An analysis of SB138

The Alaska Legislature is currently considering SB138 at the request of the governor. The substance of the bill cannot be reviewed without understanding the context in which it was submitted. The proposed legislation was submitted based on a commitment the governor made to the producers when the governor, through the Departments of Natural Resources and Revenue and the Alaska Gasline Development Corporation signed the Heads of Agreement (HOA) dated January 14, 2014. SB 138 is the result of the governor’s commitment, and most of the provisions of the legislation come directly from that commitment.

 Article 4.4 of the Heads of Agreement (HOA) states that “A decision by the Alaska LNG Parties to advance the Alaska LNG Project to FEED is subject to, among other things:

a. Enabling Legislation and other laws and regulations of the State to advance the Alaska LNG Project, including necessary fiscal and commercial terms as set forth in this HOA;”

Article 7.3 of the Heads of Agreement (HOA) requires the administration “to the extent permitted by law” to “include and support the provisions of Articles 5 through 12, inclusive, in any future legislation or contractual arrangements.”

 The question the legislature should be asking is what did the governor commit to in the HOA? How does that affect the governor’s ability to seriously consider any changes the legislature may propose? What are the actual impacts to the state of the proposed legislation? And what commitments are reasonable for the state to make to encourage the development of a major gas pipeline project? This final question is the most important, and the legislature should come to its own conclusions regarding what the state is willing to do to encourage a large diameter gas pipeline.

 

The fact that the governor signed a document in January to support certain terms does not change the decisions the legislature should make. A decision not to follow what the producers requested in the HOA is not a decision against the pipeline even though that is exactly what the producers will argue. The legislature has a responsibility to review the terms of the proposed legislation and make sure the interests of the state are protected. There will be a bias toward giving the producers whatever they want in order to be seen as supporting the gas pipeline. The legislature must understand this bias and guard against making decisions that are not supported by sound reasoning and economic justification.

The producers are generally going to attempt to change the economics of the pipeline and shift risk to the state through several means:

1)      Reducing/protecting the tax on oil.
2)      Reducing/protecting the tax on gas.
3)      Providing “fiscal certainty” on the benefits gained for the longest number of years.
4)      Getting the state to pay for as much of the cost of the pipeline as possible.
5)      Shifting as much of the risk of the pipeline to the state as possible.
6)      Having the state be an owner of the pipeline so that the producers can have the state pay for any loss of fiscal certainty or risk through the state’s revenue stream.
7)      Alignment of the parties

 Reducing/protecting the tax on oil.

The producers are well aware of the initiative process that would repeal the current tax and revert back to the prior tax. The producers will use the agreement to move forward on the gas pipeline as leverage during the vote to argue that a vote for repeal is a vote against the pipeline. Interestingly the oil tax does not have a major impact on gas pipeline economics. The pipeline economics models upon which the producers depend will attribute no more than a 5% change in economics based on the fiscal certainty on oil. The producers will argue that they must have fiscal certainty on oil or the gas pipeline cannot move forward. Their argument is that the legislature may change the tax on oil if they don’t like the deal they are receiving on gas. There is always a risk that the tax structure will change if the industry is obtaining a disproportionate value from the oil and gas resources in Alaska. That is exactly what happened to the Economic Limit Factor. When the state finally figured out that Kuparuk would pay little or no severance tax while the producers were receiving billions in revenue, it was time to change the tax. Likewise, the state should be cautious when agreeing to protect the current or a proposed tax on oil and gas for more than 15 to 20 years. My guess is that the producers will request 35 years. The state cannot project more than about 10 years into the future when it comes to taxes, and the economics of oil and gas could change substantially in that time. The longer the term of fiscal certainty, the greater the risk to the state that it made a bad decision. 

Reducing/protecting the tax on gas.

The proposed legislation sets the tax on gas with little or no analysis of what the state would receive under the current law or what the state would receive if current law is repealed by a vote of the people. When the value of what the state is giving up in the legislation is not well considered, there is a significant chance that the state is giving up more revenue than it should, especially when the proposed tax rate probably came from the producers as did much of SB 138. There has been very little review and analysis of one of the most significant terms of the legislation. There should be extensive fiscal notes and presentations of the probable revenue impacts from a proposed tax on gas.

 
Providing “fiscal certainty” on the benefits gained for the longest number of years.

This issue has been discussed above, but the key is the legislature should only provide fiscal certainty, if at all, for a limited term. Twenty years is more than enough for the producers to obtain the benefit of their bargain to commit their gas to the pipeline.

Getting the state to pay for as much of the cost of the pipeline as possible.

 
The building of infrastructure is an important aspect of the overall economics of a large-diameter gas pipeline. If infrastructure (roads and bridges, etc.) is built and maintained properly throughout the project, the result could be substantial cost savings or a higher likelihood that there will not be cost overruns due to infrastructure failure. The issue will be how to allocate the cost of infrastructure between the parties. There are suggestions in the proposed legislation and in the Heads of Agreement that the producers will attempt to shift as much of the burden of paying for the cost of infrastructure onto the State of Alaska as possible.
 
Section 31.25.005(5) states that the state corporation to the fullest extent possible should “advance an Alaska liquefied natural gas project by developing infrastructure and providing related services.”
 
Article 10 of the HOA refers to additional State Support for the Alaska LNG Project. Article 10c references “appropriations and permitting for the construction of necessary in-state infrastructure (e.g. roads and bridges) including drafting, introducing and supporting legislation.”

The cost of infrastructure improvements and maintenance required to build the pipeline could be around one to two billion dollars. As much of the cost of infrastructure as possible should be shifted to the federal government. If the state decides to pay a part of the infrastructure costs from the general fund, it should make sure it receives value for that investment.

 Shifting as much of the risk of the pipeline to the state as possible and Alignment of the parties

 
You will hear a lot of talk about alignment of the parties. Much of the alignment will be the producers, in the contractual agreement with the state, shifting risk and costs from the producers to the state. Specifically the producers will require the state to accept the risk of any legislative changes to either the oil or gas tax. This will be similar to a “poison pill.” If the legislature or any local government finds a way to extract additional revenue from the producers, the state will be required to pay the difference in revenue from the state’s portion of the pipeline revenue.
 
Another area where the producers will attempt to limit risk and liability for the pipeline is through the creation of subsidiaries. The producers will propose shell corporations that will protect the parent corporations from any liability and risk associated with the pipeline. The state should require a parent guarantee if the state decides to participate with the producers in the pipeline project. The state should not be the only deep pocket in the room. I assume the producers will argue that the state could also create a shell corporation. The difference is that the producers can allow the pipeline to go belly up and only lose what was invested in the shell corporation (still a significant value), but the state will be stuck with a similar loss as the producers plus the state will be stuck with the result of the failure even if it has created a shell to protect it from liability.

There are other areas where the producers have shifted the cost of the pipeline to the state. One example is workforce training. The producers added a credit for workforce training to the legislation. Because there is already a cap on the total credit allowed, the producers will merely shift what it normally contributes to the university and other organizations currently identified in the credit to training on the pipeline, effectively transferring to the state the cost of pipeline workforce development with a concurrent loss of revenue to the university and other educational institutions. The fiscal note on this issue is similar to a ostrich burying its head in the sand. The fiscal note argues that it cannot determine the revenue impact to the state because it cannot predict the decisions of the producers in advance.

 Summary

 It will be argued that the legislation as proposed does not commit the State of Alaska to anything. The proposed contract that will be presented to the legislature in the future is where the legislature will get an opportunity to examine the terms of the deal. Actually what the legislature is agreeing to in SB 138 is the sideboards of the agreement, and it is clear that the proposed contract, when it is submitted to the legislature, will ask for incrementally more from the state. The legislature needs to understand and be clear about what it is agreeing to in the proposed legislation. This is not legislation to support the Alaska Gas Pipeline. This is legislation that will set the terms of the deal between the producers and the state for a future gas pipeline and the accompanying revenue from that endeavor. Proceed with caution.