A Pipeline's Four Gates: How AGIA ignores all of them

It is ironic when you think about AGIA; state government dictating to the  private sector what amount of risk and reward they should accept.

It borders on ridiculous; after all when was the last time a state government went out of business? 

When you consider the factors necessary to understand before moving forward on building any oil & gas project, let alone the largest and most expensive in history, there are four critical gates that have to be passed before a greenlight is given.

And the bottom line is no AGIA or no TransCanada is going to make those decisions for the companies who will absorb all of the risk of paying the cost of the project.

The first gate is the capitol cost. How much is constructing the project going to be? There have been several cost estimates given on the Alaska Natural Gas Pipeline over the last five years.

In 2002, the producers spent over $100 million to arrive at a rough estimate of $20 billion. In TransCanada's AGIA application in 2007, they estimated the cost at $26 billion. In ConocoPhillips 2007 proposal, they estimated the cost between $26 and $41 billion. And the last estimate was completed by consultants hired by the Palin administration who have pegged the cost at $31 billion.

So over the last seven months alone, the cost estimates by three different parties have ranged between $26 and $41 billion. These numbers are critical, especially when you consider the remaining three gates you have to get through in order to obtain financing and move forward on constructing the line.

AGIA ignores this reality by propping up a third party pipeline company who will make money regardless of the price of building the pipeline with a guaranteed rate of return of around 14%. In addition, project cost overruns are paid for by the gas shippers. Under AGIA, TransCanada will still make a 7% return on cost overruns while gas shippers, including the state, will pay for the additional costs.

The bottom line is every penny it takes to build the pipeline will increase the revenue to TransCanada and will decrease the revenue to the gas shippers including the state.

The second gate is the estimated price of the commodity or in this gas natural gas. While prices have escalated significantly within the last five months and projections are for continued price gains, nobody can control the free market. A recession, a sudden infux of imported LNG, could drive the price down below the tariff.

This again is a risk that the shippers will take, not an independent pipeline company like TransCanada who will receive a guaranteed rate of return regardless of the market price of gas.

The third gate is the reserves and deliverability of gas to put in the pipe. This is again where not only AGIA but the Palin administration has really climbed out on a weak limb.

In the beginning, the idea was always a 4.5 bcf a day pipe. TransCanada's AGIA application proposed the same capacity at initial start up. In fact, Palmer had stated time and time again that TransCanada needed 45 tcf to justify the project. Many have stated that FERC has put the number at 60tcf to make the project work.

But today, with Pt. Thomson thrown into litigation, the Palin administration has now changed their tune and said a smaller project would be just as profitable. This again highlights the fact AGIA is trying to force the state's desires on the private sector who will pay the bill. 

So do you build the initial pipe capacity for 4.5bcf when you only have 3bcf a day? And lets remember, somebody pays for that extra capacity and its not going to be TransCanada.

In addition, DNR Commissioner Irwin is fond of saying that once a pipeline project appears a reality, the North Slope basin will explode with exploration. But as Senator Charlie Huggins replied, "we want to bet on the deliverability of gas not the exploration."

In fact the average length between exploration and production in between 5 to 7 years. Even Alpine which was a fairly large field, (and no one expects there to be another Alpine on the NS) took eight years to develop.

A few days ago we posted the new gas well numbers from the AOGCC and there is no sign, even with higher gas prices than years ago, that explorers are rushing to lease state land and drill gas wells. In fact one industry expert told me that only 1 in 14 wells is even successful. Look at NPRA he said, they've drilled 20 wells and nothing.

So the question is for those who are looking at taking the risk, how much base gas is there to put in the pipe?

Commissioner Irwin has stated that there is 24tcf proven on the North Slope. But if you're going only going to have that small amount of identified deliverable gas at pipeline start up, as a shipper you are not going to want to be on the hook for 25 years with ship or pay contracts due to the large amount of risk compared to the small amount of gas. The challenge will be that the financial markets, as well as TransCanada will demand 25 year commitments.

In addition, the AOGCC has determined as recent as last year that they would only allow 2.1bcf a day lifted off of the North Slope. This is a far cry from the 3.5 to 4.5 bcf that TransCanada says it needs.

As AOGCC Commissioner Cathy Foerster stated in a recent AGIA forum, it seems hard to understand how you could hold an open season in just 18 months, given that the 9tcf at Pt. Thomson is off limits due to Irwin's rejection of Exxon's development proposal.

The fourth gate is the government take. How much will it cost producers to extract the resource from the ground and get it to market? This is why many, including TransCanada, have stated the importance of fiscal certainty.

Last fall the legislature proved that not only they had the propensity to raise oil & gas taxes to the highest marginal rates in the world, but they also proved they had no problem doing it retroactively. They have proven the case for fiscal certainty.

In addition, TransCanada cannot build this pipeline without 25 year commitments from the producers. So if a company who gets a guaranteed 14% return on their investment is demanding 25 years worth of certainty, why shouldn't the producers who will pay for those 25 years get the same fiscal certainty?

The bottom line is while the Palin administration is fond of echoing the $10 billion in concessions that the producers wanted through the previous gas line proposal, this project will never, ever be built until those who are assuming the risk have an iron clad understanding of just how much government is going to take from them for producing the gas.

And no matter how many slides that are presented on the economic modeling that was done up in a vacuum by the Palin administration's consultants, without the people who will pay the bill at the table, it all means nothing. It's all political theatre.

Regardless of the rhetoric, the producers have come to understand that Alaska is not the stable market that some want to claim it is. After all, Hugo Chavez simply jacked up tax rates, he didn't try to take away assets like Irwin and company are doing at Pt. Thomson.

But as always, there are serious concerns about the state's economic modeling. 

Bradner's legislative journal reported that Legislative consultant Dan Dickinson poked holes in TransCanada’s project revenue estimates and the administration’s Net Present Value analysis.

TransCanada’s revenue estimates, in its application, do not consider producers’ costs. Total revenues to producers are estimated at $183 billion (undiscounted) over 25 years, but Dickinson estimated that $108.9 billion of this must be offset against costs to produce gas (Point Thomson development, Prudhoe capital expenditures) which puts producers’ net revenues at $74.1 billion. In this analysis state revenues are $115 billion, federal revenues are $46 billion, and TransCanada’s revenues are $15.6 billion net of outlays.

In its analysis, Black and Veatch presented Net Present Value figures for future earnings of its view of the project, which assumes higher market prices. What is interesting is that the producers’ NPV is $13.5 billion assuming a discount rate of 10 percent (an assumption of what an alternative investment could earn.) However, if a 15 percent discount rate is used the producers’ NPV drops to $5.2 billion. The state’s NPV in this analysis is $66 billion and TransCanada’s is $4.5 billion. These are gross revenues, not net. Black and Veatch’s numbers were gross, not allowing for costs.

What this tells us is that the producers’ returns may not be all that robust, according to the Bradner analysis.

So what does this all mean?

It means the same thing it did last year when they passed AGIA.

AGIA ignores the reality of who will take the risk....and ignoring reality is not going to make three of the largest oil & gas companies in the world agree to the demands in AGIA just because a few misguided souls think we can get a gas pipeline built without  negotiating with those who will assume all of the risk.