There are huge benefits for the state if Gov. Sean Parnell’s proposed state participation in a North Slope gas project goes forward: as much as $2 billion to $3 billion per year in new revenues.

If the project were expanded, as the partnership deal anticipates, state revenues could increase by 30 percent or more.

There are huge risks, too.

Of the downsides to the deal, according to consultants to the state, number one is that construction costs now pegged at $45 billion to $65 billion will increase. It is certain there will be some increases, say industry and consultants to the state.

Another risk is a dip in liquefied natural gas prices. A price drop to about $10 per million British Thermal Units, for example, could put the project under water, according to Deepa Poduval, lead consultant for Black & Veatch, the state’s top consulting firm on the gas project. To cover costs, a price greater than $12 per million BTUs is needed, Poduval said.

Forecasting energy prices 50 years into the future with confidence is impossible. Also, who can foresee some radical new energy technology being developed, like the revolution in cheap shale gas that fatally undermined the plan for an all-land gas pipeline from the Slope to Canada.

Another sobering possibility: If a buyer of LNG doesn’t pay, because of bankruptcy or by not taking as much LNG as much was contracted, the state could be caught, Poduval warned legislators in hearings.

The same thing could happen if the state can’t deliver its contracted LNG to a customer because of some production upset on the North Slope, she said. The state can’t control production.

Finally, once the state signs a “take or pay” contract with TransCanada Corp., its proposed partner in the pipeline, the state is on the hook, and this could be as much as $1 billion per year no matter what, according to studies by Black & Veatch.

What the Legislature is considering this year is a bill that would give the state the authority to take its gas production royalty and production tax “in kind,” or in the form of gas, and then commit the state gas for shipping and sale, as liquefied natural gas, through the partnership.

If the bill passes, the administration will have permission to continue negotiating a more definitive deal that would be back before the Legislature next year.

The risks sound daunting, but there are strategies for mitigating them, said Poduval, of Black & Veatch. Were the state not to pursue the partnership, and if the project were to proceed somehow anyway, many of the downside possibilities would still be there to diminish state revenues.

On a more positive note, the state will be able to get into the partnership without huge outlays of cash. The proposed deal with TransCanada is structured to lessen the state’s front-end capital requirements, a prime concern of legislators.

By having TransCanada as a partner, the pipeline company makes the capital investments in the pipeline and gas treatment plant “upstream” on the North Slope.

Also, having TransCanada’s expertise available to the state is important, not just to the state but also to the producing company partners, who don’t want to see the state suffer pains of a learning curve in owning and managing shares of a pipeline, company officials have said.

In terms of financial exposure, however, the state will own its share of the LNG plant in Nikiski directly, and would be required to contribute capital to that. Parnell said during his State of the State address that the Alaska share in the fiscal year 2015 budget for preliminary work toward the Nikiski plant could be $70 million to $80 million.

Legislators in Juneau are weighing the risks and benefits and most seem willing so far to go for the partnership.

“I like the idea of our being a partner and I have confidence in our process, although there are still questions among many lawmakers,” said Sen. Lesil McGuire, R-Anchorage.

TransCanada role

Many plans for gas projects have been put forward, McGuire said, but, “This is different, because we now have alignment for the first time in years, with all three producing companies on the same page at the same time.”

McGuire is a member of the Senate Resources Committee, which has been holding extensive hearings on the proposal. A “companion” bill in the state House is in the House Resources Committee, which also has been holding hearings.

Sen. Peter Micciche, R-Soldotna, also a member of the Resources Committee, voices similar sentiments: “I’m not bothered by having a equity investment, although I have some questions about TransCanada’s involvement.”

Some legislators are unhappy with the state having TransCanada as a partner because of the pipeline company’s involvement in Gov. Sarah Palin’s Alaska Gasline Inducement Act, or AGIA, license, which some see as having worked to the state’s disadvantage.

The Senate Resources Committee will be doing amendments to Senate Bill 138 that would allow the state to begin more detailed negotiation with the industry partners. Some amendments may include “sideboards” to limit the state’s exposure, McGuire said.

“We don’t want to end up where we were with AGIA, where we were locked into a troubled marriage. We want off-ramps, with minimal exposure,” McGuire said. 

“We are still locked into AGIA (with TransCanada) and it will cost us $100 million to get that data (acquired by TransCanada partly at state expense. If we go a different route, working with TransCanada, our exposure at the first off-ramp is $67 million. I’m leaning toward that,” she said.

Although the bill is still in the Resources Committee, Sen. Pete Kelly, R-Fairbanks, began overview hearings on the proposal in the Senate Finance Committee Feb. 19. Kelly is co-chair of that committee.

The current legislation would only give the state administration authority to continue negotiations toward a more comprehensive partnership agreement, and a proposed gas shipping contract with TransCanada, that would be before lawmakers next year.

Fiscal terms

Legislators also learned in hearings that a proposed state “fiscal stability” agreement will be part of that. An assurance by the state that taxes on the project won’t be increased is critically important, the industry partners have said, although some means of doing this will have to be found that fits within state constitutional requirements that do not allow limits to future actions by the Legislature.

There is particular sensitivity by some legislators as to whether such an agreement will be extended to oil production taxes. Sen. Hollis French, D-Anchorage, raised this question in the Senate Resources Committee. Spokesmen for all three of the producing companies involved, which were before the committee at the time, said they could not answer that question now.

Another twist in the fiscal agreement will be on how municipal property taxation is handled. The mayors of the Fairbanks North Star Borough, the North Slope Borough, the Kenai Peninsula Borough and the city of Valdez wrote to Gov. Sean Parnell Feb. 11 expressing concern about a “Payment in Lieu of Taxes,” or PILT, that might be part of an overall agreement.

The mayors are worried that effects on municipal property tax ability might be limited, and asked Parnell if they could be included in the negotiations.

Meanwhile, the Legislature’s decision on the concept of a partnership this year is seen as a “go” or “no-go” vote on the big gas project moving forward.

Poduval, of Black & Veatch, said the project is unlikely to move forward unless the state participates.

A comprehensive study by the consulting firm, which is under contract to the state, shows that under the current state fiscal regime the “government take” on the project’s revenues is about 70 percent to 80 percent, and higher than the government take on most other competing projects, Poduval told the Senate Resources Committee in hearings.

For example, the Black & Veatch study showed that government takes in two major competing nations with LNG projects, Australia and Russia, with Sakhalin LNG, are in the 50 percent range.

“We looked at several ways of modifying the government take by reducing the production tax and royalty, and we concluded that this cannot ‘move the needle’ in making the project more competitive,” Poduval said.

In contrast, an equity investment can make a big difference in reducing government take, mainly by reducing the federal tax part, she said.

There are risks, however, “But those are there whether there is an equity investment or not. Prices (for LNG) are a risk, as well as the capital cost and schedule. LNG projects worldwide are experiencing costs increases and delays and we don’t see the Alaska project as being any different.”

Risks can be managed, she said. As for capital costs and the schedule, the controls on the project execution are critical and the industry partners engaged all have good track records in project management, she said.

“Also, large LNG projects that are integrated, as is this one, demonstrate a better ability to remain on schedule with minimal cost escalation, she said.

On price risk, a common mitigation strategy is to negotiate sales contract for LNG before the final investment decision is made.

“This is a very common, almost necessary step. It is typical for large LNG projects to have the majority of the LNG committed to customers from the start,” Poduval said.

It is also not uncommon that some of the buyers have an ownership stake, typically a small share such as 5 percent, she said. Also not unusual, in large LNG projects, is for the host government to have a stake, such as is proposed with the Alaska project.

LNG customers like to see such alignment, with the host government as having skin in the game. State participation also helps the industry partners by lowering the amount of capital they have to expose, Poduval said.

“This is very important to them,” she said.

State involvement also allows it to bring in a third-party partner with expertise, in this case TransCanada, in helping manage the operation of the project.

“There is also transparency,” because the state will have access to information about the project management.

In contrast, lack of transparency is seen as one of the key problems if the state were not to pursue a partnership. If the decision were made not to participate, and for the state to leave intact its current net-profits gas production tax and to take the gas royalty “in value,” or cash, the companies would manage the different parts of the project — the gas plant, pipeline and LNG plant — in ways that would be financially to their interest, and possibly to the state’s disadvantage. 

The state’s only way to gain access to financial information will be through tax audits or, in the worst case, lawsuits, both avenues costly, cumbersome and time-consuming.

Industry wants to avoid royalty and tax audits, and the possibility of disputes, by bringing the state in as a partner, the companies have said.

There is still the memory within the producing companies of hundreds of millions of dollars spent in the Amerada-Hess lawsuits in the 1970s and 1980s over oil royalty disputes after North Slope oil production started in 1977.

This has motivated the producing companies to avoid this with a gas project, where the margins are much narrower than with oil production. The Amerada-Hess lawsuit was finally settled.

Tim Bradner is a reporter for the Alaska Journal of Commerce. He can be reached at tim.bradner@alaskajournal.com.