Dick Pierce on Alaskan Energy Policy

[Poster’s Note: Alaskan energy policy is now a subject of national interest. Expert insight into that policy and its history appears in the following note by my colleague, George Washington University Law Professor Richard J. Pierce, Jr. A leading authority on law and public policy in a wide range of fields, including energy, Dick lived in Alaska for years in the 1960s, tried the case that authorized construction of a gas pipeline from Alaska to the lower 48 states in 1978, and more recently testified as an expert witness in cases involving the value of Alaskan oil and gas. Thanks to Dick for allowing me to post this note, which I’ve edited slightly for length.]

Alaska pipeline map.jpgEnergy policy in Alaska is much more like the United Arab Emirates than the United States. Almost all Alaska’s revenue comes from state taxes on oil produced at Prudhoe Bay. Every Alaskan citizen gets an annual state check for a share of oil revenue.

When oil was discovered at Prudhoe Bay in the 1960s, the reservoir contained lots of gas, plus oil. The producers began to construct both oil and gas pipelines to the lower 48. With difficulty, and at a cost ten times the original estimate, they built the Alyeska line to transport oil.

The gas line is more difficult. Laying a chilled, high pressure gas line in permafrost raises daunting geotechnical, metallurgical, and environmental issues that the oil line did not . A gas line would be some three times longer because of the difficulty of transporting gas by tanker. A gas line also requires a certificate of public convenience and necessity from the Federal Power Commission (now the Federal Energy Regulatory Commission) under the 1938 Natural Gas Act.

In the mid-1970s, a consortium of producers and US pipelines, called Arctic Gas, applied for a FPC certificate. The application was controversial because the route would cross the Arctic National Wildlife Range and run down Canada’s Mackenzie Valley into the lower 48. The controversy prompted a competing application from El Paso Natural Gas for a pipeline that would take the gas to a liquefaction terminal on Alaska’s southern coast, to be transported by tanker to a new terminal in California. The El Paso proposal was also controversial, because more expensive and depended on the (unlikely) approval by California of the proposed terminal. A third application was filed by a consortium called Alcan, proposing 1 US pipeline and 3 Canadian pipelines that would run next to the oil pipeline until it reached the Alcan highway, through Alaska and Canada, to Monchy, Minnesota.

In FPC hearings on the three competing applications, I represented Alcan. FPC ultimately issued a certificate to Alcan and rejected applications of Arctic Gas and El Paso. With help from Patton Boggs, I got Congress to enact a statute authorizing the President to make a final unreviewable decision in the case, and President Carter issued a decision favoring Alcan.

That left only the detail of how to raise the $30 billion needed to construct the pipeline. To help raise funds, Alcan hired one of the FPC Commissioners who decided the case. (Don’t you just love the revolving door?) The most obvious financing source was the Prudhoe Bay producers. But they would not participate absent an ownership share in the pipeline and an agreement from Alaska capping the future level of taxation of the gas.

[After all, firms are unwilling to make multi-billion dollar investments in immobile assets like pipelines without an agreement with the taxing authority limiting the future level of taxes on the facility or its fruits. Most natural resource production and transportation projects depend for their viability on such agreements. If the taxing authority is unwilling to enter into such an agreement, the firm usually is unwilling to make the investment for fear that the taxing authority will appropriate the quasi-rents created when a firm invests in a large immobile idiosyncratic capital asset.]

Alaska was unwilling either to allow producers to own the pipeline or to enter into an agreement on taxing the gas. With producers unwilling to participate in financing, Alcan sought third party financing. But the pipeline was not economically viable without participation of the producers in its financing, so Alcan was unsuccessful.

The gas pipeline was stalled by that stalemate for 28 years. In the meantime, the volume of oil produced at Prudhoe Bay declined due to normal decline in deliverability from a reservoir. This created a political problem for Alaska politicians. State revenues from Prudhoe Bay oil declined, reducing the amount of the annual payment each citizen got from oil revenues and foreshadowing the day when Alaska might stop paying its citizens an annual stipend and instead to tax them.

The state grew desperate to offset declining oil production by extracting a constantly increasing share of the oil’s value through increased taxes and royalties. That produced litigation between Alaska and the producers. I testified as an expert witness in some cases. I explained that the gas in the reservoir had a value of approximately zero because there was no local market for the gas and the unit cost of transporting gas through a pipeline to be built at some uncertain future date was approximately equal to the market price of gas in the lower 48 states.

(The increasing desperation of the state for new oil and gas revenues to offset declining revenue from the Prudhoe Bay oil also explains why Alaskan politicians make drilling in the Arctic National Wildlife Range their number one priority.)

In recent years, the gas pipeline project returned to life for 2 reasons. First, the price of gas in the lower 48 increased. Second, Governor Murkowski negotiated a deal with state legislators and the producers to lower taxes on Prudhoe Bay oil, and not to increase oil and gas taxes in the future, in return for the producers’ agreement to finance and build a gas pipeline.

That might have been a good long term deal for Alaskans. Once the pipeline was built and gas began to flow, the state’s revenues would increase significantly. But that was at least ten years in the future. Meanwhile, the Murkowski deal reduced the amount of the annual payment each Alaskan received from oil revenues. Alaskans grew angry at the producers and at their elected representatives.

At this point, the previously unknown mayor of Wasilla jumped into the fray. She accused Murkowski and the legislature of selling out to the producers. Angry voters responded by making her the new Governor. She became even more popular when she persuaded the legislature to repeal the Murkowski deal and increase taxes the producers must pay, thereby increasing the annual payment each Alaskan receives from the state.

Governor Palin then announced that the only gas pipeline proposal acceptable to the state was one in which the producers get no control over the pipeline and no assurance that the state would not increase oil and gas taxes after the pipeline is built. The producers announced that they were not willing to participate in any way in such a pipeline. The Governor then solicited offers from third parties to build it. She offered $500 million in state funds to any firm willing to attempt to build a gas pipeline.

The state received and accepted a bid from a Canadian pipeline. The Canadian pipeline will collect its $500 million reward from the state, but it is not clear that it will construct a gas pipeline in Alaska. The Canadian pipeline must now finance the project if it is to go forward. It is clear that the pipeline cannot be financed without participation of the producers, and the producers are not willing to participate on the terms the Governor offers.

Thus, the Alaska gas pipeline is now where it was in 1975. If the state ever reaches agreement with the producers (necessarily after Governor Palin leaves office), the pipeline must first be certificated by FERC and then be built over a period of at least ten years.

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