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Petroleum News: Major players ask for contract changes

State receives substantive critiques of proposed gas line fiscal contract from oil and gas companies, Doyon, North Slope Borough

By Kristen Nelson
Petroleum News

Comments on the proposed gas pipeline fiscal contract negotiated by the administration of Alaska Gov. Frank Murkowski with project sponsors BP, ConocoPhillips and Exxon Mobil are posted on the Web, http://commador.ursokr.com/, and include a number of substantive comments (see story on Anadarko Petroleum’s comments on page 1 of this issue).

The gas pipeline is not opposed in the sampling of those comments Petroleum News looked at, just provisions of the contract.

Issues range from Doyon Ltd.’s concern about exclusion of Interior gas basins from the contract to Tesoro’s belief that the contract doesn’t deal adequately with access for in-state gas needs.

The North Slope Borough does not think the payment in lieu of taxes negotiated in the contract will adequately replace its present taxes and wants North Slope impacts of natural gas development addressed.

Chevron, which holds a 25 percent stake in Point Thomson gas, wants the opportunity to own part of the pipeline, and told the state it is ready to sign the fiscal contract.

Shell, a major leaseholder in federal Beaufort Sea waters, believes access and expandability must be modified.

Shells concerns are shared by BG Alaska E&P, a major international gas exploration and production company — and a partner with Anadarko Petroleum in Brooks Range Foothills and eastern North Slope acreage.

Both Shell and BG believe the gas pipeline may require substantial expansion: Shell mentioned a parallel pipeline and BG said expansions that will more than double initial capacity may be needed.

Doyon Ltd.

A gas pipeline to take “Alaska’s immense natural gas reserves to market will be critically important to the long-term economic welfare of Doyon, its shareholders and all Alaskans,” Doyon Ltd., a regional Native corporation, said in comments on the draft Stranded Gas Development contract.

But the focus shouldn’t be just on North Slope gas.

Doyon owns more than 12.5 million acres in Alaska’s Interior — more than 1.8 million acres of that in the Yukon Flats area — and wants portions of the contract limiting a uniform upstream fiscal contract to north of 68 degrees North Latitude eliminated. It said government studies have indicated recoverable thermogenic natural gas could be 5 trillion to 15 trillion cubic feet, and while biogenic natural gas has yet to be assessed it “also could be significant.”

Doyon said it also has interests in the Nenana basin, some 50 miles from the proposed pipeline route, where as much as 3 tcf to 5 tcf of gas may be recoverable.

The corporation noted that the state cited “significant gas resource potential” in Interior basins as a reason the pipeline will need to be expandable in its December 2004 comments on the Federal Energy Regulatory Commission’s proposed open season rules.

“It seems counterproductive,” Doyon said, for the state to recommend that FERC’s regulations encourage Interior development, “… while at the same time adopting a uniform upstream fiscal contract that places explorers in those basins at a competitive disadvantage.”

Tesoro Alaska Co.

Tesoro Alaska Co., in comments authored by Gene Burden, Tesoro Corp.’s senior vice president, government relations, thanked the governor for “efforts to get a gas pipeline built” and called the gas pipeline “a critical infrastructure project” for the future of Alaska. Tesoro, which has a Cook Inlet refinery, is the third largest industrial user of natural gas in the state, Burden said, “consuming and processing slightly less than 4.4 bcf (billion cubic feet) of natural gas per year.” He said continued availability of fairly priced natural gas “is critical to Tesoro’s Kenai refinery, as well as to the future of value-added manufacturing in Alaska.”

Tesoro wants the Regulatory Commission of Alaska to have a role, along with FERC and private contracts, to ensure that the pipeline provides gas for Alaskans. “FERC’s regulatory policies have not historically responded to the unique circumstances of Alaska, encouraged open access for third-party producers” or encouraged development of the state’s natural resources, he said.

Burden said that without changes in the contract, “there is also a significant risk that important matters impacting the gas pipeline that are not subject to federal regulation will also not be subject to any regulation.” The state’s ownership interest, he said, “is not a substitute for an adequate regulatory structure.”

Tesoro also asked for modification of the contract to clarify how interstate and intrastate transportation rates will be set for both initial and expansion capacity. “Rate litigation before the FERC is expensive, uncertain and unnecessary,” Burden said, and the state has the opportunity to clarify the contract “to minimize or foreclose such rate litigation.” Treatment of previously used assets, rolled-in or incremental rates and determination of mileage sensitive rates are all areas Tesoro would like to see clarified. On the in-state mileage rate, wording in the contract that in-state deliveries “may not result in ‘stranding of capacity, ‘shifting of cost responsibility,’ or reduction in existing ‘shipping commitments outside of Alaska’ … appear to create economic disincentives for transportation of natural gas for use in Alaska,” Burden said.

North Slope Borough

Mayor Edward Itta of the North Slope Borough said the borough believes natural gas development “will require a vast new layer of infrastructure” on the North Slope — not just the gas pipeline and the gas treatment plant, but “an entire collection of upstream projects to develop the reserves that will feed the gas pipeline.”
The borough needs to be treated as an essential partner in the contract, Itta said. “We may not have our signature on the stranded gas development contract, but we are a party to the agreement. The contract provisions must recognize in their substance that the project starts in our backyard. It must recognize that the North Slope Borough and its people will be uniquely impacted socially, culturally, financially and environmentally.”

The borough wants to be “a good and active partner,” he said, acting promptly to issue local permits for gravel, dredging, disposal of excess fill and other project needs. “We want to be able to sit down and work out solutions in an office, not a courtroom.”

The contract replaces the borough’s current taxation, but “does not hold us harmless and it does not recognize the increasing level of impacts we face for the next several generations because of this project.” Itta said the replacement of the borough’s historic method of taxation with the contract’s payments in lieu of taxes does not leave the borough unharmed, and makes the borough “the only municipality that is slated to sacrifice revenues to make the gas line happen.”

The contract precludes targeted taxes, defined as a tax that generates 20 percent or more of its income from the industry. “The 20 percent rule effectively means that essentially all forms of NSB taxes would be ‘targeted taxes’ because of the overwhelming influence of oil and gas spending” in the borough, Itta said. He also said that while the contract grandfathers all municipal taxes in place Oct. 1, 2005, the borough’s sales tax agreement with the producers was not grandfathered in the contract, although it was in place on that date, costing the borough $5 million a year. The exemption of certain oil and gas property from property taxation — replaced with payment in lieu of taxes — reduces the amount the borough can spend on education, forcing a 37 percent reduction in the borough’s school district budget, he said.

And because the contract exempts oil and gas property, the borough’s “assessed valuation ratios will change dramatically as a result of the oil and gas property exemptions,” which could affect the borough’s bond rating “and even cascade into the bond ratings for the state and other Alaska municipal governments.”

Itta said the borough does not receive the value of “hundreds of millions of revenue dollars that are deferred during the early years of the project” and which are “supposed to be paid back, with interest,” even looking out 30 years. The throughput basis for determining the value of oil and gas properties in the contract is based on data that is now out of date, he said, and throughput appears to have been based on the Department of Revenue’s fall 2005 production forecast, while in the spring 2006 forecast the department “acknowledged its past over-estimations” of production.

In addition to detailed issues with payments in lieu of taxation, the borough said the contract does not protect the Inupiat way of life, and Itta called for amendments to both the contract and Alaska statutes.

Chevron

The gas fiscal contract will only work for Chevron if Chevron is included as a party to the contract prior to its execution.
The uniform upstream fiscal contract, proposed to include non-gas pipeline owners in the upstream benefits of the fiscal contract, is “proposed legislation” which the Alaska Legislature may or may not adopt, Vince LeMieux, manager of Alaska new ventures for Chevron North America Exploration and Production Co., said in comments on the contract.

He said “any suggestion that the UUFC will serve to address Chevron’s concerns constitutes wishful thinking and is so speculative as to be irrelevant as a possible remedy to Chevron’s concerns.”

LeMieux said that while the current structure of the fiscal contract “may build a conducive environment for encouraging gas development … it appears to go against the spirit of the SGDA to exclude parties such as Chevron that are able and willing to take investment risks to further gas development and not provide the same conditions that other similarly positioned operators receive.”

He said Chevron needs “clear assurances” in the contract that all parties intending to produce gas off the North Slope will have equal access to both tax and fiscal provisions of the contract and “the opportunity to acquire an ownership interest in the gas pipelines and related facilities.”

Point Thomson is of particular concern as it is part of the contract and Chevron has a 25 percent interest in the Point Thomson gas reserves. LeMieux said Chevron needs assurance that each of the Point Thomson owners will be able to participate in the open season process “without assuming risks disproportionate” to those assumed by the gas pipeline sponsor group.

Chevron believes the fiscal contract, as written, “has the potential of creating two classes of gas producers on the Alaska North Slope,” the producers who execute the contract and all other North Slope gas producers, he said. Creating two such classes would violate the uniform application clause of the Alaska Constitution, LeMieux said, disadvantaging Chevron at Point Thomson, in Brooks Range Foothills’ leases and in any future state lease sales.

The development of Alaska North Slope gas is “an important purpose,” he said, but the contract would result in infringement of the open access values in Article VIII of the Alaska Constitution.

The simplest solution would be to include Chevron in the contract. “Chevron hereby unequivocally states that it stands ready to ratify and execute the May 24, 2006, draft contract,” LeMieux said. Or, the contract could be modified so that Chevron and other parties who are similarly situated would receive the same status as the project sponsors.

Shell

Shell supports the development of a North Slope gas pipeline, Marvin Odum, Shell Energy Resources Co.’s executive vice president of exploration and production for the Americas, said in comments on the proposed gas contract, but believes access and expandability must be modified, and that the contract can be improved to protect the interests of new explorers and better promote the state’s interests in promoting new development. Shell has recently returned to Alaska and established a large position in federal outer continental shelf exploration acreage in the Beaufort Sea.

New explorers and non-owner shippers must have “reasonable access to pipeline capacity,” he said, and the pipeline should be designed in anticipation of future expansion. The right of way needs to be of adequate width and environmental assessment needs to “pave the way for future incremental compression facilities, pipeline looping and/or a second parallel pipeline.”

Odum also said the project should have reasonable terms for future expansion including “a presumption of rolled-in rates and mechanism for requiring and advancing the timely completion of expansion.”

The minimum expansion capacity should be 6 billion cubic feet per day, he said, given the state’s “vast reserve potential.”

Where not regulated by FERC, facilities should be regulated by the Regulatory Commission of Alaska, and “new explorers need access to existing and newly constructed upstream facilities” which delivery gas to the pipeline, with “reasonable and fair terms” of access to the facilities to prevent facilities duplication. The project description should include the transmission line from Point Thomson to the gas treatment plant and any future upstream feeder lines, such as from the National Petroleum Reserve-Alaska, should be part of the project and subject to FERC regulation.

BG Alaska

Martin Houston, president of BG Alaska E&P Inc., said BG supports the contract as essential to develop a gas line, but has concerns about “provisions designed to ensure third party access to expansions of the initial pipeline configuration.”

BG signed a participation agreement with Anadarko Petroleum and Petro-Canada in February for a 33.33 percent equity share in 2.1 million acres of land in the Brooks Range Foothills, acreage which is believed to be gas prone, Houston said. BG has also signed an exploration agreement with Anadarko for a 40 percent share in 208,000 acres of land on the eastern North Slope near Prudhoe Bay.

BG said Section 8.7 of the contract “contains a number of flaws” which may prevent the state from promoting third-party access to expansion capacity. Because the sponsor group — as pipeline owners — has different interests than the sponsor group as producers, they may be in competition with expansion shippers.

Houston said third-party access to expansion capacity could be limited under Section 8.7 because the section does not require the sponsors, “even if all preconditions are met, to expand the project.” All that is required is submission of an application to FERC. He also said the expansion obligation applies only to the midstream elements, but not to the entire project.

BG also said the five-year frequency with which the state can compel expansion is ambiguous — does it apply only to the expansion of one midstream element? And “it is not clear what commercial purpose the five year moratorium serves, except to erect an impediment to expansion.”

Houston said “the legitimate commercial rationale behind” imitations on the size of an expansion in Section 8.7 “is unclear.”

As for the 100-mile limit on looping, he said it “seems at odds with the behavior of pipelines that have normal commercial motivations. As long as the reasonable prerequisites to expansion are met, i.e. creditworthy shippers are willing to sign long term agreements that pay for the expansion, an ordinary pipeline is typically willing to construct as many miles of loop as are required. Given the magnitude of this project, and the fact that expansions that will more than double the original capacity will probably be necessary for Alaska’s gas resources to be properly exploited, the 100 mile loop limitation is an indefensible constraint on expansion.”

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