In Support of a Pipeline but Which One

HB 132 passed the House pretty much along party lines on March 23, 2015 and was then transmitted to the Senate. Interestingly this is not a party-lines issue; it is not a conservative vs liberal issue; and it is not a pro oil industry vs anti oil industry vote, but the legislative and executive decision makers are acting like it is. The various proponents are arguing over whether to pursue a gas pipeline that will compete with the AK LNG project or throw all of their effort into making the AK LNG project a success when the focus of the debate should be on identifying alternatives and options that may enhance the economics any large diameter gas pipeline project.

The governor has proposed converting Alaska’s in-state gas pipeline project, the Alaska Stand Alone Pipeline (ASAP) to a large volume pipeline to compete with the AK LNG project. The governor argues that the new ASAP project will create competition with the AK LNG project. If the State has an alternative project, he argues, it will encourage the producers to stay on track and on schedule; and it will create a stronger negotiating position for the State. Although this may seem like a good idea at first blush, as explained below it does nothing to enhance the State’s negotiating position and does not create an alternative the State could pursue if the other project is determined to be uneconomic.

The governor argues that the producers have competing projects all over the world that are competing with the Alaska project for finances and funding. If another project wins out, the Alaska LNG project will not go forward. The governor argues that all we are doing is creating a competing project so that we have alternatives if the producers do not move forward with the AK LNG project.

There are several problems with the position the governor has taken. First, the producers generally have or can find the finances or funding to pursue any economic project they wish to pursue. Their projects don't compete with each other. The marginal projects, like the AK LNG project run the risk of not being pursued if the costs and risk of the project are too great. The focus on project economics is paramount. Secondly, even assuming the governor is correct, that the producers have projects all around the world that compete with the Alaska project, there is a substantial difference between evaluating projects all around the world to determine which project the company wants to invest in and competing with yourself on the same project. The producers don’t make a substantial commitment to moving a project forward then set up a project that competes with their own project. If they have a multi-billion dollar project they are pursuing in China, they do not set up and fund a project that competes with their own project in order to give them leverage. They understand that creating such “competition” does not creat leverage. It merely wastes additional assets trying to get the same gas to market.They will not spend double the costs for any portion of the project merely to create an illusion that there is competition.

The governor misunderstands global competition. Global competition is about countries working on alternatives and options that enhance the economics of their project over projects in other countries around the world. Neither the countries nor the producers set up alternative projects to compete with their own project.

The governor argues that we need an alternative in case the producers decide to not move forward on the AK LNG project. The governor is willing to fund a parallel process to be ready to proceed forward if the producers don’t. The governor has failed to understand that the producers will not move forward with the project only if they determine the risks are too high and the project is uneconomic. They will not commit to ship gas on an uneconomic project. If the producers do not move forward because their project is uneconomic, the State’s alternative will encounter the same problem. If the producer’s project is uneconomic, the State’s project will also be uneconomic. For those who remember the Alaska Gasline Inducement Act, it had the same problem. The State cannot “induce” a company to risk capital on an uneconomic project. A better alternative if the State wants to move forward with a project is to negotiate contract terms that allow it to move forward with the project if the producers elect not to do so. No waste of assets, no waste of time.

The governor argues that having two competing projects will enhance the State’s negotiating position with the producers as it negotiates the various project agreements. He likens it to having two cars to buy or two houses to purchase. If you have a viable alternative, you have a stronger negotiating position because you can choose the other alternative. The problem is that the State has not created another car or house; it has created a cardboard cutout illusion of an alternative. The reason the producers are not concerned is they understand that if their project doesn’t go forward, the other project will not go forward either because the economics of each project does not change merely because the number of project alternatives increases.

One probable result of the governor’s competing project proposal is the producers will try to figure out ways to leverage the proposal in the negotiations with the State team. They will argue that the competing project is creating uncertainty (which it is not). Based on that uncertainty they will request certain concessions and guarantees from the State to protect the producers from that risk. Instead of creating an advantage at the negotiation table, the governor has created a disadvantage and provided the producers with potential leverage. Their uncertainty concerns should be ignored because they don’t really exist.

The governor also misunderstands the State’s negotiating position with the producers. The State is in a strong negotiating position. The producers need the State as a partner. They call it alignment of interests. It is really more about the State carrying a proportionate share of the risk and protecting the producers form changes in the economics of the pipeline through increases in taxes or other charges against the project than it is about aligning interests, whatever that means. In the past the producers have tried to negotiate a “poison pill” provision that stated if the economics of the project change through an action by the legislature or a borough, the loss is born by the State’s interest in the project. Obviously this would not be a good provision to agree to.

The governor argues that the producers own the car and can ask any price for the car, and we would have to pay their price. The governor needs to understand that the producers don’t own the car, the State does. We can negotiate strong terms for the State. The producers can accept them or risk not having the state as a partner. That doesn’t mean that we should try to extract more value from the project by increased charges and taxes. That would create a further impediment to the economics of the project. But the State should negotiate strong protection provisions. The State should make sure that there are provisions in the AK LNG project contract agreements that allow the State and anyone else that wants to continue to participate in the project to move forward with the project. If a company wants to withdraw from the project, they should be allowed to do so prior to the project commitment decision. But they leave all their interests in the work product and permits with those who want to continue the project. And the parties that continue the project should not pay the withdrawing companies anything for the value of the permits they left behind because the withdrawing companies will be able to write off the assets; and if the remaining parties are successful in building the pipeline, the withdrawing companies will be able to make billions of dollars shipping gas on a pipline that the other parties took the risk to build.

One of the arguments the governor makes that I don’t understand is the argument that not allowing the alternative project prevents the State from marketing its gas. The reason this doesn’t make sense to me is that the State’s AK LNG team has a marketing group whose job it is to find markets for the State’s gas. Nothing is preventing the State from marketing its gas now as a part of the AK LNG project. The governor should talk to the State’s AK LNG marketing manager to determine the difficulties with obtaining long term contracts. He will find that the difficulty is not with having an alternate contract. The difficulty is with delivering the gas to the buyer at a competitive price. Strong economics and a lower tariff are the primary ways to bring gas to market, not trying to develop a cardboard cutout alternative that none of the producers believe is a viable project.

It is possible that the governor is arguing for what some have called a market driven approach. The theory is that the buyers of the gas want our gas so much that they are willing to share the risk of building the pipeline. They are willing to make firm shipping commitments without owning the gas or knowing the ultimate cost of the gas or the tariff. The governor has tried this for a number of years through the Alaska Gasline Port Authority. It didn’t work then and it can’t work now. The reason it doesn’t work is that the market will not assume the risk of the project without some level of understanding of the cost. A market driven approach shifts the risk of the project to the buyers. That is not a risk the buyers are used to accepting without more certainty of costs.

The governor is right about the ASAP gas pipeline. It seems that there is universal agreement that the ASAP pipeline is uneconomic. The Alaska Gasline Development Corporaiton still has around $200 million they are able to spend in furtherance of the project, but spending more money on an uneconomic project does not sound like a logical decision to pursue. The governor has proposed to change to focus of the ASAP team to develop a proposal for a large volume pipeline. For reasons stated above, this is not a good option. The legislature, on the other hand would allow the ASAP project to proceed forward with a snall volume uneconomic pipeline, presumably to prevent the governor from making the mistake of converting the ASAP project to a competing project to the AK LNG project. This too is a wrong approach.

What the legislature and the governor should do is direct the ASAP project team to support the State’s AK LNG team at the direction of the AK LNG team. Those members of the ASAP team that can find positions in the AK LNG team should do so. The rest of the team should be funded through the end of the year at which time the ASAP project should close its doors.

Recommendation

Regarding AGDC, as stated above, AGDC has a couple hundred million dollars in reserve. That money should not be wasted on the development of an alternative project. It should be used to support the State of Alaska’s participation in the Alaska LNG project. The ADGC team should be meeting with the State of Alaska’s management team to see how they can support the project. The ADGC team and the Alaska LNG team should look at ways that the ADGC professional staff can be utilized effectively on the AK LNG project.

Regarding contract negotiations, set strong milestone timelines that can only be changed with a 100% vote or a vote that allows the State of Alaska to veto delay of the project.

Include a provision that allows the State of Alaska the right to take over the project and transfer all the permits and data to the State and other remaining participants so that no time is lost in moving the project forward.

The State should spend more time looking for ways to make the project economic instead of wasting time on an alternative that will never occur. Focus on financing, the tariff, the cost of debt, return on equity, debt/equity ratios, transportation infrastructure,  reducing cost overrun risk, and reducing the cost of the project, anything that will make the project more economic and more likely to succeed.

What the State has failed to figure out is that projects move forward because they are economic and can make money for their investors.

It’s time to quit wasting assets on things that are not going to bring value to the project. Launching a competing project when there will be only one project that succeeds is wasting time and money. The State should focus its efforts on making one project more economic not creating alternative projects. Just make sure the State of Alaska has the right to proceed ahead with the project if the producers don’t want to move the project forward timely or if the producers determine the project is uneconomic and decide once again to shelve the project.