The AEO2007 reference case projects that an Alaska natural gas pipeline
will go into operation in 2018, based on EIA’s current understanding of
the project’s time line and economics. There is continuing debate, however,
about the physical configuration and the ownership of the pipeline. In
addition, the issue of Alaska’s oil and natural gas production taxes has
been raised, in the context of a current market environment characterized
by rising construction costs and falling natural gas prices. If rates of
return on investment by producers are reduced to unacceptable levels, or
if the project faces significant delays, other sources of natural gas,
such as unconventional natural gas production and LNG imports, could fulfill
the demand that otherwise would be served by an Alaska pipeline.
The primary Alaska North Slope oil and natural gas producers—BP, ExxonMobil,
and ConocoPhillips— became interested in building an Alaska natural gas
pipeline after natural gas prices began to increase substantially during
2000. In May 2002, they released a report on the expected costs of building
a pipeline along two different routes. Since then, construction of a pipeline
has been stalled by differences of opinion within Alaska regarding the
ultimate destination of the pipeline and the level of taxation applied
to the State’s oil and natural gas production. Recent increases in construction
costs and trends in natural gas prices are important factors that will
determine the economic viability of the pipeline.
Physical Configuration of the Pipeline
There are three different visions for the physical configuration of the
Alaska natural gas pipeline. One vision—the southern route—supports the
construction of a pipeline that would serve lower 48 natural gas markets
exclusively, following the TransAlaska Pipeline System to Fairbanks and
then the Alaska Highway into Canada. A second vision—the northern route—as
proposed by the North Slope producers, advocates a pipeline route going
east along the Alaska’s north coast to the Mackenzie Delta in Canada and
then proceeding south to the lower 48 States. In 2002, the producers estimated
that the northern route would cost approximately $800 million less to build
than the southern route, because it would be about 338 miles shorter and
would traverse less mountainous terrain. In 2001, Alaska enacted legislation
to foreclose the northern route. A third view—the south central design—supports
the construction of a pipeline that would transport natural gas to south
central Alaska, both to serve local consumers and to provide LNG to overseas
consumers.
The three pipeline proposals are based on fundamentally different priorities.
The northern and southern routes are premised on the notion that an Alaska
natural gas pipeline would be economically feasible only if it captured
the greatest possible economies of scale (the greatest pipeline throughput),
thereby ensuring the highest possible wellhead price for North Slope natural
gas and the greatest State royalty collection. The south central design
is premised largely on the idea that, because natural gas reserves in the
Cook Inlet region are declining, North Slope production should be transported
to south central Alaska to ensure the future availability of natural gas
to that region’s consumers.
Production Taxes
The Alaska Stranded Natural Gas Development Act was signed in 1998 to make
a natural gas pipeline project in Alaska commercially feasible. When the
Act was passed, lower 48 wellhead natural gas prices averaged $1.96 per
thousand cubic feet. Since then, as lower 48 prices have increased, the
political climate in Alaska has changed from one in which financial incentives
were thought to be crucial to the construction of a pipeline to one in
which some interests believe that State taxes on oil and natural gas production
are not high enough.
In May 2006, a draft stranded gas contract was made publicly available.
In the draft, the North Slope producers and the State agreed to a 20-percent
production tax with a 20-percent tax credit for future investments in Alaska’s
oil and natural gas development. The terms and conditions were negotiated
to remain in effect for the next 30 years. After the release of the draft
contact, opponents argued that the contract’s production tax rate was too
low and the investment credits too large.
In August 2006, the Alaska legislature in a special session passed an oil
and natural gas production tax, which raised the oil production tax from
the negotiated 20 percent up to 22.5 percent. The legislation, which was
signed into law that same month, also reduced the level of investment tax
credits that North Slope producers could use to offset their production
tax liabilities.
At a minimum, the discrepancy between the provisions in the August 2006
law and the draft standard gas contract will necessitate renegotiation
between the producers and the State. The governor who negotiated the draft
contract and signed the August 2006 law was defeated in his bid for reelection.
The pipeline was a major issue in the campaign, and the new governor may
not want to use the existing draft contract as the starting point for negotiation.
Other Issues
Until the State of Alaska and the North Slope producers come to some agreement
on an Alaska natural gas pipeline, a number of other issues will remain
unresolved. One issue is whether the State should be an equity investor
and owner of the pipeline [105]. Another involves the issuing of environmental
permits for the pipeline route, a process that has been contentious for
other pipeline projects, sometimes resulting in significant delays.
A third issue is who will construct, own, and operate the portion of an
Alaska natural gas pipeline that runs through Canada. TransCanada Pipelines
maintains that it has the legislated right to be the owner and operator
of the Canadian portion, as specified in Canada’s Northern Pipeline Act
of 1978 [106]. Finally, the pipeline’s regulatory framework could prove
contentious. For the portion located within the confines of the State, Alaska’s
Regulatory Commission will have jurisdiction over rates and tariffs, including
the terms and conditions associated with third-party access to the pipeline.
These other issues will not be fully addressed until after all the issues
between the State and the North Slope producers have been resolved, and
it is not clear how contentious the issues will be or how quickly they
can be settled.
Construction Costs and Natural Gas Prices
In May 2002, the three primary Alaska North Slope producers estimated the
cost of construction for a proposed southern route pipeline to the Chicago
area and its associated facilities at approximately $19.4 billion [107].
On the basis of that capital cost, they estimated a pipeline transportation
tariff of $2.39 per thousand cubic feet for natural gas moving from the
North Slope to Chicago. From May 2002 to June 2006, however, iron and steel
prices increased by 72 percent [108]. Although it has been estimated that
only 25 percent of the total pipeline cost would be associated with steel
pipe, construction costs have been increasing across the board, as equipment,
labor, and contractor costs have also risen.
A Federal law enacted in 2004 permits the Secretary of Energy to issue
Federal loan guarantees for the construction of an Alaska natural gas pipeline.
The guarantees would be limited to 80 percent of the pipeline’s total cost,
up to a maximum of $18 billion. Because the Federal loan guarantees would
lower the risk associated with recovery of the project’s capital costs,
pipeline sponsors would be able to secure debt financing at a lower interest
rate than they could in the absence of such guarantees, and the pipeline’s
financial viability would be enhanced.
Recent increases in natural gas prices, which began in 2000, have also
improved the economic outlook for an Alaska natural gas pipeline. Lower
48 wellhead prices, which averaged $2.19 per thousand cubic feet in 1999,
rose to an average of $7.51 per thousand cubic feet in 2005. Although prices
have declined since then, the AEO2007 reference case price projections
are at a level at which an Alaska natural gas pipeline would remain economically
viable if other issues surrounding the project could be resolved in a manner
that met the needs of all parties. The parties would have to agree on a
division of the projected benefits before the pipeline could be built.
Notes and Sources
Contact: Philip Budzik
Phone: 202-586-2847
E-mail: philip.budzik@eia.doe.gov |