Various discussions over the past week about the Alaska LNG (Liquefied Natural Gas) project have led us to be concerned that Alaska potentially is being set up to settle for something significantly less than what it anticipates from the project down the road.
The discussions started after we published last week’s column, which, for the reasons we explained there, urged the Legislature to “condition the construction of the Phase 1 line on the project first obtaining firm, irrevocable commitments from credible customers to purchase volumes sufficient to make Phase 2 economically viable.”
As readers familiar with the project will know, the proposed Phase 1 involves building a pipeline from the North Slope to Southcentral Alaska, where it will connect to the Enstar Natural Gas (Enstar) system to deliver gas for in-state use. Separately, Phase 2 of the project involves entering into contracts with export customers sufficient to underwrite the construction of the gas treatment, liquefaction, and other facilities necessary to export North Slope gas to international markets.
As we explained in last week’s column, the in-state market the Phase 1 facilities are intended to serve is limited, and projected construction costs are high, resulting in a cost of serving in-state consumers approaching $30 per thousand cubic feet (Mcf) at current demand levels. For reference, according to Enstar, the average equivalent price of gas into its system is currently around $11/Mcf.
Because of the much larger volumes over which to spread the costs, the projected costs to in-state customers of the line once Phase 2 starts, if it does, are much lower, in the $5–$6/Mcf range.
But to achieve those lower prices, sufficient export customers must commit to Phase 2 of the project for it to be economically viable. If they don’t, Phase 2, and with it, those lower prices won’t materialize.
We acknowledged in the column that, in its presentations to the House and Senate Finance Committees last week, the Alaska LNG project’s developer, Glenfarne, had proposed to “cap” the price of deliveries from Phase 1 at $16/Mcf, with annual inflation-based escalation. But as we discussed there, the cap acts more as an above-market floor.
To explain, we use this chart from a column we posted on our Substack page on Monday. In that column, we discussed revisions we have made to our weekly “Monday” charts to assess both the export market into which the Alaska LNG project proposes to deliver and the import market that constitutes the in-state alternatives to Phase 1. Here is the latest chart showing the in-state alternatives.
The chart tracks three price levels over the forecast period. The first line, in blue, shows the price levels over the forecast period for volumes that would be delivered from Phase 1 of the Alaska LNG project. Consistent with our understanding of Glenfarne’s proposal, the price starts at $16/Mcf in 2029 and escalates thereafter with inflation.
The green and red lines show projected alternative prices based on current LNG futures markets.
The green line in the middle, from 2029 onward, tracks the price using a common oil index-based formula for pricing LNG under long-term contracts in the Japanese and other Pacific markets. The red line tracks the “Japanese Korea Marker” (JKM) price currently used mostly to price LNG delivered under spot contracts in the same markets. As we explain in our Monday column, both the oil-indexed and JKM prices included on the chart are adjusted for the additional shipping and LNG terminal infrastructure costs that Enstar estimated in its testimony before the House and Senate Finance Committees last week are required to regasify and deliver imported LNG into its system.
A blend of the two LNG pricing approaches, as is increasingly used in Asian LNG contracts, would result in a line somewhere in between.
As we explained in last week’s column, while both the oil-indexed and JKM prices are currently elevated amid market dislocations caused by the Iran War, both highly respected analysts and, as importantly, the futures markets anticipate those prices will drop sharply once the War is resolved.
As is clear from the projections, once the dislocations from the Iran War pass, the prices along the blue line – those proposed by Glenfarne for deliveries from Phase 1 of the Alaska LNG project – are the worst of the alternatives. In terms of energy costs, Alaskans would be significantly better off economically importing LNG under either of the other pricing models, or a blend of both.
But as we understand Glenfarne’s Phase 1 proposal, once Alaska agrees to develop Phase 1, Alaska consumers would not be able to take advantage of other alternatives. To underwrite the financing of the Phase 1 pipeline, Alaskan purchasers would be required to enter into “take-or-pay” agreements covering service from the Phase 1 pipeline. That price would become Alaska’s pricing floor in the future.
As we explained in last week’s column, the analysis makes it clear that Alaska should not commit to contracting for the Phase 1 volumes until it is clear that Phase 2 will proceed. If it did so, Alaska would risk committing itself to increasingly uncompetitive gas prices well into the future.
Instead, in last week’s column, we urged that Alaska commit only at this point to the Phase 1 line, contingent on the project receiving sufficient similar commitments from export customers to underwrite proceeding with Phase 2 construction.
But after publishing the column, we began receiving significant pushback, with most claiming that the success of Phase 2 requires that Alaska agree to pursue Phase 1 first.
The justification most gave for that position started with something similar to the following claim made in Glenfarne’s presentation last week before both the House and Senate Finance Committees: “Market feedback indicated LNG buyers were not willing to contract for a fully integrated (upstream + pipeline + liquefaction) project structure.”
But most went further than this comment, asserting that Alaska must go first and commit to the Phase 1 line before export customers will commit to the Phase 2 volumes.
One doesn’t follow the other. Consistent with last week’s column, we responded that it would seem sufficient for Alaska to commit to Phase 1 of the line contingent on the project receiving sufficient similar commitments from the export customers to underwrite Phase 2 construction.
The Phase 2 customers should not be concerned with such a contingency. They could similarly condition their participation on Alaska firmly executing its Phase 1 commitment once they preliminarily committed to Phase 2. The only customers it would affect are potential Phase 1 customers, who would avoid committing to an increasingly uneconomic Phase 1 project if the Phase 2 volumes never materialize.
But those pushing back on our position were adamant. For Phase 2 to have a chance, they argued, Alaska must commit to the Phase 1 volumes now, before knowing whether the Phase 2 volumes will ever materialize.
That is what has led to our concern.
By committing to Phase 1 without knowing whether the Phase 2 volumes will materialize, Alaska is exposing itself to two significant risks.
The first is that the Phase 2 volumes never materialize, leaving Alaska stuck with an increasingly uneconomic $16/Mcf price that continues to escalate over a prolonged period (by some estimates, 30 years).
But pre-committing to Phase 1 before the project secures Phase 2 commitments also exposes Alaska to a second risk, even if Phase 2 volumes later materialize.
The assumptions about Alaska’s Phase 2 volumes being priced significantly lower than under Phase 1 depend on the Phase 2 customers bearing a proportionate share of the costs of the Phase 1 line. For example, if Phase 2 volumes are 90% of the throughput, the assumption that Alaska’s price will drop to $5-6/Mcf depends on Phase 2 customers bearing 90% of the cost of the Phase 1 line.
But what if, once Alaska has pre-committed to the Phase 1 line and it is under construction (in other words, it has become a sunk cost), potential Phase 2 customers take the position they are willing to purchase from the Alaska LNG project only if they contribute less, such as 75%, or 50%, 25% or even only 10% toward the Phase 1 costs? After all, according to Glenfarne, those potential customers already have said they are “not willing to contract for a fully integrated project structure.” From that, it’s easy to see them declining to pay full cost for the pipeline.
(And for those naive enough to think that the export customers would never insist on such terms, let us assure you that such realpolitik in the business world – often referred to as “ruthless pragmatism” – is common.)
Having committed to the Phase 1 line regardless, Alaskans will be over a barrel. Having some contribution to the line’s fixed costs from export volumes will be better than bearing them entirely on their own. But if the export volumes only bear, say, 50% of the costs, instead of the projected 90%, the resulting in-state charge won’t be $5-6/Mcf. It will be something significantly higher than that.
In effect, by pre-committing to the Phase 1 line, Alaska is being set up to subsidize the export customers by paying for the share of the pipeline they don’t.
Some argue that either the statute or the contract between Alaska consumers and the Alaska LNG project can prevent that by requiring that rate calculations assign a proportionate share of costs to export volumes. But if the export customers say they won’t commit to the project without an agreement that limits their share of the costs of the “fully integrated project structure,” it is hard to imagine either the project or the in-state customers declining unless replacement export customers are willing to take their place with a higher contribution.
At some point, potentially around the same 50% mark, the resulting charge per Mcf from such a concession would remain near $16/Mcf, with escalation due to inflation. Even with the addition of Phase 2 volumes, there would be no rate reduction relative to the Phase 1 level, and the long-term price would remain above that of import alternatives. Having found the price level in-state customers are willing to pay, it will remain at that level.
While some may claim otherwise, there is no solution to this potential other than, as we explained in last week’s column, making Alaska’s Phase 1 commitment contingent on the project receiving sufficient similar commitments from the export customers to underwrite Phase 2 construction. As we have explained, the real-world dynamics of project economics will easily cause Alaska to set aside any contractual or statutory obstacles.
As a result, once again we urge the Legislature (or the Regulatory Commission of Alaska, if the Legislature doesn’t) to consider the implications before potentially throwing the Alaska economy under the bus. Future generations won’t be pleased if this generation’s actions result in their energy costs invariably exceeding those of competitive alternatives simply because this generation was too impatient to insist on the right business terms.
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.