Alaska News

With costs higher than predicted, Interior Alaska gas project at critical juncture

With estimated costs higher than anticipated and a concession agreement due to expire at the end of December, the board of the Alaska Industrial Development and Export Authority faces some tough decisions over the future of the Interior Energy Project, designed to bring affordable North Slope natural gas to consumers in Fairbanks.

The project involves the construction of a liquefied natural gas plant on the Slope; a trucking operation to ship LNG from the plant to Fairbanks; LNG storage and liquefaction facilities in Fairbanks; and utility distribution pipelines for delivering gas to customers.

The objective is to provide gas to Fairbanks consumers at a cost of $15 or less per thousand cubic feet, to bring relief from the high cost of fuel oil that has been crippling household heating budgets and causing people to turn to pollution-causing firewood as an alternative means of warming buildings. Golden Valley Electric Association, the Fairbanks electric utility, also wants natural gas as an alternative to expensive liquid fuels for generating electricity.

Doubt over viability

During a Thursday meeting of the AIDEA board, it became clear enough is now known about the project economics to cast doubt over the project's viability. In addition, the precipitous drop in the price of oil in recent months is lowering the cost of fuel oil, making oil more competitive with gas as a fuel in the Interior.

State legislation introduced by former Gov. Sean Parnell and passed in 2013 triggered the project. AIDEA is providing financial assistance for the project through state grants and low-interest loans.

In January, AIDEA commissioned engineering firm MWH to manage the construction of the required LNG plant, with a concession agreement requiring delivery of the documents needed for a financial close for the project by Dec. 30. Those documents include a contract for the purchase of North Slope gas from BP; an agreement, including a cost agreement, for the engineering and construction of the LNG plant; an operations and maintenance agreement for the plant; and gas supply agreements with Golden Valley and the two gas utilities in Fairbanks, Fairbanks Natural Gas and the Interior Gas Utility.

With time running out on the concession agreement, albeit with a clause in the agreement including the potential for a 90-day extension, most of the documentation required for the financial close has yet to be fully completed. But MWH does have a firm cost for plant construction from Kiewit, the company expected to undertake the construction project, Rick Adcock, vice president and managing director of MWH Infrastructure Development Inc., told the AIDEA board. Also, MWH has contracted with TDX Power to operate the plant, in a joint proposal with Norgasco, the North Slope gas utility, he said.

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However, that cost estimate, agreed with by Kiewit and verified by independent consultants, is $228 million, a figure higher than the cost of $170 million to $190 million that had been envisaged a year ago. And, while that original estimate was based on an LNG plant with a capacity of 9 billion cubic feet per year, the new cost estimate relates to a plant with a reduced capacity of 6 bcf.

Demand in Fairbanks

With an initial demand commitment of 5 bcf per year, Golden Valley would account for the bulk of the gas throughput, at least initially. Fairbanks Natural Gas has an existing distribution pipeline system, currently supplied by LNG from Cook Inlet, and would commit to start with 0.1 bcf of North Slope gas, with that commitment expanding to 1.1 bcf after 12 years, Adcock said. The Interior Gas Utility has yet to build its distribution system and would have no initial committed gas demand, but a demand growing to perhaps 0.6 bcf after 12 years, he said.

These volumes represent minimum commitments required for project financing and may be lower than actual demand.

The Interior Energy Project would use an existing gas supply agreement Golden Valley has with BP, although some minor modifications are needed to that agreement. Cory Borgeson, president and CEO of Golden Valley, told the board gas prices under this contract are indexed to the price of oil. At today's oil price, the price of gas would be close to $2 per thousand cubic feet, rising to around $4.50 at an oil price of $150 per barrel, he said.

Assuming an oil price of $90 and a corresponding gas price of $2.75 under the BP contract, Adcock explained how the various elements of the gas supply chain to Fairbanks would result in a delivered cost of gas for Fairbanks residents of $18 to $20.50 per thousand cubic feet, a cost range substantially above the $15 target.

Taking into account the need for fuel gas for the LNG plant and the administrative costs of the gas supply, the true cost of gas for the project would be $3.09, Adcock said. An optimistic cost of liquefying the gas which "could go up if certain things don't work out right" would be about $5, he said. The cost of trucking the gas to Fairbanks would be another $5, with storing the LNG in Fairbanks and then gasifying the LNG costing about $1. Depending on the scale of the AIDEA funding for the Fairbanks utilities, the gas distribution cost in Fairbanks might then range between $4 and $6.50 per thousand cubic feet, Adcock said.

The biggest risk in this scenario would be uncertainty over the gas demand in Fairbanks, especially as the falling price of crude oil is likely to dampen people's enthusiasm for converting their heating systems from oil to natural gas. As the demand drops, the unit cost of delivering the gas would increase, thus further discouraging gas usage.

Borgeson, saying Fairbanks needs natural gas both as a catalyst for economic development and to resolve issues such as air pollution, said Golden Valley has proposed accepting the gas demand risk by paying for some of the gas, even if it is not needed.

"If we take that risk, we still believe there is a substantial savings to our members," he said.

Borgeson commented that the Golden Valley board would need to approve this arrangement. The board has directed him to work with the gas utilities to continue to pursue the project, he said.

Utility views

Bob Shefchik, president and CEO of the Interior Gas Utility, said with competent people on the project having done their best but having come up with deliverables unmet and costs that are too high, it was unlikely extending the project any further would somehow result in success. It is time to consider alternatives, he said.

"The big picture is I don't think we're there and I don't think we're going to get there," Shefchik said.

Dan Britton, president and CEO of Fairbanks Natural Gas, said although the project faces the dual challenges of high capital costs and a lower than anticipated LNG demand profile, he did not see what the alternatives would be for a Fairbanks gas supply. People had originally anticipated the state funding the bulk of the cost of the LNG plant, but, with a significant amount of private funding now required for the project, it was difficult to meet that original $15 price target, he said.

"We're torn … I'm having trouble spotting a better alternative," Britton said. "I'm willing to spend another three months trying to figure something out, but not much more than that."

Asked about the relative merits of shipping LNG from Cook Inlet, rather than from the North Slope, Britton commented the North Slope has relatively cheap gas and security of the gas supply. The Golden Valley gas supply agreement with BP is for 15 years -- contracts of that duration have not been seen in Cook Inlet for a long time, he said. And, rather than being indexed to the price of oil, the commodity with which Fairbanks gas competes, Cook Inlet gas is currently priced according to an agreement between gas producer Hilcorp Alaska and the state of Alaska.

However, Cook Inlet has an existing liquefaction facility and it would cost less to transport LNG from that region, Britton said. The future price of Cook Inlet gas will depend on a number of factors relating to the Cook Inlet gas market, he said.

Britton said Fairbanks Natural Gas currently charges $23.35 per thousand cubic feet for Cook Inlet natural gas delivered to residential customers.

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Shefchik expressed his concern that a perhaps temporary drop in oil prices might derail efforts to bring affordable gas to Fairbanks. The original purpose of the Interior Energy Project was to fundamentally change the impact of $4 diesel on the Alaska Interior, he said.

"People are going to be nervous that they're going to be getting the $1,000 (heating) bill again," he said.

The AIDEA board went into an executive session to discuss confidential aspects of the project.

The board has been considering the extensive testimony heard today from MWH and the three utilities on the status of the Interior Energy Project but does not yet have a timeline for taking action on the project, AIDEA spokesman Karsten Rodvik later told Petroleum News.

This story originally appeared in Petroleum News and has been republished with permission.

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