Ideas being floated by gubernatorial candidates Tony Knowles and Sarah Palin on how to advance the natural gas pipeline project are drawing some criticism from people who have been in the trenches in negotiations over the last two years.
A criticism of both candidates' statements that is widely shared among those who have been involved in negotiations is that they reflect the influence of former state Department of Natural Resources officials who resigned a year ago after disagreeing with the approach by Gov. Frank Murkowski's administration.
Tom Irwin, the former DNR commissioner who resigned, is supporting Republican candidate Palin and has given her advice. Marty Rutherford, the former deputy commissioner, is advising Knowles, the Democratic contender.
Irwin and Rutherford have a fundamental disagreement with the Murkowski administration's approach, arguing essentially that the gas is no longer "stranded" because a pipeline project is economic today.
The state Department of Revenue, in contrast, is of the opinion that the pipeline project is not economic and needs incentives and other measures - such as the state's participation in the project - to make it attractive enough for the companies to assume the risk and proceed. Pedro van Meurs, the state's chief consultant on the gas deal, shares that view.
Murkowski ultimately came down on the side of van Meurs and the revenue department. Having lost the internal battle, Irwin and Rutherford quit along with oil and gas director Mark Myers and two other DNR managers.
Sources in the administration say Irwin and others at DNR reached their conclusion mainly by putting their faith in a detailed economic model assembled by the agency that predicts that Lower 48 gas prices will not fall below $5 per thousand cubic feet (mcf) over the next 35 years. The source said that both the price of gas and the overall cost to build the project are unknown.
It's tough to put any credibility in a long-term forecast of energy prices. With natural gas there will be always be volatility, evidenced by the huge swing from $16 per mcf a year ago to about $4 per mcf now.
Economic models are useful in many ways, but there are real-life factors affecting the market cannot easily be modeled, such as the risk of cost increases and competition in the market, which can take different forms.
The people who will risk $25 billion to $30 billion will want a lot more certainty around those numbers, particularly on the cost side, he said.
Coal could trim the market
While imports of liquefied natural gas are often cited as a competitive threat if an Alaska gas pipeline is delayed for too long, a new competitor is coal. Major electric utilities in several states have recently announced plans to add new coal-fired power generation capacity, mainly because coal offers more stability in costs. Ironically this includes utilities in Texas, a major gas-producing state.
An administration source said the move to coal cuts directly into the power generation market, which constitutes 25 percent of the new growth in domestic demand for gas that has been forecast. Developments like these weren't in the DNR model.
The candidates and many legislators put faith into another long-range economic assessment conducted by Econ One, a consulting firm hired by the state Legislature. Several people familiar with the past negotiations have serious questions about the analyses given the Legislature by Econ One, particularly its discounting of the risk of cost increases.
Econ One basically came to the same conclusion as the DNR model, that the project would enjoy good profitability under the current long-range prices forecasts of about $5 per mcf.
"Econ One, however, also said there was a low chance of significant cost overruns," said Joe Marushack, vice president for North Slope gas for ConocoPhillips Alaska Inc. "We have irrefutable evidence this risk is understated by Econ One."
"The price of steel has doubled since the 2001 estimates were made. Getting enough skilled labor will be a serious challenge, so labor costs will be higher," Marushack said.
"If the cost of the project were to double, like steel prices have, that could mean a tariff well above $5. But the market price of gas was recently below $5. Does that sound like one can oversimplify that this is an economic project? It really points out that one cannot look in isolation at today's price of gas, or any specific period, and make broad statements about the project."
Steve Porter, the deputy commissioner of Revenue who led many of the state's negotiations with the producers, takes issue with a statement by candidate Knowles on the construction cost risk.
Knowles has stated that, "although significant cost overruns can occur, and these would negatively affect the overall project economics, the threat of cost overruns is typically overstated."
"This could not be further from the truth. This quote is so absurd it astounds me," Porter said in a written statement. "My research doesn't provide a single expert who agrees with this bold statement. In fact the opposite is true.
"Project developers tend to underestimate cost overrun risk, not overestimate it. Ask Bent Flyvbjerg, the author of 'Megaprojects and Risk, an Anatomy of Ambition,' or Dr. Al Rogers, from IPA Institute who was invited to Alaska to talk to the Legislature about megaproject risk," Porter wrote.
"Both will tell you that project proponents are optimists. They want to build the project. They will generally underestimate the costs and overestimate the benefits."
Knowles' campaign staff were contacted to respond to Porter's assertions, but did not provide a response.
Porter also takes on another statement by Knowles: "By the time detailed engineering is complete (well before a commitment to construction), the potential for cost overrun 'surprises' shrinks dramatically, typically to no more than 5 percent. The big cost overruns on pipeline projects occur between projections at the early stages to the more defined project planning stages."
Porter wrote that, "This is a complete misunderstanding of project costs and project risk. Mr. Knowles has the 5 percent right, but it is the cost of the budget during the planning phase, not the risks that are left after the planning phase is completed."
Ninety-five percent of the project costs and risks are still to come. Most of the major risks to the project are during construction, Porter wrote.
Weather, logistics, labor and material costs, environmental problems, regulatory and permitting delays - all are part of the real risk to the project, and they occur after the defined project planning stages.
"The former governor (Knowles) has fallen directly into the trap the Flyvbjerg says catches many promoters: they underestimate the costs and overestimate the benefits from a project," Porter wrote.
"Moving Alaska's gas to market should be one of the highest priorities of the next administration. To do it through informed decision-making is essential," Porter wrote in his statement.
Tim Bradner can be reached at tim.bradner@alaskajournal.com.
