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Halcro responds: Alaska natural gas and 'the strength of my arguments'

Andrew Halcro

An op/ed I penned last week on Alaska’s efforts to secure a natural gas pipeline has drawn fire from two respected sources that disagree with me. So just how strong are my arguments?

The first shot came from Fairbanks Daily News Miner columnist Dermot Cole, after my column was published in the Golden Heart City’s daily newspaper. He asserts that we shouldn’t be distracted by the “simple argument about what might fly in court and focus on the larger issues.”

That’s impossible. You cannot simply ignore the lessors' legal protections and think you’re going to be successful in extracting commitments needed to build a projected $20 billion LNG line to Valdez. This is about contract law, not populist politics.

To quote Clint Eastwood, “A man has got to know his limitations.”

Cole, while advocating looking past the legal issue of what the state can or cannot force, said Alaskans should tackle the larger issue like how a “dense thicket of commitments around the world,” will prevent an Alaska gas project from ever coming to fruition.

However, the dense thicket in another word is the global economy, and it’s never going backwards in time. Unlike three decades ago when the producers built the Trans Alaska Pipeline, today global opportunities are abound and resource extraction terms are more competitive. The producers have consistently made this point clear to lawmakers for the last five years as lawmakers passed an asinine gas pipeline plan and a record tax hike on the industry.

During both of those debates, many of us spoke loudly about Alaska having to compete in the global market place and the idea that ignoring market conditions would harm Alaska’s future. But lawmakers stiff armed the warnings, and proceeded to adopt oil & gas policies that make Alaska no longer viable within the dense thicket of opportunities that the producer’s have worldwide.

Cole then proceeds to argue that the Alaska project is not a stand alone project and we should have more information about how the producers portfolio of global projects influences the eventual outcome of an Alaskan project.

By all measures, an Alaska natural gas pipeline will be one of the most, if not thee most expensive oil & gas project in the world. It will require tens of billions worth of commitments along with accepting the associated risk. It is a stand alone project, as economics and market demands will be the driving force behind ensuring that the 800-mile pipeline will be economically viable. This is a decision that will be made by the legal lessees, not the public or a populist lessor.

With the less expensive geology of completing gas basins in other countries, even the officials from the Federal Energy Resource Commission testified that arctic gas was the most expensive to extract. This is a stand-alone project, in fact there is specific federal legislation that dictates governance of an Alaskan gas pipeline that was passed by Congress back in 2004.

On one hand, Cole’s belief that competing projects impact Alaska’s natural gas pipeline hopes is true.

But then again, during the ACES and AGIA debate few wanted to consider the politics and actual economics of other regions. Nobody cared how Alaska’s tax policy would intersect with the industry on a global scale. The decisions advocated by lawmakers and the Department of Revenue back in 2007 threw economics out the window while saying AGIA was the best way to get alignment for Alaska’s gas.

Now after ignoring the producer’s warnings, and saddled with AGIA being a massive $500-million loser, we are now going to demand information on how we rank in the global queue of natural gas projects? Where was this due diligence before we adopted AGIA?

Oh wait, they did run the economics during the AGIA sales pitch and the Palin administration concluded a gas pipeline was “wildly profitable,” at any price.

In 2008 when AGIA was passed, the price of natural gas topped out at $12 per unit. One year later the price had dropped to below $3 per unit. As a result, the state has lost any credibility to pronounce what is economically viable for the producers.

And while some might fall back on the old argument that producers operate in far less stable countries and whose continued operations rest in the hands of dictators or emirs, you cannot ignore the fact that Alaska lawmakers have claimed their own pound of flesh over the last five years. We’ve proven you don’t need an Emir to retroactively raise taxes and threaten to take back leases on working oil fields.

The tone of Cole’s column is more frustration than anything. Fairbanks continues to suffer through crippling heating costs and the refusal of public policy makers to be honest with Alaskans have fueled the fire of misinformation. Lawmakers and pundits have continued to sell the public on the idea that getting gas to market is just as easy as exerting state control. While that might be an argument that plays well with the uninformed, it’s false, plain and simple.

Without negotiating resource extraction terms with the legal leaseholders, the debate will continue to be relegated to blogs and newspaper opinion columns, with no substantive progress on a gas pipeline.

The second critic of my position on Alaska’s gas pipeline strategy was Craig Richards, a local attorney who specializes in oil & gas issues for an Anchorage law firm. His firm also represents the City of Valdez, who has spent vast amounts of taxpayer money to try and push the pipeline terminus to their city.

The takeaway from Richards’ criticism is that I’m wrong and the state has far more power to force a pipeline into being. In supporting his position he cites legal precedents from Texas and New Mexico. However his interpretations of the producer’s lease agreement and the court cases from other jurisdictions are incorrect.

In the Texas Supreme Court case, the court ruled, “Without the exercise of reasonable care to market the gas, there could be no compliance with the assignee’s obligations to proceed with the development reasonable and necessary to bring the lease to a normal stage of development.”

In the New Mexico Supreme Court case, the court ruled, “Obviously production without disposition of the product is futile. Thus the courts have developed the implied covenant to make diligent efforts to market the production in order that the lessor may realize on his royalty interest.”

In both cases, the courts ruled similarly that the refusal to develop the resources by the lessee does an injustice to the lessors right to realize royalties. That’s understandable, but it’s not applicable to Alaska’s North Slope.

The cases Richards cites revolved around lessees that were dragging their feet and refusing to develop reserves. Not one of the cases had to do with the lessee who was already developing over 580,000 barrels of oil per day, which more than meets their legal obligations under their hydrocarbon leases. Even the Alaska Oil & Gas Conservation Commission has testified that the producer’s are honoring their lease agreements to the letter of the law.

And while Richards’ argues that, “The law recognizes the problem and provides the remedies of damages for lost royalty and equitable termination of the lease,” again it’s not applicable to oil & gas development on the North Slope.

There are no lost royalties to the state treasury because the producers continue to produce millions of barrels of oil, all with royalties paid to the state. For an industry that has paid $0.90 out of every dollar the state spends for decades, any argument that the state is missing out on royalties, or production taxes for that matter, is fatally flawed.

In addition, there is no way the state would be able to terminate the producers leases. For once and for all, lets put an end to this fictitious idea that the state has the legal right to cancel Prudhoe Bay leases.

It reminds of a bit Johnny Carson once did after a very public and expensive divorce. While discussing a hard to believe current event in his monologue, Carson quipped, "it's about as likely as seeing my ex-wife in the day old bread line."

Think about it, if the state couldn’t take back the Point Thomson leases, just how likely is it they’d be able to take back Prudhoe Bay leases that host billions and billions worth of infrastructure that is currently producing oil? Not bloody likely.

The final point made by Richards is that “Asian buyers are willing and able to purchase North Slope gas at the wellhead and finance the construction of a gas pipeline and LNG export facilities. If ExxonMobil, BP and ConocoPhillips continue to refuse to allow Alaska’s gas to go to market in order to extract financial concessions from the state on oil, we should exercise those remedies.”

This again, ignores the fiscal and legal realities of a twenty billion dollar LNG project and the producers legal obligations under their leases.

Even if Richards’ is correct, and Asian markets are interested in Alaska’s natural gas for the long run, you still have to negotiate royalties and taxes with the companies producing the natural gas. In 2007, immediately after AGIA was introduced, former oil and gas director Ken Boyd put it best. “Sooner or later you are going to have to deal with the producers,” he told the Anchorage Daily News just days after AGIA was introduced to the state legislature.

Boyd wasn’t the first person that voiced that fact, and he won’t be the last. The CEO of TransCanada said the same thing both in a letter to former Governor Frank Murkowski in 1996 and then again after his company was awarded the AGIA license and a $500 million subsidy. “Nothing moves forward until Exxon is happy,” said Hal Kvisle, CEO of TransCanada.

While I’ve written about the four gates that must be cleared in order for the producers to move forward on a gas line, they’re worth repeating.

The first gate is the capital cost.

How much is constructing the project going to be? This is one of the reasons AGIA and the current LNG strong arm move are dead on arrival. The producers have already said they’d require ownership of any pipeline so they can mitigate their risk during and after construction.

The second gate is the estimated price of the commodity or in this case natural gas.

While prices have declined significantly in the United States, Asian markets have held a much higher price. But for how long is questionable. A recent summit in Tokyo highlighted the anger over the cost Asian countries are paying for LNG.

“Asian buyers of LNG stated that the premium they pay over natural gas prices in Europe and North America is no longer rational, fair or reflective of supply and demand fundamentals for LNG,” reported natural gas researcher Bill White in his September 28, 2012 article.

The third gate is the reserves and deliverability of gas to put in the pipe.

Producers have testified they need all of the gas at Prudhoe Bay in addition to Point Thomson in order to meet the reserve threshold necessary to consider financing a natural gas pipeline.

The fourth gate is the government take.

How much will it cost producers to extract the resources from the ground and get them to market? Even if Asian buyers say they wanted every drop of Alaska’s natural gas, the state would still face negotiating with the producers on fiscal terms such as production taxes and fiscal certainty.The producers would be foolish to succumb to public and political pressure on a $20-billion LNG pipeline based on a snap shot of prices, when target market countries are entering a phase where they will be able to pit one LNG seller against another to achieve a more favorable and realistic price.

“Eventually, it comes down to the big producers. ExxonMobil, ConocoPhillips and BP are the ones most likely to hold the shipping commitments, so whatever kind of project is put together has to be one that works for the producers," said Kvisle of TransCanada.

In the end it makes no difference if you’re promoting the stub hub, the instate bullet line, the Canadian route or the LNG route, without negotiating fiscal terms with gas producers any project is a non-starter.

I understand Messrs.’ Cole and Richards frustration, but I’m also aware that too many policy makers are creating unrealistic expectations with their constituents for a natural gas solution that’s still a decade away.

During the 2006 gubernatorial campaign, in an interview with Amanda Coyne writing for the Anchorage Press, she crystalized my gas pipeline belief. “Halcro talks about a gas line, too -- but as often as not he says it's just a speck on the horizon, and a way to avoid talking about more responsible ways to pay for police and roads and schools as we wait for someone to build one.”

Six years later and we’re still a long way from laying pipe.

It’s time to quit filling Alaskans with false hope and start being honest about what must happen before the first piece of steel is ordered.

Andrew Halcro is the publisher of AndrewHalcro.com, a blog devoted to Alaska issues and politics, where this commentary first appeared. He is president of Halcro Strategies and Avis/Alaska Rent-A-Car, his family business. Halcro served in the Alaska House of Representatives from 1999 to 2003, and he ran for governor in 2006 as an Independent.

The views expressed here are the writer's own and are not necessarily endorsed by Alaska Dispatch. Alaska Dispatch welcomes a broad range of viewpoints. To submit a piece for consideration, e-mail commentary(at)alaskadispatch.com.