Compass: AGIA has long been lost cause, and we may keep paying for it

The Parnell administration's recent announcement that it wants to void the AGIA (Alaska Gasline Inducement Act) license underscores what was obvious long ago: AGIA will fail to advance a North Slope natural gas pipeline.

This should not come as a surprise. AGIA was conceived in commercial misconceptions by the Palin administration, and could result in the largest waste of state money in history.

AGIA conveyed incentives from the state, reimbursements up to $500 million for expenditures to try to get a FERC certificate ($300 million paid so far), in exchange for certain performance requirements. It was not for want of $500 million that a $40 billion project did not proceed. The market was not feasible. Had it been, AGIA would have been unnecessary.

The Palin administration did not want producers to own the pipeline. Despite federal law to the contrary, it believed producer ownership could create higher tariffs, and limit access for non-owners. Instead, it preferred a third-party pipeline not owned by producers. So it structured the requirements to favor third-party pipelines.

Financing of gas pipelines requires shippers' long term contractual commitments to pay to transport gas. These shippers are the gas producers. The problem with AGIA performance requirements was that they created a misalignment of interests between producers who actually pay the cost of the pipeline through the tariff, and the pipeline company.

• Existing shippers would subsidize new shippers' expansion capacity.

• The pipeline company would make money off producers on cost overruns.

• Planning costs would be back-end loaded, increasing overrun risk.

• The pipeline company would be motivated to place gas in its own infrastructure even if less expensive alternatives were available

The Palin administration justified its bias with a flawed financial analysis claiming a third-party pipeline project would have a much higher rate of return than producer-owned: a whopping 30 percent at $3.50/mmbtu Lower 48 prices.

Who owns the pipeline makes no difference in the return. In the case of third-party pipelines, the economic effect of the long-term commitment is similar to ownership. Economic outcome depends on underlying inputs, cost and price, which are the same regardless of ownership.

The administration hailed the project as "wildly economic" and "solidly in the money." Yet Lower 48 prices have been above $3.50/mmbtu. If what it had said was true, the project would be economic now.

All of this was evident before the license was awarded. In 2008 the state opened the AGIA process to the world for bids. Of all producers, pipeline companies, and other entities, it received five bids, four of which were deemed non-responsive. Three bidders had virtually no assets. In other words, just one bid was received (from the eventual licensee, TransCanada, desperate to fill its Canadian pipelines). The world saw these problems for what they were.

TransCanada held an open season in 2010 to try to get commitments. It predictably failed. Afterwards, AGIA compelled the state to pay 90 percent of the costs to try to get a FERC certificate for a non-project. FERC has never granted a certificate without commitments. Currently through AGIA the state is 90 percently subsidizing the producers' feasibility studies for an LNG project, probably violating the statute.

If the licensee does not want to abandon the license, the state can only void it by showing the project is uneconomic. The legal criteria for this in AGIA are very ambiguous.

AGIA may continue to drain public coffers. The Palin administration dropped in a poison pill that makes it very hard for the state to get out: treble damages. If the state cannot void the license, but needs to help another project with tax restructuring or financial aid, the state has to pay the licensee three-times what it has spent. The language in AGIA indicates this may mean three times gross expenditures, which would be $1.6 billion in potential damages. Or the state could unnecessarily keep TransCanada involved, with limited utility and additional cost.

The expensive lesson is economics trumps politics, as it will as the producers contemplate risking billions of dollars for the project.

Roger Marks is a petroleum economist and since 2009 has been a consultant to the Alaska Legislature on North Slope gas commercialization and oil and gas tax issues. He was a longtime senior petroleum economist with the Tax Division of the state Department of Revenue.