Wednesday, June 21, 2006

Question No. 2 Of Natural Gas Pipeline Roundtable - What Is "Diligence"?

On June 7th, KTUU-TV's John Tracy met with Jim Clark, Joe Marushack, Bill Walker and David Gottstein to discuss the natural gas pipeline. The 15 questions discussed will air on the "5 O'Clock Report," the "NewsHour" and the "Late Edition." Click here to see all 15 questions (without the answers). In this post, you will see the report on the discussion of question #2.

The Panel: John Tracy, News Director of KTUU, serves as the moderator.

1). Jim Clark: Governor Murkowski's chief of staff and the state's chief negotiator. He represents the executive branch.

2). Joe Maruschak: ConocoPhillips' vice president of gas commercialization and one of the primary negotiators representing the producers.

3). David Gottstein: A financial analyst and a co-chairman of Backbone 2, a resource watchdog group.

4). Bill Walker: General counsel for the Alaska Gasline Port Authority, the organization promoting an LNG project (the "all-Alaska gas line") from Prudhoe Bay to Valdez. Since he's relying upon work done by Econ One for the legislature, he can be considered a "proxy" representative of the legislature.

Answers to questions presented without summarization.

Question #2: When it comes to work commitments, the contract uses the term “diligence” as the performance standard to be met by the participants. What is diligence, and who determines if the producers are being diligent?

Bill Walker responds: “Diligence is a very low threshold of commitment of doing something. Basically what it has to show that there is some effort being made, as minimal as it may be, towards a project, and basically it requires in 90 days there would be a planning meeting. Following that, on April 1 every year, April Fools’ Day, there would be a letter from the producers back to the state as far as what they has done the prior year. Extremely low, low test. Now there’s a whole list of things you cannot consider in whether or not they’ve been diligent or not. Things going on in Canada, whether or not there are regulatory issues in Canada. The First Nations’ aboriginal issues in Canada. Issues with TransCanada, who already have permits and say they will not want somebody else coming through the country. There’s a whole list of things that cannot be used in determining whether they are being due diligent or not. It’s a very soft test, it’s a very low test, significantly lower than the test we have right now under the leases. It’s a significant step backwards to say that it’s a diligence test".

Joe Marushack responds: “John, when I think about diligence, what I think about is are you being hard working? Are you being thorough? Are you moving meticulously forward to move the project? And the biggest test of diligence you’re going to have on this project is there are no secrets on it. As soon as the contract is signed by the Legislature, we will start what is called project planning. But what that really means is you’re going to spend about $120 million to start your permitting process, hiring your engineers, hiring your people, so that you can go to your board at that point in time and ask for $1 billion that it’s going to take to move it to that first construction phase. There’s no secrets on this project -- people are going to know how much money we are spending. That is going to be the diligence test. It’s at risk, and if folks think that the definition of work commitments is first gas or first construction, that’s just wrong, they’re being misleading. Every project that I’ve ever worked on, you must go through a very rigorous project management process. This project is no different than that".

David Gottstein responds: “Our termination rights in this contract are absurdly weak. It will be virtually impossible to terminate this contract. It’s bad enough that we don’t get paid anything by transferring this hugely valuable exclusive economic right to the oil producers to build a gas line, whether they build it or not. But on top of that, we have to transfer hundreds of billions of dollars of oil wealth through the (petroleum profits tax) even if they don’t ever build a pipeline. This diligence effort should be traded away for specific performance. Diligence just means effort. It doesn’t mean that you’re actually providing any value to the state”.

Jim Clark responds: “Just for openers, I want to correct you on the value to the state. The state gets $100 billion over 35 years from the gas and it extends taps for another 20 years and we get another $25 billion there, but nobody has properly stated the standard that’s in the contract. It is to advance the project diligently as is prudent under the circumstances. No large project in this state, including the Fort Knox project or the recent Pogo (Mine) project ever advances on a set timeline. What they do is they set guidelines and they attempt to move it forward. Why? Because they’re trying to hold down costs. The biggest threat to this project is cost overruns. We need to be very, very careful about that, so we need them to progress diligently but we need to do so thinking that we are also an owner”.

David Gottstein responds to Jim Clark: “I’m glad that you mentioned the amount of money the state will receive there. There’s estimates of over $1 trillion worth of oil remaining on the North Slope and between a half a trillion and $1 trillion worth of gas. For us to be satisfied with maybe ($100 billion) or even $200 billion over the lifetime and giving the rest to the oil companies is absurd. The way we solve that is in a free market open bidding competitive process. I can’t understand what’s wrong with the free market system, why we have to resort to a sole source non-competitive bid when we can let the free market through the lowest bidder meaning those that give the remaining, most of the state providing the maximum benefit to the state of Alaska is the best way to go”.

Joe Marushack responds: “David, you’ve got your free market system. But once you get that gas pipeline project, then you’ve got that win/win you can build everything off of. All the leases that you can lease for more oil production. All the additional gas that’s available. All the jobs that will be created and the revenue that’s created. What this gas pipeline does is the tip of the iceberg from which we can start. What I’m really interested in, which a gas exploration and development business, which is the same thing that I think you’re talking about on a free market basis”.

John Tracy's Analysis: One thing that is important to remember about this contract is that it doesn’t build a gas pipeline, it simply lays the financial groundwork in the event the producers actually proceed. They’ve got four years upon signing of the contract to make that decision. In that four years’ time, almost anything can happen that could affect that decision -- from a price collapse to even greater competition from other countries, all eager to develop their own gas projects.

Some common themes will emerge throughout the discussion. Boiling it all down, the Murkowski administration and producers say the incentives in the contract are necessary to provide the fiscal certainty needed to move forward, and if the state signs, there’s a good chance producers will build the pipeline.

And they agree that an overland pipeline through Canada to Chicago is the only project big enough to capture the biggest amount of profit. Gottstein and Walker believe the state is taking all the risk while producers get too much of the profit, and the state hasn’t done its homework when it comes to comparing competing projects, namely the so called all-Alaska LNG project to Valdez. Of course, no project is going anywhere without approval from the Legislature and that is proving to be contentious, especially as we begin to move into campaign season.

Click here to read discussion on Question No. 1.

Click here to see the proposed gas line contract and other associated documentation.

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