SENATE RESOURCES COMMITTEE March 29, 1996 3:38 p.m. MEMBERS PRESENT Senator Loren Leman, Chairman Senator Drue Pearce, Vice Chairman Senator Steve Frank Senator Rick Halford Senator Robin Taylor Senator Georgianna Lincoln COMMITTEE MEMBERS ABSENT Senator Lyman Hoffman COMMITTEE CALENDAR SENATE BILL NO. 307 "An Act authorizing the Department of Natural Resources to exchange with the federal government state land within, and adjoining, Dude Creek Critical Habitat Area for federal land adjacent to Fall Creek; and providing for an effective date." SENATE BILL NO. 318 "An Act authorizing, approving, and ratifying the amendment of Northstar Unit oil and gas leases between the State of Alaska and BP Exploration (Alaska) Inc.; and providing for an effective date." PREVIOUS SENATE COMMITTEE ACTION SB 307 - No previous senate committee action. SB 318 - No previous senate committee action. WITNESS REGISTER Senator Steve Frank, Co-chairman Finance Committee State Capitol, Juneau, AK 99801-1182¶ POSITION STATEMENT: Sponsor of SB 307. Richard Levitt, President & General Manager Gustavus Electric Co. Box 102, Gustavus AK, 99826¶ POSITION STATEMENT: Supported SB 307. Kellis Soule, Governmental Affairs Representative Gustavus Electric Co. Box 102, Gustavus AK, 99826¶ POSITION STATEMENT: Supported SB 307. Nico Bus, Acting Director Support Services Division Department of Natural Resources 400 Willoughby Ave., Juneau, AK 99801-1724¶ POSITION STATEMENT: Supported SB 307. Andy Pekovich, Regional Manager Juneau Office, Division of Lands Department of Natural Resources 400 Willoughby Ave., Juneau, AK 99801-1724¶ POSITION STATEMENT: Supported SB 307. Commissioner John Shively Department of Natural Resources 400 Willoughby Ave., Juneau, AK 99801-1724¶ POSITION STATEMENT: Supported SB 307 & SB 318. John Morgan, President BP Exploration Alaska Anchorage, AK ¶ POSITION STATEMENT: Supported SB 318. Attorney General Bruce Botelho Department of Law P.O. Box 110300, Juneau, AK 99811-0300¶ POSITION STATEMENT: Supported SB 318. James Baldwin, Assistant Attorney General Department of Law P.O. Box 110300, Juneau, AK 99811-0300¶ POSITION STATEMENT: Supported SB 318. Bill Allen, Chairman & CEO VECO Corporation 813 W. Northern Lights Blvd. Anchorage, AK POSITION STATEMENT: Supported SB 318. Carl Marrs, President Cook Inlet Regional Corporation 2525 C St. Anchorage, AK 99501 POSITION STATEMENT: Supported SB 318. David Jensen, President & CEO Arctic Slope Regional Corporation 301 Arctic Slope Ave. Anchorage, AK POSITION STATEMENT: Supported SB 318. ACTION NARRATIVE SB 307 DUDE CREEK HABITAT AREA LAND EXCHANGE TAPE 96-39, SIDE A Number 001 CHAIRMAN LEMAN called the Senate Resources Committee meeting to order at 3:38 p.m. The chairman brought up SB 307 as the first order of business before the committee. Chairman Leman asked Senator Frank if he wished to testify. Number 014 SENATOR STEVE FRANK, Co-chairman of the Finance Committee, sponsor of SB 307, stated the bill would provide for a land exchange. He said it isn't asking for any subsidies and is totally within the private sector. So he is eager to do what he can to encourage the exchange and allow it to go forward. Senator Frank stated that members have in their bill packets a copy of SJR 27, which was passed last year supporting this project. CHAIRMAN LEMAN recalled that there was no objection to SJR 27. He called Mr. Levitt to testify. Number 047 RICHARD LEVITT, President & General Manager, Gustavus Electric Co., stated the land exchange would occur between the Department of the Interior and the State of Alaska to allow the construction of a hydroelectric project to provide electricity for the community of Gustavus and Glacier Bay National Park. The land exchange is necessary because the site is within Glacier Bay National Park and Preserve, a wilderness area. The removal of land from a wilderness area must be authorized by congress. We are here today, because approval of the Alaska State Legislature is required for state land to be given up. SB 307 approves the land exchange. SB 307 is contingent on the passing of legislation in Washington, D.C., which is going forward. According to sources in Washington, D.C., the Senate Energy & Natural Resources Committee will be hearing the bill soon. We are asking for passage of SB 307 at this time, because it appears that the federal legislation will not be complete until after the adjournment of the Alaska State Legislature. CHAIRMAN LEMAN asked Mr. Levitt to remind the committee of the level of local support. MR. LEVITT responded that three public meetings have been held in Gustavus, and a vote was taken at each one. In each case, the vote was unanimously in support of the project. That is documented in minutes of the meetings and by a letter from the Gustavus Community Association, who sponsored all the meetings. Number 135 KELLIS SOULE, Governmental Affairs Representative, Gustavus Electric Co., stated he can answer any questions about the project. SENATOR LEMAN asked Mr. Soule what the expected reduction in the cost of power will be for Gustavus. MR. SOULE responded that, under a 30-year program, they estimate that the Power Cost Equalization Program will be reduced by close to $200,000.00. He believes the administration came up with a figure of $100,000.00. The discrepancy in the two figures is that Gustavus took into consideration growth in the program and a continuation of the funding of the program. There will be savings to the federal government as well. Nico Bus, Acting Director, Support Services Division, Department of Natural Resources, supports SB 307, as long as the expense for the exchange is covered. It will be about two-staff months to accomplish this project. Number 165 SENATOR TAYLOR asked if there will be any requirements of the State of Alaska to maintain any land classification, status, or use on the property, once the exchange has taken place. ANDY PEKOVICH, Regional Manager, Juneau Office, Division of Land, Department of Natural Resources, stated the process of exchange could include classification of the lands. It is his understanding that there is still chapter 50 to deal with, and the only thing SB 307 does is allow the state to do an equal acreage exchange without coming back to the legislature. It does not bypass the other elements of the exchange. SENATOR TAYLOR stated he understands that aspect of the exchange. His concern is that we are giving up state lands that right now we have the ability to classify any way we see fit. He doesn't want to go through the exchange and then find out that we've allowed the federal government to forever restrict future use of the land. Number 195 MR. PEKOVICH stated that the land is on the boundary of the national park; it is fairly wet, and it is sandhill crane area. In his opinion, it is very doubtful that the state would ever consider developing that land. SENATOR TAYLOR stated that doesn't answer his question. The question is, should there be a reason that we need to - he's not talking necessarily about development, he looked at the map and didn't think there was much to be done there, either. But should there be some need in the future, would we be precluded by the federal enabling legislation from acting in that area. Number 210 COMMISSIONER JOHN SHIVELY, Department of Natural Resources, stated Senator Taylor's concerns may depend on what the federal legislation says. We are receiving land that would come out of the boundaries of the park. He thinks the land would have no designation and that the State would be free to designate the land as they saw fit. He cannot predict what congress might do, but it would be the administration's intent to have it unrestricted. CHAIRMAN LEMAN stated Commissioner Shively was referring to the land the State would be receiving. COMMISSIONER SHIVELY responded that is correct. SENATOR FRANK stated, in other words, there would be no covenant running with the land. COMMISSIONER SHIVELY responded that is correct. SENATOR TAYLOR stated he just wanted to make sure that was the intent. SENATOR HALFORD commented as far as he is concerned, that is a condition, not an intent. Number 230 SENATOR LINCOLN asked if the analysis of the PCE (Power Cost Equalization) savings would be done in house. She also wondered why that had to be a part of the fiscal note. At one point, PCE was listed as having a 20-year guarantee. But that has been whittled away now to the point of 3-4 years. So PCE really is not long term. Will DCRA continue with that analysis? MR. BUS responded the reason that was written into the fiscal note was to figure out what the savings would be. He is not in a position to speak for DCRA, but this clearly seems like a good proposal. SENATOR LINCOLN thinks that is a good idea. Number 257 SENATOR TAYLOR asked if the exchange will allow for the construction of a hydroelectric project. SENATOR HALFORD stated that was the whole purpose behind SB 307. CHAIRMAN LEMAN reminded members of the passage of SJR 27 last year, supporting this land exchange. SENATOR PEARCE asked why they needed money. SENATOR FRANK thinks it was to hold public hearings. Number 275 MR. BUS replied that once the federal government approves the land exchange, part of the exchange process is that there will be public hearings. People in the Anchorage office will probably have to travel to Gustavus. SENATOR FRANK made a motion to discharge SB 307, and accompanying fiscal note, from the Senate Resources Committee with individual recommendations. Number 285 CHAIRMAN LEMAN, hearing no objection, stated SB 307 was discharged from committee. SB 318 NORTH STAR OIL & GAS LEASE AMENDMENT Verbatim Testimony CHAIRMAN LEMAN: That brings us next to SB 318. SENATOR PEARCE: You would think the Gustavus Electric Co. could afford the public hearing. SENATOR FRANK: I think they can; I think that... CHAIRMAN LEMAN: We're on SB 318 an act authorizing approving ratifying the amendment of Northstar Unit Oil & Gas Leases between the State of Alaska and BP Exploration, Alaska, Inc. This is a bill by request of the governor that was just introduced, and just so, Mr. Commissioner and others, you can--we're--I'm not going to ask you quite yet, that you can say that we're moving quickly on it. Introduced on the 28th--oooh, just introduced yesterday. We might get complaints in the senate about how fast we're moving on this. SENATOR LINCOLN: We might? SENATOR TAYLOR: It's the only way you can have a hearing that the governor doesn't have one first. SENATOR LINCOLN: I object Mr. Chairman. SENATOR PEARCE: Actually, this morning Senator Duncan allowed on the radio, his morning radio program, that we had slowed the bill down, which I found rather interesting. CHAIRMAN LEMAN: We've slowed it down, we've slowed it down one day then. It was read across yesterday. Let me just go through some quick opening remarks and how we're going to conduct this hearing. The purpose of today's meeting is, first, to have an overview from the Department of Natural Resources to hear how it arrived at this proposal; second, to hear from representatives of BP testifying as to why it believes this proposal is necessary; third, I hope we have the chance, I see the attorney general way in the back, to hear from the Department of Law on its' perspectives on this approach and some of the legal elements to it. We will be having future hearings; we will take the governor at his word when he asked for full and open and frank discussion of these issues, and that is what we intend to do with this committee is to have full overviews of it, and we will be announcing the future hearings and we will be looking at, among other things in future meetings in detail the net profit lease process; second, other leases that are under net profit share agreements; third, a clear showing of the economics leading up to this agreement. I would expect that will probably exhaust us as we look at some of the details behind the economics. And the fourth we will be looking at whether the agreement is in the best interest of the State of Alaska. In addition to that there may be some other topics that develop as the record is developed. I just note these will be fact-finding hearings and there will be future opportunity, even though today's testimony for the most part is invited, there will be future opportunity for public comment and we will be inviting that and will welcome it. For members of the committee, I just ask that for the first three presenters, we allow them to present, make their presentations, and if you have questions, jot them down and we'll hold them 'til the end and we can ask them to come back. Otherwise, as I know this committee is capable of doing, we could only get to the first presenter and not get to the others, some of whom have travelled a long way to get her, so, with that we will go with the first presenter, Commissioner John Shively. COMMISSIONER JOHN SHIVELY, DEPARTMENT OF NATURAL RESOURCES: Thank you Mr. Chairman; for the record my name is John Shively I'm the commissioner of the Department of Natural Resources. I would like to thank you Mr. Chairman for taking this up so quickly. I do appreciate that. I also would like to apologize at the outset for the lateness with which we presented this issue to the legislature. We realize that presents certain challenges, particularly something that's this complicated. However, we think this is a very important issue, one deserving of thorough public review, and we think this is the place to have it for a variety of public policy and legal reasons, which we can discuss in detail if you'd like. I'd like, Mr. Chairman, to go into a little bit of history about these leases, sort of bring us to where we are today and why we decided to negotiate with British Petroleum, and two, why we eventually arrived at the agreement we did arrive at. You need to take yourself back in time to the late seventies, 1979, when all but one of these leases were in a lease sale we held, I think jointly, with the federal government. In the late seventies, most people, based on what had happened in the mid seventies were predicting oil would continue to rise in price, estimates that we used, and we will provide the committee with some background material on this, but estimates ranged anywhere from $60.00 to $100.00 a barrel of oil that we'd see at this time. So the State wanting to cash in, I think, on some of that future growth, rather than having a bonus bid on these leases, decided to use a new tool and to bid these leases using net profits as a variable. This prospect, Northstar was at the time looked upon very favorably, people thinking that it might have had as much as a billion barrels of recoverable oil or more. The bidding was very active, and ultimately a consortium, primarily headed by Amerada Hess, got these leases, and their average bid on net profits was about 89%. In addition, the State required a 20% base royalty. That was for four of the leases, I believe. The fifth lease was leased in 1983; in that lease we set the net profits at 40% and set the base royalty at 12.5% and used a bonus bid as a variable. That bid, I believe, was bid for about $72,000.00. Amerada Hess, as they went through their exploration, discovered that there wasn't as much oil as anybody had hoped, and the further they went and the more delineation drilling they did, the poorer the field became. However, it is still a very attractive prospect. Today both we and I think British Petroleum estimate that around 135,000,000 barrels of oil could be recovered from this field. It is not a marginal field; it is not the kind of field we talked about last year with HB 207. It is a field fully capable of carrying its' own under the appropriate economic conditions. Amerada Hess ultimately reached a conclusion that others had reached, including the Department of Energy, which in 1993 in a study said that this field was not economic and said that the net profits requirements were one of the main reasons why this field could not be developed economically. In addition, at the time Amerada Hess was estimating that the capital expense to do the development of the field would be somewhere around 1.4 to 1.5 billion dollars. So I believe in late 1994, sometime in 1994, Amerada Hess came to the conclusion they probably would not develop it, and as the leases were themselves coming to a time when they might ultimately go back to the State if not allowed to be extended, Amerada Hess offered the sale for bidding, and it is my understanding at least two oil companies bid on these leases, and British Petroleum ultimately did provide a winning bid to Amerada Hess, and in January of 1995 the State agreed to transfer those leases to BP and later in the year, I think in April, approved a three-year development plan. At the time, I think, although BP, and they can speak to this themselves, but I think they understood approximately how much oil was in the field but really had not done any preliminary work on engineering to look at the capital expense or any real look at the economics. But they started discussing this issue with us last spring, and actually asked that net profit leases be included in HB 207. Some of you may remember HB 207 [SENATE CS FOR CS FOR HOUSE BILL NO. 207(FIN) am S: "An Act relating to adjustments to royalty reserved to the State to encourage otherwise uneconomic production of oil and gas; and providing for an effective date."] It was sort of an entertaining prospect at the end of the session which had its' own share of problems, and at least I felt, and ultimately I think BP felt, that adding another issue to the mix was probably not appropriate. However, I committed to BP at the time to discuss Northstar, but under the conditions that I believed, at the time, that I probably did not have the legal authority to make a deal with them on Northstar. And so therefore, that the individual deal itself would have to come to the legislature. That was always part of the discussions. We actually never did a thorough legal analysis of that issue because of my feeling that, not only did I basically in discussing with the Division of Oil & Gas feel we probably didn't have the authority to do this kind of deal, but I felt that the legislature would be the appropriate place to discuss any kind of major change in net profit leases. COMMISSIONER SHIVELY: We actually, I think, really got started seriously late in the fall, October, November, and December, and it took a fair amount of time because the modeling to compare net profits, leases with other kinds of schemes for government take was complex, and also we needed to get to a point where we could agree with BP on what went in to that model. There will be some discussion of that, I will tell you that some of the things that are part of the financial analysis have been given us under the confidentiality statutes by BP. Those things can be made available to the legislature under a confidentiality agreement, and I assume you will want them. Kevin Banks, who is our economist, and Patrick Coughlin, who did a lot of work on the agreement are prepared to assist in presenting that information to you at the time you think is appropriate. I have urged BP to make as much of this information public as possible; I think that makes sense. What we ultimately agreed to was that the 20% base royalty on the four leases would remain, and that could not be changed in the future. On the fifth lease, we changed the base royalty from 12.5% to 20%. Then what we essentially did was trade the net profits royalty for what we call a supplemental royalty. That supplemental royalty is based on the price of oil. It's a formula where the price of oil starts at $17.35 and is adjusted at half the producer price index over time. The formula itself is sort of a straight line formula: as price goes up, our percentage of take goes up, up to a maximum of an additional 7.5%, which would maximize our royalty, depending on what happens with the price of oil, at 27.5%. So basically we traded something that was price based for something that was profit based. In addition, we negotiated a provision that's what we call "use it or lose it", that either they get this project sanctioned by their board of directors within a year or the leases come back to us and we can release them. We believe that part of the reason for doing this is to get the development on line now. I want to talk a little bit about that, because the net profits leasing scheme is very complex, and we won't take time to explain it all today, but there is one critical part of it you need to understand, and that is something that's called the development fund. What happens is under the net profit regulations, as a company starts spending money, after they get the lease, for exploration activities, seismic drilling, all of that, that basically is accounted for in the fund, and then as they construct, that's accounted for, and they earn interest on that fund. And then, once they start development, the income comes in and the amount of that fund starts coming down. I believe that the development fund was about $260,000,000.00 that BP got. And what's sort of unique about this is that BP did not actually spend that money, Amerada Hess did. But because of our regulations, that development account goes with the leases, and therefore BP is earning interest on it. The implications for the State in that is the longer the development is delayed, the less money the State is going to get in net profits leasing. And so timing was critical to me as we negotiated this deal with BP. And that's why we put a "use it or lose it" provision in. If they want to do this, they need to do it now. If they want to sit on the leases, then, you know, that's their business, but they shouldn't get a change, in my mind, in the royalty structure if they want to do that. We also have language strengthening local hire and local contracting. I'm sure that as this goes forward, we'll discuss that in more detail. I want to talk a little bit about the numbers because there has been some confusion, somewhat because the model itself is complex and was continually being refined, and also because there are several ways to look at the supplemental royalty and compare it to what we might get under the net profit. We estimate under the model right now that if this field was developed today, using the net profits provisions, the State would receive about $85,000,000.00 over the life of the field for net profits. We also estimate right now that if you used the supplemental royalty, that we would get $37,000,000.00. So that's a considerable difference. In order for me to make this agreement with BP, I had to believe them when they said they would not develop under these terms. And I thinks that's something the legislature will have to do to. If you believe that they will develop under these terms, and develop this relatively immediately, then this deal should not be done. The State might have the ability to force them into production, but for reasons that I can explain in detail later, we do not believe that we could start forcing them into production until after the current development plan is completed, which takes place in April of 1998. That, we believe, would mean that oil would start to come on line in the year 2002, rather than in 1999, as we anticipate under this deal. If you look at what we get in the net profits royalty under that scenario, under a delayed scenario, oil coming on in the year 2002, we get $41,000,000.00 in net profit, rather than the $85,000,000.00, and I know people have questioned why I have used different figures. So then, for me, in reality, the State has to compare what the best we could do under net profits, which is order them... [At this point Commissioner Shively's testimony was cut off by the teleconference operator turning all the electronic equipment off.] COMMISSIONER SHIVELY: ...under that scenario, there's only a $4,000,000.00 difference between the supplemental royalty and the net profits royalty. We will provide you with the information on how much revenues total to the State, we believe that's about $435,000,000.00. In addition the North Slope Borough will receive some ad valorem tax. There are other positive implications if oil is brought on. Putting additional oil in the pipeline increases the tariff for existing oil, improving our economics for other oil fields. I also think that this has another major positive implication for the State. We have an oil and gas lease sale offshore scheduled for about two years from now off the north shore in Alaska, and if Northstar could be brought on, if we can prove that we can do the first offshore development with a buried pipeline ever done in the Arctic, then I think it increases the value of our other leases on the North Slope. The negotiations were long - longer than I had hoped. I had hoped to have this agreement to the legislature earlier; they were at times very difficult, but I believe that we have negotiated a deal that is in the best interests of the State. However, of course, the reason we bring it to you is so that you and the public can debate that issue, and we think it deserves a thorough debate and we're prepared to respond to any of the questions that you might have as this process proceeds, and again, Mr. Chairman, I would like to thank you very much for the expeditious way in which you've called this hearing and are handling this. With that, I will let the next person... CHAIRMAN LEMAN: Thank you. I'd just like you to run through, because I think it's important to set the record on this, the dates on when these things happened. We have when the lease was originally acquired, but then when Amerada Hess offered them, I believe you said late 1994... COMMISSIONER SHIVELY: Right. CHAIRMAN LEMAN: Ok. And then BP purchased... COMMISSIONER SHIVELY: The State... CHAIRMAN LEMAN : The leases at sometime in, did you say earlier 1995? COMMISSIONER SHIVELY: Yes, the State approved the transfer in January of 1995. I'm not sure... CHAIRMAN LEMAN: So they purchased it sometime before that. COMMISSIONER SHIVELY: Right. CHAIRMAN LEMAN: The State approved the transfer and you will have the dates... COMMISSIONER SHIVELY: It was January in 1995. CHAIRMAN LEMAN: January of 1995. COMMISSIONER SHIVELY: Right. CHAIRMAN LEMAN: And then at some time following that, BP came to you and approached you about changing the net profit share provisions in the HB 207 context. COMMISSIONER SHIVELY: Right. It was sometime, I think, I'm not sure, that date I probably can't get you, because it was not an official communication, but it was during the HB 207 debate. I didn't become commissioner until February. I would guess that the first time they raised the issue, which was in a very generic form, was in early April of last year. CHAIRMAN LEMAN: Okay. Well we can pursue that; probably we'll do it in some of our future hearings, or maybe even later today in more detail. Is this a question that needs to be asked right now, or else we can go to Mr. Morgan. SENATOR FRANK: No, it doesn't have to be asked right now. CHAIRMAN LEMAN: Okay. I'd thank you for joining us, Commissioner Shively. Senator Taylor. SENATOR TAYLOR: Very briefly. Do you believe that the legislature's consent is necessary to grant you or the governor the authority to enter into this deal? COMMISSIONER SHIVELY: Yes I do. CHAIRMAN LEMAN: Thank you Commissioner Shively. Next is John Morgan from BP. SENATOR HALFORD: Legally necessary. Qualify it next time. SENATOR PEARCE: They didn't say they had to. SENATOR HALFORD: Legally necessary. JOHN MORGAN, PRESIDENT OF BP EXPLORATION ALASKA: Good afternoon, Chairman, Senators, I'm John Morgan, President of BP Exploration Alaska. I would like to add my thanks to that of the commissioner for the very expeditious movement of this committee to pick up this piece of legislation. The bill, as you've heard, is about seeking legislative approval of a negotiated agreement between the DNR and BP Exploration Alaska, and I can't stress enough, that from BP's perspective, this was a long and very formal negotiation process, that I don't see the agreement contained in this bill as in any way being an incentive to BP; I see it as a very balanced agreement coming out of that negotiation to remove a real barrier to the development of this resource to provide certainty of early development, to unlock the potential of Northstar, and to enhance the likelihood of development of other small and offshore fields to provide a good alignment in the relationship between BP and the State, to provide substantial jobs for the citizens of Alaska, to provide real new business opportunities in the State, and of course, to provide very substantial revenues to the State. You heard from Commissioner Shively a little of the history of these leases, that in the course of their work, Amerada Hess and Shell discovered oil on these leases and evaluated the development using a well-known engineering company to work with them and determined that the cost estimate for a major for a development scheme would be, I believe something in excess of 1.5 billion dollars. From that perspective, it was clear to them that development was not possible, and at that point, I believe, they moved towards the sale of these leases. As you heard, BP acquired the leases in a competitive process in the early part of 1995. The reason that we did that was because, using the experience that we had gained in looking at small field development in Alaska, it was our view that development of the field could be possible in a cost range of $350,000,000.00 to $400,000,000.00. And that would make this field into an economic proposition. In making that acquisition, we did understand, and it was clear to us, that the issue of net profit leases represented a problem, and a problem that would need to be overcome with the State, if development was to proceed. Let me say a little about the nature of that problem. There are, I think, some 40 odd leases in existence in the State with net profit lease terms. Some of them are producing, some of them are partially explored. The Northstar leases, to my knowledge, are the only ones that have the immediate prospect of development. I don't believe that any leases have actually paid out at this point, under net profit lease terms, thought clearly that is possible in the future. There is, I believe, one example of a lease where net profit interest terms were removed in the past for a royalty adjustment, and that was the Thetis Island leases, and that did not involve legislative approval. The problem that exists is that the net profit leases create a very basic misalignment between the leasing company and the State. Once the net profit interest cuts in, then in the case of Northstar, some 90% or so of the revenue stream to the company would effectively dry up, and that would lead to the premature shut-down of the field. We have never argued that the development of Northstar could not be profitable under the terms including the net profit arrangements. In profitability in terms of return on capital, this would be possible. This is not a marginal oil field. The problem that arises is that the net income stream is simply so far reduced, once the net profit interest cuts in, that it would not be acceptable for BP, or I believe any other reputable oil company to continue to operate the field. We depend on our reputation in doing our business around the world, and we would not be prepared, as BP, to enter into an arrangement to develop an oil field in the knowledge that we would be going forward on a basis that we would prematurely shut in oil in that oil field. That's why we explained to the commissioner and the department that we would not be able to go forward. I'm certainly prepared to spend more time in the future with you explaining that issue more fully, because I understand that it is very important. The other point about the net profit interest is that it is common in the North Slope and elsewhere that as fields come on production, and as technology is applied to them, the reserve base can be expanded and additional production can be forth coming. And certainly the existence of net profit lease terms like these take away any incentive that the company would have to work on that kind of expansion of the resource. The misalignment between the industry and the State is really very serious. So what we did you heard from Commissioner Shively was, in the first instance to wonder whether there was a way of amending HB 207. We felt that was not appropriate, and then we agreed with the commissioner to enter into direct negotiations with him to try to find an alternative arrangement that would work for both BP and the State. I won't repeat the terms of that, the commissioner has explained to you, only, I think, to emphasize that we have accepted a so-called "use it or lose it" provision here, that means that we have to have this agreement sanctioned by our board and the funds released for it twelve months from the agreement to go forward. We'd hope to do it earlier than that, but clearly there could be some contingencies that would prevent it. And also to emphasize, we think that we really don't see this as any kind of concession on the part of the State; it really is a carefully negotiated arrangement that would allow development to proceed quickly, where otherwise it wouldn't do so, and without such agreement I believe that the possibility of any future development would be extremely uncertain, as would the terms, if any development did take place. I think what I'd like to do is spend a few moments just talking about the benefits, as we see it, to the State of Alaska from this arrangement. We're targeting early development of the field with the first production to begin in early 1999. The field has approximately 130 million barrels of recoverable reserves, and we are looking today at development costs of around $380,000,000. The field would have a plateau production of some 50,000 barrels a day. The overall benefit to the State can be expressed in a number of ways, but in money of the day terms, it's our view that the revenue to the State would be of the order of $575,000,000, with additional benefits from the $200,000,000 of capital expenditure likely to be spent in the State, and the $200,000,000 of operating expenditure, which would be spent in the State over the life of the field. We at BP have talked often about the potential that exists on the North Slope, in and around the existing infrastructure. We see possibly some 5 billion barrels of oil potential in that area, made up of many things: made up of heavy oil, of enhanced oil recovery in existing fields, of satellite production, and other... TAPE 96-39, SIDE B MR. MORGAN: ...things. A significant part of that potential would come from new, small fields. Northstar, if we go forward with it, will be the first of the new generation of small field developments. I believe it's very important to show that this can be done and to get on with it. The additional challenge here, and the additional advantage arises because Northstar would be the first offshore development in Alaska on the North Slope of Alaska, and success in showing that can be technically achieved would, I think, expand the potential even further. We've given a commitment in this negotiation, a commitment to hire Alaskans and to use Alaskan Contractors and to build the modules that will be required in Alaska, including modules for sea-lift, provided the facilities for those can actually be provided here. As far as jobs are concerned, the oil industry in Alaska has the best record of all Alaskan industries, but no doubt the percentage of Alaskan hire has been falling, and the industry as a whole recognizes the need to do a number of things to improve that record. The operators and the contractors have been cooperating on this and recently presented a set of proposals for improvement in the proportion of Alaska hire to the administration. The industry is committed to that improvement. I don't believe that Alaska hire issues can be resolved with any single project, but I am absolutely clear that the Northstar project has to be part of that program of improvement. We are committed to use Alaska Workers in the development. We estimate that over the peak construction period, Northstar will create some 450 to 520 direct jobs, and in the operating mode there will be approximately 50 direct jobs. Those, of course, are each subject to a multiplier effect of something over one, in terms of their further impact in the economy. We've been working from the beginning of this project with Alaskan contractors, and Alaskan contractors will do the vast majority of the work. We have companies like AIC, now part of CIRI who will construct the gravel island; HCC, who will be involved with the pipeline installation; VECO and APC, who will be involved with facilities fabrication; and VECO, who will be involved with facilities installation. Other companies will deal with trucking, with drilling, and with pipeline fabrication, and again, there will be a high Alaska content. As I mentioned, the total development spend will be approximately $380,000,000. Our best view is that something of the order of $140,000,000 will be spent out of State, and that includes around $100,000,000 which will be spent on materials that simply are not available in Alaska. That leaves something between $200,000,000 and $250,000,000 to be spent inside the State, a high proportion relative to any development in the past. In particular, as we look at the issue of fabrication, we would expect today that fabrication costs out of the total $380,000,000 would be somewhere in the order of $60,000,000. Today, if you based your view purely on commercial decisions and facilities in the State, probably about $10,000,000 out of that total would be spent in Alaska. That would basically be truckable skids. Clearly the State has established that it can build that type of module competitively. What we have said is that we will seek to bring an additional $30,000,000.00 worth, or thereabouts, of fabrication work into the State, and that we're prepared to accept some additional cost in order to do that. It does mean that the facilities to allow us to do this will have to be available at the right time and in the right quality, and that is not directly in BP's control, it will have to be done by others. There are certainly others who own existing fabrication facilities that could deal with Northstar, but more challenging is the notion of a facility that would allow the modules to be assembled and floated out for a sea-lift to the North Slope. There is no current facility in the State to do that. In the past, all of this work has been done out of the lower forty-eight. We've talked to existing fabrication contractors, and they are clearly very interested in this notion. We see a great opportunity to use Northstar to create an opportunity for new business in the State of Alaska, and we want to do that. Other players clearly will have to make those investment decisions for themselves. In summary then, we are very excited about this project. We're committee to go forward with Northstar if we have agreement from the State. We believe, and I believe, that the negotiated proposal is good business for BP and good business for the State of Alaska. If the project goes forward it will create jobs, and it will create new business opportunities in the State. If it isn't able to go forward, clearly those things won't happen. Thank you, I'm happy to answer any questions you may have. CHAIRMAN LEMAN: Thank you Mr. Morgan. I was just thinking there at the end where you were talking about the facilities for the modules, what we've been trying to do at Ship Creek over the years and work with another contractor, and I thought what a wonderful opportunity for doing something with Ship Creek, so maybe we can. That's part of my district. Senator Halford? SENATOR HALFORD: Thank you Mr. Chairman. Just a question on the fabrication question. You're talking about being able to add $30,000,000 in fabrication: is that the total value of the fabricated product, including both labor and materials, or is that the fabrication component in Alaska, which then generally is mostly labor, and not a material component? MR. MORGAN: Yes Senator, that is the fabrication component in Alaska. It does not include materials. SENATOR HALFORD: Doesn't include materials, okay. Thank you. CHAIRMAN LEMAN: In keeping with my earlier instructions, I'd like to hold questions, and Mr. Morgan, you can stay with us, can you not? So we'll get you back. I'd like to... SENATOR LINCOLN: Mr. Chairman, I do have to leave in a few minutes , and there is one quick question that I need to ask. CHAIRMAN LEMAN: Make it quick. Please, Senator Lincoln. SENATOR LINCOLN: I will. You made a statement that there's, and maybe I misunderstood you, that there's a misalignment between the State and the industry is very serious. Would you expand on that please? MR. MORGAN: Yes. What I was saying is that with the net profit arrangement in place, at the level that it exists, BP would not be prepared to go ahead with the development of a Northstar project, even though, if you run the economics, you can show that the return on investment for the project is a sound sort of return on investment. And therefore, you would say, and others have said to me, if you have a development fund which you're allowed to recover, and recover with interest, what's wrong with this? The reason is, that at the time the net profit cuts in, and that is obviously dependent on how much we spend and what the oil price is, but on reasonable assumptions with this project, you would expect at some point in the future, maybe in the middle of the first decade of the next century, that net profit would cut in. What it would do is drive the net income or the margin per barrel down to a very low level on our calculations well below $1.00 per barrel. Now the net income per barrel is one of the key financial parameters on which the oil industry works. And BP, and I believe other major oil companies would say they were not prepared to put themselves in a position where that key parameter was being driven down by having a component of their portfolio operate at that very low level of margin. And so what we said is, we have to be clear and straight- forward about this: we would never put ourselves in the position where we had to shut down an operation before the full recovery that we could make economically from an oil field was achieved. And that is what the fundamental misalignment was. CHAIRMAN LEMAN: I'm going to allow two more quick questions, if we can have very short answers. Senator Taylor, Senator Halford. SENATOR TAYLOR: Yes. You mentioned Thetis Island as another time when this same thing had occurred. Do you know if those amendments had legislative action? MR. MORGAN: My understanding is they did not. SENATOR TAYLOR: And the other only side-bar note I wanted to make was that I have at least three facilities within my district that are currently setting idle. Any one of the three has large gantry cranes, acres of flat ground, and all three have deep-water ports that you can bring any ship up to. So we're prepared to do facilities work in Southeast Alaska. MR. MORGAN: Senator, there are members of the audience who, I'm sure, are listening very carefully to that. CHAIRMAN LEMAN: There are sawmill operators who'd be happy to convert to welders, right? SENATOR TAYLOR: They're already welders. CHAIRMAN LEMAN: Oh, they're already welders. Senator Halford. SENATOR HALFORD: Thank you Mr. Chairman. Just to get some kind of parameter, I don't know whether this is, whether you're willing to make this information public or not, but I guess the question that comes to mind is what BP paid Amerada Hess for the leases. MR. MORGAN: Yes. The answer is that was covered by a confidentiality agreement, which we believe we have to honor. Frankly I would have no personal problem in making it available, but since we did enter a confidentiality agreement at the time of that acquisition, we believe we have to honor that agreement. The information has been made available under confidentiality rules to the department. CHAIRMAN LEMAN: Is that available to us, Mr. Commissioner, under confidentiality, so if we wish to have that we can go into a confidential session? COMMISSIONER SHIVELY: [Nods "yes"] CHAIRMAN LEMAN: Okay. We'll take that under advisement and at a future time we probably will have a list of other things that we may also want to hear about that may be confidential and we'll put that on the list. Senator Halford. SENATOR HALFORD: Before we get to a confidential session, I'll just say that my guess was something between $5,000,000.00 and $6,000,000.00, and that way I can't have possibly gotten it out of a confidential session. MR. MORGAN: Noted. CHAIRMAN LEMAN: In my interests, smile if he's close, and since you're smiling. Senator Frank, and then we do want to go to the attorney general. SENATOR FRANK: Your basic thrust was that the net profits feature is not conducive to maximum recovery, basically? So, I understand the State doesn't do that anymore, and it's probably a good policy, I'm not really sure. But somebody told us that BP just got through bidding on a net profits basis down in Colombia or something like that, is that true? MR. MORGAN: As far as I know, we haven't ever bid in any other part of the world, ever on an arrangement like the net profit arrangement in Alaska. And of course we did not bid on that here. If there are other examples that you would like me to discuss with you at any time, if we can get clear on the examples I would be happy to do that, Senator. SENATOR FRANK: I don't know where that came from, but... SENATOR PEARCE: Venezuela. SENATOR FRANK: Venezuela? Okay. So what was that? SENATOR PEARCE: Actually, Mr. Morgan, the offerings he's talking about we're just done at the end of January in Venezuela, and the report that we got from Cambridge Energy laid out the different offerings and who the successful bidders were, and it's my understanding from that in January, which has been fairly recent, that BP International - whoever is in Venezuela, whichever arm of the company it is, did indeed bid on some net profit share leases. Or did indeed somehow. SENATOR HALFORD: Yeah, the terminology, I think, is in partnership with the government owned corporation at percentages in the 80-90% range, which is the same affect as the net profit leases, it's not a net profit lease, though. MR. MORGAN: I think I can assure you that this was not an arrangement where there was the sudden imposition some way through the development of the field of different terms that altered the basic economics. There are a number of features that I'm aware of to do with Venezuela. I don't want to go into them in detail, but I would just say that it is an extremely low cost area, in terms of finding development and transportation cost, and that certainly distinguishes it from our activities on the North Slope. But I would be happy to talk to you in more detail at another time on that subject. CHAIRMAN LEMAN: Perhaps you or your designee would have some detail on that. When we pursue this in more detail we can have the answer to that. Thank you sir. Attorney General Botelho. You've been patiently waiting there in the back of the room with Mr. Baldwin. Just relax, you're among friends. ATTORNEY GENERAL BRUCE BOTELHO, DEPARTMENT OF LAW: Mr. Chairman, your staff requested on your behalf that we be present and available to answer any questions you had. I trust that members of the committee have received a copy of the opinion which Mr. Baldwin authored regarding the legal basis for why the governor requested introduction of the legislation to endorse the leases. We're also prepared to discuss, at the request of President Pearce, the question of confidentiality. We've actually prepared appropriate agreements of confidentiality paralleling such documents in the tax context so that the committee would be available at the appropriate opportunity to review confidential documents in full so that you're better advised of the issues, the consideration negotiated. With that, Mr. Chairman, we're available to answer any questions you may have. CHAIRMAN LEMAN: I have read your letter, Mr. Baldwin, and just for the benefit of others who may not have read it yet, could you just hit the highlights. I believe you answered four key questions. If you could do that, then... JAMES BALDWIN, ASSISTANT ATTORNEY GENERAL, DEPARTMENT OF LAW: Yes, thank you Mr. Chairman. My name is Jim Baldwin, I'm with the Office of the Attorney General. We were asked to advise as to the ability of the Department of Natural Resources to enter into the lease amendments that are before you without further statutory authority. We analyzed the framework of the statutes, existing law, and concluded that it was a better approach to have specific statutory authority. Based on the history of the amendments that were enacted last year for royalty reductions and the actual wording of existing law, it appeared that express authority would be necessary to make these changes. The bill that's before you has a couple of approaches in it for accomplishing it. One is an actual ratification of the amendments themselves, and the other one is providing the basic underlying statutory authority to make the kind of changes that are being proposed here. So that's the first part of the analysis. The next part of the analysis goes on to consider the question of whether an approval that is so specifically directed to an individual lease or and individual lease holder would violate the local or special prohibition set out in the constitution. We conclude that this is a project of such state-wide importance, that it would meet the test set out in State v. Lewis, which was a case decided in the 80's concerning a land trade in the railbelt area, and also that it would meet the equal protection analysis, which is also laid out in that case, which is not the heightened scrutiny of the strictest test for satisfying an equal protection challenge, but it is more of a rational basis type standard, and we believe that through the testimony that you're going to be hearing here before this committee that will be brought to you by the various parties that there will be an adequate basis laid to support the valid State interests in making a very narrow statute, enacting a very narrow statute to approve these lease amendments. Finally, or nearly finally, we consider the competitive bidding issues, that since this lease was initially competitively bid, the law basically States that you can't really make a material change in a competitively bid contract without really considering going back and entering into an entirely new contract. There has been some case law which further develops that to determine when you have a material change and when you don't have a material change. We set out to explain the factors which are taken into consideration in resolving that question and conclude that this would not be the kind of change that would be foreclosed by the competitive bidding statutes that are set out in Title 38, the Alaska Land Act. And finally, we discuss, and this was in response to a question that was put forward by President Pearce concerning whether this would not be some kind of an improper appropriation, since there was a reduction in the potential take into the State treasury, whether that would not constitute a violation of the public purpose doctrine. And we conclude that there are many ways of analyzing this, and that essentially there's a mutuality of consideration on both sides on behalf of the lease holder and the State, and that we think, based on the decisions that have been handed down by our Alaska Supreme Court, that there would be a great deference given to any decision made by the legislature in it's regard, that it would be in the public interest or for the public purpose to prove these kinds of lease changes or authorize them. And that basically sums up what we said in our opinion. CHAIRMAN LEMAN: I'm just going to check with you: will either or both of you be available tomorrow morning, if we want to go into detail? I have a number of fairly detailed questions that I'd like to pursue, but we have people here from out of town. I'd like to accommodate them. ATTORNEY GENERAL BOTELHO: Mr. Chairman, we'll be available. CHAIRMAN LEMAN: Yes. And I think we might, or on some of them tomorrow we may to give you time to research. I do want to pursue questioning on this section on competitive bidding principles and I think in advance so you can answer tomorrow about, if you can answer the question: when did, for example, the timing of the change and you conclude that because it's well seasoned that wouldn't be something that would be--cause particular trouble. But then I ask the question. I think this is one we need to get satisfied in our minds, is did BP enter into that contract through acquiring the Amerada Hess leases in 1980, or did they enter into it in 1995? And that's--I would like to pursue some questioning there because I think that sets the ground for at least one of the concerns that I would have, and that is maintaining the legitimacy of the whole leasing process. So you can come prepared. We'll want to ask questions along that line. Senator Taylor did you want to ask... SENATOR TAYLOR: Yes, I'd have two, and whether you're prepared or not today, tomorrow it would be fine. The first was, did you believe that it was legally necessary for the legislature to grant the governor the authority to amend this contract. And the second one was, if so, was the same contract and the same law in existence at the time that the Thetis Island amendments occurred, and if in fact your answer is in the affirmative to the first one, then was not Thetis Island done illegally? And I guess the last question is, how could we have a more significant change to a contract than this one. I can't imagine anything more material to the essence of the agreement itself, than the term that has now been amended, and to say that that is not a sufficient change to be material or significant to the contract enough to bring into compliance what the chairman was just asking about, which was the re-bidding requirements. I don't know what would be, and so I would really like to see an explanation of that. ATTORNEY GENERAL BOTELHO: Mr. Chairman would you like a brief answer now to those questions? CHAIRMAN LEMAN: Sure. If you can answer now that would be fine. ATTORNEY GENERAL BOTELHO: And I expect that this may be a subject that you wish to expand on tomorrow, but obviously first perhaps to take it in reverse order. The very point is another reason why we believe that it is most prudent for the State executive to be coming to the legislature asking for an express ratification, because clearly these are terms of significance and while we believe, as Senator Taylor well knows, lawyers can fashion arguments on all sides of an issue, and each lawyers guess, until the Supreme Court has spoken can come up with a better or a different estimate about the chances of prevailing. Our view is the most prudent course of action for that reason is to take the matter to the legislature. With regard to the earlier question, a previous net profit share lease, again, I think generally speaking, we have indicated in the opinion, actually in footnote 2, highlights our view that there is a question about whether the governor or the commissioner of Natural Resources has implied authority to make changes to leases. It's an area that is not developed in the law. We think it's highly risky, and again, led in part to our conclusion that the most prudent course, in order to speed the project along was to bring it to the legislature. But there's also, I think there are two or three facts that distinguish this lease from the state of the law at the time that the State entered into the previous lease. There has been a question about whether net profit share leases are royalties at all, and that's been a question where there's been inconsistency in the State practice long term. At the same time, there is a consistent practice that if the commissioner has the power to modify, that it occurs at the time of unitization. And that was clear at the time Commissioner Wunnicke acted. The other, again I think fairly--the only place we've seen it, but Commissioner Wunnicke's position was that she was authorized to increase the terms that is to the benefit of the State, but that she did not have the power to decrease it. Clearly what we're faced with here is with a diminution of revenues that would come to the State. Whatever the case of the law was before last year, there was a material change in AS 38.05.180, and that is the power that one would operate under is 180(p). But that in turn last year was modified to reference the process at fourth and 180(j). And that would require the commissioner in order to make the changes to make a finding that this project would otherwise not be economically feasible. And that was a conclusion which the commissioner would not and could not make. And once again, whether in theory 180 would apply, in this instance it could not apply. And, again, our reasoning supports the need to put this matter before the legislature. CHAIRMAN LEMAN: Senator Taylor, any follow up? SENATOR TAYLOR: Just follow up. If in fact the commissioner could not make that finding, then the finding must be based on something else. And if in fact it's something else, then it must be some other political consideration, such as Alaska hire, the development of modules, whatever. But it would seem to me that in a matter of this import, where we're talking about the authority of the executive branch, it would seem to me that prudent is a word used by a banker when he wants some additional collateral and coverage on a loan. The word prudent could be synonymous with political. It was politically more comfortable to have the legislature provide coverage on this issue. That's certainly what the daily news articles that I've read would indicate, and I think there ought to be a clear definition, something more than just what's prudent for the legislature to do it. There ought to be something clearly in the law that says that the executive either has to do this, or does not. And not having to do it seems to me to be somewhat of a forfeiture of power that's not really necessary. And if in fact it's not, why are we here, is my bottom line, because to put it another way, if the legislature were to turn the deal down, couldn't the governor still make the deal? ATTORNEY GENERAL BOTELHO: Mr. Chairman, whether he could or not, my understanding is, and again I think that Mr. Shively is certainly prepared to speak with this, if the legislature turns the deal down, there is no deal. And the State, again, prudent is a word that I believe is quite appropriate in the circumstance, quite apart from the view that perhaps it's a bankers term. Our deal and our goal here is try and get a project that will benefit the people of Alaska on line as quickly as possible under terms that will be beneficial to the people of Alaska. By bringing the matter to the legislature we eliminate several legal issues that otherwise could well end up in litigation, the outcome of which lawyers all of us can speculate, but for which we can provide no degree of certainty. CHAIRMAN LEMAN: I just want to note that Senator Rieger and Senator Green have joined us, and Senator Green, you've been blocked out by that very nice map there, and you both are welcome to join us at the table, and if I'm overlooking any other legislators, we have room, so come on up. Senator Halford has some questions you want to ask. I would like to get back to some questions for Mr. Morgan and Commissioner Shively, and then we have three gentlemen from out of town that I would like to get to them by 5:15, if we can, and conclude this hearing by 5:30 tonight and then we will extend tomorrow. So with that, Senator Halford? SENATOR HALFORD: Unless these are short answers, I will be asking them again, but I wanted to ask the question so there are things that you can come back with. What's the interest rate on the development fund? COMMISSIONER SHIVELY: The prime rate. CHAIRMAN LEMAN: Floating prime rate? [The answer is not picked up by the recording equipment.] SENATOR HALFORD: Okay. I would like an analysis from the Department of Law as to the carry forward of the development fund with the leases on transfer and a conclusion as to whether they in fact do carry forward so that we know the development fund really is an available issue. I would also like a list of the other bidders on each of the parcels in question at the time of sale, and the other bidders bidding on any lease in that sale that were qualified to bid on those parcels. I'd like, and one of the questions that is a question for this agreement and both for the economic analysis and the legal analysis, if there was a lawsuit that stops development because of a change of the bid variable, and that then delays the process, number one, what happens in the legal sense to the time frames that are in the agreement, and number two, what happens in the sense of the economic model to the differences in dollars based on the time delay, because it appears that the benefit is the time acceleration. And, also with regard to the economic model, if the model could be run with the variables in income to the State based on the recoverable of 135,000,000 barrels, but also based on a recoverable of double that. How sensitive is the situation if it is twice as good as we think to the changes proposed. And finally, whether or some kind of a projection on what the projected severance tax rates would be on this project under the existing provisions of the economic limit factor. ATTORNEY GENERAL BOTELHO: Mr. Chairman, we've taken note of these questions. Several of them are probably more appropriately directed to the commissioner of Natural Resources. We understand it is an obligation of the executive to try and provide that information to you. CHAIRMAN LEMAN: Senator Pearce. SENATOR PEARCE: Thank you. I have two questions right now. First, is there a federal definition of net profit leases, net profit shares, I guess. ATTORNEY GENERAL BOTELHO: Mr. Chairman, there is. SENATOR PEARCE: And, could we--I don't know if I want to see it, but could we have that, please? ATTORNEY GENERAL BOTELHO: I would be glad to provide it to you tomorrow. SENATOR PEARCE: Second, Mr. Baldwin, on page 3 of your legal opinion to Mr. Shively, first paragraph you say further under section 180(j), and that's of, I believe of last years 207, the commissioner may reduce royalty and unitize leases if the lessee makes a clear and convincing showing that a modification of royalty meets the requirements of this section and is in the best interests of the State. And then the purpose says that it is to allow for production that would not otherwise be economically feasible. And then you go on to say that you have informed us that the Northstar unit development does not meet this standard. Why is that? MR. BALDWIN: I think that's a question that's better addressed to the commissioner. When we wrote the opinion, there were certain things that were a given, and that was a policy decision by the commissioner of Natural Resources. SENATOR PEARCE: Okay. Can you tell me what the standard that you're talking about; is that the standard that it is not--that it would not otherwise be economically feasible? Or does it go back up to the standard of is it in the best interests of the State? I'm trying to figure out first of all which standard is that you said isn't being met. MR. BALDWIN: Economic feasibility is. SENATOR PEARCE: But the standard was would not otherwise be. MR. BALDWIN: Right. SENATOR PEARCE: Okay, then that's a question I'll be asking Mr. Shively. CHAIRMAN LEMAN: Okay. Commissioner Shively, will you be available tomorrow, or you have other people from staff... COMMISSIONER SHIVELY : I will have staff here. I will not be in town. CHAIRMAN LEMAN: Okay. I'm just thinking in terms of what order to do these in. I think, Mr. Morgan, I know you're not going to be available, and why don't we have you come back for questions. Thank you, and tomorrow morning at 10:00, and I would like somebody from the division who is familiar with the administration of the former leases to be with you, because some of the questions we're going to pursue I think Mr. Baldwin can answer probably a lot of it, but you'll probably want to rely on them and I'll just further note that if you wear a tie tomorrow, we won't listen to you. No, rather, we might ask tougher questions, though. We'll be fairly informal, go from 10-12. MR. BOTELHO: Thank you Mr. Chairman. CHAIRMAN LEMAN: Okay. Mr. Morgan? I'm going to start. I think the numbers you used were consistent with an article that I read in the Fairbanks Daily News Minor where you had spoken, I don't know if you spoke to a group in Fairbanks or talked with their editorial board, but you talked in terms of a $380,000,000.00 project, and then with the estimated reserves of 130 or $135,000,000.00 you said it's $2.92 per barrel, and at that--let's see--at that price the project begins to look interesting, is pretty much the quote. And I'm not sure that I or other members of this committee are experienced enough in this to know how to compare that with other projects, but would you be able to provide us with comparable numbers on a dollars per barrel invested on other projects that you've considered and have committed to developing, like Kuparek, Milne Point, Nyakuk, Point McIntyre, and other fields? MR. MORGAN: Mr. Chairman, I think we can--I'll have to take advice on this, in terms of any barriers, but I would, subject to that advice, I would be happy to try to find that information for you. CHAIRMAN LEMAN: Now, I'll ask you the other question; I think you may have said it, I know I've heard it said, is that if these changes were not made, you would not develop the field. And is that your position? MR. MORGAN: Mr. Chairman, I can and will confirm that. And I would just like again to repeat that BP is a very major international oil company. We have operations in many locations around the world, and as such, we depend on our reputation in the service that we provide to host governments in order to gain access to opportunities. We provide essentially, management and technical skills and a background of knowledge in the development, exploration for and development of oil fields. It is not just my view, but it is the basic position of the BP Corporation that we would not put ourselves in a position of developing an oil field where we were not able to do that and follow it through in the very best possible way that we can. To do that would actually be, in our view, to damage our fundamental reputation. CHAIRMAN LEMAN: Okay, but in late 1994 when you purchased these leases from Amerada Hess you knew that those were the terms in there so then, I would assume, and I would hate to put words in your mouth, but I would assume that you were then betting on being able to get a revision to the terms of those leases, so then you could go ahead and make the development. MR. MORGAN: Part of the risk that we took when we acquired the leases was that the State of Alaska may not agree to a modification of the terms that would allow us to go forward with development, and we did that knowingly and clearly. CHAIRMAN LEMAN: And the risk to you would have been that you would have been out the money for the leases and you wouldn't have developed them. You might have tried to shop them to somebody else or waited for market conditions to change. MR. MORGAN: Well, I think the risk was clearly that that investment would not be fructified, and I think there are a set of other risks around that in terms of the signals that would be sent from the State, but essentially that was the primary risk we were taking. CHAIRMAN LEMAN: Okay. Questions of others? I don't want to dominate--Senator Taylor? SENATOR TAYLOR: At any time during your negotiations, which as I understand it have carried on for some time, were you aware of a requirement that for this project to go, that you would have to have a statute passed by the legislature of the State of Alaska? Since you're--I assume two people sit down to make an agreement, and if the whole agreement is going to end up being contingent on [indisc.], that would be a major part of the discussion. MR. MORGAN: Chairman, Senator Taylor, the Department of Natural Resources and Commissioner Shively were clear with us from the beginning of that negotiation process that they believed that any agreement we reached would be subject to legislative ratification. There is no question in my mind that that position was quite clear. There was literally more or less at the time we were concluding that set of negotiations, the question appeared to be raised as to whether this may not in fact be necessary, and the discussions that we had with the administration at that time reflected a view from the Attorney General's Office, which I think you just heard, which was that there was a significant risk of some form of challenge if legislative approval was not forth coming, and that therefore, the prudent course of action was in fact to seek that approval. Neither I nor we as a company have had any concern about bringing the agreement we have reached into the public view for a full discussion of the legislature. I believe that the agreement we have reached is a very sound agreement, from the State's perspective, as well as from our own. And so I believe that it is positive for this kind of scrutiny to take place. Clearly, I very much hope that the conclusion will be a positive one to allow us to go ahead quickly with the development. CHAIRMAN LEMAN: Other questions? I'm going to ask one on your agreement, I believe it says something to the effect that if the legislature passes an act substantially similar to this act--what is your position, is it that we'd have to provide the approval as is, or would the legislature have the approval to make modifications to the agreement? MR. MORGAN: It's my understanding that the way the bill has been prepared and presented gives the legislature the opportunity to basically say yes or no to the negotiated agreement. I understand that the legislature can always seek to vary terms. I have to say that from our perspective, we have in good faith reached a negotiated agreement with the administration, and I believe that any variation of those terms would cast that whole negotiating process into doubt. So it's both my belief that that was the intent of the administration in introducing the bill, and it would certainly be my very strong preference that this should be handled essentially on an approval or disapproval basis, without the introduction of any significant or material changes. CHAIRMAN LEMAN: Let's say that in the course of the development of this record in the hearings we conduct we come up with perhaps side boards that give us a little bit more comfort, perhaps the level of commitment for local hire, the use of local contractors, or something like that. Let's face it, there's words in here that, I don't know if you want to call them weasel words, but there's words that allow you're best efforts, and things like that, and if we want to provide some additional comfort and can work out something, I just want to know if we're going to be at an impasse that's going to be all or nothing, or if there's some of those types of things that we can get agreement on, maybe through the hearing process, we say, yeah, that would be acceptable, and maybe a win-win for everybody. MR. MORGAN: Well, chairman, you asked me the question very directly. I can only repeat that my very strong preference would be that we can, between us, honor a negotiated settlement that has been a long, complex, and quite difficult negotiation where I believe the kinds of considerations you're raising are likely to have been part of our discussion. I would prefer to offer to you my own and my company's presence to deal with any of the areas of concern that you may have, and have us do our best to deal with them before you in hearings of this kind, and I will certainly do my best to make myself available to do those things. I believe that we are putting our reputation on the line, by the statements that we are making on issues around Alaska hire and the use of Alaska contractors and manufacturing in Alaska, and that we will be clearly held to that reputational test. CHAIRMAN LEMAN: Do you have any intention of marketing the Northstar unit to anybody else over the next year? MR. MORGAN: We have no current intent of any change in the equity arrangements. CHAIRMAN LEMAN: Commissioner Shively, could I ask you the same question about the legislature were to come back with some proposed modifications, how you would view that? Do you view this as an up or down or if we wanted to--I don't want to say assist, but work out something that is indeed what we believe in the best interest of Alaska and this total agreement, how would you view that? COMMISSIONER SHIVELY: Well Mr. Chairman, as John Morgan has said, we have presented this as an up or down vote. And we did it for a variety of reasons, one the negotiations we went through were long and complex. It is late in the session. On the other hand, if there are things that BP believes that they would like to agree to, we will certainly look at them. I think that really, in a lot of ways, is more between the legislature and British Petroleum than it is between the administration. I'll have to tell you that I think if you start to get in to try to renegotiate this agreement, then I would doubt that you would be able to finish this before you go home on May 7. TAPE 96-40, SIDE A CHAIRMAN LEMAN: [Tape begins midspeech] ... get some understanding at this level of what your understanding is of it so as we proceed with future hearings that, you know, we don't chase off on a area where we're clearly going to come to logger heads with the two you. Senator Taylor. SENATOR TAYLOR: Nice to have both of you at the table at once, because from the testimony I have heard so far, there certainly appears to be somewhat of a disagreement, and that may be the reason for this deal. But you as commissioner, Mr. Shively, are reported to have refused to make a finding that the project was not economically feasible, whereas Mr. Morgan believes that the project is economically feasible if, in fact, you grant him the relief sought. COMMISSIONER SHIVELY: I think that's a little confusing. You have to go back to what we did last year in HB 207, and that's the analysis that I believe Mr. Baldwin is doing. In that bill, we were looking at the sort of base royalty reduction, and in that legislation I had to find clear and convincing evidence that the change in royalty was necessary in order for the development to take place. I do not believe that no oil company in the world could develop this oil field under the current provisions. When we did the economic analysis, we believe the rate if return is sufficient for somebody to want to do it. On the other hand, BP has told us they would not do it, and, therefore, I cannot make a finding that under the current situation the development of the field is not economically feasible. It, in my mind, is economically feasible under both considerations. Both of the considerations of the net profits and using the supplemental royalty. BP has said for them it is not developable under the net profit conditions. MR. MORGAN: If I may, Chairman. What I was careful not to say, was the development was not economically feasible, and that it is the broader consideration of the economic impact of coming into force of those net profit terms before the field has been fully developed that is the consideration. So there is something of a subtlety in the words that we're all using here. CHAIRMAN LEMAN: If that's the case, then in negotiations why did you not, Mr. Commissioner, insist on a net zero change in the value to the State of Alaska when you modified the net profit share? You know, if it's still economic, it would seem to me that you deal with the issue of net profit share, but not come up with a new arrangement that results in an economic disadvantage to the State, if I can call it that, even in light of your -- you had a couple different numbers; one I think was 45 million and the other 4 million that your model projects. COMMISSIONER SHIVELY: Well, again, you have to get to the point where you believe BP, that they will not develop now under the net profits provisions. If you believe that, then the earliest we can force them into production would bring the oil on in 2002. If you do that analysis, then we're about $4,000,000, apart in what I believe we would get under the supplemental royalty and what we would get under net profits. If I believe that they would use the net profits, then I should have worked on this deal, you're right, but I believe and that's why I did it the way I did. CHAIRMAN LEMAN: Would you consider then the 4 million, in light of that model, would be close enough to a wash that its ... COMMISSIONER SHIVELY: I consider it to be very close since the only thing we know about all these numbers, since they are projections, is that they're wrong. We just don't know how wrong. CHAIRMAN LEMAN: I don't know what other members have for time constraints, but we have three others who have come from out of town that I said I'd like to have a minute at 5:15. Senator Rieger, did you have a question for these witnesses. SENATOR RIEGER: I appreciate your allowing me to participate in the hearing, and I apologize for coming in late, but I was wondering if you could just perhaps qualitatively, or if you could quantify it, describe the nature of the negotiation -- of how much of the negotiation was on the straight finances and straight economics of the lease and the modification of the lease, and how much was on other peripheral considerations that you've made reference to, like I think it was use of local contractors or whatever, but who knows what all else came up. Can you, in very rough terms, qualitatively describe how much was one and how much was the other. MR. MORGAN: Mr. Chairman, Senator Rieger. Obviously, I did not personally conduct these negotiations, although from time to time I was involved in the process, so I think my answer is essentially an impressionistic one. I think that most of the time that was spent in technical discussions between ourselves and the department was focused around under standing the issues around the impact of the net profit arrangement and the creation of options for an alternative arrangement that the State and ourselves would feel comfortable with. Most of the time that was spent was spent in that area. It was always clear that we were going to have and the agreement was going to contain areas concerning some of the broader issues around Alaska hire and contracting and the building of modules. Those things I think were more specifically focused towards the end of the more technical negotiations as it became clearer to both sides that we were likely to reach a point of agreement on the value or the technical components of this. I hope that helps you get a feeling for it. SENATOR RIEGER: That does help. Were there issues beyond the contracting of modules and local hire that were brought up, but maybe rejected? MR. MORGAN: Not to my knowledge, but, clearly, I wasn't involved in all of the discussions. CHAIRMAN LEMAN: Mr. Morgan, I don't know if Mr. Luttrell was involved in those negotiations, but it would be real good for us I think if you wanted to pursue that first and maybe we could talk to some of you folks that were involved in those negotiations. MR. MORGAN: Mr. Chairman, with pleasure -- you will be able to do that. CHAIRMAN LEMAN: Senator Halford, you had a quick question? SENATOR HALFORD: In the consideration of the economic analysis at BP, was there any question that the capital credits or development credit account went forward with the lease, or was that an area that you had conflicting legal advice as to whether it actually would go forward? MR. MORGAN: Chairman, there was never any doubt in the advice that we received and I received. That we were very clear that on acquisition of the leases the development account carried forward into our name. SENATOR HALFORD: And the $260,000,000 value of that account, is that with interest at this point, or is that a ... MR. MORGAN: Mr. Chairman, I'll have to take advice on the answer to that question. COMMISSIONER SHIVELY: Mr. Chairman. Yes, that's correct. And I will tell you, Senator, and I am sure that the Attorney General's office will provide this information tomorrow, there has been a lawsuit on that issue that I think clearly settled it, and we clearly believe that the development account goes with the leases. Not on these leases, but on ... SENATOR HALFORD: Yeah, yeah. So, I mean, there's a very significant incentive if, for example, you could buy a $260,000,000 development account for $5,000,000. That would be a fantastic starting point on the overall lease obligations. COMMISSIONER SHIVELY: Mr. Chairman. I think it would, but it's also where the State's risk is, and it's one of the reasons I thought it was important to consider this is because as that development account grows, our take only goes one direction and that's down. And the development account will continue to grow, you know ... SENATOR HALFORD: On yeah, it's a benefit to the company, not at the State's expense necessarily, but it's a benefit to the overall development of the project based on prior expenditure. The only way the State gets it back is if the State cancels the leases and resells it. Then there is no development account left. COMMISSIONER SHIVELY: That's right. MR. MORGAN: Mr. Chairman. The point I would make of course is that were that not the case, or were the account to be lower, the need for the removal of net profit would have been -- I can't say it would have been greater, but it would have been absolutely as great. And that, in a sense, one of the unfortunate effects of the net profit arrangement is that it provides a disincentive to reduce the development cost of the field. It is only because through our technical and professional efforts we were able to see the development cost in the $350,000,000 to $400,000,000 range that this actually became a live issue. CHAIRMAN LEMAN: Senator Frank. SENATOR FRANK: I've always thought that when we talk about development cost we were talking about capital cost not ongoing operating cost. Can you clarify that for me? Is that $380,000,000 totally capital, or does include the operating costs over the life of the fields? I assumed that an operating cost or a, you know, a guy spending money doing something in the field was part of the development cost. COMMISSIONER SHIVELY: There are three pieces that go into the equation until you get net profits. The first is what we would call sort of the development cost, which is like the seismic, any exploratory drilling, all of the work that goes forward to define out even if there is any oil there. And then the next thing that goes is sort of the next step of development, which is the engineering, then the capital expenses. Those all go in. Also, then once you are doing net profits, you also throw in their operating cost as an offset against revenue so that ... SENATOR FRANK: Well, I understand that. That makes sense that your operating costs would come off of your revenues and then you would have operating earnings, and those, then, would offset against the development cost before you got any net profits, right? COMMISSIONER SHIVELY: That correct. SENATOR FRANK: But my question is really the development cost because you say that there's $380,000,000 worth of development costs, and are those development costs made up of both operating and capital costs? MR. MORGAN: No, Sir. They are made up of the development cost to bring the field onto production from its current State. So that is moving ahead now from conceptual engineering, which we have already completed, and we have spent, since we acquired these leases, I think of the order of $24,000,000 on conceptual engineering work. It is to go forward now into the detailed engineering phase, the acquisition of material, the placing of orders, the spending of monies with contractors to fabricate and construct the field to bring it into operation. SENATOR FRANK: Okay, let me just follow up on that a little bit, because I'm trying to understand how that works. So, I don't think you have to put all your money in before you get your first barrel of oil, but is it true that you put all the $380,000,000 in before you get your first barrel of oil, or is that $380,000,000 -- I assume you put most of it in and then maybe some of it comes after as you do further development, or something like that. MR. MORGAN: I think the issue may be around the phasing of drilling activity, in particular, given the nature of this reservoir. There are not, in fact, a large number of wells to be drilled so it may be that the whole of that $380,000,000, including all of the drilling component of it, would not be complete by the time the field came on, but you can have full technical input on that. Certainly the vast majority of it, any residue would be a very small proportion, I believe. SENATOR FRANK: Well, that's what I always thought when they talk in terms of development costs being kind of an up-front capital cost, and then oil starts to flow, and then you have operating costs that go along and operating revenues, obviously. SENATOR LEMAN: One final easy question for you, Mr. Morgan. If my memory serves my correctly, in the past you have advocated that the State consider changing its severance tax and royalty policies in favor of more profit-based systems. And, if that's true, and, if my memory serves me correctly, how do rationalize your comments on the net profit share leasing with that view, or is there something that we're missing in the linkage that ... MR. MORGAN: Easily, Chairman, I think that it is quite clear that the net profit interest arrangements that were in place here are not profit related. They do a calculation of net profit, but then they have no impact until the point when, under those arrangements, they cut in, and then they simply cut in at that high level, certainly in the case of Northstar. That is not a profit-related arrangement, and what we're introducing here in terms of a supplemental royalty is very much closer to a profit-related arrangement. It doesn't have all the administrative complexity of actually defining and keeping detailed accounting records of profit in a formal sense, but, very clearly, the oil price is a strong proxy for the profitability of an oil field operation. So to the extent that we have now linked the supplemental royalty to oil price, we have something that is much more profit related than the so-called net profit scheme ever was. That, indeed, is part of the benefit of this, because the arrangement we have now leaves our interests, in my view, completely aligned with those of the State. We have every incentive to increase the size of this oil field going forward, and that's aligned with the State because they will clearly take a significant share. We are now talking even at 20 percent of the highest royalty rate in operation on the North Slope, and clearly, if the supplemental royalty cuts in significantly higher rates than the highest now in existence. So I think my view is that that is one of the real benefits of the arrangement that has been negotiated in that it really does align those interests going forward. COMMISSIONER SHIVELY: Mr. Chairman, if I might, just briefly. The Oil & Gas Policy Council has talked about this, and what they've talked about is the State taking more risk and the supplemental royalty is a risk-based royalty. We're taking risk on higher prices, and if those higher prices come, we get a higher take. CHAIRMAN LEMAN: Senator Halford, last question. SENATOR HALFORD: Well, and I asked the question, but the question I have is it would appear that because the net profit share comes in the back end, the real variable that affects the relative take to the State is the size of the field and the amount of recoverable oil, much more so than the price. And I think if we double the size and run the assumptions, I would be very curious to see what the differences in dollars were, because it just seems to be much more size sensitive. Because by the time you've recovered all your costs, then if you can add, you know, ten, twenty, thirty, forty, fifty thou -- every barrel you add is essentially in the net profit share of the State. COMMISSIONER SHIVELY: Well, if you double the size without any increase in investment, that is true. A lot of what's happened in terms of increase in oil production or oil fields has been a result of substantial investment, all of which goes back into the development account. So, (a) you would have to make a guess at that. The other side of it is timing, again, because our price-based supplemental royalty, if one assumes some overall growth of oil prices over the long run, we get some increase in the end, too, if the oil field lasts longer. So it is not a simple calculation to make. I would say that we have looked at the geology. We had looked at it independently -- BP actually even, I think, before the leases were transferred -- and we independently came up with an estimate that was very similar to theirs. So we're comfortable that we're in the ball park. MR. MORGAN: I hope that it turns out to be twice as big. CHAIRMAN LEMAN: Me too. SENATOR HALFORD: I'd just like to see the numbers, or twice as recoverable, maybe not twice as big, twice as recoverable. SENATOR TAYLOR: I want to thank you, Mr. Morgan and John Shively for coming forward with this. I think it's wonderful to have the opportunity to hear and to be educated on this process. But I do find myself somewhat frustrated by the questions and answers I received earlier in that it seems to me that if we are to be a true partner in the Legislature in this process, that there is a certain level of arrogance involved where we're handed a proposition and it says we want you to know all about it, to be all involved in it, but it's taking a [indisc. -- coughing]. I think that if, in fact, this is to a meaningful process and there is to be public input and participation and an affect by the elected representatives of the State, that it ought to be a meaningful involvement and that ought to involve something more than take it or leave it. And if, in fact, it is take it or leave it, I certainly want to do whatever I can to encourage both your good offices, Mr. Shively, and Mr. Morgan's company to find good resolve and produce things for this State. But I don't know that my participation or the rest of this group, our participation is either essential or necessary, other than or whatever the political purposes may be for doing so. It's good to have educated and good to have us involved, but I just don't believe that we need to be part of this process under the law that currently exists. But I think it is nice that you came in today and we've had this discussion. I appreciate it very much. COMMISSIONER SHIVELY: Well, I'd just like to say that we've considered this when we went through it, much similar to a royalty oil arrangement where the Executive Branch negotiates the arrangements, we bring those arrangements to the Legislature, and the Legislature says, well you did okay job or a good job and that's fine, or you did a terrible job and we don't want it, and that's why we did this. I do think it is the Executive Branch's responsibility to negotiate these things and to bring, particularly this deal, forward because we do not believe we have authority -- and I think negotiating an arrangement like this in this kind of body would be very difficult, even for the body. So, we're not trying to be arrogant, and we think that there have been other instances, particularly in royalty oil, where you have seen the same thing. MR. MORGAN: Chairman, I would only add that I would ask you to consider how, from the perspective of my or any other company in our business, the sense of having to negotiate an arrangement in public in a legislative arena might appear. I have to say that there is no where in the world where that happens, and I believe there are very good reasons for that. CHAIRMAN LEMAN: Thank you both, gentlemen, for being with us today. I certainly appreciate it. And, Mr. Morgan, happy traveling. I understand that you will be able to be back with us, not next week but the week after next, is that correct? Whatever, I don't remember the exact details. MR. MORGAN: Thank you. CHAIRMAN LEMAN: Carl Marrs. Standing by, Bill Allen and Dave Jensen. Sorry to keep you gentlemen waiting 17 minutes longer than I had promised. CARL MARRS, President, Chief Operating Officer, Cook Inlet Region Corporation: Thank you, Mr. Chairman, members of the committee. One of the company's principal lines of business is natural resource development, and that's what I'm here to talk about today. CIRI is heavily involved in supporting the oil industry in Alaska, including, through its three subsidiary companies, Peak Oil Field Service Company, Construction Machinery and Alaska Interstate Construction. CIRI has benefited significantly from the oil industry's trend toward alliancing and partnering and remains a significant contractor on the North Slope. It is for these reasons I'm here today to speak in favor of Senate Bill 318. So let me put my cards on the table here. CIRI and its shareholders will benefit greatly from the development of the Northstar field. Our company, Alaska Interstate, will be a prime contractor on the project. But beyond CIRI's direct benefit, I'm here today to talk to you about why this legislation makes sense for Alaska. As you are aware, with the decline of the production of Prudhoe Bay, Alaska must act quickly to develop new sources of oil in order to ensure that jobs, business activities and State revenues derived from the oil industry continue at a level that can support our economy. Northstar can help make that happen. It's one of a number of smaller reserves near existing fields and infrastructure that we can bring on fairly quickly. That will help us bridge the production gap between the decline of Prudhoe Bay and the potential long-term opportunities of ANWR. Looking at it from the State's benefit alone, Northstar will channel in order of $500,000,000 into the State coffers over the life of the field and contribute nearly $100,000,000 into the State's permanent fund. To my way of thinking, those are two excellent benefits to the State of Alaska and to support this development. Northstar can also come on line very quickly. Its projected completion date is 1999, and as far I know, it is the only significant field that we have on the State development horizon during this time frame. We ought not to miss the revenue opportunity that developing this field provides. I've appeared before legislative committees before and advocated the State being more proactive in dealing with the industry. This legislation does that. It will adjust an old, out- of-date lease that has no chance of being developed into a working field. We'll benefit from the new State revenues I've discussed, and we'll put hundreds of Alaskans to work, and that, for CIRI, is a number one priority. We'll build some instate know-how for developing larger projects on the horizon. We see it as a win/win proposition for everybody. Finally, please don't buy into the argument that changing an old lease will send the wrong signal for future development. We believe it is just the opposite. Letting the industry know that we're willing to change the past ways of doing business if it's not working is the best way to ensure that Alaska remains competitive in the future. Accordingly, on behalf of Cook Inlet Region and its 6,700 shareholders, I would urge strongly that you support SB 318 and keep Alaska moving forward. Thank you, and I'll answer any questions if there is any. CHAIRMAN LEMAN: Thank you, Mr. Marrs. I'll just note that when you talk about the $100,000,000 additional money to the permanent fund -- just yesterday or it might have been day before yesterday I was speaking with Byron Mallott from the permanent fund and he said that the permanent fund lost $300,000,000 in that one day where the market dropped what was 146 points ... MR. MARRS: Right, but its made a few billion dollars ... CHAIRMAN LEMAN: But made almost all of it back over the next two or three days -- quite volatile. Thanks so much. Any questions for Mr. Marrs? Thanks for joining us. Bill Allen. BILL ALLEN , Chairman and CEO of VECO Corporation: Good afternoon, Mr. Chairman and committee members. For the record, I'm chairman and CEO of VECO. We're one of the largest Alaskan owned companies in the State, and naturally, I'm here to talk to you about Senate Bill 318. Senate Bill 318 does a lot of unique and good things, in my opinion. It's the first field that the government and industry can work together on. It's the first field out there that [indisc.] has State and federal leases. It's the first one that we'll be able to run a pipeline to shore on. It'll add, I think, 50 thousand barrels a day to the oil coming down that pipeline, and that will help save the economics on the big pipeline for a longer period of time. It will be developed on just a six acre island, a very small footprint compared to other fields. As far as helping VECO, it'll help immensely. We've got -- well, we built the first truckable modules that was built in the State, and we've been building them ever since. So has Arctic Slope, APC. So we've got a good experience -- we have a lot of experience on building truckable modules, and we've proved that we can compete pretty well with those. The thing that is really great about this is BP's committed to build sea-lift modules if we can find a suitable facility to build them in, and I think that we can. It'll probably cost a little bit more to build sea-lift modules up here to begin with, but after we get the infrastructure in, I think we can compete with the rest of the world. And that's going to develop a new industry that we never had before. And like they said, just on Northstar it will be 500 new construction jobs and 50 permanent jobs. Well, these 500 people that's going to be working on building these modules up here, they're going to have to live here. They can't live down south and come up and work because you are going to be working five or six days a week so they'll have to live in the State. We've built these truckable modules that I was mentioning to you, and the people that work on those have to live right here. Also, by building these modules here, and particularly the sea-lift modules, we can get the expertise, we keep the people here, so if ANWR ever does go, we can build a lot of their sea-lift modules. It's really a chance to develop a new industry. And I think BP committing to that alone we ought to go ahead and give them what they want as far as 318 and what they propose. VECO has somewhere -- I don't know, we're close to 300,000 employees, and VECO and its employees urge you to see what you can do as far as getting 318 passed and through. I really want to, again, compliment BP on coming in here and willing to particularly build the sea-lift modules. You know, BP, right now, they're investing money in the State when nobody else, no other oil companies are doing that right at this time. I think if BP comes through with this and we can go ahead and build these - - ARCO is talking about building Colville modules up here. If Colville is economical, they'll build them here, so, we're really starting a new industry, and I really encourage you guys to get this senate bill through and I know BP will come through with what they said they'll do. I believe it. CHAIRMAN LEMAN: Mr. Allen, in the revisions to the lease, there is certain language, I don't know if you've seen it, on the local hire and local contracting and the words "lessee shall use best efforts to contract with Alaska firms and fabricate modules in Alaska whenever feasible" and there's a number of phrases like. Are you satisfied that these are sufficient and there is a strong enough commitment to (1) use Alaskan contractors and (2) that Alaska residents will be the workers that are working for those Alaska contractors. MR. ALLEN: Yes, I do because BP's staking their reputation on it, and I don't think that they want to be looked as some company that said they were going to do one and do something else. I've done business with them a long time, and when they commit that they're going to do something, they've never changed directions, and worked for them since 1974. SENATOR HALFORD: The question I had is -- you're familiar with the, you know, the difference in costs here to building outside. What do you think is a reasonable differential? If we were trying to insure that we're actually going to get the big modules built or the sea- lift modules and we were to ask a question as to what BP is willing to spend, recognizing that it will cost a little bit in Alaska to build the same modules, and if they came back and said that if it were anything under 10 percent they'd be willing to do it, would that cover the kind of difference that you think it would take, at least initially, to get sea-lift modules built in Alaska? MR. ALLEN: Yeah, I do. And I think once we get the infrastructure here, I think we can compete with the whole Lower 48. I don't think after we get the infrastructure here and we really get into it, I don't think they would have to spend any more here than they would in the Lower 48. SENATOR HALFORD: A big selling point, if this goes, will be because of instate activity, and if there's $30,000,000 in module construction and it's really labor cost getting into the economy, that's a big help. It's just hard to ensure that that's actually going to happen unless there's some recognition of what the differential really is. If its five percent, 10 percent and they're willing to work in those kinds of numbers, that, I think, is something we need to know. MR. ALLEN We ought to jump on it, you bet, it it's within the 10 percent. I think there's more than $30,000,000 there. I don't know where you came up with the $30,000,000, but ... SENATOR HALFORD: Well, I think the testimony was $30,000,000 more than would otherwise be done in the initial development. So $30,000,000 increase ... MR. ALLEN: I think they're being conservative. I think there will be more than $30,000,000 spent here than if they didn't -- I think they're being conservative. They'll spend more than they would have normally. SENATOR HALFORD: I think just the question of sea-lift modules was $30,000,000 more than they would otherwise spend if they didn't reach out and build in Alaska what they wouldn't have built in Alaska on just purely economic grounds. MR. ALLEN: Oh, I see, that's probably true. SENATOR TAYLOR: Mr. Allen, what do you need for infrastructure? We've got three large facilities in my district alone, all of which have major deep water ports, docks, huge gantry cranes that are sitting there on rail, large warehouses with cement floors and electricity to them. I mean, I don't know what you need for infrastructure to build this type of thing. MR. ALLEN Well, that's along the lines of what you need. You need that and then you need the skilled labor to do it with, and Anchorage and the Mat-Su Valley and Kenai have a lot of skilled labor that have moved up here and worked on construction for a long time. Also, you know, in a real rainy climate, you need some kind of a building that you can put these modules under while you're building. But all of the other stuff that you tell me, it might be real feasible. You know, like on the slope when you build stuff up there, you have to have camps so that your workers can live in them. Now that's an extra expense. In Anchorage or in the Mat-Su Valley or even in Fairbanks, you know, the people have their own homes there, so the only thing I can see that might not be as favorable down where you're at is the skilled labor living right there. SENATOR TAYLOR: Well, I think we've got quite a few of those too ... MR. ALLEN: Yeah, hey, tell you what. Loggers are good hands. SENATOR TAYLOR: We've got a lot of people like certified welders that have worked on the slope. We've quite a number of people that have worked on the slope. MR. ALLEN: Do you? Well, we ought to look into that. CHAIRMAN LEMAN: You just got an invitation from Senator Taylor to tour his district. SENATOR FRANK: Well, I think there's a lot of people in my community, in Fairbanks who feel like they're skilled in terms of this type of work. I'm hearing a lot about the modular development and I'm hearing a lot of excitement about it, and that's good and valid. I have the same kind of desire to see my community benefit from local hire as well and wondering about how you think that can be accomplished. MR. ALLEN: Well, I think it already it is. You know, you guys are going to get about 42 percent of it? SENATOR FRANK: Hey, I like that, that sounds good. CHAIRMAN LEMAN: Hmm, now that you tell me that, you might start losing some of our support. MR. ALLEN: We've done a study and you're probably going to get 42 percent of the money spent on Northstar, so you guys are ... SENATOR FRANK: Well, that's good. You know, I think that the oil industry, if they were to spread out of the benefits of local hire throughout the State adequately, they would be well served by that. MR. ALLEN: In talking to BP, they want, if it's at all possible, to build more in Fairbanks. SENATOR PEARCE: Is there a -- you may have answered this, and if you did, I apologize -- is there some sort of a written document between you and BP saying that you will get some of the work if this project goes forward? MR. ALLEN: No, but we're an alliance partner. SENATOR PEARCE: What does that mean? MR. ALLEN: We most of their construction. It's between us and Arctic Slope, the mechanical part. Usually Arctic Slope gets 50 percent and we get 50 percent and then Peak gets most of the civil work, the dirt work. SENATOR PEARCE: Is there a formal document that makes you an alliance partner, or is that just a gentleman's agreement. MR. ALLEN: Yes, there is one, a formal document. SENATOR PEARCE: Is that a public document? MR. ALLEN: No, it's not public, but I wouldn't have qualms if you wanted -- would you, the alliance agreement? MR. MORGAN: I'd need to see the agreement first. CHAIRMAN LEMAN: Further questions of Mr. Allen? Thanks for joining us and thanks for standing by. I know that sometimes these committee meetings can get tedious and I appreciate your patience. The last person to testify today is Dave Jensen. DAVID JENSEN, President and CEO, Arctic Slope Regional Corporation: Thank you, Mr. Chairman. We operate principally through our two subsidiaries: Alaska Petroleum Contractors (APC) and Houston Contracting (HCC). You've covered just about everything that could be covered with a long list of comments that I had to make here, so I'd like to shift my emphasis to a here recurring theme brought up here is what is your reassurance to you as a principal contractor, which we are one of the principal contractors in the alliance agreement for the Northstar project -- what is your assurances, do you have something in writing, are their pledges, blood documents, and so forth? And you've heard the answers to them. I would like to convey to you at this time that I have been in the industry for thirty-three years at this point. In the last two years, the entire contracting community -- and it's been a little longer than two years now, probably three; but in the last several years the contracting community, as a general entity, has entered into a variety of alliance agreements and contracts with the two principle operators on the Slope: British Petroleum and ARCO. I can tell you with a great deal of authority that those contracts have been well honored. And I have never been, in the prior thirty-some years, experienced that type of and level of cooperation both in negotiating changed conditions in terms as we run into changed conditions with them. I have the highest degree of confidence in our agreements with BP to fulfill what they have set forward in their considerations for the employment of Alaska corporations and Alaska personnel with it. It's worked well for us and we look forward to it in a very positive fashion. I almost, I thought I heard a comment that the Alaska hire in Alaska corporation work might be a peripheral issue. I take a little umbrage with that and think about that for a moment as we're all so engrossed in net profits and royalty considerations and so forth. And of vital importance are those folks we call Alaskans out there today. And generating work and future work in considerations, this particular project offers us those opportunities as we develop a more intensified, skilled labor pool which we need to do again as we've lost a great deal of that labor pool over the last ten years. They've exited the State. This gives us an opportunity for the development of a larger skilled labor force that will allow us or put us in a position where we don't have to import labor or certainly reduce the requirements to import outside labor. In addition to it, you've heard the references to developing a improved infrastructure for these manufacturing or fabricating opportunities that we have with the process module considerations. As we do this, this again opens the door to the future for us again. So, I would ask you to really look at also, as we pick apart the royalty and net profits and so forth... TAPE 96-40, SIDE B MR. JENSEN: [begins midspeech] ...aren't we all considered with our future in developing - in developing. This project offers that opportunity and we needn't be so caught up with at least from the Arctic Slope point of view, contracts that become iron clad and you promised x number of positions and dollars and so forth. We're out of that era, we're out of that era. I know that comes as news to a lot of us, but I can tell you that with a great deal of confidence. I know we're pressed for time so, I'll limit my comments to that. CHAIRMAN LEMAN: Senator Pearce. SENATOR PEARCE: Thank you. I appreciate what you're saying about contracts in the '90s, but some of the comparisons of both alliancings -- since I learned this weekend you're not supposed to say partnering anymore -- and the State's ability to have surety of how that Alaskan contractors and Alaskans. Alaskan contractors will get the jobs and then the Alaskan contractors will hire Alaskans, I guess its a two step process. We use, because these projects have come up as a basis for comparison -- things like Red Dot, where the owner, the land owner was able to force because of a very good local hire, a very restrictive local hire clause, and also the Title 29 alliancing with Alyeska which was just the topic of a dinner Wednesday night where certainly your parent company was represented along with others in the State that have alliance partnerships. And that of course, was required under federal law. And I think that there are, if not, quotas per se, there were certainly some performance measures that had to be met, and that the Department of Interior gets to actually count noses, if they so desire. I think we have not figured out of way because of the problems we've had with Alaska hirer and our inability to figure out a way to write an Alaska hire amendment in the Constitution that can stick. We're kind of trying to feel our way toward being able to go home to our constituencies and say, "We have an iron clad agreement that we're going to have Alaskan contractors and we're going to have Alaskans in those jobs," because our constituents have come to expect it because they've seen it happen in other cases. Maybe we should ask Congress if they'd write and then they could do it because they can do things that we can't do. But it is a give and take, and I understand your frustration with our wanting something iron clad, but it's something that I think the legislators feel is necessary for us to be able to explain taking -- well, to explain positive votes on some sort of a negotiated deal like this. So that's not really a question, it's how we get to our position. MR. JENSEN: Well, I can understand your concern, Senator Pearce, and to come to some quantitative solution with that that we can get down in black and white, I think you have to be so cautious that we don't run amuck with the previous issues that we've been faced with, and Alaskan preference, and Alaska hire, and so forth. So when you start to couch or incorporate in a document numbers and percentages or make more than general references to Alaska hire, we can certainly all experience a very difficult and a long and costly legal problem, and I think that will make it the fourth time for us as a State to become embroiled in that again. I know it's difficult to go back and say "Trust me." We've heard that previously, but I can again offer you my assurances and experiences that have just transpired over the last several months when we began to focus on this as a team with BP and the contractors; how we've begun to develop some conceptual frameworks of how we can accomplish this additional fabrication, transportation of these modules, modules now up to 2,800 tons, which is pretty unique when you take into consideration the modules fabricated here in Anchorage were 80, 85, 90 tons maximum. We're making quite a quantum leap with this whole approach. CHAIRMAN LEMAN: On behalf of Senator Taylor and perhaps Senator Frank, can you tell us what your distribution of employment might be throughout the State? Senator Taylor would probably offer that a number of people in Southeast Alaska would be interested in these jobs. Senator Frank, of course, interested in jobs in Fairbanks, and I'm somewhat provincial too, so ... MR. JENSEN: I can share with you what our current distribution is and that vacillates with the projects that we're doing. Currently, between APC and Houston Contracting we're a little of excess of 2,000 employees solely within the State of Alaska. Of those, approximately 80 percent are on the North Slope working for British Petroleum, ARCO and Alyeska, through the northern end of the pipeline for Alyeska. The other 15 percent of those employees are in Fairbanks and Kenai. And that shift dramatically from year to year. To give you example, if we have a shutdown at the Mapco refinery in Fairbanks associated with our other maintenance work for Mapco in Fairbanks, that number balloons significantly to a couple hundred people immediately in Fairbanks in addition to the number of Fairbanks residents that are hired, that are working on the slope. So when we look at, you know, a cross-section of where people are working, that isn't so important as to where they reside. So we have a fair number of people from the Kenai Peninsula that are employed on the North Slope, as well as Fairbanks and Anchorage and from the various bush communities also. CHAIRMAN LEMAN: I'm would just suggest that for you and for the others who are still here and listening that it would be interesting information, I think, for this committee and for other legislators to have perhaps a distribution of where these people reside so others will know if they're coming from the districts. I think that would be something that will be useful. Mr. Allen talked about 3,000, you talk about 2,000, and I think we can probably show that the impact of this project impacts probably every region of the State. MR. JENSEN: We are in the process of doing that as we speak, Mr. Chairman. CHAIRMAN LEMAN: Thank you. Any further questions? Thanks for joining us. I'll announce that we will continue this hearing of Senate Bill 318 tomorrow starting at 10:00 a.m., and we will pursue primarily legal issues with the Department of Law, but also we'd like to have the Division of Oil & Gas people here available, and I would suggest that if BP has some of your people available because undoubtedly as we get into questions we'll probably encroach on turf that you [indisc. -- coughing]. I expect that that will last for two hours tomorrow. Next, just so we can plan farther in advance, I'd expect that we will resume hearings on this next week on Wednesday. We will work with our schedule; we have other bills scheduled. We may need to go to an evening meeting on Wednesday evening like at 7:30 if we can't deal with the other bills, but we are getting stacked on some others that we do need resolve. But I want to keep the momentum up now that we're started. Monday's meeting we have posted the schedule: HJR 60, SB 311, HB 539 and HJR 58. Any further business to come before us? If not, we are adjourned.