News from Patrick Flynn

A gasline idea

While getting North Slope natural gas isn’t really within the purview of the Anchorage Assembly, ensuring our community has sufficient gas for heating homes and keeping the lights on is important to all of us.  In that spirit I offer a guest commentary, in the form of a letter to the president of the newly-created Alaska Gasline Development Corporation, Dan Fauske, from local financial consultant David Gottstein:

Dear Dan:

Thanks for the opportunity to provide you some input regarding an Alaskan gas pipeline project.  My goal is to convince government representatives that the following analysis should be formally vetted equal to any other proposals being offered, because the cost of not taking action could be enormous.  I come at the gas pipeline questions not only as an interested Alaskan, but as a twenty year company analyst and Registered Investment Advisor with a finance degree from The Wharton School.  Also having been a logistics and supply chain manager in a major grocery operation for almost ten years.   Perhaps the intersection of these two disciplines allows me to look at the question at hand differently than most, because any pipeline project is largely a combination of economics, logistics, finance and politics.

To start with, Alaska is faced with what seems to be an intractable and growing problem. We are running out of gas in Cook Inlet, and there is no current means to bring our own North Slope gas to market.  In the meantime we seem to be faced with either waiting for the Producers to decide when to build a gas pipeline, with the prognosis of importing LNG until that happens, or deciding to build an incredibly inefficient bullet or narrow gauge  gas pipeline that will saddle Alaskans with high energy costs for decades.  While at the same time severely handicapping the prospects for an export project.  There is no visibility on when there will even be visibility on when gas pricing and demand will justify, for a Producer board of directors, the large capital requirements necessary for a large gas pipeline project.  All the board of directors can do is spend money on public relations campaigns, lobbying, campaign contributions and local charities, in order to garner and or extend an option to move forward with a project if and when pricing and demand forecasts indicate it meets investment grade status. Without any intention of building in the foreseeable future. They can and do wait decades to exercise these rights.  It is important to understand that most of the gross margin in the oil business for these large multinational enterprises comes through the process of buying the rights to resources from sovereigns on the cheap, and not through the production, transportation, refining and marketing of the oil and gas. Those operational aspects are now a form of commodity.  So when they say they need fiscal certainty, it is code word for reducing the price for the resource and raising their margins.  I wouldn’t be surprised if the fiscal certainty they attach as a condition for our gas to be offered for sell in an open season, will amount to more than what would be their capital investment in the pipeline itself.

But most importantly, we have to create wealth, before we allocate it, and the only way to generate wealth from the resource is to bring it to market profitably. And that all has to do with the cost of delivery versus the value at the market.   So the only element that is within our control is logistics, which is mostly about moving weight and cubic volumes at the lowest cost per unit of distance.  And economies of scale determine everything. Any effort to get Alaskan’s gas to Alaskans that doesn’t include material export capacity will be terribly short-sighted and will cost the State of Alaska at least tens of billions of dollars over time in lost opportunity, in addition to saddling most Alaskans with much higher energy costs for decades to come, than they would have to pay by otherwise piggybacking on top of an export volume-based and efficient, distribution network.  That means at the very minimum, a large diameter pipeline from the North Slope to a logistical “Sweet Spot” in the Interior must be the anchor of any pipeline project. We should, perhaps through the utilities, concurrently spur to Fairbanks and South Central, and then let the markets determine the fate of the remaining logistical foot-print, or rather sizing and routing, of any further distribution.  Building further when the economics justify it, albeit Canada, Valdez/LNG, and or any value added processing.   A bullet, or rather a small diameter line is a very high cost alternative, and makes everything else less economic.  Only by finding competitively cost-efficient ways to deliver gas and gas products on an export basis, will we be able to generate the economies of scale for a gas pipeline sufficient to begin to lower what will other-wise be high energy costs for Alaskans.

The oil and pipeline companies must wait until they fill a pipeline through the open season process before they can commit to build because they are looking for immediate economic rent and returns on capital.  And they can’t otherwise finance such a project. (For example matching pension obligations with the certainty of tariffs and volumes.) They are all each posturing for long-term control as well. Therefore, regardless of how they may be posturing now, uncertainty about intermediate to long-term gas pricing and demand means it could be 5-10 years or more before boards of directors will be in a position to vote to dedicate the large capital investments necessary for a massive project such as the Canadian route. Everything they do in the meantime is a cost of posturing to maintain an “Option” to actually build only when they want to.

We can’t afford though to freeze in the dark waiting.  Only the State of Alaska has the vested interest in making sure we get Alaskan’s gas to Alaskans in the shortest amount of time, and provide for an efficient distribution network.  One not offered by a small diameter line.  We also need not leave our destiny to the calendars of outside boards of directors with very different interests.  And by the way, before I go further, I am not talking about the State of Alaska designing, building, maintaining, managing, or even absorbing construction risk of a gas pipeline, as all of those things can be contracted out.

One of the most important things I might offer regarding the economics, and I am not suggesting this position, but rather just offering the base-line economics, is that the State of Alaska, again just as a baseline and economic marker, not as a goal, is the only entity, as the owner of the resource, who could write a check for cash to pay for the pipeline, charge zero for the tariff, and make $50-100 billion. That is because we make the vast majority of our money selling the resource, not in the transportation of it.  When you start off with that economic focus, and calculate what you get by investing the $3 billion extra it would take to increase the size of a pipe from the North Slope to the Interior suitable for export capacity, the economic and business decision becomes quite simple because the returns are enormous.  Only the State can afford to incubate, or have a portion of the pipe idle for a period of time, and wait for the rest of the market to come to it. It puts us in a very powerful negotiating position.  How long can we wait until the pipe needs to be filled before we lose the bet?  The answer is 50-100 years if you look at it from an economic and financial perspective. I would be happy to share with staff how to make those financial calculations. And the only way we lose that bet is if China and India don’t grow sufficiently, when added to U.S. domestic demand, to make North Slope gas economic within 50 and 100 years.  We know we are going to be poor some day if we don’t harvest North Slope resources intelligently.  But to bet our whole future that we will go from being poor to poorer by bringing a mere $3,000,000,000 in State financial credit worthiness to bear to open up the North Slope to gas markets, when instead the high likelihood is that we will become prosperous by doing so, is an extremely foolish bet.

And again, I am not talking about having the State take any construction risk, or to design, build, maintain or manage the project.  That would be done by private sector partners who gain rights to future tariffs as negotiated.  Hopefully this would include The Big Three and maybe TransCanada.  And we can further separate economic rights from governance rights in our negotiations. We would invite all comers to own the portion of capacity not contracted by local utilities and other immediate users, but the State of Alaska will most likely be the only entity able to do so.  We don’t have to get into a fight with the Majors about future export routing, but just bring our own gas to ourselves, when they won’t, and position ourselves for maximum future export opportunities.

So our choices are either to: (1) Do nothing, and maintain a sure path to the poorhouse by allowing the oil to run dry and expose Alaskans to the high cost of importing LNG until we get to a better solution.  [Which by the way we should do until we do get to a better solution], (2) Build a bullet line that will steepen our path to poverty by securing high energy costs, and impeding a viable export market, (3) Have the State of Alaska become wealthy for the next 50-100 years simply by absorbing just $3 Billion in gas pipeline incubation development risk, that the oil and pipeline companies can’t or won’t do, to insure the best of all outcomes, without taking any material risk at all.

So here are 12  things that the State of Alaska gets if it underwrites, and elevates to Investment Grade, a gas pipeline with an efficient export potential footprint, made possible by $3 billion extra and patient development capital, which could be financed a number of different ways;

  1. We avoid saddling Alaskans with high energy costs for thirty years, or however long it might take to pay off the bonds necessary for a small diameter high cost per unit line.  Only when export volumes are achieved will economies-of-scale be available to pass on to consumers in the form of lower energy tariffs and costs.
  2. We avoid putting an export project at materially greater risk in terms of time and money by moving from a highly inefficient logistical foot-print to a highly efficient one.  Since we won’t then have to build two sets of pipe to move the same amount of gas that could much more efficiently pass through one.
  3. We get gas to Alaskans in as little as six to eight years.
  4. We put our future and destiny on our timeframe instead of that necessary for an alignment of uncontrollable, unpredictable, disparate, and naturally competing factors and interests outside of our control.  We become the dealer instead of being dealt a bad hand.
  5. By announcing to the energy community that we are prepared now to build, and we invite them to participate, we force them to act, for fear of being left behind.
  6. We greatly invigorate the potential for adding volumes not only to the gas pipeline, but the oil pipeline as well.  This is because not only will we have finally brought our gas to market, but we will also make it possible for new oil and gas explorers, on a spot basis, not having  participated in an open season necessary to secure capacity, to explore and produce, knowing they can get their product to market. And when they look for gas, they will find more oil sometimes, and vice versa.
  7. The Oil & Gas Commission, for the first time will be empowered to maximize their mandate by maximizing the trade-off of oil and gas values, un-constrained by capacity limitations.
  8. We position many parts of rural Alaska to benefit with reliable access to lower cost energy over time because of the economies-of-scale generated.
  9. We create the opportunity to approach Hawaii most importantly, about Alaska being a long-term significant solution to their energy needs with a project that could actually happen.  Unfettered with any export limitations.
  10. We will jump start the economy and generate decades of improved prosperity for all Alaskans.  With a long-term fiscal plan based upon the rational management of our energy wealth, resulting in being able to continue contributing to the Permanent Fund in material ways for decades to come.
  11. We avoid to a considerable degree, exposing the State to long-term fiscal decay, and hopefully put off  until long into the future, pressures to use the Permanent Fund to help pay for state government.
  12. If we have buyers, and a pipeline, the producers will have no choice but to supply our gas.  The view that the producers hold the key to everything is false.

So how do we do we earn all this?  By doing the following;

Appropriate or allocate money  from some appropriate state or federal source, as soon as possible, sufficient to vet this approach equal to anything else being considered.  Including what role the State of Alaska would have to play in order to insure the project moves forward as soon as possible, on an INVESTMENT GRADE basis. No research being done at the state or federal level currently contemplates this scenario.

If we get our gas to a hub, the rate payers can afford to take it the rest of the way.  Just doing this alone this year will put pressure on the majors to take this upcoming season more seriously.

We can wait for multiple open seasons before we get started, adding at least one to two years to a project, or we can start now.   The sooner we announce to the world we are doing as suggested, the sooner serious negotiations can begin with potential buyers. Nothing but posturing will or can happen until we do.

We could greatly expedite the process by avoiding another time consuming RFP process, simply by renegotiating the AGIA license with TransCanada, as authorized within AGIA, to convert the State of Alaska to a co-developer of the big pipe to the Interior, owning whatever rights the private sector chooses not to adequately bid on.  In the end, that could even be very little.

The only way we lose this bet is if China and India don’t grow sufficiently in the next 50-100 years to make North Slope gas economic.  That should be an easy bet.  The cost of not making that bet is likely to be enormous.  And finally, I will repeat the most important point, a small diameter line is a very high cost alternative by multiple orders of magnitude, and makes everything else less economic.  Only by finding competitively cost-efficient ways to deliver gas and gas products on an export basis, will we be able to generate the economies of scale for a gas pipeline sufficient to begin to lower what will otherwise be high energy costs for Alaskans.  That means at the very minimum, the State of Alaska must co-sponsor a large diameter pipeline from the North Slope to a logistical “Sweet Spot” in the Interior. As the oil producers and TransCanada are in no position in any foreseeable timeframe, to actually move forward with a project.  The State of Alaska, with a mere three billion dollars can build our own Erie or Panama Canal, and open up our future for decades to come.  What needs to be done is that Alaska’s elected officials and people with responsibility, must start publically legitimizing this approach so that it gets the attention and official study it deserves. As an important player in Alaska’s energy future, you are in a unique position to actually provide the resources necessary to formally vet this approach.

Thanks for the opportunity to share my views.


David Gottstein

Some interesting food for thought, no?  Certainly worth mulling over.



This contribution was made on Wednesday, 21. July 2010 at 14:49 and was published under the category Energy. You can follow comments on this entry through the RSS-Feed.

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1 Comment

  1. Mr. Flynn,

    A gas pipeline would almost certainly have spillover effects that would reduce the costs of liquid fuels as well as natural gas. While there is controversy over several other energy approaches under consideration at the present time, putting in a gas pipeline is a sound and reasonable idea. I believe investments in a gas pipeline would offer a higher rate of return than Anchorage municipal bonds, although there are issues which would likely limit the municipality’s capacity to invest, requiring state funding for such a project. Anchorage’s investment advisors can provide you with information on Anchorage’s capacity to invest and the potential returns.


    Comment: Geoffrey G. Humphreys – 22. July 2010 @ 8:00 pm

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