looked at this issue, which was with respect to Tesoro's one year contract, and Petro Star's long term contract in 1992, in the findings accompanying those documents DNR concluded the displacement effect wasn't a problem any more and that the percentage of the sales going to the gulf coast was diminishing, and was going to continue to diminish. He then stated these royalty contracts were for small quantities of oil, and therefore we shouldn't have a premium. We were getting our premium in terms of the jobs and increased competition we were selling this oil to an in-state refinery. The demand for a premium in the displacement effect resurfaced with respect to this three year Tesoro contract. He stated he could not explain why because the market hasn't changed. Obviously, Tesoro believes that DNR has been right over the last three years, and is wrong here. Be that as it may, Tesoro needs the oil, and there is no other place to get it. Number 601 REPRESENTATIVE NAVARRE asked if he could explain the displacement effect again, or should he ask Mr. Banks. Number 602 MR. TILLINGHAST stated he should probably let Mr. Banks explain. Number 605 REPRESENTATIVE NAVARRE asked if the BP price was an adjustable price. Number 610 MR. TILLINGHAST stated the price could go either up or down. Number 613 REPRESENTATIVE NAVARRE asked what would be likely to happen. Number 614 MR. TILLINGHAST stated the Representative should bear in mind the price is $10.31 rather than $10.70, or $10.80 because BP does sell on both coasts so the average price is going to be lower. Number 617 REPRESENTATIVE NAVARRE stated he had a question for the department. Number 620 CHAIRMAN ROKEBERG mentioned to Mr. Smith, the commissioner brought up his evil commissioner theory as an example of which the foundation of the contract was negotiated. Clearly, we have an arms length competitive situation, but I get the sense you are not entirely happy with the contract price but you are willing to accept it. Mr. Smith stated that was a very fair assumption. He continued by stating they did not have a good leg to negotiate on due to the time constraints. He then stated they would probably start negotiations for extending this contract next year, or the year after. Number 636 MR. TILLINGHAST stated the state has an interest in this too. Fostering in-state refining competition with a portion of North Slope royalty oil has been one of the great public policy success stories of the state, and it is amazing we have been able to accomplish what we have with a relatively small percentage of North Slope oil. In order to keep this competitive atmosphere between Tesoro, Mapco, and Petro Star is important to make royalty oil available under roughly equivalent terms to all three of them. He then stated if you put one of them under too much of a competitive disadvantage, you are going to hurt competition, and prices are going to rise. Number 645 MR. SMITH then stated they are still in negotiations with the state on their letter of credit, and they believe they will be able to furnish a contract with their charter shipping company to guarantee transportation to the state in case we do go default. That is one of their major concerns. He continue on stating if they get this slug of oil, what will happen to it if BP, or another producer takes it over? Will they have the ships available to transport it out? If not they would charge a premium which would hurt the state, but the ship which we chartered would still be available. Number 657 REPRESENTATIVE BILL WILLIAMS asked if there are ways to get around the letter of credit. Number 658 MR. SMITH stated they have worked to get the letter reduced from 90 days to 75 days. He said they had up to three days to pay for invoicing because of the system which is currently in place. He stated they have worked ways to reduce the advantage that the state has over them, and they feel they can reduce it even further with the sublease of the chartered vessels. Number 667 REPRESENTATIVE WILLIAMS asked if they got the line of credit from the bank. Number 669 MR. SMITH stated they did get the letter of credit from the bank. He then stated one of the points of this letter of credit, and the three year contract is the state originally wanted to do a one year contract or a competitive bid. Our banks would not allow us to have a one year contract. He then stated they have to have a long term supply of crude. He stated they were originally asking for an eight year contract to match Mapco's term, however, we can live with the three year contract we received. This may not be the best advantage, but it still works. Number 679 MR. TILLINGHAST then stated to Representative Williams, the financial impact of the letter of credit, by moving from 60 to 75 days they are tying up an additional eight or nine million dollars worth of borrowing capacity. Then there are annual fees because you have to pay for the letter of credit, and these fees are going to go up about $150 thousand dollars a year (indisc.) Number 683 REPRESENTATIVE WILLIAMS asked if there was any other way the company can (indisc.) other than being there. (Indisc.) Number 687 MR. SMITH stated they already have their refinery put up as a letter of credit, so that is not an option for the state to get into. He then stated a 60 day letter of credit is part of doing business, however, a 90 day letter would not be acceptable and we still believe we can get it down to 60 days. Number 694 MR. TILLINGHAST stated in addition to the letter of credit the contract also requires (indisc.) Number 697 CHAIRMAN ROKEBERG asked if he mentioned $850 thousand for the cost of the credit. Mr. Tillinghast stated it was $780 thousand with the additional $150 thousand. Number 700 CHAIRMAN ROKEBERG stated they had to wrap things up fairly quickly, but Representative Navarre wanted to ask the commissioner a question. He then thanked Mr. Smith and Mr. Tillinghast. TAPE 95-18, SIDE B Number 000 REPRESENTATIVE NAVARRE asked the commissioner about the displacement theory. Number 001 MR. BANKS (indisc.) royalty value on the part of those producers who are lifting oil and carrying it off of the market, and the impact that has, not only on the royalty but also on the severance tax. At the moment, only BP is shipping oil to the Gulf Coast. In the calculation of the value of their royalty oil they calculate the number of barrels they are moving to each destination. It is theorized, and I think it's fair assumption to make, that if we sell oil to Tesoro that is oil which BP may not sell. This means in calculating the volume of oil in each market, you must deduct this 40,000 barrel from the producers. This has an effect of changing the relative rates to the west coast and gulf coast markets. He then stated BP was currently shipping about 70 percent of its oil to the West Coast, and 30 percent of its oil to non West Coast locations. He then stated this may have the impact after accounting for the 40,000 barrels, per day, going to Tesoro, and of changing those rates from 69 percent to 31 percent. What this means is they can increase the rate of a lower value market. Number 055 REPRESENTATIVE NAVARRE asked if that theory wasn't flawed. He continued by stating if you took 40,000 barrel away here isn't it more likely you would increase the percentage of barrels sold at the West Coast rather than at the Gulf Coast. He continued stating if you take 40,000 barrels out of the equation, then you are taking it out of the overall sales. Number 071 COMMISSIONER SHIVELY stated BP wouldn't ship a drop of oil to the Gulf Coast unless they had too. So what happens is they fill up the West Coast, and anything additional goes to the Gulf Coast. Number 079 REPRESENTATIVE NAVARRE asked why they would want to put a premium on that. He stated they were getting an advantage because all of the other 40,000 additional barrels are not going to go to the Gulf Coast which means they will be sold on the West Coast. COMMISSIONER SHIVELY stated they were either sold in kind or they are sold on the Gulf Coast, those are the two options. Number 087 MR. BANKS then stated his point was that they had to focus on the percentages, and the impact they have and not on the numbers of barrels. Number 092 REPRESENTATIVE NAVARRE asked if we take 40,000 barrels away from what BP is selling now, is it more likely going to be from the Gulf Coast, or the West Coast. COMMISSIONER SHIVELY responded by stating it would be the Gulf Coast. REPRESENTATIVE NAVARRE then asked if we were taking the lowest valued oil. COMMISSIONER SHIVELY stated that was one way to look at it. REPRESENTATIVE NAVARRE then stated he sees this as an advantage to the state by taking the royalty oil. Number 105 MR. BANKS then stated what he believes is happening is we assume the West Coast market is a certain number of barrels, and what is changing is not the number of barrels delivered to either coast, but the rather who is selling them. That means if we are selling them, those are barrels BP is not selling, which means we only change the relative weighing of the barrels which BP is hauling out of Alaska to favor a larger percentage on the Gulf Coast. He continued by stating we are not changing the number of barrels delivered to the Gulf Coast nor to the West Coast. Number 118 REPRESENTATIVE NAVARRE stated that we certainly were. He stated if we are taking at the tap, 40,000 barrels away from the equation there is still the same number which can be used at the West Coast. As you have said, you assume there is a set amount which has capacity on the West Coast. If you take 40,000 barrels away from that equation, which is what you are doing when you sell it here instead of the lower 48 markets, then you are taking it from the lowest value oil. In this way you would be changing the equation in favor of the higher priced oil for the state. Number 135 MR. BANKS mentioned to Representative Navarre that his way of looking at this issue would work if Tesoro would not be operating without a royalty contract, which is a likely possibility. He then stated when he is referring to the West Coast he is speaking about all destinations on the West Coast including Alaska. He then restated his point by saying the volumes on either coast are not changing, what is changing is who is selling the oil. Number 143 REPRESENTATIVE NAVARRE asked if we didn't continue the contract, and Tesoro decided they couldn't afford this, what the impact to the state would be. He then asked if we would not be selling more of the states royalty oil on the Gulf Coast. He then said he sees this as an advantage to the state, we are selling less oil for a cheap price which drives up the weighted average. Number 155 COMMISSIONER SHIVELY stated we are making the assumption that the volume would go to the West Coast no matter what because Tesoro would buy at a comparable West Coast price for their refinery, or hire if we went to a competitive sale because they might have to bid higher in order to protect themselves or somebody else on the West Coast would buy that oil to bring up here if Tesoro shut down because there would be a market for those products in Alaska. These refined products would not come out of the Gulf Coast, they would come out of the West Coast. I think that is what Kevin is trying to say, you have to look beyond where the oil goes, you must also look at where the oil comes back to and where it is used. Number 171 REPRESENTATIVE NAVARRE then asked if you are going to look at the rest of this in that equation, shouldn't you also look at the liability Tesoro has to the state under other agreements, and how the overall contract impacts Tesoro. Number 180 COMMISSIONER SHIVELY stated Representative Navarre was correct. He then said if Tesoro felt they could not operate under this contract, they would not sign this contract. He then said we could argue what would be the best for Tesoro, and there is no question they are competitively better off at a lower price. He then said there is another issue on this price, which is, because they audit their transportation cost, it is not a set price and there was some substantial price risk for Tesoro in the BP price but that risk goes away with the Exxon price. Number 197 REPRESENTATIVE NAVARRE asked when the last time the state sold royalty oil on a competitive bid. Number 199 MR. BANKS stated the year was 1985. Number 201 REPRESENTATIVE NAVARRE said he believes he has a hard time understanding why they value this competitive bid process so highly. Number 210 COMMISSIONER SHIVELY said there is another aspect to this. He stated the theory that as the West Coast markets increase, the gulf price is going to go away. If that happened we probably wouldn't be arguing over anything today. The only reason we are arguing is because BP has an excess they can't sell on the West Coast. This also might change if the oil export ban is lifted. He then stated he thinks, given the responsibility they have to get an equal or better value for the states royalty oil, they did a good job of negotiating. He stated he does not believe Tesoro is very happy with it, but it is a fair price. Continuing, Commissioner Shively said this is basically the bench mark, and they won't find us going back and giving Petro Star a better pricing deal than the one they received. Number 230 CHAIRMAN ROKEBERG stated for the record that Representative Gary Davis joined the committee some time ago. Number 232 REPRESENTATIVE WILLIAMS stated he would like to hear the comments on the letter of credit again. Number 235 COMMISSIONER SHIVELY stated this was a complicated issue. If Tesoro stops taking oil because they can no longer pay for it, the oil industry requires that we give them substantial notice in order that they pick up the oil and sell it for us. The last time this happened, they charged us a premium because there were no tankers available and the oil couldn't be shipped, so we got less for our oil than wee would have on the market. This letter of credit protects us from that. However, we do believe there is an opportunity to take the letter of credit down to 60 days by solving the transportation problem. Number 247 CHAIRMAN ROKEBERG asked the commissioner if they considered the extraordinary burden that is on Tesoro because of their requirement to transport the oil from Valdez to Nikiski. Also, he asked if they had taken into account the ad valorem taxes, and the corporate income taxes. Number 257 COMMISSIONER SHIVELY stated the taxes they pay are part of the best interest finding, which is one of the reasons they want to keep the business alive. It wasn't taken into account, in the sale, as an economic factor. He then stated they were aware of Tesoro's competitive disadvantage in having to transport the oil from Valdez, which has two aspects to it. The first is, they have the extra transportation cost; and the second is, they can not put their residual oil back in the line. He then stated they were aware of those issues, but no credit was given for them. Number 271 REPRESENTATIVE GARY DAVIS stated he believes the major concern is on the price and the different weights. Tesoro's competitive disadvantage can probably be given some weight due to the fact their competitors have a long term contract already in place, so I suppose that is where any fluctuations in price are based on how much weight you give to that. Number 285 COMMISSIONER SHIVELY stated one competitor has a long term contract which, if we had to do over again, we wouldn't do it that way. Number 290 REPRESENTATIVE DAVIS stated that was what he meant. Different weights in terms of leveling the playing field. Number 292 COMMISSIONER SHIVELY stated they didn't level the playing field. Number 293 CHAIRMAN ROKEBERG asked if the length of the three year contract was a policy call. Number 300 COMMISSIONER SHIVELY said they would not enter into the type of long term contract which they have with Mapco because of changing market conditions. He said they agreed on three years, and they have a request from Petro Star which goes well beyond the year 2003. The Mapco contract was negotiated at a time when there wasn't a lot of in-state refining capacity, but this contract is way too long, and is not in the commissioner's mind in the best interest of the state. Number 315 CHAIRMAN ROKEBERG asked if they took into account the financial requirements of the companies. Number 317 COMMISSIONER SHIVELY stated they did, and the result of that consideration was the fact they allowed the contract to run longer than one year. ADJOURNMENT Number 322 CHAIRMAN ROKEBERG thanked the witnesses and adjourned the meeting at 10:12 a.m.