Elwood Brehmer

Alaska Air Group adds to record profits with $184M quarter

Alaska Air Group Inc. didn’t miss a beat in the first quarter, posting yet another record profit of $184 million while hashing out a deal to buy Virgin America airlines. The Seattle-based parent company to Alaska Airlines and regional carrier Horizon Air grew its net income by more than 20 percent over the then-record $149 million profit it posted in the first quarter of 2015. The first quarter is traditionally the slowest quarter in the airline industry, but Air Group’s $184 million profit nearly matches the $186 million it netted in the last quarter of 2015, also a record. Its $842 million net income for 2015 was a full-year record as well. Overall, Alaska Air Group has defied the odds in a hyper-competitive and volatile business and posted six consecutive years of record profitability. Each quarter within those years has also been a record with very few exceptions. On April 4, the company announced a $4 billion deal to purchase San Francisco-based Virgin America, which Air Group executives hope will make Alaska Airlines the dominant carrier on the West Coast. Air Group CEO Brad Tilden said in an April 21 conference call with investors that Virgin and Alaska “share similar philosophies about building alignment with and taking care of our people and about putting customers first.” A vote by Virgin America shareholders on the deal is expected sometime in the second quarter, Tilden said. The parties hope to close the deal by the end of the year. The $184 million first quarter profit translates to diluted earnings of $1.46 per share. Alaska Air Group stock closed April 27 trading at $74.35 per share. Tilden said the company’s earnings per share are expected to outperform all but 36 companies in the S&P 500. Air Group’s 12-month return on invested capital, or ROIC, is 25.6 percent, which is more than three times its cost of capital, he noted. “As we look forward, our 15,000 employees are operating safely and they are taking care of our customers and each other,” Tilden said. “Our core business is strong and we’re seeing robust demand for our product. As a result, our business is producing the sort of returns you should expect from high-quality industrials.” Operating revenue was more than $1.3 billion for the quarter, up 6 percent year-over-year; fuel costs — the largest expense for most airlines behind personnel costs — were down 29 percent. Airlines worldwide have benefitted from continually falling fuel prices over the past 18 months and Alaska Air Group’s companies are no exception. However, Alaska Air Group has additionally focused on reducing costs to improve its balance sheet regardless of fuel prices, Chief Financial Officer Brandon Pedersen said during the April 21 call. This year will be the seventh year in a row that Alaska Air Group will reduce its operating expenses, according to Pedersen. Further, the company continues to improve its fuel efficiency by 1 to 2 percent each quarter, as it upgrades its Alaska Airlines fleet of Boeing 737s. Alaska Airlines’ 20 remaining and aging Boeing 737-400s will be replaced with 737-900ERs (extended range), which are 25 percent more fuel efficient, by the end of 2017. The company’s operational cash flow was $527 million for the quarter, Pedersen said, and it finished with nearly $1.6 billion in cash. “Even after adjusting for leases, we’re in a net cash position of almost $600 million,” he said. “Our (debt-to-capitalization), including leases, now stands at 26 percent. Our net cash position, the 95 unencumbered aircraft in our fleet, our investment-grade balance sheet, and our long track record of conservative financial management put us in a strong position to raise the capital necessary to fund the proposed acquisition of Virgin America.” Pedersen added that the company is working with potential lenders to finance the deal and initial results are “very encouraging” both to the number and diversity of interested lenders. The $2.6 billion cash deal also includes Air Group assuming nearly $1.5 billion of Virgin debt — collectively making a roughly $4.1 billion transaction. Even without the Virgin America deal, Alaska Air Group is growing. Tilden said as a whole the 41 markets its airlines have added over the past two years are profitable and producing returns higher than investment costs. Alaska was also one of the first domestic airlines to request federal authorization to start service to Cuba. In state, Alaska Airlines has announced plans to spend more than $100 million over the next couple years on a new hangar in Anchorage to house the larger 737-900s, as well as remodels to 11 terminals the airline owns across Alaska. Alaska Air Group also formed McGee Air Services in March. A wholly owned Alaska Airlines subsidiary, McGee will initially operate as a vendor to Alaska Airlines and compete for its service contracts in some markets. The plan is to expand to serve other airlines as the company develops. The name pays homage to Linious McGee, who, in 1932, founded McGee Airways in Anchorage — the company that ultimately became Alaska Airlines. Elwood Brehmer can be reached at [email protected]  

Point Thomson produces first condensates for TAPS

After a decade, a lawsuit that reached the Alaska Supreme Court, and $4 billion, Point Thomson is producing. ExxonMobil Alaska announced Friday morning via social media that the large North Slope natural gas field “is now officially online.” A $4 billion development located about 60 miles from Prudhoe Bay on the far eastern edge of the developed North Slope, Point Thomson holds about 8 trillion cubic feet of natural gas. It is for this reason that the field is a lynchpin to the $45 billion-plus Alaska LNG Project; it accounts for nearly one-fourth of the North Slope natural gas the project partners hope to export. “The successful startup of Point Thomson demonstrates ExxonMobil’s project management expertise and highlights its ability to execute complex projects safely and responsibly in challenging, remote environments such as the North Slope in Alaska,” ExxonMobil Development Co. President Neil Duffin said in release. “Our strong partnership with Alaskans and Alaska-owned companies played a critical role in helping to complete this major project. It further reinforces our commitment to pursuing the development of Alaska’s natural gas resources.” About 100 Alaska companies contributed to the development of Point Thomson, according to ExxonMobil. Point Thomson facilities will initially produce about 5,000 barrels per day of natural gas liquids, or condensates, that will ultimately flow through the trans-Alaska Pipeline System. Full condensate production is expected to reach 10,000 barrels per day after several months when an additional well is brought online, a release states. There are about 200 million barrels of usable condensates, which are products similar to kerosene or diesel. The natural gas condensates can be captured because Point Thomson is a high-pressure gas reservoir. When the pressurized gas is expanded in facility separators the liquids “fall out” and are easily collected, according to ExxonMobil project leaders. About 200 million cubic feet of natural gas per day will also be recycled and re-injected at full production as it waits for an export project. ExxonMobil is the field operator and majority owner; BP holds a 32 percent working interest and ConocoPhillips has a 5 percent interest in Point Thomson. First discovered in 1977, Point Thomson’s development is a saga that stretches back to former Gov. Frank Murkowski’s administration. The Murkowski administration pulled ExxonMobil’s Point Thomson leases in 2006, contending the company did not uphold its responsibility as a leaseholder to develop the field at the time. A subsequent lawsuit reached the state Supreme Court in 2012, but the state settled with the company in 2012 under former Gov. Sean Parnell before a court ruling. That settlement laid out the schedule that ExxonMobil developed the project under, which required first production by May 2016. Look for updates to this story in an upcoming issue of the Journal. Elwood Brehmer can be reached at [email protected]

MEA gets flat-rate deal with Hilcorp; members to save $3M in first year

Matanuska Electric Association’s latest natural gas supply contract has two unique characteristics designed to benefit the utility. The contract with Hilcorp Energy, the dominant producer in Cook Inlet, is for all of MEA’s projected gas demand from April 2018 through March 2023. At an estimated annual demand of a little more than 6 billion cubic feet, or bcf, of gas per year, the contract covers about 32 bcf of gas sales over the five-year term. It was submitted to the Regulatory Commission of Alaska April 19 and is a tentative deal pending the commission’s approval. MEA General Manager Tony Izzo highlighted in an interview that the $7.55 per thousand cubic feet, or mcf, of gas price not only should save the co-op utility’s members $3 million in the first year, but also that the price is consistent regardless of how much gas MEA needs on a given day. “What I’m excited about in this contract is I pay $7.55 for everything. I have no swing gas premium,” Izzo said. “Our customers will pay that price for the lowest demand day and the highest demand day.” It has basically been standard practice for recent Cook Inlet gas supply contracts to include a base load price for the majority of a utility’s demand. Additional gas needed mostly during cold weather and dark winter months is then sold at a premium price that can be as much as 50 percent higher than the base load price for emergency, or needle peak, supply. Hilcorp Energy declined to comment on the terms of the gas supply contract with MEA. Enstar Natural Gas Co., the region’s largest natural gas buyer, agreed to a contract in February through early 2023 with Hilcorp for a first year weighted average price of $7.56, which includes premium sales. That deal will save Enstar customers $14 million in the first year of the contract. Izzo said MEA’s deal provides price certainty to its customers who won’t see feedstock fuel prices go up at the same time they are using more electricity. The cost savings are the result of a price drop from the $8.03 per mcf base load price MEA and most Cook Inlet gas customers will be paying under contracts with prices set by the 2012 Consent Decree that expires at the end of 2017. The Consent Decree deal was reached by the Attorney General’s office and Hilcorp and capped Inlet gas prices through 2017, thus allowing Hilcorp to purchase gas and oil interests from Marathon and Chevron and become the majority gas supplier in the basin in late 2012. MEA and Hilcorp agreed to a 2 percent annual price escalator after the first year $7.55 per mcf price. The Consent Decree allows for a 4 percent annual price increase. The deal also gives MEA a partial “out clause” that it can exercise on up to 20 percent of its gas demand. “For about 20 percent of my supply, if the market changes and hopefully (another producer adds supply) and the price is attractive I can notify Hilcorp at any time before or during this contract and say, ‘I’m going to exercise the turndown option,’” Izzo said. However, he noted the price from a new supplier would have to be substantially less than the current contract price because Hilcorp has the right to add 25 cents per mcf to MEA’s remaining contracted demand if the turndown option is used. Similar to what Enstar officials said when their contract went to the RCA in February, Izzo said the five-year term is a compromise between supply security and encouraging diversity among producers. He thanked Hilcorp for its work to increase gas supply from mature Inlet fields and noted that just a few years ago utilities couldn’t any contracts for longer than two years. The leaders of both utilities said Hilcorp was willing to agree to longer-term contracts. “I’m real happy with the price but at the same time I really want the market to grow; I want to have an alternative supplier; I want to diversify the portfolio and I want to see prices go down so how do I do that?” Izzo surmised. “I stick with a five-year term. It’s not forever but I was able to get this turndown option and hopefully one of these (other producers) will get some cash flow off that.” Elwood Brehmer can be reached at [email protected]

ConocoPhillips to add wells at CD-5, will reach 16K b/d goal this year

Despite low oil prices, ConocoPhillips keeps drilling. The company announced Thursday morning that it has approved a plan to spend about $190 million to add another 18 wells and associated infrastructure to fully build out its new CD-5 oil development. ConocoPhillips has completed 10 of the 15 wells laid out in CD-5’s initial development plan. Production from the site began in October of last year. The more than $1 billion overall project was designed to accommodate 33 wells, meaning the latest approved drilling program will add another 18 wells. CD-5 is the company’s latest project in the Alpine field — on the western fringe of the established North Slope. ConocoPhillips expects CD-5 will hit its production target of averaging 16,000 barrels per day this year. “The additional drilling opportunities we’ve identified at CD-5 are a positive development that should increase oil production at Alpine,” ConocoPhillips Alaska President Joe Marushack said in a release. “The competitiveness of this next phase of CD-5 drilling was improved due to the investment climate resulting from the passage of (Senate Bill 21 in 2013). We want to continue to invest in production-adding projects like this.” The company expects first oil from the next phase of drilling to begin flowing in the fall of 2017. Oil and gas industry representatives in the state have emphasized during discussions in the Legislature about trimming the state’s oil and gas tax credit program that the cost of producing North Slope crude and getting it to market — approximately $46 per barrel — means companies are losing money at today’s prices. Alaska North Slope crude was selling for about $43 per barrel at the time of ConocoPhillips’ announcement. Earlier this year BP announced it is idling three drill rigs working in the Prudhoe Bay field and several smaller independent companies have slowed or delayed development projects, citing cash flow issues and the current price environment. Development work is also continuing on ConocoPhillips’ $900 million Greater Mooses Tooth No. 1 project, expected to bring another 30,000 barrels online at peak production, with first oil scheduled for late 2018. The company sanctioned GMT-1 late last year. Farther west than CD-5, GMT-1 would be the first production on federal land within the National Petroleum Reserve-Alaska. While within the NPR-A boundary, CD-5 is on an “island” of land owned by Kuukpik Corp. an Alaska Native village corporation. ConocoPhillips has a 2016 Alaska capital budget of $1.3 billion, down 5 percent from 2015 spending. That’s the smallest reduction of any area the company operates after it lost $4.4 billion in 2015, and is greater than its cap-ex spending in Alaska in 2012. Elwood Brehmer can be reached at [email protected]

Salaries spotlighted as session continues

Most state employees will give up some, but not all, pay increases in the latest round of union contracts before the Legislature for approval. Nearly 75 percent of executive branch employees will forgo cost of living allowance, or COLA, raises under the three-year agreements negotiated with the Labor, Trades and Crafts, Alaska State Employee, Confidential Employee and Mount Edgecumbe Teachers bargaining units. However, annual merit pay increases averaging 3.5 percent for an employee’s first five years of service and biannual “step” increases of about 3.25 percent for long-term employees remain under the proposed new contracts. The current bunch of contracts expire June 30, the end of the current fiscal year. The Department of Administration is also negotiating with the Alaska Public Employees Association, sometimes referred to as the supervisors union, which covers about 2,300 of the roughly 16,600 State of Alaska executive branch employees covered by collective bargaining. Administration Commissioner Sheldon Fisher said to the House Finance Committee April 19 that he feels the agreements are fair to both sides given the state’s $4.1 billion budget deficit. The total payroll for executive branch workers is roughly $1.2 billion per year, he said. “I do feel like each of these bargaining units came to the table prepared to make concessions,” Fisher said. “We as the state gave very little in turn to get those concessions.” The contracts, which generally have similar frameworks for the major components, also require employees covered by the contracts up for approval to take 15 hours of furlough time, which is equivalent to two working days per year. State workers will have the option to cash in accrued leave time to offset the furloughs, which will likely reduce the final savings. In a March 14 presentation to the House Finance Committee, the Department of Administration calculated the net savings per year from the furloughs minus the use of leave time spread over about 7,100 employees would be $1.4 million. Additionally, they require employees on the “economy” health insurance plan — about half of eligible state employees, according to Administration — to begin paying a portion of their premium costs. Those contributions gradually increase from 5 percent to 9 percent of premium costs over the three years of the contract. Health insurance for the nearly 9,000 employees in the State Employees Association, also known as the general government unit, is paid through a health trust and the state’s contribution to that trust is reduced for fiscal year 2017. The 27 Mount Edgecumbe state boarding school teachers are exempt from the furlough and insurance contribution changes. All told, Fisher said the health care contribution changes and furloughs should save the state about $6.5 million in 2017 over the previous contracts. If the contracts are rejected by the Legislature, the existing agreements remain in place and the projected savings would be lost, he said. Republicans on the committee questioned why the state agreed to continue the merit and step raises, which cost upwards of $20 million per year, given the budget situation. Fisher said the contract changes are usually incremental; the unions agreed to kill the COLAs, add furloughs and increase insurance payments in this round of contracts. He conceded, though, that the state needs to scrutinize who receives merit-based raises, which are awarded to all employees that achieve at least “acceptable” work performance reports. “This is an area (where) as an administration we need to do better,” Fisher said. “The reality is that as a state we’re not very effective in our performance management of our employees and it tends to be that a very, very high percentage of our employees, and I don’t know what it is but I would guess it’s over 95 percent of our employees earn their merit and step increases.” Still, Fisher noted that the state has succeeded in “flattening the curve” of pay increases above inflation. COLA, merit and step raises increased an average state employees’ pay by two-thirds under the contracts approved over the last 10 years, while inflation increased about 30 percent over that time. Without the COLAs — that are eliminated in the new contracts — average pay would have increased about 40 percent over the same period, according to the department. Fisher also emphasized that the general pay for state employees, particularly highly skilled or specialized employees, is below the market rates. More generous benefit packages tend to bring overall state compensation in line with market conditions, he said. Rep. Les Gara, D-Anchorage, said most everyone understands the state can’t be “very generous” with raises right now, but contended that just keeping up with inflation would likely drive away the state’s best workers. Anchorage Republican Rep. Craig Johnson introduced legislation April 18 that would eliminate merit and step raises until the price of Alaska North Slope crude oil averages $90 per barrel for a full fiscal year and subsequently limit the raises only to employees that receive “good” or higher performance ratings from their supervisors. A March 12 memo from Legislative Legal Services responding to a question from Finance co-chair Rep. Steve Thompson, R-Fairbanks, examining the role of the Legislature in collective bargaining, states that both the Alaska and U.S. constitutions limit the Legislature’s ability to insert itself into executive branch employee contract negotiations, likely making Johnson’s bill unconstitutional if passed. Union leaders have sent letters to their labor groups asking employees to speak out against the proposal, House Bill 379. Minority legislators have also said the do not believe the bill will move. “It is the Legislature’s role to review monetary terms agreed on by the parties and presented to the Legislature and either fund or not fund those monetary terms. If the Legislature does not fund the terms, the parties must renegotiate and present new terms at a later date,” the memo states. “Beyond this, there are legal and constitutional limitations on the Legislature’s role in collective bargaining. The state and federal constitutional prohibition of impairment of contracts may be the most substantial limitation. There may be other legal obstacles as well.” The funding of COLAs was a topic of debate during last year’s marathon series of special budget sessions. The Legislature ultimately agreed to fund the raises but cut state department budgets by roughly the same amount, $30 million. Departments decided to pay the raises and “ate” the difference through other budget cuts, according to Administration officials. Elwood Brehmer can be reached at [email protected]  

Audit: Port towns mostly handled state cruise tax properly

A state audit report released this month concludes more than $270 million in cruise ship passenger tax money collected since 2007 has been used appropriately by the vast majority of Alaska communities the ships visit, with one small exception in Skagway. The audit, conducted by Legislative Budget and Committee staff, uncovered an instance in the summer of 2013 when the Skagway Borough used $114,000 of cruise passenger tax funds to buy playground equipment for the borough’s elementary school. The auditors only examined how the state tax money has been handled; the separate taxes imposed by Juneau and Ketchikan were not reviewed. Those taxes are the subject of a lawsuit filed by Cruise Lines International Association Alaska against the City and Borough of Juneau in Alaska U.S. District Court on April 13 alleging the city has spent $35 million of its own head tax revenue on since 2001 on general government expenses and capital projects that don’t directly benefit cruise vessels or passengers. Because the cruise passengers are out-of-state visitors, the Commerce Clause of the U.S. Constitution requires that the local and state head tax money be spent on industry-related projects and expenses. The audit concluded that the Skagway spending on playground equipment was a misuse of the state tax revenue. The report states local officials believe purchasing the playground equipment was an appropriate use of the funds because it is used by visiting cruise passengers and the children of seasonal tourism industry workers. Skagway Borough Manager Scott Hahn, who did not hold the position in 2013, wrote in an April 7 letter responding to the report that Skagway intends to continue to be good stewards of the cruise passenger tax funds and that “the comments about our playground project will be kept in mind for the future.” Sen. Anna MacKinnon, R-Eagle River, requested the audit early in 2015 to determine if local governments were spending the state tax money properly or stockpiling it for other purposes. The State of Alaska levies a $34.50 per person “head tax” on each of the roughly 1 million passengers that disembark from a cruise ship in the state. However, vessels stopping only in Juneau or Ketchikan are essentially exempt from the state tax because the local head taxes levied by those communities can be credited against the state tax. State head tax revenue is then distributed to cruise port communities based on the number of cruise passengers that visit each coastal town, with few exceptions. The state head tax has generated $16 million to $18 million annually in recent years and $14 million to $15 million of that has been shared with local governments each year. In its lawsuit, CLIA Alaska is seeking an injunction to prohibit Juneau from imposing its head tax. Association leaders have indicated the group does not have an issue with how Ketchikan has handled its head tax funds. The complaint specifically cites a $10 million manmade island and life-sized whale statue Juneau is building partially with head tax funds as the latest example of misspent money, as well as $22 million in government operating expenses. The city touts the artwork as a tourist attraction, while the cruise association notes it will be nearly a mile from the cruise ship docks. Private contributions are funding a portion of the project, which is being built in conjunction with a $54 million overhaul of the city’s Downtown waterfront that includes two new floating docks to accommodate larger cruise ships. The City and Borough of Juneau has yet to file a response with the court. The state audit found communities have generally used the tax revenue shared by the state for allowable projects, but that some communities lacked the necessary documentation to easily assure the tax expenditures complied with state law. It also reports that the unspent balances of the shared tax funds held by communities to be reasonable based on efforts to complete the projects the tax money was appropriated to fund. Gov. Bill Walker introduced legislation this year that would eliminate the local head tax exemption from state law. The administration agreed not to push for the bills until the audit was released. At this point, the legislation appears dead this session, as it has not moved through the committee process. Cruise industry representatives have said the tax change would be pointless because the additional $15 million or so it would generate could not be used to pay down the state’s $4 billion budget deficit. The audit report concurs with administration officials who have said something needs to be done to at least close a potential funding gap created by the current tax law, which directs the state to share $5 with each of a vessel’s first seven ports of call, meaning the $34.50 tax could eventually be insufficient. The Commercial Passenger Vessel Fund has remained solvent since the tax was instituted in fiscal year 2007 because not all vessels call on seven ports. The report also notes that while the $8 per person Juneau and $7 per person Ketchikan local head taxes combine through the state tax exemption to reduce actual state revenue to $19.50 per passenger, the state is still required to share the $5 per passenger with those communities. Nearly all of the state’s cruise visitors stop in Juneau and Ketchikan and thus the state can share a combined total approaching $10 million per year in good years when Alaska sees about 1 million cruise visitors. “To date, (Commercial Passenger Vessel) receipts have been sufficient to fund the amounts required to be distributed to port communities,” the report states. “However, significant increases to the number of passengers that visit a high number of ports would threaten the solvency of the CPV Fund.” Elwood Brehmer can be reached at [email protected]

Mental Health Trust exploring Icy Cape prospect

The Alaska Mental Health Trust Land Office is evaluating a heavy mineral prospect near Yakutat that could change the course of the agency for generations. Icy Cape is a long stretch of beach owned by the trust at the entrance of Icy Bay that appears to hold world-class deposits of several heavy minerals, according to Trust Land Office Executive Director John Morrison. “It’s difficult to quantify the value of (Icy Cape) in terms of heavy minerals; it’s just mind boggling,” Morrison said in an interview. “There’s enough heavy minerals there to run a really large mine operation for over 100 years and we’re talking about hundreds of millions of dollars every year.” The minerals are literally grains in the beach sand on a parcel of coastline that stretches for more than 30 miles and totals roughly 48,000 acres, Morrison described. Trust officials stressed that the resource evaluations are preliminary, but early drilling samples of the “ore” — sand, really — indicate up to 40 percent of the ore is heavy minerals in the broadest delta area near the point of the cape. Specifically, the samples are roughly comprised of 20 percent epidote, 19 percent garnet and 0.5 percent zircon. Epidote and zircon are semiprecious gemstones. Garnet has also been used as a gemstone for hundreds of years, but more recently the hard mineral has been put to use as an industrial abrasive on sandpapers and in sandblasting applications. It is also used in water filtration; garnet’s small pores allow for the passage of liquid while catching some contaminants. “We would be the only source for garnets on the West Coast,” Morrison said. “Specifically, there’s all sorts of metrics and parameters that the buyers of those types of materials would want and our garnets are the best you could have in terms of the size of the crystals and the way they’re fractured.” The Icy Cape sands also contain gold concentrates of about 1.4 grams per metric ton, according to the early exploratory results. The sands are comprised of two sediment patterns coming from opposite directions, those materials that have eroded and washed down from the steep mountain faces above and sediments that tidal and wave action have pushed up to the shoreline. If the preliminary resource indications are proved on a larger scale, the minerals and metal in a tonne of Icy Cape sand could be worth $190 at current market prices, the Trust Land Office estimates. The Trust Land Office manages roughly 1 million acres of land across Alaska for resource development, the proceeds of which go to fund the Alaska Mental Health Trust Authority’s work to benefit Alaskans with mental health and addiction challenges. Morrison said the trust is conservatively projecting that a full-scale mining operation could process up to 250 tonnes per hour for 270 days each year; that adds up to more than $300 million in gross revenue per year for 100 years, he said. The operation would likely start on a much smaller scale, however, of about 50 tonnes per hour, Morrison said, which would require about a $50 million investment. As a passive landowner the trust could expect to see about 20 percent of the gross revenue from any mine, but Morrison said he would hope to retain control as a more active investor and take “substantially more” risk and subsequent reward from the project. Trust Land Office revenues have varied greatly over its 20-year existence, as money from timber and land sales and other resource projects has come and gone. Since 2011, its annual revenue has been between about $10 million and $16 million; even a minority share of a $300 million per year mine would dwarf that. The City and Borough of Yakutat would also see a bump in its tax revenue from an Icy Bay mine operation, he noted. The processing, or relative lack thereof, required of the sand adds to the positivity of the prospect. Extracting the gold and heavy minerals doesn’t necessitate the intensive milling or chemical leaching common in large metal operations, meaning Icy Cape should theoretically be relatively simple to permit, according to Morrison. “It’s the sand. It’s placer mining. You literally just take a backhoe and scoop the sand into your separator as fast as you can and you get these various compounds,” he described. The Trust Land Office has held the Icy Cape property for almost all of its 20-year existence and held a timber sale there last year. Morrison said it has received interest from individuals wanting to placer mine gold at Icy Cape, but the plans were too small to entertain them. It was only recently when Icy Cape drilling samples from the 1990s were unearthed at the Alaska Geologic Materials Center in Anchorage that the Trust Land Office was spurred to do its own drilling last summer. This year the trust plans to conduct a low-altitude airborne magnetic survey and collect bulk ore samples to further delineate the resources. Then in 2017 the plan is to drill the magnetic anomalies to prove the high-grade, mineable zones, Morrison said. He added that the trust has already gotten interest from international mining companies that are supporting some of the exploration work and want to be a part of the larger development project. “I would say by the end of next summer we should be really headed down the path, depending on the results we get, of forming a joint-venture (partnership) to start the process of permitting a mine,” Morrison said. In the end, he forecasts small-scale production to start in five to eight years if all goes well. Elwood Brehmer can be reached at [email protected]

Bokan mine development slowed as rare earth prices dip

Development of the Bokan Mountain rare earth mine is on hold as the company leading the project focuses on a new processing technology and waits for rare earth metal prices to rebound. Nova Scotia-based Ucore Rare Metals Inc. finished infill drilling and drilled groundwater monitoring wells in 2014, leaving it at a natural stopping point before moving towards the next steps of development. Ucore Vice President Randy MacGillivray said in an interview the company has delineated a resource of approximately 5 million tons that is 0.65 percent total rare earth metals. Bokan, located on the southern part of Prince of Wales Island in Southeast, would be an underground mine. Rare earth metals are used in small amounts in countless technology applications. Their prices have softened in recent years along with other, more well known metals and commodities. MacGillivray said because the mine would harvest up to 15 rare earth metals it is hard to set a definitive price point at which Ucore would initiate a full-fledged feasibility study or jump into the environmental impact statement process. “Certainly a movement towards increased metal values in the rare earth metal sector and or us being able to tie up an end user agreement with defined prices would encourage development,” he said. However, there is no timeline for starting permitting. Instead, Ucore has invested in molecular recognition separation technology that has been used for other metals but not with rare earths, according to MacGillivray. Generating a revenue stream from that investment could also help the junior mining company fund Bokan, he said. Based on Ucore’s preliminary economic assessment, the mine would cost $220 million to construct over two years and employ up to 300 people during that period. Ucore has “drilled off” a resource base to support operation for 10 years, which would require about 190 jobs, he said. MacGillivray said Ucore continues to strengthen its baseline environmental work for the project. In 2014, former Gov. Sean Parnell signed legislation authorizing the Alaska Industrial Development and Export Authority to finance up to $145 million for Bokan’s construction. Elwood Brehmer can be reached at [email protected]  

Credit cuts move over industry objections

The legislation tree sprouting from Gov. Bill Walker’s oil and gas tax credit revamp grew again April 11 when the Senate Resources Committee introduced its own tax credit rewrite. Meanwhile, the House continues to grapple with the third version of House Bill 247, which barely resembles what the administration planted in the Resources committees back in January. The Senate Resources version of Senate Bill 130, now on its way to the Finance Committee, would ramp down the size of refundable capital expenditure and operating loss credits and available for Cook Inlet producers and explorers over the next two years. It would roughly cut available state support — estimated at 55 percent for developing companies and 30 percent for producers under current law — in half starting January 2017, and eliminate refundable credits entirely from the Cook Inlet basin starting in January 2018. It is assumed that by 2018 much more will be known about the future of the Cook Inlet natural gas market, which has temporarily stabilized, and current prospective purchasers of Inlet gas could be more solidified and open more opportunities for producers to sell gas in what is now a very constrained market. The iteration of HB 247 being debated on the House floor at the time of this publication would keep state support for companies working Cook Inlet beyond 2018 at average rates of 25 percent for developers and 15 percent for producers. Walker’s original proposal would have kept credits in place long-term to support about 25 percent of a company’s project development costs but also immediately end state support for Inlet producers. The governor pushed for changes to the complex oil and gas tax credit program to lessen the state’s annual obligation to pay refundable credits at a time when Alaska is facing budget deficit of about $4 billion. What started as a small, $10 million per year industry incentive program in 2003 has ballooned to a $700 million obligation this year and could eventually exceed $1 billion if left untouched, the Walker administration contends. The administration’s plan also would have raised taxes by increasing the minimum tax “floor” for North Slope production from 4 percent to 5 percent. Further, it would have “hardened” the floor to prevent companies from using operating losses during times of low oil prices or after significant capital expenses to take their tax liability below the minimum tax. How a sustained low oil price environment, such as today with prices hovering in the $40 per barrel range, would impact the minimum production tax was not understood or even considered when the overarching production tax law known as Senate Bill 21 was enacted in 2013. The House would harden the floor at a 2 percent minimum tax rate. SB 130 would not harden the floor, despite a recommendation to do so in a December Oil and Gas Tax Credit Working Group report led by Senate Resources chair Sen. Cathy Giessel. Further evaluation by the Tax Division found that the state could be stuck paying more than $1 billion in deferred Net Operating Loss credits when oil prices recover because they couldn’t be used to take a tax liability before the floor when prices were particularly low. The Department of Revenue forecasts Alaska North Slope crude prices will recover to average about $50 per barrel in fiscal year 2019, at which point the state would be on the hook for nearly $1.1 billion in Net Operating Loss credits that companies were forced to hold under both the administration and House credit bills. Under current law and SB 130, that obligation would be closer to $700 million. The progressing HB 247 would cap the amount of refundable credits each company is eligible for at $100 million per year; SB 130 sets an $85 million per year limit. It is largely believed those caps will have little impact unless a small producer or new entrant to Alaska begins an exceptionally large project. Walker proposed a $25 million per company per year refundable credit cap. Both bills contain a proposal by the administration to stop the 20 percent Gross Value Reduction credit to create or increase a net operating loss. The GVR immediately reduces the value of “new” North Slope oil before a tax liability is calculated. (Editor's note: This story has been corrected to accurately reflect that HB 247 and SB 130 would end the Gross Value Reduction credit for current oil production eligible for the credit in 2021. A previous version of the story incorrectly stated that the Gross Value Reduction credit would be eliminated entirely in 2021 under the bills.) They also put a five-year limit on the Gross Value Reduction credit and end it for current GVR-eligible production after 2021; that was not proposed by the Walker administration. The bottom line savings to the state projected from HB 247 and SB 130 start small at up to $15 million to $20 million in fiscal 2017 because most of the changes take effect Jan. 1, 2017 — halfway through the fiscal year. The 2018 savings are projected at up to $155 million from HB 247 and up to $75 million from SB 130. By 2022, the savings from HB 247 could hit the $200 million to $300 million-plus range depending on oil prices and tax credit applications; 2022 savings from SB 130 could hit $175 million, based on Revenue Department projections. The administration’s proposal was projected to save and generate nearly $500 million almost immediately through significantly reducing refundable credit expenses and adding about $100 million in revenue by hardening and raising the tax floor. A sharp response The industry, to put it mildly, is unhappy that any tax change is progressing. Alaska Support Industry Alliance General Manager Rebecca Logan took the Senate Resources Committee to task in public testimony April 12. The Alliance, as it is commonly known, represents about 600 contractor businesses in the state’s various resource development industries — primarily oil and gas contractors. Logan said the Alliance started the session with goals for the state to increase throughput in the Trans-Alaska Pipeline System and pass a sustainable budget. “You guys didn’t do your job,” she told the Resources members. “On March 15, when the (operating) budget came out of the Senate and was at $4.6 billion I knew that we were going to get to a point where you were going to have to come to the oil industry because you didn’t do your job on the budget, and so here we are. “Our position on this bill from day one has been we oppose this bill. We oppose any changes to the current tax structure but there was nowhere else for you to go because you didn’t do what you should have done with the budget.” Increasing taxes or reducing incentives will further damage an industry that is already “hemorrhaging” money with oil prices in the $40 per barrel range, she said. The average cost to produce and transport North Slope crude to market is currently about $46 per barrel before any taxes are applied, according to the Revenue Department. Alaska Oil and Gas Association President Kara Moriarty was more measured in her testimony, but noted the state is looking to change its oil and gas tax policy for the sixth time in 11 years.  Some of the most recent of those changes, in SB 21, were requested by the industry. “The industry is not asking for a tax decrease or for tax or royalty relief while we struggle through extraordinarily low prices and we asked that you proceed with caution,” Moriarty said. “The tax policy you have proposed will not encourage new entrants to come to Alaska, will not ensure current producers will remain committed to Alaska, will not lead to more jobs or more production, will not lead to more long-term revenues to the state, and will not improve Alaska’s long-term fiscal future.” Jim Musselman, CEO of Dallas-based independent and small Slope producer Caelus Energy wrote in a frankly-worded letter to Walker April 8 that a change to the current tax credit system will be successful in reducing the state’s near-term cash outlays at the long-term expense of fewer oil industry jobs and less revenue associated with lower production. Caelus leaders have called the company, which entered Alaska in 2014 by purchasing Pioneer Resources’ assets, the “poster child” success story for the state’s oil and gas tax credits. The company has delayed further work on its $1.2 billion Nuna development, which was scheduled to start production in the second half of 2017 because of low oil prices, but drilled exploration wells this winter at its large, long-term western Slope Smith Bay prospect. Job loss tally Musselman also wrote to inform the governor that low oil prices have forced Caelus to cut its full-time Alaska workforce of about 80 employees by 25 percent and suspend formerly year-round drilling at its producing Oooguruk development. Stopping infill drilling at Oooguruk also means laying off nearly 300 contractor employees, according to a Caelus spokesman. All told, the Caelus announcement brings the number of reported layoffs from producing companies to about 500 since ConocoPhillips announced last September cuts to about 120 positions in the state. The Alliance estimates roughly 1,000 industry support positions had been lost before the Caelus revelation, which brings the total to about 1,300 jobs.  The Alaska Department of Labor estimates the state has lost 1,800 oil and gas industry jobs in the last 12 months.

Capital budget sliced to $80M in UGF; federal match raises total to $1.5B

Just when it appeared Alaska’s capital budget couldn’t get smaller, the Senate Finance Committee found ways to cut state further. The committee version of the 2017 fiscal year capital budget, introduced April 11, contains just $79.7 million in new unrestricted general funds, which is more than $100 million less than Gov. Bill Walker’s original capital budget request. Combined with an expected $1.3 billion in federal matching funds, the capital budget totals about $1.52 billion. Staff for Finance co-chair Sen. Anna MacKinnon, R-Eagle River, said during a committee meeting that the budget attempts to capture and reappropriate unspent funds from previous capital appropriations to minimize the General Fund outlay in this year’s budget. “We have done everything — working with legislative finance and our team — to be able to place out into Alaska projects that will help sustain the items that we have, that we’ve invested in, but it is a reduced capital budget,” MacKinnon said. More than $20 million of the state’s match for Federal Highway Administration funding, for example, is a reappropriation of lapsing funds from projects funded in prior years, according to MacKinnon staffer Laura Cramer. A plan to issue general obligation bonds for up to $500 million in capital projects over the next two years was floated by the administration late last fall and initially had a positive reception from legislators but fell apart as the state’s fiscal situation has continued to worsen and the appetite for taking on more debt was lost. The state’s projected 2016 fiscal year deficit increased from about $3.5 billion to $4.1 billion as oil prices fell lower than expected over the winter. The bond package could have funded many millions of dollars still needed for the University of Alaska Fairbanks engineering building, the Matanuska-Susitna Borough’s rail extension to Port MacKenzie and the Port of Anchorage Modernization Project, all of which are unfinished and unaddressed in the budget. The Senate Finance capital budget is still expected to capture more than $1.3 billion in federal matching funds primarily for highway and airport projects. Cut from the governor’s request was $7 million for the Kivalina School replacement, a project that received about $40 million last year, as well as $8 million for Department of Transportation and $10 million for University of Alaska deferred maintenance projects. Cramer said the funding for DOT and university was eliminated because each had unspent funds from previous deferred maintenance appropriations. The University of Alaska estimates its total deferred maintenance bill to be roughly $700 million for its 400 or so facilities statewide. Nearly $11.3 million of general funds was also removed for school boiler replacements and energy efficiency upgrades in Kake, Petersburg and the Bristol Bay School District because those projects qualify for a public building energy efficiency improvement low-interest loan program through the Alaska Housing Finance Corp. The budget includes intent language directing school project proponents to determine if their given projects qualify for the loan program that has been in place for several years but has not been used because state grants have largely been available previously. The committee, through the capital budget bill, is also asking DOT to provide the House and Senate Finance committees with an additional list of highway projects that qualify for up to $170 million of federal funding beyond the state’s typical federal aid level for the 2018 fiscal year budget. That money went was not used by other states and it could be available for repurpose in Alaska if matched with state funds. The one notable addition to the capital budget is $32.5 million line item to pay for the Legislature’s tentative purchase of the Anchorage Legislative Information Office building. The money comes from the Capital Income Fund, not from the unrestricted General Fund. After months of debate over whether to break the $3.3 million per year lease for the Anchorage offices and move elsewhere, the Legislative Council voted March 31 to buy the building for $32.5 million and hopefully end what had become a prolonged melodrama and self-induced political headache. The building owner has tentatively agreed to the purchase price pending the details of the deal. AEA project funding The Senate Finance capital bill would appropriate about $2.7 million to the Alaska Energy Authority for its rural Bulk Fuel and Power System Upgrade programs with unspent earnings from the Power Cost Equalization Fund administered by the authority. Repurposing the excess earnings from the endowment-style PCE Fund, which subsidizes expensive diesel-generated power costs for rural residents, follows the intent of Senate Bill 196 that would direct unspent PCE money to support AEA’s popular Renewable Energy Fund grant program and other capital project programs the authority manages. The Renewable Energy Fund, which supports rural energy infrastructure projects, has historically been paid for with direct General Fund appropriations. A $5 million request was cut out of the governor’s amended fiscal year 2017 budget. Introduced by Finance Committee member Sen. Lyman Hoffman, D-Bethel, the bill passed the Senate on April 13. The $970 million PCE Fund often earns more in investment returns than the roughly $30 million to $40 million it has paid out in subsidies each year, leaving it with excess earnings available for appropriation. SB 196 would cap the annual power cost assistance payout at $30 million and the rural energy program payout at $25 million, while lowering the maximum annual PCE payout from 7 percent of the fund balance to 5 percent. Some reconciliation with the House’s version of the operating budget will likely be needed if SB 196 passes and is signed by the governor because the current House budget diverts $24.7 million of excess PCE money to one-time fund part of the University of Alaska budget.   Elwood Brehmer can be reached at [email protected]  

Alaska Airlines starting to spend its record profits

Alaska Airlines keeps making news, seemingly for all the right reasons. The company announced a $4 billion deal to purchase Virgin America April 4, a deal that when finalized will make Alaska the fifth largest domestic carrier. Spokesman Tim Thompson said to Anchorage Chamber of Commerce members April 11 that Alaska will “leapfrog” JetBlue — the airline Alaska reportedly outbid to buy Virgin — to take over the spot as the fifth-largest U.S. airline. Specifically, the deal breaks down to $2.6 billion in cash and Alaska Air Group Inc. will assume roughly $1.5 billion in Virgin debt. Seattle-based Alaska Air Group is the parent company to Alaska Airlines and its regional carrier Horizon Air. Alaska Airlines leaders have emphasized the deal will solidify the company’s stronghold on the West Coast, with Virgin being headquartered in San Francisco. Thompson said Virgin’s network out of San Francisco and Los Angeles will also give Alaska more “east-west connectivity” to the mid-Atlantic seaboard, adding to Alaska’s traditionally north-south routes along the West Coast. The state of Alaska currently accounts for about 20 percent of the airline’s overall market share. When the deal closes, which is expected by the end of the year, the combined airline will have about $7 billion in annual revenue, a fleet of more than 280 aircraft and 18,000 employees. Alaska Airlines will have two years to decide whether to keep the Airbus fleet operated by Virgin, with possibly of returning 31 leased aircraft by 2021. Virgin’s order for 40 Airbus A320neos reportedly has favorable cancellation provisions. In January, Alaska Air Group announced its sixth consecutive record annual profit. The reported $842 million 2015 net income was a 47 percent improvement over 2014. Air Group CEO Brad Tilden said at the time that while low fuel prices for going on two years now have greatly benefited the airline industry as a whole, Alaska Airlines performance is based on operational reliability and efficiency and customer growth and satisfaction. At the end of 2015, Air Group’s debt-to-capitalization ratio stood at 27 percent. A corporate emphasis to reduce the company’s debt load, before the Virgin purchase, has significantly cut its debt-to-cap ratio, which was as high as 81 percent as recently as 2009. Alaska Air Group’s first quarter 2016 earnings call is scheduled for April 21. Air Group stock closed April 12 trading at $79.25 per share, up 25 percent over the past year. The company has split its stock twice since March 2012. Alaska Airlines is also in the midst of updating its branding for the first time in nearly 25 years. The look of its aircraft and the recognizable Eskimo tail logo are largely staying the same, with refinements coming to typeface and a new-look website. In March, Alaska Airlines also applied to the U.S. Department of Transportation for license to fly to Cuba, proposing twice daily, nonstop service between Los Angeles and Havana. Horizon Air announced April 12 that it plans to purchase 30 new Embraer E175 jets that will be delivered from 2017 to 2020. The total order includes 33 options and is valued at $2.8 billion. The 76-seat E175s will fly routes for Alaska Airlines that are too long for Horizon’s fleet of Bombardier Q400 turboprops but don’t have the demand to necessitate mainliner service, according to a company release. Horizon currently services Alaska Airlines routes between Fairbanks, Anchorage and Kodiak with its Q400s. “The E175s position Horizon for growth beyond our current West Coast destinations while providing better customer utility in the growing Alaska Airlines network,” Horizon President David Campbell said in a release. “The spacious E175 offers a passenger experience that’s on par with much larger jets. This aircraft opens up tremendous new opportunities to fly to places that would not have been feasible with our existing aircraft.” Alaska Airlines also has plans to spend nearly $100 million just in, and for, Alaska over the next couple years. The airline is in the early planning stages of building a new, $50 million maintenance hangar at Ted Stevens Anchorage International Airport to accommodate Boeing’s latest 737-900s. The new hangar will fit two of the largest 737s, according to Alaska spokesman Thompson. Alaska is also decommissioning its five-plane, freighter-passenger “combi” fleet flown primarily to rural parts of the state. The combis and one dedicated 737-400 freighter will be swapped out for three all-freight 373-700s. The three larger 737-700s will add about 20 percent more cargo capacity to the small Alaska freighter fleet, Thompson said. Finally, it is investing about $30 million in its 11 rural Alaska terminals over the next three years. Thompson said expanding the footprints of the terminals mostly built before 2001 will provide more space for Transportation Security Administration officials as well as a better customer experience. Barrow, Kotzebue and Kodiak are the first terminals on the to-do list.   Elwood Brehmer can be reached at [email protected]  

AGDC narrows CEO search; AK LNG sticks with 42-inch pipe

The Alaska Gasline Development Corp.’s search for a new CEO appears to be winding down. AGDC board member Hugh Short, who has led the board’s hunt for a new president and CEO, said in an interview that the board has winnowed its list of candidates down to one finalist and a secondary candidate. From a broad perspective, the depressed nature of worldwide oil and natural gas markets has been a concern during the process, but Short said the near-term uncertainty regarding the status of the $45 billion-plus Alaska LNG Project has not challenged the search. Rather, the State of Alaska needs someone with the experience and expertise to market the project and maintain its prominence worldwide in the minds of potential LNG buyers, he said. There is no timetable for when a new president will be named. Former AGDC President and CEO Dan Fauske abruptly resigned in late November at the request of Gov. Bill Walker. At the time the state had just approved the buyout of TransCanada Corp., which previously held the state’s share of the 800-mile pipeline and the North Slope treatment plant. After the buyout, the state now owns a full 25 percent share of the entire project. Walker said then he wanted more pipeline experience in AGDC’s top role as a result. Fauske, who had led AGDC since its inception as a subsidiary of the Alaska Housing Finance Corp. in 2009, has significant experience in the finance industry. Fritz Krusen, previously a vice president, has been AGDC’s interim president since mid-December. The Alaska LNG Project has been AGDC’s primary focus in recent years, but the corporation is still sitting on the design for the smaller, in-state Alaska Stand Alone Pipeline project, or ASAP, the project for which AGDC was originally formed. Specifically to the Alaska LNG Project, it appears the pipeline size is staying the same. Project spokeswoman Kim Fox of ExxonMobil wrote in an email that the project team has recommended it stick with the current 42-inch design after a five-month study process in which the 42-inch and 48-inch pipe sizes were evaluated. Walker pushed for the larger pipe study — which cost $20 million to evaluate — contending added capacity in the pipeline would encourage more natural gas exploration on the North Slope and could give companies searching for gas along the pipeline corridor — Doyon Ltd. is exploring near Nenana — a better opportunity to get their gas to market. The 42-inch pipeline would be dominated by North Slope gas owned by BP, ConocoPhillips and ExxonMobil, as well as the state’s gas, for about the first two-thirds of the project’s 25-year design life, before depletion from the Prudhoe Bay and Point Thompson fields is expected to start gas throughput decline at about year-18. Legislators on AGDC board A bill that would add three legislators to the AGDC board of directors is on its way to the governor’s desk. Senate Bill 125 passed the House April 9. It would put three nonvoting members of the Legislature — a senator appointed by the Senate president, a representative selected by the House Speaker and a member of the joint minority caucus — in oversight positions on the gasline corporation board. The AGDC board currently consists of five public members appointed by the governor and two state commissioners other than the heads of Natural Resources and Revenue. Sponsored by Anchorage Republican Sen. Mia Costello, the bill’s intent is to better inform the Legislature on AGDC’s work and increase collaboration between the corporation and the Legislature, which must approve any long-term contracts AGDC enters into.  “Having legislators participate in an advisory, nonvoting capacity adds experience and continuity to the board,” Costello’s sponsor statement reads. “Legislators understand they type of budget decisions that will be needed to meet the state’s cash calls for a gasline project, and would be helpful for discussions on project financing.” House Speaker Rep. Mike Chenault, R-Nikiski, also sponsored a similar bill this session. There are questions surrounding the constitutionality of SB 125, however. Assistant Attorney General Jerry Juday said to the AGDC board at its April 8 meeting that he thinks the bill is unconstitutional because a provision in the state constitution prevents dual office holding and having legislators serve on the board of an executive branch corporation could violate the separation of powers between the branches, Juday said. A March 30 memo from Legislative Counsel Emily Nauman to Chenault notes, as Costello’s sponsor statement does, that legislators already serve in similar roles on other state boards, such as the Knik Arm Bridge and Toll Authority and Alaska Seafood Marketing Institute. Nauman wrote that the nonvoting role may not violate the separation of powers doctrine, but also acknowledged that legislative positions on any state board might stand today simply because they haven’t been challenged. “What is clear is that the issue of nonvoting legislative members on executive branch boards is unsettled,” Nauman wrote. “The only sure resolution is a decision by the Alaska Supreme Court. I would certainly warn that there is a risk involved in placing nonvoting legislative members on the AGDC board, as the board is serving an executive branch function.” Gasline budgets The agencies working on the Alaska LNG Project are waiting just like everyone else to see what comes out of the House and Senate budget conference committee. AGDC’s $10.4 million budget request for fiscal year 2017 made it in the House version of the operating budget but was omitted from the Senate version. Corporation officials said at an April 8 board meeting that they are anticipating being funded in the resolved budget but are in “standby mode” until it is finalized. AGDC had a budget of roughly $13 million in previous years; the reduction to about $10 million is a result of eliminating 13 positions always vacant from its budget request. The corporation has never had more than 25 employees but was established with 38 potential positions. The Department of Natural Resources cut its final funding request for the North Slope Gas Commercialization Office by $18.7 million from the $35.7 million that was in the governor’s original budget to $16.9 million as progress on the commercial side of the project has all but stalled. Most of the money in the remaining request would be used by the Department of Law to pay for the state’s outside counsel in ongoing contract negotiations with the project partners — BP, ConocoPhillips and ExxonMobil — through reimbursable service agreements between the departments. DNR eliminated $2.6 million from its ask to fund new marketing lead and marketing negotiator positions, but the department is still looking to add seven high-level positions to the Gas Commercialization Office at a cost of nearly $1.6 million. Walker’s original budget request, made late last fall, would have added 21 positions to the state’s Gas Commercialization team with a personnel cost of $11.1 million. Slower-than-expected progress in negotiations between the producers on lynchpin agreements to determine how and when natural gas can be pulled from the Prudhoe Bay and Point Thomson fields has held back progress on other contracts needed to move the project into the front-end engineering and design, or FEED, stage, according to DNR officials. A decision to move to FEED in the gated process of the project is roughly set for early next year. At one point it was expected those agreements would be in place by last fall, or by the end of the current legislative session. However, with DNR still reporting a lack of progress on the commercial terms of the project that timeline could be muddled. Elwood Brehmer can be reached at [email protected]

Study: Pensions underfunded, underperforming

The back-and-forth over who will pay what to state retirement plans has caused plenty of consternation in Juneau the last two weeks, but a new study concludes the debate would be unnecessary if Alaska had just followed its own guidelines the last time state pensions were reformed. Coincidentally released March 29 — a day after Republican Senate Finance Committee co-chairs Sens. Pete Kelly, R-Fairbanks, and Anna MacKinnon, R-Eagle River, introduced legislation to shift some of the state’s pension fund obligations to municipal governments — a Reason Foundation study claims Alaska’s $6.7 billion unfunded pension liability is largely a result of underfunding by the state and overly optimistic investment return expectations. The suite of Senate Finance bills and the Reason study address the state’s Public Employees Retirement System, or PERS, and the Teacher Retirement System, or TRS, pension plans. Senate Bill 209, which would shift the part of the state’s obligation to pay for unexpected PERS costs to local governments, was put on hold after intense public criticism and new consultant analyses that suggest the payments may not be as large as once suspected, at least in the near-term fiscal years. The defined benefit retirement plans were closed to new participants at the end of the 2006 fiscal year over fears the state could not support the ever-growing pension liability the plans were generating. That liability was a combined $1.9 billion for the plans that were more than 80 percent funded at the end of fiscal year 2004, according to the Reason study. To stem the liability tide, the Legislature passed the Alaska Retirement Security Act in 2005, which closed PERS and TRS and put state employees and Alaska teachers hired after July 1, 2006, on defined employee contribution plans similar to 401(k) plans in the private sector. It is there where Reason picked up the story. According to the study, the state was “erratic” with its PERS and TRS contributions in the years following the passage of the Retirement Security Act, fully funding its annual obligation in only three of the 10 years after pension reform was thrust into the limelight. Cumulatively, the state funded 88 percent of its required contribution from 2005-14. “The lower-than-required contributions made budgeting easier for lawmakers, but at the long-term expense of the plan, with the missed payments simply being added to unfunded liabilities,” the study states. It does not examine the state’s health care, disability and medical benefits plans. The Reason Foundation is a Los Angeles-based policy think tank that advocates for free market ideals. The underfunding was most prevalent in fiscal years 2005-07, when required contributions in the $400 million per year range to stay on track were paid with actual contributions that were $100 million to $200 million per year short. After two years of full funding, the short stacks resumed in 2010 and carried through 2013, although the second time each year’s contribution was short less than $100 million when yearly cost plus unfunded amortization payments were calculated at $400 million to $600 million per year. The nine-member Alaska Retirement Management Board, which includes seven public members and the commissioners of Revenue and Administration, sets the annual required contribution for the funds. Legislators do have a say in how amortization of the unfunded liability is calculated and funded. Lofty investment return goals also added to the PERS-TRS unfunded liabilities, according to the study. Alaska’s pension plans were, and continue to be, based on 8 percent average predicted returns for invested funds. However, during the study period from 2005-14, the pension funds earned a combined average return of 5.8 percent. After 2008 the average return dropped to 5 percent, primarily due to the financial crisis known as the Great Recession in 2008-09. Study co-author Anthony Randazzo said in an interview that Alaska is not alone in failing to adequately fund its pension plans and not achieving its targeted rate-of-return for the funds, but the fact that misery loves company doesn’t change the challenge the state is facing. According to Randazzo, roughly one-third of states have explicitly under-funded their public employee pensions and nearly all have missed investment return goals, which historically have been in the 8 percent range. An 8 percent investment return was much more feasible in the 1980s when interest rates were higher and most funds were invested in fixed income bonds, he explained. Today, pension funds hold mostly equities and real estate, but common return goals are still in the 7 percent-plus range, Randazzo said. He contends pension managers should use much more conservative return goals closer to 4 percent per year. “The actuarial community believes, based on demographic patterns, even if plans are underfunded today, as Alaska’s badly is, you can still use high rates-of-return because the feel there is enough money flowing in to pay the benefits out,” Randazzo said. “That is a short-term focus.” Further darkening the picture, according to the study, is the fact that future obligation projections are based on an 8 percent average investment return. If that return is not met the unfunded gap grows again. Randazzo suggested the overly optimistic investment goals over time could compound into the pension plans being up to 40 percent underfunded over 50 years. “Alaska is part of a group of states that are walking over a fiscal cliff in the coming decades and Alaska is in the group that’s at the head of that pack,” he said. Officials in the Revenue and Administration departments said the state’s required contribution to its defined benefit plans in fiscal 2017 is still being calculated because it is based on salaries that are projected for the upcoming fiscal year. Estimates put the state’s 2017 defined benefit PERS obligation at approximately $340 million and the TRS obligation at more than $116 million. The study acknowledges that Alaska’s PERS and TRS funds are in a better position today than if the state had not closed the defined benefit plans. Randazzo said Alaska, along with Michigan, was studied because they were among the first states to close defined benefit pension programs. Through fiscal year 2014, the last year of data included in the study, the PERS plan would have been 61 percent funded without the 2005 reform based on historical state funding, the study concludes. As of the end of fiscal year 2015, the state’s total PERS liability was $13.4 billion, on a net fund position of $8.6 billion, or 64 percent of its obligation, leaving a $4.8 billion unfunded liability. For TRS, no reform would have resulted in only 55 percent of the state’s liability being funded. The fiscal year 2015 annual report puts the TRS fund at a 74 percent funded position, with a $1.9 billion unfunded liability. Combined, the funds carry an unfunded liability of roughly $6.7 billion, significantly less than the $8.4 billion unfunded burden the state would have faced without closing the defined benefit plans, according to Reason. The liabilities at the end of fiscal 2015 include a $3 billion infusion from state savings to offset yearly pension payments that were forecasted to approach $1 billion without a substantial down payment. Still, Randazzo said the state likely would not have had to make that big payment to start the 2015 fiscal year if it had better managed the plans. By paying fully the annual actuarially determined contributions and using a more achievable rate-of-return the State of Alaska could have a $4.1 billion unfunded liability instead of the $6.7 billion it faces today. “There’s almost no world in which the state would’ve taken $3 billion to pay down a $4.1 billion unfunded liability given that the funding ratio on it would be so much better,” he said. Instead, that $3 billion that was pulled from savings would likely be available to relieve pressure on the state’s current $4 billion-plus budget gap. Elwood Brehmer can be reached at [email protected]  

Owners ‘conceptually’ agree to $32.5 million offer for LIO

The Legislative Council made a $32.5 million offer to purchase the Anchorage Legislative Information Office building late March 30. It is the first substantive progress to resolve an issue that has lingered during a session in which policymakers are faced with financial decisions that could impact the course of the state for years to come. Rep. Mark Neuman, R-Big Lake, was the lone no vote among the 14 council members on a motion to approve the purchase offer. Council Vice Chair Rep. Bob Herron, D-Bethel, said the purchasing the custom-built, six-story office building would save the state about 50 percent over 20 years compared to the $3.3 million per year lease terms the Legislative Council agreed to in 2013 for renting the building. “It’s time to put this issue to rest either way. Our state faces great fiscal uncertainty and this distraction takes away valuable time and energy from our ability to focus on continuing the great work that we’ve done to shrink the day-to-day cost of government, and focus on reforms to major cost drivers like Medicaid, prisons and crime and retirement systems,” Herron said in a statement. “Thank you to my colleagues on the council for tonight’s decision.” The building owner group, 716 West Fourth Avenue LLC, named after the Downtown Anchorage address of the building and led by real estate developer Mark Pfeffer, had made repeated attempts to sell it to the Legislature for $37 million starting in October. That is the amount Pfeffer’s group invested in the $44.5 million project. Pfeffer said April 6 that “conceptually, we are in agreement on the price pending other details of the transaction.” The annual lease rate for the premium office space — nearly five times what the Legislature paid for the former, smaller, decrepit Anchorage LIO — has drawn public and political ire from many who say the state should not be spending multi-million dollars per year for off-season legislative offices when it is trying to find its way out of a $4 billion budget deficit. The Legislature contributed $7.5 million for tenant improvements. It moved into the building shortly after it was completed in December 2014. The lease, invalidated by a March 24 Superior Court ruling, is paid through May 31. Judge Patrick McKay deemed the process by which the lease was procured in 2013 by then-Legislative Council chair Rep. Mike Hawker, R-Anchorage, to have violated competitive bidding guidelines in state procurement code. 716 filed a motion for reconsideration with the court March 30, arguing the ruling was premature and exceeded the court’s authority — that simply finding the council’s procurement process to be flawed does not automatically invalidate the lease. The Alaska Supreme Court has ruled in similar cases involving public procurement issues that the governing body can be obligated to pay for work done by a contractor under an improperly secured agreement because a private party should be able to trust a public body will uphold a deal and is not responsible for how it was reached. An attorney for 716 cited multiple cases in which judgments in favor of the private contractor were reached in a March 27 letter to hired Legislative Council attorneys. Prior to the Legislative Council meeting, Pfeffer revised 716’s offer several times, ultimately settling on a sale price of just less than $34 million. An independent financial analysis of the Legislative Council’s options done in early March found purchasing the LIO with low-interest bonds for $35.6 million would match the long-term price, on a per square-foot basis, of moving to the nearby Atwood Building. The state-owned Atwood houses executive branch agencies. The full Legislature could seemingly purchase the building outright through a direct appropriation or finance a deal with state bonds. Council chair Stevens said during the public portion of the meeting that, “nothing is precluded from finding a way to finance this project.” Some legislators have pushed to move the Anchorage offices into the Atwood Building to rid the state of its expensive political headache. Department of Administration Commissioner Sheldon Fisher told the council prior to an executive session that included Pfeffer at its March 31 meeting that the prospective space at the Atwood would not be fully move-in ready until January 2018. Elwood Brehmer can be reached at [email protected]  

UA president has big ideas to manage smaller budgets

There are major changes coming to the University of Alaska. Many of the changes will, unsurprisingly, be budget driven, as Alaska’s institutions of higher education absorb their share of the state’s $4 billion budget deficit nightmare. However, UA President Jim Johnsen said in a March 30 interview with the Journal that strictly focusing on improving the bottom lines at Alaska’s campuses would miss major opportunities to reinvest in what they do well. “I think it’s much smarter for the university, in its mission to serve the state well, actually to be clear and conscious about what our priorities are, and even though our budgets are being reduced, to actually focus on — set aside money for — investment in key areas even as we’re being cut,” Johnsen said. “Some people think that’s nuts. They say, ‘Let’s all stick together here and everybody take a 5 percent or 10 percent or whatever reduction and we’ll all be here and we’ll save our jobs.’” Now seven months into the lead role, his primary goal is to avoid what happened to the university system after Alaska’s first oil price-driven fiscal crisis. Johnsen’s first job with the University of Alaska came in 1996, when he was hired as director of labor relations. He saw a collection of schools with “demoralized” and thin ranks of faculty and staff after years of rash budget cuts that started in the late ‘80s, Johnsen recalled. “There was nothing that was excellent — that was carrying people through — and so I want to focus on distinctive and unique strengths of each one of our universities,” he said. Johnsen was UA vice president for administration when he left the system for the private sector in 2008. Determining what Anchorage, Fairbanks and Southeast do well is the easy part. The University of Alaska Fairbanks is the most oft-cited Arctic research institution in the world. In the R/V Sikulliaq, its School of Fisheries and Ocean Sciences has operating rights to one of the nation’s premier research vessels. Through partnerships with Oregon and Hawaii, UAF leads one of a handful of federally designated test sites for unmanned aircraft research. “Research is going to happen in Alaska; it’s going to happen here for many years,” Johnsen said. “Are we going to let Dartmouth do it all or the University of Colorado, because they’re going to do it, or do we train our own research workforce?” UA Anchorage prides itself on its nursing and engineering programs. UAA’s Institute of Social and Economic Research was another “unique strength” Johnsen cited. The economic impacts of prospective state budget cuts detailed in a study led by ISER Director Gunnar Knapp were sought-after figures as the House and Senate drafted their respective versions of the state operating budget earlier this session. The University of Alaska Southeast is Alaska’s primary liberal arts institution, but also runs the world-class Center for Mine Training. Strengthening what the state’s universities already do well will not come without sacrifice, however, particularly when the system’s budget is not getting bigger. Gov. Bill Walker’s 2017 fiscal year budget proposal would cut the university’s unrestricted General Fund budget by about $15 million, or about 4 percent, to $335 million. That would be on par, percentagewise, with the cut in the current 2016 fiscal year. Unrestricted General Fund support from the Legislature accounts for roughly 40 percent of the UA budget. It peaked in fiscal year 2014 at $371 million. This year, the Senate passed a university cut of about $25 million; in the House it was closer to $50 million. The final UA budget will be hammered out in a conference committee in the coming weeks. The three main campuses absorbed the cuts in the current 2016 fiscal year primarily — without discounting some employees who were laid off — through attrition and defunding vacant positions. Johnsen said the university system will continue to eliminate vacant positions and try to minimize layoffs, but also noted that capturing savings through employee attrition doesn’t allow UA to chart its own course. With hesitancy towards cutting faculty, the only place to turn is administration. The Senate’s budget could mean cutting between 300 and 500 positions statewide, according to Johnsen. “I think the people of Alaska are going to demand if you’re reducing academic programs by ‘X’ percent, we’d sure like to see your administration reduced by a comparable or more percent,” he said. He added that on top of the now yearly budget cuts, the UA system absorbs about $25 million per year in “unfunded mandates” — negotiated salary increases, benefit increases and ever inflating deferred maintenance costs. The system’s latest estimates put its total deferred maintenance need at roughly $700 million. The administration proposed $10 million for university deferred maintenance needs in its capital budget. Johnsen emphasizes to legislators that he understands the university budget can’t be spared, he said, but at the same time that it can’t absorb drastic cuts if it is to successfully “bridge” to a leaner, more focused and prosperous future. He said a drastic cut this year from the Legislature would expedite and challenge the system’s Strategic Pathways initiative to evaluate structural academic program reform. Johnsen pitched the Strategic Pathways to the Board of Regents in January and has said it would take two or three years to fully identify and implement the changes with the funding in the governor’s budget. If the UA unrestricted General Fund appropriation is much less than the Senate’s proposed $325 million for fiscal year 2017, Johnsen said, “It’s going to be very, very difficult to take that kind of time to do a deliberate, data-based and really inclusive process and so then it’s going to have to be sharp and it’s going to have to be pretty fast and when you do that you end up with unintended consequences.” A piece of the near-term funding bridge will probably be another look at tuition rates, he said, but that decision is ultimately up to the UA Board of Regents. At an average of about $6,100 per year for lower level undergraduate resident tuition, Alaska’s campuses remain among the most affordable state schools in the nation, despite the fact that the UA Regents have increased tuition by 5 percent each of the last two academic years. Johnsen also noted that Alaska ranks very high in terms of the state’s per student contribution from its General Fund to its universities. “It’s the share of the cost that students bear; we’re super low,” he said. However, he hopes to de-link, at least to some degree, tuition at the system’s community colleges from the three main campuses. Tuition at Alaska’s community colleges is the same as at the three large campuses because the satellite schools are extensions of the hub universities. That has led to Alaska having some of the lowest traditional university costs but some of the highest community college tuition in the country, Johnsen said. He commended the Kenai Peninsula Borough for voluntarily supporting the Kenai Peninsula College in Soldotna with about $700,000 of property tax revenue each year and suggested that could be a model used at some of the other community colleges. The future, according to Johnsen, also likely includes consolidating some of the system’s 478 degree and certification programs to specific schools, as many of them are duplicated across the state. Through increased use of distance learning between campuses, students could receive the same education without the expense of redundant faculty and classroom space for some programs, he surmised. He has also discussed the concept of admissions standards, at least for the three main campuses, with the leaders of UAF, UAA and UAS. Some sort of academic requirement to enroll at the universities would address the issues of high numbers of students with remedial course needs as well as the system’s poor graduation rates for baccalaureate students, Johnsen said. “Fifty percent of our students require developmental or remedial education,” he said. “Fifty percent, that is a whopper of a number; and you’re not getting credit towards a degree for that (coursework) and yet you’re writing a check for that — you’re borrowing money for that.” Less than 30 percent of UA students working towards baccalaureate degrees graduate within six years, according to the UA system. That is roughly on par with other open enrollment universities, but is far short of the 56 percent graduation rate after six years nationwide. By funneling students that need refresher courses to the community campuses first, in a more traditional higher education model, students should be better prepared to successfully pursue their degrees once at the main universities, Johnsen said. Elwood Brehmer can be reached at [email protected]

Nuna development delayed by at least a year

Caelus Energy is delaying work on its $1.2 billion Nuna oil development and is asking the state to extend a royalty reduction agreement for the project. Casey Sullivan, a spokesman for the company, wrote in a statement that the central North Slope project has been deferred due to sustained low oil prices and uncertainty regarding the future of the state’s oil and gas tax credit program. The schedule for first oil from Nuna has been pushed back a year or more from September 2017 to late 2018 or early 2019, according to the Division of Oil and Gas. Legislation introduced by Gov. Bill Walker to revamp the oil and gas tax credits is working its way through the committee process. The latest version of the bill in the House would reduce some subsidies for Cook Inlet projects but do little to change the tax regime on the North Slope. Acting Department of Natural Resources Commissioner Marty Rutherford approved a royalty modification request for the project in January 2015 that would reduce the state’s royalty share of production to 5 percent until total revenue from Nuna reaches $1.25 billion. At that point, which company officials have said would likely be about three years after first production, the state royalty would return to the traditional 12.5 percent rate on the project’s five leases. The modification was contingent upon Caelus sanctioning the project by April 2015, which it did, and sustained oil production commencing by the end of September 2017. Sullivan confirmed the Dallas-based independent has requested an extension to the modification agreement from the department. According to the Best Interest Finding supporting the original modification, the state would forgo about $66 million in revenue at the temporary 5 percent royalty rate. However, the state is expected to collect more than $1.2 billion over the life of the field and Caelus contends it would not develop Nuna without the royalty reduction. Adjacent to Caelus’ offshore Oooguruk field unit, the company estimates peak production from Nuna will be 20,000 to 25,000 barrels per day. A 22-acre gravel pad is complete and the first phase of development includes drilling 30 hydraulic fractured wells, 15 each for production and reinjection. Caelus delayed development work at Nuna this winter to focus on exploring its promising Smith Bay leases in near shore state waters adjacent to the National Petroleum Reserve-Alaska in a remote part of the western Slope. This winter’s Smith Bay program entailed drilling two exploration wells from a grounded ice pad. Caelus CEO Jim Musselman has said Smith Bay is the company’s biggest prospect on the Slope with “billion-barrel” potential. The company also holds significant leases on the eastern Slope that it hopes to start exploring sometime in 2017. Caelus entered Alaska in 2014 when it closed a deal to acquire the in-state assets of Pioneer Natural Resources. The company is leading development of hydraulic fracturing techniques on the Slope. The expense associated with fracking is among the reasons the royalty modification is needed to develop Nuna, according to Caelus. Subsequently, the Caelus agreed to share typically proprietary information on the drilling technologies to be employed at Nuna within two years after initial production as part of its agreement with the state.   Elwood Brehmer can be reached at [email protected].com.  

Legislative Council makes $32.5 million offer for Anchorage LIO

The Legislative Council made a $32.5 million offer to purchase the Anchorage Legislative Information Office building late Thursday night. It is the first substantive progress to resolve an issue that has lingered during a session in which policymakers are faced with financial decisions that could impact the course of the state for years to come. Rep. Mark Neuman, R-Big Lake, was the lone no vote among the 14 council members on a motion to approve the purchase offer. Council Vice Chair Rep. Bob Herron, D-Bethel, said the purchasing the custom-built, six-story office building would save the state about 50 percent over 20 years compared to the $3.3 million per year lease terms the Legislative Council agreed to in 2013 for renting the building. “It’s time to put this issue to rest either way. Our state faces great fiscal uncertainty and this distraction takes away valuable time and energy from our ability to focus on continuing the great work that we’ve done to shrink the day-to-day cost of government, and focus on reforms to major cost drivers like Medicaid, prisons and crime and retirement systems,” Herron said in a statement. “Thank you to my colleagues on the council for tonight’s decision.” Amy Slinker, spokeswoman for the building owners, wrote in an emailed statement that the group is glad the council made a decision to try to resolve the issue that has become a burden for both sides. The offer has not yet been accepted, and the full Legislature will have to approve the appropriation to purchase. “Now we have something to talk about,” Slinker wrote. “We are going to analyze it and get back to (the council) soon.” The annual lease rate for the premium office space — nearly five times what the Legislature paid for the former, smaller, decrepit Anchorage LIO — has drawn public and political ire from many who say the state should not be spending multi-million dollars per year for off-season legislative offices when it is trying to find its way out of a $4 billion budget deficit. The building owner group, 716 West Fourth Avenue LLC, named after the Downtown Anchorage address of the building and led by real estate developer Mark Pfeffer, had made repeated attempts to sell it to the Legislature for $37 million starting in October. That is the amount Pfeffer’s group invested in the $44.5 million project. The Legislature contributed $7.5 million for tenant improvements. It moved into the building shortly after it was completed in December 2014. The lease, which was invalidated by a March 24 Superior Court ruling, is paid through May 31. Judge Patrick McKay deemed the process by which the lease was procured in 2013, a process led by then-Legislative Council chair Rep. Mike Hawker, R-Anchorage, to have violated competitive bidding guidelines in state procurement code. 716 filed a motion for reconsideration with the court March 30, arguing the ruling was premature and exceeded the court’s authority — that simply finding the council’s procurement process to be flawed does not automatically invalidate the lease. The Alaska Supreme Court has ruled in similar cases involving public procurement issues that the governing body can be obligated to pay for work done by a contractor under an improperly secured agreement because a private party should be able to trust a public body will uphold a deal and is not responsible for how it was reached. An attorney for 716 cited multiple cases in which judgments in favor of the private contractor were reached in a March 27 letter to Legislative Council’s outside counsel. Prior to the Legislative Council meeting, Pfeffer revised 716’s offer several times, ultimately settling on a sale price of just less than $34 million. An independent financial analysis of the Legislative Council’s options done in early March found purchasing the LIO with low-interest bonds for $35.6 million would match the long-term price, on a per square-foot basis, of moving to the nearby Atwood Building. The state-owned Atwood houses executive branch agencies. The full Legislature could seemingly purchase the building outright through a direct appropriation or finance a deal with state bonds. Council chair Sen. Gary Stevens, R-Kodiak, said during the public portion of the meeting that, “nothing is precluded from finding a way to finance this project.” Some legislators have pushed to move the Anchorage offices into the Atwood Building to rid the state of its expensive political headache. Department of Administration Commissioner Sheldon Fisher told the council prior to an executive session that included Pfeffer at its March 31 meeting that the prospective space at the Atwood would not be fully move-in ready until January 2018.   Look for updates to this story in an upcoming issue of the Journal. Elwood Brehmer can be reached at [email protected]

Cruise tax increase on hold pending audit

Gov. Bill Walker’s attempt to touch every major state industry in his overall plan to balance the state’s upside down budget has hit a snag as it pertains to the visitor industry. House Bill 252 and its mirror Senate Bill 136, proposed by the Walker administration, would repeal current law that allows cruise operators to deduct the local “head tax” each passenger pays from their state head tax obligation. While the current deduction is eligible statewide, it applies mainly to Juneau and Ketchikan, as they are the communities with significant cruise traffic that have local head taxes — $8 per passenger in Juneau and $7 in Ketchikan. The Department of Revenue projects eliminating the tax deduction would bring in an additional $16.6 million per year to the state, which would primarily come from taxing each of the roughly 1 million cruise passengers that stop in Juneau and Ketchikan another $15 in total. Current state law considers a taxable voyage to be one that includes at least 72 hours in state waters — waters within three miles of shore. HB 252 would remove the state waters requirement and tax all commercial passenger vessels that dock at an Alaska port and including all travel time on a voyage, not just those that spend at least 72 hours in state waters. The Revenue Department estimates it would collect, as part of the $16.6 million, about $1.8 million per year from cruise voyages that currently are not taxed because of the “state waters” loophole. That money would be shared with the communities in which the vessels were docked. John Binkley, president of Cruise Lines International Association Alaska, said in an interview that eliminating the local tax deduction is pointless in regards to attempting to balance the state budget because the additional state head tax money is restricted General Fund revenue and therefore could not be used to plug Alaska’s $4 billion budget deficit. “What’s the point of raising another $15 million if you can’t use it?” Binkley said. The commerce clause of the U.S. Constitution generally prevents states from taxing interstate travel, which is what most Alaska cruises are because they largely originate from Seattle. Alaska’s $34.50 per cruise passenger head tax gets around the U.S. Constitution because the revenue is dedicated to the Commercial Vessel Passenger Fund subaccount within the state General Fund and supports dock improvements and other amenities that benefit the cruise industry in the communities that ships call on. The State of Alaska currently pays $5 per passenger to each of the first seven communities a cruise ship calls on. In fiscal year 2015 the state paid 16 municipalities just more than $15 million based on head tax revenue collected from the prior calendar year’s cruise ship stops in each of the communities that received tax money, according to Revenue’s Shared Taxes and Fees Annual Report. Prior to a 2010 settlement between the state and industry that reduced the state tax from $46 to $34.50 per passenger and increased the number of ports per voyage eligible for funding from five to seven, communities could either collect their own head tax and be ineligible for state support or allow the state to collect the tax and receive the distributed revenue afterward. The settlement also established the current head tax sharing guidelines, which allows communities with local taxes — Juneau and Ketchikan — to collect their own taxes while also receiving Commercial Vessel Passenger funds from the state. At the same time, the state allows cruise operators to deduct their local tax payments from their state obligations. Deputy Revenue Commissioner Jerry Burnett said in an interview that the administration was not only trying to include the cruise industry in its larger budget solution by eliminating the tax deduction, but also that the legislation would fix what he called a “very fundamental problem” that exists in current statute. “Depending on which seven ports of call you’re sharing $5 with, the way the tax is written now you could be short money to share. In fact, people were afraid we were short of money last year,” Burnett said. “$34.50 is not $35.” The concerns about the Commercial Vessel Passenger Fund balance, or CPV, were raised in legislative committee hearings last year, according to Burnett. The fund held $2.1 million after at the end of fiscal year 2015 last June 30 after the just more than $15 million disbursement to local governments. Its ending balance has dipped slightly in recent years. The fund held nearly $2.8 million at the end of 2013 and $2.5 million after 2014, according to the state Tax Division. Burnett said the fund has to date stayed in the black because not all cruise ships visit seven ports in their voyages across the state. Community tax audit Neither of the administration’s head tax bills introduced in January have moved from their original Labor and Commerce Committee referrals at least in part because the Legislature is waiting on an audit to see if local governments have been spending the shared head tax money properly. Burnett said the administration is not objecting to the Legislature holding up the bills until the audit is released. Finance Committee co-chair Sen. Anna MacKinnon, R-Eagle River, last March requested the audit be done by Legislative Budget and Audit Committee staff. MacKinnon wrote in a memo to Budget and Audit chair Rep. Mike Hawker, R-Anchorage, that “it has been asserted that some communities are ‘stock piling’ their CPV shared taxes and not using them on appropriate projects.” Budget and Audit Committee members in executive session reviewed the preliminary audit March 18 and the final audit should be reviewed by the committee again in a closed-door meeting sometime in mid-April near the end of the regular legislative session before being released to the public, according to committee staff.

Owners: Legislature not off the hook for costs after ruling

An attorney for the owners of the Anchorage Legislative Information Office building contends a judge’s ruling invalidating the Legislature’s lease of the building does not absolve the governing body of its responsibility to pay for the political hot mess. In a five-page letter dated March 27, Easter Sunday, to Legislative Affairs Agency attorneys obtained by the Journal, Donald McClintock, attorney for the building owner group 716 West Fourth Avenue LLC, wrote that a cancellation of the $3.3 million per year lease based on the court’s ruling would expose the Legislature to a substantial portion 716’s damages. 716 West Fourth Avenue is the Downtown Anchorage address of the LIO building. The owner group includes longtime Anchorage real estate developers Mark Pfeffer and Bob Acree. The Legislative Affairs Agency handles business matters for the Legislature. McClintock’s letter asserts that 716 gathered $37 million through financing and equity in 2013 to fund the build-to-suit project and that several banks extended credit based on the promise the Legislature would hold up its end of the 10-year lease. “It would be a clarion call to the entire financial community — and a serious blow to the public interest — if the state could cancel a lease (even under the guise of a court’s ruling) for its own failed procurement process, and walk away after the other side had fully performed,” McClintock wrote. “716, at a minimum, would be entitled to be made whole through an award of its reliance damages.” He added that 716 believes the Superior Court ruling “is wrong on many levels” and intends to point out its deficiencies in a motion to reconsider. Written much like a court brief, McClintock’s letter cited multiple cases in which the State of Alaska and local governments were held liable for damages to private contractors after government was found to have violated procurement statute. Judge Patrick McKay ruled the lease invalid March 24 because he determined it to not be an extension of an existing lease, and therefore the arrangement negotiated by former Legislative Council chair Rep. Mike Hawker, R-Anchorage, violated state procurement guidelines. The Legislature moved into the building on the 10-year lease after it was completed in late 2014. Anchorage attorney and owner of the adjacent Alaska Building Jim Gottstein filed suit against 716, the project development group, and the Legislative Affairs Agency March 31, 2015, contending the lease was not an extension of a former agreement because it was for renting a new building. Gottstein also argued the lease further violated state statute because the $281,000 per month rent for the 64,000 gross square-foot building with underground parking exceeds a requirement for state rents agreed to through a lease extension to be at least 10 percent below market rate. The rental rate did not need examining, according to McKay’s order, because the lease was improperly secured. The Legislature has paid rent for the building through May 31. Aftermath The Legislative Council, now chaired by Kodiak Republican Sen. Gary Stevens, has gotten heavy pressure from the public and many legislators to cut ties with the LIO because of the high lease rate at a time when the state is faced with a roughly $4 billion budget deficit. Stevens has said he believes the state simply can’t afford the lease, citing a “subject to appropriation” clause in the contract that could presumably void the agreement with little or no recourse for the owners if the Legislature decides not to fund rent payments. Other members of the council have repeatedly expressed similar sentiment, but have also said they worry about the message moving out of the building would send to the business community about the trustworthiness of the State of Alaska. At a Dec. 19 meeting, the council unanimously recommended the full Legislature not fund the lease in the 2017 fiscal year state operating budget unless a solution to stay in the LIO that is cost-competitive, on a per square-foot basis, could be found. 716 spokeswoman Amy Slinker noted in a prepared statement March 29 that several appraisals valued the building project at more than $44 million and that multiple lenders approved the appraisals and based credit on them. “We are continuing good faith negotiations with the Legislature and are hopeful a deal that benefits all parties can be agreed upon soon,” Slinker wrote. She also confirmed that Pfeffer met with Stevens March 28 and will attend a March 31 Legislative Council meeting in executive session to discuss the LIO. Prior to McKay’s ruling, Pfeffer indicated an intent to sue the Legislature if it walked away from its lease at the LIO. McClintock wrote that the goal of his letter was “certainly not to give notice, nor does it have any bellicose intent,” but under the circumstances, “Walking away from the lease would require 716 to proceed with a contract claim against the Legislature in order to protect the full economic benefit promised under the lease.” Attorneys for Legislative Affairs and 716 stressed to McKay in oral arguments March 22 that the Legislative Council repeatedly sought proposals from other parties for suitable Anchorage office space through public requests for information starting in 2007. When no solution was found, Hawker was given authority by the council to act as the contracting officer for the project and he agreed to rebuild on the existing LIO lot at the time. The $44.5 million project also included purchasing and demolishing the next-door Anchor Pub. The defendants also claimed that because the steel support structure and foundation of the former, smaller LIO building remained intact during construction, the 10-year lease was an extension of the previous rental agreement and not one for a new building. House Minority Leader Chris Tuck, D-Anchorage, praised McKay’s ruling in a formal statement, saying he hopes it ends “these kinds of backroom deals.” The LIO is the home office for 25 Anchorage legislators and is often the de-facto meeting place for hearings when the Legislature is not in session. It substituted as the capitol building last spring when the Republican-led Legislature ignored Gov. Bill Walker’s demand that a special session to resolve budget issues be held in Juneau. Instead, legislators “gaveled out” of the Juneau special session called by Walker and reconvened in Anchorage. McKay noted in his frankly worded order that the Legislature fronted $7.5 million of tenant improvement costs during project construction, a requirement he believes further pushes the lease beyond the realm of an extension. “Plain common sense — a principle which jurisprudence should not require to be checked at the courtroom door — mandates a finding that a contract to lease over 2.5 times more newly constructed space for just under five times the current rent with an introductory payment of $7.5 million for leasehold improvements is not a simple lease extension,” McKay wrote. “A court finding that this leasing scheme could be sole-sourced would eviscerate the competitive principles of the state procurement code.” Legislative Affairs outside counsel Kevin Cuddy argued in a Feb. 26 brief to the court that many of the issues surrounding the case were nonjusticiable — that the court did not have authority to rule on issues such as the Legislative Council’s procurement procedure and whether the new Anchorage LIO was in the best interest of the state because they were political in nature. However, Cuddy conceded that the court could rule as to whether the lease constituted an extension of the previous agreement or was a standalone contract. Options with costs At its meetings in recent months, the council has been reviewing the cost feasibility of purchasing the building or of a potential move to the nearby Atwood Building, which houses state executive branch agencies. A March 14 report from San Francisco-based Navigant Consulting found that after 20 years of ownership, the inflation-adjusted cost of purchasing the LIO for $37 million with bonds at the current market rate to be nearly on par, on a cost per square-foot basis, with moving to the Atwood. The $37 million price tag is what Pfeffer has repeatedly said 716 would be willing to sell the building for. According to Pfeffer, it is roughly the amount 716 would need to recoup its investment in the project that cost $44.5 million to complete, minus the $7.5 million state contribution. Purchasing the LIO for $37 million equates to a 20-year net present value cost of $31.7 million and the 20-year cost to move to the Atwood would be $24.2 million, according to the Navigant analysis; the additional usable space in the LIO closes the per square-foot cost gap to $3.08 per square foot to stay and buy the LIO versus $2.95 to move to the Atwood Building. The report found $35.6 million to be the sale price at which the LIO, with 42,900 square feet of usable space, would match the $2.95 per square-foot price of moving to the Atwood, which has 34,100 square feet of available space, a fact highlighted by McClintock in his letter to LAA. Included in the cost of moving to the Atwood is $3.5 million Legislative Affairs expects it would cost to make the available Atwood space suitable for legislative offices. Extending the now-voided $3.3 million per year lease similarly for 20 years would cost $61.8 million in today’s dollars, which is an even $6 per square-foot, the Navigant analysis concluded. Moving out of the LIO could also cause the state to lose the $7.5 million investment in the building, which combined with the first year’s rent and operating costs brings the total cost of occupying the building for less than two years to more than $11 million.

Tourism again a bright spot in ‘16

Alaska’s tourism industry should be a bright spot in 2016 as other sectors of the state’s economy face uphill battles.  The final tally of cruise passengers, which often make up more than half of all visitors to the state, is expected to be up about 2 percent over what was a strong 2015, according to Cruise Lines International Association Alaska President John Binkley. “We anticipate exceeding the million-passenger mark in our cruise Alaska pipeline,” in 2016, Binkley said. “Our throughput is increasing.” The bump in cruise visitors is primarily due to larger ships being committed to Alaska and not increased sailings, he said. Holland America Line is swapping out the 1,900-passenger Oosterdam with the 2,100-passenger Nievw Amsterdam this summer. Royal Caribbean will employ the more than 1,000-foot Explorer of the Seas, with capacity for about 3,100 passengers, in Alaska waters to replace 2,100-passenger Jewel of the Seas; and Princess Cruises will call on its Crown and Ruby Princess ships for Alaska, each with staterooms for nearly 3,100 passengers as well. Binkley said cruise customers are driving the industry shift to larger vessels because they provide more waterside amenities that cruisers want. He added that the ships’ capacities are based on two passengers per stateroom, but the rooms often have bed space for three or four individuals, meaning the actual number of travelers could exceed expectations. “We’re seeing much more multi-generational family travel in cruising to Alaska — grandparents bring grandkids, that sort of thing — so you have more than 100 percent, usually 104, 105, 106 percent of lower berth capacity is what the ships actually bring,” Binkley said. Nearly all cruise sailings to Alaska waters originate in Seattle and Vancouver and traverse the Inside Passage, with stops in Ketchikan, Juneau and other Southeast communities. About a third of the ships then continue across the Gulf of Alaska to the Southcentral ports of Whittier, Seward, Homer and Anchorage. Statewide, Alaska saw a record numbers of visitors last year, with more than 1.7 million people traveling to the state in the summer of 2015, according to the state Commerce Department.  Additionally, each visitor spends an average of about $940 per person once they get to Alaska, according to Commerce estimates. Travel Juneau CEO Liz Perry said there was also a significant bump in air traffic into Juneau last year as Delta Air Lines increased its presence in the market. However, she said Delta was not pulling traditional business from Alaska Airlines, which also had a 3.5 percent increase in passengers to Juneau last year. The upward trend in air travel, driven by a strong Lower 48 economy and lower fuel prices translating to lower airfares, is expected to continue. “We’re enjoying about 100,000 independent travelers this (summer) season, too,” Perry said. Independent travelers typically make up about 10 percent of all visitors to Juneau, according to Perry. She also said the $54 million cruise ship dock expansion project led by the city is on schedule, with the first of the panamax-capable docks on track to be finished later this year and work on the second wrapping up in 2017. The project will provide public shore side infrastructure to accommodate two 1,000-foot vessels at once. Currently, the only 1,000-foot vessel capable dock in Juneau is the privately owned AJ Dock. Juneau’s cruise season will kick off April 30 this year, a couple days earlier than usual, with the arrival of the Crystal Cruises Crystal Serenity. Visit Anchorage CEO Julie Saupe said the continued healthy number of cruisers in Southeast should translate to a strong and stable number of cruise passengers in Southcentral as well. Last year, roughly 330,000 cruise passengers visited Southcentral ports, which was an 8 percent increase from 2014. Saupe said port schedules are about the same as last year, but a slight increase in passengers could come from larger ships making the port calls. Visit Anchorage tracks cruise ships arriving to all Southcentral ports because the vast majority of those passengers end up in Anchorage via coach bus or the Alaska Railroad once the ocean leg of their voyage is complete. Once the passengers arrive, it’s Visit Anchorage’s job to keep them here. “I think with the strength of the U.S. economy — our U.S. passengers at least — we have a good shot at encouraging them to stay a few extra days and do some of the land tours, which we’re always working on,” Saupe said. Increased passenger traffic through Ted Stevens Anchorage International Airport last year is expected to hold as well, she noted. Almost exactly 1 million passengers passed through the Anchorage airport during the peak summer months of June, July and August last year, a nearly 8 percent increase over 2014. Saupe also said after most of the summer visitors return home Anchorage will host the Adventure Travel Trade Association’s World Summit Sept. 19-22. While the industry conference is limited to 700 participants, she said the benefits of this particular trade show could go well beyond a brief influx of visitors. “The neat thing about this group is they are people who sell adventure travel around the globe, so they’ll have a chance to experience Alaska firsthand and we hope that they’ll go forth and sell (Alaska)” she said. Elwood Brehmer can be reached at [email protected]

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