China Deal Renews Hope for Alaska LNG Line but Hurdles Remain

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By Tim Bradner

Alaskans have chased the will-o'-wisp of a North Slope gas pipeline for decades. Several times the prize seemed within our grasp only to slip away, usually because of some unexpected, and adverse, market development. In recent years, the technical prowess and success of U.S. shale gas developers led to a domestic gas supply glut and plummeting prices, ending hopes for an all-land gas pipeline to the Lower 48 states.

Even more recently, a crash of crude oil prices and with it prices for liquefied natural gas, or LNG, has ended an industry-led initiative to build a pipeline and large LNG export project. The state of Alaska, which had been a partner with industry in that, moved to pick up the pieces and keep the LNG project alive, with the state-owned Alaska Gasline Development Corp., or AGDC, leading the effort.

For a period of time the state’s quest seemed quixotic, with a small, untested state agency attempting to develop a $43 billion project amid a worldwide glut of LNG and a host of competitors who are planning big export projects without the burden of having to build an 800-mile pipeline across Alaska.


China deal a game-changer?

Seemingly against the odds, Gov. Bill Walker may have pulled off a coup, landing a potential huge customer, and financier and investor, in Chinese energy company Sinopec, Bank of China and China Investment Corp., that nation’s sovereign wealth fund.

The governor and the AGDC team engineered a deal signed Nov. 9 in Beijing, with U.S. President Donald Trump and China’s president Xi Jiang looking on, for Sinopec to negotiate for 75 percent of the Alaska LNG Project’s 20-million-tons per year of LNG capacity, in which Bank of China would provide financing for the 75 percent project debt and China Investment Corp. an investment in the equity part, planned now at 25 percent.

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There are still doubts among Alaskans, and observations that the “Joint Development Agreement” signed Nov. 9 is non-binding and similar to the several “Memorandums of Understanding” signed previously with potential buyers including Korea Gas Corp. and, most recently, Tokyo Gas Corp. Like the MOUs, the joint development agreements simply set the ground rules for further talks.

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Huge uncertainties remain

There are still huge uncertainties, however. In his telephone press conference with Alaska reporters on Nov. 9 Gov. Walker acknowledged that this is not a done deal, and a lot of work remains to be done. The target is for the roles of respective parties to be agreed by May and a final agreement by the end of 2018, but this is a huge, complex undertaking and the December goal may prove ambitious.

The governor also said he hopes for a final investment decision by the end of the first quarter of 2019 (the “FID” is what will trigger procurement and a start of construction) but that seems unrealistic because final engineering on the project cannot be done in such a short timeframe.

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Still, the remark raised concerns among some industry professionals who worry about AGDC attempting to hurry the project to meet artificial deadlines. There is ample experience with large industry projects that hurried work at the beginning can lead to mistakes and cost overruns. Chevron Corp.’s Gorgon LNG project in Australia, which suffered huge cost overruns, is cited as an example of inadequate front-end planning, senior Chevron officials have acknowledged. Alaska had its own experience with the Trans Alaska Pipeline System in the 1970s, which was hurried mainly for national security reasons. Luckily for TAPS the margins enjoyed in oil production were enough to absorb the cost increase. Margins in gas production will be much narrower, however. There is less room for mistakes.


Small Alaska labor pool

One reason why there is a concern for cost control is that the Alaska skilled labor market is very small compared with the needs of this large project, which means most of the project workforce will have to be imported from outside Alaska, mainly from the Lower 48 states. Although Chinese investors and customers will push for Chinese “content” in construction, this is most likely in materials and equipment, and some engineering services.

There would be skilled Chinese labor among the professional technicians and engineering staff, but the bulk of the rank-and-file labor would be U.S. particularly if there are project labor agreements, which will almost certainly be the case. However, the labor demand could result in some upward push on wage rates and benefits in Alaska, which happened during TAPS construction. This could lead to higher project costs (labor scarcity was also a factor in Gorgon’s overruns).


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Can the project withstand competition?

There is no doubt that there is formidable competition among world LNG suppliers for any market opening in Asia, and that the need to build the 800-mile pipeline is a disadvantage for Alaska. The most serious competitors are the new shale gas export plants on the U.S. gulf coast, who can tie into existing pipelines and access gas from the large domestic supply, which is now very inexpensive. Gulf coast LNG suppliers will be able to land their product in Asia for about $9 per million British Thermal Units (mmBtu is the international energy unit used in international energy transactions, and it is equal approximately to the U.S. standard unit, one thousand cubic feet, or mmcf).

AGDC argues that the disadvantages of the pipeline are overcome by the shorter shipping distance from Alaska to Asia, which is about one-third the distance from the U.S. gulf and with no Panama Canal transit fee. Alaska has the advantage, however, of an assured gas reserve that could be made available at a long-term price that can be locked in by contract, compared with gulf coast competitors who are subject to variations in U.S. domestic gas prices. These are low now but they were very high in recent years. The potential for more stable pricing was mentioned by China Investment Corp., one of the potential investors, in its statement when the agreement was signed Nov. 9. While the North Slope gas producers would negotiate their own gas sales agreements they would no doubt see the advantages of this approach, but the state itself owns about one-fourth of the North Slope gas as its royalty and tax share of production and is in a key position to influence commercial terms.


AGDC foresees possible $1/mmBtu “netback” gas value

On a straightforward comparison AGDC feels it can land Alaska LNG in Asia for a price equal to or below U.S. gulf competitors, or $9 per mmBtu, mainly because of the shorter shipping. However, after the expenses of the pipeline and LNG shipping are paid from a hypothetical $9 per mmBtu sales price, the “netback” value of the gas on the North Slope would be about $1 per mmBtu for the gas supplied by the producers and the state. Whether this is enough for the producers is unknown but this must be weighed against what alternatives there might be for the gas, which are few.

A $1 per mmBtu price would translate to $1 billion per year paid for the gas, of which the state share would be $250 million per year, or one fourth. AGDC points out that this would increase substantially for the state and producers once the debt on the project infrastructure is paid, which is estimated at 25 years. After that is paid the payments for gas would be several billion dollars a year, AGDC has said in briefings. At that point, once the infrastructure is paid for, the Alaska LNG Project will be very competitive against international competition. When this is combined with the large “upside” potential for new gas discoveries – geologists estimate as much as 100 trillion cubic feet of conventional gas could be discovered once gas exploration begins – the Alaska project is very attractive. The 35 trillion cubic feet (tcf) of proven gas reserves occurred as a byproduct of oil exploration and discovery.


What could go wrong?

There are still challenges. One is still the risk of cost overruns and the problems of managing construction of such a large project. One issue that will have to be resolved early in the commercial negotiation is who carries the risk of non-completion or a delay, or added costs, the China partner or Alaska? Secondly, where will the 25 percent equity investment come from? The assumption is that China Investment Corp. would make an equity investment but AGDC has said that Alaska will maintain “control,” presumably 51 percent of the equity. If the 25 percent equity requires $10 billion, what Alaskan entity would invest 5 billion? AGDC? If so, could that agency issue revenue bonds to raise funds (it has bond authority)? Would bond buyers require the Permanent Fund or, more likely, some of its earnings, to guarantee the bonds?

There is also the danger that China itself may switch course. Alaska’s LNG project is not the only place where Chinese energy companies and banks are investing. They are in projects on the U.S. gulf, Australia and most recently in Russia’s Yamal LNG project, which will soon be shipping LNG to Asia and Europe through Arctic waters.



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