Setting the record straight: Knowles makes mistakes in his assessment of gas line

Voices Of The State

Posted: Monday, October 30, 2006

Last week the Alaska Journal of Commerce published the gubernatorial candidates’ positions on the gas pipeline (web posted Sunday, October 22, 2006). This was of interest to me, having spent most of the last two years as the state’s chief negotiator on the Alaska North Slope gas pipeline contract.

My first thought was that former Governor Knowles must have been misquoted, but I checked. It was a written response to the Journal with too much detail for misunderstanding. This was an accurate description of his position. These were his words.

The former governor has a few misconceptions in his gasline position that I think must be addressed.

First he states, “Ideally the state would want the pipeline financed with 80 percent debt. The federal ANGPA statute provides loan guarantees of up to 80 percent of the cost of the pipeline. However, there is a balance to be struck between ensuring that tariffs are as low as possible and being reasonable commercial partners. The majority of ‘new-build’ pipelines are financed with a 70-30 debt-equity capital structure. Given that is the norm and the unusual opportunity for federal loan guarantees, it is certainly reasonable to have a 70-30 capitalization as criteria.”

Mr. Knowles properly recognizes that the state ideally wants a pipeline financed with 80 percent debt. But then he continues to explain his position by stating he is willing to give up that financing structure and accept up to a 70 percent debt to equity capitalization structure.

This is a huge mistake for the person who is vying for the job of lead negotiator for the state. What negotiator tells the opposing side, “I want 20, but I’ll accept no more than 30.” He just guaranteed the other side will offer no less than a 70/30 capitalization structure.

The state has worked hard to get strong language included in the state’s proposed Alaska North Slope pipeline agreement that commits ExxonMobil, BP, and ConocoPhillips to a finance strategy of 20 percent equity and 80 percent debt because we believe it will bring in the lowest tariff for the state’s gas.

The last thing we want to see is someone casually gives it away to the producers, to TransCanada or anyone else who comes along and wants to build the pipeline.

The former governor continues, telling you how much he has given away. He states that each percentage increase of debt financing reduces the tariff by a penny. Actually it is more than a penny, but assuming he is right, he just increased the cost of the tariff by ten cents.

That doesn’t sound like much until you understand that the ten cents he gave away is charged for each thousand cubic feet of gas shipped on the pipeline and we will be transporting four billion cubic feet of gas through the pipeline each day, 365 days per year.

After 20 years Mr. Knowles has just assured the pipeline owners they will make an additional $2.9 billion. That is money out of the state’s pocket and out of the pocket of every present and future shipper of gas.

Next the former governor states “although significant cost overruns can occur, and these would negatively affect the overall project economics, the threat of cost overruns is typically overstated.”

This could not be further from the truth. This quote is so absurd it astounds me.

My research doesn’t provide a single expert who agrees with this bold statement. In fact the opposite is true.

Project developers tend to underestimate cost overrun risk, not overestimate it. Ask Bent Flyvbjerg, the author of “Megaprojects and Risk, an Anatomy of Ambition” or Dr. Al Rogers, from IPA Institute who was invited to Alaska to talk to the Legislature about megaproject risk.

Both will tell you that project proponents are optimists. They want to build the project. They will generally underestimate the costs and overestimate the benefits.

t would seem impossible to get such critical data backwards but the former governor continues. He says, “By the time detailed engineering is complete (well before construction is committed to), the potential for cost overrun ‘surprises’ shrinks dramatically, typically to no more than 5 percent. The big cost overruns on pipeline projects occur between projections at the early stages to the more defined project planning stages.”

This is a complete misunderstanding of project costs and project risk. Mr. Knowles has the 5 percent right, but it is the cost of the budget during the planning phase, not the risks that are left after the planning phase is completed.

Ninety-five percent of the project costs and risks are still to come. Most of the major risks to the project are during construction.

Weather, logistics, labor and material costs, environmental problems, regulatory and permitting delays — all are part of the real risk to the project and they occur after the defined project planning stages.

The former governor has fallen directly into the trap the Flyvbjerg says catches many promoters: they underestimate the costs and overestimate the benefits from a project. But Mr. Knowles has gone a step further. He has stood them on their head.

Moving Alaska’s gas to market should be one of the highest priorities of the next administration. To do it through informed decision-making is essential.

If the state of Alaska decides to participate in the ownership of a gas pipeline as a means of moving the gasline project forward, we should do so with our eyes open, fully understanding the risks of the endeavor.

Steve Porter is the deputy commissioner of the Alaska Department of Revenue.

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