Roadmap to a Fair Tax

First, a fair tax on oil and gas will not result from “negotiations” with the producers even though it may be a good idea to meet with them to discuss and hear their concerns with the present fiscal system prior to and during any proposed changes to the current tax system.

Generally the producers will oppose what they don't agree with and aggressively oppose what they really don't agree with. The question is how to get the producers engaged in a way that creates productive exchange. The answer is you open up a public dialogue about oil and gas taxes. In that discussion they will explain what they don't like but not help you draw a line on what would be acceptable to them. Their goal will be to continue to put downward pressure on the system and to achieve the lowest tax they can achieve. That position does not allow them to support any tax changes even if the changes would be better than they are now. Their answer will be "that is not good enough." They will also not commit to additional exploration or additional investment based on a tax change.

With that in mind what is required is to get as analysis through models you can trust and try to develop a fair tax. During that analysis you will need to filter the comments made by the producers and figure out if what you are doing is fair based on their negative input. Here is how I would go about the analysis. First, separate analysis should occur for oil and for gas. The pipeline tariff on gas and the substantial volumes of gas that need to be transported to make a reasonable profit makes gas economics substantially different than oil economics.

A fair tax on gas includes an understanding of the possible range of tariffs for a gas pipeline. But the actual cost of the pipeline is not the critical element. The gas tax, like the oil tax should be fair at a range of prices from a marginal net value to a value of gas that is “wildly economic” as some used to say.

Once you distinguish the differences in economics between gas and oil, then break down the discussion between the different economic types of production and exploration, i.e., major know oil fields like Prudhoe and Kuparuk, extension exploration that extends the limits of the fields or that finds puddles near infrastructure, heavy oil production in those fields, known fields like Point Thomson which are large and have economic potential under the right circumstances, smaller marginal fields, exploration on state lands, exploration in NPRA, exploration offshore - state lands and fed lands. On offshore prospects distinguish prospects that can be explored from onshore and from bottom-founded rigs from exploration that must be conducted in the summertime from floating structures. Distinguish the Chukchi from the Beaufort. Recognize that we get no revenue from the Chukchi or Beaufort OCS but we should continue to pursue it (exploration and revenue). Next a comparative economic analysis should be done with other oil and gas provinces to determine the competitiveness of Alaska exploration and development from those in other provinces. Once you understand the relative economics of each of the above variables you can then begin to discuss deductions and credits vs reduction in tax.

Regarding progressivity - I still like some form of progressivity, but we need to remember that progressivity was based on a contractor spreadsheet that modeled Prudhoe Bay development, the most economic of all oil and gas development in Alaska. We knew at the time that there was a possibility that the tax might be too high. The bellwether areas for negative impact due to the tax would be heavy oil and exploration. We now have enough data to begin to see the impacts of the tax on exploration and heavy oil production. BUT we must always remember GEOLOGY IS KING. If the prospects aren't there, the producers won't explore no matter how low the tax. What we can't determine is if the producers aren't exploring because they think the taxes are too high or because the prospects are poor.

What we do know is that there is plenty of heavy oil and the producers aren't pursuing it aggressively. So there is a strong likelihood that economics are affecting the producers' desire to develop heavy oil on the North Slope. A discussion regarding the economics of heavy oil would be a productive discussion for the governor and the legislature to have with the producers.

If the legislature conducts the above analysis, it will have sufficient basis and understanding to make good decisions regarding one of the most important issues facing the state this year.

Legislative Agenda Proposal

Responsible Annual Budgeting, Budget Surplus, Budget Transition Period, Long-term Fiscal Plan, Permanent Fund, Nonrenewable Resources, Reserves Potential, Fiscal Stability, Fiscal Certainty, Fair Oil Tax, Fair Gas Tax, Alaska Large Diameter Gas Pipeline, Alternatives to a Large Diameter Gas Pipeline, Cook Inlet Gas Requirements, Interior Alaska Gas Requirements, Southeast Energy Requirements, Rural Energy Requirements, Alaska’s Gas for Alaskans, Point Thomson, what do all the items in the above list have in common? They, along with many other issues, must be considered in the context of each other to arrive at a comprehensive strategy to move the State of Alaska forward in the coming years.

A stable long-term fiscal strategy that does not require short-term changes to oil and gas taxes to balance the budget goes a long way to create the fiscal stability the oil and gas industry requires to invest in Alaska.

A fair tax on oil and gas that is fair at low prices and high prices, that is fair for marginal prospects robust prospects, that is fair for remote prospects as well as close-in prospects creates an investment climate that encourages explorers to test Alaska waters.

An annual budget that shows fiscal restraint and forethought about the future encourages business to invest because they are not concerned that they will be the ones called upon to supply the funds necessary to balance the budget now or in the future.

Examining those actions the state can take to encourage a large diameter gas pipeline may result in identifying certain steps that actually helps the pipeline move forward.

Getting existing development back on track encourages a business climate where industry can once again believe in fair treatment in the regulatory process.

Understanding the difference between meeting Alaska’s energy needs with “Alaska’s Gas” and meeting Alaska’s energy needs with the most economic energy alternative, for the short-term and the long-term is essential prior to making major funding decisions regarding energy projects.

Understanding and encouraging exploration to capture Alaska’s reserves potential while basing budgets on known resources is essential to sound decision-making.

Understanding that the Permanent Fund must play some part in the future of Alaska, more than just paying Permanent Fund dividends, is essential in developing a viable long-term financial plan.

The State’s obligation is to create a fiscal environment whereby business is secure and willing to take the investment risk necessary to succeed. It’s time to create that fiscal environment.

The above list is long and many complex issues are included, but it is one that can be accomplished. It’s time to get started. It is time to establish a plan. It’s time to lead. My hope is that the governor and the newly elected legislature are up to the task.

Consider the Candidate

My son made an interesting comment to me this morning after watching a few minutes of TV. He said, “I wish they would outlaw negative campaigning so that we could understand the views of the candidates.” His comment is important to remember. When we vote tomorrow, we should try to ignore all the negative campaigning that has occurred and try to remember what we know about the candidate.

 Are they people of integrity; are they people we can trust?

Are they respected by their contemporaries? Will others respect and listen to them if they are elected?

What about their positions; have they held them a long time? Can they express them in a way that will influence others to agree with them? Will they make a difference if they are elected; is the difference they are going to make one that we want?

Consider what you know about the candidate as you go to the polls tomorrow, not merely what others have said about them. Vote for someone you think might do the best job, not against someone based on what others have said about them.

NPRA Oil and Gas Reserves History

It might be helpful to understand the current USGS NPRA oil potential predictions in context. Below are some historical projections made by the USGS.

1.9 BBO      USGS 1976

2.1 BBO      USGS 1980

1.48 BBO    December 31, 2000 (EIA, 2001)

9.3 BBO      USGS 2002 NPRA Only

10.6 BBO    USGS 2002 NPRA Entire Area

10.4 BBO    June 30, 2005 (Bird, et al 2005 and AOGCC, 2005)

0.896 BBO  2010 Updated USGS Assessment of the NPRA

What is apparent from the above is that the current 2010 projections are only slightly less than the projections in 2000. The big change came in 2002 when the USGS increased the potential reserves almost 10 fold. The question one might want to ask is what happened between 2000 and 2002 to allow the USGS to increase reserves of the entire NPRA to such a great extent. The assumptions the USGS made in 2002 turned out to be wrong. They have now scaled back to the projections they made in 2000.

The USGS continues to be optimistic on gas. Below are the historical projections made by the USGS on gas. Please note the substantial change in reserves potential predicted in 2002.

6.3 tcf      USGS 1976

8.5 tcf      USGS 1980

59.7 tcf    USGS 2002 NPRA Only

61.4 tcf    USGS 2002 NPRA Entire Area

52.8 tcf    USGS 2010 NPRA

The USGS may be right about the potential for gas reserves in NPRA because there has been very little exploration for gas in the basin, but we will not find out if they are correct about their projections unless there is a major gas pipeline from the north slope to market the gas. No exploration company will explore for gas without the reasonable likelihood of getting that gas to market.

Repost - Resource Potential of the Alaska North Slope

The USGS recently published a 2010 Updated Assessment of Undiscovered Oil and gas Resources of the National Petroleum Reserve in Alaska (NPRA). The report can be found at http://pubs.usgs.gov/fs/2010/3102/pdf/FS10-3102.pdf


In that report the USGS downgraded the oil resource potential of NPRA from 10.560 billion barrels of oil to 0.896 billion barrels of oil. The new total is only about 10 percent of the total oil estimated in their 2002 assessment.  They also slightly downgraded the gas potential of NPRA from 61.352 trillion cubic feet of gas to 52.839 trillion cubic feet of gas.

Earlier this year I wrote an article regarding the resource potential of Alaska’s North Slope. I am reposting it here. What I attempted to show in that article and is apparent from the recent USGS revision is that “optimistic assumptions” about Alaska’s resource potential are exactly that – optimistic assumptions. Present budgets and future budget projections should not be based on the hope that large discoveries of oil and gas will be made in Alaska in the future.

In my next article I will discuss Alaska’s long term outlook in light of the USGS revised projections. I will also discuss some potential options Alaska should consider based on a range of outcomes that may occur in order to protect itself into the future.

Repost - Resource Potential of the Alaska North Slope

The Department of Energy, National Energy Technology Laboratory published a report titled “Alaska North Slope Oil and Gas A Promising Future or an Area in Decline in August 2007. The NETL recently published an Addendum to the Report. The report has often been quoted and used as a basis for projections of future oil and gas potential of Alaska’s North Slope.

The report is helpful in evaluating the prospectivity of certain areas of the North Slope as compared with other areas. For example, onshore state lands between the Colville and the Canning rivers and State Beaufort Sea, (basically all state lands on the North Slope) represent only ten percent (10%) of the future economically recoverable oil potential on the North Slope. Ninety percent (90%) of all future economically recoverable oil potential will be discovered on lands not owned by the state: twenty-one percent (21%) will be discovered in NPRA where the state will receive a production tax but no royalty; forty-seven percent (47%) will be discovered on the federal OCS lands where the state receives no royalty or production tax; and twenty-two percent (22%) will be discovered in ANWR where it is unknown what the state’s revenue percentage will be.

The state fares slightly better in the future economically recoverable gas potential. State onshore lands between the Colville and the Canning rivers and State Beaufort Sea represents almost twenty-five percent (25%) of all future economically recoverable gas potential on the North Slope. Seventy-five percent (75%) of all future economically recoverable gas potential will be discovered on lands not owned by the state: Twenty-two percent (22%) will be discovered in NPRA where the state will receive a production tax but no royalty; fifty-one percent (51%) will be discovered on federal OCS lands where the state receives no royalty or production tax; and a small percentage of gas may be found in ANWR where it is unknown what the state’s revenue percentage will be.

While the relative prospectivity of each area may be important to understand, the reality of what may be found in each area will be quite different. The NETL has modeled the potential for each area, not what they project will be discovered in each area. Figure 3-55 on page 3-107 of the report illustrates the production forecast for oil if the NETL’s “optimistic assumptions” (their term) are accurate. What the chart shows is current production will remain relatively flat for the next 10 years followed by a substantial increase in production until production peaks in 2042 at 3,000,000 barrels per day. This would mean the current oil pipeline would be at peak capacity and the state would have built a second pipeline to accommodate the additional production. This is based on NETL’s projection of the discovery of 35 to 36 billion barrels of oil. Obviously there is a very low chance of this occurring.

Figure 3-56 on page 3-108 of the report illustrates the production forecast for gas if NETL's "optimistic assumptions" are accurate. These optimistic assumptions of the discovery of 137 tcf of gas would have the state producing 11 bcf of gas per day by 2032 which would require all expansions by compression of the proposed 4.5 bcf per day gas pipline and then looping of that line. This too is a virtual pipe dream.

Many believe that the 137 tcf referred to in the NETL report will be discovered and produced over the next 50 years. In fact, they believe the potential is much greater. The only way to ground that belief in reality is to examine what they must also believe about the oil potential that was referred to in the same report. If they believe the 137 tcf will be produced, then they must also believe the 35-36 billion barrels of oil will be produced and that the existing TAPS pipeline will once again be at full capacity and an additional oil pipeline will be build to transport the surplus oil that has been discovered. The absurdity of such a position becomes apparent once it is understood in context.


Hopefully the above perspective will bring a bit of reality and understanding to the discussion of the oil and gas potential on the North Slope. The state should be an advocate for the oil and gas potential on the North Slope, but it should base its economic and business decisions on a more realistic analysis of North Slope potential. It is one thing to dream about winning the lottery, it is another thing to base your current business decisions on that assumption.

The August 2007 Report is located at http://www.netl.doe.gov/technologies/oil-gas/publications/EPreports/ANSFullReportFinalAugust2007.pdf



The April 2009 Addendum Report is located at http://www.netl.doe.gov/technologies/oil-gas/publications/AEO/ANS_Potential.pdf



If the above reference doesn’t work, the April 2009 Addendum Report can be accessed from the following page. http://www.netl.doe.gov/technologies/oil-gas/AEO/main.html

Security Guards Need Education on Private Rights

The basic rule for public or quasi-public gatherings is that any member of the public has a right to attend the meeting so long as they conduct themselves in a manner expected of all members of the public in that situation.

For example, in the Miller forum conducted at Central Middle School in Anchorage members of the public were expected to come and listen to Joe Miller speak about his candidacy for Senate. They were also expected to ask questions during and after the event. So long as a newspaper reporter stayed within those boundaries, he could not be considered as trespassing on the event.

If the reporter had tried to take the stage and speak to the audience, he could have been asked to leave. If the reporter had forcibly blocked an entrance preventing people from leaving the building, he could have been asked to move. But attempting to ask a candidate a question the candidate does not wish to answer does not violate any law nor does it give the security guard the right to handcuff the reporter, even if the reporter’s persistence is irritating.

The mere renting of a facility does not give the renter an absolute right to eject a person from the facility as a trespasser just because the person does not agree with or irritates your boss. The security guard misunderstood his rights under the law when he announced to the reporter that the campaign had rented the school, and they had the right to exclude anyone. Rental of the facility gives you certain rights and obligations under the rental contract between you and the owner of the facility. Your obligation to the public that attends the meeting is different from your rights under the rental contract. Your obligation to the public is not dictated by your rental contract and your rental contract cannot withdraw rights from the public that they would otherwise have.

Your rights and obligations to the public are dictated by your invitation. Miller could have sent out invitations to specific individuals to attend his meeting. Only those receiving invitations would be allowed to attend. All others would be trespassers and could be asked to leave. But that is not what happened here.

The campaign through its invitation granted the public the right to attend and participate. The invitation and the methods of announcing the event clearly did not intend to only invite a specific group of individuals. In fact, I assume the more people that attended the event, the happier the campaign would be.

The campaign invited the public to come listen to Joe Miller and ask questions. And to the extent the campaign invited the public to attend, they must treat all members of the public equally, even those that may disagree with the campaign, even reporters.

To do otherwise would illegally tread on individual constitutional rights, rights which I am sure Joe Miller understands.

Equal Time for Parnell

Some have complained that I only write about Ethan Berkowitz, but actually, I write about what I hear or read in the press. Recently, I finally got a chance to listen to a soundbyte from Governor Parnell thanks to a posting from the Fairbanks Daily News-Miner. If your are interested in watching the soundbyte go to:

http://www.youtube.com/watch?v=wLkf1TJxhH4&feature=player_embedded#!

In the video Governor Parnell defends his position on the Alaska Natural Gas Pipeline and the need to continue to support the $500 million reimbursement to TransCanada and ExxonMobil by citing the benefits of AGIA. The problem is that most of his justifications are either wrong or are of little value.

The method I have used in the article is to quote the governor and then provide my analysis and response, and where appropriate I have also provided the subject law or regulation.


It assures that there are 5 offtakes for gas for Alaska communities. – Governor Parnell

This is his first justification for supporting the $500 million.

Offtakes will occur where they are economic, not based on a demand by the state. As I stated in a previous article regarding the benefits of AGIA, or lack thereof, the only reason the Palin administration demanded 5 offtakes was because the Murkowski administration required 4. Offtakes will occur wherever the demand is sufficient to pay for the facilities necessary at the offtake site to provide access to the gas. Offtakes are about economics, not about meaningless demands. The state could have demanded 10 offtakes sites and the pipeline company would have agreed because the basis for the offtake site was that it would be paid for entirely by the entity taking the gas.

The real answer to the offtake issue is that all compressor stations should be designed to allow for offtake of gas.

My evaluation of this justification. – It’s not wrong, it’s just not important and certainly doesn’t justify giving a pipeline project $500 million.

AGIA must have #12 at AS 43.90.130(12) is reprinted here for your convenience.

(12) commit to provide a minimum of five delivery points of natural gas in this state;


It ensures that tariffs, instate tariffs for gas delivered to Alaska communities are measured by distance sensitive rates, meaning we are only going to pay for mileage for that gas from Prudhoe to Fairbanks for Fairbanks gas. We are not going to pay for mileage from Prudhoe to Chicago and back to Fairbanks which is what the producers could do if Alaska didn’t have that kind of protection. – Governor Parnell

Governor Parnell states that without the protection of AGIA the producers could charge Alaskans a tariff that included the cost of transporting the gas from Prudhoe to Chicago and back to Fairbanks. This simply isn’t true. It wasn’t true when AGIA was passed, and it is not true now. Surprisingly, AGIA even cites the federal law that would prohibit what the governor says could happen. So the Governor must know his statement is untrue and that protecting distance based tariffs is not a reasonable justification for providing TransCanada and ExxonMobil $500 reimbursement for moving the project forward.

My evaluation of this justification. – It’s wrong and doesn’t justify giving a pipeline project $500 million.

AGIA must have #13 at AS 43.90.130(13) is reprinted here for your convenience.

(13) commit to
    (A) offer firm transportation service to delivery points in this state as part of the tariff regardless of whether any shippers bid successfully in a binding open season for firm transportation service to delivery points in this state, and commit to offer distance-sensitive rates to delivery points in this state consistent with 18 C.F.R. 157.34(c)(8); and
    (B) offer distance-sensitive rates to delivery points in the state consistent with 18 C.F.R. 157.34(c)(8);

18 C.F.R. 157.34(c)(8) is reprinted here for your convenience

    (8) Based on the In-State Study and the delivery points within the State of Alaska identified in paragraph (c)(1) of this section, there must be an estimated transportation rate for such deliveries, based on the amount of in-state needs shown in the study. Such estimated transportation rate must be based on the costs to make such in-state deliveries and shall not include costs to make deliveries outside the State of Alaska;


It assures access to that pipeline on favorable rates for future explorers so that the producers don’t control the pipeline but there is possibilities for more abundant cheaper gas from other areas. – Governor Parnell

This is the state’s “rolled-in” rates argument which I have written about previously. The governor’s argument here is accurate. AGIA does require that the pipeline company advocate for “rolled-in” rates, but that does not mean that this position is in the best interest of the state.  There is no argument from either pipeline proposal or the shippers that the first expansions by compression will be through “rolled-in” rates. So, as a practical matter, the demand by the state that the pipeline company propose “rolled-in” rates is unnecessary because it is in the pipeline company’s interest and the shippers interest, and the FERC will probably require it. The real debate is over expansions by “looping,” building a second parallel pipe beside the first in order to expand that segment of the pipeline. I have written about this in other articles, but the effect of requiring the pipeline company to propose “rolled-in” rates under these circumstances will probably result in the state arguing for a reduced tariff for the owners of gas found in offshore federal waters where the state receives no royalty or taxes, the reduced tariff to be paid for by existing shippers already shipping gas in the pipeline, including in-state shippers. The result will be an incremental increase in the price of gas in Alaska to be paid for by Alaskans to benefit a gas owner that will pay no royalty or taxes to the state, clearly the wrong position.

My evaluation of this justification. – This argument I would rate as accurate but either not important or slightly detrimental to the state depending on which expansion the governor is referring to. But you certainly wouldn’t pay $500 million for a pipeline company to hold a position that is either not valuable to the state or possibly could hurt the state’s interests in the future.

AGIA must have #7 at AS 43.90.130(7) is reprinted here, in part, for your convenience.

(7) commit that the applicant
    (A) will propose and support the recovery of mainline capacity expansion costs, including fuel costs, from all mainline system users through rolled-in rates as provided in (B) and (C) of this paragraph or through a combination of incremental and rolled-in rates as provided in (D) of this paragraph;


That $500 million dollars is protection for Alaskans in a deal that gets negotiated between multinational corporations. I think that’s a fair price to pay to assure that Alaska interests are protected. – Governor Parnell

I am not sure what the Governor is arguing here, but I think he is arguing that the $500 million is justified to protect Alaska’s AGIA requirements. As I stated above and in a previous article on AGIA, the $500 million was an incentive to encourage a pipeline company to do what no rational pipeline company would do, to move forward to filing for a FERC certificate after a failed open season. The only way to get a pipeline company to do this was to pay for the vast majority of the costs of doing so.

Maintaining the obligation to pay the $500 million may be the right answer, but it is not for the reasons stated by the governor. Justifying the commitment of $500 million to the project should be based on whether it helps move the project forward. Does it encourage the major players BP, ConocoPhillips, TransCanada and ExxonMobil to resolve their differences and move a single project forward or does it continue to provide one of the bases of dissention between the parties? Currently the “20 must-haves” of AGIA are one of the bases of disagreement between the parties. BP and ConocoPhillips do not agree with the requirements of AGIA. TransCanada has agreed by contract to meet the requirements of AGIA, but TransCanada’s partner, ExxonMobil has not agreed to those requirements. Currently AGIA stands in the way of the major parties to the pipeline in resolving their differences. Someday it may be time to abandon the requirements of AGIA, but the state may want to consider maintaining its commitment of $500 million to the project, but only if it can be used as a tool in the negotiations to bring the parties together and move the project forward, not as a burden that stands in their way.

Natural Gas Pipeline Options

The gubernatorial candidates have been debating alternatives for a natural gas pipeline and which alternative makes more sense. Berkowitz is a staunch supporter of the state building a natural gas pipeline, I assume to Valdez, while Parnell is a supporter of staying the course and supporting AGIA. This article will provide some clarification regarding the passage of AGIA and make some recommendations on the proper path forward, or at least which path not to follow.

First, AGIA was not about the administration getting rolled as Berkowitz says in his ad. Governor Palin, Lt. Governor Parnell at the time, and 59 out of 60 legislators did not get rolled by the pipeline companies, especially Exxon. At the time Exxon was arguing against AGIA. AGIA was about rolling Exxon and the other producers. It was about bribery to get a pipeline company to, as Commissioner Galvin put it, do things they would not otherwise do. The state, through AGIA, made a requirement that the pipeline company, regardless of the results of open season, push the project forward through filing a FERC certificate. As an incentive the state would reimburse the project for up to $500 million. The percent of reimbursement after open season would be 90%. The reason for the 90% was because no rational pipeline company would move forward past open season unless the open season was successful. I assume the AGIA proponents expected the open season to fail; so they made sure the pipeline company had the incentive to move the project forward anyway.

So even though Ethan Berkowitz attempted to rewrite history in his ad and failed, we should still ask if he has a valid point regarding the state building a pipeline to Valdez or other port?

Actually, if his proposal was the right answer, and the all-Alaska option is really a viable economic option, the shippers will have bid at the Trans-Canada open season. Trans-Canada provided all shippers with the option to bid their gas to Valdez. The Trans-Canada option would also have the added benefit of a private company or companies funding and taking the risk on the project.

The only way it makes sense for the state to build the pipeline is if Trans-Canada’s open season failed. Denali’s open season would also have to have failed as well. That means that the shippers of the gas believe the project to Valdez and the project through Canada are both uneconomic. Based on this assumption let's look at the state owned and funded all-Alaska project.

Does Ethan Berkowitz propose the state retrace the same ground the pipeline companies have gone over so far? Does he propose the state appropriate the funds to bring the project to open season? Since the economics of the pipeline project haven’t changed, the pipeline costs the same to build, the owners of the gas are the same, the risks of shipping are the same, wouldn’t Ethan Berkowitz expect the same result to occur at the open season? Only two years from now? Perhaps he proposes the state not hold an open season. Who needs shippers to commit to the pipeline anyway? Maybe the state will just build the $20 to $30 billion pipeline to Valdez. Surely the gas owners will ship their gas on an existing pipeline? And if they don’t, we will sue them and take away their gas. Sounds logical enough ---- except that it is short-sighted and extremely shallow thinking.

If the state does not hold an open season and builds the pipeline without contracts, the shippers will have no contractual obligation to ship the gas. They will only have the reasonably prudent operator standard/obligation under their leases.

A reasonably prudent operator will ship gas when it can make money selling the gas and a reasonably prudent operator will leave the gas in the ground when it is not profitable to ship it.

Lets assume it cost $4 to ship the gas to the point of delivery. It may cost much more if the state is the builder of the pipeline, but lets assume the state was an efficient designer and builder of the pipeline, tankers, and all facilities to get the gas to market. Any time the gas owner can ship the gas for more than $4, they may agree to ship their gas on the state’s pipeline. Any time the price of gas is less than $4, the shippers will leave their gas in the ground and no one will ship gas on Alaska’s pipeline. The state will have taken 100% of the risk of building the pipe and 100% of the shipping risk. Eventually this will backfire on the state because sometime in the future the price of gas will go below the cost of shipping the gas and the state will eat the cost of staffing and owning an empty pipe, not to mention the other facilities required to get the gas to market.

The problem with Ethan Berkowitz’s pipeline proposal is that it sounds good and may get the votes of those who haven’t done their research or seriously considered the ramifications of his idea, but the proposal is not well thought out. He has not considered the viability of his proposal or the risk he is forcing on the state. If you don’t agree with me then help me answer just a few of the questions I have proffered above. How does Ethan Berkowitz propose to fill the pipe? Does he plan to hold an open season? Does he plan to commit the state’s gas to the state’s pipeline? How about the other facilities required to get the gas to market? Who will take the risk of building those facilities without shipping contracts?  How does he plan to fund such an expensive pipe? Please don’t tell me through PFD checks. I have already written another article about the viability of that proposal.

To answer the above questions you can’t guess. You must find the answers in the documentation Ethan Berkowitz has created or in a speech he has given. If you cannot find the answers, then Ethan Berkowitz’s proposal is shallow and not well thought out. If you find the answer, please provide them to me. I will be glad to analyze them and let you know if they are viable. Campaign soundbytes can only get you so far. Eventually someone is going to ask for meat on the bones of your proposal. I'll be waiting.

Clarification on the MidAmerican Deal

A recent article stated that the Berkowitz campaign says that the MidAmerican deal looked like a project that was going forward, until the Murkowski administration changed the terms and it fell apart.

In reality the MidAmerican deal fell apart because MidAmerican demanded it be granted the exclusive right for five years to develop the pipeline without any commitment to move forward with the project. This would have stopped negotiations with all other parties proposing projects under the terms of the Stranded Gas Development Act. The state was not willing to accede to MidAmerican’s demands; so MidAmerican withdrew its proposal.

The information provided in this clarification was obtained from an article written by Gianna Trinca, KTUU-TV, Updated 12:00 a.m. ET March 26, 2004

State Ownership of the Pipeline

The most important thing the state can do to encourage a pipeline is get its fiscal house in order. The gas shippers are primarily concerned with fiscal certainty and fiscal stability. They want to know what they are required to pay and they want to know that they can depend on that decision for many years to come. They also want the payment, i.e., the tax, to be fair.

There are other secondary issues that, if understood and approached properly, can increase the likelihood of a natural gas pipeline. One of those is state participation in the pipeline. State participation in the gas pipeline can take two forms: one as an owner of the pipe and one as a shipper of royalty gas. Both have potential positive benefits to the state and to the overall success of the pipeline and both carry an increment of risk associated with deciding to participate.

State Ownership of the Pipeline

If the state decides to participate as an owner of the pipeline, it can bring certain valuable benefits to the ownership team. If it participates as an owner, it can advocate its interests in front of regulatory bodies and Congress in ways and with credibility that the oil companies and pipeline companies do not have.

The state as owner could shoulder its proportionate share of the risks involved in the development of the pipeline. But the value here is only achieved if the other pipeline owners know and agree to the ownership interest of the state prior to construction (and preferably sooner). The state does not increase the likelihood of success of the pipeline if it attempts to purchase an interest in the pipeline after the risk has been taken and the pipeline has been completed. The later the state waits in the process to obtain an interest in the pipeline the less value it brings to the table and the less interested the pipeline owners will be in allowing the state a participatory interest in the pipeline.

Of course, the reason the state would bring value to the pipeline by taking an ownership interest in the pipe is because it is taking the same risk through planning and construction of the pipeline as the other owners of the pipe. This is not an insignificant risk and the state should not take the risk lightly. If the state elects to negotiate a participatory interest in the pipeline, it must have a sound financial plan in place that includes how it is going to manage project failure, cost-overruns, and project delays, to name a few issues. The state must approach participation as a business decision with a sound business plan. Otherwise it should stay out of this private sector project.

Public ownership of the pipe brings no financial benefit to the state's analysis of participation in the pipeline. Financially public ownership of the pipe is more of a burden to be managed than a benefit to be encouraged. There are other reasons, primarily political, to offer pipeline ownership to the public, but those reasons do not meet any type of straight faced economic analysis. The small amounts of money the public would bring to the table and the large number of owners required to make any significant contribution would add an administrative burden to the project that far outweighted the financial benefit the public owners would bring to the table. I will discuss the benefits of public ownership later in this article, but it is important to remember that public ownership could be valuable, but that value is not financial. It is not because of the small amount of money they would bring to the table.

If the state were to own a participatory interest in the pipeline, the state would be at the table with the other owners of the pipeline. It would be able to protect the state’s interest in decision-making. Every owner of the pipeline will vote its interest in the pipeline to benefit it individual corporate interest. The state would have a better chance of protecting the interest of the people of the State of Alaska if it was at the table to argue those interests to the other owners. For example, when the state was negotiating a participation agreement in the first pipeline negotiations, the owners were considering an 80/20 debt equity ratio for funding and financing the pipeline instead of the debt equity ratios proposed by either of the current pipeline proposals now moving forward. This could have resulted in a lower tariff for gas and lower overall costs to Alaskans. If the state were an owner of the pipeline, we might have seen better tariff terms proposed by the pipeline.

There is at least an argument that if the state owned a portion of the pipeline, the legislature would be less likely to pass punitive legislation against its own interests. The pipeline company might get a fairer review by the legislature before the legislature passed legislation affecting the pipeline.

State Ownership of the Gas

The state owns its royalty share of the gas, something more than 12.5% of the gas depending on which units participate in bringing their gas to market. The state has a right to allow the owners of the gas to transport and sell the state’s share of the gas or the state can elect to take its share of its gas “in kind” which means the state can elect to take its royalty share of the gas, pay for its transportation, and sell its gas instead of having the gas owners sell the state’s gas for the state.

If the state took its royalty gas in kind, the likelihood of litigation over gas value would be substantially diminished even though there are now regulations in place that substantially reduce the likelihood of litigation regarding gas valuation of the state's gas. If the state were to sell its own gas the issue of the value the state should receive for owner sales of state's gas would go away.

Assuming the two current open seasons fail and a new open season occurs from a consolidated pipeline group, if the state elected to take its gas in kind and bid its gas at the open season, the state would be in the same risk position as the other shippers. And even though the state has argued that the risk on the shippers is not that great, I am sure the state will not elect to take its gas in kind prior to completion of the pipeline. If the state has the right to take its gas in kind prior to construction and bid its gas at the open season or sometime after the completion of construction, it does not make sense for the state to take the construction risks that are placed on the shippers through bidding at the open season and eventually leading to shipping contracts that will allow the project to move forward to construction. The state is much better off allowing the upstream gas owners to take the shipper risk prior to construction and if the state decides it wants to take its gas in kind, wait until sometime in the future after the construction of the pipeline when it knows the tariff costs and knows that the pipeline is a viable project.

ON THE OTHER HAND, if the state really wants to increase the likelihood of a pipeline getting built, it should take its gas in kind, show up at the next open season, shoulder its proportionate share of the risk with the other gas owners and commit to ship its gas on the pipeline.

Form of State Ownership

What would state ownership look like?

First, state ownership of the pipeline is not a right the state has, unless the state wants to be the owner and builder of its own pipeline. If the state wants to participate in the ownership of either of the two existing pipeline projects or in the ownership of a future consolidated group of the two pipelines, then the state must convince the other owners that the state would add value to the success of the pipeline. The other owners must see state participation as more benefit than negative and worth the hassle to allow state participation in the project.

If the pipeline companies allowed the state to participate, the pipeline companies would be looking for certain things in the creation of the state entity that would hold the ownership interest of the state in the pipeline.

The pipeline companies have certain requirements for providing information to the public and the state and federal regulatory agencies. All other information is private and kept confidential. This isn’t because they are doing something bad or illegal, it is just the way they do business from a competitive standpoint. They do not like to reveal to the public, the regulatory bodies, or their competitors anything they are not required to reveal. The state entity would have to abide by the same corporate policies regarding what is public and what is kept private. The state entity would have to be insulated from influence from the governor, the legislature, or other political or public groups. The state entity employees would be bound by the same confidentiality obligations as the employees of the other owner pipeline companies. A corporation would be the likely form the state entity would take.

The other pipeline owners would have to be assured that the state would pay its proportionate share of all costs and take all the same risks as the other corporate owners of the pipeline. The owners would have to be assured that the legislature could not hold the pipeline hostage through the appropriation process.

The other pipeline owners would have to be assured that the state would not vote against its own financial interests by attempting to influence the pipeline, through the state’s vote, to take a position that may be in the interest of some in the state, political or otherwise, but is not in the state’s economic interests regarding a successful pipeline.

In essence, the other pipeline owners would be looking for the state to create an entity that looks and acts like a private corporation without influence from the public, the governor or the legislature. And the other pipeline owners would have to be assured that the legislature would not change the state entity at some future date. The other pipeline owners might require the state entity to grant the other owners the right to purchase the state’s interest in the pipeline if the legislature attempted to change the entity. The purchase may even need to be with some penalty to the state it make sure some future legislature does not attempt to meddle in the state entity’s business in the future.

If the state is not willing to agree to the above criteria, I recommend the state not consider state participation in the pipeline because the pipeline owners will probably not consider granting the state the opportunity to own an interest in the pipeline.

Public Ownership of the Pipeline

Public ownership of the pipeline can only come through ownership in the state entity created for that purpose.

If set up properly, the state could offer ownership shares of the pipeline to the people of Alaska. This would help the people of Alaska feel like they had a stake in the pipeline. It would also add additional protection against adverse legislative action against the pipeline. If there were a substantial number of Alaskans or a number of influential Alaskans that had an ownership share of the pipeline, the legislature would more thoroughly consider any legislation potentially adverse to the interests of the pipeline company.

The other owners of the pipeline would probably not see public ownership of the pipeline as a negative so long as the public was limited to buying non-voting, non-participatory shares and public ownership did not place any additional burdens or obligations on the other owners of the pipeline. The public owners could also not have any additional rights to influence the decisions of the corporation or be given access to information that was not already available to other members of the public. Anything different from this and the other owners of the pipeline would probably not consider allowing the state to participate in the ownership of the pipeline with them.

Conclusion

The above is just a shapshot analysis of some of the issues that must be addressed if state ownership of a pipeline is considered. state ownership, in and of itself, will not increase the likelihood of a pipeline. In fact there are other issues that are more important to the success of a natural gas pipeline that need to be addressed by the legislature. But if state ownership is considered, the form that ownership should take is one that looks more like a private corporation than a public entity if the state wants it to be effective in increasing the likelihood of success of the pipeline.

Political Posturing

The Parnell and Berkowitz campaigns recently traded barbs regarding the plan Ethan Berkowitz put forward to allow individual Alaskans to own a piece of the pipe through a dividend check-off program. Although the debate was interesting from a political posturing standpoint, substantive debate on the issues was not advanced by their exchange.

The Proposal

Ethan Berkowitz advanced the idea that Alaskan’s should own a piece of the pipe through a dividend check-off program. The implication was that all Alaskans would have a right to participate and that 20% of them probably would elect to participate. The impression was also given that the 20% participation would be from a cross-section of Alaskans. Diane Benson, the lieutenant governor candidate, added weight to that impression by stating that she would have been excited to have had an opportunity like this when she was a young mother of limited means. The intent of the campaign was to appeal to all Alaskans. This may have been a good political sound-byte, but it had problems its application to reality.

The truth is the average Alaskan could not afford to give up their dividend to invest it in a pipeline. Only those Alaskans with surplus spendable income would be able to participate in the project and only a small percentage of them would participate after they found out how long it would take for them to begin to receive a return on their investment. An optimist might suggest that 20% of Alaskans could afford to participate in the program and maybe 20% of those eligible would elect to do so. That would mean an optimistic estimate of 5% of Alaskans would participate, and I am not an optimist; so I believe the number would be much smaller.

The Parnell Campaign Response

The Parnell campaign then decided to assume the Berkowitz plan was accurate, crunched the numbers using a report produced by Scott Goldsmith and argued that the own a piece of the pipe proposal would cost the state 2,000 jobs. The reasoning was that if investing the PFD in the economy created 10,000 jobs, taking 20% of that investment out of the economy would cost the economy 20% of the jobs created; thus the state would lose 2,000 jobs through the own a piece of the pipe proposal.

The Parnell campaign knew as well as anyone that a cross-section of Alaskans would not participate in the own a piece of the pipe dividend check-off. They knew that the average Alaskan could not afford to participate in the program and that the impact of the program would be much smaller that what they projected. But instead of arguing the truth, that the program would not be effective, they decided to “believe” what Berkowitz proposed and argue that the program was bad because it was going to cost Alaskans jobs. They went for the sound-byte instead of the truth. Then to add insult to injury, when they were caught at assuming bad numbers, their response was effectively, “that was my response and I am sticking to it.”

Berkwitz Response

Not to be outdone by the Parnell campaign’s poor judgment, the Berkowitz campaign accused the Parnell campaign of playing political games. The only thing that came to mind at this point is the old saying about the pot calling the kettle black. The Berkowitz campaign, apparently forgetting what they initially suggested in their initial rollout of the proposal, now argued that the Berkowitz campaign can’t control what people will do with their dividends and that they won’t control what people are doing under the plan, apparently supporting what Goldsmith had said about the impact of the plan not being the potential loss of 2,000 jobs. I assume they now believe that 20% of Alaskans won't participate in the dividend check-off proposal.

The Result

Both campaigns have soiled their reputations by their responses to each other. Hopefully this is not a sign of what is to come in this election.

Pipeline Ownership

The Berkowitz campaign has stated that individual ownership through the dividend check-off proposal will enhance the likelihood of success of getting a pipeline. The Parnell campaign believes that staying the course through AGIA provides the state with the greatest likelihood of getting a pipeline.

A substantial amout of research and analysis was done during the Murkowski administration regarding providing Alaskans the opportunity to own a piece of the pipe and regarding the importance and value of state ownership of the pipeline despite the Berkowitz campaign argument that they are the first.

In a future article I will discuss state ownership of the pipeline, what is required if the state wants to participate and the timing of that participation. I guarantee it won’t be what either campaign is recommending.

Berkowitz Revenue Proposal Analysis

The 100% Royalty Solution


Ethan Berkowitz has proposed a new approach for the State of Alaska to use for collecting oil revenue through its two main sources: royalty and taxes. What follows is a quote from his web page.

“The debate about Alaska’s oil and gas revenues has been too much about short-term gain and not enough about long-term interests. The result is a system that fails to optimize outcomes for either the state or industry. Alaska can do better – we can have a system that reduces development risk, increases production and jobs, gives Alaska a fair share of the revenues, enforces budget discipline in Juneau, strengthens the Permanent Fund, and takes the politics out of the state's relationship with the oil industry. Doing better, however, requires a new approach.” – Ethan Berkowitz



I like the goals he has set for the new system, but how does his proposal stack up against reality?

Ethan Berkowitz states that a 100% royalty solution provides fiscal certainty for the oil and gas industry. The industry has been looking for a way to lock in the state’s share of production. This would lock in the state’s share for the term of the contract, as long as 40 to 50 years. This would seem to provide the oil and gas industry with what it is looking for.

But the first problem with a 40 to 50 year lock on the state’s share is that the state has not been able to predict a reasonable tax structure for more than about 15 years. After about 15 years, unforeseen problems with the tax structure begin to show up. The economic limit factor worked for about 15 years before the problems with disproportionate revenue sharing created a need to change the tax laws. ACES has only lasted a couple of years before signs of problems have begun to show up. Heavy oil development and exploration on state and federal lands where the state has the power to tax are both showing signs of being impacted by the tax. If the state agrees to a fixed royalty system for the life of the leases, which could be 40 to 50 years, the system is sure to fail. Oil and gas prices are too volitile. A fixed 100% royalty solution will only work for a narrow range of oil and gas prices. When oil prices are low, the industry will be paying too much revenue to the state and when oil prices are high, Alaskans will believe they are not getting their fair share. That is why progressivity was added to the tax so that the revenue paid to the state by the producers could more closely match the revenue stream: lower taxes during times of lower prices and higher taxes during times of higher prices.

There can be debates about the rate of progressivity, but the intent of progressivity was to more closely match a fair split of the revenue stream between the producers and the state at low and high oil and gas prices.

In addition the only way a 100% royalty solution would work is for the state to pass an amendment to the constitution prohibiting oil and gas production from being taxed. Otherwise there would be no certainty for the oil and gas industry. If a constitutional amendment was not passed, the royalty would be fixed as it is in the current leases and the state could still impose a tax on the revenue if the state determined some day in the future it was not getting its fair share. Thus the industry’s fiscal certainty that it got through signing the 100% royalty leases would be lost anytime the next legislature wanted to pass a tax.

Passing a constitutional amendment prohibiting the state from taxing the oil and gas revenue would create its own problems. The state gets royalty and tax revenue from state lands but it only gets tax revenue from NPRA; so a 100% royalty solution would mean that the state would give up any revenue it might receive from production in the NPRA. I don’t think this was Ethan Berkowitz’s intention. I think he probably didn’t understand that the state doesn’t have the right to negotiate a royalty share from NPRA. And the state has neither the power to receive royalty or to tax the federal OCS.

As far as I can determine from the proposal, the state would negotiate royalty leases on existing production, presumably giving up something to get the industry to agree to the new contracts. The producers will not negotiate fixed long-term contracts to put them in a worse position than they already are. These 100% royalty only leases would then give the industry the fiscal certainty to explore new oil and gas prospects. Once again this sounds good until the proposal is applied to the facts.

According to the NETL Report, existing units on state lands have approximately 6 billion barrels of reserves left to produce. So the state would give up a certain amount of revenue on the 6 billion barrels left to produce to incentivize the oil and gas industry to explore for the additional 3 billion barrels of oil yet to be found on state lands. Existing units on state lands have approximately 34 trillion cubic feet of natural gas to produce. The state will also fix the royalty on the 34 trillion cubic feet of natural gas for the life of the leases as an incentive for the oil and gas industry to explore for and additional 30+ trillion cubic feet of natural gas on state lands. If the additional gas is discovered, those leases will also have fixed royalty rates for the life of the leases and pay no tax. The deal sounds more like giving up two in the hand for one in the bush than getting Alaska its fair share of the revenues.

In addition, in the NPRA the state does not have the right to collect royalty from the leases and only has the power to tax. So the state would be giving up the ability to tax all future oil and gas revenue from NPRA. According to the NETL Report, that would be an additional 6.5 billion barrels of oil and an additional 31 tcf of gas that the state would give up the right to tax.

Ethan Berkowitz could argue that the State of Alaska would only give up the right to tax oil and gas revenue on state lands and continue to tax the revenue on federal lands. This may sound like a good idea but it wouldn’t stand up to a challenge in the courts. The law would not allow the state to discriminate against owners of lease rights on federal lands by taxing them and not the owners of lease rights on state lands.

Ethan Berkowitz has recognized the need for changing circumstances in his proposal. He has proposed that all contracts should have reopener clauses. This would reduce the effect a fixed royalty would have on a fluctuating oil or gas price. When prices were low the unit owners would request a contract reopener and ask for a lower royalty. If the state determined that the royalty should be reduced, a contract amendment could be negotiated reducing the royalty rate. When prices were high the state could ask for a reopener…… but the industry wouldn’t agree. There is no incentive for a Unit owner to agree to pay a higher royalty unless it is getting something additional in return. The only way for the state to get a rate increase under that circumstance would be the take the Unit owners to court and argue that the new price of oil or gas was not contemplated when the original 100% royalty lease was negotiated. The industry would argue that of course the higher price was within the contemplation of the parties since the historical price of oil has been well over $100.

Ultimately reopeners will not work for oil and gas leases in the United States because the State does not have the right to nationalize the oil if they cannot come to an agreement with the Unit owners. Reopeners require both parties to have something to gain and something to lose for a reopener to be successful.

Alternatives that make sense

There does seem to be a problem with the current ACES tax system. The bellweathers for problems with the tax system are heavy oil production and exploration. Heavy oil production should see declines in production before all other production because it is the most expensive to produce. And exploration will see impacts because higher taxes changes project economics and requires larger potential field sizes to be worth spending the money to explore. Both heavy oil and exploration have shown signs of declining investment.

Based on this, it is probably time to reexamine the ACES tax system. Are tax credits sufficient incentive to change industry economics? Does the progressivity factor need to be reexamined? What about the base tax? Does it need to be adjusted downward? Wholesale change is probably not necessary, but a methodical approach to the problem is essential. New ideas and innovation are good but they need to be tested before they are proposed as a final solution to our problems.

Berkowitz Oil Revenue Proposal

Ethan Berkowitz has proposed a new approach for the State of Alaska to use for collecting oil revenue through its two main sources: royalty and taxes. What follows is a quote from his web page.

“The debate about Alaska’s oil and gas revenues has been too much about short-term gain and not enough about long-term interests. The result is a system that fails to optimize outcomes for either the state or industry. Alaska can do better – we can have a system that reduces development risk, increases production and jobs, gives Alaska a fair share of the revenues, enforces budget discipline in Juneau, strengthens the Permanent Fund, and takes the politics out of the state's relationship with the oil industry. Doing better, however, requires a new approach.” – Ethan Berkowitz

I like the goals he has set for the new system. My next article will address how effective his proposal is in accomplishing those goals.

Analysis of the Twenty "Must Haves" of AGIA

Overview

There was a substantial amount of importance placed on the twenty "must haves" during the debate on the Alaska Gasline Inducement Act (AGIA). The twenty “must haves” were the basis and reason for the State of Alaska being willing to provide the applicant with up to $500 million in reimbursement for a commitment to the twenty must haves and to move the project forward to applying for the FERC certificate of convenience and necessity. To quote one administration official, the must haves were required to force the applicant to do what they otherwise would not do.


When looked at individually many of the must haves didn’t seem that important or were completed the moment the RFA application was filed. For example, the very first must have required the applicant to submit their application by the filing deadline established by the commissioners. Not exactly, something to fall on your sword over. All contract RFA’s have a filing deadline, and if the applicant does not file by the deadline, their application will not be considered. It was unnecessary to put this item in statute. It merely beefed up the number or requirements without providing additional value to the state.

Other must haves seemed to have little in the way of substantive analysis as the basis for their inclusion. For example, must have number 12 required the applicant to commit to at least five delivery points. The only justification for five points seemed to be that the previous governor, Governor Murkowski, has proposed at least four.

A couple of commitments seemed to make up the core of why the administration needed the must haves and were willing to pay the applicant to make sure they occurred. Must have number 3 requiring the applicant to file for a certificate of public convenience and necessity by a date certain, and must have number 7 regarding rolled-in rates were at the top of the administration’s list. For the reasons listed below, I did not find either of these must haves compelling.

But even if none of the must haves hold any remaining value there may still be a reason to maintain the State’s financial obligation (the $500 million reimbursement) under AGIA.

TransCanada just completed its open season process and Denali is in the midst of its open season. Normally, at the conclusion of the open season process, if it is unsuccessful, the pipeline company will spend most of its energy attempting to determine what went wrong, then rewriting its plan to meet the needs and concerns of its shippers. It would then hold a new open season process in an attempt to have a successful open season. AGIA circumvents this process and requires the applicant to move forward to filing the FERC application even if it doesn’t have the shipping commitments to justify such action. TransCanada is willing to do so because the State of Alaska has agreed to reimburse the pipeline company for 90% of its costs up to $500 million.

As a practical matter this will allow TransCanada to continue to move the engineering and field work forward for at least a year while TransCanada, ExxonMobil, BP, and ConocoPhillips attempt to settle their differences and merge their efforts into a single pipeline proposal. So long as the State is willing to allow the parties to use the $500 million as a bargaining chip and is willing to waive those must haves that get in the way of the negotiations, then AGIA may still have some value left in it for at least another year.

The remainder of this article is a summary analysis of each of the twenty must haves and their remaining value to the State of Alaska.

For those interested in seeing the twenty must haves in context of the rest of the statute, please refer to the State of Alaska AGIA webpage reference below:
http://gasline.alaska.gov/Findings/Appendix%20B%20-%20AGIA%20Statute.pdf

Short Summary of the twenty "must haves"

1) Done. File the application by specified deadline.

2) Done. Provide a thorough description of proposed project.

3) Only remaining obligation is to file for a FERC certificate of public convenience and necessity by a date certain. TransCanada has proposed October 2012.

4) Done. N/A reference to Regulatory Commission of Alaska.

5) Ongoing obligation to assess market demand every two years.

6) Ongoing obligation to expand pipeline in reasonable engineering increments.

7) Ongoing obligation to commit to propose rolled-in rates.

8) Done. State how applicant plans to deal with gas treatment plant.

9) Done. Propose percentage and total dollar amount of reimbursement.

10) Ongoing commitment to propose capital structure of not less than 70% debt.

11) Done. Describe means of preventing and managing cost overruns.

12) Done. Commit to minimum of five delivery points.

13) Done. Commitment to offer distance sensitive rates and firm transportation service to delivery points in Alaska.

14) Done. Commit to establish local headquarters.

15) Ongoing local hire obligation.

16) Done. Waiver of right to appeal department license decisions.

17) Ongoing commitment to negotiate project labor agreements.

18) Done. Commitment that state reimbursement won’t go into rate base.

19) Done. Provide detailed description of applicant and all participating entities.

20) Done. Demonstrate readiness, financial and technical resources to build pipeline.



Analysis of AS 43.90.130 – the twenty "must haves"

The 20 “must haves” of the Alaska Gasline Inducement Act are found in Alaska Statutes Section 43.90.130. Application Requirements. Section 130 requires the application for a license must meet certain criteria – the twenty must haves. Some are timing obligations, some are information requirements that must be submitted as a part of the Request for Applications (RFA), some are obligations with commitments in the future; others are met at the moment the application is filed.

AS 43.90.130(1) requires that the application must be filed by the deadline established by the commissioners. This obligation was met at the moment the applications were filed, and there are no ongoing or future obligations associated with this “must have.”

AS 43.90.130(2) requires that the application provide a thorough description of the proposed natural gas pipeline project, including the proposed route, the location of receipt and delivery points, an analysis of the project’s economic and technical viability, and a technically viable work plan, timeline, and associated budget. The requirements of this “must have” are common to all pipeline projects moving forward to an open season process. They are not unique to the Alaska Natural Gas Pipeline and are not in the category of those requirements that are needed to force the applicant to do what it would not otherwise do. This obligation was generally met at the moment the application was filed, and there are no ongoing or future obligations associated with this “must have.”

AS 43.130(3) requires that the applicant agree to (A) conclude a binding open season within 3 years of receiving a license, (B) apply to the FERC to use the prefiling process before filing an application for a certificate of public convenience and necessity, and (C) apply for a FERC certificate of public convenience and necessity by a date certain.

Subsections (A) and (B) have been completed, and TransCanada has proposed filing for the FERC certificate by October 2012 in compliance with (C). The date certain can be amended under AS 43.90.210 Amendment or Modification of the Project Plan.

The “date certain” obligation under AS 43.120(3)(C) is a continuing obligation that will not be met until the applicant files for a FERC certificate of convenience and public necessity. This certainly is one of the obligations that are in the category of those requirements that are needed to force the applicant to do what it would not otherwise do. This is one of the provisions that most pipeline companies would not agree to because they know that, statistically, date driven projects have a greater chance of failure and cost overruns than projects that are milestone driven. The saving grace of this provision is that the language of the statute provides for an “out” if the applicant runs into difficulty complying with the date they proposed, i.e., the project can still be milestone driven and if the applicant doesn’t meet the “date certain” they will have justification for an amendment so long as they have diligently pursued the project. The additional “sweetener” for this provision is that the State of Alaska will reimburse the applicant for 90% of its costs after Open Season up to $500 million to pursue the project through filing of the FERC certificate.

AS 43.90.130(4) provides that if the project is subject to the jurisdiction of the Regulatory Commission of Alaska (RCA), the applicant will commit to similar obligations that it was obligated to do in (3) above. Since there has been no allegation that the project is subject to the jurisdiction of the RCA, this “must have” can be deemed complete or not applicable.

AS 43.90.130(5) requires to applicant to assess market demand for expansion every two years. This obligation is specific and will require some form of documentation that the applicant met the obligation. As a practical matter, every pipeline company is continually assessing the market demand for capacity. Pipeline companies are incentivized to provide expansion when it is needed by the market. Although this “must have” is ongoing, the value of it is limited because pipeline companies do not need to be told to be on the lookout for pipeline expansion opportunities. This provision had little value when enacted unless you were a conspiracy theorist and believed that the major oil companies on the north slope would conspire to lock up initial capacity on the pipeline and ship only their gas and not expand the pipeline to allow other gas owners on the slope access to the pipeline. Even conspiracy theorists are no longer concerned with this provision because TransCanada won the license and TransCanada, a pipeline company, is incentivized to expand the pipe at every economic opportunity made available to them.

AS 43.90.130(6) requires the applicant to commit to expand the pipeline in reasonable engineering increments and on commercially reasonable terms. This provision sounds good, but is unnecessary. No rational pipeline company would try to expand a pipeline on non-commercially reasonable terms or in unreasonable engineering increments, and the FERC wouldn’t allow such an irrational act to occur even if you found a pipeline company that would consider such unreasonable behavior. This provision, although still an ongoing requirement, is not important to the overall goal of getting Alaska’s gas to market. It will happen with or without the State of Alaska’s insistence.

AS 43.90.130(7) requires the applicant commit to propose rolled-in rates for all expansions so long as the final rates would not result in rates that are more than 15 percent above the initial maximum recourse rates for capacity. This provision is interesting because of the strong positions taken by the State of Alaska and by the major oil and gas owners on the North Slope. Yet the likelihood of this provision ever becoming a real issue is very small. In order for there to be a conflict over this provision there would have to be three expansions of the pipeline.

Everyone generally agrees, based on the submittals of TransCanada and Denali that the first two expansions would result in a reduced tariff and “rolled-in” rates would be perfectly acceptable to all. Only the third expansion would result in a difference in rates.

The third expansion would be through “looping”, that is, building a parallel pipeline alongside the proposed gas pipeline for certain sections of the route.

The State of Alaska argues that a third expansion might not be economic without rolled-in rates; and therefore the pipeline company should propose them.

The North Slope oil and gas owners argue that they should not be required to subsidize a third party gas owner’s expansion through rolled-in rates.

As a practical matter, the only probable scenario that could result in expansion by looping is if Shell found substantial amounts of gas in the Chukchi Sea. The pipeline would have had two expansions by compression and any gas that Alaskans needed would have been under contract in one of the first two expansions. The likely recipients of gas from the third expansion would be Canada, the lower-48, or Pacific Rim markets.

The State of Alaska would require the pipeline company to propose rolled in rates in the third expansion which would mean higher rates for everyone currently receiving gas from the pipeline, and if the FERC approved the rolled-in rates, rates for Alaskans would increase. The State of Alaska effectively made a requirement that was against its own interests. Rolled-in rates for the first two expansions makes sense for Alaskans. Rolled-in rates for the third expansion through looping will increase rates to Alaskans in order to pay for Shell or another major gas producer to ship their gas from the Chuckchi Sea through Canada and to the lower-48. To add insult to injury, the major gas producers will pay no royalty or taxes to the State of Alaska for this benefit bestowed upon them. Once again there is a saving grace to this provision, the chance of explorers finding sufficient gas reserves to keep the current pipeline full, find enough reserves to expand the pipeline twice through compression, and then find enough gas to make an expansion through looping is slim to none. Neither the State of Alaska or the North Slope oil and gas owners should spend any energy arguing over this provision.

There is an additional problem with requiring an applicant to propose rolled-in rates. The obligation must be considered in the context of how it relates advocacy before a regulatory body. The obligation to propose rolled-in rates results in exactly the opposite impact from what the State was attempting to do. First, recognize that a regulatory agency is going to fulfill its responsibilities regardless of what the State has contractually obligated a party to do. Next, if a party is legally obligated to advocate for a particular position, the regulatory agency will know that. The regulatory will discount that advocacy to the extent they believe the position is based on a legal obligation rather than what the party believes. If two parties come before the regulatory agency with a comment, one has a legal obligation to advocate a particular position, and the other can advocate what it believes, the regulatory agency will accept both comments but will recognize that one party may or may not be advocating what it believes.



AS 43.90.130(8) requires the applicant to state how it proposes to deal with a North Slope gas treatment plant. This provision was complete once the application was filed.

AS 43.90.130(9) requires the applicant to purpose the percentage and total dollar amount for the State’s reimbursement of the applicant. This provision was complete once the application was filed.

AS 43.90.130(10) requires the applicant to commit to propose and support rates that are based on a capital structure for rate-making that consists of not less than 70 percent debt. This provision requires a “commitment to propose” and was completed once the application was filed. The license binds the applicant to the commitment. Although this provision is considered complete so long as the applicant does not violate its obligation under the license agreement, the provision itself is not a strong provision. When the State of Alaska was considering participation as an owner of the pipeline, they were evaluating a provision that required a capital structure for rate-making that consisted of not less than 80 percent debt if the financial market would allow it. This would have been a much greater benefit to the people of the State of Alaska than the 70 percent debt number required as a part of the twenty must haves.

AS 43.90.130(11) requires the applicant to describe the means for preventing and managing cost overruns and for minimizing their effect on the tariff. This provision is an important part of the applicant’s proposal in the open season. All bidders want to know how cost overruns will be handled. This provision was unnecessary because it would have been required as a part of any proposed open season, but it is also complete because the TransCanada open season has been held.

AS 43.90.130(12) requires the applicant to provide a minimum of five delivery points of natural gas in the state. This provision is interesting in that there was no real justification for five delivery points. The only justification was that Governor Murkowski proposed four delivery points. Actually the best way to approach delivery points is to talk to the engineers that are designing the compressor stations. Th compressor stations will probably be used as the delivery points for natural gas because using an existing compressor station will be the least expensive way to access gas for Alaskans. When I asked the engineers (one pipeline company set of engineers) if they could design all the compressor stations so that access to gas would be available at each station, they said they could do so without substantial additional cost. If a compressor station is built along the line, it should be designed in such a way as to easily allow access to gas for local use. The local user would still have to pay for the connection costs, including compression and processing, but the access would be available wherever there was a compression station. In addition the federal government requires the applicant, in their notice of open season to provide for delivery points at the locations identified in the in-state needs study which effectively makes this provision unnecessary.



AS 43.90.130(13) requires to applicant to commit to offer firm transportation service to delivery points in the state and to offer distance sensitive rates to delivery points in the state. Interestingly the provision also cites the federal CFR that requires that same thing effectively making the “must have” unnecessary.

AS 43.90.130(14) requires to commit to establish a local headquarters in Alaska. For TransCanada, at least until it is further along in the project, this means it must open a token office to comply with the provision. It is logical for TransCanada to keep most of its staff in Canada close to its executive management team prior to commencement of construction. For Denali (ConocoPhillips and BP), since they both have offices in Alaska, it is easy for them to open local headquarters and staff them with more individuals since they are close to their management teams here in Alaska. This provision has been met by the applicant and is complete.

AS 43.90.130(15) requires the applicant to hire qualified residents and contract with local businesses. This provision looks good but does little to encourage pipeline companies to pursue Alaska workers. The State of Alaska should encourage the pipeline companies to work with local businesses in advance of contract bids. The pipeline companies should size contracts so that local business can bid on the projects. One of the easiest ways to prevent local participation in the bid process is to create a contract that is so large that the local business cannot compete. The pipeline companies need to size contracts to encourage local participation in the bid process. Then the pipeline companies should create programs that help local businesses write business plans that would allow them to participate in the project and allow them to survive after the project is completed.

AS 43.90.130(16) requires all applicants to waive their rights to appeal rejection of their applications. It only applies to applicants and was complete at the time the application was filed.

AS 43.90.130(17) requires applicants to commit to negotiate project labor agreements. This provision sounds good but requires nothing of substance. The provision does not require the applicants to agree to project labor agreements, merely to negotiate them. In all probability the pipeline companies will come to terms with the unions and will agree to project labor agreements, but it will not be because it was required by the State of Alaska. It will happen because it is economic and expedient.



AS 43.90.130(18) requires the applicant to agree to not include the state reimbursement in the applicant’s rate base. I’m not sure the FERC would allow an applicant to add costs to its rate base if it ultimately could not prove it paid for them; so I assume that the FERC would not allow the applicant to add the state reimbursement to its rate base even if the state did not have this provision. This provision is fine but is probably covered by the FERC.

AS 43.90.130(19) requires the applicant to provide a detailed description of themselves and all entities participating with the applicant including the commitments of the other entities participating with the applicant. This provision can assure the State that if a number of entities got together to propose an application, the State could evaluate the entities as a whole to determine if the applicant was ready and able to complete the project. This provision was complete at the time the application was filed.

AS 43.90.130(20) requires the applicant to demonstrate its readiness, financial resources, and technical ability to perform the activities specified in the application. This provision was compete at the time the application was filed.

Alaska Gasline Inducement Act (AGIA)

My next set of articles will address the “must have” requirements of the Alaska Gasline Inducement Act (AGIA) found at AS 43.90.130. The AGIA “must haves” can be categorized into three groups:

1) Provisions that apply to the Request for Application (RFA),
2) Mom and Apple Pie requirements, and
3) Requirements that an applicant might not otherwise do if not required to do so by the State.

I will address which requirements have been completed, which are unnecessary, and the value, if any still exists, in the remaining requirements of AGIA.

Own a Piece of the Pipe - Part 2

A Greater Likelihood of Success


In my first article Own a Piece of the Pipe - Part 1, I evaluated the use of the Permanent Fund Dividend check-off as a vehicle to fund state ownership of the pipeline. In this article I will evaluate the argument that state ownership enhances the likelihood of success of a gas pipeline; I will evaluate the justification for that position; and I will propose some principles that should be considered when developing a plan or strategy for State participation in a gas pipeline.

"If we take advantage of this opportunity, we have a greater likelihood of seeing a pipe come true."- Ethan Berkowitz.

In the Frequently Asked Questions (FAQ) portion of his website Ethan Berkowitz, as support for his position that state participation increases the chance for success of the pipeline, refers to the Alaska Natural Gas Development Authority report in FAQ Q.1, the Alaska Natural Gas Development Corporation report in FAQ Q.13, and the Alaska Gasline Development Corporation report in FAQ Q.16. The report I assume he is referring to is the Alaska Gasline Development Corporation Project Progress Report titled “Alaska Stand Alone Gas Pipeline Project Update and FY 2010 Deliverables.” Page 28 of that report states that “All cost of service models run indicate the predicted cost to consumer will be higher than the current costs in the Cook Inlet.”

Dan Fauske, the CEO of the Alaska Housing Finance Corporation, in his presentation of the report update to a group of legislators, recognized the challenged economics of the gasline when he stated "There will need to be some type of equity infusion or some type of subsidy.”

I assume this was the basis of Ethan Berkowitz's position that equity invested in the pipeline through the PFD dividend checkoff will at least partially address the need for equity infusion and create "a greater chance making a pipeline become real."

There are two problems with this position. First, the equity infusion or some type of subsidy Dan Fauske was referring to needs to be of the type of infusion that would ultimately reduce the tariff. Mere ownership does not reduce the tariff. A State capital contribution reduces the tariff, and I am sure Ethan’s  PFD owners are not interested in donating their dividends to the pipeline company.

And second, and most important, the report Ethan Berkowitz is using to support his position has nothing to do with a large diameter pipeline. It was drafted as an update on the in-state gasline! The Alaska Gasline Development Corporation was created “for the purpose of planning, constructing, and financing in-state natural gasline projects or for the purpose of aiding in the planning, construction, and financing of in-state natural gasline projects.” The Alaska Gasline Development Corporation and any reports it creates has nothing to do with a large diameter pipeline.

The economics of an in-state gasline and the large diameter gasline are entirely different. And the justification for state participation in a large diameter pipeline are entirely different that the justification for participation in an in-state gasline.

Major concerns of the large diameter pipeline are pipeline costs, cost overruns, tax stability,  and the long-term price of gas in the lower-48. The major hurdle for an in-state line is economics of size. The in-state need for gas doesn't justify the cost of building a gasline from the north slope to southcentral Alaska.

This means that the primary justifications Ethan Berkowitz is using to support state participation in the pipeline has nothing to do with the large diameter pipeline he is proposing to own. But it is possible for state participation to enhance the likelihood of success of the pipeline, just not for the justification proposed by Ethan Berkowitz.

Participation in a Large Diameter Gasline

 In order to draft a successful plan for state participation in a large diameter gasline, it is important to understand the view of state participation from a pipeline company standpoint.

The following are some principles that should be considered and followed if possible:

1) First, it must be remembered that the State does not have an automatic right to have an ownership share of the pipeline. It will only be invited to participate as an owner if it brings value or adds value to the pipeline entity.

2) A state entity would need to act like a corporation, not a regulator.

3) A state entity would need to keep information confidential that is normally kept confidential by a private corporation participating in the pipeline.

4) The State’s shareholders cannot have access to confidential information. Only information made available to the public in general will be provided to them. The State entity’s board of directors and staff will have access to confidential information, but only if they agree to keep the information confidential.

5) The State’s ownership interest cannot fluctuate throughout the time the pipeline is being built. Voting rights are based on ownership interest and cannot be changed just because more individuals want to invest their permanent fund dividends in the ownership of the state entity.

6) If there are cost overruns and all the other owners are required to pay their proportionate part of the overrun, the State will pay its proportionate share also.

7) The rights and responsibilities of the State entity that is participating in the pipeline cannot be subject to legislative changes that would violate their obligation under the participation contract they sign, commonly an LLC agreement.

8) Some pipeline companies would like to see the state own the same share of the pipeline as its royalty share of the gas. Other pipeline companies are not as concerned with this issue.

If a participation proposal is fashioned that meets the above criteria, it will have a greater chance of getting agreement from a pipeline company to allow the State an ownership position in the pipeline than if the criteria are ignored.

Own a Piece of the Pipe - Part 1

A Straight-forward Idea or a Complex Evaluation


At first blush, Ethan Berkowitz’s Owning a Piece of the Pipe idea seems fairly simple. In fact he stated, "To us and most Alaskans this is a pretty straight forward idea, the notion that Alaskans should also have the right, if they individually choose, to be able to own a piece of the pipe."

The idea may sound simple, but the implementation is decidedly more complex.

For example, Ethan Berkowitz has selected the Permanent Fund Dividend check-off as the appropriate vehicle to raise funds for participation in the pipeline project. But no analysis is provided regarding the impact on Alaska businesses if the program is as successful as he hopes.

A successful PFD check-off program will divert money from the Alaska economy and Alaska small businesses to a pipeline project that may or may not need the assistance of Alaska financial support to be viable.

"If we have about 20 percent of Alaskans participate in this proposal, which is what our projections would be, we'll see the cumulative effect of about $800 million in investment."

Ethan Berkowitz projects about 20 percent of Alaskans will participate in the opportunity to invest in the pipeline resulting in the cumulative effect of about $800 million in investment and perhaps close to $1 billion.

What will the impact be of diverting as much as $800 million to $1 billion away from the Alaska economy and into supporting a gas pipeline project? Many small Alaska businesses, in order to balance their budgets each year, depend on people spending their Alaska PFD’s and purchasing goods and services in Alaska. I think that Alaska small businesses would be very concerned about the impact on the viability of their businesses of such a large diversion of permanent fund dividends to the pipeline project.

An analysis should be done of the impacts of such a substantial loss of revenue to Alaska businesses prior to proceeding ahead with such a proposal.

Who will invest?

Diane Benson, the lieutenant governor candidate, says she would have been excited to have an opportunity like this when she was a young mother of limited means. Her statement suggests that she believes all Alaskans, regardless of their financial status, would seriously consider investing their PFD’s in the pipeline. Actually, reality is far different than the picture she projects. A young mother of limited means is barely able to balance her budget. The last thing she is going to consider is taking her PFD, investing it in a pipeline project, paying the taxes on the PFD income, and hoping some day that her investment will return a profit to her. She, and many others like her, will be using their dividends to catch up on paying bills, and possibly, they hope, have a little left over to do or spend on something special with the surplus.

The typical person that will be able to invest their PFD in the pipeline is a middle to upper income individual that does not need the PFD to pay for the basic necessities of life, a person that has sufficient surplus income that they can afford to lose it if the pipeline project fails to reap a profit.

So even though this program is touted as benefiting all Alaskans, as a practical matter, a much smaller cross-section of Alaskans will be able to avail themselves of the opportunity to participate. And if they participate, there has been no research, and apparently the question hasn’t even been asked, about the impact on the Alaska economy of these individuals diverting their PFD’s to the gas pipeline instead of investing them in their local community.

Ethan Berkowitz may want to reconsider using the Permanent Fund Dividend check-off as the vehicle for providing Alaskans with an opportunity to participate in the pipeline.

He may find that the negative impacts from the loss of revenue to the economy will exceed the benefit received by the pipeline. He might still want to consider some form of state ownership or participation in the pipeline and perhaps allow the public the opportunity to participate in the project through participating in the financing of the project. Perhaps the public could be provided the opportunity to purchase bonds in the project instead of acquiring an ownership interest. This would be a much safer, less risky venture for the Alaska public.

If Ethan Berkowitz continues to propose this idea, the next stage of his multi-part plan should begin to address this issue.