August 20, 1999

Governor Tony Knowles
Office of the Governor
P.O. Box 110001
Juneau, Alaska 99811-0001

Dear Governor Knowles:

As part of its ongoing assessment of the potential impacts of the BP Amoco-ARCO merger, the Joint Special Committee on Mergers has heard the concerns of Alaska residents and business groups, has had discussions with FTC officials, and most recently has reviewed various documents filed by BP Amoco as part of the Hart-Scott-Rodino pre-merger notification process.

As you know, many Alaskans are very concerned about the economic effects of this merger and the loss of competition on the fields and in the pipeline, resulting in the increased vertical integration of production, transportation, and marketing of our oil. It is our duty to ensure that Alaskans' best interests are protected through a thorough review of the merger and consideration of conditions that must be met if the merger is to proceed.

The Attorney General has requested that we share our conclusions by mid-August. At this point, the committee feels it is premature to have conclusions. However, we have identified a number of concerns and will not endorse any formal position on the merger until these concerns have been addressed.

These concerns fall into two broad categories, the merger's impact upon state revenues and its impact upon competition. We discuss each of these categories below.

Revenue Impacts

We believe that ARCO and BP Amoco must provide assurances that, at a minimum, the merger will be revenue neutral for the State of Alaska. In its recent Circular to Shareholders, BP Amoco states that the merger should result in annual pre-tax savings of $1.0 billion annually. Given that the proposed merger will significantly reduce costs and increase profitability, Alaskans ought to share in this benefit through guarantees of a positive revenue impact. There are a number of related issues under this category.

I. Royalty Oil

It is common knowledge that the methodology used by ARCO to report the value of its crude oil for royalty purposes is more favorable to the state than that used by BP Amoco. What may be less well known is the magnitude of the disparity. The figures provided by the Department of Natural Resources for the month of June, 1999, show that ARCO reported a well head value, before field costs, of $12.42 per barrel on Prudhoe Bay production for royalty purposes, whereas BP Amoco reported a value of $9.67. This difference of $2.75 per barrel on all of ARCO's production is obviously very significant to state revenue, and therefore a concern for the committee. We believe BP Amoco should guarantee that the ARCO methodology will continue to apply to ARCO sourced production post-merger and consider negotiating a revised methodology for new discoveries.

II. Taxes and Royalty Impacts

In order to come to a conclusion about the revenue impact of the merger, the committee requests an analysis of the oil production tax, the gas production tax, oil and gas royalties, oil and gas property tax, oil and gas corporate property tax, and the general corporate income tax over the next five years. We have attached a detailed request that the committee sent on June 25th to Attorney General Botelho. As you know, we have not received a response from the Attorney General on these important questions.

III. Tariffs, Tankers, and West Coast Crude Prices

In a recent newspaper article, Commissioner Condon and members of his staff were quoted as saying the merger would not have much impact on the state's revenue because the major fights with the oil companies have been resolved and now provide a means for the state to assure itself that the companies are playing by the rules. We request that the department share with the committee the analysis supporting those conclusions. This analysis should go hand in hand with an explanation of the basis for the wide discrepancy between ARCO and BP Amoco's royalty valuations requested above. It seems likely that the basis for this discrepancy is a combination of several factors including differences in valuation of the crude oil at its West Coast market, tanker charges, and tariff charges. In order for the committee to reach an informed conclusion, we feel a number of questions must be answered as part of this analysis.

With regard to TAPS, are the BP Amoco and ARCO TAPS tariff filings each currently at the TAPS Settlement Methodology (TSM) ceilings? Are they expected to remain at ceiling post-merger? Even more fundamentally, is the TSM, which was negotiated in a significantly different environment, still a fair methodology in today's oil environment where Exxon acquires Mobil and BP Amoco acquires ARCO? As we understand the TSM, the state's goal was to devise a methodology which would encourage competition, giving the pipeline companies an incentive to charge a tariff below the TSM ceiling. Will a merged BP Amoco-ARCO have any incentive to charge rates lower than the TSM ceiling? Regardless of predicted incentives, we should pursue guarantees regarding fair TAPS rates as part of any final negotiation.

Tanker charges raise virtually the same questions as the TAPS tariff. Are the ARCO tanker deductions less than the BP Amoco deductions, and, if so, why? Will the recent reorganization of the tanker trade between Alaska and the West Coast prohibit BP Amoco from increasing its tanker deductions? If not, what assurances should the state obtain to make sure that BP Amoco will not use its integrated position to increase tanker deductions, resulting in a reduction in the valuation of crude on the North Slope and less revenue for the state?

The Merger's Impact Upon Competition

Competition is a fundamental requirement of the capitalist system. It is necessary to ensure that prices are fair, costs are minimized, and it fosters creativity and technological innovation. Companies who compete for a market or resource act as "watchdogs," continually keeping an eye on each other, and providing information on any abuse or wrongdoing. For these and other reasons, antitrust issues are at the heart of both the Administration's and the FTC's investigations. Our goal is to ensure that competition in the exploration, production, and transportation of Alaskan crude oil be increased rather than diminished as a result of the merger. We have identified several specific matters which should be addressed towards that end.

I. Access to Production Facilities.

We are concerned that the merger will make a bad situation worse with respect to access to production facilities on the North Slope. Any company that discovers oil on the North Slope must either build its own production facilities or enter into an agreement with the owner (or operator) of existing production facilities to be able to move its oil to the TAPS pipeline for transportation off the North Slope. After the merger, virtually the only company that an owner of oil will be able to deal with is BP Amoco. We must ensure that access to existing production facilities will be on terms that are fair and equitable to existing owners and will attract new owners to the North Slope.

II. TAPS Tariff Competition.

In addition to the revenue concerns stated earlier, if BP Amoco and Exxon-Mobil have no incentive to compete, there will be no assurance that North Slope producers without pipeline affiliates will get reasonable pipeline costs. This seems especially true given that post merger BP Amoco-ARCO will control 72% of the pipeline's capacity. Even if the merger fosters competition in the remaining pipeline owners, they will control a tiny fraction of the pipeline and will have a very small effect on pipeline costs for unaffiliated producers. Accordingly, the state should adopt a position that maximizes competition among all the pipeline companies and requires the majors to file at less than the maximum tariff. We should explore the possibilities of compelling divestiture of some or all of BP Amoco-ARCO's interest in the pipeline or renegotiating the terms to the TAPS Settlement and Capacity Agreements.

III. Access to Tankers

Like the field production facilities, and unlike the TAPS pipeline, tanker traffic is not provided on a common carrier basis. As a result, inability to obtain fair and equitable access to tankers can serve as a substantial deterrent to anyone seeking to enter into or expand their existing North Slope oil or gas production. We must ensure that all owners of North Slope oil production have adequate access to tankers for the movement of their oil from the North Slope.

Conclusion

As you are aware, there are a number of other issues that need to be considered as part of an overall state response to the merger. These include considering divestiture of production assets, which would diversify ownership of North Slope properties. We should also explore the possibilities of agreements that secure commitments to continue pursuit of the development of North Slope Natural Gas and to continue investment in further exploration and development in Alaska.

We are committed to taking the necessary time to pursue a thorough investigation and ensure that we have gained all the benefits for Alaskans that we can through the negotiation process. We understand that the Administration has completed some of the preliminary review and that you propose to present some findings of your investigation by the end of August. We look forward to receiving the information your working group has compiled on their consideration of the above topics as we continue to examine the merger and the role the state can play in ensuring the best possible agreement for Alaska.

Sincerely,

Original signed by:
Senator Rick Halford,
Chair, Joint Special Committee on Mergers
Senator Drue Pearce,
President of the Senate and committee member
Representative Brian S. Porter,
Speaker of the House and committee member

Note: To obtain a signed copy of this letter, please call Juli Lucky in Senator Halford's office at (907) 694-4958.