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Weekly UpdatesAlaskans have long supported the idea of value-added manufacturing, of making something from natural resources within the state rather than exporting the resources in the raw. Manufacturing creates jobs, business for local firms and tax base for local communities. It also allows Alaskans to buy the products made here without having them shipped back from out of state.
It's an idea that is relevant whether the resource is logs, fish, minerals or oil and gas, but it is in oil and gas that there has been the greatest success in making the vision a reality.
Natural gas provides the basis for two large industrial plants on the Kenai Peninsula, and crude oil is used to manufacture fuel products in refineries near Keuai, Fairbanks and Valdez. For the future, many Alaskans believe natural gas liquids delivered through a new gas pipeline built from the North Slope could provide the raw material for petrochemical plants in Interior or Southcentral Alaska.
The process can't be force-fed, however. Government's track record in creating industry is poor, as the state's effort to create agriculture in the Interior in the 1980s and a high-tech seafood plant in Anchorage in recent years illustrate.
It isn't as well known, but the state's efforts to build a petroleum-based manufacturing industry in the 1980s were a disaster. A consortium called Al-petco promised to build a petrochemical , plant in Valdez in return for receiving state-owned royalty oil. The consortium got the oil but no plant was ever built.
Despite these failures, there also has been success in creating Alaska value-added manufacturing, and in one case, a state policy' decision created an industry. Agrium Corp.'s ammonia and urea fertilizer plant and a liquefied natural gas (LNG) plant owned by Conoco-Phillips Alaska Inc. and Marathon Oil Co., both located on the Kenai Peninsula, are examples of creative innovations by industry in 1969, when they were built. Oil refineries near Kenai and Fairbanks, and more recently Valdez, is a case where initiatives were led by industry but given crucial help by the state in making state-owned royalty crude oil available.
UNCERTAINTIES AHEAD
A storm cloud on the horizon, however, is that the very industries cited as successes-fertilizer, LNG and fuels refining-now face major uncertainties because of the economic conditions that made them successful changed. The Agrium and ConocoPhillips plants, for example, were built on the basis of Cook Inlet gas supplies that were in surplus and inexpensive in 1969. However, there is no longer a surplus of gas in the Southcentral region and it is getting more expensive.
Agrium Corp. faces the most serious immediate challenge with its fertilizer plant near Kenai because prices for Cook Inlet gas are increasing and it will be increasingly difficult for the plant to buy gas at a price it can afford.
IN COMES COAL
To deal with this, Agrium is engaged in an effort to recast the economic foundations of its business. It hopes to replace natural gas as a chemical feedstock to the plant with a synthesis gas made from coal that would be barged from a planned coal mine at Beluga, on the west side of Cook Inlet. The project involves building a coal-gasification plant alongside the existing fertilizer plant. It is one of the first projects in the nation to gasify coal for a chemical plant, and because of that it is a risky but potentially rewarding solution to the gas supply problem. If the project goes forward, the plant would have a long-term feedstock at a price lower than what natural gas is expected to cost. Agrium currently has gas supply contracts through October 2006, and hopes to secure an extension to those contracts. If the contracts are not renewed, Agrium plans to suspend operations in November and restart if the coal-gasification project can be done.
WHERE'S THE GAS?
The ConocoPhillips-Marathon LNG plant in Kenai also faces challenges, mainly because of the dwindling gas supplies in the Southcentral region.
This casts uncertainty over whether the plant's export permit will be renewed when it expires in 2009, and because the plant, in continuous operation since 1969, may soon need major replacements and upgrades of its facilities.
To get an extension of its export license, ConocoPhillips and Marathon will have to demonstrate that the gas they will convert to LNG for export is surplus to local needs. Given the declines in reserves in the existing gas fields, this may be difficult to do.
There is potential for new natural gas discoveries in the Southcentral region, however, and there is also discussion of a spur pipeline that would bring North Slope natural gas to Southcentral from a planned large-diameter pipeline built through Interior Alaska to the Lower 48 states. If either or both of these developments occur, the Kenai LNG project could continue to operate.
OIL WOES
Alaska's oil refineries also face challenges, although none are as endangered as the fertilizer and LNG plants. There are four refineries in the state, including Tesoro Alaska Petroleum Co.'s plant at Nikiski, near Kenai; the Flint Hills Resources plant at North Pole, near Fairbanks; and two smaller refineries operated by PetroStar Inc. at North Pole and near Valdez.
The refineries manufacture a variety of petroleum products for the Alaska market, mainly jet fuel, gasoline and diesel.
The refining industry is one case where a state policy action was successful in creating an industry. Following development of commercial oil fields on the Kenai Peninsula and Cook Inlet, entrepreneurs began looking into the possibility of a refinery on the Kenai Peninsula to serve local fuel markets. Cook Inlet producers, however, had their own refineries or longtime customers in California and were reluctant to sell crude oil to the new refinery, which made it problematic. Tom Kelly, the state Commissioner of Natural Resources at the time, took an action to solve this problem. Since the offshore oil fields in Cook Inlet were on state submerged lands, the state held a one-eighth royalty. Kelly exercised the state's option to take its royalty in-kind, in the form of oil, and sell it to the new refinery. When that happened, Tesoro Petroleum Corp. took over the project, developed the refinery and has operated it since.
THE SAGA CONTINUES
Tesoro has continued to invest in upgrades to its refining business, including construction of a pipeline to carry fuel products to Anchorage. There was a time a few years ago, however, when rising costs and problems in getting crude oil brought the company close to closing the plant. The decision was made to continue operations, however.
Tesoro does face problems at the Kenai refinery, however. The plant was built on the basis of refining the relatively light, low-sulfur crude oil produced in Cook Inlet. As oil production from the Inlet has declined, Tesoro has had to buy heavier, higher-sulfur North Slope crude oil in Valdez and ship the crude through Prince William Sound and up Cook Inlet to the refinery near Kenai. The special requirements for tug escorts of tankers in Prince William Sound that applied to the big North Slope producers also applied to Tesoro's shipment of crude oil, and those costs were added to challenges of refining a heavier crude oil at the Kenai plant.
DIESEL FUEL TO MARKET
Today Tesoro relies on a variety of sources of crude oil, and supplements oil from Cook Inlet and the North Slope with oil imported from overseas, from places like Sakhalin, in Russia's Far East, and Indonesia. The refinery still faces a fundamental issue in that, in its location, it can no longer be easily supplied with crude oil from local sources.
In a new signal of confidence, however, Tesoro announced last year that it would invest in new facilities to remove sulfur at the refinery so that diesel products can meet the new federal Ultra-Low Sulfur (ULS) fuel rules. Under an arrangement with Flint Hills Resources, Tesoro will also supply ULS diesel to that company for its customers. Since the new federal rules will soon apply to most diesel fuel used in Alaska, Tesoro's decision in invest in desulfurization equipment means that its plant near Kenai will be the major supplier of diesel fuel for most of Alaska outside the Southeast region.
THEN THERE'S FLINT HILLS
The Flint Hills refinery near Fairbanks faces a different set of issues, including some created, ironically, by the state of Alaska. It was also a state decision to make royalty crude oil available from the state's royalty share of North Slope production that made this refinery possible. As the trans Alaska oil pipeline was being built in 1975, North Slope producers were as reluctant as were Cook Inlet producers in 1968 to sell oil to an independent refinery. As it did in Cook Inlet, the state decided to take some of its oil in-kind and sell it to the refinery, which was being developed by Earth Resources, a Dallas-based company. With a supply of crude oil assured, the refinery was built and has operated since, although under several owners, including Mapco, Williams Companies and most recently Flint Hills Resources.
The North Pole refinery is still mostly dependent on state royalty oil for its crude oil supply, and a new issue that has developed for Flint Hills is a dispute over the tariffs charged by the trans-Alaska oil pipeline owners for shipping crude oil through the pipeline. The price that Flint Hills pays the state for crude oil is largely set by the value of crude oil on the North Slope plus a premium paid to the state and an intra-state transportation charge to Fairbanks. Since Flint Hills also owns a small percent of the TAPS pipeline, it would typically contract with its pipeline subsidiary to ship the royalty crude oil to the refinery near Fairbanks.
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