The Regulatory Commission of Alaska is grappling with issues raised by new proposals for natural gas price-setting strategies for Southcentral Alaska that are intended to give gas producers incentives to explore for and develop new reserves.
The thorniest issue is whether to allow Enstar Natural Gas Co. and Marathon Oil Co. to use a Louisiana-based gas trading index to set prices for gas from local fields with proven reserves. The commission previously approved two contracts linked to the Henry Hub Index in Louisiana, but those were based on gas produced from new exploration, not existing reserves.
Older contracts let by the utilities to producers base gas prices on oil prices.
Enstar filed Nov. 14 for RCA approval on its new contract with Marathon. The contract would fill a projected gap in the utility's needs from 2009 through 2017. On Dec. 2, state Attorney General Dave Marquez filed objections to the Enstar-Marathon contract over its pricing mechanism and other issues.
In a Jan. 5 action, the commission established a docket for its proceedings on the agreement and set a Feb. 9 date for hearings.
The attorney general's key concern is the contract provision that would link the price Enstar pays to the Henry Hub Index for proven reserves, but Marquez also objected to a provision that Enstar would base its price on a 12-month average of the index. The two other Enstar contracts linked to the Henry Hub are based on a three-year average of gas sold at the hub.
Basing the price on a 12-month average rather than a 36-month average could increase the potential for consumer rate shock, Marquez warned in a brief filed Dec. 2. Enstar passes its costs for buying gas on to residential and business customers in the Southcentral region.
Enstar disagrees with this assessment, arguing in its filing with the RCA that the use of a 12-month average really adds protection for consumers against gas market volatility because it will more quickly reflect falling prices in the Lower 48. It will be generally more "market-responsive," lessening the risk that the price Alaska consumers pay will be above the actual Henry Hub price if it falls for any extended period.
"This gas supply is critical to Southcentral Alaska," said Enstar spokesman Curtis Thayer. "The net result of this contract is that Enstar's customers have 60 billion cubic feet of natural gas.
"Cook Inlet gas production is declining rapidly, and without the new contract, Enstar will be short of gas in 2009," Thayer said. "No other producer offered to sell us gas in 2009 and beyond with deliverability that meets our needs."
Thayer said shortages in daily deliverability of gas during cold weather are now occurring. "During the very cold weather before Christmas, Enstar had enough gas for its customers, but there was not enough gas to serve everyone and gas service to some industrial customers had to be curtailed by suppliers," he said.
People familiar with Alaska natural gas pricing, speaking on background, said Enstar's goal is to have a "portfolio" of gas contracts with different price-setting mechanisms so that consumers wouldn't get hit suddenly with price increases.
The state's key objection to the Enstar-Marathon contract is the link to Henry Hub for proven reserves. While some have objected to the principle of basing the Cook Inlet price on a distant index not actually connected to the local gas market, in reality, the use of different out-of-state indices for local gas and crude oil pricing has been done for years.
Current gas purchase contracts by Chugach Electric Association and other utilities link prices to crude oil and even refined fuel prices that are influenced by market forces outside Alaska.
Thayer said Cook Inlet gas is actually connected to world markets because liquefied natural gas from the Kenai LNG plant is sold in Japan at prices set there, and ammonia and urea from the Agrium plant is sold in foreign markets at prices influenced by gas prices elsewhere.
In its Dec. 2 brief, the state said that in the commission's earlier proceedings on the use of the out-of-state index, Enstar "claimed a pricing premium in the form of Henry Hub price indexing was necessary in order to entice producers to use their worldwide exploration funds here in Cook Inlet."
Unocal's contract required it to spend in excess of $11 million in new exploration in areas outside existing fields. Another contract with NorthStar LLC, a small independent firm, contains exploration work commitments to drill and develop two production wells and to increase the proven reserves of its small North Fork gas field from 12 billion cubic feet to 14.5 billion cubic feet, according to the state's brief.
"The Marathon agreement requires no exploration. There is no evidence that performance of Marathon's duties under the gas sales agreement will require it to make any materially significant capital expenditures," the brief said.
That only tells part of the story, sources familiar with regional gas issues have said. Marathon has actually spent as much or more than Unocal on exploration for new gas in recent years.
The exploration was successful, as was Unocal's. In fact the two companies were partners in exploration and development of the new Ninilchik field on the Kenai Peninsula. Marathon also found new gas in an exploration well near Kasilof, which it will begin producing later this year.
Additionally, Marathon will have to make investments in wells and production facilities its existing fields so the company can meet the 2009 supply commitment made to Enstar under the new contract.
"Marathon has committed proven reserves to the contract, but significant capital will still be needed to actually develop and produce the gas. If projects elsewhere promise higher returns the capital will go there, not to Cook Inlet," Thayer said.
Having the security of proven reserves, not gas that might or might not be found in exploration, is important to Enstar. "If you needed natural gas for your home you would probably pay more to buy from someone with a proven gas reserve rather than someone who hoped to find new gas through exploration," said an industry source, speaking on background.
Under the contract, Marathon would essentially become Enstar's peak-demand supplier, obligated to crank up production during winter cold snaps. But being prepared to do that imposes costs because wells would have to be developed to have the capability of peak production rates, but they would actually produce less on a year-around basis.
The fixed costs of the higher capacity would have to be spread across less overall production, raising the company's costs per unit of production, the sources said.
Tim Bradner can be reached at tim.bradner@alaskajournal.com.
