Friday, August 4, 2017

How gullible is Alaska ...

A rash of news articles and commentaries this week are focusing on oil company BlueCrest's announced decision to "pause" activity at its Cook Inlet Cosmopolitan Unit while it arranges a new round of financing.

From all of the headlines and commentary many seem to think that the project has been cancelled, and that it's the state's fault that it has. 

For example, this is how the Alaska Dispatch News headline read, "Oil company says it likely can’t continue to drill unless state pays tax credits," KTVA's lead was "BlueCrest Energy halts project on the Kenai, says state credits are the cause,"

In response, many are calling for the Governor and legislature to reverse course and "honor" the state's alleged "commitments." For example, the Alaska Chamber has started running a Facebook ad campaign based on that very theme.

But for those that read further down -- and you have to read all the way to the 26th paragraph, fourth from the bottom, of the ADN article to get there, but for those that do -- you soon realize this really is about something else: BlueCrest only has hit a "pause" while it deals with a financing issue.
"Johnson said BlueCrest officials decided on Tuesday to pause drilling after they realized they can't secure a loan fast enough to drill a third well.
"'There's a limit on how quickly you can borrow tens of millions of dollars,' he said. 'It's not easy to do.'"
So, what is really going on here?

It's all about financing options.  Blue Crest, like any profit-maximizing enterprise, wants to arrange the lowest cost financing it can.

Financing from the State of Alaska through the cashable oil tax credit program is the cheapest of all -- it doesn't cost the company a thing:  no interest, no equity stake, no obligation to repay if things don't work out, no obligation even to continue drilling if you decide it's not worth it.  It's just a straight up, no cost subsidy, designed to artificially lower the cost of exploration and development in Alaska (and in doing so, subsidize Alaska's high cost oilfield service sector) by transferring part of the cost to the state.

The financing does come with one risk, however.  As we have discussed previously on these pages, under the program the participants share with the state the risk of lower oil prices and production levels.  If the state's revenue from oil production taxes -- which are largely driven by oil price and production levels -- decline, so does the extent of the state's obligation to contribute to the fund that cashes out the credits.

In short, if lower oil prices result in the state receiving reduced revenue from oil production then the state has the right -- and indeed, from an overall fiscal policy perspective, some would argue the obligation -- to stretch out the rate at which it pays the credits.  See "Oh good lord,"

The companies participating in the program knew -- and by participating in the program, accepted -- that risk from the outset; the terms have been in the statutes since the program first began.

But that doesn't mean they agreed not to try to push the envelope a little -- or a lot -- if the risk of lower oil prices, and thus stretched out payments, materialized.

And as those risks have materialized, the companies -- BlueCrest is only the latest -- have done exactly that: tried to push the envelope.

Many companies, like many consumers, treat financing terms as negotiable.  They respect the terms if the future stays as anticipated (or turns out better for them than) at the time the financing was negotiated.

But if things change adversely, then companies try to change the terms of the financing as well.

During the current oil downturn banks and other sources of debt financing have become accustomed to approaches from oil companies seeking a variety of changes in the terms of their loans, such as extensions of their repayment obligations or even the conversion of all or a portion of the debt (with the attendant obligation of repayment) to some sort of equity.

What is going on here with BlueCrest is the Alaska version of that.

As the tie between the terms of the cashable oil tax credit program and oil price levels has become a constraint, BlueCrest and others are attempting essentially to renegotiate the terms of the financing by pushing the state to contribute additional funds to the program earlier than (i.e., in advance of) when required.

As BlueCrest's Johnson admits (albeit in the 26th paragraph of the ADN article), it's not that the companies don't have other financing options, it's just that they cost more and take some time to arrange.

If instead Alaska can be convinced essentially to waive the terms of its program, so much the better.  Zero cost financing always trumps other options.

And unlike dealing with other sources of financing (which always extract some sort of fee for changing the terms of their deals), the costs involved in such efforts appear to be minimal.  All that it appears to require to persuade at least some (like the Alaska Chamber
) is a dash of extreme verbal hyperbole (about no one ever "trusting" Alaska again) and some lobbying fees.

Other, commercial sources of financing quickly would see through -- and even more quickly dismiss -- the hyperbole.  The response would be essentially, "let's see, the terms of the program explicitly give us the right to do what we are doing. You are way off base (i.e., "nuts") to claim that it's 'untrustworthy' to utilize those rights when the risks we explicitly agreed to share materialize."

And they would be immune to political lobbying.

But BlueCrest and others are hoping the state will react differently to the hyperbole (what some call "puffing" or in other contexts, "alternative facts") and lobbying. 

Maybe Alaska is that gullible -- some in the business community and legislature, see, 
appear to be -- but we certainly hope those making the final decisions aren't.