Hearings and Business Meetings
May 1, 2006
SD-366 Energy Committee Hearing Room 02:30 PM
Mr. Bill Boycott
General Manager, Agrium U.S.A., Inc.
AGRIUM BLUE SKY PROJECT
United States Senate
Committee on Energy and Natural Resources
Industrial Gasification Provisions of the Energy Policy Act of 2005
William A. Boycott
Kenai Nitrogen Operations
Agrium U.S. Inc.
May 1, 2006
Good afternoon Mr. Chairman, Members of the Committee. Thank you for the opportunity to appear before the committee to discuss the Energy Policy Act of 2005 and its applications to industrial coal gasification. My name is Bill Boycott. I am the General Manager of the Agrium U.S., Inc. Kenai Nitrogen Operations (KNO). I am here to address how provisions of the Energy Policy Act of 2005 (EPAct 05) could potentially benefit Agrium’s Blue Sky coal gasification project.
KNO is a manufacturing facility located in Kenai, Alaska, that relies upon natural gas as a feedstock to produce ammonia and urea fertilizers. Like many U.S. fertilizer manufacturers, we are unable to assure ourselves of a reliable, long term, reasonably priced supply of natural gas the primary feedstock required for fertilizer production. As a result, KNO actively is evaluating the feasibility of constructing a coal gasification facility to produce the necessary hydrogen and carbon dioxide feedstocks for fertilizer production. As part of our feasibility evaluation, we have analyzed all of the provisions of the Energy Policy Act of 2005 that potentially could facilitate investment in and development of the Blue Sky coal gasification project. We have determined that two particular provisions – the Internal Revenue Code §48B industrial gasification tax credit and the Title XVII loan guarantee authority – could be of significant value to the project, depending on how they are implemented.
Agrium is a leading global producer and marketer of agricultural nutrients. Our wholesale division manufactures, markets and distributes over 8 million tons of nitrogen, potash and phosphate fertilizers each year from 12 production facilities in the United States, Canada and Argentina. Agrium is also one of the largest agricultural retailers with more than 500 retail centers in 31 States and more than 30 stores in South America. These facilities are staffed by more than 8,000 employees worldwide.
KENAI NITROGEN OPERATIONS
Agrium acquired the Kenai facility from Unocal Agricultural Division in 2000. The facility was constructed in 1968 and expanded in 1977. It is the second largest nitrogen complex in North America with the capacity to produce in excess of 2.0 million tons of fertilizer per year when operating at full capacity. KNO is one of the largest manufacturers in Alaska, employing 230 employees when operating at full capacity. It is one of Alaska’s few value added industries – for every one thousand cubic feet of natural gas used, more than $9 in total economic output is generated.
COOK INLET NATURAL GAS SUPPLY & DEMAND
The Cook Inlet region of Alaska has a variety of established industries that were built around an abundance of low cost natural gas. The local natural gas supply is finite. The once large reservoirs of natural gas have been depleted, the historic pricing structure has not promoted exploration for new reserves, and demand, principally for electric power generation and commercial and residential uses, has grown significantly. Gas dependent industries have ceased operations and the cost of natural gas to electric utilities and their customers, as well as end-users of the fuel, has risen dramatically. This combination of factors has created a situation in which we are unable to contract for a long-term reliable supply of natural gas.
KNO has been confronted with ever deepening supply shortages since 2002 and acquiring and maintaining a steady supply of natural gas has been a challenge. Because of these shortages, long-term natural gas contracts are not possible and we now operate on year-to-year gas contracts. Under these short-term arrangements we have been unable to acquire sufficient natural gas to meet our needs and, as a result, reduced our operations to 50% in 2005. This resulted in a reduction of 85 of our 230 full-time employees. This January, during a cold spell that significantly increased residential and commercial demand for heating, we were forced to shut down the entire operations for almost two weeks. See Appendix A for a depiction of the reduction in gas use at KNO over the last four years as a result of lack of available supply.
We only have an assured supply of natural gas for another six months, until October 31, 2006. If we are not successful in arranging additional supplies beyond that date we will be forced to shut down the plant on November 1, 2006. Closing the KNO facilities will have a devastating effect on the Kenai Peninsula area of Alaska -- 230 high paying skilled jobs will be eliminated and another 420 indirect jobs will be lost along with the more than $100 million KNO injects into the Alaska economy each year. It will also add to the long list of domestic fertilizer production facilities that permanently have shut down due to feedstock pricing and supply issues.
Mr. Chairman, I should explain here why the Alaska natural gas pipeline, which has been the subject of much discussion in this Committee over the last several years, is not a solution to KNO’s dilemma. As you know, that pipeline will access the 35 trillion cubic feet of known natural gas reserves on Alaska’s North Slope. To achieve the economies of scale necessary to finance the extraordinary capital costs of such a project, the pipeline needs to transport a very large volume of gas (4.5 billion cubic feet per day) to a market that can absorb such a large volume. The residential, commercial, utility and industrial consumers of the lower-48 states comprise the market for North Slope gas. As a result, none of the vast North Slope gas reserves will be available for consumption in the State of Alaska until a project to deliver that gas to lower-48 consumers is constructed. Even then, a small “spur” pipeline of approximately 340 miles would have to be constructed at an approximate cost of $750 million to deliver North Slope gas from the main trunk line to the Kenai Peninsula. Under the best-case scenario, KNO would not have access to Alaska North Slope natural gas before 2016. We can not last that long on current Cook Inlet supplies and need to find another solution if we are to keep the KNO facility operational.
THE BLUE SKY PROJECT
To maintain operations at the KNO facility, Agrium must find a long-term supply of feedstock to substitute for natural gas. Fortunately, multi-year supplies of undeveloped Alaskan coal can be found some 25 miles from the KNO facility. Given the proximity of these coal reserves, coal gasification may be the answer to providing the long-term feedstock that is essential to keep KNO operational.
In 2005, KNO initiated a two-year feasibility study to examine the use of gasification technology utilizing Alaskan coal and other appropriate indigenous fuel resources to produce the hydrogen, nitrogen and CO2 we need to manufacture fertilizer. We are calling the gasification project the Blue Sky Project. This project would utilize commercially offered gasification technology and capitalize on unique market conditions and strategic partnerships to provide a long-term commercial alternative to natural gas reliance in the Cook Inlet region of Alaska. Our engineering work to date has led us to the conclusion that our project will not be designed as an IGCC facility. Rather, we plan to construct a state of the art gasification facility as well as a traditional pulverized coal-fired power plant, using the latest in emissions control technology. The power plant will provide needed electricity to the Kenai fertilizer facility as well as coal-fired power to Alaska residences and other Kenai industries. If we move forward, the plan is for the facility to be commissioned in 2011. To date, Agrium has committed $3.3 million to this study.
The benefits of the Blue Sky project are substantial: we could retain the annual production of 0.8 million tons of ammonia and 1.3 million tons of urea, along with associated jobs, community support and business opportunities for Alaska companies. In addition, the project could provide low cost power for use in the population centers of Alaska, which currently rely heavily on natural gas fired generation. Blue Sky also could capture and supply excess CO2 to recover up to 300 million barrels of Cook Inlet oil through enhanced oil recovery. The project also provides the anchor demand necessary to develop a world-class coal mine. This will in turn assist in the economic development of other Alaskan communities and companies by supplying an alternative for by-products and demand for services.
Given the cost and magnitude of Blue Sky, the current view is that the ultimate business structure will include several strategic partners with an interest in the overall structure or perhaps individual components with strong contractual ties. Agrium could bring nitrogen production experience and use its existing marketing capacity and network to market the product. Usibelli Coal Mine Inc. (UCM) brings to the project over 60 years of experience as the only operating Alaskan coal mining company. The proven experience of Agrium and UCM, combined with the excellent operating performance of the Kenai Nitrogen Operations, is a strong foundation on which to build Blue Sky. Ultimately this project will need additional equity participants to be successful. These participants could include power producers, gasification technology providers, and oil and gas companies interested in enhanced oil recovery.
COMPONENTS OF THE BLUE SKY PROJECT
See Appendix B.
The Blue Sky Project envisions constructing two Shell coal gasification trains to produce the hydrogen, nitrogen, steam and carbon dioxide required by KNO. The process dries and pulverizes delivered coal conveying it to the gasifier where the coal reacts with sub-stoichiometric amounts of pure oxygen to form a gas stream rich in carbon monoxide and hydrogen (syngas). This gas is reacted with water in shift converters where the carbon monoxide (CO) is shifted into carbon dioxide (C02) and hydrogen (H2). The CO2 is then removed from the syngas along with sulfur and other impurities. Finally a pure hydrogen stream is supplied to the KNO nitrogen plant where it will be combined with pure nitrogen from the air separation unit and then converted into ammonia (NH3).
Air Separation Unit
The air separation unit (ASU) processes air directly from the atmosphere to generate the nearly pure oxygen required by the gasification block. The air separation unit is the largest power consumer in the envisioned complex due to the large compressors required to liquefy and separate pure oxygen and nitrogen from the air. The gasifier block requires pure oxygen to process the coal, all of which is supplied by the air separation unit.
The nitrogen plant takes pure hydrogen from the gasifier and pure nitrogen from the air separation unit and combines them in a high-pressure converter to form ammonia (NH3). Some of the ammonia is then refrigerated and sold into the global market. The remaining ammonia is combined with carbon dioxide (CO2) in a high-pressure reactor to form urea (NH2CONH2). The urea is sold as the highest grade of solid nitrogen fertilizer produced for agricultural and industrial markets.
The Blue Sky Project will require approximately 100 MW of electricity to power the gasifier block, the ASU and the nitrogen plant. Since there is not sufficient power generating capacity in the Kenai area to supply this amount of electricity, the Blue Sky Project envisions building a pulverized coal-fired facility to supply power to the Project. These units also have the potential to generate additional power for sale into the electrical grid that serves the population centers of the Kenai Peninsula, Anchorage and the Matanuska Valley. The project will use best available control technology (BACT) for emissions control. We are also considering the application of additional technology that could further reduce emissions.
Enhanced Oil Recovery
CO2 not used in the fertilizer manufacturing process may be captured and sold to Kenai area oil producers who will inject it into the aging Cook Inlet oil fields to produce an estimated 300 million barrels of additional crude oil from these fields. The potential daily oil production increase is estimated to be as much as 25000 barrels per day. The use of CO2 to enhance the recovery of oil from existing fields has been proven in many fields across North America. The unique properties of CO2 allow this gas to dissolve into the remaining heavy oil in the reservoir and change the oil’s flow characteristics. The result is that more oil is able to flow from the reservoir, be recovered and CO2 emissions to the environment are reduced. The Department of Energy has sponsored two studies that have identified the high potential for oil recovery in the Cook Inlet fields.
The Blue Sky Project could utilize up to five million tons of coal per year. The long-term nature, volume and location of this demand can support the development of new coal mining opportunities in Alaska. UCM is evaluating options associated with utilization of coal from the Beluga coal fields on the west side of Cook Inlet as well as from the existing coal mine at Healy, Alaska. UCM is also evaluating the transportation of coal to the Blue Sky facility. A draft report is expected by early summer 2006. Phase 2 of the project will continue to expand on this and will narrow the scope to identify the most viable strategic option. See Appendix C.
EVALUATING THE ECONOMICS OF THE BLUE SKY PROJECT
Our preliminary estimates are that the total cost of the Blue Sky Project will be between $1.5 and $2 billion. Determining whether Agrium and its partners should invest this amount of capital in the project is a challenging and expensive undertaking.
Keep in mind that KNO is in a substantially different position than most other U.S. industrial firms that are reliant on natural gas and that are evaluating a gasification project. These other firms basically have three options from which to choose – continue current operations using high priced natural gas for energy and feedstock; convert to coal or another alternative source of energy and feedstock by installing gasification technology; or cease U.S. operations and move overseas. Because KNO does not have an assured supply of natural gas at any price, we in effect have only two options – develop a coal gasification capability or permanently close the facility.
Our limited options do not mean, however, that we can construct the Blue Sky Project regardless of the economics. We still must market our ammonia and urea competitively. And, as production of fertilizer shifts from traditional industrialized nations to the areas of the world with low cost stranded natural gas, these areas are setting the world price. Thus, we are using very sharp pencils to determine if the Blue Sky Project makes sense.
KNO is evaluating the economics of the Blue Sky Project through a two-phase feasibility study. Phase 1 began in October of 2004 and consists of preliminary engineering, commercial and environmental feasibility assessments. We anticipate having the results of Phase 1 within the next four to six weeks. If the results of Phase 1 are positive, we will advance to Phase 2, in which we will develop a Front End Engineering and Design (FEED) package. We hope to complete Phase 2 by late 2007 at which time we will be in a position to make the “go / no go” decision on the Project.
We expect the total cost of Phase 1 to approach $ 4.0 million and that Phase 2 will cost at least another $28 million. Mr. Chairman, for the Committee to fully understand the difficulty in advancing one of these projects to the construction stage and the role EPAct 05 plays in that regard, it is important for the Members to appreciate that these Phase 1 and Phase 2 expenditures are “at risk” dollars. In other words, if we determine at the end of Phase 2 that the Blue Sky Project is not commercially viable, Agrium and its partners will have spent nearly $32 million and all we will have to show for those dollars are a number of studies and analyses. A key component of these plans and any decisions to put more dollars at risk is the certainty of the federal government’s assistance if it is offered. Suffice to say at this point, if we determine that federal assistance is crucial once the studies are completed, then it is imperative that the federal assistance be there.
ENERGY POLICY ACT OF 2005
A significant component of our Phase 1 work has been a comprehensive analysis of the EPAct 05 to determine whether any of the programs authorized by the Act could improve the commercial viability of the Blue Sky Project. We have concluded that there are two programs that could be beneficial – the industrial gasification tax credits authorized by §48B of the Internal Revenue Code and the innovative technologies loan guarantee program authorized in Title XVII of EPAct 05. These programs have the potential to provide significant benefits to the Project. However, the potential value of these programs will be determined by the manner in that they are implemented by the Executive branch.
That only two of the multiple programs authorized by EPAct 05 are relevant to our Blue Sky Project may be surprising to some. It was somewhat of a surprise to us. One of the basic reasons for this is that a significant majority of the EPAct 05 programs are applicable only to research and development projects, and are not available for commercial scale projects. While we believe it is appropriate for the federal government to support long-term research and development, we would suggest that, if development of capital intensive commercial scale projects utilizing innovative energy technologies is a priority, the Congress may want to consider focusing additional resources on assisting such projects to get over the financial risk hurdles that confront them.
Before discussing the two specific programs, we would like to note that we have found EPAct 05 to be beneficial in an intangible way. It has been our experience that the enactment of EPAct 05 has sent a strong signal to government agencies, particularly the Department of Energy (DOE), and the commercial market place that supporting and promoting the development of these projects is a high priority of the Congress. This signal, in turn, has resulted in a more favorable environment for projects such as Blue Sky. It does not mean that we can ignore commercial realities, but it does mean that we have a greater opportunity to present the case for such projects.
Under IRC §48B, the Blue Sky Project could be eligible for a maximum of $130 million in tax credits. Our preliminary analysis shows that these tax credits could improve the rate of return on investment in the project by up to one half of one (0.5) percent, which could be the difference between going forward and not. However, the manner in which the Internal Revenue Service (IRS) proposes to implement the tax credit authority creates some fundamental uncertainties, not only the Blue Sky Project, but also for other industrial gasification projects. The guidance issued by the IRS calls for DOE to determine which projects should receive the tax credits through a competitive process. Since the total amount of credits is currently limited to $350 million, it is highly likely that only two or three projects will be chosen to receive the credits. Applications for the credits must be submitted by June 30, 2006 with the final decisions regarding which Projects qualify for the credits to be made by November 2006. Given that our Phase 2 detailed study will be just underway on June 30, we will, by necessity, have to submit an application for the tax credits that is somewhat contingent on the outcome of that analysis. We already have amassed a great deal of reliable information but the timing for tax credit applications may be a factor that works against the Blue Sky Project. While we understand the IRS’s desire to expeditiously implement the §48B program, the proposed schedule does not match well with the timing of the Blue Sky Project and other projects being evaluated in the United States.
Mr. Chairman, I understand that you played a significant role in the development of the Title XVII loan guarantee program. Thank you for your foresight. The policy behind Title XVII – that the federal government should share some of the risk of commercializing capital intensive projects such as Blue Sky – has the potential to be the most beneficial and far-reaching contribution of EPAct 05 to the development of innovative energy technologies. However, this potential may not be realized if the Administration takes an overly restrictive approach to implementation of the program.
First, there does not seem to be a uniform commitment within the Executive branch agencies to this program. While DOE appears to be anxious to move forward and lay the groundwork for implementation, it is our understanding that the Office of Management and Budget (OMB) has not yet approved the funding necessary to staff and operate the program. Second, once the program is up and running, every project that hopes to take advantage of a loan guarantee must address the issue of the “risk premium” for the guarantee. Unlike other federal loan guarantee programs, Title XVII permits the DOE to collect funds for the project seeking a loan guarantee to “cover” the probability that the project will default on the guaranteed loan (so-called “risk premium”). Other guarantee programs require that federal appropriations be provided to cover the risk premium in order to support the issuance of a guarantee. While the self-funding device is a creative means to initiate the Title XVII program without impacting the federal budget, everything depends upon how the premium amount is determined.
DOE, in consultation with OMB, will determine the amount of the required risk premium by estimating the probability of default on the guaranteed loan. This default probability determination will be the most important factor in whether the Blue Sky Project (or any other gasification project) will benefit from a Title XVII loan guarantee. If DOE and OMB employ a very conservative approach designed to protect the federal government from virtually all risk, then the premiums for the loan guarantees are likely to be so large that either a federal appropriation will be infeasible or payment of the premium by the applicant will more than offset whatever financing cost benefits are gained by the loan guarantee. As an example, if the total cost of the Blue Sky project were $1.5 billion and we sought a loan guarantee for the maximum 80% of the cost allowed by Title XVII, the guaranteed amount of debt would be $1.2 billion. If the default probability were determined to be 10%, the risk premium would be $120 million. In light of the current federal budget situation, it is doubtful that Congress would appropriate this amount for one project. In the alternative, KNO and it partners would have to provide the $120 million thus increasing the overall cost of the project by 8 percent. This added cost is likely to make the project uneconomic.
In addition to the risk premium issue, we understand that DOE is considering requiring "risk sharing" from lenders. It also appears that DOE has an expectation that the federal loan guarantee will only cover certain negotiated risks during project execution as opposed to providing 100% guarantee coverage on 80% of total project cost as authorized by Title XVII. Likewise, it appears that DOE may limit the applicability of the guarantee to certain identified periods of time rather than the life of the construction loan and/or the term of the permanent financing for a project.
As noted earlier, the policy behind Title XVII is that the federal government will share some of the risk in order to move these new technologies into the marketplace. If DOE and OMB administer the program to eliminate virtually all of the government’s risk exposure then the objective of the Title XVII program will be lost. We would encourage the Congress to provide special oversight to this portion of Title XVII implementation.
Finally, I would note that we have not yet determined whether using the Title XVII loan guarantee program would force Agrium to comply with other federal requirements, specifically the Davis Bacon prevailing wage provisions or some type of domestic content requirements. Having to comply with one or more of these types of requirements will simply add to the overall cost of the project and diminish whatever benefit is gained from the loan guarantee.
Thank you again, Mr. Chairman and Members of the Committee for this opportunity to present our Blue Sky Project. As you see, these projects are massive undertakings that involve a great deal of risk. Enactment of EPAct 05 has created an environment that is more favorable toward industrial gasification projects than in the past and certain programs authorized by the Act have the potential to improve the commercial viability of some projects. However, unless these programs are implemented in the manner that you intended they will not provide sufficient support to stimulate or sustain value added industrial manufacturing in the United States.