Parnell's AGIA: The Audacity of Nope

February 2, 2010: It's hard to believe three years has passed since the Palin-Parnell AGIA natural gas pipeline strategy was thrown on the table. Safe to say we all know a lot more today about the critical economic evaluation that goes into approving the largest and most expensive oil & gas project in the world.

Growing world inventories, weaker consumer demand, growing unconventional supplies, all have become significant challenges to making Alaska's dream of a natural gas pipeline a reality. Compare these real world challenges to just three years ago when the Alaska State Legislature approved AGIA and rammed through a plan that completely ignored the risks born by gas shippers.

For the last few years I and others have questioned the economics used by the Parnell administration to make their argument that the natural gas pipeline is "wildly profitable" under all circumstances.

Now, with AGIA's open season under way and critical cost data now becoming public, we once again ask as we have for three years, "What the hell were these people thinking?"

Last Friday, TransCanada filed paperwork to begin open season which includes revised construction cost estimates and proposed shipping costs for two major pipeline alternatives: delivering the North Slope gas to a pipeline hub in Alberta, Canada; and piping it to a liquefied natural-gas terminal in Valdez.

TransCanada has said previously it is possible to build one but not both, given the capacity required to operate the pipelines and the amount of gas known to exist on the Slope. Either project could start delivering gas by 2020 and be fully in service by 2021, the company said.

TransCanada estimated the cost of building the Alberta project at $32 billion to $41 billion and the Valdez LNG project at $20 billion to $26 billion. The LNG cost estimate does not include the cost of building tankers or a necessary liquefaction plant in Valdez.

In 2007, TransCanada predicted the Alberta project would cost around $26 billion. Since then costs have skyrocketed for oil and gas projects worldwide while the U.S. dollar has taken a dive.

The resulting cost difference is staggering and again highlights the commonly heard warnings about state government becoming a market participant instead of a market regulator through AGIA.

It also highlights yet another reason why AGIA should be abandoned for a process that recognizes the legal and fiscal realities that gas shippers will face in trying to build this mammoth project. 

In a May 1, 2007 presentation to the Senate Finance Committee, Parnell administration officials used a projected tariff of $1.96 mmbtu on a 4.5 bcf pipeline costing $20 billion.

They proceeded to tell lawmakers the project was "wildly profitable" and "deep in the money" under any scenario. This was plain wrong, contrived by simplistic economic equations all while failing to take into account any of the risk factors that existed.

However in their January 29, 2010 FERC filing, TransCanada now states the tariff will be anywhere from $3.02 to $3.89 per mmbtu in nominal dollars on a 4.5 bcf pipeline costing anywhere from $32 to $41 billion.

Reading through the revised cost estimates, I can't help but think about former Governor Palin's letter to Conoco CEO Jim Mulva back in January 2008. In the letter she tells Mulva that AGIA means, "The economic terms under which oil and gas is produced "upstream" and the construction of a pipeline should be independent". 

Mmmm, ignoring construction cost as it applies to upstream economic terms; I wonder how long Conoco was supposed to ignore those costs before the state began handing them bills for their share of anywhere between $32 to $41 billion? 

And while the administration can try and downplay shale gas in the lower 48, the rush of major oil & gas companies, both domestic (i.e. Exxon) and foreign (i.e. Statoil), into the shale gas play certainly paints another picture.

In addition to the cost and tariff revisions, there was also much made about how TransCanada said they were going to save shippers half a billion dollars a year if they signed up early, by only recovering 80% of the capital costs in the tariff. 

Even one state legislator was so pleased with the offer that he told the media he's heartened by TransCanada's announcement that it will lower the amount it will charge the oil companies to ship the gas by $500 million a year for 25 years. That would provide more money to the producers and the state, he said.

However, according to TransCanada's AGIA application, they will be allowed to collect the remaining 20% after the initial 25 years is up.

From TransCanada's page A-4 of Exhibit A to their Precedent Agreement (Item # 5 of their negotiated rate principles) (emphasis added by me):

For the Initial Service Term and any extension of that term, depreciation on transmission and gas treatment plant used for purposes of deriving rates will be calculated annually.

An FTSA with an Initial Service Term of 20 to 25 years will recover 80% of the Shipper’s proportional share of capital costs approved by FERC for Recourse Rates, and AFUDC and property tax paid during construction (“Approved Capital Costs”), during the Initial Service Term, with Shipper’s proportional share equal to Shipper’s MDQ divided by aggregate MDQs as of the Commencement Date.

An FTSA with an Initial Service Term exceeding 25 years shall recover 80% of Shipper’s proportional share of such costs in the first 25 years and the remaining 20% shall be recovered in an additional period of not less than five years, with Shipper’s proportional share based on Shipper’s MDQ divided by aggregate MDQs as of the last month in the Initial Service Term.

The promise of reduced capital costs from TransCanada equates to very little because TC brings no real value to the project. If the producers really wanted to lower tariffs and improve cost takeaways, they'd look at eliminating unnecessary overhead like TransCanada, who is offering little more than the Parnell administration's pipe dream and the audacity of nope.