Point - Counterpoint: AGIA

This week I had a lively exchange with fellow blogger Robert Dillon about the must haves in AGIA and the ultimate role they will play in getting Alaskans a natural gas pipeline.

Robert has just sent me responses to my various assertions and I have posted them here so my readers could view them. I will post counter points this weekend.

Thanks to Robert for furthering the discussion because I enjoy a good healthy debate. Especially on an issue so important to Alaska's economic future.

From Robert Dillion:

FERC has said since day one that "the law says this is an open access pipeline", which obviously means this is not going to be a "locked up, closed in pipeline"

When Andrew says that FERC guarantees the gas line will be an open access pipeline, he's only referring to the initial open season. Beyond the first offering of capacity in the pipeline, FERC does not have the authority to order expansion of gas pipelines.

According to FERC rules, once a pipeline is fully subscribed at the initial open season, the operators are under no obligation to expand its capacity.

Once it's sold out, new explorers are out of luck until a shipping contract expirers or there's an expansion -- we're talking a wait of 25 years or more before a shipping contract expires.

The problem?

A produce-owned pipeline could be build, and most likely would be build, with a capacity equal to the proven reserves the companies already have under lease. Such a scenario would restrict development of the North Slope basin -- exactly as oil development has been restricted under the producer-owned trans-Alaska oil pipeline.

But wait, isn't TransCanada proposing a pipeline with similar initial capacity? Yes, but TransCanada has agreed, under the terms of AGIA, to offer to expand the line every two years, and to spread the cost of expansion among all shippers, so-called rolled-in rates. (More on rolled-in rates later.)

Also, an independent pipeline company has every incentive to expand the line because the more gas it carries, the more money the operator makes.

By contrast, producers who own and operate their own pipeline are more interested in protecting their upstream interest -- the gas itself -- and have little regard for what it costs to send gas down the pipeline since they are paying themselves.

Instead of expanding the pipeline so that competitors could move their gas to market, producer-owners would rather restrict the pipeline's capacity until they were ready to develop the new resources themselves.

The producers can obstruct other explorers from accessing the pipeline by refusing to expand or structuring the capital on the pipeline in such a way that it results in a higher tariff. (More on the debt-to-equity question later).

The 2004 Alaska (Natural) Gas Pipeline Act gives unprecedented power to FERC to regulate both expansion and access for independent explorers and producers.

ANGPA Section 105 does give FERC additional power to regulate the gas line but it has never been tested in court.

The Natural Gas Act actually prohibits FERC from requiring an expansion of a pipeline. And ANGPA requires a prospective shipper to initiate proceedings (legal term for making explorers go through the lengthy process of asking FERC to take action) to force a mandatory expansion order from FERC.

ANGPA also prohibits rolled-in rates for expansions, which would increase the cost of accessing the pipeline for new shippers, potentially to the point that they would decide it wasn't worth exploring the North Slope altogether. (Remember what I said in a previous post about Conoco trouble accessing TAPS before it bought Phillips.)

AGIA does not mandate expansion either. However, under AGIA the pipeline operator agrees to solicit new shippers every two years and further agrees to rolled-in rates for expansions.

AGIA both avoids the potential legal fight before FERC over mandated expansion and guarantees new explorers can access the pipeline at the lowest possible rate, therefore encouraging exploration of the North Slope basin.

FERC has no anti-trust concerns if the pipeline is producer owned is because they have the ability to make sure anyone who wants to ship gas, can.

Again, Andrew is referring only to the initial open season and not anytime beyond.

Andrew is also incorrect. FERC does have antitrust concerns, and what's more so do the U.S. Department of Justice and the Federal Trade Commission.

FERC regulates shipping rates and services, it's not the lead agency on antitrust issues. Justice is more likely the agency that will tackle the antitrust issue, and we have previous actions by Justice that provide a good idea of what might happen this time.

In the 1970s, Justice concluded that producer ownership of the Alaska pipeline creates incentives to deny or impede future expansions. In 2005, the then-chairman of FERC, Pat Wood, said those antitrust concerns were still valid.

The Justice Department is traditionally not in favor of the kind of regulatory fixes FERC would come up with to handle antitrust concerns. Instead, Justice could easily order the producers to divest some ownership in the gas line to remove the antitrust concern completely.

Think of it this way, the producers are like a bunch of kids alone in a room with a giant jar of candy. FERC's approach would be to watch the kids to make sure they don't steal any of the candy. Justice would more likely just order the candy jar removed from the room completely to avoid any possibility of bad behavior.

Such a Justice-ordered divestiture of assets would surely prompt a legal challenge by the producers, further delaying construction.

Other non-owner companies might also be inclined to challenge a producer-owned pipeline in court, which would also delay the project.

There is also the potential that the government would impose conditions on a producer-owned project that the companies would simply refuse to accept, delaying or even canceling the project.

AGIA, on the other hand, requires the operator to accept whatever stipulations FERC places on a federal certification.

Ordinarily under FERC rules if there is a pipeline expansion, and the new capacity is more expensive on a per unit basis than the base capacity, the shippers on the additional capacity pay the difference. This makes perfect sense. Otherwise, the base shippers are subsidizing the expansion shippers.

However, since the base shippers will be subsidizing the expansion shippers, this is one reason why the current North Slope producers will never commit gas to an AGIA project, why it is virtually certain AGIA will have a failed open season, why TransCanada will subsequently fail to get a FERC certificate, and why AGIA will fail to result in the construction of the pipeline.

First, rolled-in rates will encourage explorers to postpone exploration, and to not commit gas at the first open season. Because their expansion capacity will be subsidized, they can afford to sit back and wait and see whether the pipeline has cost overruns, and how gas markets look down the road.

Wrong, companies like Anadarko are in the field now feverishly looking for gas. Such companies would be happy to bid at the initial open season, if they had all their wells drilled and the gas ready to produce. They don't. That is why it is important that they can get into the pipeline at a fair and reasonable rate in the future.

Under AGIA, new explorers would get that chance in 2012. And by then, I'm pretty sure Anadarko could be ready to ship gas.

In the 1990s, FERC dropped its requirement that operators use rolled-in rates because of the sheer number of pipelines in the Lower 48 meant that shippers could more easily get their gas to market.

Alaska isn't so lucky. The state would be a one-pipe town where new explorers could have their access to market blocked through exorbitant shipping costs.

Incremental rates create a two-tier tariff system, with the expansion shippers paying the full cost of the expansion on top of the initial shipping rates. Rolled-in rates spread the cost of the expansion across all shippers, meaning a small increase to everyone.

There is 35 trillion cubic feet of proven reserves of natural gas on the North Slope. But geologists believe the real prize is the some 300 trillion cubic feet of gas yet to be discovered.

If access to the pipeline is restricted by higher incremental rates, that gas may not be discovered and produced for decades. That's bad for Alaska and bad for the country.

Another point that's important is that the first round of pipeline expansion -- most likely from 4.5 Bcf to 6 Bcf -- is expected to reduce shipping rates because the expansion could be done relatively inexpensively by adding compression, and the increased volume would reduce the fee per Mcf.

Furthermore, rolled-in rates is the law in Canada, so when the pipeline crosses the border rolled-in rates would be enforced. It would just be in the U.S. that incremental rates would be used.

It is also important to realize that FERC is just trying to get a project moving. It is less concerned with how much gas will be discovered in the future as it is with getting the first 4.5 Bcf to Lower 48 consumers. This is shortsighted since most of the gas on federal acreage is likely to reach market only after expansion, but it is a fair assessment of FERC's priorities.

To sum up, with AGIA, the state is only trying to protect its interest -- and the interest of all Alaskans -- in much the same way the producers do when they deal with an independent pipeline operator in the Lower 48.

The producers don't expect FERC to look after their interests, they negotiate directly with the pipeline operator -- and independent pipelines are the norm in the Lower 48 -- for the best possible rates. The state is doing the same with AGIA.

I'm baffled that any Alaskan would object to such an effort.