Legislative audit takes aim at 'inappropriate' state loan to Mustang oil project in 2015

The owners of the troubled Mustang oil development project on the North Slope owed the Alaska Industrial Development and Export Authority $90.5 million as of the end of March.

AIDEA invested $20 million in an access road and gravel pad in 2012, and $50 million in equity funding over four years, starting in April 2014 when oil prices were above $100.

About $16.5 million of the debt was from a loan that the state Department of Revenue made under former Gov. Bill Walker to the LLC as it sought to develop a 21-million barrel oil field southwest of Kuparuk.

That loan is the subject of a detailed legislative audit released Friday that says the deal should never have been made by the Walker administration.

The collateral to back up the loan took the form of future state “tax credits” that the promoters expected to collect from the state.

The tax credits were actually cash subsidies that the state made for years to relatively small oil companies in the hope that they might get more oil into production.

The loan was, in essence, an advance payment to the private entity of the state cash subsidies. The borrowers promised the state that if they could not repay the loan, the state would keep its cash subsidy.

But the predictable schedule for paying cash subsidies went away with the state’s financial squeeze. The state didn’t pay all the cash subsidies to oil companies that earned them, state debts that remain on the books today.

When the Mustang project stalled because oil prices dropped and private investment capital disappeared, the loan made by the Department of Revenue went bad because the tax credits were not paid to the LLC. The loan began as a line of credit of up to $22.5 million approved in October 2015. Within four months, the state loaned the LLC $19.3 million.

“The loan was originally due in full on December 31, 2016. However, DOR amended the agreement twice to extend the maturity date by over 18 months to July 15, 2018. During that period, funds appropriated to pay tax credits were significantly decreased,” the state audit of the loan says.

The only payments made were $1.6 million in 2018 and $4.1 million in early 2019.

Enter the Alaska Industrial Development and Export Authority, a state entity that agreed to pay off the principal and back interest for the revenue department in 2019 at the request of the revenue department.

Aided by the AIDEA money, the revenue department gained $4.29 million on the loan. But AIDEA lost $1.77 million, the audit says, and could “record a significant allowance for loan loss.”

The transfer “simply moved the investment out of the general fund and reclassified it as a loan receivable of a component unit,” the audit says.

Now, AIDEA is waiting, along with lots of other private entities, for the state to make the belated tax credit cash payments. AIDEA will use the tax credits to pay down the loan.

“According to AIDEA management, AIDEA has first rights to all outstanding MOC 1 (Mustang Operations Center 1 LLC) tax credits, which total $15 million,” the audit says.

The matter of borrowing tax credits from Peter to Pay Paul raises many important questions about the need for better safeguards and more disclosure.

Some of this is a mirage. There is no clear program on repaying tax credits to AIDEA or anyone else. This AIDEA document claims the tax credits from the state are due by next month.

“Continuing accrual of unpaid interest on the loan, coupled with the possibility of other MOC 1 creditors challenging AIDEA’s rights to the tax credits, could increase AIDEA’s losses over time,” the audit says.

The audit came about following a 2018 request from Sen. Bert Stedman. At that time, Revenue Commissioner Randy Hoffbeck told the Alaska Journal of Commerce the state “already had skin in the game through AIDEA” and the loan was an effort by the revenue department to protect that investment.

Other companies that had cash subsidies coming were not offered loans, but they didn’t have investments by AIDEA. The revenue commissioner, or someone chosen to represent the commissioner, serves on the AIDEA board.

The response letter in the audit from Revenue Commissioner Lucinda Mahoney says there were “internal control issues identified by this audit that occurred during the Walker administration,” but she said that “no financial harm to the general fund ultimately resulted.”

She said it is “premature to declare the Mustang project a loss.”

This report makes clear that the goals of the revenue department to collect money for the state do not line up with those of a state corporation that looks to promote economic development, taking risks in doing so.

The loan was legal, the audit said, but it was not prudent and there were conflicts of interest. There was also confusion among DOR managers about whether the money was a loan or an investment.

“Overall, the audit found the DOR commissioner’s decision to loan up to $22.5 million to MOC 1 under the authority of the department’s investment statutes was inappropriate when compared with behavior that a prudent person would consider reasonable. In support of this conclusion, auditors noted the following: the loan was made outside of DOR’s established investment procedures and DOR management failed to adequately document consideration of the associated risks when making the loan; adequate internal controls were not implemented over the accounting, reporting, and management of the loan; and the loan created conflicts of interest that were not sufficiently mitigated. These facts demonstrate the need for additional oversight of DOR’s investment functions.”

Mahoney said that she is in the process of setting up a “nonpolitical, external investment commission of fiduciaries” to oversee investment practices.

Here is an overview by Petroleum News of where the Mustang project now stands.

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