After three decades, Alaska still doesn’t export natural gas. Here’s why.

I was born in Alaska. Today, it feels like I should get my passport stamped when I visit there. My father was a major player in the construction of the original Trans-Alaska Pipeline System (TAPS) that delivers oil from Prudhoe Bay to Valdez, and ultimately to California and other locales by oil tanker. I have vivid childhood memories of playing inside 48-inch pipe segments at construction sites along the haul road.

Almost as soon as TAPS construction was complete and oil began to flow in 1977, the talk around our dinner table and across Alaska turned to the next great pipeline project – the Trans-Alaska Gasline System (TAGS, or just The Gas Line). Its construction was obvious then, and design was set to start immediately. Now today, 30 years later, with the promise of high prices and overseen by a hugely popular, aggressive, and beautiful governor, Sarah Palin, its construction is still obvious, and design is set to start almost immediately.

Literally as I wrote this article BP and ConocoPhillips announced that they will team up to build The Gas Line, dubbed “Denali.” I’ve heard this claim many times before, so I am not moved. Unless there is a marked change in the status quo, my estimate is that the gas line will not be constructed for another 20 years. And today I speak not as an Alaskan with childhood memories, but as a resident of Austin, Texas, an advisor to presidents, dictators, and Fortune 500 companies.

Problems with the Status Quo

Since 1977, one of the most recurrent themes in Alaskan politics has been The Gas Line. Since the TAPS was completed, the state has elected six governors: three Democrats, two Republicans, and one Independent – and more important than partisan politics has been each governor’s enthusiasm for getting The Gas Line built. Walter Hickel was governor from 1966 to 1969, when he resigned to serve as Nixon’s Secretary of the Interior. Hickel was elected a second time in 1990, touting his Interior Department experience and claiming that he was the man who could deliver The Gas Line. He didn’t.

The common theme for these governors – and I count former governor Steve Cowper as a personal friend (he lives in Austin, too) – was that they were “seeking the highest good for all Alaskans.” The current governor is better than any of her predecessors (sorry, Steve) in that she has an almost unbelievable approval rating of 90 percent. She has charmed the masses, which in Alaska means a few hundred thousand people. The problem is that Alaskans and their politicians feel quite certain that they are just one BP-Conoco news release, one governor, one special session away from getting The Gas Line. A common statement in Alaska is, “Have you heard the news? The Gas Line is getting ready to take off.” And so it has been. For 30 years.

The principle of “highest good” is a lopsided concept in a state where there is very little private ownership of land or minerals. Just as in a foreign country, the game is one of inducing investment from those with the money (oil companies) and then changing the rules as necessary to extract the maximum benefit for the locals. Stirring up the mob against the evil outsiders (oil companies) keeps the populist in power. In foreign countries, the end game is nationalization, sometimes once per generation. In Alaska, taxes are the proxy. (Note: the situation in Texas and Oklahoma is much more intrinsically stable because of private land ownership – many legislators and some of the voting public are also mineral owners.)

In Alaska this proclivity to inventing and changing the rules at the behest of popular (non-landowner) opinion has left a minefield to navigate for each succeeding generation of elected officials, regulators, and oil executives. Some of the populist demands are aggravating but can be tolerated. Others, one in particular (see Number 4 below), will break the deal.

1. Alaskans want the line they want. It was Gov. Tony Knowles who coined the phrase “My way is the highway,” meaning that he would force the pipeline to take his preferred route (he was a restaurant owner in Anchorage before entering politics). This generally meant following TAPS to Delta Junction, and then the Alcan Highway to Alberta, and eventually into Chicago: a single 52-inch line with a capacity of 4 billion cubic feet per day, running some 3,600 miles through the most rugged country in North America at a cost of $40 billion. Knowles clearly had more confidence in Soviet-style central planning than market-driven commerce. In 2003, Knowles and the state changed the rules to effectively outlaw the main competing plan for a new gas pipeline – the “over-the-top” route. State agencies are today prohibited from issuing permits for any pipeline that enters Canada above 68 degrees North latitude, a pretty arrogant move when 70 percent of the proposed line is in Canada. Canadian oil and gas interests will be negatively impacted when Alaska gas passes them by and is dumped in the Midwest, a key Canadian market. North Slope producers may be able to choke down the political manhandling, but probably not the Canadians.
2. Alaskans want the jobs. This is intuitive and logical at one level (and a common demand in foreign countries), but possibly a bit disingenuous under the surface. First, if Alaskans clamor for so many add-ons that they destroy the climate necessary for any line to be constructed, then they will be guilty of splitting up a pie that does not exist. Second, direct employment benefits relatively few people. Maximizing oil and gas revenue benefits all Alaskans (every resident receives an annual Permanent Fund Dividend check from oil and gas profits). Plus, a huge wave of temporary construction jobs may well create as many social and economic problems as it does opportunities. Back in the ’70s when TAPS was built, a disproportionate segment of the workforce had to be imported from Texas and Oklahoma.
3. Alaskans want access to cheap gas. Again this oft-cited demand is a bit confused. Natural gas feedstock industries such as those in southeast Alaska – most notably the Agrium chemical plant and LNG export facilities in Nikiski – are market-driven artifacts of stranded natural gas. By definition, pipeline-connected gas ends at a market terminus, which implies premium pricing. Subsidizing stranded gas industries that no longer make commercial sense is a special interest play that only benefits Alaskans who happen to live along the pipeline route. In the Agrium example, it amounts to corporate welfare.
4. Alaskans want the gas line built on fiscal terms of their own choosing. In particular, Alaska has refused to establish fiscal certainty (i.e., the tax rate) for the life of the project. The other three points may be silly or aggravating to the Big 3 North Slope producers – ExxonMobil, BP, and ConocoPhillips – but they are still tolerable. Lack of fiscal certainty on a $40 billion project (before cost overruns that will put it well beyond $50 billion) is a deal killer. It was the deal breaker that ended the progress of the Big 3 after their $125-million producers group study in 2001; it was the centerpiece and then the undoing of the negotiations between the Big 3 and Gov. Frank Murkowski; and notwithstanding the enthusiastic announcement by BP and ConocoPhillips, it remains the make-or-break issue today.

The primary response from Alaska politicians when confronted with the need for fiscal certainty – Gov. Palin in the current context – is that such guarantees would be unconstitutional. A better response might be to consider whether the request is fair. It is both reasonable and fair for investors preparing to commit $40 billion on a project with a 30-year life to receive fiscal certainty over that period. If the state constitution is an impediment to fair and reasonable terms, a constitutional amendment should be in the offing.

Unfortunately, populism has never produced a good starting point for sound decisions. The temptation for a highly popular governor (who in Alaska may be elected with no more votes than needed for a city council member in a large U.S. city) is to grab all she can from the bounty of ExxonMobil and the like.

Palin v. ExxonMobil

Upon taking office (and after spending just 30 days to get her mind around a 30-year problem), Palin quickly introduced a new framework called the Alaska Gasline Inducement Act, or A.G.I.A. She dressed up the status quo by declaring the position of the Big 3 producers invalid, based on the testimony of “the Legislature’s own experts.” She then re-asserted all of the state’s wants as non-negotiable.

Palin’s framework offers “inducements” in the form of $500 million of state money (maybe 1.3 percent of the cost of the investment, based on a $40 billion project) and a 10-year freeze on tax-code changes, which the producers have consistently said is too short a term.

None of the producers responded to the request for proposals under A.G.I.A. There were a few responses to A.G.I.A., including bids from Sinopec, China’s second largest oil company, TransCanada, a Canadian pipeline company with longstanding aspirations to participate in the gas line’s construction, and two government agencies. Clearly (see Table) TransCanada does not have the financial strength or assets necessary to lead a $40 billion project.

ConocoPhillips, the smallest of the Big 3 North Slope producers, did submit a proposal to the state in November 2007, but it was outside of the A.G.I.A. process. The main deviation from the A.G.I.A. guidelines was apparently ConocoPhillips’s request for 20 to 25 years of fiscal certainty, far less than the producers as a group had sought previously. ConocoPhillips’s compliant posture is not surprising, as their North Slope holdings are much bigger than those of BP or ExxonMobil when viewed as a proportion of their worldwide oil and gas portfolio. Coincidental with their proposal, ConocoPhillips undertook an aggressive publicity campaign in Alaska, apparently with limited success.

Palin rejected ConocoPhillips’s proposal on January 9, 2008, taking offense to their attempts to subvert her A.G.I.A. process and pointing out that they seemed to be asking for a deal similar to the one negotiated by Murkowski.

Despite the rejection, the supermajors remain hopelessly optimistic that they can break through the populist posturing. On April 8, 2008, BP announced that it would team up with ConocoPhillips on their (rejected?) proposal. And, no surprise, TransCanada (their conforming bid notwithstanding) has also expressed an interest to join (the non-team?).

It’s worth noting that BP, ConocoPhillips, and TransCanada have a combined market cap that is less than ExxonMobil’s standing alone. Which in some ways is good for Palin: ExxonMobil provides the unifying external threat that every good populist needs. In the Lower 48 states, people hate ExxonMobil because of expensive gasoline. In Alaska, it’s a bit different. Palin wants to portray ExxonMobil as attempting to deprive sovereign Alaskans of their rights, their oil and gas riches, their very identity. Think of events in Venezuela. Think Russia. Think Argentina.

The not-so-subtle stick that the fashionable governor wields is that (at least in theory) she can revoke ExxonMobil’s North Slope lease(s) if they fail to participate in the pipeline process. Initial salvos have already been launched in this battle. The state took initial steps to strip ExxonMobil of its Point Thompson Unit lease. After a lot of arguing, ExxonMobil agreed to invest $1.3 billion in the unit over the next seven years. Was this a victory for Palin or ExxonMobil?

In February, ExxonMobil signed a contract to supply LNG to a small Fairbanks company, a move hailed as a “historic first” and a win-win for all parties. It could rather be seen as ExxonMobil putting down pieces for the battle to come. I can almost hear the words “demonstrating its commitment to commercialize North Slope gas.” And according to the letter of the law it’s true. Remember that the state sued Exxon in 1977 over claims that the company deliberately inflated costs to construct TAPS. The case took a decade to settle. In February of this year, the U.S. Supreme Court heard arguments in the class action suit against Exxon related to the Exxon Valdez spill, which happened in 1989. Court actions alone are a 20-year path. It might be better for Palin to just march in with the militia and take over the fields.

Palin might learn some lesson from Hugo Chávez, another populist leader who has recently done battle with ExxonMobil (kicking it out of Venezuela after it refused to accept the new unilateral terms of its venture there – and he did promise military intervention, if needed). On February 7, Exxon announced that it had obtained interim court injunctions in the United States, Britain, the Netherlands, and the Dutch Antilles, which would prevent PDVSA, Venezuela’s state-owned company, from disposing of over $12 billion in assets. Oil production has dropped by 40 percent since Chávez became president of Venezuela.

Also, if Alaskans believe that running ExxonMobil out of the state will bring a bevy of replacements, this is not obvious. Even if the company does not intimidate Alaskans and their populist governor, it is clear that ExxonMobil has extensive business dealings (and considerable leverage) with almost every major oil company you can name.

Where to from Here?

1. Consider the status quo, with a twist. Governor, I don’t think you are on the right path. But if you insist on pushing this $40 billion gold-plated option and your long list of “wants,” then it is probably wise to seize on the ConocoPhillips-BP-TransCanada effort to re-gain momentum. Maybe you can allow ConocoPhillips and BP back in under the application of TransCanada, just to claim that your A.G.I.A. framework was a success. Be aware that TransCanada is less than 1/20th the size of ExxonMobil (see Table), but not too many people will notice that. Then you had better get to work on that constitutional amendment – if one is really needed – to give the oil companies a fair and reasonable fiscal certainty.

The alternative is a showdown with ExxonMobil. But unless you want to have the showdown for the sake of the huge news coverage that will result, this is a bad idea. If you do take this route, then be prepared to go to the mat. Court orders are not your friend. Think instead of bringing out the militia to shut down Prudhoe Bay, like your counterparts did when negotiating with producers in Oklahoma and Texas back in the 1930s. No half-measures. You may need to end up being Teddy Roosevelt on this one.

And there will still be the detail of facing the National Energy Board in Canada. Elected officials in the Northern Territories are excited about the proposed highway line, but ultimately, this will be decided in Ottawa, where they also have some popular elected officials with their own list of populist promises, issues, and conditions. No time to get into that now.
2. Rethink the all-Alaska line. This has always been a bad idea, prima facie, based on capital efficiency. Simply stated, it makes no sense to spend some $12 billion to deliver gas to a stranded market where it will have little value.

But the rise of China breathes new life into this option. First, they desperately need the resources, and second, China has been known to accept lower returns on investment compared to their Western counterparts. So an all-Alaska line to tidewater in Kenai or Valdez, liquefaction of the gas (LNG), and exports to China might just work. You would not have to deal with Canada, so you control your own destiny. Construction of the line is greatly simplified. And you have an advocate with big money. If the Chinese are willing to shoulder the capital inefficiency and exposure to tax rates that may change at the whim of a few hundred thousand voters (I haven’t talked to them yet, but they may have the same trouble as the Big 3), then you might have your lead dog (dragon).

Of course, in this case you will also pick up a new enemy: the Sino-phobic American public and their representatives in Washington. Natural gas exports to China make sense economically and even strategically (supplying China with energy is a security enhancement and a step toward balance of payments), but it won’t be popular. And since I heard your name mentioned this weekend as a potential running mate for John McCain, this idea perhaps should wait until after the election.
3. Consider oil-for-gas. My friend and colleague Phil Lewis has outlined a plan that would afford the conversion of North Slope gas for North Slope oil, and would obviate the need for a new pipeline. The general idea would be this: natural gas from Prudhoe Bay and Kuparuk would be a relatively inexpensive source of thermal energy to be used in the production of the 30 billion barrels of heavy oil that has been identified on the North Slope. Even at prevailing Midwest or Louisiana spot prices, natural gas is only 60 percent as valuable as oil on a Btu basis. This is no different than the observation that natural gas from the Mackenzie Delta will be almost entirely consumed in the heavy oil projects in Alberta.

With Phil’s plan, Alaska could effectively export its natural gas (as a liquid) through the existing oil pipeline. This is a viable proposal. It would involve a complex negotiation, but ConocoPhillips’s disproportionate share in the heavy oil (which largely overlies Kuparuk and West Sak) gives you a relatively cooperative partner. And they speak English.
4. What to do if all else fails? (And it probably will.) The first gas line to be built will be the MacKenzie Valley pipeline. As you know, this project has many of its own difficulties, with cost overruns, disputes with First Nation groups, and so on. Still, the hurdles for this line are far fewer than for The Gas Line. First, there are no competing national interests; it is all in one country. It runs down a soft river valley rather than through the ultra-rugged terrain of the Alcan, so construction is much easier. And in turn, it is much cheaper (just $15 billion!).

When the Mackenzie line is built, probably a decade from now, then the conversation will change to how to link up the last hundreds of miles to Prudhoe Bay. Prudhoe gas, under almost any economic and political reality (I assume that you won’t actually call out the militia), will go down the Mackenzie River Valley. There will be multiple looped lines, not a single 52-inch line. This is how pipelines are built when the market is free to work without the encumbrances of populist politics or central planning. Among other advantages, incremental construction reduces financial risk, construction complexity, cost overruns, and negative price gyrations caused by supply that gets behind and then ahead of demand. Just ask your friends at TransCanada. Their marquee “pipeline” that carries 5 bcf/d across Canada is actually seven lines.

Populism does not have a favorable history of delivering on its promises of wealth and opportunity for its constituents. But popularity is also fleeting, so Palin may have a chance to back up and reconsider before she’s done. If not, more governors will come and go, and we’ll recycle this article yet again – maybe on the 50th anniversary of the construction of TAPS.