SENATE RESOURCES COMMITTEE January 29, 1996 9:30 A.M. Anchorage, AK MEMBERS PRESENT Senator Loren Leman, Chairman Senator Drue Pearce, Vice Chairman Senator Rick Halford Senator Georgianna Lincoln MEMBERS ABSENT Senator Steve Frank Senator Robin Taylor Senator Lyman Hoffman OTHER MEMBERS PRESENT Representative Gene Kubina COMMITTEE CALENDAR Alaska Natural Gas Project WITNESS REGISTER Jeff Lowenfels, President and CEO Yukon Pacific Corporation 1049 W. 5th Ave. Anchorage, AK 99504 Judd Miller, Jr., Vice President Natural Gas EXXON, Co. USA P.O. Box 196601 Anchorage, AK 99519-6601 Ken Thompson, President ARCO Alaska, Inc. P. O. Box 100360 Anchorage, AK 99510 John Morgan, President BP Exploration P.O. Box 996612 Anchorage, AK 99519-6612 Wilson Condon, Commissioner Department of Revenue P.O. Box 110400 Juneau, AK 99811-0400 ACTION NARRATIVE TAPE 96-7, SIDE A Number 001 CHAIRMAN LEMAN called the Senate Resources Committee meeting to order at 9:30 a.m. and announced a hearing on the Alaska Natural Gas Project. JEFF LOWENFELS, President and CEO, Yukon Pacific Corporation, narrated a 15-minute slide presentation. He said Yukon Pacific is the sponsor of the trans-Alaska gas system. The Trans-Alaska Gas System (TAGS) consists of a conditioning facility at Prudhoe Bay, three pump stations along a pipeline that is the existing right-of- way corridor that is designed to handle 28 million tons of gas per year (even though the project economics are based upon 14 million tons per year), an LNG plant and facility marine terminal in Valdez, and the equivalent of 15 - 125,000 cubic meter LNG tankers. They think the project would cost $13.4 million. They think $15 million, estimated by others, is too high. And this is because the $10 billion cost of the Alaskan facilities already contains a 20 - 25 percent contingency factor for cost over-runs. That number is based upon technology that in 1991 was new, but today has advanced beyond that, so new X-90 pipe is now less expensive. Their project was permitted upon an assumption, posited to them by regulatory agencies as a result of discussions with the oil companies that own the Alyeska Pipeline, MR. LOWENFELS said. They are required to stay 200 ft. away from the pipeline in all instances, except where crossing the oil pipeline. They have heard much from the producers about the ability to use shared facilities which they agree with. They actually agree on about 90 percent of the issues. They have negotiated in their pipeline rights-of-way the ability to be closer than 200 ft., if they can justifiably demonstrate why they should be. The area they disagree on is the Valdez terminal. Number 80 MR. LOWENFELS explained that the LNG markets are Japan, Korea, and Taiwan, with a possibility for China (PRC) in the future. Alaska started the LNG trade into Asia, through the Phillips LNG facility, which has been operating for 27 years. During that time, other facilities have been constructed in Japan, with Korea and Taiwan starting construction now. In addition, both Korea and Taiwan are putting in pipeline infrastructure, similar to our in-star system, to supply the whole country with natural gas. Many of the facilities are being served by supply sources today that are running out of natural gas. There is no question in their minds that there is a growing demand for LNG in Asia. MR. LOWENFELS said a number of permits are required to put an LNG plant together anywhere in the United States, but Alaska has a couple of extra permits. He said they have in hand today the six permit licenses that you need to have in order to build an LNG facility here. They believe there is enough natural gas to supply the existing markets until about the year 2000. Now, there are only 12 buyers of LNG and there are currently six sellers of LNG - Alaska is one of them. After the year 2000, they believe Alaska gas is capable of meeting the new demand which develops. By the year 2005 the gas short-fall is conservatively projected to be about 23.5 million metric tons per year and by 2010, about 35 - 36 million metric tons per year. These numbers are based upon a series of numbers developed by consulting experts, governments, and trading companies in Japan, Korea, and Taiwan. These numbers assume that Japan will complete its desires to build 40 nuclear power plants between now and the year 2010. Each power plant is capable of being replaced by 1 million tons of LNG and they do not believe Japan will actually complete the power plants. By 2005 there will be a large enough short-fall to begin to put into the market place gas from Alaska. Number 165 There is a lot of competition for these markets. In addition to Alaska, there are several projects in Sakhalin, Natuna, Papua New Guinea, a large project in Australia, a project in Yemen, a gigantic project in Qatar, and a relatively small project in Oman. All of the projects are seeking to serve the same market. Regardless of whether Alaska is competing for the market place, the Asian markets will obtain the LNG they need. MR. LOWENFELS said they believe there is a market window. The market must make long-range plans soon in order to provide enough natural gas to avoid a projected shortfall. The single most important thing that can be done to reduce the price of gas delivered from Alaska to Asia is to shorten the ramp- up period. Every ton of LNG we allow some competing project to get, is a diminution of our ability to reduce the ramp-up period of an Alaskan project. Alaska is in a serious horse race, he said, and we'd better start believing it. The risk to Alaska is that another project will get into the market place and take away Alaska's ability to get the required 14 million tons per year into the market place. He said we are in the race because of work completed by the TAGS project so far. We need the economics to support a 800 mile, $6 billion gas pipeline. We already have developed natural gas at Point Thomson and Prudhoe Bay. We have the actuality of a 56-year supply of LNG. LNG contracts are for 25 years and they could hold contracts for 50 years. There is probably additional gas to be discovered. Infrastructure already exists, not only on the North Slope, but up and down the right-of-way. We are poised to do an LNG project; it is already one of Alaska's largest exports, he said. Number 234 MR. LOWENFELS said they have always used $5 per mmbtu as the price for gas delivered in Japan. This is the worst-case scenario. They know there are $.40 worth of savings that can be achieved in Alaska through industry cooperation. There are other opportunities to knock another $1.88 off that price, bringing it down to about $4. Alaska has non-price competitive advantages. We have source diversification; we are a secure and stable supplier and we have flexibility of expansion during the seasonal peak needs in the Asian markets. We are clearly capable of having a gigantic impact of $4 billion per year on the balance of payments for the next 25 years at 14 million tons. The project, once in will be expanded up to 28 million tons, which would represent $8 billion on the positive side of the balance of things. Number 280 MR. LOWENFELS said that gas could be delivered from Valdez to not only Asia, but to the rest of Alaska. This is an opportunity to get the Asian markets to pay for natural gas to be delivered to communities in Alaska. Studies have shown that Anchorage will run out of natural gas in 15 years, so it is imperative that this project is put together for the Alaskan market. The hold-up now is the North Slope gas supply. He said there is a question whether oil loss will occur at the end of field life. It is certain there would be 25 years of revenue from a gas project. He said that the real risk for Alaska is in not competing and the loss of 10,000 construction jobs, $400 million per year, and the loss of natural gas for communities in Alaska. The discrepancy between their start-up date and the oil companies' start-up date is in how they look at the market. The oil companies are saying the Japanese will be able to buy gas in 2010, but the risk is, they will buy that gas from someone else who will be able to get into the market place before Alaska. MR. LOWENFELS said it would take 7 - 9 years to build a project like this. We will not be on schedule and will not hit the window, if we don't hit it soon. His suggestions for the State to help in this endeavor are to solve the fiscal gap, including entering into a tax treaty regarding the North Slope gas project. This would help alleviate producer concerns which appear to be a major impediment to moving TAGS forward. He mentioned also a continued encouragement of the Point Thomson project and the use of the already existing pipeline office should be taken up to ensure consistent and efficient permitting. There should be serious assistance by the State to resolve the Prudhoe Bay problems in a non-confrontational way. A joint marketing trip by the Prudhoe Bay unit operators, the Point Thomson individuals, and the permit- holders of Yukon Pacific to the Asian markets to talk about the $1.88 worth of savings should be taken. A continued commitment from both the Knowles and the Clinton administrations to actively support and promote the only U.S. start-up, a project that has a larger impact on the balance of trade than anything else put together. He noted that missing from his list was a request for any State of Alaska officials to visit the market countries to market Alaskan gas. He repeated that the State's role is to balance the budget, working on gas development, and helping with Prudhoe Bay. They need assurance that Alaska will not use gas as a tax whipping-boy, he said. Yukon Pacific is able to finance this project, if the gas were committed to the project: 16 - 20 trillion cubic feet of gas. Number 503 SENATOR LEMAN asked on what he was basing his assumption that gas prices would go up. MR. LOWENFELS said he based his price on the combined economics of their project: a decent well head price for the producers and the State, transportation costs, etc. They have derived a landed price in Japan. Number 539 SENATOR LEMAN asked if his well head numbers were in the range of what gas producers could expect to be paid in the market place. TAPE 96-7, SIDE B Number 575 MR. LOWENFELS replied that he would have to ask the producers. He thought these numbers were possible, if they can coordinate the markets involved. This is why he would like to get into the market before 2005, even though it's just a small incremental increase. He thought we could get good financing through Japan, because we are in a stable area. He reiterated that he thought their numbers were very conservative. SENATOR LEMAN asked if Point Thomson could be used as a significant part of the ramp-up period to minimize the disruption to Prudhoe Bay, but to allow a start-up that would make their economics better. MR. LOWENFELS said he had conversations with members of the Point Thomson unit and that it was possible to start with Point Thomson gas around 2004 and to work the project so that Prudhoe Bay gas is not needed for several years. Number 520 JUDD MILLER, Vice President, Exxon, said they have put considerable effort and money into commercializing natural gas. He said their options include export to the far east markets, the pipeline, gas to the lower 48 markets. None of these options are currently economical. Since 1992, EXXON, ARCO, and BP have jointly studied the potential for LNG export to the far east. They have agreed to have Ken Thompson of ARCO present the results of their studies. KEN THOMPSON, President, ARCO Alaska, Inc., said Prudhoe Bay has about 85% of the known North Slope gas reserves, about 26 trillion cubic ft. of gas. He said there are huge gas reserves in the oil rim and large liquid reserves in the gas cap. One question that often comes up is, do the differences between the oil rim and the gas cap create an impediment. None of the three producers believe that at all, he said. He said there are no major differences in ownership of the gas, and he said this is an issue that is sometimes played up by others. It is not an issue with the producers. MR. THOMPSON said the Alaska/Asia Gas System (AAGS) was work initiated by ARCO and the Japanese Institute of Energy Economics. Other options have been considered, he said, like gas conversion that would convert the North Slope gas to liquid hydro carbons and ship it down the TAPS Pipeline, a technology that is, perhaps, 15- 20 years away for broad commercialization. Two things that differ from any LNG project that is currently being considered are the large reservoir of oil in the same area, so there is concern about oil loss (but, he did not think it would be a very serious problem) and the pipeline piece. All other projects are on water or are close to water. This is the only project that faces a $5 billion, 800 mile pipeline for the southern route. That is an incremental cost other projects don't face. Cook Inlet gas has already been in production for over 20 years. If North Slope gas were on Cook Inlet today, it would be commercially competitive. He said Alaska has 25% of the production that the Asian market will need. If you get to the market too early, you drive price downward. The trick is to work in 14 million tons as demand grows, such that you can also have an economic price, along with the volumes. Most contracts are tied to other fuels, such as other LNG, oil, and coal, so all of these prices will affect Alaskan LNG price. We are closer to the major Japanese markets than the Middle East, he pointed out, which allows for less shipping costs. It would be advantageous for Alaska to have a balanced budget. He said the producers had intensified efforts since 1994 by forming teams to address these issues. Number 450 JOHN MORGAN, President, BP Exploration, said the focus of their work has been on reducing costs to become competitive, and the pipeline cost is a major problem, because competing schemes don't have to face it. They have tried to reduce the cost of the southern route by integrating that route more closely with the existing oil pipeline. They are also looking at alternative western routes, but a lot more technical work is needed. Their position on the cost estimate is around $15 billion. They have come up with approximately $3 billion of potential cost savings through looking at infrastructure sharing, both in the pipeline and at the port of Valdez. He emphasized that $1.4 billion of the savings could come out of the linkages that could exist at the port of Valdez. Other sources of savings come from different approaches to pipeline construction, the technology of the steel that can be used, approaches to actually laying the pipeline, and by using larger LNG carrying vessels. MR. MORGAN said the Japanese market would be crucial to any project put together in Alaska, although multiple markets would be required for success. Three quarters of the gas sent to Japan is used for power generation, and there is competition for other fuels in this instance. The producers have based their demand assumption on figures from the consumers which have a low to a high range of demand. The high demand rises to 110 million tons a year which would require by 2010 something like 26 million tons per year of supply. The lower end of the demand range rises to 88 million tons per year, in which case, only some 4 million tons of additional supply per year would be required from potential grass roots schemes. They believe this is a reasonable range to be looking at and that is why they talk about the market capability to absorb new grass roots schemes running from the period of 2005 - 2010. There may well be a need for additional gas in Taiwan or Korea a little earlier than that, but without the Japanese component of this market, there would not be an Alaskan LNG scheme. Number 332 MR. MORGAN reviewed with the committee the competition from other countries. It is almost certain, he said, that in the whole of the 1990's there will only be one new grass roots LNG scheme and that's the Qatar gas scheme. Having potential for expansion to up-and-running schemes is a substantial competitive advantage over building a new grass roots scheme. There are three potential expansions they believe are likely to come to the market and are likely to have a competitive advantage over the Alaskan scheme. He emphasized that if we are not realistic about these things, we will almost certainly not succeed. Since these schemes deal in such huge sums of money, the fiscal terms are extremely important, both the level of fiscal terms and the degree of stability. International agreements to guarantee large sums of money are being considered as well as government participation. He emphasized that cooperation between producers and government is necessary to have the strength to compete successfully. In conclusion, MR. MORGAN said, that there are going to be many parties making this link economic, but the link between the producers and State and federal government is a critical one, certainly for the next step which is in the area of fiscal and tax regulations and the general regulatory environment. Government participation in downstream facilities is another possibility. The market timing itself is a major uncertainty. Number 222 SENATOR LINCOLN asked if there were more specific recommendations the legislators could review to see how close they are to their plan. MR. THOMPSON said they are working on fiscal recommendations for this project, but the State needs to look at other LNG projects to see what their governments do for them and see what Alaska can do to be competitive. MR. MILLER said in 1996 they are looking at some of the regulatory and environmental challenges at both the State and federal level. They will also have informal discussions with Yukon Pacific. If costs are reasonable, maybe Yukon Pacific could play a role there. In 1998 they are looking at project structure and agreements, and they will be looking at a number of investors. SENATOR LEMAN asked if part of the reason for delays in the Alaska gas project was due to their international involvement. He noted that for a number of reasons the State would like to see the project happen sooner rather than later. Number 100 (There was indistinct testimony on the tape at this point.) MR. MORGAN, BP Exploration, said they have involvements in Abu Dhabi and the Northwest Shelf of Australia which will expand, probably, before all the rest. He said they would work all of their projects hard and that they would work their Alaskan project just as hard as any other around the world. The challenge is to make the project competitive. TAPE 96-8, SIDE A MR. MORGAN discussed exploratory discoveries of gas in Indonesia which could be proven with additional drilling to be large finds, a possible LNG resource. He said that his goal was to make both the Alaskan and the Indonesian projects competitive in order to move forward. In the meantime, maximizing the North Slope gas is important. North Slope gas is being reinjected in order to maintain reservoir pressure for Prudhoe Bay as well as for miscible gas enhanced oil recovery. Currently, just under one million barrels a day of oil are produced from Prudhoe Bay. MR. MORGAN pointed out that 200,000 barrels of that million comes from North Slope gas reinjection. From the enhanced oil recovery end of this, it is the world's largest miscible gas project. Prudhoe Bay will have one of the highest ultimate oil recoveries (at 60 percent) of any miscible gas project in the world. MR. MORGAN emphasized that efforts would continue to utilize gas in ways to keep pressure up which decreases oil rate decline and to discover new ways for enhanced oil recovery through miscible gas. In response to CHAIRMAN LEMAN, MR. MORGAN affirmed that there are disagreements between the companies regarding the natural gas liquids and whether those should be shipped down the pipeline or used for miscible injectant. There have been AOGCC hearings on that issue and the companies are in discussions to resolve the differences. He believed that those differences would be resolved and emphasized that there are no disagreements about major gas sales; the agreements are very clear on that issue. Major gas sales will be driven by the following: cost reduction, a market that can fit in the large volumes and economic prices, and the cooperation with the state and federal government in order to have fiscal and tax certainty. CHAIRMAN LEMAN asked if there was any merit to using Point Thomson for start-up with Prudhoe Bay gas for later production, which would reduce the impact on oil production at Prudhoe Bay; if so, what are the time frames? MR. MORGAN pointed out that Exxon is the unit operator of Point Thomson. Exxon has committed to the study of that issue in the coming year. The Point Thomson field is undeveloped; there is no infrastructure. Mr. Morgan noted that at first review, the Point Thomson project poses some tough economic obstructions. CHAIRMAN LEMAN thanked him for the presentation. Number 017 WILSON CONDON, Commissioner of the Department of Revenue (DOR), said that he had distributed a briefing document which specifies a series of recommendations. The project's feasibility is determined by the following factors: (1) What can the gas be sold for in the destination markets? Currently, the Far East is the focus of the destination markets. (2) What is the project going to cost? (3) What rate of return will investors require in order to make an investment in the project? Currently, LNG sells for $3.50 per million BTU in the Far East. If the project cost is $15 billion and investors required a four percent rate of return, the cost to move gas from the North Slope to the Far East would amount to $5.00 per million BTU. Those assumptions in the current Far East market would result in a negative wellhead value of -$1.50 on the North Slope. Therefore, revenue from the production of North Slope gas has not been included in the State's revenue projections. Number 085 MR. CONDON explained that in Far East destination markets LNG prices parallel closely to oil prices. Therefore, projected oil energy prices determine the LNG prices for the future. He forecast that energy prices would increase somewhat faster than inflation. Assuming the $15 billion project cost was to increase with inflation and real energy price grew as projected in the Fall forecast, North Slope gas would have a negative wellhead value until the year 2116. After that time, North Slope gas would have a positive wellhead value. If one assumed that the project costs would not inflate and oil energy prices would increase in accordance with DOR's Fall forecast, North Slope gas would have a $.50 well head value in the year 2009. MR. CONDON pointed out that the difference in the economics of the project is related to keeping the construction costs down. Number 146 He noted that there are some ways to improve on the economics of this project. He pondered what would be necessary to achieve the $.50 wellhead value prediction. In today's market with a $15 billion project, $5.50 per million BTU in the Far East would be required. That is equivalent to oil prices of $27 per barrel. Currently, gas prices are at $3.50 and North Slope oil is at $16.50. In order to obtain the $.50 value, a 60 percent increase in energy prices would be necessary. If the $.50 value were obtained, a 20 mill tax on oil and gas property would be imposed. At the project's completion, the in-State property (the conditioning plant, the pipeline, and the liquefaction plant) would have yielded $220 million in property tax revenue. As the project depreciated over time, the current statute requires that the taxable value decline as well. He said that the decline would be $9 million per year beginning in the first year of the project's operation. Half of the revenue from the property tax would be funneled to local communities as the current statute states. Royalty revenue and severance tax would each amount to $30 million per year under the $.50 wellhead value. The expected State corporate income tax would be approximately $30 million per year. In conclusion, the State revenue would result in $200 million per year with total revenue of $300 million per year when the $100 million given to the communities is added. The $200 million per year would decline in real dollars. Number 203 MR. CONDON reiterated the three factors determining the feasibility of the project. He pointed out that the State can do nothing to change the price of energy in the marketplace. The State can take actions to reduce the cost of the project. For instance, if the project could be built today for $10 billion, the project would be feasible at $3.50 energy prices in the Far East. In this case, the project would yield a zero wellhead value. Therefore, the State's revenue would be limited to property tax on the pipeline and corporate income tax, because the transportation companies would be making a profit at that level. If the project could be constructed for $13 billion, as Mr. Lowenfels predicted, then the project would be feasible with destination prices in the Far East being $4.00 per million BTU. MR. CONDON mentioned that the destination price required would be lowered if the project cost were reduced to the $12 million which the producers had hoped. MR. CONDON responded to the specific questions requested by the committee. He reiterated that Far East gas prices are approximately $3.50 per million BTU. That price is projected to grow modestly in real terms over the next 15 years. Currently, a dramatic increase is not anticipated. Mr. Condon informed the committee that no State revenues are projected from a gas pipeline project. Those revenues would be included in a revenue projection when a feasible project was presented. The royalty on North Slope gas is approximately 12.5 percent with little variance. Mr. Condon stated that the required wellhead value for gas in the year 2005 and 2010 is located in the briefing document. The required well- head value was determined by accepting the producer's projection that there would be a $400 million liquid loss if gas delivery began in the year 2005. If gas delivery began in the year 2010, the loss would be reduced to $100 million. MR. CONDON said that the Governor has directed Department of Revenue, the Department of Natural Resources, the Department of Commerce and Economic Development, and the Department of Law to move forward on the 14 recommendations contained in the briefing document. SENATOR HALFORD did not realize that the Department's projection model extended to the year 2116. WILSON CONDON replied that the model does not extend to the year 2116, but the variables can be utilized in order to review the crossing of the lines. REPRESENTATIVE KUBINA suggested that the companies should come together with the State as well, in order to merge their points of view. MR. CONDON agreed and pointed out that they share all drafts of all the analyses with Yukon Pacific and the producers. MR. CONDON said the Department would welcome any communication regarding the analyses. CHAIRMAN LEMAN asked what was the reason for the discrepancy in Mr. Lowenfel's revenue projection for the state of $400 million and Mr. Condon's projection of $200 million. MR. CONDON did not know and had not been able to meet with him to reconcile the projections. MR. CONDON did not know how the $400 million could result from the data as it exists today and the way in which it is evolving. There are actions the government can take, but the result would not be $400 million, unless energy prices dramatically increase. Number 368 CHAIRMAN LEMAN noted his belief that this was the first formal legislative committee hearing on this topic in about 10 years. He encouraged more communication among the participants and some resolutions to the discrepancies. He really wants a resolution to the discrepancy in the projected revenue stream. There being no further business before the committee, the meeting was adjourned at 11:37 a.m.