It's An Uphill Road For An Alaska LNG Project

Whether most Alaskans appreciate it or not, the best hope for a successful, Alaska LNG project is that Alaska's largest producers support it.  Today, we analyze why that so.

by

Dave Harbour

Alaskans have consistently supported higher taxes on Alaska's oil companies and higher spending on social services — with some exceptions.  

The Alaska tax and spend model is not unlike the model employed nationally, in Washington D.C., except national leaders are capable of spending more than they take in by merely printing more money.  

Ultimately, that model taxes the public via inflation rather than directly, diminishing the value of the money as it lowers the value of individual savings and paychecks.  

The beauty of that model is that a future generation pays for the votes attracted by this generation of politicians.

As politicians increase tax levels, their overspending redistributes wealth to some individuals and to supporters able to maintain investments in real estate, land, capital projects and enterprises producing recurring revenue — investments that benefit from inflation.

It can be and often is an intellectually dishonest, but effective formula for gathering reelection votes from some at the expense of others.  

Logically, that concept is unsustainable.  The concept is unsustainable because more and more taxation must end at some finite point and because ever higher government spending depends on that finite tax revenue.

As the unsustainable economy approaches, liberal lawmakers have historically found it quite tempting to unfairly demonize companies for not, "paying their fair share", and to embarrass fiscally responsible lawmakers for being, "uncaring and insensitive to the needs of…."

As we'll explain, the day of reckoning has now caught up with Alaska.  The state imposes high taxes, is depleting its remaining savings accounts while continuing its spending spree.  (No one can say Alaska's leaders were not warned!)

Background

Alaska's elected leaders tasted an addictive elixir of $900 million in bonus bids from the 1969 Prudhoe Bay Lease Sale.

In 1971 Congress approved the Alaska Native Claims Settlement Act, critical to the approval of a project to transport the immense Prudhoe Bay oil reserve to market. 

Congressional approval of the Trans Alaska Pipeline System (TAPS) in 1973, by the tie breaking vote of Vice President Spiro Agnew, coincided with mid eastern turmoil, including the Arab oil embargo and a later takeover of Iran's monarchy by Islamic extremists, still in power.

So, oil prices remained high, for a time.

Alaska's government spending and tax policies were mostly controlled by democrats and a few liberal republicans during the decades of the seventies and eighties, when the high oil prices magnified the value of high production, around 2 million barrels per day.  

Yes, the former 'pioneering state' had now become addicted to a growth in income and spending phenomenon that is probably unique in the history of American states.  (Other states, because of the blessing of advanced 'fracking technology' are encountering tax and spend challenges, too.)  We believe none have reached the level of tax and spend excesses adopted by Alaska — though Alaska could serve as a role model for the need to avoid unsustainable tax and spend policies.

When oil prices began to fall in the mid-eighties, many oil field and support industry employees — and those dependent upon them — left the state.  However, production was still strong and the state pretty much continued its march toward becoming the most attractive welfare state in the nation.  We are not aware of any significant social program anywhere that is not replicated in Alaska, and, at a high per capita cost.  

From the 80s onward, Alaska has became the highest per capita taxing and spending state and with the highest number of not-for-profit organizations per capita in the U.S., a vast number of which came to depend on government largess — 90% funded by oil taxes. 

So now, TAPS' North Slope crude oil throughput has diminished by about 3/4, even though companies are working hard to find and produce Arctic oil.  
 
Because of its spending policies, Alaska's government operating budget has become about 90% dependent on TAPS' North Slope throughput.
 
Unlike the 80s when throughput remained high during a low price period, Alaska is now experiencing low TAPS throughput and low prices for that throughput.
 
This double whammy, though it would not have been unexpected by prudent planners, has caused chaos in Alaska's political model that requires ever higher oil revenue for ever higher costs of government.  Unfortunately, such circumstances can lead to a phenomenon known as an, "Economic Death Spiral", wherein higher and higher taxes produce less and less revenue.  While Alaska has not reached that level of hopelessness, the fact that the condition exists is sobering incentive to make the best possible decisions, early enough.
 
The 48" TAPS oil pipeline traces a path from the Arctic, over the mountains of Alaska to the Valdez seaport, some 800 miles.  TAPS was built mostly above ground, and insulated against the cold, so it could move the otherwise viscous oil in a warm-fluid state…even during many sub-zero months.  (In contrast, a gas pipeline would be mostly buried in the cold ground with cold gas flowing through it.)
 
But the day surely approaches — says the 'prudent planner' within us — when the warm oil throughput is so little and maintenance costs are so high and winter temperatures are so cold, that production must cease.
 
Who would be the first to suffer?  Not the oil companies.  They would dismantle TAPS, revegetate the right of way and transfer exploration and production budgets to more attractive areas.  
 
Those suffering from a TAPS shutdown would be citizens dependent on programs funded by oil tax and royalty revenue.  Especially vulnerable would be Alaska Native villagers who value 'subsistence' lifestyles, lifestyles which have become tethered to the benefits of oil money: health clinics, schools, airports, ports, SUV's, snow machines, fuel subsidies and myriad social programs.
 
The foregoing demonstrates why Alaskans are so focused on the need to both find and produce more oil…but also to market Alaska's North Slope natural gas reserves.
 
From Oil to Gas
 
For decades Alaskans have lusted over a project that would monetize the huge natural gas reserves on the Alaska North Slope, at least 35 Trillion Cubic Feet (tcf).
 
In other places, we have documented the history of Alaska's gas projects, all of which have failed to prove economically feasible.
 
Today, Alaska's three major producers have committed to creating a feasible gas project but have maintained their position over decades that any multi billion dollar gas pipeline project must have fiscal certainty.
 
In other words, we could not imagine investors putting another 800 miles of pipe in Alaska, along with a tidewater LNG plant, with the risk that the state will then increase taxes on oil and/or gas.  This could dilute the value of the investment–perhaps even to the extent that politicians could render the investment infeasible after investment decisions were made based on current tax statutes.
 
The state Constitution requires that the taxing ability of the state remain unabridged and that no legislature can take action that binds a future legislature.  A Constitutional amendment is likely required in order for elected officials to be able to provide large project investors with appropriate evidence of fiscal certainty.
 
Just as the project led by Alaska's producers (AK-LNG), approaches final sanctioning decisions, the Governor and Legislature are faced with the challenge of obeying the Constitution while meeting the reasonable, fiscal certainty needs of major gas pipeline investors.  And, they must do so as dependent constituents cry out for the government to, "Feed me, feed me".
 
Recently, the Governor of Alaska presented a letter to producers stating his willingness to work on fiscal certainty for the gas project, but not for oil investments.  The letter also named other 'demands'.
 
This is troubling for a number of reasons.  One reason we are troubled, is the reality that the owners of the gas are also the owners of oil.  What's to prevent gas investors from spending $60 billion on an Alaska LNG project only to have a predatory legislature/governor swoop in for an increase of oil taxes?  The result of unpredictable oil tax increases could be equally damaging to a gas pipeline investor's bottom line.  In short, we must suggest to Alaska's governor that fiscal certainty for a gas pipeline investor not applied to that investor's Alaska oil and gas activity is — in our opinion — no fiscal certainty at all.
 
Meanwhile, Alaska's gas competes with everyone else's. 
 
Our mid-Atlantic energy analyst friend, who prefers to remain unnamed, warns us today that the LNG market is becoming increasingly competitive.  Many of the three dozen North American LNG projects investors are considering will simply not remain economically feasible for a number of reasons unique to those projects.  
 
How will Alaska fare with its competition when most competing projects have:
  • more moderate climate and terrain
  • more inexpensive logistical costs
  • better proximity to the markets
  • gas reserves closer to LNG tidewater facilities (i.e. no cost for an 800 mile Arctic/Sub Arctic pipeline)
  • lower labor costs
  • lower political risks 

 Conclusion

TODAY, the Vancouver Sun published this report that British Columbia Premier Christy Clark's government is recalling the legislature for a "rare summer session" to pass key legislation enabling a liquefied natural gas project.  
 
This would be BC's version of increased fiscal certainty.
 
Meanwhile, faced with this competition, Alaska continues to spend its depleted savings, allow run-away spending and make rather hostile demands on the oil/gas investors.  At the same time, the Governor and his Revenue Commissioner are hinting that oil tax increases are lurking behind the dark horizon.
 
Alaska's leaders from the Governor to every legislator better start accepting the fact that the large, North Slope oil and gas producers are Alaska's greatest economic friends.  They are the golden goose.  They are the human treasure which provides the money, technology and capability to explore for, produce and monetize Alaska's remotely located resources.  
 
Treating investors with courtesy, fiscal stability and good communication is the best way to both improve throughput of TAPS and entice a gas pipeline/LNG project investment.
 
The second best way to assure that prosperity is for elected leaders to do what they were elected to do: put Alaska's financial house in order.  Make the budget sustainable.  It may not be a pleasant job, but if today's crop of politicians can't do it they should make way for others who can do it.
 
Yes, the great, Alaska North Slope gas monetization project is on an uphill road.  Hazards abound as does competition and internal strife.  Great skill and determination are required to achieve the summit.
 
If Alaska's leaders can just rise to the occasion, summon the required diplomatic, communication and common sense attributes … and recognize that their very best hope for success is a willing, capable and dedicated group of major producers … great things can happen for all the participants.  
 
Otherwise, Alaska could find itself overtaken, outmaneuvered and outclassed by other oil and gas jurisdictions that have a greater ability to lead, cooperate, make wise decisions and act.
 
Will Alaskans snatch victory from the jaws of defeat, or will the gas monetization challenge be too great for this generation of leaders?
 
The AK-LNG project's window of opportunity seems still to be open.  For how long, we do not know.  We hope the state's elected leaders can muster the mighty effort required to accommodate the needs of investors to create the new gas project reality that Alaska's economy and citizens so desperately need.
 
 
 
 
 
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·        There are many global players trying to enter the market, including over 35 projects seeking ground-breaking in North America

·        Prices of the underlying commodities have slipped dramatically. This includes crude oil (Far Eastern LNG is linked to oil prices), natural gas for LNG, and land-based gas deliveries

·        Japanese nuclear power is re-emerging after being shut down, and China (among others) are seeking more nuclear plants

·        The rate of demand for power appears to be slowing, in keeping with slower global economic growth (see charts below)

A report CITI crossed our desk today, which underlines (and adds to the count of) growing pains being felt by the global LNG market. In particular, this raises serious questions about the ability of LNG exports from the US to have much impact on raising the price structure for domestic natural gas. 

 

Dave Harbour, publisher of Northern Gas Pipelines, is a former Chairman of the Regulatory Commission of Alaska and a Commissioner Emeritus of the National Association of Regulatory Utility Commissioners (NARUC).  He served as NARUC's official representative to the Interstate Oil & Gas Compact Commission (IOGCC).  Harbour is past Chairman of the Alaska Council on Economic Education, former Chairman of the Anchorage Chamber of Commerce, and past President of the American Bald Eagle Foundation and the Alaska Press Club.  He is Chairman Emeritus of the Alaska Oil & Gas Congress.

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