A Citizen’s Guide

Part 2 of 2

JUNEAU—Gov. Frank Murkowski says state participation is the best way to entice Alaska’s major oil companies to build a multibillion dollar gas pipeline from the North Slope to markets in Canada and the Lower 48.

Murkowski maintains that the 45-year contract he says he’s negotiated with Exxon Mobil, BP and ConocoPhillips will revive oil production on the North Slope and bring Alaska jobs, new industry and upward of $70 billion over the life of the contract.

• Public has chance to weigh in this week

• List of gas line events

The plan includes separate legislation that would overhaul the state’s oil taxes, which Murkowski says would be rolled into the contract to provide the companies a long-term guarantee that their tax liability to the state won’t increase.

The governor is betting his legacy on getting the Legislature to agree.

Many lawmakers, though, are wondering whether the state is assuming too much of the risk in the gas agreement with no guarantee the pipeline will ever be built.

North Pole Republican Sen. Gene Therriault, chairman of the Joint Legislative Budget and Audit Committee and the Senate’s point person on the oil tax and the gas agreement, says he’s approached the contract cautiously since it was unveiled May 10, because of concerns that it ties the hands of future Legislatures to set taxes.

“I share the concern that has been expressed by many over locking the fiscal terms of the contract in for such a long time,” he said.

Therriault is among a growing group of lawmakers who say the contract contains a number of potential pitfalls that could cost the state treasury billions.

Pipe dreams?

The contract contains no start date for construction and only requires the producers to advance the project as “diligent as is prudent under the circumstances.”

Pedro van Meurs, Murkowski’s top adviser on oil and gas, maintains it would be impossible to set an exact start and finish date on a project of this size. Nevertheless, he says the contract provides sufficient security that the project will be completed.

If lawmakers sign off on the contract, the companies would have 90 days to start work on determining whether the project is feasible. They would eventually be required to spend no less than $125 million toward determining the feasibility.

But whether they move forward diligently could be difficult to prove since, under the current version of the contract, the state would surrender its sovereign right to take the companies to court.

“There’s no hard start date and all the protections we currently have are removed by this contract,” said Rep. Eric Croft, an Anchorage Democrat and candidate for governor this fall.

Under the timeline laid out in the contract, the companies would complete engineering and other studies in the next two years—a process that’s expected to cost $1.2 billion, of which the state would have to contribute up to $300 million—and then hold what is called an “open season sale” for future shippers to book capacity in the pipeline.

The participating companies would then apply for the necessary federal and Canadian permits to build the pipeline—a process that is expected to take another two years and would include settling disputes with Canadian First Nation groups on right-of-way issues.

“Once you have all that in place,” van Meurs said, “the risk is probably less than 1 percent that the pipeline won’t be built.”

With the permits in hand, the companies could then order the 6 million tons of steel needed to build the massive line. Construction could start by 2012 with the first gas flowing by 2015, said Ken Konrad, a vice president of natural gas at BP.

“The scale of this project in materials and labor presents a huge logistical challenge,” he said.

Rep. Les Gara, D-Anchorage, an outspoken critic of the contract, argues the work commitments in the contract are too weak to be effective. He says the contract could effectively force the state to wait until all three companies are ready to build a pipeline, though others disagree.

“You want a contract that forces the companies to lay pipe,” he said. “A lot of the provisions in this contract seem to let them not build a pipeline.”

The state’s only recourse in case the producers drag their feet is to terminate the contract. To do that, the state must submit to binding arbitration and provide “clear and convincing” evidence that the producers have not been diligent.

The state couldn’t cancel the contract because of “errors in judgment,” delays caused by the Canadian regulatory process or First Nation land disputes.

The producers, however, could drop out simply by notifying the state 60 days in advance. If they do so after the contract is signed, the companies would forfeit all oil and gas leases on the North Slope.

“Companies have the right to withdraw from the pipeline like any other investor,” van Meurs said. “But if they withdraw, they leave everything on the table.”

If a company wants out of the project, it would simply find a buyer for its portion, van Meurs said. The new company would be bound by the contract to complete the pipeline, thereby providing adequate assurance to the state that the project will be completed, he said.

Tax caps

The three companies say they need to be sure their tax bills won’t go up during the life of the project in order to invest the billions of dollars needed to start laying pipe. But the security they’re asking for goes well beyond levies on oil and gas development.

Under the contract, the companies would receive fiscal certainty on all state corporate income taxes related to the project as well as oil and gas income from Cook Inlet and other potential sources.

The companies’ liability on other municipal and borough taxes—such as sales taxes, severance taxes on gravel, and excise taxes on such items as hotel stays and gasoline—would also be capped, at $4 million during construction of the pipeline and $5 million after completion.

The companies maintain the cap is an arbitrary figure that would never be reached. BP doesn’t even keep track of how much it spends on local sales and bed taxes, Konrad said.

“Only if they become unduly bothersome would we even bother to keep track of them,” he said. “So we don’t expect there to be any need for reimbursement.”

What the cap would do, though, is assure the companies that a community won’t pass new taxes to try to capture revenue specifically from the pipeline.

“The cap is in there basically to prevent abuse,” said Dan Dickinson, a former state Tax Division director and now a Murkowski oil and gas consultant.

A company doing business in a municipality with a 5 percent sales tax would have to spend $120 million to hit the cap. If a company did breach the limit, though, the state would be responsible for reimbursing any excess tax payment.

“The municipalities wouldn’t be penalized,” Dickinson said.

One change that could impact boroughs and municipalities, though, is how they assess property taxes. Instead of taxing the value of the pipeline and resource crossing their land, communities would receive 2.4 cents for every thousand cubic feet of gas that flows through the pipe.

Dickinson said the communities should collect more revenue under the plan, but the actual amount will depend on the federally set transportation tariff, which itself is dependent on the cost of building the line.

“The borough will get more money if there are no cost overruns and our expansion expectations are right,” he said. “But if costs run rampant and there’s no expansion, then the they would get less than what they’d get under the current system.”

Pipeline participants would also be protected against increases of certain local taxes, such as one on ships using the Valdez dock.

That worries House Speaker John Harris, R-Valdez, who thinks his community could lose out on a vital revenue stream if the contract blocks future increases.

“That would obviously foul up the city of Valdez pretty bad,” he said. “I’ve already told the governor I couldn’t accept that.”

Harris questions why the Valdez tax is even mentioned in the contract since the gas line is supposed to follow the Alaska Highway. He says it’s an example of the administration giving away too much in pursuit of a gas deal.

Rep. Beth Kerttula said the state has a track record of not living up to its promises to municipalities. Her concern is that future legislatures could cut tax reimbursement payments to communities in lean times.

“Once we have to pay for the municipal tax,” she said, “we won’t.”

More protection

Under the contract, companies would be protected from all future attempts to increases taxes. Governors, legislators and even the people of Alaska could not demand more for the state’s oil and gas resources.

That includes a proposal on the ballot in November that would tax leaseholders $1 billion a year until the pipeline is built. If the contract is ratified and the initiative passes, the state simply wouldn’t collect the tax. Murkowski says the reserves tax initiative is the biggest threat to the pipeline and one that must be done away with in the contract.

While under the reserves tax companies could recover a portion of the tax in the form of tax credits once gas starts flowing, Murkowski says it’s unlikely the full amount could be recovered, even at high gas prices.

“The reserves tax in itself is a deal-breaker,” he said at a recent news conference. “The expectation of that being accepted by the companies is highly unlikely.”

Anchorage Democrat Croft, one of the sponsors of the reserves tax, says the governor has it backward.

“I think this deal allows Exxon and the other companies to continue to delay,” Croft said. “The reserves tax is the only thing that will hold their feet to the fire.”

The reserves tax isn’t the big question, however. Almost everyone involved agrees the big issue remaining to be settled is whether it’s constitutional for lawmakers to sign a contract that restricts future legislatures from raising taxes.

Many lawmakers say it’s unnecessary given the Legislature’s record—it’s changed tax rates on oil five times in the last 30 years. They also say it’s risky because no one knows how future economic and technological changes will affect Alaska.

“Stripping the Legislature of its future ability to set tax policy and stripping away the ability of the public to modify that policy is a big concern,” said Therriault, the North Pole senator.

Clark says the administration’s attorneys maintain tax rates can be locked in under the constitution, but he acknowledges there will likely be a court challenge on the issue.

“We’re not going to know until the Supreme Court rules and we’d be shirking our duty if we didn’t go forward with the contract,” he said.

If the Supreme Court eventually does throw out the contract, the state would have to return to the negotiating table and would most likely have to give up at least a portion of its take.

“The consequences would be devastating,” van Meurs said. “If it goes down, the companies would immediately argue that they need a much better deal from the state.”

To get a deal for a natural gas pipeline, the administration’s strategy has been to improve the companies’ economics wherever possible without sacrificing the state’s portion of the profits. Central to that strategy has been the ability to guarantee the companies’ that their tax bills won’t increase in the foreseeable future.

In an effort to reach a compromise, Senate President Ben Stevens, R-Anchorage, has spoken with the administration about including a clause in the contract to allow lawmakers to revisit the tax issue during the life of the contract.

Clark said it’s too early to talk about putting a reopener clause in the contract. He said he wants to wait until after the 45-day public comment period that began May 10.

“It’s something we’re going to need to look at, but right now it’s premature,” he said.

Opponents say having one chance or even more to review the tax rate during the contract is a good idea but that what’s been talked about so far—a single reopener after 20 years—is too little, too late.

“That’s the 800-pound gorilla in the room,” said Sen. Gary Wilken, R-Fairbanks. “The producers have to give us something more if we’re going to lock this up for a generation.”

Local impacts

Alaskans are fond of remembering the 1970s as the state’s heyday when construction of the trans-Alaska oil pipeline brought promise and plenty of cash. A bumper sticker that came out after the cash was gone summed up how Alaskans felt about the project: “God, please give us another boom—we promise not to piss it away.”

Murkowski says a gas line will cause another boom, creating substantial revenue for the state and municipalities and thousands of jobs.

A gas pipeline would certainly be a boon for the construction industry, but it could first cost the state and municipalities along the pipeline route hundreds of millions of dollars.

The state Department of Transportation has identified $400 million in roads, bridges and other infrastructure improvements that will need to be built prior to construction of the pipeline and an additional $800 million in cleanup costs after the line is built.

The department estimates an additional $125 million in costs would be incurred by state and municipal governments to cover the added strain on education, health, public safety and other services during construction of the pipeline.

The contract provides for the participants in the pipeline project, including the state, to contribute $125 million to the affected municipalities. But that money would not pay for infrastructure improvements. That’s done through the federal and state departments of transportation.

“We do expect that the state will have to cough up some of that money,” van Meurs said. “But it will easily be made up for by profits from the pipeline.”

As for employment opportunities, critics say the contract provides only weak provisions for making sure Alaskans receive some of the expected 9,300 direct construction jobs on the pipeline.

The contract requires the companies to spend $5 million on training their own management to be sensitive to the need to hire Alaskans, but it falls short of mandating that a certain percentage of jobs go to residents of the state.

Clark says the state cannot force the companies to hire workers locally—previous attempts have been struck down by the courts. But he said the administration is committed to putting Alaskans to work on the project.

“We’re going to have to use the bully pulpit to get them to hire Alaskans,” Clark said.

To prepare, the state has identified $35 million in state and federal funds available for training Alaskans in fields that will be in high demand once construction begins. The Legislature this session approved funding for a pipeline training center in Fairbanks.

Arbitration questions

One of the bigger problems lawmakers say they have with the contract is that it surrenders some of the state’s sovereign rights.

If the state runs into a dispute with the companies, the contract does not permit it to take the fight to court. Instead, the state must submit to binding arbitration in which a tribunal of three would hear the debate and choose from a predetermined set of offers.

Clark says arbitration will avoid the drawn-out court battles the state has repeatedly found itself embroiled in with the oil companies in the past.

“The belief on both sides is that these disputes are taking forever,” he said. “We think arbitration will result in faster resolution.”

He says arbitration is already being used successfully by the Department of Natural Resources to settle royalty disputes with the oil companies.

Critics, however, say the arbitration process is heavily biased in favor of the companies, allowing them greater rights than the state in selecting arbitrators, three times the number of depositions and exemption from arbitration on such issues as failure to move the project forward because of commercial disputes or regulatory issues.

No state oversight

The contract requires the state to protect its pipeline partners against some rulings by the Regulatory Commission of Alaska.

The Federal Energy Regulatory Commission would have oversight of the pipeline and would be responsible for setting the transportation tariffs on gas designated for use in Alaska and beyond.

That’s different than how the trans-Alaska oil pipeline is regulated. Federal and state agencies each set their own tariffs depending on where the oil is bound.

“It’s an opposite world on gas lines,” said Bob Loeffler, a consultant for the state Department of Law. “You practically can’t do anything without approval from FERC.”

Since FERC is expected to have jurisdiction in determining intrastate and interstate transportation charges, the administration agreed to indemnify the companies against conflicting rulings by the RCA, Loeffler said.

Under the contract, the state would reimburse the companies for judgments made against them by the RCA.

Critics of the provision argue that neutralizing the RCA adds even more risk to the state by blocking it from seeking remedy in case the companies overcharge outside explorers for using the pipeline or treatment facilities, which could discourage new investment on the North Slope.

They say if the federal government turns over regulation of the pipeline to the state during the 45-year term of the contract, the state couldn’t effectively regulate pipeline tariffs and terms for expansion.

Those things would instead be done by negotiated agreement.

The RCA has ruled in the past that the companies have overcharged by as much as 57 percent for transporting oil within Alaska.

Gas for Alaska

Under the contract, the state could ask for up to four taps along the pipe where businesses could access gas. While the takeoff points would make it possible to get gas, a municipality or private interest would have to finance any additional needed infrastructure.

Businesses that want to tap into the pipeline to sell gas to local markets will also have to tell the producers how much gas they intend to buy during the open season, which could be just two years from the signing of the contract. If they pass up that first season and hope for a second one, they could face a higher rate.

Rep. Mike Kelly, R-Fairbanks, says businesses are going to have to start work now if they want to take advantage of the pipeline.

“It’s going to be difficult,” he said. “But they’re going to have to find the market in preparation for the open season.”

Van Meurs says the state would most likely expand the pipeline to handle 6 billion cubic feet a day within the next decade, which would provide a second chance for Alaska business to buy gas.

Other issues

The questions over whether the contract is a good deal for the state don’t stop there. Legislators have other concerns:

• While the contract allows companies to sell gas in Alaska, it does not require them to do so.
• The need for an escalator on gas to bring more of the benefit to the state at high prices.
• The need for stronger language prohibiting the producers from building a pipeline over the top of Alaska into Canada.
• The lack of cash for the state and the requirement for the state to go into the business of marketing its gas.

BP’s Konrad says the important thing for Alaskans to remember is that the contract has the potential to double revenue to the state and revitalize work on the North Slope.

“If we can get this gas pipeline built and the right fiscal system in place, we actually set up a 50-year future for Alaska,” he said.

COMING WEDNESDAY: The News-Miner will publish a special edition, “The Citizen’s Guide,” to help readers better understand the debate.

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