It is unreasonable to think that the state will get a return on an investment in the Alaska Liquefied Natural Gasline project for 8-12 years. While waiting, the state should do everything in its power to support the project, including taking its gas in kind and providing fiscal certainty on taxes.
However, there should be a discussion between Gov. Bill Walker’s administration and the Legislature about the risks the state will face after it buys out TransCanada. By owning 25 percent of the project, the state will be required to pay 25 percent of the pre-construction costs prior to a decision by the producers whether or not to build the project. What happens to those funds if the state’s partners (BP, Exxon-Mobil and ConocoPhillips) decide not to build the project? We propose two alternative ways to avoid that risk.
The front end pre-construction costs that the state must pay (even if the project is not built) are considerable. It has been estimated that front end engineering and design (FEED) will cost about $2 billion, of which the state’s share would be $500 million.
But the state’s share could be more — detailed engineering and design is normally 7-8 percent of a project’s capital cost. Assuming that the capital cost is $55 billion, the state would owe over $1 billion by this measure. How much state money would actually be at risk is hard to know at this point because a spending schedule is not available.
The project risks are considerable. Alaskans will not have a more realistic estimate of the cost of construction ($45 billion to $65 billion) until FEED is completed. At present we have no permits, no construction schedule, no agreement on the size of the pipe (42 inches versus 48 inches), no ramp up schedule for LNG production (the market can only take so much LNG at the start of such a project without depressing demand, thereby reducing the price) and no real ability to estimate what the price of LNG will be 8-12 years from now.
However, Walker’s administration is proceeding on the assumptions that after buying out TransCanada the state will own, and pay for, its 25 percent share of the project and that the producers will build the project 8-12 years from now. The first assumption is dangerous because the second assumption is unknowable..
For example, FEED is next big project decision the producers need to make. If they decide to proceed to the FEED stage, the state would be required to pay its 25 percent share, ranging from $500 million to over a $1 billion. If the producers then decide for whatever reason not to build the gasline, a decision which the state has no control over, Alaska would lose its investment.
The state’s record of losing its pre-construction investments on gasline projects demonstrates the risk of assuming that a project will be built 8-12 years in advance of first gas. For example:
• The 1978 Legislature awarded a 27-year contract to Texas-based Alaska Petrochemical Company, selling them nearly all of our royalty oil. Three years later the company, known as AlPetCo, closed its doors and walked away, owing the state nearly $60 million.
• Gov. Wally Hickel used private money to fund Yukon Pacific, but the line was not built and its investors lost money.
• The state made $500 million available to TransCanada to build the line under Gov. Sarah Palin’s Alaska Gasline Inducement Act (AGIA), and is now spending another $150 million to buy out of the agreement.
• Had AGIA succeeded in constructing a gasline to the Lower 48, it would have lost the state money because of the advent of new shale gas technology.
• The Port Authority failed to build a gasline to Valdez and lost the pre-construction money invested by Fairbanks, Valdez and the North Slope Borough in the process.
Each of these projects was advanced in good faith by Alaskans who had the best interests of the state at heart. The problem is that whether a project that has an 8-12 year lead time will actually ever be built is unknowable.
There are two ways to advance the project while preventing the state from losing pre-construction risk money if it is not built. Under the first alternative:
• The State would maintain the same level of project participation and oversight that it is now doing, except that Alaska would not advance pre-construction risk money.
• In cooperation with the producers, Walker’s administration would determine what the pre-construction costs are and make that information available to the Legislature and the public.
• The Producers have been clear that they require fiscal certainty on taxes and a state commitment to takes its gas in kind before spending billions on FEED. In exchange for the state agreeing now to fiscal certainty on taxes and taking its gas in kind, it is equitable for the state to require that the producers, not the state, advance the FEED and pre-construction risk money to develop the project.
• If the producers elect to construct the project, Alaska would then pay its 25 percent share of the pre-construction costs as part of its financing of its 25 percent share of the construction costs.
• So, if there is no project the state would not pay the pre-construction costs.
For a second alternative:
• The state would provide fiscal certainty on taxes and commit its gas to the project as royalty in kind, but the state would not be an owner of the gasline or the liquefaction plant. This is the same arrangement we currently have with TAPS.
• The state would be responsible for selling its gas. It would pay a transportation tariff to the gasline owners.
• In advance of reaching such a decision, the state would make an economic analysis of the financial impacts of ownership (including the risk of loss of pre-construction dollars and construction cost overruns) versus non-ownership. The analysis would also compare what would have been the economic consequences had the state owned a share of TAPS versus the funds the state has made without owning such a share. This information would be made available to the Legislature and the public for discussion.
In conclusion, it is equitable to have the producers take the risk of losing the pre-construction costs in exchange for fiscal certainty, and the state taking its gas in kind because the producers control whether or not to construct the gasline. Moreover, these are risks the producers take on projects all over the world. Conversely, as the record above shows, the state has already lost significant amounts of money in taking these pre-construction risks.
Finally, prudence dictates that the state avoid significant financial risk at a time when it needs to conserve state funds because of low oil prices and falling production.
• Harry Noah is former commissioner for the Alaska Department of Natural Resources and a former bullet line manager; John Reeves is president of Fairbanks Gold and former director of the Port Authority; Frank Murkowski is former governor of Alaska and served in the U.S. Senate; Jim Clark served as Frank Murkowski’s chief of staff while governor of Alaska; Marc Langland is CEO of Northrim Bank; and Perry Green is with Green Furriers of Anchorage.
