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Alaska’s Natural Gas Problem

Dealing with project economics

Larry Persily speaking to the Alaska Municipal League in November 2010.

Larry Persily speaking to the Alaska Municipal League in November 2010.

Photo ©2012 Michael Penn-Juneau Empire

Natural gas burns the same pretty much the world over: about 1 million Btu per 1,000 cubic feet into your home. If the mixture is too rich, your stove will blow up. If it’s too lean, your tofu won’t brown as nicely.

No one really cares all that much where the gas comes from as long as it’s there when they turn on the burner. Unlike salmon, where we can charge a premium price for our product, Alaska’s natural gas smells and cooks the same as Russian gas, or Qatari gas, or Australian gas—or U.S. shale gas.

That leaves Alaska with a problem. We have gobs of a commodity the world is using more and more of every day. But our North Slope gas is far away from potential customers, and costs more to move to market than our competitors’ gas. I’m talking total cost from the wellhead to the burner tip, not just the shipboard expense for delivering liquefied natural gas across the ocean to Japan or a pipeline to Canada.

That cost is what has kept Alaska’s gas from leaving the North Slope for almost 40 years. We would have lost money on every molecule of gas we moved to the Lower 48 or overseas most years during the past decades. Market prices were too low to cover the costs—forget about any profit and taxes.

Our pipeline dream has hit the brick wall of economic reality for years. In fact, Alaskans have been waiting for a North Slope gas pipeline a decade longer than the average resident has been alive.

Actually, that’s OK. The gas has been reinjected to pressure billions of extra barrels of the make-us-wealthy oil out of the ground. That repressurization has been extremely valuable to Alaskans—feeding rich public works spending, the Permanent Fund and state budget surpluses of the past decade.

 

Time to Get Serious

But now it’s time to get serious about channeling some of that gas into a pipeline to ship to customers—somewhere, anywhere. The older North Slope fields are producing much more water and gas than oil as they age; the equipment to process and reinject all that gas is maxed out; and we’d be a more attractive investment opportunity for oil and gas companies if they could sell their gas with the oil.

The pluses of trillions of cubic feet of natural gas flowing to market will far outweigh the minuses from declining oil production in the decades ahead.

The attraction of a gas line is especially big for Shell. Spending perhaps tens of billions of dollars to develop offshore fields would look a lot better if the natural gas could someday turn a profit, too.

I assert it is time Alaska joined the global gas business.

According to a recent study by the University of Alaska Anchorage Institute of Social and Economic Research, half of all jobs in the state are due to the oil and gas industry, either directly or through state outlays financed by royalties and taxes. But North Slope oil production today is running at less than one-third its 1988 peak, and the volume is heading lower. Despite good intentions, there is no evidence to prove the trend will soon reverse itself.

Rising oil prices (and higher taxes) have protected the state from the economic pain of this production decline. Adding natural gas to the mix would help diversify our revenue portfolio just when we might need it most.

But who wants our gas? No, forget that. It doesn’t matter who wants it, just as it doesn’t matter that I want a new car but am unwilling to sign a lease or a loan. More to the point, who is willing to sign binding, take-or-pay, long-term contracts to buy our gas. Such contracts are required before anyone will loan money for the project.

A developer may build a duplex on speculation, without having the units presold, but no one will loan you money to build the most expensive energy project in North American history unless you have paying customers under contract.

 

Project Financing

Cheniere Energy’s proposed LNG export plant at Sabine Pass, La., is a good example of that rule of project financing. Cheniere is looking to salvage its seriously underused LNG import terminal at Sabine Pass by adding a liquefaction operation for exports. But to secure the billions of dollars required to build the plant, it needed customers.

Cheniere has succeeded where Alaska dreams to someday go.

It has 20-year contracts from four buyers for capacity at its proposed terminal. The buyers, from the U.K., Spain, India and South Korea, have pledged to pay for their contracted capacity regardless of whether they use it. Those deals total more than $40 billion in binding commitments to pay at rates roughly between $2.25 and $3 per thousand cubic feet. (There also is an inflation factor built into the contract rate.) That means day in and day out, month in and month out, the buyers will pay Cheniere’s invoice, regardless whether they run any gas through the plant.

With these binding commitments, Cheniere can raise money for construction of the plant to handle more than 2 billion cubic feet of gas a day.

Sabine Pass LNG can be landed in Japan for an estimated $9 per thousand cubic feet total cost if the gas itself can be obtained for about $3 per mcf. The price components are Henry Hub gas prices plus 15 percent to cover gas consumed during liquefaction, $2.25 to $3 for liquefaction and terminal fees, and less than $3 for shipment aboard LNG tankers.

 

Laws of Finance

The Sabine Pass story reflects how the sober laws of finance apply to big gas projects, whether you want to send the molecules to Asia or the Lower 48. Companies—even rich oil companies—select the best opportunities for the limited capital dollars they have to invest. The best opportunities for gas projects will involve customers on binding contracts signed after they have shopped the world for the cheapest price.

Alaskans can’t wish these laws away. The argument in Alaska shouldn’t be whether it’s our gas, or what the state Constitution says about maximizing development of our resources for the people; or why North Slope producers don’t do what we want, when we want and how we want; or whether Canada will steal or tax our gas; or whether it should be a big line, a small line, a bee line to the coast, a straight line to Fairbanks—or, worse yet, a pandering line in a campaign speech.

Those arguments assume Alaskans can dictate what gets built and when, which is possible only if we are willing to pay the bill for a potentially money-losing project without customers.

The discussion should be how much do the state and its residents need and want a gas line, and what are we willing to do to get someone else to write the checks and take the risk so that we can share in the rewards?

First, Alaskans need to accept that we need a gas line. I mean really need it for the decades of affordable fuel it will carry to Alaskans. That would be natural gas for Railbelt communities, and hopefully propane and compressed or liquefied natural gas for everyone else.

Yes, the fuel in a big pipeline project would be affordable.

Alaska would benefit from existing federal and state laws that require what are called mileage-based tariffs. Alaska customers would pay the pipeline costs only for the miles they use and their share of the gas flow. Other customers would pay 95 percent, maybe 98 percent of the construction, borrowing, operating and maintenance costs of a large-volume pipe running through Alaska to serve out-of-state markets, whether East Asia or the east side of Milwaukee.

Second, Alaskans need a gas line for the jobs and tens of billions of dollars in investment it would bring—for the additional barrels of oil that would accompany new exploration and production to keep the gas line in business for decades, especially for all that oil. Alaska is a much more attractive investment play if gas is part of the long-term cash flow for new fields.

Third, after all those good things, Alaska needs the project for tax and royalty dollars, too. No, not nearly as much as oil taxes and royalties, but whatever comes in would be a bonus to the benefits of gas for local needs, jobs, investment, and extending the trans-Alaska oil pipeline’s life.

Fourth, Alaskans need to accept that natural gas is a commodity, just like corn, soybeans and frozen orange juice. Buyers want the cheapest supply they can find. And they will bargain hard to get it, especially when the market is oversupplied and there is a lot of competition among sellers.

 

Best Advice

The best advice I can give is for Alaskans to just deal with it. Not my line, I stole it. Some Navy SEALS visited the Arizona Diamondbacks’ spring training camp last year to help prepare the team for the losses, injuries and problems that inevitably occur during the six-month baseball season. The SEALS told the players to deal with it, just as the Navy teaches the commandos to deal with whatever comes up.

Deal with the reality that we’re not going to get a Nordstrom price in a WalMart world for natural gas.

Deal with the fact that our natural gas isn’t worth as much as we thought it might be.

Deal with the fact that the market is flooded with competition.

Deal with the fact that Alaska will not get stinkin’ rich off gas as it did oil, but we could live a comfortable, warm life with natural gas.

What can the state do to help convince large, multinational players to commit tens of billions of dollars to an Alaska gas pipeline? To convince buyers to sign contracts?

First, accept the fact that while the Gov. Frank Murkowski administration and the 2004-2006 Stranded Gas Development Act negotiations made “fiscal certainty” a dirty word in Alaska politics, a gas line project still needs fiscal stability. A producer needs stability to negotiate its price in a long-term supply deal.

 

Project Economics

The state could help the project economics several other ways.

An equity investment from the state could help. It would reduce the producers’ risk and could turn a profit for the state. On the negative side, however, it would put the state on the hook for its share of any cost overruns and put the state in the position of regulating something it also owns.

The state also could help by looking at its property taxes.

Under Alaska law, levying property taxes on the steel pipe, project material and equipment would start the year the stuff lands on Alaska soil. The state and municipal property tax bill on a large-volume project could total $1 billion (2010 dollars) during construction, before a single molecule of gas moves down the pipe. Not great for developers’ cash flow. Maybe there is a better answer, one that also would resolve, in advance, the annual tax assessment battles that likely would ensue for the gas line just as they have endured for years on the oil line.

The state could look at making shipping commitments for its royalty share of gas, in effect signing its own long-term contract to use the line, thereby lessening the producers’ risk on the project.

And the state could look at helping finance construction cost overruns. Not pay the bills, but help with the financing if project finances are tight. The state could hold off collecting on its loan until the other project debt is paid off. Sort of like a second mortgage, with deferred payments. This might help keep the pipeline tariff affordable for shippers.

This, of course, is not a complete list of what could help move the gas line project along, but is instead a composite of suggestions for Alaskans to consider if they want to see a gas line built with private dollars; a gas line that would benefit the state; a gas line that faces tough competition for investment dollars and gas sales contracts.

We can deal with it, or we can just complain.

 

About the Author

Larry Persily is Federal Coordinator for Alaska Natural Gas Transportation Projects. Persily, who was appointed by President Barack Obama in December 2009, served almost 10 years with the Alaska Department of Revenue, governor's office and as a legislative aide on oil and gas issues before taking a turn at federal service. He previously worked as a newspaper reporter, editor and owner in Alaska for almost 25 years.

 

This article originally appeared in the May 2012 print edition of Alaska Business Monthly magazine.

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