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(Archived from The Oil Patch July 1, 2008;
originally posted on Home Page March 2, 2007)

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Trans-Alaska Pipeline System: Economics

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Trans-Alaska Pipeline System:  Economics

Alaska Department of Law Imitates
Wrong-Way Corrigan: Famous Aviator
Left New York For L.A., Landed in Ireland

With increasing recognition focusing on Trans-Alaska Pipeline System (TAPS) shipping costs, does the peculiar history of TAPS tariff ratemaking hold lessons for the proposed natural gas pipeline?

By RICHARD FINEBERG *
March 2, 2007

New Report : State Losing $404 per Minute in Reduced Royalties and Petroleum Profits Taxes due to Excess TAPS Tariffs. (Click Here)

The good news: A stinging rebuke to the owners of the Trans-Alaska Pipeline System (TAPS) by the staff of the Federal Energy Regulatory Commission has prompted the Alaska State Legislature to take a long-overdue look at TAPS tariffs (shipping costs). The FERC staff brief, filed Feb. 16, endorsed the 2002 findings of the Regulatory Commission of Alaska (RCA) that the TAPS owners had failed to provide credible justification for its perennially high TAPS tariffs.

The bad news: In the two weeks since the FERC staff filed its 111-page brief, the state loss in revenue due to the reduction in royalty and petroleum profits tax payments caused by excessive TAPS tariffs can be estimated at approximately $8.2 million. That's more than $404 per minute. By the end of this year, continuing loss to the state treasury due to TAPS tariff overcharges since North Slope operations began in 1977 will top $3 billion (more than $4.5 billion in 2007 dollars).

These state loss estimates are based on this writer's comparison between the post-1996 tariff of $1.96 per barrel ordered by the RCA in 2002 for in-state oil and the significantly higher tariff the TAPS owners charge on oil bound for destinations outside Alaska, which is regulated by FERC, currently $5.10 per barrel. (The RCA tariff applies to approximately 11 percent of the oil shipped on TAPS; the FERC tariff applies to the remaining 89 percent.) (1)

The state's long-running failure to stop the TAPS revenue hemorrhage is also bad news for the proposed North Slope natural gas line. High gas pipeline tariffs could ruin the economics of the giant project by eating much - or even all - of the revenue the state hopes to receive from the huge North Slope gas line project. Excessive pipeline tariffs would pose a special whammy for independent producers, who pay pipeline shipping costs out of pocket to get their North Slope treasure to market. In contrast, for the producer-owner, an excessive tariff charge is an internal transfer payment.

A key fact to remember in this regard is that the major TAPS owners - British Petroleum, ConocoPhillips and ExxonMobil - own approximately 95 percent of TAPS and production rights to a similar share of discovered North Slope crude oil and natural gas. Under these circumstances, the state's long-running failure to assure low tariffs on TAPS may be seen as deterrent to potential independent producers at the same time that the state is offering inducements to new companies in hopes that they will come north to explore and find the yet-undiscovered natural gas necessary to assure the economic success of the proposed natural gas pipeline.

The major North Slope producers claim the state should award the contract for the gas line project to them because these companies, as both producers and shippers, have a natural interest in holding down shipping charges. Last spring, a Department of Law consultant, representing the Administration, followed the industry line in assuring legislators of the pipeline owners' natural interest in low tariffs. The attorney did not explain the contradiction between his assurance, based on theory, that the producers would keep pipeline tariffs low on the proposed gas line and the fact that the Department of Law has joined shippers Anadarko and Tesoro in petitioning FERC to compel the TAPS owners to lower tariffs on the oil pipeline. (2)

The 1985 TAPS Settlement

The Department of Law's somewhat schizophrenic testimony on tariff issues last spring may stem in part from the fact that the state's legal department played a leading role in designing the complex methodology used for determining TAPS tariffs under FERC's jurisdiction. The current FERC-approved tariffs are determined under a complex set of formulae known as the TAPS Settlement Methodology (TSM), established in 1985 by an agreement between the state, represented by the Department of Law, and the TAPS owners.

The complex ratemaking formula departed from standard ratemaking methodology, which would have required the TAPS owners to pay extensive refunds for overcharges between 1977 and 1985. The essence of the settlement deal was that the state would give up the lion's share of its eight-year quest for refunds in exchange for the promise of low tariffs in the future, long-term tariff certainty and an end to tariff litigation. (3)

The Reagan-era FERC, the U.S. Justice Department and the Internal Revenue Service were all willing to get the complication litigation at FERC over with. But
not everybody was sure the TAPS settlement was a good thing. In June 1985, one week before the final settlement was presented to the FERC, the U.S. House of Representatives Subcommittee on General Oversight and the Economy of the Committee on Small Business held a hearing to learn why the state Department of Law and the federal Department of Justice had decided to abandon the standard ratemaking methodology they had been asking Congress to adopt by legislation. Among other factors they considered were the claim by independent operators that the settlement would harm them and loss of payments to the U.S. Treasury.

During the hearing, Rep. Berkeley Bedell (D-Iowa) noted that FERC had estimated that the settlement would cost the U.S. Treasury more than $7.8 billion. He asked a FERC representative (Justice and the I.R.S. had declined to participate in the hearing), "Are you concerned about that?" After a pause with no response, the congressman continued:

"You don't have to answer. It took you so long to answer, obviously you are not very concerned, because I don't think most people would take that long to say yes we re a little bit concerned about $7.885 billion . . . . What do we do besides tear our hair out here?"

Rep. Norman Sisisky (D-Va.) asked the attorney from the Department of Law:

"To Alaska now. Isn't the real problem that they stonewalled you? They stonewalled you and you gave in? They used the power of the corporate treasury, of the courts, to absolute stonewall anything that happened. Isn't that really what happened?"

The Department of Law representative declined to reply, saying that the state would reserve its comments for its upcoming presentation to the FERC. (4)

In the absence of protests from shippers who were directly affected at that time, the FERC adopted TSM in late 1985 and the RCA followed suit. A particularly disturbing aspect of the settlement record is the misinformation that flourished behind a veil of confidentiality that made it difficult, if not impossible, for state legislators to evaluate the settlement.
Legislative questioning of the 1985 TAPS tariff settlement failed to alter what many - this writer included - thought at the time to be the Department of Law's misguided course on behalf of the administration. In 1990, after leaving the administration, this writer prepared a report for state House leadership on the manner in which confidentiality crippled effective review of the settlement steamroller.

Two documents from the 1985 settlement review are particularly noteworthy. The first is the major piece of information on the settlement available to legislators and Executive Branch policy-makers prior to settlement, an undated memorandum from the Dept. of Law, "Summary of Proposed TAPS Settlement." This 40-page memorandum (27 pages of text followed by 13 pages of tables and graphs) contained a 5-page, single-spaced summary and was labeled, "Confidential-Advice of Counsel." This key document:

  • underplayed and obscured the potential refunds at issue;
  • emphasized sthe difficulty of collecting refunds; but
  • failed to mention a unanimous 1978 U.S. Supreme Court decision that established the right of shippers - and, presumably, the State - to collect any refunds due from the TAPS litigation. (5)

The second item is the briefing on which the governor made his final decision approving the final TAPS settlement in October 1985. That document contained tables showing how specific issues affected the overall economic results for the state. But due to modeling errors, those tables incorrectly reduced the potential revenue from a litigation victory and increased settlement gains. These mistakes made continued litigation seem far less attractive economically than it really was.

What happened when the data errors was discovered is even more surprising: Administration personnel issued a call for the return of all copies of the erroneous document and destroyed them; an altered, public version released to the public several weeks later omitted critical tables and discussion of refunds and corrected the erroneous data on which the governor had been briefed. Officials of both the Departments of Law and Revenue later denied that the public version of the document had been changed from the erroneous confidential document (6)

The Last Two Decades

For most of the two decades following the 1985 settlement, the Department of Law vigorously rejected all criticism of the settlement. For example, in 1997 this writer, following up on a statement by the President of Conoco that high pipeline tariffs were a significant factor in that company's decision to leave Alaska in 1993, prepared a report for Oilwatch Alaska calling for an investigation of whether TAPS was in fact inhibiting competition. In that report, the author summarized the continuing TAPS tariff litigation in the intervening 12 years on a variety of technical issues and noted that the Department of Law had been paying its principal pipeline tariff consulting firm an average of more than $2.0 million per year between 1994 and 1997. (7)

Alaska's Attorney General rejected the request for an investigation in a letter that:

  • mis-stated the report's central premise (then proceeded to knock down the straw-man arguments the Department of Law had created);
  • questioned whether the statement of the Conoco chief executive, mentioned above, was true (in fact, the interview containing that statement was circulated by the company public information division in color brochure);
  • claimed no knowledge of antitrust complaints (in fact, an independent tanker company had filed an antitrust complaint against Alyeska Pipeline Service Co. and the TAPS owners in Juneau in May 1997).

By 1997, Tesoro had launched its challenge to TSM at the Alaska Public Utilities Commission (APUC, the predecessor to the RCA). The Department of Law sided with the TAPS Owners and testified against the shippers, citing a clause in the settlement to which it had agreed saying that the State "shall cooperate . . . at its own in expense . . . in defending against any litigation affecting the validity and enforceability of this Agreement, or any provision thereof." The Department of Law's rigid interpretation of the "duty to defend" clause is difficult to understand in view of the fact that the state had challenged the implementation of the settlement provisions on numerous occasions. (In this regard, it should be noted that the TSM only set a ceiling on TAPS tariffs but did not constitute an actual tariff filing.)

As the 1985 settlement's continuing high cost to the state treasury comes into focus, troubling questions about the Department of Law's implementation of state tariff policies arise. From a public policy standpoint, it is reasonable to ask: Could the clause in the 1985 settlement requiring the state to cooperate with the TAPS owners in defending the settlement have been satisfied by less vigorous action than that undertaken by the Department of Law for two decades. Could the state have found ways to fulfill the obligations to which it willingly agreed in 1985 without actively opposing the efforts of independent producers and shippers to secure just and reasonable tariffs on TAPS? To what extent did the Department of Law's intransigent defense of the 1985 settlement for nearly two decades deter the state from recognizing and effectively dealing with the costs and the anti-competitive implications of excessive tariffs on TAPS?

Early in 2004, the Department of Law publicly recognized the importance of low TAPS tariffs and proudly announced that it was entering into talks with the TAPS owners to renegotiate the TSM. Eleven months later, in filing an aggressive challenge to the TAPS owners' filed rate increase under the TSM at FERC, the department disclosed that the negotiations had failed - and that the State had backed off on its current-year claims at FERC during the unsuccessful talks. From this point on, the Attorney General said, the state was going to pursue lower tariffs aggressively. (8)

The end of the 2004 negotiations marked the state's third failed effort in a decade to take meaningful action address TAPS tariff problems. Tariff issues were briefly discussed, then swept under the table without resolution, during the ARCO/BP merger negotiations in 1999-2000 and during TAPS lease renewal reviews in 2002. Bottom line: During the past decade, under three different administrations, the state had failed to take advantage of opportunities to accomplish the goal of reducing TAPS tariffs.

In 2006, State Superior Court Judge John Suddock flatly rejected the challenge to the RCA 2002 order by the TAPS owners and their faithful ally, the state. In a strongly worded, 51-page decision, the judge affirmed the RCA's decision "in all respects." (9) The TAPS owners will continue their opposition to the RCA's rejection of the TSM before the State Supreme Court March 13. But this time around the Department of Law, now joined with the TAPS shippers at FERC in opposing the tariff levels under TSM, will no longer be at the TAPS Owners' side.

This analysis does not attempt to define the point at which the state action justified under duty to defend its 1985 bargain with the TAPS owners could or should have been limited. Suffice it to say that for nearly eight years between 1997 until the end of 2004, while the Department of Law was opposing the Tesoro challenge to TAPS tariffs at the RCA, the difference between the TSM tariff and the tariff ordered by the RCA for those years cost the state more than $700 million in 2007 dollars in reduced royalty and production tax payments. In the last three years, as the TAPS owners have continued to increase their TAPS tariffs, the Department of Law's posture has shifted; the state now sides with the shippers it opposed at the RCA in seeking reduced tariffs at FERC. During this recent period, TAPS tariff overcharges have cost the state an additional $470 million in 2007 dollars in reduced petroleum revenue.

Conclusion

In January, the press reported an Alaska Department of Revenue (ADOR) estimate that under the new petroleum profits tax (PPT), at current forecast prices the state will lose $102 million during the current year. This analyst's report estimates the current year loss attributable to TSM to be more than twice that amount. The differences between the analysis presented here and ADOR's figures result from the fact that ADOR is measuring the change between last year's tariff and this year's. This metric that may provide information for short-term budgeting, but it offers little useful information for long-range policy planning. To assess the Department of Law's pipeline tariff policies, it is necessary to evaluate the consequences of tariff changes against meaningful landmarks.

Put otherwise: The ADOR approach to tariff increase is a bit like trying gauge the significance of one degree of fever without knowing one's body temperature. As long as adult body temperature remains below 100 degrees, some medical sources will say that a one degree increase is not a fever at all. On the other hand, if a body temperature increases from 104 degrees to105 degrees, that one-degree increase in temperature may be quite serious. ADOR's measurement fails to provide a baseline standard for assessing the Department of Law's pipeline tariff policies.

In contrast, the analysis presented here rests on comparisons against a very important standard that has been available since 2002: The tariff level established by the RCA. Although ignored by the ADOR metric, the RCA standard has been reaffirmed by the commission, upheld by the courts to date and, most recently, commended by the FERC staff. Moreover, the RCA benchmark tariffs are the product of standard ratemaking principles. The estimates in this writer's analysis therefore provide landmarks in an otherwise featureless bureaucratic landscape.

In 1938, the aviator Douglas Corrigan became known as "Wrong Way Corrigan" after he took off from New York City in a small, single-engine plane, headed for California, but landed 29 hours later in Ireland. Like Wrong Way Corrigan, the Department of Law's tariff policies seem to be directionally challenged. Whatever the cause, the state's current revenue loss - measured against the RCA benchmark at $404 per minute currently and approaching $1.0 billion over the last decade - constitute a clear fiscal indication of the existence of a significant and long-running public policy problem.

Meanwhile, the Department of Law is requesting $33.1 million in a supplemental appropriation to deal with oil and gas issues. While two-thirds of the request supports the natural gas pipeline initiative, the supplemental request also states that TAPS tariff renegotiation is a major issue. TSM, having set the course for a multi-billion dollar revenue loss over three decades, TSM expires in five years and, under the settlement terms, it is now renegotiation time. Unfortunately, the supplemental request information available on-line is notably lacking in compass bearings, timelines and benchmarks to assure that the Department of Law's new negotiationg effort will not be a repeat performance of 2004.

As noted earlier in this analysis, TSM failed to achieve the three major goals frequently cited as the reasons for entering into the 1985 settlement: lower future tariffs, tariff certainty and an end to litigation. In baseball, the rules are clear: Three strikes and you're out. But for the Department of Law, the rule seems to be that after three strikes you get to ask for a $33.1 million supplemental appropriation.

The failure of the Legislature to deal with TAPS tariff issues while overhauling the petroleum fiscal regime in 2006 marks the fourth time in recent years the state has not taken advantage of an opportunity to deal with this important problem. Now, sparked by the mounting legal stack of authoritative reviews and legal decisions rejecting the merits of the 1985 TAPS settlement agreement and the TAPS owners' defense of its gains from that deal, a new Legisalature and a new administration have another chance.

There is one difference this time around: The current costs to the state treasury of the long-running failure to take action on TAPS tariffs can now be estimated: $404 per minute.

The clock is ticking.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Notes to "Wrong Way Corrigan"

1. See this writer's estimate of state revenue losses due to excessive TAPS tariffs since North Slope oil began flowing in 1977, prepared for the Alaska Budget Report.

2. The effects of excessive TAPS tariffs on independent North Slope producers and shippers were discussed In this writer's April 30, 2006 commentary on the deliberations on production tax revisions; June 6, 2006 follow-up commentary on production tax deliberations; and in Stranded Gas and PPT: Update and Observations (June 6, 2006). For Department of Law and producers' claims of interests in low tariffs, see comments of Brad Lui during the Governor's briefings on the gas line proposal at the Egan Center, Juneau, May 12, 2006 and comments of Sen. Gene Therriault at Senate Republican Minority Press Conference, Mar. 1, 2007.

3. For background on the 1985 TAPS tariff settlement, see: State of Alaska and United States Department of Justice, Explanatory Settlement of the State of Alaska and the United States Department of Justice in Support of Settlement Offer (Federal Energy Regulatory Commission Docket No. OR 78-1, etc), June 28, 1985.

4. See: U.S. House of Representatives, Committee on Small Business, Subcommittee on General Oversight and the Economy, H.R. 245 and Trans-Alaskan Pipeline System Tariffs, June 18, 1985, pp. 157-158.

5. The 1985 TAPS Settlement: A Case Study in the Effects of Confidentiality on Information Available to Decision Makers in Oil and Gas Revenue Disputes (Supplemental Report), Alaska State Legislature (1990), p.18 and Appendix 1.

6. See: The 1985 TAPS Settlement, p. 31 and Appendix 3.

7. See: The Big Squeeze: TAPS and the Departure of Major Oil Companies Who Found Oil on the North Slope, Oilwatch Alaska (1997), Ch. 5.

8. Alaska Department of Law, "State and TAPS Owners Enter MOU," Jan. 27, 2004 (News Release); "State Protests 2005 Trans-Alaska Pipeline Oil Transportation Tariffs: Attorney General Says Rates Are Too High," Dec. 15, 2004 (News Release).

9. See: Decision and Order, Amerada Hess Pipeline Corp., et al, v. Regulatory Commission of Alaska (Case No. 3AN-02-13511 CI), Jan. 18, 2006, p. 76. (For additional background see archived articles, Recent Articles on Trans-Alaska Pipeline Tariff Issues, August 2004 and June 2005.)

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* Richard A. Fineberg observed deliberations on the 1985 TAPS settlement from the State Office of Management and Budget but had no responsibility for oil and gas policy formulation at that time. In 2001, he testified in the TAPS rate case at the Regulatory Commission of Alaska (RCA) as the Expert Witness for the commission's Public Advocacy Section. His reports on TAPS tariff issues cited above can be found in the Archives and Reports sections of this web site.

 
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