Pricey move?

Lease buybacks could cost state $100 million, lawmakers told

Posted: Friday, February 06, 2004

The price of buying back eight lower Kenai Peninsula shallow gas leases the state sold to a developer last year for $500 each could include compensation based on the estimated value of the gas, a cost that could drive the price tag as high as $100 million, Mark Myers, the director of the Division of Oil and Gas told the Senate Community and Regional Affairs Committee on Wednesday.

Some committee members expressed skepticism any buyback payment would reach such figures. One questioned if the numbers were meant to be alarmist.

Myers' comments were delivered as the panel was taking testimony on Senate Bill 250, a gas-lease buyback proposal sponsored by committee member Sen. Gary Stevens, R-Kodiak. Myers said the high-end figures were based on the best estimates of gas potential and were not outside the realm of possibility.

The committee needed to hear a realistic estimate of possible outcomes of a buyback, he said in a later interview.

According to Myers, any buyback effort would begin by trying to negotiate a fair settlement with the leaseholder, Lapp Resources Inc., which acquired the eight leases last June in a non-competitive, over-the-counter sale allowed under the state's shallow-gas development program. Since little, if any, significant work has been done by Lapp thus far on any of the leases, buyback costs should be relatively minimal at this point. Myers said the state could reimburse for such costs as acquiring seismic data, doing geological fieldwork and hiring personnel.

However, if no negotiated agreement could be reached, the state might have to resort to using eminent domain, a process by which the state takes private property. In this case, it would take the leaseholder's rights to look for and develop the shallow gas in order to meet a higher public interest. The Alaska Constitution requires "just compensation" in such cases. Myers said that could include compensating Lapp for a lot more than just the cost of the leases and work performed.

"In that condition, it is reasonable to assume we would have to look at compensating them for the lost revenue from the potential of the resources," Myers said.

Estimating lost revenue is difficult. Just making accurate guesses about how much gas is present, much less its actual value is "an art," he said, adding that even experts disagree. For instance, in competitive bidding lease sales, bids from competing companies often can vary by a factor of ten, indicating that opinions about the potential of a gas source can be all over the board.

Much would depend on the data available, and it is the lack of data on shallow-gas development in Alaska that makes estimating the potential value of the leases so problematic.

Myers said the division had done "some quick ballpark work" to try and develop some rough estimates, but had to rely on "analogues" -- that is, making estimates based on known onshore deposits north of the Homer area where conventional drilling and development already is under way.

The geology around Homer is on "structural trend" with those around known resources, so the method is not without merit, Myers said.

Speaking hypothetically, Myers said, under the right geological conditions, if a fifth of the 22,000 acres were productive (and tapped by "conventional" gas drilling methods), it might produce around 20 billion cubic feet of recoverable gas, and perhaps as much as 100 billion cubic feet if all 22,000 acres were productive. Figuring a net profit of $1 per thousand cubic feet, Myers said the value estimates could range from $20 million to $100 million.

Coal-bed methane production, on the other hand, could mean more potential gas -- perhaps 150 billion to 500 billion cubic feet -- but tougher economics. A company with a lot of experience and unlimited money might be able to find that level of reserves and do quite well, but as yet, there is no proof coal-bed methane development will work in Alaska, Myers said Thursday.

"I can't really say what it would take, but generally, conventional is more economic," he said.

A precise estimate is difficult because it depends on many factors, including risk, Myers told the committee Wednesday.

"But the numbers could be substantial," he said.

Committee member Sen. Kim Elton, D-Juneau, expressed doubts about the potential costs.

"I'm puzzled. People can get a lease for $500 and that lease isn't predicated on the value of the resource, but if, in fact, we buy it back, then the state has to predicate how much they pay because of the value of the resource? That doesn't make sense to me," Elton said.

In an interview Thursday morning, Elton said he'd been left "incredulous" by Myers' comments on the cost of a buyback.

"First, if, in fact, we can lease our resources for $500 and have to buy them back at what he suggested was multiples of millions of dollars, we need to sit back and say, 'Does this make sense?'" Elton said. "If we are leasing properties of this value for $500, Alaskans are making a big mistake putting money in equities instead of leases."

Elton said he wondered how alarmist the estimates were meant to be.

Shallow gas leasing has become a topic of heated discussion on the lower peninsula.

Residents around Homer have expressed concerns about weaknesses in the state's shallow gas leasing process, most notably, its lack of public notice, as well as the potential threat development poses to groundwater. It was public reaction that led Stevens and Rep. Paul Seaton, R-Homer, to propose legislation for a buyback.

Stevens said Wednesday that if the Department of Natural Re-sources is admitting that its process for leasing on the lower peninsula had problems, discussions with area residents might lead to some acceptable middle ground short of a buyback based on the highest possible value of the resource. That might include buying back some, but not all the leases.

"There are negotiations," he said. "There could be other options along the way."

Whether any shallow gas drilling will ever occur on the lower peninsula is questionable, Myers asserted.

Many, if not all the leases, likely would never be explored and would return to the state, he told the committee.

"Our expectation is that many will not see exploration," he said.

Thursday, Myers said he provided the committee with the high buyback figures not to alarm but to provide members with "a realistic proposal of what the range of outcomes could be."

Under buyback circumstances, companies could be expected to take negotiating stances meant to maximize their return, he said, because that is how oil and gas companies have operated in various resource negotiations in the past. Myers also said Unocal likely would be a player in such negotiations because Lapp had sublet six of those leases.

"You can expect them (Lapp and Unocal) to take a hard line in negotiating with us," he said.

That is not to suggest that Lapp Resources or Unocal would run right out and start drilling in order to better a position at the negotiating table. It isn't that easy. To do any drilling, companies have to engage in the "full regulatory permitting process," which takes time, Myers said.

However, he also noted there are "dozens of things they could do (preliminary development efforts) without touching the ground."

Meanwhile, time is running out on the three-year lease terms. A year is already gone, and Myers noted that Lapp "has never operated a well in this state."

Thursday, Stevens said he was glad his bill had had a hearing and he hoped Sen. Bert Stedman, R-Ketchikan, committee chair, would hold another, this time with public input.

Stedman chose not to take public testimony at Wednesday's hearing, a move criticized by some of those who showed up at the Homer Legislative Information Office prepared to add their two cents to the debate.

"I'm appalled and disappointed," that no public testimony was allowed, said Homer resident Mike O'Meara.

He said he didn't know Sted-man, whose decision it was not to take testimony from residents, and couldn't second-guess his motives.

"It's either a very nave move on his part or just an appalling example of the kind of arrogant disregard for public process that created this whole abominable situation," he said.

As for Senate Bill 250, O'Meara said he would wait and see what becomes of the bill, and for now, accept on good faith that the committee was made up of people trying to do a good job.

Stedman was unavailable for comment Thursday, but an office aide said that while future hearings are possible, none currently are scheduled.

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