Legislature(2015 - 2016)BARNES 124

03/28/2016 01:00 PM RESOURCES

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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Moved HB 373 Out of Committee
Heard & Held
+ Bills Previously Heard/Scheduled TELECONFERENCED
        HB 373-APPROVAL OF SALE OF ROYALTY OIL TO TESORO                                                                    
1:03:07 PM                                                                                                                    
CO-CHAIR  NAGEAK announced  that the  first order  of business  is                                                              
HOUSE BILL  NO. 373, "An Act  approving and ratifying the  sale of                                                              
royalty  oil by  the State  of Alaska  to  Tesoro Corporation  and                                                              
Tesoro Refining  and Marketing Company  LLC; and providing  for an                                                              
effective date."                                                                                                                
1:03:42 PM                                                                                                                    
JAMES   SHINE,   Special   Project  Assistant,   Office   of   the                                                              
Commissioner, Department  of Natural Resources (DNR),  said HB 373                                                              
would  affirm the  contract  of  sale of  royalty  oil to  [Tesoro                                                              
Corporation  and   Tesoro  Refining  and  Marketing   Company  LLC                                                              
("Tesoro")].    To review  the  bill's  provisions he  provided  a                                                              
PowerPoint presentation  entitled, "Proposed  Sale of  the State's                                                              
Royalty Oil to Tesoro:  House Bill 373."                                                                                        
MR. SHINE displayed  slide 2, "Royalty In-Kind  versus Royalty In-                                                              
Value," and  explained that  the State of  Alaska has a  choice to                                                              
receive its royalty  share of oil production in-kind  (RIK) or in-                                                              
value (RIV).   A  presumption in  statute is  that the  state take                                                              
its  royalties in-kind  unless it  is  found in  the state's  best                                                              
interest to take  it in-value.  Conversely, the  commissioner also                                                              
has to make a  best interest finding when the  state takes royalty                                                              
in-kind.   He advised that when  the state does a  royalty in-kind                                                              
process the  department must  perform a  solicitation of  interest                                                              
to gauge  market demand.   A letter was  sent last January  to the                                                              
five  companies   with  in-state   refineries:    BP   Exploration                                                              
(Alaska)  and  ConocoPhillips  Alaska  each  have  a  North  Slope                                                              
topping plant;  Petro Star Inc.  has refineries in North  Pole and                                                              
Valdez;  Tesoro  has  a  refinery  in  Nikiski;  and  Flint  Hills                                                              
Resources, even  though it  ceased operations  in June 2014.   Two                                                              
responses,  one from  Petro Star  and one from  Tesoro, sought  to                                                              
refine  the state's  oil within  the state.   The Tesoro  response                                                              
met  the demands  of price  contained  within DNR's  solicitation,                                                              
whereas  Petro Star  responded affirmatively  to purchase  royalty                                                              
oil but  proposed a  different pricing structure  that was  not as                                                              
advantageous  to  the state.    Thus,  the department  elected  to                                                              
proceed  on a  non-competitive contract  negotiation with  Tesoro.                                                              
Historically  since 1979,  the  state has  elected  to choose  its                                                              
royalty in-kind,  although not all  portions of the oil  have been                                                              
taken  in-kind.  He  clarified that  since February  1, the  state                                                              
has been  taking all of its  royalty in-value because  the state's                                                              
most recent  Tesoro contract terminated  on January 31, 2016.   Up                                                              
to that  point, commencing  in 1979, the  state has disposed  of a                                                              
significant  volume of  its  royalty oil  to  Petro Star,  Tesoro,                                                              
Flint Hills, Williams, and other in-state users.                                                                                
1:06:38 PM                                                                                                                    
MR. SHINE turned  to slide 3, "Non-Competitive  RIK Sale Process."                                                              
He advised  that DNR  elected to proceed  with Tesoro  and started                                                              
commercial  negotiations with  Tesoro in  February or March  2015.                                                              
The contract in  the committee packet is the  culmination of those                                                              
commercial   negotiations.      He   explained   that   when   the                                                              
commissioner elects  to take the  royalty in-kind it  is necessary                                                              
to make a Best  Interest Finding (BIF) that what  is being done is                                                              
maximizing  the benefits and  the value  of the state's  resources                                                              
for the citizens  of the state.  Showing slide  4, "Commissioner's                                                              
Decision  Criteria,"  he  said  that  under  AS  38.05.183(e)  the                                                              
commissioner must  consider the  cash value offered,  the economic                                                              
benefits,  the benefits  of  refining in-state,  meeting  in-state                                                              
demands, as well  as the criteria that the Alaska  Royalty Oil and                                                              
Gas  Development Advisory  Board  ("Royalty  Board") considers  as                                                              
directed by the legislature in AS 38.06.070.                                                                                    
1:08:04 PM                                                                                                                    
MR.  SHINE  displayed  slide  5, "Approval  Process  for  the  RIK                                                              
Sale," and  noted that DNR goes  through the BIF  process outlined                                                              
in statute  on why the  royalty in-kind  (RIK) election is  in the                                                              
state's  best  interest.    He  said  this  process  commenced  in                                                              
January 2015 with  a solicitation of interest, and  then a lengthy                                                              
commercial  negotiation  with  the  Division  of  Oil  &  Gas  and                                                              
Tesoro.  The  department then presented the proposed  contract and                                                              
a preliminary  BIF for public comment  in early February  2016 for                                                              
30  days, and  comments were  received  only from  Petro Star  and                                                              
Arctic  Slope   Regional  Corporation   (ASRC).    Subsequent   to                                                              
receiving  those comments,  DNR  revised the  contract to  address                                                              
the concerns  raised in those  comment letters.   After addressing                                                              
the  concerns the  next  step was  presenting  it  to the  Royalty                                                              
Board  on March  15,  2016.   The  division's  Commercial  Section                                                              
provided  the overview  of  the contract  and  walked through  the                                                              
process.   The  Royalty  Board voted  unanimously  to approve  the                                                              
contract  and forward  its recommendation  to  the legislature  to                                                              
ratify  the  contract.    Included  within  the  committee's  bill                                                              
packet are a resolution  signed by the board members  and a report                                                              
to the  legislature on why this  proposed contract meets  the best                                                              
interests of the state.                                                                                                         
MR.  SHINE  moved   to  slides  6-7,  "Royalty   Board's  Decision                                                              
Criteria,"  and  said the  report  outlines  the reasons  why  the                                                              
proposed contract  meets the statutory  criteria that  the Royalty                                                              
Board  considers in  its  deliberation.   The  eight criteria  are                                                              
similar  to  what the  DNR  commissioner  considers in  regard  to                                                              
economic  and price  issues with  respect to  how they impact  the                                                              
1:10:16 PM                                                                                                                    
MR.  SHINE reviewed  slide 8,  "Tesoro  RIK Contract  Terms."   He                                                              
advised that the  goal of the proposed five-year  contract that is                                                              
before  the  committee is  to  commence  deliveries on  August  1,                                                              
2016.  The  state would sell  to Tesoro between 20,000  and 25,000                                                              
barrels per day  over the course of the contract.   There are some                                                              
safeguards  and  other provisions  within  this contract,  one  of                                                              
which  is if  Tesoro nominates  zero  barrels over  the course  of                                                              
three months, the  contract terminates.  Some of  these provisions                                                              
are  customary  for what  has  been  done  in  the past  with  RIK                                                              
contracts.    For example,  in  2013  the legislature  ratified  a                                                              
contract  with  Flint Hills.    When  Flint Hills  terminated  its                                                              
operations  in spring  2014, the  state's RIK  contract ceased  to                                                              
exist after  that point.   The  state has  provided security  - if                                                              
Tesoro's credit  rating falls  below a certain  level it  then has                                                              
to  provide a  Letter of  Opinion from  a financial  analyst or  a                                                              
Letter of Credit  equal to the value  of 90 days' worth  of Alaska                                                              
North Slope  (ANS) oil.   The purpose  of that security  provision                                                              
is  essentially  if the  state  is  delivering  oil and  for  some                                                              
reason someone goes  out of business, then the state  at least has                                                              
the Letter  of Credit that provides  the state some  security that                                                              
it  is  not going  to  be  providing  oil and  not  receiving  any                                                              
compensation.    This  has  not  happened to  date  but  is  still                                                              
something that is included in the state's contracts.                                                                            
MR. SHINE  pointed to two other  provisions in the contract.   In-                                                              
state processing  is a consideration  that the commissioner  makes                                                              
in  issuing the  Solicitation  of  Interest for  meeting  in-state                                                              
demand.    Therefore,  the  contract   provides  that  Tesoro  use                                                              
commercially  reasonable efforts  to use  the refined products  of                                                              
ANS royalty  within the state.   Over the  last two  years, Tesoro                                                              
has been  purchasing royalty  oil from the  state and  has refined                                                              
them in its Nikiski  facility.  The department has  been told that                                                              
nothing  is changing  with respect  to this  contract, that  these                                                              
barrels are intended to be refined within the state as well.                                                                    
1:12:38 PM                                                                                                                    
REPRESENTATIVE SEATON,  with regard to the 90 days  of ANS royalty                                                              
oil on  slide 8, inquired  as to whether  that is looking  forward                                                              
or the  situation where if there  was a bankruptcy  the bankruptcy                                                              
court  could go  back  90  days before  and  ask for  those  being                                                              
preferential payments and therefore claw them back.                                                                             
MR. SHINE  understood the 90-day  value of  ANS royalty is  if the                                                              
purchaser  falls   below  a  certain   credit  rating;   then  the                                                              
purchaser would  be required,  per this  contract, to  provide the                                                              
value of  90 days  of ANS  crude.   He said  he assumes that  that                                                              
would be  90 days' value  of ANS crude  as it currently  exists at                                                              
that time,  not at today's  dollars.  In  the event  this happened                                                              
in 2019  or 2020, the  [contract] would look  at the value  of the                                                              
crude at that point and require that 90-day payment.                                                                            
REPRESENTATIVE SEATON  said his point was not  that current dollar                                                              
value.   He asked  whether that  is looking  backwards so  that 90                                                              
days  before that  date,  payments  that were  made  to the  state                                                              
would not be subject  to recapture from a bankruptcy  court, or is                                                              
it  going forward  from that  date so  Tesoro would  have to  post                                                              
that  so  it has  money  on  file  for  oil that  would  be  being                                                              
purchased  from  that point  on  where it  would  have  to post  a                                                              
Letter of Opinion.                                                                                                              
MR. SHINE  replied he  does not  have an  understanding of  how it                                                              
works in  a bankruptcy proceeding.   He said this  particular term                                                              
is intended  to address  a situation in  which under  the contract                                                              
the  state is  selling and  Tesoro is  purchasing oil  on a  daily                                                              
basis.     If  Tesoro's  credit   rating  fell  below   a  certain                                                              
threshold,  at  that  point  the  state  would  require  a  90-day                                                              
payment,  essentially a bond  payment, to  backstop any  potential                                                              
shortfall the  state would experience  through a non-payment.   He                                                              
reiterated  that  the  state  has  never  had  to  implement  this                                                              
provision  but it is  a safeguard  the state  includes in  its RIK                                                              
contracts to  ensure that  should a purchaser  not meet  a certain                                                              
credit  threshold that  the state  does have  some protection  for                                                              
the purpose of the royalty barrels that have already occurred.                                                                  
1:15:28 PM                                                                                                                    
MR.  SHINE  returned  to his  presentation,  addressing  the  last                                                              
bullet  point on  slide 8  with  respect to  employment of  Alaska                                                              
residents.   He  explained  that while  the  state cannot  require                                                              
Alaska hire in the contract it does encourage Alaska hire.                                                                      
MR. SHINE  turned to  slide 9, "RIK  Contract Price,"  and advised                                                              
that the valuation  methodology for RIK takes the  ANS spot price,                                                              
which is essentially  the monthly average of the  daily average of                                                              
the  two reporting  agencies  Platts and  Reuters,  and then  nets                                                              
back from  that point  to get  the RIK  price.   The $1.95  is the                                                              
actual  RIK differential  deducted from  the spot  price, and  the                                                              
other deductions  or adjustments  from that  point onward  are the                                                              
same ones that would  be seen in an RIV valuation,  which includes                                                              
the  tariff  allowance  for  transportation  in  the  Trans-Alaska                                                              
Pipeline  System   (TAPS),  Quality   Bank  adjustments   per  any                                                              
direction  from the  Quality Bank  administrator, as  well as  any                                                              
subtraction  in  line loss  from  Pump  Station  1 to  the  Valdez                                                              
Marine Terminal  (VMT).   He noted  that the biggest  differential                                                              
between RIK  and RIV  would be  with respect  to the RIK  location                                                              
differential  as it  relates to  what would be  experienced  in an                                                              
RIV   world,  which   is   a  marine   transportation   deduction.                                                              
Currently,  the  marine  transportation deduction  on  average  is                                                              
about $3.50  per barrel.   The delta  between the $3.50  deduction                                                              
from a barrel of  RIV to the $1.95 deduction for  RIK is where the                                                              
state will see the  most benefit in this contract  over the status                                                              
quo of RIV.   Based on predictions, the department  estimates that                                                              
the delta between  RIV and RIK will bring the  state approximately                                                              
$45 million  to $56 million  more than  it would have  realized if                                                              
it  had taken  these  barrels in-value  over  the  course of  this                                                              
contract.   So, approximately  $10 million per  year more  will be                                                              
realized as a result of this contract.                                                                                          
1:17:37 PM                                                                                                                    
MR. SHINE  explained that  slide 10, "Contract  is in  the State's                                                              
Best  Interest,"   goes  into  more  detail  about   the  location                                                              
differential and  transportation deduction.  Criteria  the Royalty                                                              
Board and the  commissioner considers are the  economic and social                                                              
benefits to  the economy.   Tesoro employs 210 Alaskans,  provides                                                              
$127  million  in  benefits  to the  local  economy,  and  refines                                                              
approximately   59,000  barrels  per   day  at  Tesoro's   Nikiski                                                              
refinery.  Eighty  percent of each barrel that is  produced at the                                                              
refinery  is put back  into the  local economy  through jet  fuel,                                                              
home heating fuel, and ultra-low sulfur diesel (ULSD) fuel.                                                                     
MR.  SHINE  said   slide  11,  "Additional  Royalty   Oil  Sales,"                                                              
outlines another  provision that  DNR added  to the contract  with                                                              
Tesoro.   The department is also  including this provision  in the                                                              
contracts  it is  currently  negotiating with  Petro  Star.   This                                                              
provision is that  if the state has additional  volumes of royalty                                                              
oil available that  are not under contract, there  is a nomination                                                              
period 100  days prior to a  purchaser taking possession  of those                                                              
barrels where  the state would  offer those additional  barrels on                                                              
an equal  basis to the two  in-state refiners to purchase  so that                                                              
the state maximizes  the value of its resources  and also provides                                                              
more royalty oil to the local refining industry.                                                                                
1:19:21 PM                                                                                                                    
REPRESENTATIVE SEATON  referred to slide  9 and asked  whether the                                                              
line  loss, the  loss of  volume between  Pump Station  1 and  the                                                              
Valdez Marine Terminal, is mainly from temperature.                                                                             
MR. SHINE  replied that it is  a formulaic multiplier  intended to                                                              
represent loss  due to  temperature and  processing.   He deferred                                                              
to the Division of Oil & Gas to answer the question further.                                                                    
CORRI  FEIGE,  Director, Division  of  Oil  & Gas,  Department  of                                                              
Natural  Resources   (DNR),  deferred  to  Greg   Bidwell  of  the                                                              
Commercial Section.   She said he was involved  in the calculation                                                              
and contract  drafting and  would be  able to  speak to  line loss                                                              
estimations specifically.                                                                                                       
GREG  BIDWELL, Commercial  Analyst,  Commercial Section,  Division                                                              
of Oil and  Gas, Department of Natural Resources  (DNR), responded                                                              
that the definition  of line loss  that was provided is  fine.  It                                                              
is a  measurement error  as well  and is  something that  has been                                                              
part of the TAPS  tariff since inception, so it has  been there as                                                              
part of the item for paying royalties and value in-kind.                                                                        
REPRESENTATIVE  SEATON asked whether  there is  a loss  in getting                                                              
to the  Valdez Marine  Terminal from processing  and, if  so, what                                                              
is  the processing.   He  further  asked whether  there are  other                                                              
types  of loss,  or  a calculation  of  an assumed  percentage  of                                                              
loss, or a temperature volume consideration that is adjusted.                                                                   
MR. BIDWELL  answered that he  thinks it is primarily  temperature                                                              
and measurement  rather than  processing.   He explained  that the                                                              
first four  pump stations run  off of natural  gas from  the North                                                              
Slope  and the  rest  of the  pump stations  use  diesel, but  not                                                              
diesel  from the  oil itself.   There  is not  any processing,  it                                                              
just  temperature   measurement  oriented  differences   that  are                                                              
applied through the system.                                                                                                     
1:22:58 PM                                                                                                                    
REPRESENTATIVE JOSEPHSON  observed that the Arctic  Slope Regional                                                              
Corporation's  (ASRC's)  letter  of  March 7,  2016,  argues  that                                                              
there should have  been proportional proration.   He requested the                                                              
department to speak to this.                                                                                                    
MR. SHINE  responded that that  is correct.   With respect  to the                                                              
original  contract  presented to  the  public in  early  February,                                                              
Petro  Star and  ASRC  raised two  primary  concerns.   The  first                                                              
concern was  the proration  preference granted  to Tesoro  through                                                              
the course  of commercial  negotiations, and  that has  since been                                                              
removed.  He  explained that the department typically,  when it is                                                              
selling royalty,  if there is for instance a  service interruption                                                              
or  seasonal  maintenance  work   that  happens  and  there  is  a                                                              
reduction  in  royalty  volumes  available  to  meet  the  state's                                                              
contractual  demands  or  contractual obligations,  then  all  RIK                                                              
purchases   will  be   prorated   down  proportionate   to   their                                                              
percentage  of purchasing  of the  state's royalty  oil.   Through                                                              
the   course  of   negotiations,   Tesoro   reduced  its   maximum                                                              
nomination  volume  to make  more  room, so  to  speak, for  Petro                                                              
Star's  ability  to purchase  royalty  oil  from  the state.    In                                                              
exchange  for that  the state  granted  the proration  preference,                                                              
but   after  public   comments  and   internal  deliberation   the                                                              
department decided  to strike  that term from  the contract.   So,                                                              
there is  no longer a  proration preference,  it went back  to the                                                              
status quo  in which if there  is any proration required  it comes                                                              
down  proportionate to  each purchaser.   There  is no  preference                                                              
for any RIK  purchasers at this  time.  The second  concern raised                                                              
by Petro  Star and  ASRC with  respect to  the draft contract  was                                                              
the term  of the contract.   The proposed  contract that  went out                                                              
for public  comment had a five-year  initial term with  the option                                                              
to extend  for five years among  consent of the state  and Tesoro.                                                              
That extension  has since  been struck from  the contract.   Thus,                                                              
the  contract  before  the  committee has  a  five-year  term,  no                                                              
extensions, and no proration preference.                                                                                        
1:25:29 PM                                                                                                                    
REPRESENTATIVE  SEATON  returned  to slide  9  and the  $1.95  RIK                                                              
differential  comparison to  the $3.50 marine  transport  for RIV.                                                              
He  inquired whether  that  means the  $1.95  is basically  marine                                                              
transport  between  Valdez  and  Tesoro's terminal.    He  further                                                              
inquired whether  that also applies  then to the other  buyers and                                                              
whether they  have the same  $1.95 in their  term whether  they do                                                              
marine transport or not.                                                                                                        
MR. SHINE  answered that  the $1.95 RIK  differential is  meant to                                                              
represent  the   selling  of  crude  within  Alaska,   not  marine                                                              
transportation per  se.  He said  he is unsure of  Tesoro's actual                                                              
cost to  ship between the Valdez  Marine Terminal and  its Nikiski                                                              
refinery.     Regarding   the  second  question,   he  said   this                                                              
absolutely applies  to Petro Star;  these are the same  RIK prices                                                              
on which the  state is currently negotiating contracts  with Petro                                                              
Star, which  is meant to  represent the  cost of selling  a barrel                                                              
of oil in the state, exclusive of marine transportation.                                                                        
1:26:58 PM                                                                                                                    
REPRESENTATIVE  TARR referred to  the overall  use of RIV  or RIK,                                                              
and noted  the transmittal  refers to  the remaining volume  being                                                              
available for  Petro Star.   She recalled  that in 2013  the state                                                              
signed  a contract  with Flint  Hills  and asked  whether that  is                                                              
still in place as far as the overall distribution.                                                                              
MR. SHINE  answered no,  that contract  is terminated  since Flint                                                              
Hills  has  ceased  operating.    The  legislature  ratified  that                                                              
contract in  2013 and the  volumes were 18,000-30,000  barrels per                                                              
day  over the  course  of five  years.   When  Flint Hills  ceased                                                              
operating in June  2014 that contract terminated.   Currently, the                                                              
state does not have  any RIK barrels under contract  and is taking                                                              
everything  in value.   There have  been a  couple periods  in the                                                              
course of  history starting  in 1979 that  this has  occurred, but                                                              
primarily the state  sells its available volumes in  RIK, which is                                                              
what is before the committee.                                                                                                   
REPRESENTATIVE  TARR surmised  that when  talking about the  total                                                              
volume available, it would be between these two at this time.                                                                   
MR. SHINE  replied that  the Commercial  Section has reviewed  the                                                              
production forecast  and current  production levels  and estimated                                                              
that  the  state   has  approximately  50,000-52,000   barrels  of                                                              
royalty  oil   currently  available.    With   current  production                                                              
forecasts  and only  considering  current  production  that is  on                                                              
line  today  without  considering  potential  new  projects,  that                                                              
decline curve over  the course of this contract will  come down to                                                              
approximately  36,000-38,000  barrels  per  day.   Therefore,  the                                                              
20,000-25,000  barrels  the  state  is  selling  to  Tesoro  today                                                              
represents  approximately  55-60 percent  of  the state's  overall                                                              
royalty volume  available for  purchase.  Over  the course  of the                                                              
next  five years,  that  percentage  will increase  as  production                                                              
forecasts continue to fall.                                                                                                     
1:29:15 PM                                                                                                                    
REPRESENTATIVE   OLSON  asked  what   the  current   Quality  Bank                                                              
adjustment is under this contract.                                                                                              
MR. SHINE  responded he does not  know what the  actual adjustment                                                              
is in  dollar figures  right now  because that  is something  that                                                              
happens   through  the   Quality   Bank  administrator.      Those                                                              
adjustments   are  considered   in  this   contract  through   the                                                              
department's  evaluation  process  that takes  into  account  what                                                              
comes  from  the  Quality  Bank  administrator  for  Quality  Bank                                                              
adjustments, whether they are up or down.                                                                                       
REPRESENTATIVE  OLSON  therefore surmised  that  if  he wanted  to                                                              
compare  it to  what  it was  for  Flint Hills,  it  would not  be                                                              
something the committee could receive today.                                                                                    
MR.  SHINE  answered   he  does  not  have  that   figure  at  his                                                              
fingertips right now,  but said he does not imagine  that it would                                                              
be much  different than  under the Flint  Hills contract  of 2013.                                                              
It  is  the same  provision  that  was  allowed  for in  the  last                                                              
contract, but  the Quality Bank  administration is  something that                                                              
happens exclusive to how the department operates.                                                                               
1:30:23 PM                                                                                                                    
REPRESENTATIVE  OLSON  understood  the adjustment  was  originally                                                              
for companies like  Flint Hills that were putting  a waste product                                                              
into the pipeline.   Given Tesoro is not doing  that he questioned                                                              
how they could be similar.                                                                                                      
MR. SHINE  replied that  Representative Olson  is correct.   Flint                                                              
Hills  and  Petro  Star  take  their  main  fee  stock  for  their                                                              
refining  off  of  TAPS  and  then refine  it  and  then  have  to                                                              
reinject the  residual or the heavy  ends of the barrel.   They do                                                              
pay a  Quality Bank  penalty for  putting that  lower quality  oil                                                              
back in and  it gets co-mingled  among the other streams  that are                                                              
not taken out  and refined.  So,  they are subject to  a different                                                              
Quality Bank  adjustment than,  for instance,  would be  Tesoro as                                                              
an end-stream  user at the Valdez  Marine Terminal.   Tesoro, just                                                              
because  of its  location,  would not  necessarily  be paying  the                                                              
same  kind of  penalty  as Petro  Star's  North  Pole facility  or                                                              
Flint Hills' former facility.                                                                                                   
REPRESENTATIVE OLSON  remarked that what  he is getting at  is how                                                              
they  could almost  be  the  same, in  that  one is  flushing  the                                                              
toilet and the other is the mixing zone.                                                                                        
MR.  SHINE allowed  he misspoke  in not  considering the  location                                                              
between the two  refineries.  What he meant to allude  to was that                                                              
the Quality Bank  adjustment is not something the  state controls,                                                              
it is  determined by  the Quality Bank  Administer.   He explained                                                              
that when  he is comparing  RIV versus  RIK, the barrels  that get                                                              
to the Valdez Marine  Terminal are purchased by Tesoro  or sent to                                                              
the West Coast  on the state's behalf  by the producers  in an RIV                                                              
situation.   The  netback  formula for  both  of those  situations                                                              
will include a Quality Bank adjustment that will be the same.                                                                   
1:32:27 PM                                                                                                                    
REPRESENTATIVE  CHENAULT,  regarding  Mr. Shine's  statement  that                                                              
the Quality Bank  adjustment will be the same,  posited that Flint                                                              
Hills would  pay more for  the Quality  Bank end and  Tesoro could                                                              
actually see  a credit, because  the quality  of the crude  oil is                                                              
less at the  Valdez Marine Terminal  than at Pump Station  1.  So,                                                              
for any  draw, he said,  Flint Hills or  Petro Star would  have to                                                              
pay more for  the Quality Bank versus  Tesoro at the other  end of                                                              
the line.                                                                                                                       
MR. SHINE responded that that is his understanding as well.                                                                     
1:33:30 PM                                                                                                                    
CO-CHAIR NAGEAK opened public testimony on HB 373.                                                                              
FRED  PARADY, Deputy  Commissioner,  Office  of the  Commissioner,                                                              
Department   of  Commerce,   Community   &  Economic   Development                                                              
(DCCED);  Board Member,  Alaska  Royalty Oil  and Gas  Development                                                              
Advisory Board, noted  that in addition to his  position as deputy                                                              
commissioner of  DCCED, he is the  designee to the  Royalty Board.                                                              
He  related  that  the Royalty  Board  carefully  considered  this                                                              
contract and  made appropriate  revisions to  it during  its board                                                              
meeting and the  board supports the recommendation  that is before                                                              
the committee.     He pointed  out that  the declining  volumes in                                                              
throughput  through  TAPS  are   resulting  in  declining  royalty                                                              
barrels for  in-kind purposes in  this proposed contract  and said                                                              
"the amendments  that were  worked to  it takes  care of  both our                                                              
in-state refining facilities."                                                                                                  
1:35:03 PM                                                                                                                    
MATT  GILL,   External  Affairs  Senior  Manager,   Tesoro  Alaska                                                              
Company,  testified in  support of  HB 373.   He paraphrased  from                                                              
his  March  18,  2016, letter  to  the  House  Resources  Standing                                                              
Committee,   which   reads  as   follows   [original   punctuation                                                              
     I am writing to you in support for House Bill 373 "An                                                                      
     Act approving and ratifying the sale of royalty oil by                                                                     
     the  State of Alaska  to Tesoro  Corporation and  Tesoro                                                                   
     Refining  and Marketing Company  LLC; and providing  for                                                                   
     an effective date."                                                                                                        
     Tesoro Corporation  is a Fortune  100 company and  is an                                                                   
     independent   refiner   and    marketer   of   petroleum                                                                   
     products.  Tesoro's refining  operations started  Alaska                                                                   
     with the purchase of the Kenai refinery back in 1969.                                                                      
     Our  Kenai  refinery  has the  operational  capacity  to                                                                   
     produce up  to 72,000 barrels  per day and  is primarily                                                                   
     focused  on  Jet  and  Diesel   production  followed  by                                                                   
     gasoline  and  gasoline  blendstocks,  heating  oil  and                                                                   
     heavy fuel oils,  propane and asphalt. We  operate a 68-                                                                   
     mile, common-carrier  products pipeline  that transports                                                                   
     jet  fuel,  gasoline and  diesel  fuel  to the  Port  of                                                                   
     Anchorage and  the Anchorage International  Airport. The                                                                   
     wholesale  delivery of our  products occurs through  our                                                                   
     terminals  in Kenai,  Anchorage,  our  Nikiski dock  and                                                                   
     the Port of Anchorage.                                                                                                     
     In addition  to being the largest taxpayer  in the Kenai                                                                   
     Peninsula  Borough,  Tesoro  is  also  able  to  provide                                                                   
     around  225  family wage  jobs  at the  refinery,  along                                                                   
     with  about 30  full-time contractors  that are  working                                                                   
     in  and  around  the refinery  year  round.  We  provide                                                                   
     retail  fuels at  our company-owned  Tesoro 2-Go  retail                                                                   
     outlets  as well as  at numerous  branded and  unbranded                                                                   
     outlets. We  employ operators who work at  our terminals                                                                   
     in the Port of Anchorage and in Nikiski.                                                                                   
     We  are a  major supporter  of the  Cook Inlet  Regional                                                                   
     Citizens  Advisory  Council  (CIRCAC)  and  the  largest                                                                   
     member  of the Cook  Inlet Spill  Prevention &  Response                                                                   
     team (CISPRI).                                                                                                             
     We actively  support a  wide range  of local events  and                                                                   
     programs  - from  employee  fundraising  for the  United                                                                   
     Way to youth  sports programs. Each year we  sponsor all                                                                   
     of  the  5th   and  6th  grade  classes  on   the  Kenai                                                                   
     Peninsula to  conduct a mission at the  Kenai Challenger                                                                   
     Learning  Center and  we are  the  Signature Sponsor  of                                                                   
     "Caring for the Kenai" program.                                                                                            
     Tesoro  strongly urges  you to support  House Bill  373,                                                                   
     "An  Act approving  and ratifying  the  sale of  royalty                                                                   
     oil by  the State  of Alaska  to Tesoro Corporation  and                                                                   
     Tesoro   Refining  and   Marketing   Company  LLC;   and                                                                   
     providing for an effective date."                                                                                          
     This legislation  is the  result of constructive  dialog                                                                   
     and productive  negotiations  between the Department  of                                                                   
     Natural  Resources and  the Tesoro  Corporation. By  all                                                                   
     accounts,  our  company  was  very  impressed  with  the                                                                   
     State's ability  to understand our issues and  arrive at                                                                   
     a mutually  beneficial  agreement that  is truly a  win-                                                                   
     win for  both parties  as well  as accommodating  to the                                                                   
     other refineries in the State.                                                                                             
     For the State,  the DNR estimates that it  will continue                                                                   
     to  receive a  price for  its  Royalty-in-Kind oil  that                                                                   
     exceeds the  price it would  have receive if  it elected                                                                   
     to keep its Royalty Oil in Value.                                                                                          
     For  Tesoro, this  five year  contract  will provide  us                                                                   
     with a stable  supply of ANS crude while  also giving us                                                                   
     the   volumetric   flexibility   to   help   accommodate                                                                   
     seasonal fluctuations in demand for refined products.                                                                      
     The availability,  flexibility  and stability that  this                                                                   
     contract  offers  will have  a  positive impact  on  our                                                                   
     ability  to  maintain  our  ongoing  operations  at  our                                                                   
     Kenai refinery.                                                                                                            
     In  order to  accommodate  the needs  of  the other  in-                                                                   
     state  refiners,  Tesoro  and the  State  modified  this                                                                   
     contract  to  reduce  volumes  as well  as  eliminate  a                                                                   
     proration clause and a five year extension option.                                                                         
     Tesoro believes  in Alaska's future and is  committed to                                                                   
     being an  active corporate  citizen. We look  forward to                                                                   
     continuing  to  provide  Alaskans   with  clean  burning                                                                   
     fuels to keep  your homes warm and your  cars, boats and                                                                   
     snow machines traveling across this great state.                                                                           
     I urge you to support House Bill 373.                                                                                      
1:39:14 PM                                                                                                                    
REPRESENTATIVE SEATON inquired whether the calculation of the                                                                   
sales price is a daily or monthly value.                                                                                        
MR. GILL deferred to Damon VanZandt to answer the question.                                                                     
DAMON  VANZANDT,   Senior  Director,  North  American   Crude  Oil                                                              
Strategy and  Trading, Tesoro  Petroleum Corporation,  offered his                                                              
belief that  the contract references  two pricing  sources, Platts                                                              
and Reuters, and  they publish a price for the  Alaska North Slope                                                              
(ANS) crude which  is actually a West Coast (WC)  delivered price.                                                              
That is  a daily  assessment, they  produce a  high and  low price                                                              
and the  contract takes the  average of  those highs and  lows for                                                              
one day,  and then takes a  monthly average where it  computes the                                                              
average  daily price  for  the entire  month  of  delivery.   That                                                              
establishes the monthly average price that Tesoro pays.                                                                         
MR.  VANZANDT addressed  an  earlier  question regarding  how  the                                                              
marine  transportation  discount  of $1.95  was  arrived  at.   He                                                              
pointed  out  that that  price  is  a U.S.  West  Coast  delivered                                                              
price, so it is  a price that represents cargos of  ANS that trade                                                              
down  into  California and  the  Pacific  Northwest.   That  $1.95                                                              
marine  discount represents  the  marine transportation  to  those                                                              
delivery  destinations from  Valdez.   So,  taking  the $1.95  off                                                              
arrives back at the Valdez price.                                                                                               
1:41:20 PM                                                                                                                    
REPRESENTATIVE  SEATON  appreciated  that  the price  is  averaged                                                              
monthly.  He  understood that $3.50 is the  average transportation                                                              
charge between Valdez  and West Coast port, and  asked whether the                                                              
$1.95 is related to transportation from Valdez to Nikiski.                                                                      
MR. VANZANDT offered  his belief that the $3.50  is representative                                                              
of the royalty  in-value marine discount, which is  the reason the                                                              
royalty  in-kind contract  is basically  $1.55  better.   "Royalty                                                              
in-value contracts  that you sell,  it costs you another  $1.55 to                                                              
sell  those back  to the  producers," he  continued, and  actually                                                              
Tesoro just  deducts the  $1.95, which is  the same  discount that                                                              
Tesoro and Petro Star take off the ANS published price.                                                                         
1:42:28 PM                                                                                                                    
REPRESENTATIVE  JOSEPHSON  recalled  Mr.  Shine's  testimony  that                                                              
since  1979 there has  been the  rare occurrence  where the  state                                                              
has taken  royalty in-value.   He  asked Mr. Gill's  understanding                                                              
of this gap and whether it is avoidable in the future.                                                                          
MR. GILL offered  his understanding that it became  very difficult                                                              
to  buy royalty  oil  in the  past, there  were  netbacks and  the                                                              
coming  back on  contracts Tesoro  had with  additional fees  year                                                              
after year after  the fact.  That appears to  have been alleviated                                                              
recently.   Tesoro  engaged two  years  ago in  its first  royalty                                                              
contract in  many years, and Tesoro  is very satisfied  with terms                                                              
it came up with  and extended it for one year  and that expired in                                                              
January.   Tesoro has  had a  great working  relationship  and the                                                              
majority  of the  issues have  been  ironed out  that kept  Tesoro                                                              
from engaging in  royalty oil in the past.  Tesoro  is happy to be                                                              
back in business with the state.                                                                                                
MR.  SHINE clarified  that there  has  been only  a few  instances                                                              
where the state  has taken all of its royalty in-value  (RIV); the                                                              
state always takes  a certain portion of its  royalty in-value, at                                                              
least 5 percent.   In that manner the state is  still given market                                                              
information  and netback  pricing so  the state  can ensure  it is                                                              
still receiving  better than  RIV.  He  reiterated that  the state                                                              
has been  selling royalty in-kind  (RIK) since 1979, a  portion of                                                              
the state's  overall volume,  but that  fluctuates depending  upon                                                              
who is  purchasing, the  actual production,  and how many  barrels                                                              
the state  has available.   With  respect to  the state's  current                                                              
situation,  it was  a  combination of  market  factors with  Flint                                                              
Hills.   The state had 18,000-30,000  barrels under  contract with                                                              
Flint  Hills before  it shut  down.   So when  Flint Hills  ceased                                                              
operation in  2014 the state had  a one-year contract  with Tesoro                                                              
which was subsequently  extended and terminated January  31, 2016.                                                              
Given  the lengthy  public process,  there  was a  long lead  time                                                              
involved  in these  commercial negotiations  to get  the state  to                                                              
where it  is today.   The state cannot  essentially flip  a switch                                                              
and  start selling  RIK oil  for long-term  contracts when  things                                                              
become available, it takes longer than that.                                                                                    
1:45:04 PM                                                                                                                    
REPRESENTATIVE  TARR, regarding  the five-year  extension and  Mr.                                                              
Shine's explanation  about the  amount of  lead time,  inquired as                                                              
to how much  time that actually  will take.  She  further inquired                                                              
whether  the  state  will start  that  process  somewhere  mid-way                                                              
through this contract  so that the state is not  pushed up against                                                              
any deadline and  whether that is how it would  naturally occur if                                                              
the Flint Hills anomaly had not taken place.                                                                                    
MR.  SHINE replied  correct, the  lead  time based  upon what  has                                                              
been seen in this  process is approximately 14 months.   The state                                                              
went out  for solicitation  in January 2015  and now it  is toward                                                              
the end  of March  2016 with  the contract  before the  committee.                                                              
If  Tesoro is  interested  in purchasing  RIK  volumes after  this                                                              
five-year  contract terminates,  that conversation  will start  in                                                              
advance of  the termination  of this contract.   At that  time the                                                              
division will  go out  for an additional  public solicitation  and                                                              
gauge market  demand to  determine which  entities are  interested                                                              
in  purchasing at  whichever volumes  the state  has available  at                                                              
that time.   In an earlier  statement he mentioned that  the state                                                              
is currently negotiating  a contract with Petro Star  and is doing                                                              
a  one-year contract;  concurrently  the  state is  negotiating  a                                                              
four-year contract so  that that would commence at  the end of the                                                              
one-year  contract.    So,  both   entities  will  have  five-year                                                              
contracts  terminating at  approximately  the same  time in  2021.                                                              
At that  time the state  will have a  better handle  on production                                                              
forecasts and  which royalty  volumes the  state has available  to                                                              
sell to the market.   If all goes well, the committee  will have a                                                              
Petro Star contract before it next spring.                                                                                      
REPRESENTATIVE  TARR understood  that the  shorter term  contracts                                                              
can be  done without  the same  kind of  legislative approval  and                                                              
surmised this is  why the legislature was not  so closely involved                                                              
in what took place during the gap with Flint Hills and Tesoro.                                                                  
MR. SHINE  responded correct.  Under  AS 38.06.055, a  contract of                                                              
less  than 365  days does  not require  legislative  ratification,                                                              
and  contracts   of  one  year   or  longer  require   legislative                                                              
ratification.   To meet  Petro Star's  near-term demands,  and for                                                              
the state  to deliver royalty barrels  to Petro Star in  2016, the                                                              
state  is now  seeking to  do a  short-term, less  than one  year,                                                              
contract  while currently  negotiating  a  new four-year  contract                                                              
that would extend past when the one-year contract terminates.                                                                   
1:47:59 PM                                                                                                                    
REPRESENTATIVE OLSON  noted the cheapest  Tesoro gas on  the Kenai                                                              
Peninsula  is about  one-half mile  from the  refinery.  He  asked                                                              
whether it  is being trucked out  from Anchorage or  being trucked                                                              
over from the refinery.                                                                                                         
MR. GILL  offered his belief  that it is  being trucked  over from                                                              
the refinery.                                                                                                                   
REPRESENTATIVE  OLSON  remarked  that  there  has been  a  lot  of                                                              
speculation on that.                                                                                                            
MR. GILL said he has heard a lot of stories.                                                                                    
1:48:26 PM                                                                                                                    
REPRESENTATIVE TARR  understood that the in-state  use of Tesoro's                                                              
refined products  is predominantly jet fuel and  not retail fuels.                                                              
She inquired about the numbers for the in-state products.                                                                       
MR. GILL  replied that  pretty much all  of Tesoro's  gasoline and                                                              
all  of its  jet diesel  is consumed  in  the state.   When  Flint                                                              
Hills shut down  the demand for gasoline picked up  and Tesoro was                                                              
able  to fill  that.   About  the  only thing  that  goes out  [of                                                              
state] is  the bottom one-third  of the barrel, the  heavy bottoms                                                              
that Tesoro  cannot do anything  with because of how  the refinery                                                              
is configured.   So, it has to  be stored and a home  found for it                                                              
somewhere down south.                                                                                                           
1:49:21 PM                                                                                                                    
REPRESENTATIVE  OLSON  asked  whether  there  is  another  federal                                                              
mandate  coming  down on  production,  like the  ultra-low  sulfur                                                              
diesel mandate that came down a few years ago.                                                                                  
MR. GILL  offered his belief that  Tier 3 gasoline  standards will                                                              
go into  effect this year.   It is  volumetric and  requires extra                                                              
hydro  treating of  the gasoline  to pull  out additional  sulfur,                                                              
and Tesoro is prepared to meet those standards.                                                                                 
1:49:58 PM                                                                                                                    
REPRESENTATIVE  JOSEPHSON recalled  that  this issue  has come  up                                                              
with  the cruising  industry and  that the  cruising industry  has                                                              
highlighted the impact on its market and prices.                                                                                
MR.  GILL answered  that that  is  different, it  is heavy  bunker                                                              
fuel and what is  allowed to be used in the ships.   He understood                                                              
that ships  within  three miles  [of the coast]  must use  cleaner                                                              
burning  fuels,  which  are  more  expensive.   That  is  what  is                                                              
driving some  of the cargo companies  to switch over  to liquefied                                                              
natural gas (LNG), he posited.                                                                                                  
CO-CHAIR NAGEAK  closed public  testimony after ascertaining  that                                                              
no one wished to testify.                                                                                                       
1:51:01 PM                                                                                                                    
REPRESENTATIVE  TARR said she  is pleased  that the committee  has                                                              
something  before it,  because it  appears the  RIK will bring  in                                                              
roughly $50 million more in value, which is good news.                                                                          
REPRESENTATIVE  OLSON commented  that  this is  probably the  most                                                              
non-controversial bill the committee has had all session.                                                                       
REPRESENTATIVE HERRON remarked it is the most unamended bill.                                                                   
1:51:56 PM                                                                                                                    
CO-CHAIR TALERICO  moved to  report HB 373  out of committee  with                                                              
individual  recommendations  and  the accompanying  fiscal  notes.                                                              
There  being no  objection, HB  373  was reported  from the  House                                                              
Resources Standing Committee.