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Loan guarantees tend to reduce the cost of debt and consequently reduce the tariff. This is good, but it reduces the cost of debt only by a small margin making only a minor change to the tariff.
The loan guarantees are important to the pipeline builders, but they do little to create incentives for the shippers. The risk to the shippers is substantially unchanged. The State of Alaska needs to look for solutions that reduce the risk to the shippers and solutions that make a substantial reduction to the tariff and thus increase the economics of the pipeline.
I have two recommendations regarding how to change the economics of a large diameter pipeline: one for the Alaska portion of the pipeline and one for the Canada portion of the pipeline.
Alaska Portion of the Pipeline
Regarding the Alaska portion of the pipeline, I recommend the State of Alaska fund the equity portion of the pipeline, take a debt rate of return, and not start receiving payment on its investment until the original debt is paid off. This funding mechanism could take the form of a financial interest or an ownership interest. That could be determined by discussing the proposal with companies that might want to participate in the ownership of the pipeline.
The benefit of this proposal is that it would change the economics of the pipeline and reduce the tariff more than any other single proposal that has been put forth so far. Combined with other risk reduction actions, it may be sufficient to move the gas pipeline forward.
The cost of this proposal would probably be up to $10 billion for a success scenario but less than $2 billion to see if it would be likely to succeed. The risk capital would be invested to develop a proposal and hold an open season. If the open season was successful, then the project could move forward to a FERC certificate. It is possible that up $3 billion would have to be expended to get to a project sanction decision, but this capital would only be expended after a successful open season and signed precedent agreements from the shippers.
One hundred percent of equity contribution should be invested in the Alaska portion of the pipeline only. That way Alaska gets the full benefit of the investment, and the tariff on the Alaska portion of the pipeline sees the greatest impact, thus providing cheaper gas for Alaskans.
If Alaska decides to make such a commitment to the pipeline, Alaska should approach the federal government to see what they can do to support Alaska’s commitment. The two things Alaska should ask for are 1) Alaska’s fair share of the revenue from federal offshore development, and 2) Alaska should ask for the chance to explore in ANWR.
Regarding AGIA and TransCanada, Alaska should get TransCanada to either agree that the current AGIA plan is uneconomic or get TransCanada to waive their rights to damages under AGIA in exchange for the opportunity to participate in the Canadian portion of the pipeline. I am fairly certain that TransCanada would not want to own a piece of the Alaskan portion of the pipeline under to above plan. I am also not worried about TransCanada threatening to sue under AGIA. It is clear that the present plan is uneconomic; so, there will be no liability under AGIA if TransCanada does not agree to waive their rights.
In addition, contrary to AGIA’s capital contribution, Alaska would get a return on its capital investment and future generations would receive the benefit. Consider the investment a savings account for the future when Alaska may need the return.
Canada Portion of the Pipeline
TransCanada has proposed a 70/30 debt equity ratio (with some modifications). They propose to invest 30% of the cost of the pipeline in equity. The equity rate of return on the pipeline will probably be greater than 12%. The cost of the debt, on the other hand is closer to 5% depending on who the borrower is and their credit rating. Clearly it is better to have more of the pipeline funded by debt and less by equity because the return on the equity is more than twice as expensive to the pipeline as the debt.
Alaska should try to get TransCanada to agree to an 80/20 debt equity ratio. This will lower the tariff by a certain amount and save the State of Alaska and the shippers over the life of the pipeline billions of dollars. In the alternative Alaska should argue to the Canadian government for an 80/20 debt equity ratio. Alaska should also argue for a return on equity of 12% or less on the Canadian portion of the pipeline. Once again this would lower the tariff and make the pipeline more economic. These two terms are not unreasonable. Both were given serious consideration during the initial pipeline negotiations with the producer group.
As a reminder, gas pipeline economics is a major element of achieving a successful gas pipeline, but there are many more elements that must be addressed to move the project forward.
The issues that need to be addressed are:
1) Fair oil and gas taxes
2) Long term fiscal plan
3) Short term annual capital and operating budgets
4) The permanent fund, its present and future use
5) Gas pipeline economics (discussed in this article)
6) Exploration and filling TAPS and the Gas Pipeline
7) Fiscal certainty/stable oil and gas tax environment
8) Point Thomson (hopefully this will be resolved soon by the State of Alaska and the Point Thomson owners)
In summary if Alaskans really want an Alaskan Gas Pipeline, they need commit their resources to its success. They need to be disciplined fiscally. They need to lead instead of follow. They need to take charge of their future. The result is they will be better off by pursuing such a direction. If the pipeline is a success because of their efforts, they will reap the benefits. If the pipeline is not a success then they will be prepared for the new world they will find.
