Basis for Estimates of Alaska North Slope Netback Oil & Gas Values (revised September 6, 2010)

(Revised to reflect the addition of an estimated netback value for “Bullet Line Gas.”)

The purpose of these estimates is to provide an indication of the relative value of Alaska North Slope (“ANS”) oil and gas to the Alaska economy.  The estimates provide values, netted back to the field, for ANS oil, and ANS gas delivered through three outlets – through an overland pipeline through Canada to the Lower 48 (“AGIA Gas”), through a pipeline to Valdez, Alaska, for conversion to LNG and ultimate sale in the Pacific Rim (“Valdez LNG”) and through a pipeline to Southcentral Alaska for conversion to LNG and ultimate sale to the Pacific Rim (“Bullet Line LNG”).  These estimates attempt to provide field netback values because that is the starting point used to calculate royalty and production taxes which, together, fund a large portion of Alaska state government.

To be clear, none of the market outlets for ANS gas actually exist today.  The reported value for the Alaska Gasline Inducement Act (or “AGIA”) market estimates what the current netback to the ANS would be for gas transported initially to the Canadian AECO hub through a pipeline yet to be built, and then on to the Lower 48 through either existing pipeline systems or additional pipelines yet to be built.  The second value, for “Valdez LNG,” estimates what the current netback to the ANS would be for gas transported initially by pipeline yet to be built to Valdez, Alaska, then liquefied at an LNG liquefaction facility yet to be built, then transported by ship and sold in markets in the Pacific Rim.   The third value, for the “Bullet Line,” estimates what the current netback to the ANS would be for gas transported initially by a pipeline yet to be built to Southcentral Alaska, then liquefied at the existing LNG export facility located near Kenai, Alaska, then transported by ship and sold in markets in the Pacific Rim.

Simply because the facilities for those market options have yet to be constructed, however, does not mean that current estimated netback values for gas using those market outlets cannot be constructed.  A current market price for gas available at the AECO hub (named for the Alberta Energy Company facilities first used as a pricing point), for example, is reported for each weekday by publicly available sources.  Similarly, a current netback price for LNG delivered to the port of Sodegaura, Japan, from the terminus of an existing LNG liquefaction facility of comparable shipping distance as from Valdez and Kenai is periodically reported by the Oil & Gas Journal.  In addition, substantial public information has been developed and made available over the last two years regarding the cost, and likely tariffs, of the facilities necessary to deliver gas from the ANS to those points, enabling the construction from public data of an estimated netback value from those pricing points to the ANS.

A value for ANS oil netted back to the North Slope can be constructed similarly.  As with gas delivered into the AECO hub, a current market price for ANS oil delivered to West Coast ports similarly is reported for each weekday by publicly available sources.  The Alaska Department of Revenue (DOR) estimates and publicly reports annually the costs involved in transporting the oil first through the Trans Alaska Pipeline System, and then on tankers, to those ports.  Netting the reported transportation costs against the reported West Coast ANS price can be used to estimate a field netback value for ANS oil.  Again, such estimates are not intended to provide a basis for determining a precise netback value each day of ANS oil, but are sufficient for purposes of providing an estimated value to be used to provide a comparison on an apples-to-apples basis between oil and gas.

With that background, the estimated netback values for each alternative have been constructed as follows:

ANS Oil.  The estimated netback value for ANS Oil is constructed by taking the price reported daily for “ANS West Coast” on the homepage of the Alaska Department of Revenue, Tax Division (http://www.tax.state.ak.us/), and deducting the “Transit Costs and Other” forecast for the relevant year by the Department of Revenue as contained in its “Spring Forecast.” A link to the then-current Spring Forecast is contained on the homepage of the Department of Revenue, Tax Division (http://www.tax.state.ak.us/).  The “Transit Costs and Other” normally are included on Figure 7 of the “Spring Forecast” (“Basic Data Used for Oil & Gas Production Taxes”) and are used to determine the estimate of “ANS Wellhead in dollars per barrel” used in calculating each Spring’s revenue forecast.

AGIA Gas.  The estimated netback value for AGIA Gas is constructed by taking the price reported for “Aeco spot” for the previous weekday at the webpage entitled “Industry Statistics & Information, Market & Commodity News, Compliments of First Energy Capital” (http://www.psac.ca/firstenergy/), converting that price (which is reported in Canadian dollars) to US dollars using the relevant day’s conversion rate (available from the same website), and deducting transportation costs from the North Slope to the AECO hub largely determined from the information provided online by the Alaska Pipeline Project (the “AGIA Project”) as part of its FERC Open Season materials (http://www.thealaskapipelineproject.com/ferc_open_season_notice).

The transportation cost which will be used from August 30, 2010 forward, is the weighted average of the midpoint of each range for “Alaska-Canada Pipeline, $2009 – $/MMBtu, Negotiated Rate Range and Recourse Rate Range, Term 25 years, Total PBU – Alberta” (the weighted average of the midpoints is US $3.24/MMBtu), plus a component for fuel as reported on the same site (6.5%), plus 15 cents and an additional 1% fuel (to account for the additional charge which is applicable for moving gas from the terminus of the Alaska Gas Pipeline project to the AECO hub).

The transportation rates and fuel component used in constructing this estimate are set forth on Table 1 of the “Open Season Notice” for the project, available at http://www.thealaskapipelineproject.com/docs/ferc/open_season_filing/APP_OS_Plan_Open_Season_Notice_FINAL_v_2_.pdf.  To give effect to both options, the weighted average rate is calculated by attributing two-thirds of the value to the Negotiated Rate Range, and one-third to the Recourse Rate Range.  The transportation rates from the “$2009 – $/MMBtu” category are used in order to better reflect what current transportation costs would be if the option was available currently.

The basis for the 15 cents, plus 1% fuel, additional charge is set forth at Section 5.4, Summary of Estimated Tariffs, AGIA NPV Analysis Report, included as App. G-1 to the Commissioner’s Findings and Determination, Alaska Gasline Project, available at http://gasline.alaska.gov/Findings/findings.html (“The total rate from the ANS to the AECO market in Alberta Canada is expected to be $4.73/MMBtu.  This rate includes an estimated $0.15/MMBtu for accessing the AECO pricing point from the terminus of the pipeline via the TransCanada NOVA system. … Fuel retention for this project configuration is estimated by the Technical Team to be 7.9% plus 1% for the NOVA system”).

Valdez LNG Gas. The estimated netback value for Valdez LNG Gas is constructed by taking the price reported for deliveries from “NW Shelf” (Australia) to Sodegaura, Japan, from the “Purvin & Gertz LNG Netback Matrix” updated bi-weekly on the “Oil & Gas Journal Industry Statistics” page of the online version of the Oil & Gas Journal (http://www.ogj.com/index/industry-stats.html).  Deliveries to Sodegaura are used because that is the market listed in the Matrix to which Alaska LNG supplies most likely would be delivered.  Netback values to NW Shelf are used because the primary variable in determining the netback is transportation distance and the transportation distance between Sodegaura and the NW Shelf (3600 nautical miles) and Valdez (3400 nautical miles) are closely approximate.  The basis for the prices reported by Purvin & Gertz for deliveries to Sodegaura is explained in the online version of the Oil & Gas Journal at http://downloads.pennnet.com/orc/statdefinitions/purvin_gertz_lng.pdf.

The prices reported by Purvin & Gertz are FOB the LNG export point and do not include the costs of (i) transportation from the point of production to the liquefaction facilities, and (ii) of liquefaction.  Costs for those have been calculated using the same sources as used to calculate the transportation costs used in determining AGIA Gas.

The transportation cost which will be used from August 30, 2010 forward, is the weighted average of the midpoint of each range for “Valdez Pipeline, $2009 – $/MMBtu, Negotiated Rate Range and Recourse Rate Range, Term 25 years, Total PBU – Valdez” (the weighted average of the midpoints is US $3.08/MMBtu), plus a component for fuel as reported on the same site (6.2%).   The transportation rates and fuel component for the Valdez Pipeline used in constructing this estimate are set forth on Table 1 of the “Open Season Notice,” available at http://www.thealaskapipelineproject.com/docs/ferc/open_season_filing/APP_OS_Plan_Open_Season_Notice_FINAL_v_2_.pdf.  To give effect to both options, the weighted average rate is calculated by attributing two-thirds of the value to the Negotiated Rate Range, and one-third to the Recourse Rate Range.  The transportation rates from the “$2009 – $/MMBtu” category are used in order to better reflect what current transportation costs would be if the option was available currently.

Estimated costs for the liquefaction facility are not included in the proposed AGIA Open Season rates.  As a results, the costs of the liquefaction facility have been derived from the study done by the State at the time they approved the award of the AGIA license, included in Section 7, Summary of Estimated Tariffs, AGIA NPV Analysis Report, included as App. G-1 to the Commissioner’s Findings and Determination, Alaska Gasline Project, available at http://gasline.alaska.gov/Findings/findings.html.  In order to use costs which match the volume used by the Alaska Pipeline Project in calculating the transportation rates, the costs have been derived from the “2.7 Bcf Case.” That case projects a total cost of transportation, liquefaction and shipping equal to $9.68/MMBtu (Figure 7-1), plus 15.8% fuel (Section 7.8.2). In order to determine the costs of liquefaction alone, the total cost has been adjusted to remove the portion attributable to shipping ($1.01/MMBtu, Section 7.8.1) and transportation and the GTP (approximately $3.70/MMBtu, Figure 7-1). The remainder, which represents the costs of liquefaction before fuel, have been further adjusted to convert the costs, which are stated on a nominal dollar basis, to costs stated on a 2009 dollar basis, using the same ratio of $2009 to $Nominal reflected in the Alaska Pipeline Project Open Season Notice, for the Valdez Pipeline (80%, calculated from Table 1 of the Open Season Notice).  The resulting costs for liquefaction used in determining the estimated netback for Valdez LNG Gas is $3.97/MMBtu.  Fuel attributable to liquefaction used in the calculation is 9.6%, which is equal to the total fuel component included in the “2.7 Bcf Case” (15.8%), less the fuel for the pipeline and GTP reflected in the Alaska Pipeline Project Open Season Notice (6.2%).

Bullet Line Gas.  In order to ensure consistency, the estimated netback value for Bullet Line Gas is calculated using the same starting point as the estimated value for Valdez LNG Gas, by taking the price reported for deliveries from “NW Shelf” (Australia) to Sodegaura, Japan, from the “Purvin & Gertz LNG Netback Matrix” updated bi-weekly on the “Oil & Gas Journal Industry Statistics” page of the online version of the Oil & Gas Journal (http://www.ogj.com/index/industry-stats.html).

As noted above, the prices reported by Purvin & Gertz are FOB the LNG export point and do not include the costs of (i) transportation from the point of production to the liquefaction facilities, and (ii) of liquefaction.  Estimates of these costs are deducted from the Purvin & Gertz price in order to determine the estimated netback value to the Alaska North Slope.

A Bullet Line was not included in the AGIA Open Season.    The State, however, recently has conducted a study of estimated transportation costs for such a line using the same approach applied in its early study of the proposed AGIA line and the pipeline to Valdez.  The costs of transportation for the Bullet Line have been calculated based on the estimated transportation rates included in that study, “Alaska Stand Alone Gas Pipeline Project Update and FY 2010 Deliverables:  Submitted to Alaska Gasline Development Corporation,”  Prepared by the Stand Alone Gas Pipeline Project Team, available at http://www.ahfc.state.ak.us/iceimages/agdc/final_project_update_071510.pdf (July 15, 2010) (the “Update”).

Potential transportation costs are available at Figure 7 of the Update at varying thruput levels.  Because the calculation here assumes that a portion of the gas transported through the Bullet Line is being delivered for LNG sales, and that such sales – along with the development of other potential markets – will allow the Bullet Line to achieve higher rates of thruput, transportation rates are derived from the “1000 mmcf/d” case.  The transportation rates contained in the Update are stated in nominal dollars and do not include the negotiated rate discounts reflected in the transportation costs for the other two options.  Because negotiated rate options likely would be available as well in a Bullet Line and in order to restate the rates on the same “2009” basis as the other two options, the transportation rate taken from the Update has been adjusted to state it on a comparable basis with the rates used in the other two calculations.  The adjustment is to cause the resulting rate used in the calculation ($5.66/MMBtu) to bear the same ratio to the rate contained in the Study as the transportation rate used to calculate the Valdez LNG netback bears to the transportation rate reported for the same service in the State’s earlier AGIA NPV Analysis Report. The Update does not contain an estimate for fuel for the Bullet Pipeline.  This calculation uses the same fuel component (6.2%) as used for the Valdez LNG pipeline.

The costs of a liquefaction facility are different for the Bullet Pipeline than the Valdez LNG project.  The Valdez LNG liquefaction facility does not exist and the charge estimated for that option reflects the costs of a new facility.  The Kenai LNG Plant, however, exists and has been in operation since the late 1960’s.  As a consequence, although there certainly have been additional capital investments over time, most of the facility’s capital costs have been recovered.  As a result, while the charge for the use of the facility would need to be sufficient, of course, to recover ongoing operating costs and provide a sufficient return to provide an incentive for continued investments necessary to keep the plant operational, the charge would not be in the same order of magnitude required to build and operate the Valdez LNG facility.

Because it is older and smaller, however, the Kenai LNG facility likely experiences higher operating costs than those of new facilities.  The Kenai LNG facility is not required to report operating costs, but factoring up publicly estimated costs for units using a similar process to account for size and age differences, a reasonable estimate for operating costs, exclusive of fuel, is in the range of $0.40/MMBtu.  Adding $.60/MMBtu to provide for the recovery of ongoing capital costs and an incentive for continued operation produces a charge for liquefaction of $1.00/MMBtu.  Fuel attributable to liquefaction used in the calculation is 9.6%, which is equal to the fuel component for the Valdez LNG plant and in the range of fuel usually consumed in a liquefaction facility.