To our hundreds of Canadian readers: We apologize for the lack of news directly affecting you today; but we must focus on an Alaska Governor who exhibits a certain hubris impacting both the energy industry and Alaska’s future.  You may find object lessons which also apply on your side of the border.  In this not very well organized stream-of-consciousness video, Governor Walker repeatedly emphasizes that his gas reserves tax idea is not intended to punish industry.  He goes on to say that he has a budget problem that must be addressed.  He adds, unbelievably, that he has no problem taking over the energy industry if it does not conform to his will.  Watch out for fireworks ahead! -dh

Alaska LNG Project Risk

Is Alaska’s Reliance For Government’s Equity Participation In A Multi-Billion-Dollar LNG Project Based On Rosy or Reliable Assumptions?

Commentary by

Dave Harbour

Yesterday, our radio host friend, Glen Biegel (NGP Photo) asked that we join him for an Alaska LNG project discussion.  Most of the discussion revolved around a Black and Veatch document commissioned by the Alaska Department of Natural Resources.  Download the B&V study here.

Listen to part of our Black & Veatch conversations here (Dave Harbour Interview; Glen Biegel and Tom McGrath discuss legislative session and socializing industry; Senator Cathy Giessel on the Legislative Session); especially interesting are the discussions about risks not enumerated in the study.

This writer has concluded that the B&V paper does not rise to the level of a “study” partly because of the noteworthy omission of project risks, but also because, as it states, a good deal of the data for the paper was provided — without critical analysis — by the Governor Bill Walker administration’s Department of Revenue.

The paper attributes other input to the state-owned Alaska Gasline Development Corporation (AGDC).

In yesterday’s Alaska Journal of Commerce (AJOC) report by journalist Elwood Brehmer, Walker was quoted as saying of the B&V paper: “I appreciate this objective review of the consequences of the state purchasing or not purchasing TransCanada’s share of the (Alaska LNG Project)….”

Here, Walker offers a deceptive statement to the people of Alaska.  The review is not “objective”, as he promises, because it uses Administration input to support the Governor’s desire to seek maximum equity position in a highly risky project whose risks are understated or ignored by the B&V consultants.

As close as the paper gets to ‘risk factors’, can be found on Page 49 which itemizes the paper’s assumptions.  The “implied” risks are, therefore, associated with how reliable the “assumptions” turn out to be.

The AJOC piece reports that the, “…overall cash flow to the state over the first 20 years of operations would increase $7.4 billion, or about 6 percent, without TransCanada (TC), according to the report. It estimates annual state revenues in the $3 billion to $5 billion range, totaling $76.7 billion over 20 years with TransCanada’s participation and $84.1 billion without the extra partner.”

But this and all other projections are based on the Page 49 “assumptions”.

For example, do our readers think that:

• This massive project will be completed by 2025/26?  If not, there will be a cost of delay.  That is a risk.  Does having the state involved in the decision making create delays?  The paper says the state can hire some of the TransCanada technical experts should the state buy out TC; either way, could personnel disruptions create delay?  B&V says on Page 46 that no technical delays are “expected”.  In short, the rosy revenue picture depends on everything going as “expected”.  And, if things don’t go as “expected”, if the “assumptions” don’t pan out, well, that will be a budget problem for a future administration and legislature.  Don’t increased project costs result in a revenue requirement demanding higher, less competitive LNG tariffs?
• The State’s royalty will be taken ‘in kind’ (RIK) as opposed to ‘in value’ (RIV)?  What do readers think; should Alaska’s royalty gas be taken ‘in kind’?  Taking gas as RIK means the state thinks it can market its own gas for a higher price and under better terms than the producers could get.  BP, ConocoPhillips and ExxonMobil are some of the most effective, successful, sophisticated, well connected gas marketers in the world.  If the state would just take the royalty in value (RIV), as cash, the producers would sell royalty gas along with their own and the state would be the beneficiary of their expertise in achieving the best possible price.  It really does seem like egotism-gone-wild when a governor thinks he can successfully joust in a quixotic adventure to negotiate better than those whose entire world-wide business is based on obtaining the best value for their oil and gas resources.  In essence, Alaska’s gas marketing effort, if it takes royalty gas “in kind”, will likely be directly competing with the gas marketing efforts of the producers.  Isn’t it likely that the state could at some point say to the producers, “You need to back off trying to market to xxCompany/Country.  That’s where we want to sell our royalty gas”?  Accordingly, a new state gas marketing bureaucracy the Governor creates to market gas is untried and unproven and should represent to Alaskan citizens another grave, risk factor not vetted by B&V.  (Note: Yes, we are aware that the producers want Alaska to take the royalties they owe “in value” because it supposedly creates better “alignment” among the state and private pipeline participants.  We would only caution what what may look like ‘alignment’ today could more resemble a relationship nightmare later.)
• The Alaska LNG project will cost $45 billion in 2015 dollars, when producers have always said the project could be expected to cost in a range between $45 – $65 billion?  The final and best cost projection for the project’s capital cost is not currently available but the governor wants decisions to be made in the special session based on a pretty flimsy assumption that the project’s capital cost is limited to $45 billion.  If, as is likely the case, the project costs more, the tariff increases, gas sale income decreases and Alaska LNG becomes less competitive with other sources.  This is a huge risk.  Is that huge risk really what citizens want their government to embrace?
• Long term oil prices (upon which B&V) bases a gas price, will be about $85 per barrel?  A year and a half ago, the price was over $100.  Now, Alaska crude is valued in the $45 – $50 range.  So what if the long term price is $45 or less?  Do Alaskans seriously want to bet their future on oil prices rising to $85 or more?  Because if that dream does not come true, the Alaska investment will be worth much less and at some point the state could be required to sell its gas by subsidizing the transportation costs (and, with what money?).
• Alaska will be able to sell its royalty gas under this formula: 13.5% x Oil Price + $1?  But our June LNG price reports demonstrate that the spot market in Japan has tumbled from $18/MMBTU over a year ago to $7.65 this past June.  If Alaska were in the business now, it would still have to pay the transportation tariff even though it would lose money on the gas sale.  An important risk for citizens to accept with the Walker approach, is that the state may or may not make enough from sale of its gas to pay the transportation tariff.   Since part of that tariff goes to pipeline/LNG owners and since Alaska’s governor wants to be an owner, there is a very real risk that the state would have to move money from one pocket of the general fund (i.e. for a tariff payment) to another pocket of the state (i.e. as tariff income).  The risk is that the state marketers, in a volatile world LNG market, would not be able to “break even”.  Meanwhile, can you imagine the headlines, the legislative hearings, the conflicts between gas owners, gas transporters, gas marketers and politicians?  One would hope for unimaginable consensus and good will; one fears for unimaginable strife, threats, demonizing and economic uncertainty.  Note: the governor has said he seeks a 51% equity position in the project.  Increased control means proportionally increased risk.
• The cost of debt will be 5% and the return on equity will be 12%.  Since the 2008 recession/depression the federal government has gone deeper than ever into deficit spending, with current debt approaching $20 trillion.  The Federal Reserve sold bonds (i.e. and incurred debt thereby) to raise cash for deficit spending but has also engaged in QE, quantitative easing, the selling of even more debt for the stated purpose of providing more liquidity to the market place.  When you have a lot of something, its value decreases.  Accordingly, with the volume of money increasing, the cost of debt has stayed in the low single digits during these years.  Money has been cheap.  Older citizens will remember the inflated interest rates of three decades ago rising to the level of 18-21%.  So this B&V assumption that for the 20 year life of a project debt cost will remain low, in the 5% range, constitutes a predictable and likely risk.  If project borrowing rates increase, another assumption is affected: the return on invested equity (ROE).  Many of the risk factors above, if not appearing as enticing as B&V and the Governor hope for, could have a drastic effect on the ROE hoped for by pipeline owners.  Oil companies are used to taking such risks; it is part of their business and they have become proficient in operating in that risk environment.  Do you believe a state government should gamble its resources by undertaking the types of ownership risks discussed here?  As an observer, all we ask is that citizens accept such risk to their economic future with eyes wide open, not just on the basis of an – in our opinion – incomplete paper provided by a consultant who obtains his raw input from a biased client.

In addition to the “Assumptions” B&V listed, we would add these:

• Additional cost risk could increase the overall tariff which could make LNG from this project uncompetitive with gas from other LNG exporting countries.  Competitors include but are not limited to Australia, British Columbia and the Lower 48, among many others.  Most of those projects enjoy all or some of these natural advantages over Alaska:
  • gas at tidewater, no need to pay for an expensive, 800 mile Arctic pipeline.
  • less expensive operating climates.
  • less difficult geography and port challenges.
  • lower labor costs.
  • lower logistical costs.
  • closer proximity to markets.
• The B&V paper concludes with the statement on Page 47 that, “This presentation was prepared for the State of Alaska (“Client”) by Black & Veatch Corporation (“Black & Veatch”) and is based in part on information not within the control of Black & Veatch.”  While the state and consultant will surely respond that, “Well we put his sort of statement at the end of all of our work products,” it should, nonetheless, be taken very seriously by citizens of Alaska whose economic future rides on decisions made, in part, on the validity of information the Walker-purchased paper provides.  In essence, this statement points out the risk — if not the likelihood — that information provided to the consultant is one-sided, wrong and/or misleading.
• Credit worthiness.  The rating agencies have calculated increased risks to investors in Alaska.  Those risks include : 1) a deficit budget, 2) an unfunded state employee pension liability rivaling Detroit’s a few years ago, 3) lack of discipline to cut spending, 4) the propensity to add new entitlements (i.e. Medicaid), and 5) the tortuous relationship between the state tax and regulatory authority and its largest investors.  The agencies and a multitude of New York analysts also consider, 6) the reliance of the state on one source of revenue and the tenuous reliability of that revenue source on an oil pipeline that is running nearly 3/4 empty.  Accordingly, the risk of lowered bond ratings could increase the interest rates Alaska will pay on General Obligation and/or Revenue Bonds.  An increase in interest rates could dramatically alter the happy picture painted by B&V and its client.  Are Alaskans prepared to support this and all the other potential risks noted here?

First, the Governor has said he wants legislators to consider a gas reserves tax to use as ‘leverage’ against the producers; apparently he believes that threatening producers with a tax on gas that is not being marketed will force them into investing billions into a gas project in the event they should not want to pursue a project–or find it infeasible.  

But — as of today, as Senator Giessel noted — the Governor has provided the legislature with no draft bill to accomplish his idea of a reserves tax.  (The video gives our readers a revealing perspective of the Governor’s position on matters he wants the special session to cover.  What do you make of it?)

The Governor also wants the legislature to consider whether to end the relationship with TransCanada Pipe Lines, Ltd. or not.  But neither has he provided draft language to implement his TC desires.

*     *     *

Our editorial position expressed a hope, when Governor Walker won his election, that he would be successful.

But we have carefully followed his progress.  We find, as further substantiated by many recent reports, including this one, that the emperor is not fully clothed.

With humility, we still believe he could develop a positive working relationship with the State’s major investors.  With courage, he could work with the legislature to craft a sustainable budget.  With good judgment, he could seek wise counsel from good counselors rather than dictating policy emanating from an unsuccessful, decades-old career in his quixotic but failed search for an Alaska LNG project.

We seriously hope he can still achieve that dream, for his success could be Alaska’s success.  We are also certain he will fail again unless he changes his attitude.

His rigid pattern of wanting to force an LNG project into reality “his way”, is not the way to create one of the largest construction projects in the history of the world.  He often suggests that this is what his past governor mentors, Bill Egan and Wally Hickel, would do in pursuing the interests of an ‘Owner State’.  Many older Alaskans knew both of the former governors well and some might say, “I knew them and I know Governor Walker; Governor Walker is not them.”

Such an enormous accomplishment (i.e. as a major Alaska North Slope gas monetization project) can only materialize with the enthusiastic, voluntary support of the free market, encouraged by a governor’s unselfish but firm, diplomatic and inclusive leadership skills.

So far, Alaska’s leaders have not very well articulated the risks associated with government ownership of energy projects.  Hopefully, the Legislature will identify the risks and make sure that citizens do not see gas pipeline ownership as a sure bet for billions in future revenues.

Since the early 1970s industry as attempted and failed to produce an economically feasible Alaska North Slope gas monetization project.  Luckily.  For if the project had been built earlier, various economic cycles (i.e. circa. 1996 & 2007) could have killed it.

Today’s citizens should not focus on dreams of future dollars.  If they ignore the enormous risks, they may ignore the billions their governor wants to spend or borrow now, in his determination to command and control private sector energy projects.

In such hands may rest the largest, most dangerous risk of all: the risk of flawed judgment.

Audio files below:

• ​Tom McGrath – Glen Biegel
• Glen Biegel – Dave Harbour
• Senator Cathy Giessel – Glen Biegel