A Citizen’s Guide

Part 1of 2

JUNEAU—Lawmakers are scratching their heads over whether a complex contract proposal worked out by Gov. Frank Murkowski with three major oil companies to recover the North Slope’s massive natural gas reserves is in the best interest of Alaska.

Murkowski released the draft contract on May 10, a day after the end of the regular session, and immediately called legislators into special session to evaluate the agreement. He hopes a favorable review will lead them to—in a special session later this summer—approve the agreement, which could eventually lead to construction of a gas pipeline to Canada and perhaps Chicago.

• Public has chance to weigh in this week

• List of gas line events

• Governor’s gas agreement Web site

Oil companies have historically said Alaska’s natural gas, locked in ice beneath the remote Arctic coast, was too expensive to develop. But consumer demand has pushed up prices in recent years, making the cost of a project more feasible.

To sweeten the pot, the administration put together an offer that guarantees the companies their tax liabilities won’t increase and has the state shoulder some of the financial risk of building the immense metal straw needed to carry Alaska’s gas to market.

“We had to find a way to improve the rate of return on the project without lowering revenue to the state,” said Pedro van Meurs, Murkowski’s chief adviser on oil and gas. “That’s how we decided on state participation.”

Murkowski, who has made a pipeline the focus of his administration, says Exxon Mobil, BP and ConocoPhillips have already agreed in principle to the deal. Now all he needs to achieve what no other governor has been able to do since oil and gas were discovered on the North Slope in the 1960s is a thumbs-up from the Legislature.

“It’s up to the Legislature on whether they accept it,” Murkowski said in a recent news conference. “But if they reject it they better have something better in their hip pocket.”

The North Slope holds 35 trillion cubic feet of proven gas reserves and increased exploration is expected to double that number, according to state geologists. That’s the equivalent of 12 billion barrels of oil. Royalties and taxes on oil make up 75 percent of the state’s current general fund revenue, but production is declining. Depending on market prices, a deal on gas could be worth an additional $500 million to $3 billion a year to the state treasury.

“This amounts to another Prudhoe Bay,” said Jim Clark, Murkowski’s chief of staff and one of the administration’s principal people involved in the talks with the oil companies. Senate President Ben Stevens, R-Anchorage, said he was originally against the state taking an ownership stake in the project but he’s since warmed to the idea.

“It’s a very progressive, forward-looking concept that really changes the structure of how the state will receive revenue for its resources,” he said. “The state absorbs substantially more risk without question, but it would also get substantially more benefits.”

Other lawmakers, however, say the 352-page contract is chock-full of lucrative incentives for the producers and of risks to the state. What’s more, they say, it offers no guarantee a pipeline will ever be built.

Nearly two weeks of orchestrated explanation by the administration in Juneau’s Centennial Hall hasn’t helped resolve many of the central issues for critics.

“As you get more of the answers, you see how bad a deal this really is,” said Rep. Eric Croft, an Anchorage Democrat who’s running for governor this fall. “It takes away any ability of the Legislature and the people to control how they sell their resources.”

No guarantees

The contract does not—and the administration and the producers say it cannot—guarantee construction of a pipeline. Instead it lays out the terms for how the state would own 20 percent of the pipeline and take a similar portion of the gas in place of receiving royalties and taxes in cash. Van Meurs says tapping the gas is not a problem—gas is a natural byproduct of oil production. The challenge is getting the producers to build the costly infrastructure needed to get it to market.

That’s the reason offered for the administration’s designing of a contract that aims to reduce the financial risk inherent in what would be the largest private construction project in the world by having the state participate in the investment.

“By taking care of our own gas, we’re going to accept 20 percent of the risk of building the pipeline, which increases the rate of return for the companies,” van Meurs said.

To further entice the companies, the state is offering a 35 percent tax credit on construction of gas treatment plants and lateral lines between the fields and the treatment plant.

The state would also agree to lock in oil tax rates for 30 years and gas taxes for 45 years to guarantee the companies their tax bills won’t increase.

“The important thing is that we know the rules and that the rules are clear enough for us to invest a lot of money,” said Ken Konrad, vice president of natural gas for BP. The British-owned oil giant plans to invest up to $15 billion in Alaska over the next decade, half in gas, half in oil, Konrad said.

Before it can, though, oil executives say the sheer magnitude of stretching a pipe 2,100 miles to Alberta—and possibly another 1,500 miles to Chicago—requires BP and the other producers to be certain the state won’t raise taxes on oil to make up what it might have given up on gas.

“It’s a long contract, but this is a very big project,” Konrad said. “Ten years and $25 billion (the figure most often cited as the cost of the project) is a long time before you get a penny back.”

Going too far?

Some lawmakers say the terms of the draft contract favor the companies too much. They worry the companies could benefit from hundreds of millions of dollars in tax credits under a related proposal to rewrite the state’s oil taxes without a single section of pipe ever touching the tundra on the gas project.

“A lot of provisions protect the oil companies from risk and give the state very little in return,” said Rep. Les Gara, D-Anchorage. “They could go two or three years and do nothing and not owe the state anything for delaying the pipeline.”

Under the terms of the contract, the state would own a percentage of the main pipeline and nearly all other gas facilities on the North Slope proportional to the amount of state-owned gas flowing through them. For facilities and pipelines on state land, that amounts to 20 percent; on federal land, it’s 7.25 percent. If the producers choose to build a gas liquefaction plant in Alaska—although it’s not part of the current proposal—the state would take a 20 percent ownership stake in that facility, too, according to the contract.

“It’s the participation by the state that is really the main piece that pushes this project forward,” Stevens said.

There’s concern, though, that the state could end up subsidizing up to 48 percent of the cost of the needed infrastructure on the North Slope if companies are allowed to combine the credits in the contract with changes to the oil tax being considered by the Legislature.

“The extra costs and credits will cost the state billions of dollars and could actually cause the state to go negative on the project while the producers are still making a good profit,” said David Gottstein, co-chairman, along with former Gov. Walter Hickel, of the citizen group Backbone II, which has been critical of the governor’s attempts to get a gas line.

Gottstein’s fear is that companies could shift their costs to reduce their taxable income, resulting in a loss after generous credits are applied.

“The appalling thing is that we don’t get anything in return,” he said. “We have to give them things and maybe they give us something—and that something is a pipeline.”

Since the state would take its share of the gas directly at the field boundary, it would be required to own a share of the smaller lines linking existing gas fields with the pipeline, as well as an interest in transmission lines to future finds including discoveries within the National Petroleum Reserve-Alaska.

It would also pay a 22-cent fee on every thousand cubic feet of gas it takes in lieu of taxes.

Critics of the plan say it would be more cost-effective for the state to take its gas farther downstream. They point to the service fee as just another way the state could lose billions by taking gas instead of cash.

Accepting the gas at the boundary and the fee are just additional methods of making the deal cost-effective for the companies, Van Meurs said.

Making it work

The cost of building a 48-inch diameter, underground pipeline from the North Slope to Alberta, Canada, including a gas treatment plant and transmission lines is estimated at $19 billion. Extending the pipeline to Chicago could add an additional $8 billion to the project.

Overall, it would cost the state about $4 billion to buy a minority stake in the mega project.

Clark said the state would likely incur $3.2 billion as debt as part of the federal government’s $18 billion loan guarantee for the project. The remaining $800 million would have to be ponied up in cash. He noted that the Legislature already set aside $300 million this year to forward-fund future projects under the Alaska Housing Finance Corp. that could instead be used toward the project. “That’s money we would go after for the pipeline,” he said.

The pipeline would be able to carry 4 billion cubic feet of gas a day with the ability to expand it up to 6 billion. The total governmental share of the profits—including federal, state and Canada—is 51 percent. Alaska’s portion would be 23 percent.

The potential revenue to the state under the contract is roughly equal to what it would earn under the current tax system if gas could actually get to market under that system. The key to the contract is the state’s willingness to take all of its revenue in-kind, van Meurs said.

“That’s what got the producers to the table,” he said.

It will cost about 5.5 cents per thousand cubic feet for the state to market its share of the gas, van Meurs said. That’s a total of about $17 million a year for the state to market its gas including any potential discount it might offer.

BP’s Konrad said the benefits to the state of taking its share of the profits in gas are higher revenues, fewer disagreements with industry and lower administrative costs.

Opponents of the plan say the state will have a difficult time getting the best price for its gas when competing against three of the biggest energy companies in the country. Once Alaska’s gas comes online, Exxon Mobil, BP and ConocoPhillips combined would control 21 percent of the gas market in the Lower 48.

Van Meurs says the state would hire topnotch marketers, much like how the Alaska Permanent Fund hires investment managers, to make sure it receives the highest possible price for its gas.

“We will all be selling in the same highly competitive market,” he said.

The state also runs the risk of having to pay the producers for transporting the gas if prices dip back below $2.50. That’s how much it costs to move the gas from the North Slope to market.

The West Coast market price of natural gas on Friday was $5.77 per thousand cubic feet.

COMING MONDAY: Other points of contention in the governor’s plan

Staff writer R.A. Dillon can be reached at (907) 463-4893 or rdillon@newsminer.com .