As regular readers of this page may recall, our last two columns have been about what we view as the most significant risk to Alaska families that the Governor and Legislature are creating with the proposed bill relating to the Alaska Liquefied Natural Gas (Alaska LNG) project. This will be the third.

The risk is not from the tax-related provisions of the bill. Any perceived deficiencies in those provisions can be offset by oil and corporate tax reform, by the passage of a broad-based tax mechanism, or, if still needed, by later modification of the property tax provisions included in the bill. Those don’t have permanent effects.

Instead, the most significant risk to Alaska families the Governor and Legislature are creating with the bill is by enabling the so-called Phase 1 of the project to proceed full speed ahead of a determination of whether – and how – Phase 2 is economic. The risk is that, by proceeding with Phase 1 before ensuring their rates are lowered by Phase 2, Alaska families will be stuck paying above-market energy costs long into the future.

Given that this project is being sold largely as a way to lower the energy costs of Alaska families, creating the risk that it could have the reverse effect is a legislative failure of major proportions.

We have explained in the first two columns how that could happen. The first is that Phase 1 is built, but Phase 2 never is, leaving Alaska families tied entirely to the economics of Phase 1. The second is that Phase 2 is built, but the export customers exercise the increased bargaining power created by pre-building Phase 1 to significantly reduce the rates they pay for the portion of the Phase 1 facilities they use, leaving Alaska families stuck covering the remainder of the costs and, potentially as a result, with the same long-term rates as in Phase 1. 

Some respond that being stuck in Phase 1 is better than the alternative. At first blush, that is nonsense. As the charts on the Phase 1 economics provided by legislative consultants Gaffney Cline during the recent hearings show, at current demand levels, the delivered price of gas from the Phase 1 facilities would be around $30/Mcf, even with the gas cost component held at $1/Mcf. That well outstrips even the most pessimistic outlook for the price of alternative supplies from imported LNG and is the reason the so-called Bullet Line (now referred to as “Phase 1”) has never been built.

In response, most have pointed instead to a proposal by Glenfarne, the project developer, to “cap” the price of gas delivered from Phase 1 to the in-state market at $16/MMbtu. But as we explained in last week’s column, while that price may look good compared to the current Iran War-inflated LNG price levels, it doesn’t over the intermediate or, looking at the trend lines, longer terms. 

While the $16/MMbtu “capped” price offered by Glenfarne continues to escalate annually with inflation, LNG prices are projected to decline significantly relative to their Iran War-related highs. As highly respected Bloomberg oil & gas columnist Javier Blas explained in a recent column:

It’s a story as old as the commodity market: Today’s high oil prices will sow the seeds of tomorrow’s low ones. For a short period, LNG costs may remain somewhat high as importing countries, particularly in Europe, rebuild their inventories ahead of the 2026-2027 winter heating season and everyone purchases a little more than needed, just in case the fighting in the Gulf flares up again. But a buyer’s market is around the corner.

Reflecting that, here is a chart we included in last week’s column comparing the Glenfarne price cap, escalated for inflation (in blue), to current LNG futures prices.

As we explained in last week’s column, both LNG prices (in green and red) are adjusted for the additional costs that Enstar has said would be required to cover regasification and other facilities necessary to deliver imported LNG into the Enstar system. Even with that, both the LNG prices determined by use of an oil index (green) and by reference to the Japan Korea Marker (JKM, red) are increasingly less than Glenfarne’s proposed Phase 1 price from 2029 forward.

Glenfarne’s price cap is also subject to the additional risk of being artificially set by contract rather than driven by actual low costs. We anticipate that most readers of this column have been around long enough to realize that contract terms that fail to reflect the economic reality underlying them usually become the subject of later litigation and, if the economics are bad enough, are set aside in bankruptcy. What looks too good to be true in contractual form usually is.

Some look past the point and argue that Phase 1 – and the artificial price that goes with it – will be temporary, and will be supplanted by significantly lower prices for the in-state customers once Phase 2 is implemented.

There is some basis for that if sufficient Phase 2 export volumes are ultimately committed to the project and those volumes bear a fully proportionate share of the costs of the Phase 1 facilities.

We show the potential effect in this chart.

This chart estimates the per-unit prices (vertical axis) at certain projected volume levels (horizontal axis) as of 2033, after the projected start date of Phase 2. The starting point (at 300 Mmcf/d) is taken from Gaffney Cline’s presentation to the Senate Finance Committee, including gas costs of $1.50/MMBtu, at the midpoint of the projected capital cost range for Phase 1 as estimated by Glenfarne in its testimony to the Senate Finance Committee ($15.05 billion).

We then scale those across the range of potential volumes to 3000 MMcf/d, projected as the fully utilized level. The $4.00 price at that projected volume reflects the Department of Revenue’s recent estimate (at a gas cost of $1.50), assuming full utilization and that all volumes from both in-state and export customers bear a proportionate share of Phase 1 costs.

But as we explained in last week’s column, the assumption that the Phase 2 export volumes will bear a proportionate share of the costs of Phase 1 is far from guaranteed.

Because the Phase 1 facilities will already have been built, the Phase 2 export customers won’t need to commit to pay a proportionate share of the costs to ensure that the pipeline facilities are available. Construction costs will already have been “sunk.” The facilities will already be in place.

Instead, as we explained in last week’s column, the price they will pay for the Phase 1 facilities, practically speaking, will be the result of something of an auction. If there are a sufficient number of bidders willing to pay the fully allocated costs of the Phase 1 facilities, then the result will be the $4.00 fully allocated price anticipated by DOR.

On the other hand, as we explained in last week’s column, it is reasonable to believe that some price discounts may be necessary to attract sufficient Phase 2 customers to fill the line. The higher Phase 2 prices included on the chart at the 3000 MMcfd throughput level reflect the results. 

The red line (with an ending price of $9.50 for in-state customers) assumes that Glenfarne can fill the pipe only by offering a 20% discount off the fully allocated costs of the Phase 1 facilities to the Phase 2 export customers. The maroon line (with an ending price of $15.00 for in-state customers) assumes that, to fill the pipe, Glenfarne will need to offer a 40% discount on the fully allocated costs of the Phase 1 facilities to the Phase 2 export customers.

The green line (with an ending price of $20.50) assumes that, to fill the pipe, Glenfarne must offer a 60% discount on the fully allocated costs of the Phase 1 facilities to the Phase 2 export customers.

Some argue that both the proposed bill and the contract prevent such discounts by requiring the Phase 2 export customers to bear a proportionate share of Phase 1 costs. But as we explained in last week’s column, the potential Phase 2 export customers aren’t bound by that. They can simply meet their LNG requirements from other sources and bypass Alaska LNG, leaving in-state customers stuck at Phase 1 prices.

Facing that, as long as the addition of the contributions made by the Phase 2 export customers results in a reduction in the prices to the in-state customers below the Phase 1 prices, both the state government and in-state customers will likely accede to making whatever changes to previous legislation and contracts are necessary to accommodate the additional volumes. 

For example, looking at the chart above, if the choice is between continuing to pay the Phase 1 price ($17.66) and a Phase 2 price of $9.50, which would result from a 20% discount off the fully allocated costs of the Phase 1 facilities to the Phase 2 export customers, both the state government and the in-state consumers will likely accede to the change. Although the in-state price won’t fall to $4, it will still be below the Phase 1 price they would otherwise be obligated to continue paying.

The same is true if the choice is between continuing to pay the Phase 1 price ($17.66) and the Phase 2 price of $15, which would result from a 40% discount applied to the fully allocated costs for Phase 2 export customers. Again, the price will stay below the Phase 1 price that in-state customers would otherwise be required to pay. But at that point, in-state consumers will also end up paying a rate above the LNG import price they would have otherwise paid had the Phase 1 facilities not been pre-built.

By betting on lower prices by pre-building the Phase 1 facilities, the in-state customers will end up paying a higher price than if they had just contracted for LNG imports.

At some point, agreeing to continued steep price discounts won’t make sense. For example, an in-state price of $20.55, which would result from a 60% discount applied to the fully allocated costs for Phase 2 export customers, would be worse than continuing to pay the Phase 1 price ($17.66). There is no reason for the state government or in-state customers to agree to such a change.

But agreeing to any discounts that lower the Phase 2 price for in-state consumers below the Phase 1 price makes sense. Based on the numbers discussed to date, the break-even point appears to be somewhere around a 50% discount.

Some argue that even if using price discounts to attract Phase 2 export customers results in significantly higher prices for in-state consumers, Alaska will still be better off because the price discounts will facilitate the receipt of additional royalties, production taxes, and, potentially, higher corporate income tax payments to state government from the related sale of higher North Slope gas volumes. 

That assumes, however, that discounts aren’t also sought and applied to the upstream sales prices and taxes. Even if they aren’t, unless those additional revenues are rechanneled directly into offsetting reductions in in-state energy costs, the additional state revenues will come at the expense of reduced living standards for in-state consumers. 

To provide some perspective, if the effect of the Phase 2 discounts is to raise in-state prices by $5, the negative incremental impact on an in-state market of 70 Bcf will be $350 million annually.

The reason we propose to defer construction of the Phase 1 line until the Phase 2 commitments are clear is to avoid a situation in which in-state users become committed to Phase 1 rates that exceed the alternative of imported LNG. That would occur if the Phase 2 commitments never materialize or if price discounts of roughly 35% or more (using the above numbers) are required to attract sufficient Phase 2 export customers.

It is impossible to know whether those conditions will exist before the actual Phase 2 commitments are received. Construction of the Phase 1 line should not proceed until those commitments – and the resulting economics applicable to the in-state customers – are known.

Brad Keithley is the Managing Director of Alaskans for Sustainable Budgets, a project focused on developing and advocating for economically robust and durable state fiscal policies. You can follow the work of the project on its website, at @AK4SB on Twitter, on its Facebook page or by subscribing to its weekly podcast on Substack.