Summary Report on the Review of the Alaska LNG Project Process Office of the Governor State of Alaska September 24, 2015 The following report summarizes the results of a review of the process established for the proposed liquefied natural gas (“LNG”) project currently being worked on by the State of Alaska, TransCanada, ExxonMobil, BP, and ConocoPhillips under the negotiating framework most recently enacted in 2014 by Senate Bill 138: the Alaska Liquefied Natural Gas Project (“AKLNG Project,” “AKLNG,” or “Project”). The majority of challenges are structural and commercial in nature rather than technical. The report will first discuss the history of prior Alaska gas pipeline development efforts, and then the commercial difficulties faced by the AKLNG Project. I. HISTORY OF EFFORTS TO COMMERCIALIZE NORTH SLOPE GAS The current configuration of the AKLNG Project is the latest in numerous efforts to export North Slope natural gas dating back to the 1970s. This section of the report discusses those efforts in context of the current AKLNG Project and what can be learned from those prior unsuccessful attempts. A. Early Projects Prior to the mid-1980s, there were efforts to advance several different Alaska gas pipeline projects, including those by Prudhoe Bay leaseholders BP, Atlantic Richfield and ExxonMobil (together with successor companies, the “Producers”), and separately by El Paso and Foothills (a predecessor to TransCanada). These attempts reflected, among other issues, the two competing themes consistently present in North Slope gas commercialization efforts. First was the ongoing debate about whether a project should be a North American project through Canada or an LNG project to tidewater in South Central Alaska. For instance, in 1977, the Carter Administration determined a project should go through Canada, and Congress enacted the Alaska Natural Gas Transportation Act to enable the same. Competing national priorities – based largely on ever-fluctuating Lower 48 gas prices and estimated gas supply – saw seesawing support of a Canadian and LNG project. The Reagan and George H.W. Bush Administrations supported the Yukon Pacific Corporation (“YPC”) LNG export effort (discussed below), including a presidential finding in 1988 that North Slope gas could be exported to Asia as well as cooperation in that almost decade long permitting effort. In 2004, the Alaska Natural Gas Pipeline Act was enacted, which was aimed at inter alia supporting rapid permitting of a Summary Report on the Review of the AKLNG Project Process Page 1 Canadian project. However the Act also provided support for an LNG project by extending federal loan guarantees to a project that exported gas to the Lower 48. High natural gas prices and advances in drilling technology led to the “shale gas revolution” and a major market shift in the 2007 to 2010 timeframe, which saw increases in Lower 48 natural gas reserves and production, and decreases in current and projected North American gas prices. This once again confirms that the primary markets for Alaska gas are global (primarily Asian) and not domestic, and thus support an LNG as opposed to a Canadian project. The second reoccurring theme running through various project development efforts remains whether the project should be developed by the Producer companies or by an independent corporate or governmental effort. Multiple starts and stops have reflected this contentious three- decade plus dynamic. B. Yukon Pacific Corporation In 1983, former governors Wally Hickel and Bill Egan, following the suggestion by Governor Hammond, formed YPC, which was a proposed LNG project to export to Japan, South Korea, Taiwan and possibly the U.S. West Coast, but not exclusively the West Coast as El Paso’s earlier proposed project had planned. In 1986, a deep pocket became part owner with YPC: Texas Gas Transmission Inc., a subsidiary of Lower 48 railroad and shipping giant CSX Corp. Through the 1990s, YPC expended approximately $100 million to engineer and permit a LNG project from the North Slope to Valdez, to run parallel to the Trans Alaska Oil Pipeline (“TAPS”). This effort advanced further than any North Slope gas commercialization effort before or since, including, with the issuance of a Final Environmental Impact Statement by the Federal Energy Regulatory Commission in 1995, securing the senior federal and state permits necessary to construct a project. This was the most aggressive effort of a non-Producer project sponsor to follow the “permit it and they will come” strategy. But like other independent efforts, YPC was unable to secure access to the gas resource from the Producers or support from the State administration. Different justifications have been offered regarding why the Producers would not commit gas, including the economic environment, the need to continue re-injecting gas at Prudhoe Bay to maximize oil production, and a view that the Producers simply refused to deal with an independent company. Without gas to ship, YPC began slowly winding up its efforts and all permits and rights-of-way lapsed by 2011. C. Stranded Gas Development Act Since at least the late-1990s timeframe the Producers have followed a strategy that is still being followed today. This approach requires the State of Alaska to provide “fiscal certainty” before the Producers will build or allow to be built a North Slope natural gas pipeline. Although the scope of fiscal certainty has varied over the years, it has retained the constant hallmark of requiring the State of Alaska to adopt royalty and tax terms on oil and gas acceptable to the Producers, and for those terms to be locked in and unchangeable by the State for a prolonged period. Summary Report on the Review of the AKLNG Project Process Page 2 In 1998, the Alaska legislature adopted the Stranded Gas Development Act (“SGDA”) as a specific legislative framework for the State to negotiate a proposed gas pipeline deal including fiscal certainty. Although SGDA negotiations theoretically allowed proposals by independent pipeline companies, and several large companies like TransCanada, Mid-America, and Sempra Energy did attempt to participate, during this era the State focused almost exclusively on a deal with the Producers for a project through Canada. Under this iteration the Producers held off on substantial permitting and engineering work until a fiscal deal with the State was finalized and approved by the legislature. Thus the State was in the position of not seeing work on a gas pipeline project advance until each Producer was satisfied with fiscal terms. Like the current S.B. 138 process, the State had little to no leverage and found itself negotiating to the least common denominator on each issue, and on the project schedule, with three different companies. As the party that most desired the project, and desired it on the most rapid timeline, the State made drastic concessions to achieve an agreement. The SGDA process resulted in significant turnover and resignation in the Department of Natural Resources (“DNR”), including an estimate the SGDA contract would have cost Alaska $13.5 billion including concessions on oil While a contract with the Producers was negotiated and finalized by the State’s executive branch in the spring of 2006, the terms of the contract were not perceived as acceptable to Alaskans. The unacceptability of the contract, in conjunction with the political corruption accompanying the companion deal negotiated by the State with the Producers on the overhaul of state production taxes on oil, meant the contract was neither seriously considered nor approved by the legislature. It was abandoned when Governor Palin took office. D. Alaska Gasline Inducement Act In response to the perceived failings of SGDA, the Palin administration pushed for and the legislature passed in 2007 the Alaska Gasline Inducement Act (“AGIA”). This process solicited bids from companies interested in state financial subsidies to permit and potentially build a pipeline. In 2008, TransCanada’s bid to obtain the required permits along the route to Canada (with a secondary option to permit to Valdez for LNG export) was selected. Pursuant to the terms of AGIA, the State subsidized 50% of TransCanada’s qualified expenditures incurred before the end of the first binding open season in June 2010, and 90% of TransCanada’s qualified expenditures thereafter. Frustrated by the stranglehold the Producers had during the prior SGDA process, and the State’s lack of leverage in the same, the State attempted with AGIA to independently advance a project with a YPC-like “permit it and they will come” concept. For a number of reasons the effort failed. Within days of the award of the contract to TransCanada, TransCanada let it be known they expected Producer participation, and ExxonMobil was later brought in as a project partner. Thus the “independent” pipeline project was now controlled by a Producer company. Over the next few years, after the 2010 open season failed, it became clear the gas markets had changed several years prior and a project through Canada was no longer viable. However, rather than TransCanada and ExxonMobil pursuing an LNG project as allowed under the AGIA bid, the AGIA process morphed into an SGDA-like process for an LNG project controlled by the Producers. This is notwithstanding the strong expression of interest from Asian buyers in purchasing LNG from an AGIA project in response to the 2012 AGIA solicitation of interest. Summary Report on the Review of the AKLNG Project Process Page 3 Neither company responded to any of the Asian market’s written expression of interest in LNG from the AGIA process. E. Denali Pipeline At the same time that AGIA was launching, BP and ConocoPhillips began a pipeline project to Canada along the same approximate route as AGIA. Whereas ExxonMobil chose to join the AGIA process, BP and ConocoPhillips opted to develop their own project as an alternative to having to participate in the AGIA effort.