The Friday Alaska Landmine column: ENSTAR’s confusing claims

Some are pushing the Legislature for subsidies for Cook Inlet gas, but on the surface the claims behind the push don’t hold water; we consider what else may be going on

At a time when the Legislature and the public urgently need clarity and transparency around Cook Inlet gas issues, we are having a difficult time reconciling claims made by Enstar President John Sims on the subject, as recently reported in a Petroleum News Alaska story by long-time Alsaka oil and gas reporter Kristen Nelson (“Sims: Not price, but market size preventing more gas development”).

Here’s how Nelson starts the story:

Is there a lot of natural gas remaining in Cook Inlet?

Yes, Enstar President John Sims told the Resource Development Council March 21.

Would offering producers a higher price lead to development of more volumes?

That hasn’t worked.

Sims said Enstar has offered higher priced contracts but that didn’t result in additional volumes of natural gas offered under contract.

He said it’s not the market price for Cook Inlet natural gas that’s holding back exploration and production to meet the looming natural gas shortage, it’s the small market size, which means companies can’t, in a reasonable amount of time, earn returns from the needed massive investment.

How can Alaska address that issue? Here’s the portion of Nelson’s story addressing that:

What can be done locally?

Sims said incentives from the Legislature — tied to firm contracts for Cook Inlet utilities — are essential because of the inability of the market to provide the needed investment.

There are a lot of ideas being floated in Juneau, he said, but urged focus on solutions the producers have told legislators are necessary for investment, particularly royalty reduction. Sims said royalty reductions would need to be tied to firm contracts with the utilities for the gas.

There are two parts to Sims’ description of the problem and the solution that are confusing.

First, royalty costs can easily be made an element of price. As the gas market in the Lower 48 increasingly faced shortages in the 1970s, producers there made many of the same claims we are hearing now from some Cook Inlet producers: they couldn’t afford to make the investments necessary to develop additional gas supplies given the burden of royalty and state taxes levied on their production. In response, purchasers there sometimes added what were termed “royalty and tax reimbursement” clauses to their contracts, committing to pay as a part of the price whatever the producer incurred as royalty and tax costs.

Of course, the clause raised the purchasers’ prices. But the offset was that the provisions resolved those disincentives, at least to the degree they actually affected investment levels. Neither party looked to the state to resolve the issues; they did it themselves through market responses.

Nelson’s story doesn’t address whether Enstar has made that offer in this situation, but we know of nothing that would prevent it from doing so. And if that is the actual concern of some producers, doing so would resolve it, without the need for state subsidies.

Second, Sims’ repetition of some producers’ claims that state “royalty reduction” would resolve the situation doesn’t make much sense based on the Cook Inlet’s current commercial landscape. According to Sims, the problem with incentivizing new production is “the small market size, which means companies can’t, in a reasonable amount of time, earn returns from the needed massive investment.”

But at least on the surface, royalty reduction does nothing to address the “small market size” of the Cook Inlet. The Southcentral utility gas market is highly unlikely to take a massive jump in size if producers are able to eliminate royalties from their costs. At most, the elimination is designed to hold current gas prices steady in the face of increasing development costs. The size of the Southcentral utility gas market already is the size it would be at current gas price levels. Holding that price steady is highly unlikely to result in a significant market increase.

So, if neither of Sims’ two explanations seems to hold water, what is actually happening?

One explanation is that Enstar and the other Southcentral utilities want a state subsidy to help reduce the price required to contract for additional supplies but don’t want to say so directly. Potentially viewed from their perspective, creating a producer-driven explanation before a producer-friendly Legislature has a much better chance of success and gets them to the same place. If the state waives its royalty payments, the producers don’t have to include them in their costs and, thus, can charge the utilities a lower price and still receive a full return. The producers are in the same place, and the utilities are better off. Only state government revenues — which otherwise would receive the royalties if the utilities paid full price — are hurt.

A second explanation is more complex. It is possible the producers are actually looking at a potential market increase — the reopening of the old Agrium (now, Nutrien) fertilizer plant on the Kenai, perhaps — but need to be able to offer a lower, royalty-relief-driven price to do so. Likely, claiming that they need royalty relief to be able to supply Southcentral utilities — and through them, local consumers — is much more palatable politically than explaining why the state should subsidize the reopening of a private facility.

We’ve noticed, however, that, in their arguments before the Legislature, the producers seeking royalty relief have avoided saying the relief should apply only to sales made to Southcentral utilities. If applied to all of their production, as some of the current bills before the Legislature do, the state-subsidized relief would also be available to sales made to non-utility purchasers.

The thought of using state-subsidized hydrocarbons to benefit private industry certainly would not be new. In Diapering the Devil, former Governor Jay Hammond recounted this story from his time as Governor:

One example of a popular project that clearly failed to meet those criteria [e.g., does it provide “maximum benefit” to the people] was a petrochemical plant proposed for the Kenai Peninsula that would create scores of high-paying new jobs. Since the mantra of many politicians is “Jobs! Jobs! Jobs!” they fail to ask the question “At what cost?” In this particular case those costs were substantial. The only way the plant would be economically feasible was if the state would agree to sell our royalty oil at a discounted rate, which translated into a $240,000-per-year subsidy for each job created.

As we explained in invited testimony last month before the House Resources Committee, we aren’t necessarily opposed to state subsidies in the Cook Inlet market as long as they are needed for a specific objective, are transparently limited in time and scope tailored to that objective — for example, to elicit production required to fill a utility supply gap that may occur before liquified natural gas (LNG) supplies are available — and are paid for by more equitable means than additional cuts in the Permanent Fund Dividend.

On the other hand, we are adamantly opposed to open-ended subsidies to either producers or utilities that aren’t tailored to a specific objective or would be paid for through PFD cuts.

We oppose open-ended subsidies because there are significantly lower-cost options over the intermediate and longer-term for supplying gas to Southcentral purchasers than production from Cook Inlet. As we explained in a previous column, according to the “Alaska Utilities Working Group Phase I Assessment: Cook Inlet Gas Supply Project” (July 2023), the most recent, detailed, publicly available study on the issue, here is an overview of the price levels associated with potential Cook Inlet gas supply options:

While additional production from Cook Inlet wells (in red) is the lowest-cost option in the near term — other than for the estimated price of gas from the Alaska LNG project at full volumes if it were able to develop international markets — as further exploration and development are required to develop additional supplies, the cost of that option quickly escalates to among the highest. Looking at the intermediate term, the midpoint of the range is approximately $17.40/thousand cubic feet (Mcf).

On the other hand, the projected midpoint of the cost range for imported LNG delivered through the Kenai LNG plant (in yellow) is significantly lower, at $12.80 Mcf, as is indeed the projected cost of all of the imported LNG options other than by barge.

Because there are significantly lower-cost intermediate and longer-term sources of supply, continuing to subsidize either the producers or Cook Inlet utilities on an open-ended basis over the intermediate and longer-term could end up costing Alaskans significantly more than pursuing other alternatives. While some narrowly drawn and time-limited subsidies might be needed to keep the Cook Inlet market physically supplied over the near term as the lower-cost imported LNG option is put in place, attempting to maintain the subsidies past that point just keeps costing the state more.

We oppose paying for any subsidies through PFD cuts because doing so would focus the cost of the subsidies inequitably on middle and lower-income Alaska families statewide, while the beneficiaries would largely be consumers in Southcentral Alaska. Even if one assumed that the geographic scope of the beneficiaries was larger — as Representative Tom McKay (R — Anchorage), chair of the House Resources Committee, suggested during our appearance before the Committee — there is still a significant mismatch between those funding the subsidies using PFD cuts and the beneficiaries. The beneficiaries would include businesses, governmental entities (such as Joint Base Elmendorf-Richardson), and those in the top 20%, all of whom would contribute zero or, at most, a trivial share by funding the subsidies through PFD cuts.

Certainly, there should be a much broader base if a portion of the subsidies is used to fund a private enterprise, such as a reopened Nutrien plant. Most should find it repugnant to push the cost of subsidizing a private profit-seeking enterprise largely off on middle and lower-income Alaska families. If that’s a purpose, all Alaska families and non-residents should help fund the subsidies equitably.

We do not doubt that a potential crisis is brewing in the Cook Inlet gas market. But appropriately addressing that crisis requires clear, cogent statements about the nature and scope of the problem so that any solutions involving state subsidies can be narrowly drawn. Neither of Enstar President John Sims’ statements reported in Kristen Nelson’s article meets that standard.

In addressing this crisis, Alaskans should expect the Legislature and the government agencies involved in various aspects of it, particularly the Regulatory Commission of Alaska, which oversees the state’s utilities, and the Department of Natural Resources, which oversees production from state lands and waters in Cook Inlet, to emphasize implementing the lowest-cost solutions, utilizing broad-based funding sources to pay for any subsidies.

Following the reasoning of former White House Chief of Staff Rahm Emanuel, who famously once said, “You never want a serious crisis to go to waste,” some apparently see the current Cook Inlet situation as an opportunity to improve their commercial position by convincing the Legislature and agencies “to do things that you think you could not do before” — such as full-scale royalty relief for any sales made by Cook Inlet producers, subsidized fully through PFD cuts.

But that is neither good nor fair policy. All Southcentral families and businesses are in this together. To address the situation, we should relentlessly pursue the lowest-cost options and, if subsidies are required, limit them to only the amount necessary and recover them equitably from everyone involved.