Legislature(2017 - 2018)BUTROVICH 205

01/30/2017 03:30 PM Senate RESOURCES

Note: the audio and video recordings are distinct records and are obtained from different sources. As such there may be key differences between the two. The audio recordings are captured by our records offices as the official record of the meeting and will have more accurate timestamps. Use the icons to switch between them.

Download Mp3. <- Right click and save file as

Audio Topic
03:30:22 PM Start
03:31:13 PM SB30
04:05:32 PM Oil Production Forecast Methodology Overview
05:01:46 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Overview: Alaska Oil Production Forecast TELECONFERENCED
Department of Revenue
Department of Natural Resources
-- Testimony <Invitation Only> --
Moved SB 30 Out of Committee
-- Public Testimony --
        SB  30-APPROVAL: ROYALTY OIL SALE TO PETRO STAR                                                                     
3:31:13 PM                                                                                                                    
CHAIR GIESSEL  announced SB  30 to be  up for  consideration. She                                                               
said  this  bill  cannot  be  amended since  it  is  ratifying  a                                                               
contract  for  royalty  oil  between  the  Alaska  Department  of                                                               
Natural  Resources (DNR)  and  Petro Star.  Last  year this  body                                                               
considered  and   ratified  the   contract  between   the  Alaska                                                               
Department of  Natural Resources  and Tesoro. She  explained that                                                               
Alaska's Constitution  mandates developing the resources  for the                                                               
maximum benefit of the people of  Alaska and when the state takes                                                               
its  royalty oil  in kind  (RIK)  it needs  to prove  that it  is                                                               
getting more money than it  otherwise would taking royalty in the                                                               
traditional means of in value (RIV).                                                                                            
JIM  SHINE,   Commercial  Manager,  Division  of   Oil  and  Gas,                                                               
Department  of  Natural  Resources (DNR),  Alaska  Department  of                                                               
Natural  Resources (DNR),  said he  would first  provide a  brief                                                               
overview  on the  contract ratification  process and  then review                                                               
the contract.                                                                                                                   
ED   KING,  Special   Assistant  to   the  Commissioner,   Alaska                                                               
Department of Natural Resources (DNR), introduced himself.                                                                      
MR.  SHINE noted  that DNR  Deputy Commissioner  Mark Wiggin  was                                                               
available  on line  as well  as other  members of  the Commercial                                                               
Team who were involved in the negotiation with Petro Star.                                                                      
He explained  that when the state  takes royalty it has  a choice                                                               
to receive it  in kind (RIK) - physical possession  - or in value                                                               
(RIV).  When it  elects  to  receive its  royalty  in value,  the                                                               
producers  ship, co-mingle,  and sell  the state's  royalty share                                                               
with  theirs and  remits the  state's  value to  it by  way of  a                                                               
check. When  the state elects  to receive RIK, the  state assumes                                                               
ownership over the  actual oil and the  DNR Commissioner disposes                                                               
of it  through sale  procedures described  in statute.  The state                                                               
has regularly sold  RIK to in-state refiners dating  back to 1979                                                               
with Mapco/Williams.                                                                                                            
The contract  that is before them  in SB 30 for  ratification has                                                               
gone  through  a thorough  public  review;  the preliminary  best                                                               
interest finding  (BIF) was out  for a 30-day public  comment and                                                               
no comments  were received.  A revised BIF  was presented  to the                                                               
Royalty Oil  and Gas Development  Advisory Board  (Royalty Board)                                                               
in August and  it considered the contract,  the presentation, and                                                               
the BIF and recommended unanimously  that the legislature approve                                                               
3:35:01 PM                                                                                                                    
MR. SHINE  clarified that  there are two  contracts, and  the one                                                               
that is currently  in place is a one-year  contract commencing on                                                               
January 2017  for the sale  of royalty  oil to Petro  Star, which                                                               
does not require legislative  approval. Following the termination                                                               
of  that  contract  starting  in   January  2018,  the  four-year                                                               
contract  in SB  30  would  commence. The  state  will receive  a                                                               
combined  benefit from  the two  contracts of  $29 -  $37 million                                                               
more than  if it had  received the  same barrels over  those five                                                               
years in value.                                                                                                                 
SENATOR COGHILL joined the committee.                                                                                           
CHAIR GIESSEL asked who is on the Royalty Board.                                                                                
MR.  SHINE  replied that  the  Royalty  Board consists  of  eight                                                               
members:  three  commissioners  from the  Department  of  Natural                                                               
Resources (DNR)  who is  a non-voting  member, the  Department of                                                               
Revenue  (DOR), and  the Department  of  Commerce, Community  and                                                               
Economic  Development (DCCED),  as well  as five  public members:                                                               
Bruce  Anders  (Chair),  Dana   Pruhs,  Kathryn  Dodge,  Lawrence                                                               
Gaffaney, and Steve Selvaggio.                                                                                                  
SENATOR  WIELECHOWSKI asked  if  the lower  tariffs are  factored                                                               
into  the  $29  -  37  million  in  savings  from  the  increased                                                               
production in the  pipeline that would result in  more revenue to                                                               
the state.                                                                                                                      
MR. SHINE replied the $27 -  $37 million figure is spelled out in                                                               
the BIF.  The real benefit  is the difference between  the marine                                                               
transportation deduction,  which is present  in the RIV  net back                                                               
formula  versus  RIK net  back,  which  is an  in-state  location                                                               
differential, which he would describe later.                                                                                    
SENATOR  WIELECHOWSKI asked  again if  that savings  figure takes                                                               
into  account the  lower  tariff that  would  result in  slightly                                                               
higher taxes to the state.                                                                                                      
3:38:12 PM                                                                                                                    
MR. SHINE answered  that both RIK and RIV formulas  have a tariff                                                               
reduction  as  part of  the  net  back  formula. If  the  royalty                                                               
volumes  are coming  from Prudhoe  Bay, the  tariff is  from Pump                                                               
Station 1 to the Valdez  Marine Terminal. Tariffs from any fields                                                               
upstream  of Prudhoe  Bay would  include  transportation to  that                                                               
3:38:32 PM                                                                                                                    
However, before  taking RIK the  commissioner must find it  is in                                                               
the  state's best  interest. The  state  can dispose  of its  RIK                                                               
through  a   competitive  bid   process  or   a  non-competitive,                                                               
negotiated  sale  process.  The  DNR  issued  a  solicitation  of                                                               
interest  in  January  2015  to five  refineries  -  Petro  Star,                                                               
Tesoro, Flint  Hills, BP, and  ConocoPhillips - within  the state                                                               
to determine  market interest in  purchasing the  state's royalty                                                               
barrels.  The two  responses  it received  were  from Tesoro  and                                                               
Petro Star,  and last  year the  Tesoro negotiated  sale contract                                                               
was ratified. This  year the Petro Star  negotiated sale contract                                                               
is before them.                                                                                                                 
Based  on the  responses, it  was determined  that there  was not                                                               
enough competition  for a competitive  sale, Mr. Shine  said, and                                                               
while  Tesoro  agreed  immediately  to the  price  terms  in  the                                                               
solicitation,  Petro   Star  was  seeking  a   different  pricing                                                               
mechanism  that is  not as  advantageous  to the  state. At  that                                                               
point  the DNR  commissioner  determined that  a competitive  bid                                                               
sale was  not in the  state's interest and entered  into separate                                                               
negotiated sales.                                                                                                               
The first contract  in effect right now is less  than one year in                                                               
length  to relieve  market  conditions and  allow  Petro Star  to                                                               
secure its feed stock for refineries  in Valdez and North Pole in                                                               
the  near term  while also  negotiating a  long term  contract to                                                               
provide a  secure source  of supply for  the refineries  over the                                                               
next four years.                                                                                                                
He explained the reason for  having both contracts terminate near                                                               
the same  time in 2021  is because  at that point  the department                                                               
will have a  better sense of what royalty  volumes are available.                                                               
Historically, the state  has been able to enter  into 10-year RIK                                                               
sale contracts, but with declining  throughput and uncertainty of                                                               
what volumes would  be available, it's been  determined that five                                                               
year contracts are more accurate at this point.                                                                                 
3:41:26 PM                                                                                                                    
MR. SHINE said AS 38.05.183(e)  states that the commissioner must                                                               
sell the  state's royalty  oil to the  buyer who  offers "maximum                                                               
benefits  to the  citizens  of  the state,"  and  in making  this                                                               
determination, the commissioner must consider:                                                                                  
1. The cash value offered,                                                                                                      
2.  The projected  effects  of the  sale on  the  economy of  the                                                               
3. The  projected benefits of  refining or processing the  oil in                                                               
4.  The  ability of  the  prospective  buyer to  provide  refined                                                               
products for  distribution and  sale in the  state with  price or                                                               
supply benefits to the citizens of the state, and                                                                               
5. The eight  criteria listed in AS 38.06.070(a),  as reviewed by                                                               
the Royalty Board.                                                                                                              
3:42:08 PM                                                                                                                    
For approval  of an RIK  sale the DNR  must make a  Best Interest                                                               
Finding  (BIF)  in  support  of  the  sale.  In  this  case,  the                                                               
preliminary BIF was issued in July  2016 and the final was issued                                                               
in  September  2016.  DNR  presented the  proposed  sale  to  the                                                               
Royalty Board  on August  31, 2016, and  it unanimously  voted in                                                               
Resolution 2016-2  that the proposed  disposition of  ANS royalty                                                               
oil to Petro  Star meets the requirements of  AS 38.06.070. Prior                                                               
to finalizing the RIK contract,  the legislature must pass a bill                                                               
ratifying the contract with Petro Star (HB 70; SB 30).                                                                          
3:42:58 PM                                                                                                                    
The  Royalty Board's  decision criteria  was listed  on slide  6.                                                               
Slide 7 had the actual contract terms:                                                                                          
1-year contract:                                                                                                                
from 18,800 bpd to 23,500 bpd for Jan. 2017 -Dec. 2017                                                                          
4-year contract:                                                                                                                
     from 16,400 bpd to 20,500 bpd for Jan. 2018 -Dec. 2018                                                                     
     from 13,200 bpd to 16,500 bpd for Jan. 2019 -Dec. 2019                                                                     
     from 10,800 bpd to 13,500 bpd for Jan. 2020 -Dec. 2020                                                                     
     from 8,400 bpd to 10,500 bpd for Jan. 2021 -Dec. 2021                                                                      
MR. SHINE  explained that the  range is a minimum  nomination per                                                               
day  and  the high  number  would  be  the maximum.  The  numbers                                                               
decline over  the next  five years,  whereas the  Tesoro contract                                                               
last year had a static number of 20,000-25,000 barrels per day.                                                                 
The Petro  Star contract is  meant to  give them as  much royalty                                                               
volume as  the state can project  to not exceed in  the next four                                                               
years.  Typically they  don't nominate  more than  95 percent  of                                                               
expected  royalty volumes  and so  the  Tesoro contract  combined                                                               
with  the Petro  Star contract  is about  95 percent  of expected                                                               
royalty  volumes  under contract  to  local  refiners within  the                                                               
The net back formula provides a  higher revenue to the state over                                                               
RIV  that  uses  a  marine  transportation  deduction,  which  is                                                               
basically the  price to ship a  barrel of oil from  Valdez to its                                                               
destination   on   the   West  Coast.   The   in-state   location                                                               
differential  is a  deduction in  the net  back formula  meant to                                                               
represent the cost of a barrel of oil within the state.                                                                         
3:45:26 PM                                                                                                                    
MR.  SHINE explained  that the  flexibility of  quantity provides                                                               
for a  three-month consecutive turnaround clause  in which either                                                               
refinery  may  nominate  below  its  minimum  range  for  planned                                                               
service  interruptions  for factory  upgrades,  de-bottlenecking,                                                               
and  efficiencies, which  is customary  in the  refining and  the                                                               
upstream oil and gas industry.  The reason the state doesn't want                                                               
to keep 5  percent of expected royalty oil is  to keep markers on                                                               
what the  marine transportation deductions  are and what  the net                                                               
back formulas look  like to ensure the department  is meeting its                                                               
statutory mandate to meet or exceed  royalty in value when the it                                                               
elects to  sell the state's royalty  in kind. If more  royalty is                                                               
available than  projected, additional volumes will  be offered to                                                               
both Petro  Star and  Tesoro on equal  terms consistent  with the                                                               
pricing mechanisms in each contract.                                                                                            
He said that Petro Star has  filed a $46 million surety bond with                                                               
the state  as provided in the  one-year contract in the  event an                                                               
in-state refiner  or royalty purchaser defaults  (or denominates)                                                               
on  its  obligations  to  pay   the  state  for  royalty  already                                                               
delivered.  Both  contracts   encourage  commercially  reasonable                                                               
efforts  to manufacture  refined  products within  the state  and                                                               
promote  local  hire of  Alaska  residents  and contractors.  All                                                               
communications with Petro  Star have indicated that  they have no                                                               
intent to  do anything but  refine the products within  the state                                                               
for  local use  as jet  fuel,  home heating  fuel, and  ultra-low                                                               
sulphur diesel, to name a few.                                                                                                  
3:48:31 PM                                                                                                                    
MR. SHINE  said the  RIK net  back formula is:  ANS Spot  Price -                                                               
$1.95 -Tariff Allowance +/-Quality Bank Adjustments -Line Loss.                                                                 
He explained that the ANS spot  price is a monthly average of the                                                               
daily average of the two  reporting agencies, Platts and Reuters.                                                               
The in-state  location differential  is deducted from  that $1.95                                                               
as well as the TAPS and  upstream tariffs to Pump Station 1. Then                                                               
there  are Quality  Bank adjustments  and a  small percentage  of                                                               
line  loss.  Line  loss  is   a  .09  percent,  industry-standard                                                               
deduction  from net  back  formulas that  is  meant to  represent                                                               
small  differences in  measurement  between  meters upstream  and                                                               
downstream as  well as  any loss in  product due  to evaporation,                                                               
friction,  ice  build-up, or  paraffin  as  is  the case  in  the                                                               
TransAlaska Pipeline System (TAPS).                                                                                             
3:50:00 PM                                                                                                                    
SENATOR WIELECHOWSKI said if you  take 20,000 barrels out of TAPS                                                               
he understands that  the tariff will go up  slightly for everyone                                                               
else who put  oil in the pipeline.  Then that in turn  is able to                                                               
be deducted from the production taxes  that are paid to the State                                                               
of Alaska,  which ultimately causes  a small loss for  the state.                                                               
He asked if that is factored into this.                                                                                         
3:50:44 PM                                                                                                                    
ED  KING,   Special  Assistant,  Alaska  Department   of  Natural                                                               
Resources (DNR) answered that the  oil that is being delivered to                                                               
Tesoro  is presumed  to have  already been  produced and  shipped                                                               
through  TAPS  through  the  Petro Star  refinery,  so  it  would                                                               
already be calculated  into the tariff calculation.  If the state                                                               
weren't selling oil  to Tesoro the assumption is  that they would                                                               
be purchasing  the same volumes of  oil from someone else  and it                                                               
wouldn't have any net effect.                                                                                                   
SENATOR WIELECHOWSKI  said that  didn't answer his  question, but                                                               
they could discuss it afterwards.                                                                                               
SENATOR COGHILL asked who puts  the calculation together and what                                                               
value that adjustment means at the end of the line.                                                                             
MR.  SHINE answered  that the  Quality  Bank administrator  makes                                                               
those determinations,  which is  meant to measure  the difference                                                               
in value  of the  oil streams  into the  co-mingle point  and the                                                               
stream of oil  coming out in Valdez. So, adjustments  are made to                                                               
those entities who  are contributing a lower quality  of oil that                                                               
result in  a benefit to  the upstream  producer who has  a higher                                                               
quality product.  Those adjustments  can be made  as far  back as                                                               
eight years in this contract  when the Quality Bank administrator                                                               
or FERC makes a determination.                                                                                                  
SENATOR COGHILL  said that is interesting,  because this contract                                                               
has a huge variable.                                                                                                            
MR. SHINE said that is the  reason for the eight-year tail in the                                                               
contract.  Even though  it is  a five-year  contract having  that                                                               
tail move  out eight years provides  the state with a  little bit                                                               
more  certainty that  if adjustments  were made  that they  would                                                               
benefit the state, too.                                                                                                         
MR.  KING noted  that  the  Quality Bank  adjustment  is also  in                                                               
existence  if they  were to  take  RIV as  well as  RIK. So  this                                                               
contract has no actual effect on the value in that regard.                                                                      
3:53:36 PM                                                                                                                    
MR.  SHINE continued  that  the  contract will  yield  $29 -  $37                                                               
million in  additional revenue  to the state  over what  it would                                                               
have received taking the same  barrels in value. The real benefit                                                               
between RIV and  RIK is really realized in  the in-state location                                                               
differential  and the  RIK net  back  formula as  opposed to  the                                                               
marine transportation deduction, which is  present in the RIV net                                                               
back  formula. The  marine transportation  deduction for  FY17 is                                                               
somewhere  in the  $3.30-$3.40/barrel  range and  is expected  to                                                               
move up  by about 10  cents per year until  2021 when it  will be                                                               
about  $3.70/barrel. The  static  $1.95 RIK  differential in  the                                                               
current  contract as  well as  the Tesoro  contract is  where the                                                               
state is getting  the most benefit from the sale  of royalty over                                                               
The value realized by the different contracts is:                                                                               
      1-year contract (Jan. -Dec. 2017): from $7.6 to $9.5                                                                      
     4-year contract (Jan. 2018 -Dec. 2021): from $22.3 to                                                                      
     $27.9 million                                                                                                              
3:55:04 PM                                                                                                                    
He explained that some of  the criteria that the commissioner and                                                               
the Royalty  Board consider  are the  impacts to  local economies                                                               
and local hire; and Petro Star  provides benefits to the state in                                                               
terms of employment, its in-state  refining capabilities, as well                                                               
as providing ultra-low  sulphur diesel, jet fuel,  and asphalt to                                                               
local economies. He presented a  comparison of the volumes of the                                                               
two contracts  on slide 10  and said  he was available  to answer                                                               
CHAIR GIESSEL asked if he had any objections to this contract.                                                                  
MR. SHINE  answered no and  no public comments were  received; no                                                               
adverse comments were presented at the Royalty Board.                                                                           
3:56:09 PM                                                                                                                    
DOUG  CHAPADOS, President  & CEO,  Petro  Star, Inc.,  Anchorage,                                                               
Alaska,  thanked  the DNR  Division  of  Oil  and Gas  for  their                                                               
efforts and past and present  commissioners for the work they had                                                               
done  in getting  this contract  in place.  These are  critically                                                               
important contracts  for their company, because  without oil they                                                               
are out  of business.  With the decline  of TAPS  throughput they                                                               
have found  it more and more  difficult to source crude  oil from                                                               
producers on the North Slope.  Being a consistent source of crude                                                               
in the  future, the state  has brought  Petro Star back  and they                                                               
look forward to refining this  oil and making products for Alaska                                                               
SENATOR  COGHILL commented  that  the investment  Petro Star  had                                                               
made was immediately beneficial to the  North Pole area and he is                                                               
very grateful.                                                                                                                  
3:57:59 PM                                                                                                                    
SENATOR MEYER asked  if it matters to him or  the refinery if the                                                               
oil is heavy or light, or what the gravity or sulphur rate is.                                                                  
MR. CHAPADOS said  they like to see higher quality  crude oil and                                                               
Petro Star refineries  are designed to process a  barrel of crude                                                               
in a very simple way. They  like to see lots of middle distillate                                                               
materials in  the crude:  kerosene, jet  fuel, and  diesel fuels.                                                               
That allows  them to retain  more from each barrel  they process.                                                               
Typically  they retain  25-30 percent  of each  barrel that  they                                                               
process and  the balance is  returned back to the  pipeline. That                                                               
is where  this Quality Bank  liability is generated,  because the                                                               
oil they  return is considered  to be  of lower quality  than the                                                               
balance  of the  oil that  is being  shipped through  TAPS. Crude                                                               
from the Alpine  Field is an example of a  lighter crude oil that                                                               
has a high concentration of jet fuel range material in it.                                                                      
SENATOR MEYER asked if he gets to choose which oil he gets.                                                                     
MR. CHAPADOS  answered he wished  he could, but they  are subject                                                               
to whatever is being shipped  through TAPS, which is a co-mingled                                                               
stream from  all the  fields. Over  time the  quality of  the oil                                                               
increases and decreases;  it's at a good point  now between those                                                               
that are coming on line and those that are declining.                                                                           
4:00:20 PM                                                                                                                    
SENATOR MEYER  said he  had heard that  pipeline oil  is becoming                                                               
heavier, so  it is encouraging to  hear that CD-5 and  the Willow                                                               
discovery have high gravity rates.                                                                                              
MR. CHAPADOS responded  that he believes that the  new fields are                                                               
of reasonably good quality.                                                                                                     
4:01:13 PM                                                                                                                    
MR. CHAPADOS said Senator Wielechowski  questioned whether or not                                                               
the sale  of this royalty  oil to  Petro Star would  increase the                                                               
tariff rates  for the  remaining barrels  that are  being shipped                                                               
through TAPS,  and the  very quick  and simple  answer is  no. He                                                               
explained that  prior to the  state royalty oil  contracts, Petro                                                               
Star  was buying  oil from  another North  Slope producer.  Those                                                               
barrels were  being shipped  through TAPS  just as  these barrels                                                               
will be. So, at  the end of the day, it's really  a zero net gain                                                               
in terms of  how many barrels are being shipped  through TAPS and                                                               
where it's being shipped to.                                                                                                    
4:02:20 PM                                                                                                                    
CHAIR GIESSEL  opened public testimony, and  finding none, closed                                                               
SENATOR COGHILL moved to report  SB 30, labeled 30-GS1873\A, from                                                               
committee  with individual  recommendations  and attached  fiscal                                                               
note(s). There were no objections and it was so ordered.                                                                        

Document Name Date/Time Subjects
SB 30 Transmittal Letter.pdf SRES 1/30/2017 3:30:00 PM
SB 30
SB 30 Request for Hearing.pdf SRES 1/30/2017 3:30:00 PM
SB 30
SB0030A.pdf SRES 1/30/2017 3:30:00 PM
SB 30
SB 30 Fiscal Note-1-2-012017-DNR-Y.pdf SRES 1/30/2017 3:30:00 PM
SB 30
SB 30 Royalty Board Resolution.PDF SRES 1/30/2017 3:30:00 PM
SB 30
SB 30 Report from Royalty Board.pdf SRES 1/30/2017 3:30:00 PM
SB 30
SB 30 PPT to SRES 01.30.17.pdf SRES 1/30/2017 3:30:00 PM
SB 30
SB 30 Contract.pdf SRES 1/30/2017 3:30:00 PM
SB 30
SB 30 Best Interest Finding.pdf SRES 1/30/2017 3:30:00 PM
SB 30
SB 30- Support-Petro Star-1-30-17.pdf SRES 1/30/2017 3:30:00 PM
SB 30
DNR Production Forecast SRES-1-30-17.pdf SRES 1/30/2017 3:30:00 PM
Oil Production Forecast
DOR Production Forecast SRES-1-30-17.pdf SRES 1/30/2017 3:30:00 PM
Oil Production Forecast
SB 30 Support-GVEA-1-30-17.pdf SRES 1/30/2017 3:30:00 PM
SB 30