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Halcro's right about AGIA, but still wrong on Alaska's natural gas line

Andrew Halcro recently responded to my commentary that pointed out the state has the right, as a landowner, to demand natural gas be sold to third party companies on the North Slope. Mr. Halcro also criticized Fairbanks Daily News-Miner columnist Dermot Cole's opinion that we should understand any conflicts of interest the North Slope leaseholders have in taking Alaska LNG to market.

Mr. Halcro and I lay out two competing visions for how to get a gas pipeline built. Mr. Halcro does a good job articulating the case for "fiscal certainty," which is the North Slope leaseholders' position that for them to commercialize Alaska gas, the state must largely forgo its role as a regulating government in favor of it becoming a contractual partner. Although "fiscal certainty" is multi-faceted, its core is for the state to surrender its taxing power in favor of contractually defined government take on oil and gas, and to give up much of its regulatory oversight. This includes not only a large reduction in state taxes on oil, but amending our constitution such that our revenue share cannot be altered by the Legislature in the future. I and others advocate it is not in the state's best interests to do so, and that instead Alaska should exercise its contractual rights and demand gas be sold at the wellhead so that other companies can make the financial commitments necessary to take a gas pipeline forward.

Mr. Halcro specifically critiques my analysis by arguing: (1) The North Slope leaseholders do not have an obligation to sell Alaska gas because they are already producing oil; (2) the state does not have the right to terminate Prudhoe Bay leases for refusal to market gas; (3) regardless of the development approach adopted by the state, we will ultimately have to provide fiscal certainty to the North Slope leaseholders for a gas pipeline to move forward; and (4) AGIA and Gov. Parnell's Point Thomson settlement provide support for his position.

The first and second arguments are incorrect. The duration of an oil and gas lease is so long as there is economic production, which is the case for Prudhoe Bay due to oil. However, current production does not excuse a lessee (tenant) from further development and marketing activities, and the law specially protects the lessor (landlord) in such situations. One treatise typically explains oil company lessees have, among others duties, the implied legal obligation to continue exploring after initial production, reasonably develop the lease, market the product, and continually and diligently conduct all operations on the leasehold that affect the lessor's royalty interest. Specifically, the implied covenants require a lessee to develop and market gas, or additional oil, even if a leasehold is currently in production.

And does that include an obligation for BP, ExxonMobil and ConocoPhillips to sell gas to third parties? Of course it does. The Arkansas Supreme Court holds, "Once the lessee-producer drills a well resulting in the commercial production of natural gas on the leased premises, the lessee-producer has the immediate duty to market the gas. In order to market such gas effectively, it is the custom of the industry and is usually necessary for the lessee-producer to sell the gas under a long-term gas purchase contract." Or the Oklahoma Supreme Court: "[A] producer has a duty to market the gas. In order to market gas it is usually necessary to enter into a gas purchase contract – frequently a long term one ... We have recognized this necessity of the market and we believe that lessors and lessees know and consider it when they negotiate oil and gas leases."

The consequence of a lessee refusing to market gas at the wellhead is understood. Article XIII, section 8 of the Alaska Constitution requires that, "Leases ... shall provide ... for forfeiture in the event of breach of conditions." Consequently, our leases (clause 34 of the DL-1 lease form) provide that a failure to comply with the implied covenants result in forfeiture of the leasehold. For leases in production, our leases say forfeiture occurs by judicial decree with the lessee retaining such wells in which it is not in breach. This is a normal remedy, and one that actually understates a lessor's right to forfeiture as interpreted by the courts in the circumstances of a refusal to market gas. As one treatise states, "If the lease contains an express provision for forfeiture ... there would seem to be no doubt that the lessor is entitled to declare a forfeiture for breach of the implied covenant to market[.]" There are many nuances relating to how forfeiture occurs, but make no mistake even when such a remedy is not express, courts will decree forfeiture to prevent a lessee from subordinating the landowner's financial interests to its own purposes. And to preempt the next argument, the aggregating of leases into a producing oil and gas unit does not change that outcome.

Addressing Mr. Halcro's fourth point, we appear to be in agreement that the award of a license to TransCanada under AGIA was a waste of time and resources. The intent of AGIA was, similar to what I advocate, to circumvent the demands of the North Slope leaseholders for fiscal certainty. However, AGIA provided no clear mechanism for either fiscal certainty or state control. To compound that error, the state picked the wrong partner pursuing the wrong project. The consequence of TransCanada being selected, in combination with Gov. Palin and her team leaving government and Gov. Parnell's team taking over, is that we are saddled with a reluctant champion that is unwilling to aggressively advocate the state's interests vis-a-vis the North Slope leaseholders. (Mr. Halcro also mentioned Point Thomson, but because I am involved in related litigation I will not discuss it here).

That leaves us with Mr. Halcro's third point, his realpolitik thesis that, notwithstanding the North Slope leaseholders' legal obligations or the market interest from other global companies, "without negotiating fiscal terms with gas producers any project is a non-starter." That certainly reflects the opinion of the Murkowski and Parnell administrations, as we'll see in upcoming legislative sessions when Governor Parnell brings forward a modified version of Governor Murkowski's stranded gas development act contract for ratification. However, I think it highly unlikely that such a deal, unpalatable in 2006, will be acceptable to the Legislature or the Alaskan people when ACES and a rise in oil prices has subsequently doubled state take on oil from $4 billion to $8 billion. The alternative I suggest, and the one contemplated by the law, is for the state to demand sale of natural gas at the wellhead to companies that are not trying to leverage gas pipeline development to force reductions in oil taxes.

Finally, addressing Mr. Halcro's critique of Dermot Cole's article, I believe there is little about Mr. Cole's opinion that is objectionable. Mr. Cole suggests that the state needs to understand potential conflicts BP, ExxonMobil and ConocoPhillips have in bringing Alaska's gas to market. In particular, ExxonMobil has an interest in liquefaction capacity of approximately 65 million tonnes per annum, which is over 25 percent of global capacity of roughly 240 million tonnes per annum. Thus ExxonMobil, through its relationship with Qatar and others, has a strong economic interest in ensuring LNG prices to Asia remain tied to the price of crude oil. It is unlikely Qatar will allow an Alaska project -- which can deliver gas to Asia cheaper than the Middle East -- to move forward if it puts pricing pressure on Qatar's gas. This point is driven home by ExxonMobil's recent announcement that its proposed export facility out of Texas includes Qatar as its project partner, a move that ensures Qatar has a say in how LNG from the Lower 48 is priced when it enters global markets. It is simply good business to understand how the North Slope leaseholders' decisional process is impacted by these competing financial interests.

Craig Richards is a life-long Alaskan who grew up in Fairbanks, and now practices oil and gas law in Anchorage at Walker and Richards LLC.

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.