In the final hours of the 2014 legislative session the Alaska state Legislature passed a bill providing incentives for the in-state refining of crude oil.
Introduced in early April by Gov. Sean Parnell in response to the February announcement by Flint Hills of the closure of its refinery at North Pole, the bill would enable refineries to obtain tax credits for certain types of infrastructure expenditure. The bill also encourages the sale of Alaska oil to in-state refiners by establishing a procedure whereby a state oil lessee can use the price of the oil it sells to a refinery to set the value of the royalty oil that it owes to the state.
Significant debate
The rushed passage of the bill through the Legislature during the last week or so of the session provoked some significant debate. But, with the prime purpose of the bill being to avert the closure of two refineries operated by Petro Star along the trans-Alaska pipeline, following the closure of the Flint Hills refinery, legislators eventually opted to pass the bill, albeit in a somewhat altered form relative to the governor’s original version.
There are four commercial refineries currently operating in Alaska: the Tesoro refinery at Nikiski on the Kenai Peninsula; the Flint Hills refinery at North Pole on the trans-Alaska pipeline; the Petro Star refinery, also at North Pole; and another Petro Star refinery on the trans-Alaska pipeline in Valdez. However, the anticipated closure of the Flint Hills refinery by early June would preclude that refinery from using the tax credits unless a new owner purchases the refinery and continues operating it.
The terms of the bill preclude the tax credits from applying to refineries operated by the oil producers on the North Slope, for the producers’ own use.
Up to $10 million
The final version of the refinery bill, which also incorporates the authorization of the continued sale of state royalty oil to the Tesoro refinery, allows a tax credit of 40 percent of qualified refinery expenditures, but with a maximum credit of $10 million per refinery per year. If a tax credit exceeds a refinery’s state tax liability, the refinery can request payment of the unused portion of the credit as a refund from the state.
Expenditures that qualify for the tax credit consist of the installation or modification of infrastructure for the in-state manufacture or in-state transportation of refined petroleum products or petroleum-based feedstock.
The governor’s original version of the legislation provided for a maximum tax credit of $20 million per year for each refinery, with only part of that credit having to relate to infrastructure expenditures. The final version of the bill reduced that maximum credit to $10 million and limited the credits to just infrastructure expenditures. The final version also includes a provision requiring a refinery operator to refund a prorated portion of credits received in the nine years prior to a refinery closing, if the refinery closes.
Liquid fuels only
During the passage of the bill through the Legislature, lawmakers had considered expanding the scope of the legislation to include liquefied natural gas facilities and Agrium’s Kenai Peninsula fertilizer plant. But the final version of the bill only applies to the manufacture of liquid fuels such as gasoline, diesel and jet fuel.
Parnell had tagged the refinery incentives legislation onto an existing bill extending state royalty oil sales to Tesoro. And, quizzed by lawmakers about why the administration had introduced such potentially contentious legislation at such a late stage in the legislative session, Joe Balash, commissioner of the Alaska Department of Natural Resources, explained that Flint Hills’ announcement of the closure of its North Pole refinery had caught the administration by surprise in February.
“It landed with a thunderclap,” Balash told the House Finance committee on April 11.
Domino effect
Balash said that he became extremely concerned about the potential domino effect of the Flint Hills closure. In particular, Flint Hills and Petro Star share the $4.5 million annual operating costs of the pipelines that deliver crude oil from the trans-Alaska pipeline to the North Pole refineries and that carry residual, unused crude oil components back from the refineries to the pipeline. Currently Flint Hills picks up 85 percent of those costs, while Petro Star pays 15 percent: With the Flint Hills refinery closed, Petro Star would be saddled with the entire $4.5 million bill, Balash said.
And that raised a question over whether the Petro Star refinery could remain in business.
“I had understood that 2012 was a very, very thin margin for Petro Star, and that 2013 was breakeven at best,” Balash said, adding that he had called the Petro Star CEO and had been unable to obtain any assurance as to the company’s future. Petro Star is owned by Arctic Slope Regional Corp.
Economic challenges
Balash told the Senate Finance committee on April 19 that, apart from issues raised by the Flint Hills closure, refineries on the trans-Alaska pipeline currently face two major economic challenges: the relatively high price of Alaska crude oil and the cost of payments made into the pipeline’s quality bank.
The oil price issue arises from a recent divergence between the price of North Slope crude delivered to the U.S. West Coast and the price of West Texas Intermediate crude. With the price of the Alaska oil rising significantly above that of oil at the Texas trading hub, refineries using Alaska crude have difficulty in competing with refineries from elsewhere, with products such as jet fuel imported to Alaska having the potential to undercut the price of the local product.
The quality bank, the other source of angst, provides the mechanism whereby the owners of oil shipped on the trans-Alaska pipeline compensate each other for the differences in value of different crudes from different North Slope oil fields. The refineries on the pipeline return the unused components of the crude they process back into the line and then make payments into the quality bank, to compensate the oil shippers for the way in which the refineries have diluted the overall oil quality.
The Federal Energy Regulatory Commission, or FERC, regulates the operation of the quality bank. There is a current FERC hearing in which the refiners are challenging the level of the quality bank payments.
Troubling consequences
Balash told Senate Finance that the closure of the Petro Star refineries could have some extremely troubling consequences, given that Petro Star supplies jet fuel to military bases in Alaska; jet fuel for the international airports in Anchorage and Fairbanks; and marine diesel to the U.S. Coast Guard. Curtailment of local Alaska jet fuel supplies for the military could, for example, jeopardize the future deployment of the F35 fighter in Alaska, Balash said. And, with commercial cargo aircraft becoming ever more fuel efficient, the loss of local fuel supplies could render the operation of air-freight hubs in Alaska uncompetitive, he said.
As one means of collecting royalties on the production of its oil, the state accepts actual barrels of oil from oil producers, rather than taking royalty payments in dollars. When asked what it would take to keep the Petro Star refineries open, Petro Star had suggested a discounted price on the purchase of some of this royalty oil from the state for use in the refineries, Balash said. But the state rejected this option, recognizing that a discounted price for Petro Star would inevitably lead to discounted prices for other royalty oil purchasers, thus leading to a loss of perhaps $150 million per year in royalty oil sales, he said.
The state also considering allowing tax credits for quality bank payments by the refineries but rejected that idea on the grounds that it would have been viewed as unfair by refineries not connected to the trans-Alaska pipeline, Balash said.
Instead the state came up with the combination of measures in the bill that eventually was presented to the Legislature. Part of the concept in that bill is that the tax credits would support Petro Star in modifying the oil transportation infrastructure between its North Pole refinery and the trans-Alaska pipeline, to reduce the transportation costs, Balash said.
Cost to the state
The House Finance committee grilled Balash over the cost to the state of the tax credits specified in the bill.
Balash said that the cost to the state of the tax credits should be more than offset by some avoided cost to the state, should the refineries close. For example, loss of additional royalty and production tax value that accrues to the state as a consequence of quality bank payments by the refineries could amount to around $50 million per year, he said. Moreover, the state would lose the opportunity to sell royalty oil to the refineries — the sale of royalty oil in this way results in higher state revenues than the collection of royalties in cash, he said.
One question that came up in House Finance was the possibility of encouraging infrastructure upgrades through low-interest loans from the Alaska Industrial Development and Export Authority, or AIDEA, rather than through tax credits. Balash later told Senate Finance that he had discussed with AIDEA the possibility of refinancing the pipelines between the trans-Alaska pipeline and the refineries, but that the prospect of financing an enterprise without some surety that it is going to remain in business “raised a lot of red flags.”
