Heritage Foundation Leadership for America

248 February 22, 1983 EXPORTING ALASKA'S OIL AND GAS INTRODUCTION I A huge resource df oil and gas is locked up in Alaska by federal legislation that prohibits its free commercial export.

As a result, Alaskan oil is currently creating a glut and discour aging oil production in California. Half of Alaska's oil produc tion therefore has to be shipped to the East Coast and Gulf Coast at considerable cost, ultimately borne by American consumers.

Removing export restrictions would gain the federal treasury about $1.5 billion per year and also increase Alaska's revenues substantially. It would reduce the nation's deficit trade balance with Japan and the Far East by up to $20 billion in potential oi l and gas exports. Beyond these financial benefits, the action could help break the impasse in trade relations with Japan and ensure supplies of energy to close allies who are very vulnerable to interruptions in the flow of Middle East oil. In addition, it would render unnecessary the construction of a $2 billion pipeline from Puget Sound to the Midwest and eliminate the current costly and wasteful tanker traffic to the East Coast I I Most important, it would stimulate Alaskan producers to develop more oil for export, probably from 0.5 'to 1 million barrels per day (mbd)--worth about $5 to $10 billion per year.

And it would blaze the way for exports of natural gas in the form of liquid natural gas (LNG) or as raw materials for fertilizer, with great.benefits to the economic development of Alaska. Gas exports of about 1 tcf (trillion cubic feet) would be worth about Changing the law that bans overseas sales of Alaskan oil will take a measure of political effort. That ban has a powerful constituency in the mar i time unions. Under a 1920 law--the Jones 2 Act--all shipments between American ports must be made in American flag ships, manned by American crews. All the oil that leaves the southern Alaska port of Valdez for terminals on the West and Gulf Coasts falls under the Jones Act. Even though only part of the 1.6 million barrels of oil that run through the Alaska pipeline each day might be involved in export to Japan, the maritime unions would fight to keep the law from being changed.

A second problem involves e quity for the American companies engaged in northern Alaska oil production. Legally barred from selling this oil to foreign countries, Exxon, Standard Oil Company of Ohio, and Atlantic Richfield Corporation invested heavily in tankers to ship oil from Val d ez to other U.S. ports. In addition these companies are'under a three-year contract to move some of the oil going to the Gulf Coast through a pipeline across Panama offloading from tankers on the Pacific side, reloading to tankers on the Caribbean side. T hese investments, entered into in good faith, would have to be protected.

But on balance, more would be gained than lost if exports were permitted. Moreover, export of Alaskan hydrocarbons poses no threat whatsoever to U.S. security. On the contrary, putti ng another 1 mbd (or more) of non-OPEC hydrocarbons into the world market would enable the consumer nations to reduce the amount of oil imported from unreliable OPEC producers. Allowing export of Alaska oil and gas also could improve U.S. relations with J apan.

Not only would it narrow the U.S.-Japan trade imbalance ($16 billion surplus for Japan in 1982 but it would go far to allevi ate Japan's fears of energy dependence on unstable Middle East nations.

ALASKA'S HYDROCARBON POTENTIAL In January 1968, roug hly 19 billion barrels of oil and 26 trillion cubic feet (tcf) of natural gas were discovered at Prudhoe Bay, Alaska. In 1968-1969, Alaska sold the basic leases for about $900 million, reserving for itself a 12.5 percent royalty interest. Development of t h e Prudhoe Bay field and plans for an oil pipeline commenced almost immediately. Congress became involved in the decision-making process of selecting the best route for transporting Alaskan North Slope (ANS) oil to market because any oil pipeline would hav e to cross federal land.

While oil and natural gas have been produced at Cook Inlet since 1954--and successfully exported to Japan in the form of LNG by Phillips-Marathon--it was the 1977 opening of the Trans-Alaska Pipeline System (TAPS) to the Prudhoe Ba y field that turned Alaska into a major energy supplier. Last year, Alaska averaged over 1.7 mbd of crude oil production, including over 1.6 mbd from the North Slope. Another 80,000 was added to the TAPS throughput with production from the new Kuparuk fie l d just west of Prudhoe Bay. By the mid-l980s, the $3 billion Waterflood Project will keep up Prudhoe Bay's production by maintaining reservoir pressure 3 through seawater injection. At the same time, Kuparuk production is expected to be at least 0.2 mbd. So production from the North Slope will come near to TAPS' capacity of 2.0 mbd this decade even if there are no new discoveries.

Estimates of North Slope reserves have been made for the wells and production in the Prudhoe Bay and Kuparuk fields. As of August 1980, Alaska estimated its "most likely" discovered resources at 10.2 billion barrels of oil and 35.4 trillion cubic feet (tc f) of gas: Under stricter.definitions, the American Gas Association (AGA) estimated (in January 1982) proven gas reserves to be 26 tcf for the North Slope and 31.9 tcf for all of Alaska.

These estimates are for known, existing fields. Though not confirmed by drilling, undiscovered reserves do exist. The AGA study estimated potential gas reserves for Alaska at 145 tcf.

The National Petroleum Council issued estimates (December 1981 for the North Slope and the Bering Sea using averages of other studies. They put undiscovered recoverable resources at a mean of 24 billion barrels of oil (high of 55 billion barrels) and 109 tcf of natural gas (high of 246 tcf). These estimates were based on current energy market conditions. Using historical changes in prices and technology, Heritage Foundation analysts estimate Alaska's potential oil reserves at between 48 and 124 billion barrels, with commensurate increases in potential gas reserves For comparison, recent annual U.S. consumption was about 5.5 billion barrels (bb ) of oil, and about 20 tcf of natural gas.

Note that 1 tcf of gas has a heat content of 1 quad 1,000 trillion BTU's, and is equivalent to 0.17 bb of oil RESTRICTIONS ON EXPORTS The two primary alternatives for carrying the oil to the lower 48 states were a proposed Trans-Canada pipeline, which was to deliver the oil to Midwestern refineries, and the TAPS to deliver the oil to a tanker terminal at Valdez, Alaska, from where it would be shipped south. Certa,in groups vigorously opposed the Trans-Alaska route , arguing that it would result in serious ecological degradation of the tundra (they were wrong and that the West Coast would not be able to absorb all of the Alaskan oil (they were right). There were also charges by consumer groups and representatives of Midwestern and Eastern states that the ultimate purpose was oil companies' desire to ship Alaskan North Slope oil to Japan.

When the TAPS bill was passed by Congress, two weeks after the beginning of the Arab oil embargo, concerns about domestic energy sec urity resulted in inclusion within the Act of tight limitations on domestic oil exported to noncontiguous nations such as Japan. The Act established two broad criteria to determine whether exports should be permitted 1) The President must make a finding t h at the exports would "not diminish the total quantity or quality of petroleum available to the United States and are in the national interest and are in accord with the Export Adminis I 4 tration Act of 1967 and (2) upon such a finding, the President is r equired to publish and report it to Congress, which then has 60 days during which it can veto exports by passing a concurrent resolution.

Additional restrictions were put on the export of oil to noncontiguous nations by the 1977 and 1979 amendments to the Export Administration Act (EAA). The 1979 change required that both houses affirm a presidential export proposal. Restrictions on exports have become so tight that it is'accurate to speak of an effective export ban for noncontiguous nations.

The reason fo r the increasing severity of export restrictions has been the continuing, though incorrect, assumption that exports would undermine national energy security. Clashes over the TAPS issue have only made the matter more complex and politically sensitive.

Pri marily because oil prices have increased from $2.50 to over $30 per barrel, the demand for oil has not increased as much as both government and industry officials anticipated. As a result, there is an oil surplus on the West Coast. Of the 1.6 mbd of Alask an oil leaving Valdez, only half is refined in Cali fornia. The other half is carried by tankers through the Panama Canal (or trans-Panama pipeline) or around Cape Horn to refineries on the East Coast, the Gulf Coast, and the Caribbean..

The maritime indus try has a vested interest in the transpor tation of Alaskan oil, because the Jones Act mandates that any cargo transported between U.S. ports be carried in U.S. bottoms and with U.S. seamen. Half of Jones Act traffic is devoted to Alaskan oil, and about o ne-quarter of Jones Act traffic would be affected if Alaskan oil were to be freely exported.to other countries by cheaper foreign flag tankers.

Another development affecting the maritime industry is the longstanding effort to build a west-to-east oil pipeline.

Northern Tier Pipeline Company, for instance, proposes to construct a pipeline from Port Angeles, Washington, to Clearbrook, Minnesota.

The project would cost an estimated $1.9 billion (1981 dollars).

This 42" diameter line ultimately would carry . 933 mbd. The original project was vetoed by Washington Governor John Spellman for environmental reasons. A new proposal would carry the oil around, rather than across, Puget Sound. Naturally, if such a line were to be constructed, the maritime industry wo u ld lose much of its Jones Act business The Clearly, the time is right for Congress to consider all the options available for Alaskan oil and gas, including the removal of restrictions on exports. 5 THE SECURITY ISSUE The maritime industry aside, the princ i pal objection to Alaskan exports stems from security concerns. In case of an embargo or oil cut-off, the argument goes, the U.S. must be guaranteed sufficient Alaskan oil to meet American needs. This argument was born in the period of the first Arab oil e mbargo.

It is no longer valid, if it ever was. The export of Alaskan oil would in no way compromise U.S. security. Indeed, it could enhance it, for the following reasons 1) The Inconsistency of Oil Export Restrictions There are no prohibitions regarding the expor t of oil pro ducts, such as gasoline and fuel oil. It seems strange, therefore that there should be a prohibition against exporting crude oil.

There also are no restrictions on exporting oil during emergencies to U.S. partners in the International Energy A gency. In fact the U.S. has an agreement concerning the sharing of oil supplies during emergencies. It has never been tested, but all IEA members are bound to honor it. Why then should the U.S. not permit the export of Alaskan oil and gas during nonemerge n cy periods 2) Ineffective Embargoes There are two kinds of potential embargoes. The first is an embargo declared against the United States without a production cutback. The second is an embargo coupled with a production cutback. The level of production is the critical factor; the simple declaration of an embargo would make little difference to the U.S. except for psychological pressure.

An embargo against the United States cannot be effective--and has never been effective. Oil imported from overseas comes from a number of different sources. If any one of these, or even a combination of them, should embargo oil to the United States, one or both of the following scenarios might develop: (1) the oil companies would sell the oil to another customer, say France , but oil destined to France from, say, Africa, would be diverted and shipped to the United States 2) oil from the countries involved in the boycott would come into a transshipping terminal, such as Rotterdam, and then be shifted to the U.S. under a swap a rrangement.

The point is that oil is a fungible substance. Its source matters little An embargo would be effective in one instance: if an adver sary imposed a naval blockade against the United. States along both coasts. Such action would be difficult for a ny power to mount. But if it were successful, it would interfere with the traffic from Alaska to California and certainly to the East Coast. Short of military actions by opponents, however, the U.S is immune to any simple embargo. 6 3 But what if the emba r go were coupled with production cutbacks Production Cuts and tge Market Price I such that simple swapping procedures would not be possible supply--now reduced--to the demand. Any production cutback thus would raise the world price, whether the production c utback were coupled with an embargo, or caused by an accident or by third parties, such as a war or sabotage. Everyone would have to pay the higher price in these circumstances--not just the United States. Indeed, the Alaskan oil exported would also comma nd the higher price (as would all domestic oil, in the absence of price controls).

There is often talk about countries l1outbidding1' each other during a supply crisis, but in a free market this would not be the case. As the price went up, those persons (n ot countries wishing to buy the oil would have to pay the higher price, and oil use by others would fall. This redistribution of oil would be entirely automatic, in response to normal market forces, not to government allocation efforts.

Some time could el apse before the new supply relationships were established following an oil cutoff. there could be dislocations and shortages just as there are shortages in retail outlets when the inventory is low. To soften such short-term disruption, the United States a nd other industrial- ized countries have provided for strategic reserves of petroleum.

The U.S. reserve is designed to replace 90 days of imports sufficient for orderly adjustments to take place--even if all imports were cut off If, on the other hand, only imports. from the Middle East were affected, then the stockpile could last well over six months). The release of oil from the U.S. stockpile (or from the stockpiles of other industrialized countries) would limit any price increase due to sudden interrupt i ons in production levels. If the supply interruption persisted, the oil market would reach equilibrium at a higher price; if it were only tempo- rary, there would be no long-term change in price--although, of course, stockpiles would be partly depleted In that case the market could take over and adjust the available I I During this time 4) Two Case Studies--1973 and 1979 What happened during past embargoes? In October 1973, producers on the Arabian peninsula declared an embargo and cut back their productio n scare people. The cutback in production, however, increased the price of oil, which eventually soared from about $3 to $12 per barrel The declaration itself did little but There was considerable market disruption in the United States in Spring 1974, char a cterized chiefly by long lines at gasoline stations reaction of the federal government, which sought to allocate gasoline and other oil products to achieve a "fair distribution.Il These lines were caused by the exaggerated 7 Yet federal bureaucrats had no more success than any other planners in trying to simulate the workings of the market, and misallocation inevitably followed. IlShortagesIl occurred widely in 1974 because well-meaning government interference with the market process was compounded by pric e controls on domestic oil movement of prices, there was no reason for demand to fall to the new, reduced level of supply--other than by the forced decline in consumption because of waiting in line. (The 1974 experience has been discussed and documented in some detail by a number of authors, for example, Professors Paul MacAvoy, H.A. Merklein, and others.) But nothing was learned. In 1979, the Department of Energy again put into effect an allocation system--with predictable results: long lines at gasoline s tations Without free Further proof that embargoes do not work is found in the events of November 19

79. When the U.S. Embassy in Teheran was occupied, President Jimmy Carter declared that the U.S. would no longer buy Iranian oil The action was, in effect, a self-imposed embargo--a boycott. Of course, nothing happened. The Iranian oil went elsewhere, and the U.S. bought oil from other sources.

There was no psychological impact either--perhaps because the word llembargoll was 'never mentioned.

One of the fi rst acts of the Reagan Administration was to remove price controls on oil. Congress still believed that an allocation system had to be instituted during emergencies and tried to force the White House to agree to such a system. In vetoing the bill, Preside n t Reagan explained why the market allocates more successfully than any bureaucrat or combination of bureaucrats. The U.S. Senate upheld the presidential veto It should seem clear that embargoes and production cutbacks do not work, when oil prices are deco n trolled and a large strate gic stockpile keeps prices from moving too high. An embargo threat is little more than a psychological tool that is effective only if the victim thinks it might be harmfu1.l Security Benefits from Alaskan Exports There are certa i n security benefits that should be taken into account when contemplating export of Alaskan oil were to be permitted, the oil companies holding concessions on the North Slope would certainly increase production and put more oil into the world market. A con s ervative estimate is that the additional output could amount to 0.5 mbd (more optimistic esti mates exceed 1 mbd), in addition to the 1.6 mbd now being supplied through the pipeline.2 exceed 0.5 mbd of oil equivalent If exports The liquid natural gas expo rts could It should be noted that President Reagan ousted Libyan diplomats from Washington, and Libya made no effort to institute retaliatory action in the oil market against the United States; they also know that embargoes don't work.

If production rises above 2 mbd, the pipeline's capacity can be increased at relatively little cost 8 Putting more oil and gas onto the world market would be very beneficial to the United States. Not only would it improve the trade balance by about 15 billion per year, and m a ke money for the Treasury, Alaska, and the stockholders of American oil com panies, but it would weaken the power of OPEC. As American oil captured a share of the world market, it would decrease consumer dependence on OPEC oil. It would also put downward p ressure on the world price by limiting what the OPEC cartel could sell If U.S. exports to Japan were increased by 1 mbd, for instance Japan could reduce its imports from Mexico by a like amount, and the U.S. could replace 1 mbd of Middle East imports by m o re Mexican oil. Clearly U.S. security would be enhanced, Mexico would gain through lower transportation costs, and even more important, the world oil price would probably be lowered by approximately 5 percent. Since OPEC is currently earning about 200 bil lion a year in revenues, this would reduce the oil bill of the importing countries, including the United States, by about 10 billion a year.

ECONOMIC BENEFITS AND COSTS OF ALASKAN EXPORTS The effective ban on exports has led to an established market of Ala skan North Slope (ANS) crude oil on the Gulf and West Coasts. About half of North Slope production is used on the West Coast; the rest is shipped to the Gulf and East Coasts.on U.S. flag tankers. The exportation ban, the Jones Act, and the lack of a west- east U.S. oil pipeline mean there is no other marketing option--except not selling oil at all. Eliminating the export ban would open up other, more profitable markets for the surplus.

For an estimate of the scale of the export potential, market prices may be approximated using the price of Persian Gulf (i.e Saudi Arabian) oil, plus the costs of its'transportation to each market. The llwellheadll price which producers receive for their crude oil is the market price (say, in Houston) minus transporta tion co sts. These costs vary with shipping distances, tanker size, and other factors.

Jones Act requirements set U.S. tanker rate s well above world tanker rates. Table 1 gives some relevant tanker rates Table 1 CRUDE OIL TRANSPORTATION COSTS barrel Departure Port Alaska Va ldez Persian Gulf Destination Port West Coast Gulf Coast Japan West Coast Gulf Coast Japan Tanker Costs 1.47 4 .00 51 1.50 2.03 96 9 The different rates mean that ANS producers receive different wellhead prices for their oil, depending on its destination.

Using market prices established by Persian Gulf oil, ANS producers would net back $2.00/barrel more for their W est Coast shipments than for the Gulf Coast shipments. They could use such a price advantage to drive the West Coast price down and expand their market share by discounting. In fact, there is already increasing although incomplete, evidence of some West C o ast "discounting.I If the ban on exports were lifted, ANS producers could increase the wellhead prices of their currently Gulf Coast-bound shipments by $2.42 per barrel (i.e 1.97 0.96-0.51) by chang ing the destination to Japan and taking advantage of low e r shipping costs. At the same time, of course, a change in the destination of ANS crude would reduce the glut in the West Coast market, and West Coast crude oil prices could rise by as much as $2.00 per barrel. So there would be an increase in the netback to the ANS and to the local California producers, who were previously forced to lower their prices to match the ANS competition.

Another factor in the equation would be the reduced shipping costs associated with the Alaska-West Coast route. The reduction in the demand for U.S. tankers because of the reduced Alaska to West Coast trade and the absence of Jones Act requirements on exported oil would mean more competition along the American coastline--further raising the ANS netback. (For computation ease, it is assumed here that Alaska-West Coast shipping costs would fall by $.42 per barrel, from $1.47 to $1.05, although larger decreases have been forecast in wellhead prices resulting from these factors is given in Table 2 A summary of total possible increase s Table 2 ESTIMATED INCREASES OF CRUDE OIL WELLHEAD PRICES AFTER THE LIFTING OF THE OIL EXPORT BAN barrel Originating Export Ban No Export Ban We 11 head Market Port Increases Conditions Destination Wellhead Destination Wellhead with Export Port Price Port Price Ban Removed No California West Coast PG 1.50 West Coast PG 1.50 00 Alaska West Coast PG 03 West Coast PG I45 .42 Discounting Alaska Gulf Coast PG 1.97 Japan PG 45 2.42 Full California West Coast PG 50 West Coast PG 1.50 2.00 Discounting (by Alaskan A laska West Coast PG 1.97 West Coast PG 45 2.42 Producers in Alaska Gulf Coast PG 1.97 Japan PG 45 2.42 California PG=Persian Gulf price 10 ANS oil shipments to the eastern U.S. amounted to more than 0.8 mbd in 1982. 0.82 mbd was used for calculations of g r oss wellhead revenue increases if the oil.were exported to Japan and 1.1 mbd for California production). The wellhead increases would be between $804 million per year and $1,391 million per year for ANS production, and up to $803 million per year for Cali fornia production receive all of these benefits. Alaskan royalty oil and severance and income taxes would take over 32 percent of ANS increases.

The federal government would take 7 percent in corporate income taxes and 52 percent in windfall profit taxes f or most current production. California oil producers' increases in revenue would also be taxed. Analysis suggests that the division would leave ANS producers with 8.27 percent of the increases or between $66 million and $115 million per year revenue incre a ses and its division are given in Table 3 But the private producers would not The gross yearly wellhead Market Conditions Table 3 ESTIMATES OF GROSS REVENUE INCREASES AND ITS DIVISION millions/year Gross Yearly Increases Gross Wellhead Fede ra 1 Revenue P r oducer State Taxes Prof its Taxes No Discount 804 66 262 475 Full Discount Alaska producers 139 1 115 45 4 822 177 California producers 803 626 Total 2194 999 Increased revenue to oil producers and the governments does mean some costs to others. Initially the wellhead gains could come at the expense of the tanker owners and crews, the new Panama pipeline, and other groups involved in the transportation of the Alaskan oil to the Gulf Coast. The West Coast refiners and their consumers would also lose the pre s ent discount. And some tax revenue would be lost from those companies and indivi dual But these losses would occur in any event if the proposed I Another cost to the federal government could be for the acquisition of U.S. tankers whose loans are guarantee d under Title XI. A U.S. Maritime Administration working paper put the one-time net government cost at $593.8 million that all of the tanker tonnage is displaced permanently so the actual government cost would be less But this figure is based on the worst- c ase projection This is unlikely 11 West-to-East oil pipeline were built. In any case, such losses would be surpassed by the savings in transportation, the new commercial opportunities of the export trade, and the long-run benefits of a freer and more effi cient market.

ALASKA GAS TRANSPORTATION OPTIONS Through the middle 1970s, the development of Alaska's hydro carbon' resources focused primarily on the state's enormous oil reserves. For nearly thirty years, a small amount of natural gas has been produced i n the southern portion of the state for export to Japan in the form of LNG; butthe huge gas reserves of the Alaskan North Slope remain untapped which transports North Slope.oi1 to the port of Valdez, gives the gas reserves associated with that o,il a new i mportance. The gas has been reinjected into the formation from which it was drawn but reinjection provides at best a temporary solution. After a time, this practice results in a reduction in oil field pressure and an accompanying reduction in the-amount o f oil that would ultimately be recovered. Moreover, since up to one-third of the gas is consumed in the'process of reinjection the technique carries a high energy penalty. Still, absent a means of transport ing the gas, the only other option was to burn it off, or Itflareif it--as industry experts call the practice The opening of the TAPS The Alaskan Natural Gas Transportation Act of 1976 also contains export limitations. Section 12 states that "the President must make and publish an .express finding that s uch exports will not diminish the total quantity or quality, nor increase the total price of energy available to the United States."

The situation with respect to natural gas is somewhat similar to the oil case. The Prudhoe Bay field contains the largest d iscovered gas reserves on the North American continent; it represents 10 percent of proved reserves and more than a yearls supply for U.S. consumers.4 Several companies studied ways to move the natural gas to markets. Proposals were filed with the Federal Power Commission (now the Federal Energy Regulatory Commission), beginning in 19

74. Of the various proposals, the one finally selected, the Alaska Natural Gas Transportation system (ANGTS would move gas by pipeline from the North Slope to the Midwest thr ough Canada. However, ultimately the very high cost.of the pipeline, now estimated to be in excess of $40 billion has made the.proposa1 impractical. With higher wellhead prices for natural gas, and with a limited deregulation approaching in 1985, a great deal of gas has been developed in the lower 48 states.

Alaskan gas competitive in price with gas from the lower 48.

The various provisions of the Act can do nothing to make The appraisal of undiscovered probable ANS reserves is'of the order of a 10-year s upply 12 I One of the proposals submitted to the Federal Power Commis sion (FPC) was by the El Paso Alaska Company to transport natural gas from Prudhoe Bay through approximately 800 miles of 42 pipeline, to a gas liquefaction plant and terminal located o n Prince William Sound at Point Gravina, Alaska. There the gas would be converted to LNG and shipped via cryogenic tankers to Point Conception near Santa Barbara, California. However, the LNG could be shipped just as easily to Japan, Korea, Taiwan, and oth er users in the Pacific Ocean basin--but more cheaply from the Kenai peninsula than from Point Gravina. The amount would be on the order of 2.8 billion cubic feet per day or approximately 1.0 tcf per year, worth approximately $6 billion per year.

The Alask a Gas Transportation System (ANGTS) faces problems with financing, cost overruns, and doubts over the marketability of the relatively expensive Alaskan gas in the lower 48 states which are awash with far less expensive conventional'gas. As a result, Alask a ns have begun to reexamine the alternatives avail able to them to determine if some other approach to the problem of marketing their oil and gas might be more sensible principal options currently under consideration include The To continue to pursue finan c ing for the ANGTS project, in hopes that the use of innovative rate structuring and the decline of interest expense might make Alaskan gas more competitive at some future date To select an alternative means of transporting North Slope gas in hopes that it will prove less expensive again making the gas more competitive in the lower 48 states To determine whether Alaskan producers should abandon the notion of marketing the gas in the lower 48 and instead focus on the export market To examine ways of using th e gas within the state to establish some sort of manufacturing base.

Determining the best solution for the North Slope gas is As the patterns of this change become clearer, it is The policymakers currently examining Alaska's options doubly difficult becaus e the oil and gas market, both in the U.S and internationally, is undergoing a period of rapid and dramatic change evident that the traditional view of the gas market is no longer valid. must thoroughly understand the evolution that is taking place, as it will affect fundamentally the economics of those options.

THE CHANGING NATURAL GAS MARKET I1Shortage1l into Surplus It is easy to forget that, as recently as five years ago the conventional wisdom held that the United States would soon 13 run out of natur al gas. Throughout the first. half of the 1970s interruptions in natural gas deliveries on the interstate market increased, and gas reserves committed to that market diminished.

By the winter of 1976-77, the situation had reached crisis propor tions, as r egions of the Northeast and Midwest faced massive gas shortages that .threatened economic chaos. Policymakers were quick to point to these shortages as evidence that the exhaustion of America's natural gas reserves was imminent. This view was embraced wit h particular enthusiasm by officials of the past Administration, many of whom were convinced that all of the world's resources were on the verge of exhaustion Against this background, Alaska's enormous North Slope gas reserves were very tempting to policym akers who believed the United States faced the prospect of running out of oil and gas.

The high cost of utilizing these reserves seemed of little conse quence.

As early as 1979, however, evidence began to appear that the dire a ssessment of gas reserves, widely taken as axiomatic, was grossly overstated. The first sign was the appearance of a so-called gas'bubble-a large volume of gas that Ilfound'l its way into the market. According to the prevailing view of reserves it should n ot have appeared. Analysts tried to explain it as merely a temporary "market anomaly" that would soon be absorbed leaving the U.S. once again with the shortage. The bubble however, did not disappear; the shortage did. In fact, in 1981 for the first time i n more than a decade, the U.S. added more new natural gas to its reserve base than it used. In 1982, instead of a shortage, there was a surplus of natural gas estimated at fully 15 percent. The surplus is currently so great that gas companies, which once c o uld not serve all of their existing customers, are now seeking new ones. But more important, the unexpected availability of natural gas has taken place at prices far below those needed to make North Slope gas economic. Should natural gas prices be decontr olled this year, even greater volumes of gas priced below an economic level for Alaskan production under current circumstances are expected to find their way into the market.

Growina ComDetition Competition from natural gas produced in'the lower 48 states is not the only factor limiting the marketability of Alaskan gas in the United States. The import of large volumes of natural gas from Canada and Mexico will also provide stiff competition. Both Mexico and Canada are experiencing great economic pressure t o move their gas into the U.S. market. Until recently, both coun tries had priced gas at levels that limited its attractiveness to U.S. consumers. But these pricing policies--which seemed strange ly similar--were simply the product of the seller's market f o r energy existing in the middle to late 1970s. With the crumbling of OPEC, the steady decline of world oil prices, and energy conservation, both Canada and Mexico have had to rethink their 14 policies. As a result, both nations are now willing to make pri ce concessions. Canadian gas, for instance, sells in the United States at only 65 percent of its authorized price. Despite this reduction, the volume taken is down from just a few years ago.

For Mexico, whose gas reserves far outstrip those of either the U nited States or Canada,'increased sales of both oil and natural gas are critically important. The country's financial collapse was only a warning signal. The need to feed and find employment for its burgeoning population makes it imperative for Mexico to e xpand sales of its oil and gas. The United States is its most logical market, and so competition from Mexico seems likely to be an even greater barrier to the marketing of Alaskan gas in the lower 48 states than competition from domestic or Canadian gas p roducers.

Competition from conventional sources of natural gas, whether domestic or foreign, is not the only factor affecting the market ability of Alaskan gas to lower 48 consumers. Of equal importance will be competition from other fuels, and especially from residual fuel oil, or "resid" as it is commonly termed. Since the largest share of natural gas is consumed in the industrial boiler market industrial consumers effectively determine the price at which gas is sold from the fact that most industrial bo i lers were modified to accommodate a variety of fuels during the 1970s, when natural gas supplies were subject to the federal regulators. Many of these boilers can burn either natural gas or resid. As a result, the latter's price effectively caps the price at which natural gas can be sold. At present, resid sells for roughly the equivalent of gas priced at between $4 and $4.50 per thousand cubic feet mcf). But residual fuel oil prices are expected to decline further in the future because.of oversupply Part of their ability to influence gas prices stems Given the intense competition, and the probable future price trends in the natural gas market of the lower 48 states, it seems unlikely that North Slope natural gas will be competitive.

Therefore, the current price structure must be modified, or an alternative market sought, if Alaska's hydrocarbon resource is to be utilized and further developed.

Reshaping the ANGTS Project One of the reasons Alaskan gcs will be so expensive in the first few years after Alask a Natural Gas Transportation System ANGTS) comes into service is that loans made for its construction must be repaid. If the repayment schedule can be renegotiated to stretch the payments over a longer period, the selling price of the gas might be reduced . The effectiveness of this approach will hinge on two major factors ture the pipeline's financing call for the payment of interest The first.is the interest rate. Since most plans to restruc15 the interest rate and capital repayment schedule (even if defe rred will have to be such that the final price of Alaska gas is compe titive.

The second factor, of course, is the prevailing price the lower 48 gas market. Just what this might be in the future is hard to say, but one thing is certain: if Alaskan gas expe cts to compete, its current projected cost of $10 per mcf (in 1982 dollars, equivalent to $60 oil) must be reduced. Recent attempts to market deep gas at a similar price have failed. In fact several pipeline companies recently informed a group of deep gas producers that the lines would pay no more than $5 to $6 per mcf for deep gas. This seems to be compelling evidence that Alaskan gas will have to sell in the $5 range if it is to compete with alternative sources of gas.

POSSIBLE ALTERNATE ROUTES One possi ble solution to the North Slope gas dilemma would be an alternate means of transportation. Everything from huge atomic submarines to a variety of pipeline routes has been suggest ed, but the best alternative to the ANGTS appears to be the so-called All-Al a ska Pipeline, proposed several years ago by the El Paso Company, which would be built parallel to the existing oil pipeline. At the time the proposal was first put forward estimates of its cost included funds to build a California LNG terminal and purchas e eleven LNG tankers. Adjusted to current dollars, the original cost estimates for the All-America route compare favorably with the $23 billion estimate for the Alaskan segment of the ANGTS pipeline A simple inflation escalation of the original estimates f o r the All-America route, however, does not give an accurate probable cost figure for the project. There are numerous LNG tankers available on the present world market for their scrap value. Others have been converted for bulk commodities such as grain. So the current low cost of LNG tankers should be built into revised cost estimates. This factor alone would imply that the All-Alaska route should be supported, if financing for ANGTS fails to materialize. But the All-Alaska route has another, possibly more i mportant, advantage over ANGTS it does not restrict Alaskan gas to the domestic market, and thereby opens the prospect of Alaskan gas exports Some have been sold just A committee appointed by the Governor of Alaska in January 1983 has recommended the cons truction of such a 820-mile pipeline to carry natural gas from Prudhoe Bay to the coast, where it would be liquefied and shipped to Japan. The scheme is a viable alternative to ANGTS.

The committee proposes that the 36-inch line follow the route of the Tra ns-Alaskan oil pipeline as far as Fairbanks, 16 where it would continue west to the Kenai Peninsula. Cost of the line is estimated at $14.6 billion (as-spent dollars). The liquids would be removed at a $2.5 billion conditioning plant on the coast billion. Total costs would be $25.4 billion in current dollars 14.3 billion in 1982 dollars=-a far cry from the $43 billion total anticipated for ANGTS The liquefaction plant would cost an estimated $8.3 The committee suggests that the project be built in three ph a ses, with revenue from the first phase providing the cash flow for financing the rest of the project. The line's initial capa permitting export of 4.8 million tons/year of LNG. In the second phase, starting in 1990, the line would carry 1.75 billion CF/da y of gas, and LNG production would be 8.9 million tons. In the third phase, set for 1992, the levels would be 2.8 BCF/day of gas and 14.5 million tons of LNG projected to exceed 110,000 bbl/day by 1992. city, beginning in 1988, would be 950 million CF/day o f gas Natural gas liquids production is ALASKAN NATURAL GAS AND THE EXPORT MARKET A worldwide trend toward greater use of natural gas has been well established. The most logical export markets for Alaskan gas are the nations of the Pacific Rim, especially Japan. The Japanese already import small amounts of LNG from Alaska. Signi ficantly, Japan is moving aggressively to make use of LNG, and recently contracted with Indonesia for major purchases of the fuel. As a result of this policy, Japan has the necessa r y LNG terminals in place, and already owns LNG tankers. Hence a pipeline processing facilities, and liquefaction plant would be the only U.S. infrastructure necessary to market LNG to Japan. Japan might even be willing to help finance the project decision would have to be made quickly; otherwise Japan might find supplies elsewhere However, the A number of economic advantages, beyond the obvious revenues would be associated with the export of Alaskan gas to Japan.

First, such trade would go a long way towar d reducing the current U.S./Japan trade imbalance. Secondly, it would reduce Japan's dependence on fuel imported from the politically unstable Persian Gulf, and thereby greatly enhance the world's energy security.

Most important, by directly reducing the world's oil consumption Alaskan gas exports could also help to keep world oil prices down It would seem, therefore, that exporting Alaskan gas to foreign markets would be advantageous--for Alaska and for the world in general. These advantages would not ma terialize if the This location would incur less environmental risk than Point Gravina which would have cut through the Chugach range the travel time to Japan.

It would also shorten 17 gas were marketed only within the U.S lower 48 would not displace foreig n oil; domestic usage would have no effect on the U.S. balance of'payments; and building a pipeline to transport gas domestically would be a far more expen sive proposition than building a pipeline to transport gas for foreign markets. Exporting Alaskan g a s would therefore appear to be the optimum solution to the North Slope gas dilemma, from a national standpoint Alaskan gas sold in the DEVELOPING AN ALASKAN EXPORT STRATEGY I Gas exports could provide the catalyst for establishing a stable industrial base in the 49th state. Throughout its history Alaska's economy has been characterized by sharp cycles. The primary reason for the erratic behavior of the Alaskan economy has been its dependence on the extraction and export of raw materials. Whether the Klondi k e Gold Rush or the Prudhoe Bay oil find, Alaskan resources went to the lower 48 for finishing, along with potential jobs and revenues from further processing has been unavoidable. Alaska's total population numbers less than half a million, and roughly hal f of its residents live in small communities scattered across a vast expense of wilderness.

Construction costs can often range as much as 50 percent above those in more temperate climates. Nonetheless, modern technology could make local processing of some portion of the state's hydro carbon resources a realistic possibility. If processing operat ions proved to be economic, an industrial base to supply continuing employment, and economic stability would finally materialize.

But the shape of such a processing industry must be tailored to the state's limitations and advantages. Although Alaska's clim ate and small population are obvious limitations, its remoteness from America's industrial heartland is a drawback only if the U.S domestic market is the export goal. If Korea, China, Japan, and the rest of the Pacific Rim became the principal market, Ala s ka's position would actually be advantageous. Furthermore, by using gas exports as a means of underwriting the cost of a pipeline to bring natural gas down from the North Slope, the other products produced from the fuel could more than offset the competit i ve disadvantage caused by the state's higher construction costs i In many respects, the removal of raw materials for processing Urea and ammonia rank high on the list of products that might lend themselves to in-state fabrication for the export market. Th ese commodities are the basic components of the ferti lizers needed so desparately in the People's Republic of China.

Whereas any attempt to market fertilizers produced in Alaska in the lower 48 would be doomed to failure because of the enormous cost of tr ansporting the products to market, shipment to the Far East would entail a relatively easy haul. Moreover, the commodi ties could be moved in bulk, further reducing their cost. Most important of all, they could be produced in automated plants using highly skilled, well-paid workers. In sum, the production 18 of fertilizer components would seem ideally suited to the state's unique charactertistics.

LNG is also well suited to Alaska. Like fertilizer produc tion, modern LNG facilities are highly automated and employ a small number of skilled workers. Moreover, a pool of experienced LNG workers already exists in the state because of the LNG facility in operation on the Kenai peninsula.

CONCLUSION The legislative restrictions on Alaskan oil exports had their origin in the fear of an oil cutoff by overseas producers.

It is now clear that oil, as a fungible substance, cannot be embargoed from the United States. Any 'supply shortfall must be shared by all consumers through the world oil market, which will raise th e world price of oil. Now that its price has been freed in the U.S oil will be imported at the higher price in case of a supply shortfall, but Alaskan oil also will be sold at the same higher price. ultimately borne by the U.S. taxpayer. Shipping Alaskan o il to the East Coast leads to great economic waste, as would the con struction of a special pipeline to the lower 48 states Blocking the export of Alaskan oil imposes great costs The optimum solution for North Slope gas appears to be its export as LNG, us ing a pipeline paralleling TAPS. The construc tion of such a system would also encourage the use and manufacture in Alaska of urea and ammonia fertilizer (for export to the Far East restrictions, so that Alaskan oil and gas can be freely exported.

This mak es sense economically and from a foreign policy perspec tive as well by increased American energy sales to the Japanese higher return for producers, will act as a powerful incentive for Alaskan oil producers to develop more production. more oil and gas on the world market, such exports would reduce the need for OPEC oil and apply downward pressure on the world oil price--to the benefit of industrialized countries and oil importing developing nations alike The sensible option for Congress would be to remove U.S.-Japan relations would be enhanced considerably The possibility of exports of additional oil, bringing a By putting S. Fred Singer Senior Fellow Milton Copulos Policy Analyst David J. Watkins Research Economist