By Tim Bradner
Alaska Journal of Commerce

JUNEAU — The notion that underlies Gov. Sarah Palin's Alaska Gasline Inducement Act is that a $30 billion-plus North Slope natural gas pipeline is wildly profitable for the companies that hold oil and gas leases, and the only reason the pipeline isn't under construction is the companies are holding out for big tax breaks from the state.

Antony Scott, chief of the commercial section of the Division of Oil and Gas, told a legislative committee in Juneau that producers will earn internal rates of return exceeding 50 percent per year over the 25-year life of a project if a pipeline company builds and owns the pipeline.

If the producers build and own the pipeline, their profits drop to an average 16 percent internal rates of return, Scott said. Profits decline because the return on the pipeline portion of the investment is limited by the Federal Energy Regulatory Commission.

Producing companies say Scott's analysis is all wet because it doesn't take into account the financial commitments the producers must make to the pipeline to purchase capacity. Without those contracts, the pipeline can't borrow the funds needed for construction.

No matter how rosy the profits appear in computer modeling, the huge financial obligations the companies must make to the pipeline need to be taken into account as well as the risk of cost overruns.

These commitments could total as much as $144 billion if they are for the full 25 years of the project, according to Dave Van Tuyl, BP's gas commercialization manager. Wendy King, ConocoPhillips' manager for North Slope gas development, told the House Resources committee that even if the shipping commitments were for 20 instead of 25 years, the total would still be more than $100 billion.

ConocoPhillips' share of that could be as much as $26 billion, she said. “The magnitude of these shipping commitments are just staggering,” she said.

“I'm really troubled by statements that someone will know what the economics of this project will be out 30 years into the future,” King said. There are too many things that can go wrong, she said.

Van Tuyl said the producers are on the hook to pay if there are cost overruns on the pipeline, or even if the pipeline isn't completed.

“If for some reason the pipeline company goes bankrupt, the lenders turn to the firm transportation commitments made by the shippers to get repayment. The commitments would indeed be paid to the lenders, so they are a real commitment and have to be taken into consideration when evaluating project economics,” Van Tuyl told the House Resources Committee.

Scott, however, poured cold water on these arguments. In his presentation to the Senate Judiciary Committee, Scott argued that the producers aren't so financially exposed, because they would be likely to finance the commitment on an independent project basis so that not all of the parent companies' assets would be on the line. “It's a misconception that only the producers have the financial strength to back the project,” Scott told the Judiciary Committee.

He said the major independent pipeline companies have sufficient assets to insulate companies that ship the gas and sign the firm transportation contracts, from cost-overrun risks. The trend in the pipeline industry today, Scott said, is for pipeline companies to assume more financial responsibility for the projects.

“At the end of the day, independent pipeline companies are fully capable of handling the non-completion risk associated with the project,” Scott told the Senate Judiciary Committee.

The producers disputed this, too. Daren Beaudo, spokesman for BP, said there may be cases of pipeline companies sharing risks with shippers in the Lower 48. However, the sheer scale of the Alaska gas pipeline, which is several times the size of any pipeline built or being built elsewhere in North America, makes it doubtful any of the major pipeline companies could handle a cost overrun of any size.

King, of ConocoPhillips, and Van Tuyl, of BP, also disputed Scott's argument that project financing would lessen the financial effects of the long-term commitments on the producing companies.

“We are required to disclose these commitments to the SEC,” Van Tuyl said, and they do show up as obligations of the parent firms. “Commitments of this magnitude will be taken into consideration by financial entities like banks when evaluating our company. That's because it's a real obligation.”

Scott also said, in his presentation, that the gas reserves in the ground, not corporate credit, provide the ultimate backstop to the pipeline debt. “We expect only limited recourse to the parent companies' finances. The real credit support is the gas in the ground,” he said.

Van Tuyl had problems with this statement, too. “The firm transportation contract is actually a financial commitment. In reality, a company doesn't have to really own gas to buy capacity contracts, it just has to be credit-worthy.”

King said, “It's not necessary for a company to own gas to take on capacity in a pipeline,” she said. There are times when producers or others will buy more capacity than they have gas for, because they expect to find more gas. “It's called buying on speculation.”

Van Tuyl said a lot of people get confused on these points, and the jargon adds to the confusion. “I've sometimes heard the firm transportation agreements as 'committing gas to the pipeline.' I've heard that from industry as well as others, so I'm not pointing fingers. It's actually a financial obligation, however,” he said.

Tim Bradner can be reached at tim.bradner@alaskajournal.com.