Expert: Alaska could lose out in pursuing LNG
By Tim Bradner
Alaska Journal of Commerce
Publication Date: 01/01/06
Alaskans could be making a big mistake if they ditch proposals for an all-land natural gas pipeline to the Lower 48 in favor of a liquefied natural gas (LNG) project, says a University of Alaska professor who has studied natural gas markets.
Dr. Douglas Reynolds, an associate professor of economics at the University of Alaska Fairbanks, has studied natural gas markets extensively and was a consultant to the state Legislature in 2002. He said the state could lose as much as $1 per thousand cubic feet (mcf) in value if the gas is sold as LNG on the West Coast or in Pacific export markets rather than in the U.S. Midwest by way of an all-land pipeline.
That's a big deal, considering that the wellhead value of the gas on the North Slope, to which state revenues are pegged, might be only $2 per mcf. Reynolds' point is that Alaskans could risk losing half the value of the gas resource if they force it into an inefficient transportation system.
His views of the economics of LNG are different than those of the Alaska Gasline Port Authority, a municipal group promoting an LNG project based in Valdez. The port authority says its studies indicate LNG could be sold on the West Coast at prices sufficient to give the state a high value for its gas.
Three oil and gas companies owning the majority of North Slope gas leases, as well as TransCanada Corp., a Canadian pipeline company, favor an all-land pipeline built to the Lower 48 through Interior Alaska and Canada along the Alaska Highway. The port authority, formed in 1999 by the city of Valdez, the Fairbanks North Star Borough and the North Slope Borough, favors a pipeline across Alaska to Valdez, where a gas liquefaction plant would be built.
In a talk to the Alaska State Chamber of Commerce Dec. 1, Reynolds said Alaskans shouldn't be distracted by the lure of a short-term construction boom and should focus on long-term revenues from gas production.
Most of the construction workers for any gas project will have to come from out of state because Alaska's pool of skilled labor is too small to meet the demands of a multi-billion-dollar project. Alaskans should still be trained for pipeline-related jobs, he said, but most of the pipeline workers will inevitably be nonresidents.
He argued that more long-term Alaska jobs and economic growth would be created by maximizing revenues to the state treasury and using the money to develop the economy of all parts of the state, not just a few communities.
Reynolds also believes the state should change its taxes on gas to profits-based taxes to capture the greatest value from the resource. State taxes are now based on gross revenues and do not bring in as much money when markets are strong as a profits-based tax would.
The biggest problem with the LNG concept, Reynolds said, is that it would put the gas into markets where there is significant competition, like Asia Pacific, or on the West Coast, where the market is small compared with the U.S. Midwest. "If you move a lot of gas into California the buyers will have the upper hand in pricing, and they will force a lower price," Reynolds said.
"You could sell the LNG, but it's a weak market. The buyers have more options, so you are assuming more risk (of low prices)," he said.
"You will also be competing head-to-head with LNG producers in Indonesia, Australia and Sakhalin," who will be able to supply gas at lower costs than Alaska. LNG producers currently serving the Pacific region have 167 years worth of reserves at hand.
Estimates are that LNG can be landed anywhere on the U.S. coasts, assuming there are import terminals, for about $3.50 per million British thermal units. That sets a price that an Alaska LNG project would have to match.
"The California market for gas will be about 1 (billion) to 2 billion cubic feet a day for the foreseeable future, and they already get about 1 billion cubic feet a day from New Mexico," Reynolds said. It's difficult to imagine that the West Cost market can absorb enough LNG from Alaska to make a project economic.
While gas could, in theory, be supplied to the Midwest via existing pipeline connections from a West Coast LNG terminal, those pipelines would need to be expanded and that will add to costs. It is much more efficient to supply the Midwest by a direct route in a pipeline that is big enough to achieve economies of scale.
Under the LNG scenario, West Coast gas prices could easily be $1 to $2 per thousand cubic feet less than the Chicago gas price, which would be served by the proposed all-land pipeline along the Alaska Highway, Reynolds said.
There are also challenges to developing an LNG project. It will likely take longer to build and will probably experience more chance of costs overruns than the all-land pipeline, he said. Most LNG projects are built in increments with modules that process half a billion cubic feet of gas per day. There are larger modules now under construction, however, that can process 800 million cubic feet per day.
An LNG project based in Valdez would either have to start small and grow gradually into the market, as most LNG projects do, or its developers can try and make the project larger to achieve economies of scale by installing several modules at once.
The Bonny Island LNG project in Nigeria required 11 years to build its capacity to 3 billion cubic feet per day, Reynolds said. A huge LNG project at Trinidad required years to reach its current capacity. The latest expansion increment of 1 billion cubic feet per day required three years to build in Trinidad.
Given the constricted space in Valdez and possible logistics bottlenecks in supplying equipment and thousands of construction workers, the potential for cost overruns will be quite high, Reynolds said. "On a pipeline project, in contrast, construction work is spread out geographically with teams working simultaneously on several sections of the project, which means the opportunities to manage costs are much better," he said.
While he favors an Alaska Highway route, Reynolds also feels the state shouldn't just kow-tow to the chief sponsors of the all-land route - the North Slope producers or TransCanada. If they have to, Alaskans should rattle some swords, particularly if the gas project negotiations currently underway are not concluded soon, he said. The three major gas producing companies are discussing a special fiscal contact on a pipeline project with the state administration.
Reynolds also cautioned, however, that almost every option for sword rattling against the producers, whether imposing a reserves tax or threatening to cancel leases, carries risks of lawsuits which could just further delay the project. But that doesn't mean the state shouldn't at least try to get tough if the producers appear to balk on a deal, Reynolds said.
Tim Bradner can be reached at tim.bradner@alaskajournal.com.
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