Sunday, February 20, 2011

Kenai LNG plant set to close this spring

ConocoPhillips, Marathon to mothball facility due to weak market conditions; plant has been shipping to buyers in Japan since 1969

By Eric Lidji
For Petroleum News

With news that ConocoPhillips and Marathon Oil plan to mothball their liquefied natural gas plant on the Kenai Peninsula this spring, Alaska is left standing on a bridge without a keystone. Since making its first shipment in 1969, the Nikiski export facility has held the Cook Inlet natural gas market together, even as that market began to change with age.
In its first few decades in operation, the facility justified the production of large Cook Inlet gas fields for local use by providing a large market outside Alaska. In the 2000s, it provided backup for utilities as local deliverability declined. Now, the plant could theoretically be converted to an import facility to bolster declining local production.
ConocoPhillips and Marathon made their decision based on market conditions, but those conditions aren’t easily delineated. As recently as last summer, the owners felt confident enough about the Asian market to apply for another two-year extension of their export license, but it appears the companies could not secure contracts through April 2013.
The reasons abound. The plant used to be the sole supplier to Japan, but now supplies only one half of one percent of that market. The LNG shipments leaving Alaska were once the largest in the world, but are now among the smallest. Supply contracts between Alaska and Japan used to run for 15 years, but have recently run for two-year terms.
Now, the future of the plant is uncertain.
“Right now, our intent is to get the plant preserved. We’re going to be evaluating options,” Dan Clark, ConocoPhillips’ manager of Cook Inlet assets, told Petroleum News. Those options range from closing the plant, to reconfiguring it, to selling it.
The bad news ripple effect
While Asian markets don’t appear to be mourning the news, the closure’s impact on Alaska markets will be wide ranging because of the unique role the LNG facility plays.
Once the plant is mothballed in April or May, it will jeopardize more than 100 direct and indirect jobs and tens of millions in taxes and royalties for state and local governments.
With the coldest months over by then, Southcentral should be no worse off than expected for this winter, but peak demand will be a critical issue next winter. Although Enstar Natural Gas, through Cook Inlet Natural Gas Storage Alaska, is building a new third-party storage facility, it won’t be ready until 2013. Even once it comes online, it won’t make up for the combined loss of the plant and declining Cook Inlet production.
“This storage facility is not intended to be a be-all end-all solution for Cook Inlet,” said John Sims, a spokesman for Enstar Natural Gas, the largest consumer in Alaska.
While Enstar expects to start getting firm shipments from the North Fork unit starting in March, those deliveries won’t fill the shortfall Enstar is facing in the coming years.
“That insurance policy that we had is lost,” Sims said. “And that’s a big one.”
Some wells to be shut-in
Until storage is available, ConocoPhillips will have to shut-in some wells once local demand drops in the summer. Because of the aging nature of Cook Inlet reservoirs, it’s unknown how those wells will produce once ConocoPhillips brings them back online.
(However, ConocoPhillips will continue to operate the Tyonek platform at the North Cook Inlet unit. While that unit primarily feeds the export facility, it is not isolated from the grid. North Cook Inlet and Beluga River will now be used to fill local contracts.)
The closure could also dampen exploration in Cook Inlet.
Through a deal with the state, ConocoPhillips and Marathon Oil bought third-party natural gas at their export facility, creating a market for explorers. Even though Alaska is craving natural gas, the local market might still not be large enough to support all of the potential production from the Cook Inlet leaseholders currently interesting in drilling.
The loss of an overseas market could also jeopardize plans to bring North Slope natural gas to Southcentral. Various plans for an in-state pipeline require an “anchor tenant,” like the export facility, to keep residential and commercial customers from bearing the full cost of the project. Meanwhile, an “all-Alaska line” from Prudhoe Bay to Valdez is based on exporting LNG, although the larger volumes available from the North Slope could change the market dynamics, allowing Alaska to better compete against other basins.
A plant in gradual decline
The closure of the plant is not entirely unexpected.
The last decade brought fundamental changes to the operation of the plant.
Phillips Petroleum and Marathon Oil built their facility at the dawn of the global LNG trade, only a few years after Great Britain began importing it from Algeria in 1964.
The Kenai plant started its life as a pioneering infrastructure system: a liquefaction plant in Alaska and a re-gasification plant in Japan, the two largest LNG tankers ever built and the new offshore Tyonek platform along with new pipelines and wells to support it.
The facility originally operated on long-term contracts with two Japanese utilities, Tokyo Electric Power Co. Inc., and Tokyo Gas Co. Ltd. The first export license ran from 1969 to 1984 with a five-year extension. The second license ran from 1989 to 2004.
Starting in the mid-1990s, the idea of shipping gas overseas caused heartburn at home.
In 1996, Phillips and Marathon applied for a five-year extension, through 2009, but local utilities and producers argued that continued exports would cause shortages in Alaska.
The U.S. Department of Energy approved the extension, but the issue reared its head again when ConocoPhillips and Marathon asked for a two-year extension through 2011.
The State of Alaska only backed the request after the companies agreed to certain concessions, like meeting local needs, increasing drilling and buying third party gas.
Utilities supported last extension
Last summer, when ConocoPhillips and Marathon requested another two-year extension, though 2013, the changing nature of the Cook Inlet changed the nature of the opposition.
Aside from a group of Democratic lawmakers worried about local supplies meeting local demand, the request got wide support from utilities, producers and the State of Alaska.
That happened for two reasons. First, ConocoPhillips and Marathon asked only for more time to ship volumes already approved for export. Second, storage and deliverability became more immediately pressing issues in Southcentral than production.
In the past decade, though, the plant and Cook Inlet began to show their age.
A 2006 report estimated that the plant would need significant investments to continue operating beyond 2011. ConocoPhillips recently put the cost of that investment in the range of several hundred million dollars. Except for an expansion in the mid-1990s, the plant, including its two turbines, has been in service since operations began in 1969.
(Reconfiguring the plant for imports would create additional costs.)
In 2007, Agrium mothballed its nitrogen fertilizer operations on the Kenai Peninsula after years of declining gas purchases because it could no longer secure a supply contract.
In April 2009, ConocoPhillips and Marathon cut their tanker fleet in half, reducing the volume of shipments. “Looking back on it, that was sort of the first step,” Clark said.

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