In 1985, the administration of Gov. Bill Sheffield struck a multibillion-dollar deal that ended an eight-year dispute over the rates charged to ship oil through the trans-Alaska oil pipeline.
At the time, critics warned that the state was being overly generous and said the deal would cost the treasury billions of dollars. In light of a ruling issued last month by the Regulatory Commission of Alaska, it appears the critics were right.
Acting on complaints by two Alaska refineries, the commission said the pipeline rates, or tariffs, that the state blessed in the settlement were higher than the owners could justify. Fifty-seven percent too high, to be exact. Through 1996, the commission said, the settlement allowed pipeline owners to collect $9.9 billion more than justified by standard pipeline rate-making principles.
The commission's ruling was the first independent scrutiny of the 1985 settlement. At the time, the deal won speedy, almost pro-forma approval because none of the oil shippers or their customers objected.
It wasn't until 1997 that two Alaska refineries, Williams and Tesoro, decided to challenge the pipeline charges they were paying. From 1997 forward, the refiners claimed that rates were too high. Judging that claim required the commission to evaluate the rate structure the state accepted in the 1985 settlement. The commission concluded that the refiners were paying too much under the rates allowed by the state's 1985 settlement.
The $9.9 billion in pipeline overcharges drained somewhere between $2 billion and $2.5 billion from the state treasury. That's because pipeline charges are deducted from the selling price of oil before the state calculates its royalty and severance tax payments. For every dollar of pipeline overcharges, Alaskans lose between 20 and 25 cents of state income.
Not only did the state make a lousy deal, it signed off in blood. Besides surrendering the right to recoup overcharges, the state also promised to defend the settlement against legal challenge. So when the Williams and Tesoro refineries exposed the flaws in the state's deal, the state locked arms with pipeline owners and helped them try to justify it.
In 1985, the Sheffield administration claimed the settlement was a victory on two major fronts. The deal ended litigation that had cost more than $35 million to that point. And by settling for higher tariffs in the early years, the deal produced much lower tariffs later on, to encourage development at smaller, less profitable oil fields.
The commission's ruling suggests the state could have obtained far lower tariffs by pursuing the case. In fact, the same day the settlement was announced, the Federal Energy Regulatory Commission issued a ruling, known as Williams II, that bolstered the state's claims. In the end, the state didn't gain much with the settlement except savings on legal fees -- and it gave up more than $2 billion. You can spend a lot of years and a lot of money on lawyers if at the end of the process the payoff is another $2 billion.
At this point, the state has little recourse for recouping the money it signed away with this spectacularly bad deal, which runs through 2011. But there is an opportunity, albeit small, for the state to limit future losses. As of Jan. 1, 2007, the state can open negotiations on a new agreement. If two years of good-faith negotiations fail to produce a new deal, the state can terminate the old agreement early.
The Murkowski administration ought to start laying the groundwork now to reopen the agreement and make sure the state gets the best possible terms in renegotiations. The state deserves a far better deal than it got in 1985.
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