Legislature(2015 - 2016)BARNES 124
02/25/2016 01:00 PM House RESOURCES
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| Audio | Topic |
|---|---|
| Start | |
| HB247 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 247 | TELECONFERENCED | |
| + | TELECONFERENCED |
1:03:12 PM
CO-CHAIR NAGEAK announced that the only order of business is
HOUSE BILL NO. 247, "An Act relating to confidential information
status and public record status of information in the possession
of the Department of Revenue; relating to interest applicable to
delinquent tax; relating to disclosure of oil and gas production
tax credit information; relating to refunds for the gas storage
facility tax credit, the liquefied natural gas storage facility
tax credit, and the qualified in-state oil refinery
infrastructure expenditures tax credit; relating to the minimum
tax for certain oil and gas production; relating to the minimum
tax calculation for monthly installment payments of estimated
tax; relating to interest on monthly installment payments of
estimated tax; relating to limitations for the application of
tax credits; relating to oil and gas production tax credits for
certain losses and expenditures; relating to limitations for
nontransferable oil and gas production tax credits based on oil
production and the alternative tax credit for oil and gas
exploration; relating to purchase of tax credit certificates
from the oil and gas tax credit fund; relating to a minimum for
gross value at the point of production; relating to lease
expenditures and tax credits for municipal entities; adding a
definition for "qualified capital expenditure"; adding a
definition for "outstanding liability to the state"; repealing
oil and gas exploration incentive credits; repealing the
limitation on the application of credits against tax liability
for lease expenditures incurred before January 1, 2011;
repealing provisions related to the monthly installment payments
for estimated tax for oil and gas produced before January 1,
2014; repealing the oil and gas production tax credit for
qualified capital expenditures and certain well expenditures;
repealing the calculation for certain lease expenditures
applicable before January 1, 2011; making conforming amendments;
and providing for an effective date."
1:03:48 PM
JANAK MAYER, Chairman & Chief Technologist, enalytica, and
consultant to the Legislative Budget and Audit Committee, noted
that enalytica will be providing two presentations over the next
two days analyzing the projected impacts of HB 247 on the oil
and gas industry in Alaska. He said today's PowerPoint
presentation, "IMPACT OF HB 247: NORTH SLOPE ASSESSMENT," will
focus on the North Slope and how enalytica views some of the
proposed changes from a North Slope prospective, while
tomorrow's presentation will focus on the Cook Inlet.
1:06:03 PM
MR. MAYER turned to slide 2, "KEY QUESTIONS RAISED BY HB 247 RE
NORTH SLOPE," to provide some of enalytica's high level thoughts
and conclusions. He said the biggest thing in looking at HB 247
with regard to the North Slope is that on the one hand it is not
a tax overhaul, it is not looking at fundamental pieces of the
fiscal system and making widespread changes. On the other hand,
the bill includes a number of very small changes in key
parameters that collectively have a substantial effect. There
are legitimate concerns that the bill raises, including many big
ones such as the roll of the gross floor, how that protects the
state when prices are low, and what the right approach to that
is - the balance between what the fiscal system does when prices
are high and what the fiscal system does when prices are low,
what the state's potential liability is in terms of refunded
credits in various scenarios into the future. These are
important questions to be contemplated.
MR. MAYER advised that the impact of the bill's proposed changes
will be highly variable per company depending on each company's
positions and investment profiles. Most companies would see
substantial adverse effects over the coming years from the
biggest changes that are being proposed. He said enalytica also
has concerns in regard to the retroactivity of some of the
proposals as well as the proposed July 1 [2016] effective date
in the context of investment cycle in that they are on numerous
major projects currently underway, and some projects sanctioned
as recently as late last year. Additionally, large oil and gas
companies have a budgeting cycle and have made plans for this
year. They would need to come back because halfway through the
year everything has substantially changed due to the passage of
new legislation.
1:08:16 PM
MR. MAYER stressed that stability, more than anything, is the
single most important element in any fiscal system as long as a
system is broadly competitive and does not have horrendous
problems in terms of what the returns are to the investor or
horrendous problems in terms of the sustainability for the
sovereign. More than anything, what matters is that when an
investor calculates the economics on its projects and makes a
final investment decision to proceed or not, the investor needs
to know that the terms it counted on are going to remain the
terms into the future or that if the terms change they change
very rarely and for reasons that are well understood and well
thought through.
MR. MAYER said enalytica's biggest concern with HB 247 in regard
to the North Slope is not any single one of the changes, but
rather a collection of small incremental steps, each one of
which is a small tax hike. From an investor's or oil company's
perspective it is easy to look at this incremental approach of
taking a little more revenue here and a little more there and
wonder where it will stop. That is scary from an investor's
perspective. When it is one change because it was not the right
policy call and needs to be changed and there is clearly
articulated rationale for why it needs to change, an investor
can look at that and understand it even if not liking it, but
have some degree of certainty that from this point forward there
will be some stability. Mr. Mayer said that more than anything
else when looking at a series of incremental revenue-raising
measures, his biggest concern is about the message that is being
given about the stability of the regime in terms of not big
policy decisions but the danger of incrementalism.
1:10:56 PM
REPRESENTATIVE HAWKER asked whether Mr. Mayer is aware of any
other jurisdiction that is significantly increasing taxes on an
industry that is clearly losing money all around the world,
particularly when the stated intent behind the tax increase is
only for the purpose of raising government revenues.
MR. MAYER replied he thinks anyone would say that, in general,
raising taxes on industries that make losses is not optimal
policy. When looking around the world the answer to that
question depends greatly on how resource dependent a
jurisdiction is. Oil and gas companies consider jurisdictions
with high degrees of resource dependency a form of substantial
political risk precisely for this worry. Large and well-
diversified economies for whom oil and gas revenues are only a
small piece of a well-managed overall tax base can manage this
sort of volatility. One would therefore expect that in times of
an industry downturn jurisdictions would be trying to make life
easier for that industry, not harder. However, that is not
always the case in smaller, less-diversified, highly resource
dependent economies and that is one reason why companies look at
those places and think twice about what things are going to be
like in a range of circumstances before investing. So, while he
wouldn't say that nowhere in the world does it happen that a
resource dependent economy tries to extract more when times are
tough from the goose that lays the golden egg, it would
certainly not be optimal policy if one could avoid it.
1:12:52 PM
REPRESENTATIVE HAWKER opined that for a company to invest in
Alaska, a highly resource dependent state, the company would
understand that Alaska is a much higher political risk than is
investing in jurisdictions with a more balanced economy. He
inquired whether that would not also lead to a presumption that
the industry, in order to invest in Alaska, would require a
higher return in the face of a higher risk.
MR. MAYER agreed. More than anything else, he said, the biggest
thing Alaska can do in any price environment to reduce that risk
is to show over time that in fact it is a stable jurisdiction
and that it does not try to tweak the levers every time it has a
problem. As a hybrid system, Alaska tries to have the best of
both taking on the high side through net taxation and taking on
the low side through gross taxation. Always focusing on
whichever price environment the state is in and trying to do a
little better has some serious problems when it comes to long-
term stability and predictability of a regime and overcoming the
hurdle of being a resource dependent state, and therefore
needing to show that the state is in fact stable and dependable.
1:14:25 PM
REPRESENTATIVE SEATON inquired whether enalytica's presentation
is coming to the committee from the perspective of a resource
investor or from the aspect of the state's financial capability
to sustain these credits.
MR. MAYER responded he would like to think that enalytica has
always tried to balance those things and give the most objective
advice it can. Part of enalytica's responsibility in providing
dispassionate advice to the state is to think through when the
state has certain policy objectives and proposes a course of
action. What are the impacts of that on an investor? If one of
the policy aims is to encourage investment, do changes that meet
certain policy objectives have unfortunate consequences on other
fronts because of the way they are seen by investors? That is
part of what enalytica tries to give advice on.
REPRESENTATIVE SEATON requested that as Mr. Mayer goes through
his presentation he make clear to the committee as to whether
enalytica is recommending a policy for investors and their
stability or for Alaska's fiscal certainty and fiscal stability.
1:16:03 PM
REPRESENTATIVE JOSEPHSON, following the logic described where
the industry might view with more anxiety a situation where a
sovereign is virtually wholly dependent on that industry, stated
that what this administration seems to be saying is that through
no fault of anyone Alaska cannot do that anymore, Alaska must
wean itself from the industry and find stability in another way.
The administration has about a dozen measures and HB 247 is part
of that fiscal stability. He asked whether this tracks with
what Mr. Mayer is saying about industry wanting stability.
MR. MAYER answered that it comes back to his starting point of
saying that certain big questions are raised by the bill and
that are legitimate questions to raise about what is optimal tax
policy for the sovereign to maintain its revenue base across a
wide range of oil prices and all the rest. Different people can
come up with different conclusions in that regard. But, from an
investor's perspective, one could see changes made that one
really did not like or found very painful, particularly if taxes
are being raised at a time when there is no value to tax and is
essentially just extracting money. One might still be able to
live with that in some scenarios if one thought that this was a
solidly debated, well-thought-through change and things were not
going to change any further after that. Mr. Mayer said that
what gives him the most cause for concern is the overall
impression of making slice-by-slice-by-slice progress in
extracting further revenue. Always most disconcerting about
that approach from an investor's perspective is where does that
stop. There is a substantial difference between a well-reasoned
debate on some issues and a resolution of them in a way that one
feels confident that things are not going to keep changing
versus gradual incrementalism. More than anything else, that is
what he would warn against.
1:19:03 PM
CO-CHAIR NAGEAK remarked that, like it or not, Alaska is a one-
resource state. He recounted that when he was growing up the
federal government ran all of Alaska because it was a territory.
After becoming a state the state took over most of the
responsibilities to govern itself. When he was growing up the
resources available for funding the state were fisheries,
logging, and mining. Then, when oil was discovered in the
1960's, state government became oil and gas taxes. As a one-
resource state Alaska must find ways to use its other resources.
For example, a road is needed to his house so the state can take
advantage of those resources.
1:20:25 PM
REPRESENTATIVE HAWKER requested Mr. Mayer to state who he is
working for while he is before the committee today.
MR. MAYER stated that enalytica and he as an employee and
officer of enalytica are employed for the legislature as
consultants by the Legislative Budget and Audit Committee to
give dispassionate advice to the entire legislature.
REPRESENTATIVE HAWKER inquired whether it would be fair to say
that, as chair of the Legislative Budget and Audit Committee, he
asked enalytica to provide a fair analysis to the best of its
ability of HB 247 for the legislature to consider in making its
decisions.
MR. MAYER replied, "Absolutely yes."
REPRESENTATIVE HAWKER asked whether Mr. Mayer has allegiances to
anyone else in this matter.
MR. MAYER responded, "Absolutely not."
REPRESENTATIVE HAWKER inquired whether Mr. Mayer is providing
any testimony on behalf of the industry or any other investor in
the state of Alaska.
MR. MAYER answered, "We provide testimony ... on behalf of no
one other than ourselves and our best dispassionate analysis of
what is in the best of the State of Alaska." In doing so,
enalytica tries to think through what a particular change looks
like from an investor perspective, what might the consequences
of that be, and therefore whether the policy does or does not
meet that test of the best interest of the State of Alaska.
REPRESENTATIVE HAWKER asked whether Mr. Mayer is an expert here
to testify on the state's budget issues and the state's cash
flow requirements and needs.
MR. MAYER replied that enalytica's focus is on questions of oil
and gas fiscal systems and commercialization of oil and gas more
broadly. There is some degree of overlap between good fiscal
system design and what that provides the state in terms of a
solid financial position in terms of cash flow over a range of
price decks. But, beyond that, enalytica is not here to provide
advice on how the state manages its budget.
REPRESENTATIVE HAWKER thanked Mr. Mayer for the clarity.
1:22:59 PM
MR. MAYER moved to slide 3, "REFUNDED CREDITS REACHED NEW HIGH
IN FY 2015." He said one large key to this debate in the
difficult fiscal circumstances that the state finds itself in,
is the question of the role of tax credits in general and in
particular refunded credits that the state pays out through the
tax system. This is about what the state pays out as refunded
credits to individual companies, particular to companies that
meet the threshold of being below 50,000 barrels a day in
production. Then, there is the question of gross minimum floor
and credits that can take a company below that floor. But core
to all of this is this question of credits. At $628 million
this last fiscal year, refunded credits reached the highest
point ever. Not only has the amount of refunded credits been
growing for the last many years, most striking about this is how
the balance has clearly shifted. In 2014 and 2015, however, the
majority of credit refunds were spent in Cook Inlet, not the
North Slope. According to forecasts by the Department of
Revenue (DOR), refunded credits will exceed $1 billion in fiscal
years 2016 and 2017. Part of that may be self-correcting in
that investment may not be what was hoped in an extended period
of low prices. When one considers the impact of low prices on
the state's revenues, anyone should look at those numbers and
conclude that serious thought needs to be given to what the
impact of this is and how sustainable this is.
1:25:41 PM
MR. MAYER drew attention to slide 4, "BIG DIFFERENCE BETWEEN
NORTH SLOPE AND COOK INLET," and explained that the graph uses
actual 2015 numbers for revenue and credits. He said the split
between the North Slope mostly relies on actual DOR numbers and
the royalty is an estimate by enalytica rather than hard
numbers, but the totals on the graph are hard numbers. The
fiscal system overall still generates more than $2 billion in
revenue. Relatively speaking much, much, much less of that
comes from production tax than from royalty. Two years ago that
was a very different situation and that is because the idea of a
Net Production Tax is to tax profit, to tax value. When there
is very little profit to tax, that number is always going to be
very small and that is an intentional design of the system. As
a whole the system still generates more than $2 billion of
revenue, he reiterated, and that is true just looking at the
North Slope in isolation. Compared to that $2 billion in
revenue, the system overall spent a little over $200 million on
credits this last year. However, he continued, the Cook Inlet
is a very different scenario. [The year 2015] is just one
snapshot in time and does not take into account the question of
what future revenues those credits may or may not generate. The
Cook Inlet is much, much less revenue for relatively much
greater credits. This is an important distinction to draw and
understand, he said, and is why enalytica is reviewing the North
Slope and the Cook Inlet on two different days.
1:27:52 PM
REPRESENTATIVE HAWKER understood that the real imbalance with
regard to Cook Inlet is because these credits are refundable and
are not required to be used by the person actually generating
them, and this is why there is a significant amount of negative
cash flow for Cook Inlet.
MR. MAYER confirmed the aforementioned and further noted that
Cook Inlet has no production tax on oil and only has a low fixed
[production tax] on gas of $0.17 per thousand cubic feet (MCF).
Another big driver of that imbalance is that the Cook Inlet has
all of the credits that the Alaska's Clear and Equitable Share
(ACES) [House Bill 2001, passed in 2007, Twenty-Fifth Alaska
State Legislature] system applied to the North Slope, as well as
some additional credits on top of that.
1:28:42 PM
REPRESENTATIVE SEATON inquired whether local property tax share
is included in that or whether it is actually the share of money
from the North Slope or Cook Inlet that comes to the state and
that the state has available to pay those credits.
MR. MAYER responded that these high level numbers are statewide,
so they do include money from property tax that goes to
municipalities and to the state. The graph shows unrestricted
royalty revenue to the state in yellow and restricted royalty
[in orange]. Responding further, Mr. Mayer noted that the total
amount of restricted royalty revenue is $670.5 million and the
total amount of unrestricted royalty revenue is just over $1
billion.
REPRESENTATIVE SEATON requested Mr. Mayer to distinguish between
how much revenue goes to the state and how much goes to the
municipalities as he proceeds in the presentation.
1:30:49 PM
MR. MAYER moved to slide 5, "ALASKA'S HYBRID SYSTEM: LOTS OF
BIRDS, FEW STONES," to discuss the fiscal regime that applies on
the North Slope. He pointed out that Alaska has a hybrid system
of both gross and net taxes, which enalytica is lightheartedly
describing as "lots of birds, few stones" in the context of an
ideal world where one likes to kill as many birds as possible
with a single stone. It is an effective metaphor because that
is difficult if not impossible to do. The analogy is that
Alaska has many aims that it wants to achieve from its fiscal
system - it would like to take as much of the profit as possible
when times are good, but would like to protect itself on the low
end when times are bad. There is some extent to which one can
do both of those things, but it is limited, there is a trade-off
to be made here. It is hard to be both Norway and North Dakota
at the same time. North Dakota has a very regressive fiscal
regime that is very punishing when prices are low, but is still
an attractive place for investment across the commodity cycle
because it also gives away a lot when times are good. Norway
has a net profit based system that has very high government take
at high prices, but because it is a pure net system it is also
relatively more attractive when prices are lower.
MR. MAYER elaborated that the idea and benefit of a net system
is to aim to minimize distortion and maximize returns across the
commodity cycle. However, a net system can be quite volatile in
the way it generates revenue. For that reason, net systems are
particularly well suited to large diversified economies that can
manage revenue well, or to economies that take as prudent and
thoughtful an approach to managing their revenues as possible in
terms of things like sovereign wealth funds and, to the extent
that one is a highly resource dependent state, that tries to run
off its source of endowment rather than off the government
revenue that it generates from taxes. States that run off
government revenue that is generated off taxes struggle the
hardest in some ways with net profit tax systems because net
profit systems amplify that volatility.
1:33:37 PM
MR. MAYER noted that royalties and gross taxes minimize that
volatility because they take the greatest share of value,
including all or more of the value, when times are the worst,
when costs are high, or when prices are low, and they take the
least when times are fat. For that reason, there are lots of
circumstances under which gross systems can be quite distorting,
quite prohibitive, of certain types of investment. High cost
investment becomes very difficult in certain gross systems. It
becomes very difficult to invest in gross systems in prolonged
periods of low prices, but the great benefit they provide the
sovereign is relative stability over the revenues over a long
period of time because they are fundamentally regressive.
MR. MAYER pointed out that it gets very difficult to balance
these two competing priorities. In lots of cases there is one
system or the other. Alaska, partly because of its resource
dependence and partly because of the historical circumstance of
having come from a long tax royalty tradition, has a mix of both
gross and net taxes. That has many strengths. However, the
danger is that when times are good, the focus and the emphasis
is always on "times are really good and we have this net profit
tax, shouldn't we maybe be getting a little bit more for the
money now that there is so much coming in and are we really
getting the fair share?" And when times are bad the focus is on
"times are really bad, wouldn't it be good if we were better
protected at the low end?" He said he thinks that dynamic has
been played out in public debate and in politics and discussion
on this issue over many years and ultimately one can, to a
limited extent, address both of those competing priories but the
ability to do that is very limited.
MR. MAYER advised that a competitive fiscal regime balances risk
and reward. A lot of certainty can be had at the low end if one
is willing to give away a lot at the high end. Or, one can take
a lot of the high end if one is willing to distort as little as
possible and be as generous as possible at the low end. But one
cannot always do both - too many birds, not enough stones.
1:35:58 PM
MR. MAYER turned to slide 6, "GROSS VS. NET TAX: TWO VERY
DIFFERENT APPROACHES," to review the aforementioned in more
detail. He stressed that it is important to understand the math
of gross taxes versus net taxes and how they work. Having a
true understanding of that becomes very important when getting
into questions such as the gross minimum floor and how that
works. Gross taxes and net taxes look very different across
different prices and different spending environments. He
reiterated that gross taxes are less volatile, they shift risk
to the private sector, and they are simple and easy to
administer because the only two things that need to be known are
how much oil came out of the well and the price it sold for.
Gross tax has a very high government take at low prices and low
government take at high prices.
MR. MAYER addressed the gross tax example in the left column of
slide 6 and noted that it is essentially the simplest possible
fiscal system - nothing other than a single 10 percent gross
tax. He explained that the gross and net examples depicted on
the slide include three columns for three different oil prices
(shown in blue) and three columns for three different capital
expenditures ("capex") (shown in blue). The constant number of
$10 [for transportation cost] is subtracted from each of the
different prices to arrive at the Gross Value at the Point of
Production (GVPP). Operating expenditures ("opex") and capex
are then subtracted and, in this example, they are each $18.
These calculations arrive at the net value, which in Alaska's
system is called the Production Tax Value (PTV) per barrel. At
a price of $90 there is Production Tax Value of $44, the value
that is there to be taxed after deducting all the costs. At a
price of $60 the Production Tax Value is $14. At a price of $30
the Production Tax Value is minus $16, assuming a tax system
that recognizes a negative value. Alaska's tax system does
effectively allow negative value by saying that that number
cannot go below zero but there is a net operating loss. A 10
percent gross tax on the GVPP is a tax of $2 at a price of $30,
a tax of $5 at a price of $60, and a tax of $8 at a price of $90
(GVPP values of $20, $50, and $80, respectively). When looking
at what the $8, $5, and $2 represent as a proportion of the net
value, the $8 tax at a price of $90 represents 18 percent of the
net, the $5 tax at a price of $60 represents 36 percent of the
net, and for the $2 tax at a price of $30 there is no number
applicable for the percent of net because there was no value in
the first place.
1:40:08 PM
MR. MAYER continued addressing the gross tax example on slide 6,
explaining that as prices go higher and higher, the percent of
the net becomes a lower and lower share. As prices go lower and
lower, the percent of the net becomes a higher and higher share;
it looks like a "hockey stick" as an infinite rate of tax is
approached at the lowest prices. He said this same variation is
true when looking at different spending levels. If the price
remains constant at $60, but the capex spending varies at levels
of $30, $20, and $10 (shown in blue), the same aforementioned
effect occurs. A 10 percent gross tax is a much lower net tax
rate (23 percent) for the lowest cost of production ($10 capex)
and a much higher net tax rate (250 percent) for the highest
cost of production ($30 capex). This is an example for when it
is said that there is high government take at low prices and low
government take at high prices and, similarly, higher government
take on the most expensive production and the least government
take on the cheapest production. However, the overall numbers
in a gross tax system change relatively little. In the worst
case, the government gets $2 a barrel and in the highest case
the government gets $8 a barrel. That compares in a net tax
system to maybe getting as much as $11 a barrel in the highest
case, but possibly a negative value when times are bad and a net
loss is being generated. So, this is that fundamental question
of revenue volatility and the difference between very stable
revenues, relatively, under the gross system and very volatile
revenues under the net system.
MR. MAYER then reviewed the net tax example in the right column
on slide 6. He explained that the tax is a constant 25 percent
of the net value, the production tax per barrel, and is always
the same at all the different costs and at all the different
prices. The idea behind net tax is that it is as minimally
distorting on investment as possible. Whether an investment is
very cheap or very expensive, if it makes sense in and of its
own terms it is wanted for the imposition of this tax to not
change that. Whereas under a gross regime an investor might not
proceed with a high cost investment because of how the gross tax
fundamentally alters things. The idea behind the best net
profits taxes is to be as close as possible to an equity
investor: when times are bad and an investor is cash negative,
the government is also cash negative; when times are good and
the investor is taking lots of cash, the government is also
taking lots of cash. In the best of these systems there is
almost no difference between - from a cash flow perspective -
what that looks like versus what an equity investor looks like.
Over the course of commodity cycle, one can, in general, take
more of the overall profits over the entire cycle because it is
non-distorting. If an investor takes that long-term view the
investor can do substantially better through a net system.
Also, more investment is encouraged because those high cost
projects that might not have been possible under the gross
system are possible under the net system; but, the jurisdiction
ends up with these more volatile revenues that it needs to find
a way to manage.
1:43:13 PM
MR. MAYER moved to slide 7, "CASHFLOW TAXES: MORE EFFICIENT,
MORE VOLATILE," to discuss the distinction between taxes on cash
flow versus taxes on income. In the pure world of net taxes,
one can tax either of these, he explained. In the world of
resource taxation, one frequently tends to see net taxes
structured as taxes on cash flow. This is because, when wanting
to minimize the distorting impact on investment, the best way to
do that is to make the state's receipts from the tax system as
close as possible to those of an equity investor in a project.
The idea behind a cash flow tax is that in the years an investor
makes an investment, that investor is cash flow negative and so
is the state through the tax and credit system. In the years
when that investment is paying off and generating a lot of cash,
the state is cash flow positive and generating a lot of cash
through the system. The distinction in that sense between the
cash flow tax versus the income tax is that the cash flow tax
treats costs as happening in the year they actually occurred,
whereas an income tax does not think about that and instead
capitalizes and depreciates assets over time and that provides
this measure of stability.
MR. MAYER brought attention to the example on slide 7 of highly
simplified cash flow and income. In the early years there is no
revenue, he explained, because there is not yet any production.
The capex gives a negative cash flow [shown in red and labeled
"Pre-Tax Cashflow"]. At a pure 25 percent rate, which in the
context of Alaska can be thought of as a 25 percent Net
Operation Loss Credit, a company gets that money back as either
a refund from the treasury or as a write-off against its other
tax liabilities. In an income tax world, that negative cash
outflow is not recognized because instead of subtracting the
opex and capex and ending up with a tax value that asset is
capitalized at the point that it enters production and is then
depreciated over time (labeled in the chart as asset value and
depreciation). Referring to the red line labeled "Net Income",
Mr. Mayer explained that if, after calculating the cash flow,
the capex is added back in and the depreciation is instead
subtracted, the result is something roughly approximating net
income; it is always positive, it never goes negative the way
the cash flow did. When the income is taxed rather than the
cash flow, there is not as much revenue in the later years and
there are no negative outflows when the investment is happening.
The reason Alaska has a cash flow focused system and not an
income focused system is because it aims to be as close as
possible to an equity investor in a project in its impact over
time, which is to say to have the least distorting impact
possible. These distinctions are very important to bear in mind
at times like this when a number of companies have said that
their Alaska operations are cash flow negative. That may
particularly be the case when, for booking purposes, the
companies post a profit for certain months of the year. The
profit that they are posting is a profit on an income basis, not
taking into account what they are actually spending, but the
depreciated asset at their values over time. It is important to
understand the distinction between those things and how a
company can post a small profit for parts of the year but still
be cash flow negative when prices are low and the company is
spending a lot of money.
1:47:29 PM
MR. MAYER turned to slide 8, "ALASKA'S PRODUCTION TAX: ORIGINS
IN 2006 PROPOSAL," to address the way Alaska's tax regime works.
He explained that it is useful to first think about the system
that was proposed [in 2006] by Dr. Pedro van Meurs, a previous
administration's consultant who worked on what a profit based
tax might look like. It remains the heart of Alaska's fiscal
system today even though it has changed over time with the
production profits tax (PPT) and ACES systems. Dr. van Meurs'
proposal included a 25 percent flat tax on cash flow; a 25
percent credit for Net Operating Losses (NOLs), meaning the
value can go negative and when it does the state pays out
instead of receives; and a 20 percent credit for capital
spending. So overall there could be up to 45 percent government
support for spending for [both new and incumbent players]. For
example, a small company that is newly developing a resource
with no other tax liability is cash flow negative in those early
years when it is spending money but not receiving any. That 25
percent credit would be paid out to the company, which is
exactly the way an equity investor in the project would
contribute 25 percent of the upfront capital, and then in the
later years the company pays 25 percent of the cash flow through
the tax system. The additional 20 percent capital credit could
also be received regardless of whether a company was large with
a tax liability and able to write down 25 percent of the value
of its spending on its tax liability or whether a company was a
small producer claiming that Net Operation Loss Credit.
MR. MAYER remarked that in today's environment it is interesting
to go back and read Dr. van Meurs' paper written [10 years] ago.
Dr. van Meurs looked at gross floors and recommended against
them because of the idea that they distort investment, among
other things. But, Dr. van Meurs did say that one of the aims
should be to have a statewide floor of zero on the tax base,
which is to say that a responsible sovereign needs to manage its
revenues and should not, in net, be paying out. The idea in Dr.
van Meurs' model was that credits would be tradeable rather than
actually paid out by the treasury. A small company with a
negative liability could take the credits that it is owed and
sell them to a company that does have a tax liability and that
could then use the credits to reduce that liability. But, in
net, that system could not go below zero. In subsequent years,
Mr. Mayer said, that turned into a system of reimbursement for
reasons related to what the value of the credits were when they
were traded. Probably having a system of reimbursable credits
has made all sorts of things happen that might not have
otherwise happened, but they also mean that there is no longer
that statewide floor of zero that having solely traded, rather
than reimbursable, credits creates.
1:51:15 PM
REPRESENTATIVE HAWKER requested Mr. Mayer to explain why a
reimbursable credit can take the state below zero, but a
tradeable credit would not.
MR. MAYER replied that a new company developing a new asset and
not yet making any money would have a new cash outflow; it would
under such system effectively have a negative liability which it
can take as a credit. The impact is very different when the
company cannot take that credit to the state for payment in cash
but must instead do something else with the credit. The only
place this new company can go with that credit is to a large
company that does have a liability and can use that credit to
reduce its liability by the value of the credit. In net, this
system can only pay out down to zero because when no one has a
liability then there will be no one who wants to buy a credit.
The only remaining source of potential funds into this system
would be the state itself and the state has said that it does
not purchase these credits, it only issues them and allows them
to be traded.
1:52:48 PM
MR. MAYER returned to slide 8 and reviewed the example on the
lower half of the slide. He said working through this example
will help in remembering the starting core as the calculations
become more complex in forthcoming examples. He began with the
scenario of an oil price of $60 from which a transportation cost
of $10 is subtracted to arrive at a Gross Value at the Point of
Production (GVPP) of $50. He then subtracted [opex and capex at
$18 each] to arrive at a net value of $14. A 25 percent [net]
tax on the $14 is $3.50 per barrel. He added in the 20 percent
capital spending credit of $3.60 to arrive at an after-credits
loss [of $0.10]. The percent gross would then be 0 percent.
The percent net would be a negative [1 percent] tax rate on a
loss; what was a 25 percent tax before the capital credit
becomes effectively negative after the application of the tax
credit. Mr. Mayer related that in the context of Senate Bill 21
[passed in 2013, Twenty-Eighth Alaska State Legislature] he
often hears that it is a 35 percent tax rate, but is really not
a 35 percent tax rate because there is a fixed dollar per barrel
credit that takes it down below. That is absolutely true, he
said, and it was true of the original system proposed by Dr. van
Meurs and of ACES. In this case, the feature that made that
happen was the 20 percent capital credit. In this case, capital
spending is independent of the oil price, at least in the short
run. It is a fixed amount versus the oil price and the oil
revenue which go up and down. Because it is a fixed portion it
represents a much bigger portion when prices are low and a much
smaller portion when prices are high. It is by itself, without
any of the ACES progressivity, a progressive tax rate. It will
go up and approach 25 percent at the highest prices but it will
approach it asymptotically, meaning it will never actually get
there, and it will come down or come to zero or even go negative
because at certain prices the capital credit by itself is enough
to take it there. It is important to understand that that basic
dynamic has been in the tax system since the word go, and even
before the word go, which is the intellectual genesis of the
idea behind the tax system rather than the system itself. Any
net tax system with some sort of fixed credit component is
inherently progressive. One reason for that is because there is
a highly regressive component, the royalty, and the aim is in
part to balance these two things against each other to create
something that is overall a little more neutral.
1:56:07 PM
MR. MAYER addressed slide 9, "ACES: STEEP PROGRESSIVITY, HIGH
SPENDING SUPPORT," to look at how some of the aforementioned
basic ideas morphed into the system known as ACES. In ACES, he
explained, the 25 percent fixed tax rate was changed to a
sliding system that could go from 25 percent up to 75 percent,
varying with Production Tax Value per barrel. The 20 percent
capital credit remained, a 40 percent exploration credit was
added, and the 25 percent Net Operation Loss Credit remained.
That high progressivity where it could go from 25 to 75 percent
meant there were very high marginal tax rates, up to 86 percent,
meaning that through a $1 increase in the price of oil, 86
percent of that increase went to the state and only 14 percent
went to the company. Similarly, a $1 increase in spending by a
company could see $0.86 of that dollar effectively written off
against taxes. From a producer's perspective, that meant that
the period of very high oil prices, particularly above $100,
never really happened in Alaska because the vast majority of the
cash that would have resulted went to the state rather than to
the companies. So, the corresponding incentive to get out and
build new developments while prices are high and crazy profits
are to be made never happened in quite the same way in Alaska as
it did in some of the regressive regimes in other states that
saw a big investment boom during that time. It also meant that
a company could have potentially very high state support from
the spending. A new producer with no tax liability could get
the 25 percent loss credit and could get a 20 percent credit
stacked on top of that for pure capital spending, for a total of
45 percent government support for the spending. A large
producer at the highest prices could potentially write up to 80
percent or more against its taxes and also have a 20 percent
credit. In certain circumstances that could be the full value
of the spending or maybe even slightly more. The value of that
benefit varied wildly with volatility in oil prices. So, on one
level it might be a real benefit, but on the other hand it is a
benefit that is very hard to model when running economics on a
project because what that looks like can vary so significantly
day by day with the oil price.
1:58:57 PM
MR. MAYER noted that overall the ACES system meant that when
prices were high and spending low, massive amounts of cash were
brought into Alaska's treasury. This is very clearly seen when
looking back at the last several years of the state's finances.
It also meant that there was a huge potential liability from the
system if prices were ever low and spending was ever high
because it is a system with very high government support for
spending. Bringing attention to the table for different prices
on slide 9, he pointed out that the first several lines on the
table at an oil price of $60 look exactly the same as the table
on slide 8: transport, opex, and capex are subtracted from the
Gross Value at the Point of Production (GVPP) to arrive at the
Production Tax Value (PTV) per barrel [of $14.00] to which is
applied a 25 percent net tax rate for a net tax of $3.50 per
barrel. If a 4 percent gross tax is applied instead of a net
tax, the tax is $2.00; that $2.00 is less than $3.50, so the tax
rate is $3.50. At an oil price of $30 a barrel, the 25 percent
tax would yield the state nothing while a 4 percent gross would
yield the state $0.80 so the tax rate is $0.80, which is the
basic idea of how that gross floor works. However, in the ACES
system, that gross floor was not actually binding because there
was still the question of capital credits and these credits were
applied after that calculation was done. Adding the Capital
Credit and the Net Operating Loss Credit to the $0.80 results in
a tax after credits of negative [$6.80]. Even if a company
could not take a reimbursed Net Operating Loss Credit because it
was below the production threshold that enabled it to do that
even if the company could not be negative at all, this negative
amount may be something that is accrued through the tax system
as a future loss rather than taken out in cash. The ACES system
either paid some part of this out in large amounts of cash at
low prices or accrued that as a loss against future years'
income. So, notionally, there was a 4 percent gross minimum
floor, but in practice as long as there was any spending that
occurred, it never actually existed and therefore a large
producer could go down to zero and a small producer could
receive net cash from the state.
2:01:41 PM
REPRESENTATIVE SEATON understood that in the aforementioned ACES
example, Mr. Mayer was calculating and showing the net cash even
though it might be a carry forward.
MR. MAYER replied that for the larger companies it was carried
forward as a liability. For producers that were eligible for
that reimbursement, it was actually a net negative cash outflow.
This was because at various stages in the process between PPT
and ACES came the ability to have credits reimbursed from the
state.
2:02:20 PM
MR. MAYER moved to slide 10, "[SENATE BILL] 21: PROTECT ON THE
LOW END, GIVE BACK AT THE HIGH," and reviewed the basic ideas
that were behind the bill. He said a big motivator was that the
ACES system took a lot when prices were high due to the very
high marginal rates. The idea was to try to have a more even
distribution over the range of prices between what the state
receives and what the company receives in order to create an
overall more attractive environment for investment. But, in
return for doing that, the state should have some better
protection on the low end. For the production making up the
vast bulk of Alaska's revenue base, there is the sliding-scale
Per-Barrel Credit that effectively reduces the tax rate steadily
as prices go down, but eventually a hard 4 percent floor is
reached and that floor is binding in a way that it wasn't under
ACES. On the revenue generated from legacy fields, that
substantially increases the amount of revenue brought in in the
lowest prices. At an oil price of $90 the Gross Value at the
Point of Production (GVPP) is $80 after subtracting $10 in
transport cost, and after subtracting the opex and capex the
Production Tax Value (PTV) is [$45]. Applying a 35 percent
[net] tax rate gets a notional tax liability of $15.40. The
sliding-scale Per-Barrel Credit is $7.00. Subtracting the $7.00
of credit arrives at a net tax liability of $8.40 rather than
$15.40. A 4 percent gross floor is $3.20 and since the net of
$8.40 is higher than the gross, the net tax rate is $8.40. As a
proportion of the actual net value that is effectively a 19
percent tax rate after taking out the $7.00 sliding credit. At
a price of $150 it would be a full 35 percent [tax rate] because
at that point the sliding tax credit is zero. At a price of $60
the net tax rate is 14 percent. As prices go down this rate
steadily decreases, except it decreases down to somewhere not
much below that and then it starts to go up again. The reason
it starts to go up again, and it goes up very steeply, is
because the gross floor is hit.
2:05:23 PM
MR. MAYER demonstrated how the gross floor works under Senate
Bill 21 by reviewing the price scenarios on slide 10. At a
price of $90 the tax rate would be 19 percent, he noted. At a
price of $60 the tax rate would go down to 10 percent, but
because of the gross floor a tax of $2.00 is applied rather than
a negative tax value [of $3.10], making the tax rate go up to 14
percent. Senate Bill 21 provides, however, that the Net
Operating Loss Credit can penetrate that floor, the idea being
that if industry is losing money barrel by barrel on a cash flow
basis, the state will lower the tax rate to zero but no further.
For example, at a price of $30 a barrel the tax after credits is
negative $4.80, but for a large producer the tax would be capped
at zero and be carried forward as a future liability rather than
being paid out. He explained this sets the stage for what the
committee is thinking about in terms of the net tax system, the
gross floor, how some of these things interact with the sliding-
scale Per-Barrel Credit and stepping through how that actually
works. Where the ACES system had a widely varying level of
support for government spending, from 45 percent up to 100
percent, the idea in Senate Bill 21 was that it should be 35
percent support for everyone. It was to ensure that even for
smaller companies that are actually receiving net cash from the
state it should never be more than 35 percent. There was a
transitional period where it was 45 percent and it was brought
down this year to 35 percent. A big part of this impetus was to
acknowledge being painfully aware of the potential liabilities
to the state from some of these things in the lower oil price
environments. So, while the state is taking less on the upside,
it is limiting the potential liability on the lower side. All
those things were key to some of the provision that were put
into Senate Bill 21.
2:08:07 PM
REPRESENTATIVE TARR agreed with the aforementioned, but pointed
out that regarding the Net Operating Loss Credit the committee
never looked at an oil price of $30 [during its consideration of
Senate Bill 21] and therefore she does not think the committee
fully considered a scenario where the big three producers would
have had a year of operating loss. Thus, she added, the column
on slide 10 for a price of $30 helps answer questions about the
unintended consequence of that low price scenario.
MR. MAYER allowed that in the oil price environment of a couple
years ago not many people thought about a scenario in which the
major companies might be in a position to have a net operating
loss. It is a difficult question to ask as to what the correct
policy in that environment should be, he said. On the one hand
the state wants to protect itself and its revenues. On the
other hand the difficulty with a gross floor, particularly in
times where there is actually a net operating loss being
generated, is that it is just extracting money and is not taxing
value because there is no value left to tax. It is just asking
for money because "we're the state and we want to protect
ourselves," he continued. That is a benefit of a gross system,
but, again, it is about that balance between the protections
that a gross system offers the state and the benefits that a net
system gives the state and how to judge that balance.
2:09:52 PM
REPRESENTATIVE HERRON asked whether there is any tax regime that
did predict the oil price environment of today.
MR. MAYER replied that, in general, any pure gross tax system,
whether in the heavily royalty based systems of the world such
as some of the Lower 48 resource plays, is not necessarily that
they predicted that or that those tax systems exist primarily
for that purpose. In many cases those systems exist because
they are simple to administer since the royalties are collected
by landholders rather than by sovereigns. But their effect is
to provide very good protection at the low end and, in return,
they give away a lot at the high end.
2:10:50 PM
REPRESENTATIVE HAWKER noted that Alaska crude was recently
trading at $26 a barrel and agreed that this was not an
anticipated circumstance. He inquired at to what the worldwide
consequences might be upon the industry and its ability to
survive should this cycle of $25-$30 per barrel be prolonged.
MR. MAYER answered that in any sustained low price environment
the costs involved in the industry have to come down
substantially. Costs have risen very substantially over the
last decade. A decade and a half ago a price of $30 would have
seemed like a really great price. It seems so painful now
because the costs involved in producing a barrel of oil have
skyrocketed. Part of that increase in cost was that high prices
enabled more and more difficult, less economic resources to be
tapped. That is the natural flow and effect of high prices and
what high prices are supposed to do. The boom for investment
that created different projects competing for capital, steel,
and labor drove a steady escalation in costs across the entire
industry. In any prolonged period of low prices a lot of those
costs have to come down. That can be seen happening across the
Lower 48 as companies get incredibly squeezed by this price and
have to become much more efficient at what they do, and only the
most efficient will survive. Looking at the last year across
the world, no one is sanctioning anything that breaks even above
$50 a barrel, and in the last couple months probably no one has
sanctioned anything. Commodities are cyclical, he said, and
part of why they are cyclical is the dynamic he described
earlier. When prices are high, everyone wants to pile in and a
bunch of new resource is developed. Because of the lags in all
of these things the tendency is to overshoot and develop more
resource than the market can actually handle. When prices are
low everyone cuts backs and because everyone cuts back the
resource becomes underdeveloped for what the market is going to
need in the future. The longer the period of depressed oil
prices, the more will be cut back. That has dramatic
implications for the industry as a whole across the globe, and
also increases the possibility of the subsequent boom that
eventually happens when all that shakes out.
2:14:17 PM
REPRESENTATIVE HAWKER drew attention to the statement on slide 7
that the philosophy behind the net cash flow tax system is that
it makes the state's cost and benefit as close as possible to an
equity investor, it is sharing the equity in a project. The
fact that the state can tax more money out of an entity does not
mean the state is increasing its economic pie, he opined. The
state is not increasing the value available to be taxed, rather
it seems like the state as an equity investor is overdrawing the
equity from the relationship between the investor and the state,
leaving a weakened investor and unsustainable growth in state
government. This tax structure was designed to make the state
in parity as an equity investor. Industry is scaling back to
reduce costs and this ought to be the state's reaction rather
than trying to extract more money from a shrinking economic pie
that even further weakens the state's investors.
MR. MAYER replied that in an ideal world he would agree. There
are very difficult tradeoffs and choices that come with having
to make these decisions in these sorts of time without wanting
to pay for all of the essential services that the government
provides. In a resource state it is easy to turn to the goose
that lays the golden egg. It is important to remember that the
goose that lays the golden egg does so because it can generate
returns across a wide range of prices and across a commodity
cycle. The more one turns to that as a sole source of cash when
times are hard, even if there is no value to turn to for tax
purposes, the more unstable the system is over time and the less
attractive that is as an investment proposition in the future.
2:16:41 PM
REPRESENTATIVE SEATON stated he likes the idea of mimicking an
equity investor as being put forth by Mr. Mayer. However, he
continued, he does not recall legislators as having looked at
the system they were designing as [the state] being an equity
investor and the ramifications. He recalled there being a
discussion that maybe [the state] should be an equity investor
with a production sharing agreement or something, but it was
discounted as being too radical from the current system. If in
retrospect [the state] is considering itself as mimicking an
equity investor, then [the state's] response would be to limit
the credits or cash that it is investing during this time of low
prices, he proffered, just like projects are not being
sanctioned. [The state] cannot be the only investor and trying
to take a bigger and bigger share of the equity investment. He
asked whether he is wrong in this analysis of talking about [the
state] as being an equity investor.
2:18:13 PM
MR. MAYER allowed the aforementioned are excellent points, but
answered the question by describing Australia's fiscal regime,
which he said looks more like a pure profit tax. In general,
Australia does not have the protection of the gross royalty that
makes that relationship very different, he said, so in many ways
Australia's system is designed to look much more like a pure
equity investment. In previous tax reform periods in Australia,
efforts have been made to take that one step further to being
more like an equity investor by paying out what would be the
equivalent of Alaska's credits in times of bankruptcy and other
things; that is a way where Australia really is not like an
equity investor in that when an investment fails Australia is
not on the hook. A way to look at a regime like that is that it
tries to be as much like an equity investor as possible. From a
company's perspective, the cash flows look like an equity
investor but the state is not really a very reliable equity
partner. This is because, while the state may have actually put
up all the cash and may provide more cash further down the
track, unlike a real equity investor the company cannot rely on
the state for a capital pool. The other side of that is that
the state sort of has cash flows that look like an equity
investor but the state does not have the control that goes to an
equity investor; the state is not around the table thinking
about whether or not it can afford the investment and be on the
hook if the investment goes ahead. The Australian system does
not have traded credits of the sort originally proposed and in
part enacted when this system was first developed in Alaska.
All of Australia's credits are carried forward at essentially
the government bond rate, or, in most cases, at a rate higher
than that, which is to say that they maintain their net present
value rather than there being a steady reduction in the time
value of money. So, already from an equity investor's
perspective, the state is much better protected in that
environment. However, from a company's perspective notionally
in academic terms, the net present value of the state's
contribution and eventual take out from this project may be the
same as an equity investor but it is the company putting up all
the capital, and that looks very different. It is a really
difficult balance, particularly given the state does not have
control in seeking to mimic the behavior of an equity investor
through the tax system. Absolutely, he advised, there are
sensible things the state should do to protect itself, but where
to draw the best line can vary.
2:21:40 PM
MR. MAYER continued answering Representative Seaton's question,
pointing out that the final thing to layer into the Alaska
example is that Alaska has a 12.5 percent royalty. Therefore,
as an equity investor Alaska is already much better protected on
the downside than is a pure equity investor or would be the case
in a pure net tax system. There are numerous ways to protect on
the downside, he said, and one of them would have been the
original system that was proposed of traded credits and a hard
floor of zero across the state. When one does not have that,
the present scenario and the present outflow of credits are less
concerning than a scenario in which a major new resource is
discovered and goes into development, he warned. Prices would
presumably need to be substantially higher than they are at the
moment for that to occur, but it could happen that prices are
not high enough that that is not a billion or multi-billion
liability for the state. It is therefore quite reasonable to
look at that scenario and think about what the state could be on
the hook for in a range of prices and potential future capital
environments; those are all really important questions to be
asking. However, while there are a number of things in the bill
that are important questions to be asking and thinking about,
his worry is about some of the specific solutions and some of
the incremental nature of what is proposed.
2:23:20 PM
REPRESENTATIVE SEATON opined that an investor would have the
same response of cutting back its investments and capitalization
as would a company during times of very low oil prices. The
refundable tax credits and their usage are talked about as being
an investor, and the response of an investor is to cut back on
its costs in times of low oil prices. He requested Mr. Mayer to
address this.
MR. MAYER agreed this is true, but pointed out that any large,
well-capitalized company in this price environment is still
making investments. A benefit had by Alaska is that it has
small independent companies as well as some of the largest
companies in the world with large balance sheets that can
maintain investments across a broad range of the commodity
cycle. Large companies make those investments not because they
are going to pay off in the next one to five years, but because
they are multi-decade investments that must continue to be made
despite the tough times and cuts in operating costs in order for
the company to have the ongoing cash for future operations in
five or ten years' time. That same analogy also holds true for
the State of Alaska as far as it being a particularly hard time
right now and as far as having had a remarkable degree of
success in sanctioning new projects. Even with low prices last
November, major capital spending on the North Slope was
sanctioned. That implies cost write-downs against production
tax, or potential Net Operating Loss Credits, or other things
that are very difficult on the state's current tax base. Those
investments are very, very difficult for those companies to be
making in this time. It is also really good that they are - for
their financial futures and the state's. It is really hard to
reinvest when times are tough, but it is also really important
to continue to do it.
2:26:27 PM
REPRESENTATIVE JOHNSON commented that the balance the committee
needs to strike is that decision point of continuing to make
those investments and not doing anything in HB 247 that would
tip the scale because the companies could decide that there are
other places where they could invest more. "I just want to be
keenly aware that we are on a teeter totter here," he said, "we
can go down just as easily as we could go up."
2:27:05 PM
REPRESENTATIVE OLSON inquired whether any other sovereign
nations or states are using a taxing mechanism similar to that
proposed in HB 247.
MR. MAYER replied he is unsure whether it is particular aspects
of HB 247 that Representative Olson is thinking about in terms
of the changes that would be made. He said his overall
impression of HB 247 is that it does not change the fundamental
tax system or tax structure that exists, but it does raise some
important questions about things like the gross floor and limits
on tax credits that need to be debated. However, there needs to
be caution on the impacts of those things. In other areas HB
247 is a sort of series of incremental tax increases that can be
done without fundamentally changing the tax structure and which
are the things that give him the greatest pause for concern. In
and of itself, HB 247 is not a tax structure as far as comparing
it to other regimes around the world.
REPRESENTATIVE OLSON asked whether what is being done now is
closer to Mexico, Venezuela, and some of the emerging countries
in how they handle this issue, or whether it is similar to the
Lower 48 in broad terms of protecting the state on the top and
bottom. Noting that Alaska's structure changes every two or
three years, he further asked whether the game changes that
often anywhere else around the world.
MR. MAYER responded he cannot think of many places that debate
oil and gas taxes, and oil and gas fiscal systems, on such a
regular basis as does Alaska.
2:29:10 PM
REPRESENTATIVE TARR noted that HB 247 proposes to change some of
what is refundable to being carried forward for a future year.
She requested Mr. Mayer to comment as to the relative value from
an investor's perspective of using each of these two methods for
a net operating loss.
MR. MAYER said he will be dealing with this in future slides.
REPRESENTATIVE TARR recalled Mr. Mayer's statement that any
large company will still be making investments even in today's
low price environment because the company is looking five to ten
years ahead and wanting to ensure volume and profit during those
time periods. A challenge in understanding what the impacts
would be relative to the proposals in HB 247 is that it is
simultaneously being heard that there is a long planning time of
five to ten years ahead while also hearing that these small
modifications will have immediate changes. For example, during
consideration of Senate Bill 21 it was heard that the changes
were going to lead to increased investment fairly immediately
after the new tax regime was put in place and in the case of HB
247 people are talking about immediate reactions to the proposed
changes. She said she is having difficulty reconciling these
two things from the perspective of the company.
MR. MAYER specified that long term and short term varies
dramatically depending on where geographically in the world the
nature of the resource is being talked about. For example, some
of the resource places in the Lower 48 can change levels of
investment and production very quickly based on price signals
and other things because there are operations that are quite
variable, such as whether to engage a rig next month or next
quarter or how many wells will be drilled. There is some of
that work on the North Slope, such as within the existing mature
producing fields about what level of activity the company wants
to invest in. For example, there may be a rig that the company
does not own and that would be an investor variable rather than
fixed cost as far as whether the company wants to be paying for
that rig to be drilling infill wells. In places like the North
Slope, however, most of the activity is very, very long lead
time, high dollar, investment activity, even when coming to the
question of Senate Bill 21 and its impacts. He reiterated that
even in this low price environment there has been a surprising
amount of new projects being sanctioned, which can be seen by
looking at the data showing drilling numbers in recent times as
well as the hiring activity. Some of that impact in terms of
production is still in the forecast as far as how long the
decline can be flattened. Passage of Senate Bill 21 did not
suddenly fire new production because that is not the nature of
the oil and gas investment cycle in general and particularly not
in a place as capital intensive as the North Slope where
projects are big capital investments that have long times.
2:34:04 PM
MR. MAYER drew the committee's attention back to slide 10 to
resume his presentation. He said [key aims of Senate Bill 21]
were to provide 35 percent government support for both new
entrants and incumbents with a substantial tax liability, as
well as a hardening of the floor as compared to ACES.
MR. MAYER then moved to slide 11, "[SENATE BILL 21]: SPECIAL
INCENTIVES FOR 'NEW OIL.'" He explained that new oil reduces
the Gross Value at the Point of Production (GVPP) in general by
20 percent and for certain units by 10 percent. The purpose
behind the GVPP is to provide an effective reduction in the tax
rate on new oil versus old oil. Previous bills had tried to do
that directly by proposing a specific different tax rate on new
production. But a problem with that is a key feature of the
fiscal regime that has always existed on the North Slope, which
is that nothing is ring fenced - costs incurred in one place and
costs incurred in another place are all the same thing. A
company's production, total revenues, and total costs are
deducted against each other slope-wide to arrive at the
company's total tax liability. Ring fencing would instead look
project by project and allocate costs to each project, and that
gets very difficult and very complicated very quickly. In
general, net systems, whether they are net taxes, whether they
are production-sharing contracts, are much more complicated to
administer than gross regimes because the costs have to be
actually assessed and there must be the ability to audit them
and all the rest. That gets even more complicated when trying
to establish a legitimate cost, exactly where it was incurred,
and to which project it should be attributed. So, when wanting
to differentiate tax regimes between mature producing assets
versus new investments, and trying to split those two things out
and allocate cost between them, the idea is to instead focus on
the easy to distinguish amount of production and the gross value
of that production. With gross systems all that needs to be
known is what came out of the well and the price at which it was
sold. The idea behind the Gross Value Reduction (GVR) is to
reduce and hypothetically imagine the Gross Value at the Point
of Production. For example, at a price of $90 and a
transportation cost of $10, the net of $80 is instead considered
to be 20 percent less [$64] and the production tax is then
calculated on that basis to arrive at a lower production tax
rate. The aim of the system is to lower the rate further than
the 35 percent or what would have been even lower after the
application of the credit, and thereby provide an incentivized
rate for the new oil without having to get into the messy
business of attributing costs to one place or the other.
2:38:26 PM
MR. MAYER further explained that [during consideration of Senate
Bill 21], the 20 percent reduction was seen as an already big
incentive and therefore the GVR-production-eligible fields would
not receive the sliding Per-Barrel Credit of $0-$8 because in
many scenarios it would take it down to $0 or below. So, there
was deliberate discussion to say that the floor was being
hardened on the base production because that was fair game in
terms of protecting the state on the low side. That the purpose
of net taxation was to be as minimally distorting of investment
as possible and for that reason on new production the hard floor
could go down to $0 when there was no value to tax, but to at
least ensure a more gradual decline by having the fixed $5
credit rather than the varying $0-$8.
MR. MAYER demonstrated how the calculation would work for new
oil by using the $90 price scenario on slide 11. Subtracting
the $10 transportation cost arrives at a gross value of $80 at
the point of production before applying the 20 percent GVR.
Twenty percent of $80 is $16 and subtracting the $16 arrives at
$64 in Gross Value at the Point of Production after GVR. For
purposes of the tax system for new oil, the gross value is then
assessed at $64 rather than $80. The opex and capex are then
subtracted from the $64 to arrive at a Production Tax Value of
$28. Multiplying the $28 by the 35 percent net tax rate arrives
at a net tax of $9.80. Because the $9.80 is higher than the 4
percent gross floor tax of $2.60, the $9.80 is the tax that is
charged. The $5 Per-Barrel Credit is subtracted from the $9.80
to arrive at a tax of $4.80 before subtracting the Net Operating
Loss (NOL) Credit, but because a profit is being made, the NOL
Credit is $0. Thus, the tax after the GVR and credits is $4.80,
which is a tax rate of effectively 11 percent. At the lower
prices of $60 and $30, the tax after applying the GVR and the
two credits is a negative number, so the company would receive
money from the state for its net operating loss.
2:41:47 PM
REPRESENTATIVE SEATON observed that every scenario on slide 11,
except the one at a price of $90, arrives at negative gross and
net tax rates. He proffered that as time goes by, new oil will
become a larger and larger percentage of the total oil
production and therefore it will be a negative situation unless
prices are high. He requested Mr. Mayer to give his perspective
on this relationship.
MR. MAYER answered the question by turning to slide 18, "CHANGES
MAKE REGRESSIVE SYSTEM EVEN MORE SO." He explained that the two
graphs represent the output of a lifecycle economic model and
what the different components of government take would be on
GVR-eligible oil (new projects) at different prices [the graph
on left being for Senate Bill 21 and the graph on the right
being for HB 247]. The hypothetical model is for a new field of
1 million barrels producing 20,000 barrels a day by a new
producer able to claim the GVR, the Net Operating Loss Credit,
and all the rest. A big part of the design of Alaska's system
was to say that across the widest range of prices possible, as
neutral a system as possible is wanted, and that Alaska would
like to be relatively speaking at the lower end of the
government take threshold compared to where the state has been
historically and more in the realm of the places elsewhere in
the world that Alaska is competing against. That aim was around
62 percent government take, which is not one of the most
generous fiscal regimes around, but is a highly competitive one.
As seen on the graphs, that net result is indeed very flat at
that level [of 62 percent] across a really wide range of prices.
MR. MAYER continued, pointing out that the production tax (in
green on the graphs) is a substantial amount at high prices,
tapering down as prices go down until at prices below $70 the
production tax is no longer a feature in the tax system. He
explained that the graphs depict what the contribution would be
over time of each of the elements of the fiscal system when
using the assumption that a new project developed today goes for
20 years and the price is applied consistently for the entire
20-year period. He noted that under the former ACES system
there would have been a much higher take at prices of $70 and
upward, but below $70 the take would have been pretty similar.
Part of that is by design: underneath the production tax is a
big regressive royalty that takes up more and more of the value
of the barrel as prices decline. The purpose of the net tax
that is put on top is not to increase the burden of that net
royalty when prices are lowest. [As prices go down from $150 to
$40 a barrel, the royalty goes from being a low level of
government take to being more than 100 percent in government
take.] Rather, the idea is that a profits tax only kicks in
when, after the royalty and all the other things have been
calculated, there is actual value to tax. What is trying to be
created is something that is as neutral as possible across a
wide range of price environments. Mr. Mayer drew attention to
how the production tax goes negative at the lowest prices, which
is essentially saying that on the one hand across the cycle of
the investment there were credits put in up front, there was
production tax in the tail, and at the lowest prices the
production tax in the tail is nowhere near as much as the
credits that went in up front. But, when put in the context of
the overall fiscal system, this is still not a fiscal system
that is doing anything but generating a proportional share of
value from the project, it is never going down below that 62
percent level, and it is still actually regressive at the lowest
prices because of the element of the royalty.
2:47:17 PM
REPRESENTATIVE SEATON observed on slide 11 that the percentage
of the gross is always negative except in the price scenario of
$90. He opined that new oil will account for a greater and
greater percentage of production under this fiscal system, that
there is a negative percent of the gross [at prices below $90],
and that the system is only barely positive on the percent of
the gross at a price of $90. He asked how that will create
long-term stability for any fiscal system for the state.
2:48:19 PM
MR. MAYER replied by again drawing attention to the charts on
slide 18 and saying they are more useful than slide 11 because
the price scenarios are shown in increments of $10 rather than
$30, and the charts look at the actual cash flow across the
cycle of an actual investment. There are times when there is an
outflow from the credits and times when there is an inflow from
the tax, and the net result of those two things is seen. It is
a net positive down to a price of about $70; a price of $60
starts to be a net negative; and prices of $50 and below are
substantially negative. That is happening precisely at those
levels that the royalty, as the regressive element of the
regime, is taking off in terms of overall government take, and
it is partially compensating for that but not fully compensating
for that. If Alaska had nothing but a completely neutral net
profits tax, the state would still be taking more at the low end
than it would be if it had an Australian, United Kingdom, or
Norwegian model of pure net profits tax, regardless of the level
of government take. Those completely neutral regimes are
neutral across the price deck, [but Alaska's system] uses a
tapering and progressive tax that across the cycle can go
negative because the credits are greater than the value that is
paid out. This partially, but not fully, counteracts the
regressive nature of the royalty, which is why the dashed line
depicting government take across the price deck is 62 percent
across almost all the prices until reaching a price of about $50
a barrel. At a price of $50 per barrel, that government take
starts climbing until at $40 it reaches 100 percent despite that
the production tax element is net giving out money; the rest of
it is taking so much when there is no value to take that it is
still at 100 percent government take. Mr. Mayer noted that for
legibility purposes the chart is cut off and the royalty
actually goes up to about 250 percent government take at a price
of $40 a barrel and net outflow from the production tax is
slightly greater than [negative 50 percent]. The point of the
chart, he explained, is to show the total government take of the
overall system as depicted by the dashed black line. It is
important to see there is an interplay between the production
tax and the royalty. Just focusing on the production tax
without thinking about the rest of the system fails to see that
this was not an accident in design. There was an intention here
to create an overall neutral system for as much of the price
deck as possible.
2:51:41 PM
REPRESENTATIVE SEATON clarified he is not talking specifically
about the production tax as a whole across this. Rather, he
does not see the chart on slide 18 as looking at new oil. The
chart is not separating out that new oil as the new oil becomes
a greater and greater proportion of the production and which is
taxed at a different rate than is existing oil.
MR. MAYER responded that the purpose of slide 18 is an
assessment on the actual lifecycle cash flow economics of a new
investment to which the GVR applies.
2:52:36 PM
REPRESENTATIVE JOSEPHSON offered his understanding that slide 18
is, effectively, showing that the industry is suffering so much
that the state is getting all the money because of royalty. He
inquired whether Mr. Mayer is saying that, even though the state
is impoverished, when looked at vis-à-vis the industry, the
state is the rich one.
MR. MAYER answered "absolutely correct." He stated that he is
discussing the distinction between gross and net taxes and
showing what gross taxes do at low oil prices due to being
regressive. The point is that the royalty at these low prices
quickly takes everything and more than everything, and that to
achieve anything even close to neutrality, by definition there
are other elements of the system that are handing back money.
REPRESENTATIVE JOSEPHSON related that his general sense of what
is going on in the North Slope is that there is development from
the small independents and ConocoPhillips is still investing
particularly in the western field. However, he said, he is not
so sure it is a time of high investment in Alaska. He therefore
questioned the accuracy of the statement on slide 18, "In times
of high investment...."
MR. MAYER clarified that the statement is, "In times of high
investment or low prices." He further clarified that the
statement "as in 2016" refers to the confluence of some major
capital spending projects being in the pipeline from recent
years or before, such as the CD5 and Point Thomson projects.
These are each billion or multi-billion dollar projects and
these costs have been incurred last year or this year. The
dollar per barrel cost figures in the Revenue Sources Book are
staggering. The spending that is happening now for future
production is being deducted against the current tax base. When
there is high spending relative to declining production, and low
prices meaning very low revenue, and a fixed gross royalty of
12.5 or 16 percent plus a 4 percent Gross Minimum Tax, a point
is very quickly reached where there is no value left to tax.
Taking a fixed portion means that 100 percent, 400 percent, and
eventually an infinite amount are being taken because there is
no value left.
REPRESENTATIVE JOSEPHSON asked whether he is correct in
recalling that Mr. Mayer earlier stated that HB 247 does not
change the fundamental structure of the existing system.
MR. MAYER replied that he said HB 247 does not change the
fundamental structure or system that exists, instead it
incrementally takes small slivers without changing that
fundamental structure. It makes small alterations and small
revenue enhancements, which, in some ways, is more concerning.
This is because fundamental changes done to the structure for a
well thought through and well-reasoned purpose, and that an
investor has reason to believe will remain stable going into the
future, is very different than thinking that when the
environment gets bad folks are going to come back to look at
where another slice can be taken.
2:57:45 PM
REPRESENTATIVE TARR commented that slide 18 is interesting given
that royalty has not previously been talked about as being a
regressive feature of the overall tax system. She surmised
there are not any alternatives or ways to fix that because the
royalty is always going to be a fixed percentage and will be
independent of the price per barrel. Royalty has not been
discussed as one of the levers in the system that might be
adjusted to make changes. She remarked that it is a new overlay
to think about this as being a regressive impact.
MR. MAYER responded that during the early days of debating
Senate Bill 21 he spent a lot of time talking about this. There
were various attempts at proposing some sort of progressive
production tax. There had to be some degree of progressivity
simply to counteract the regressive nature of the royalty and
this has always been part of the design.
2:59:04 PM
The committee took a brief at-ease.
2:59:36 PM
REPRESENTATIVE HAWKER remarked that he does not want to leave a
misinterpretation on the table. He drew attention to two of the
statements on slide 2: "HB 247 is not a tax overhaul but it
includes major changes along several key parameters" and "But
most companies will see substantial adverse effects". He said
he wants to avoid the semantics of coming back later and having
it argued that Mr. Mayer said this is not a significant deal.
MR. MAYER agreed.
3:00:37 PM
MR. MAYER resumed his presentation. He moved to slide 12 to
discuss four of the changes proposed in HB 247. He qualified
that this list is by no means exhaustive, but consists of the
proposed changes that enalytica sees as having the biggest
impact on the fiscal system overall and on project economics,
making them particularly important to focus on and talk about.
The first proposed change is the question of the interaction
between the Per-Barrel Credit and the Gross Minimum Tax. The
status quo is that it is an annual tax system, everything about
it is assessed annually. Tax liabilities are assessed annually
which provides a smoothing impact of price volatility. This is
like a person's federal income tax that is assessed annually:
when a whole bunch is earned in one month but not much in
another, the person does not pay the top rate in the month for
which a lot was earned. This proposed change in HB 247 would
calculate monthly that interaction between the Gross Minimum Tax
and the Per-Barrel Credit. Had this proposed change been in
place in 2014, the state would have netted about $100 million
more. This proposed change is an example of what he meant when
he said there is a series of small incremental changes that
appear to be about revenue raising rather than anything else and
that are the things that give him greatest pause for concern.
MR. MAYER said another change proposed by HB 247 relates to the
interaction between the Gross Value Reduction (GVR) and the Net
Operating Loss (NOL). He reminded members that the Gross Value
Reduction reduces the Production Tax Value by changing the gross
and then that flows through to the net. By flowing through to
the net, it also flows through to the way the Net Operating Loss
is calculated. So, in addition to reducing the effective tax
rate, the GVR has the side effect of also increasing the size of
the Net Operating Loss Credit, resulting in more than 35 percent
support for government spending. This proposed change would
make it so that there would always be 35 percent support for
government spending. This proposed change is a legitimate point
that is worth thinking about very seriously, he advised.
3:03:31 PM
MR. MAYER reviewed the change in HB 247 proposed for the Gross
Minimum Tax. He explained that the status quo is a 4 percent
floor that is binding for legacy output [if net value is
positive], but if net value is negative the Net Operating Loss
Credit can reduce a company's taxes below that floor and down to
zero. The proposed change would provide that the NOL cannot
take a major producer below the floor and the proposed change
would also raise the floor from 4 percent to 5 percent. For new
producers, the status quo is that GVR-eligible production with
the $5 per barrel credit can take the new producer down to zero
tax, the idea being minimizing the distorting impact of the
gross minimum floor when things are hardest. The proposed
change would provide that the Small Producer Credit and the $5
Per-Barrel Credit cannot take a new producer below the proposed
hard floor of 5 percent. Thus, the proposed change would raise
the hard floor from 4 percent to 5 percent for incumbent
producers and for new producers it would raise the hard floor,
as a gross floor, from 0 percent to 5 percent.
3:04:53 PM
MR. MAYER examined the proposed change for the Net Operating
Loss Credit. Under the status quo, he said, reimbursement of
the Net Operating Loss Credit must be carried forward by those
producers with production greater than 50,000 barrels a day, and
for those companies with less than 50,000 barrels a day the
credit can be reimbursed by the state. This proposed change
would put an annual limit of $25 million per company on the
reimbursement. It would also require that very large companies
with annual revenues greater than $10 billion must carry forward
the credit regardless of the amount of their production. He
said he understands the desire to limit the state's potential
liability through the credit system; however, he continued, when
thinking about what a $25 million cap per company would do, both
in general and particularly if enforced in July 2016, a company
involved in this would be very scared.
REPRESENTATIVE JOSEPHSON thanked and complimented Mr. Mayer for
slide 12 being a fantastic slide.
3:06:18 PM
REPRESENTATIVE HAWKER stated that slide 12 could be made better
by including Section 31 that proposes to disallow wellhead value
from going below zero. He requested Mr. Mayer to add this
change to the slide along with the impacts it would have.
MR. MAYER agreed this change should have been included. He said
this issue is one of the incremental pieces in that the Gross
Value at the Point of Production would not be able to go below
zero. He reiterated that it is not a ring fenced system, taxes
are assessed company-wide across the North Slope, which means
all of a company's production and costs across the North Slope.
Because of how the calculation works and the language in HB 247,
this change would mean that if Gross Value at the Point of
Production cannot go below zero for some particular piece of
production, it would mean that the costs that a company actually
incurred at that place could not be written down against
production that the company had in other places. That would
actually be a substantial change to the tax system because at
the moment it is Slope-wide costs and Slope-wide production. A
company that has gone ahead with an expensive, loss-making
investment for reasons that it wants to see a field developed in
the future, did so under the belief that it could write those
costs off against all of its production, not simply against the
production that came from that one project.
REPRESENTATIVE TARR asked whether now would be the appropriate
time for her to ask about her point of changing it to a carry
forward for the majors.
MR. MAYER replied he will be coming to that in about two slides.
3:08:46 PM
MR. MAYER resumed his presentation and began to elaborate on
what the impacts would be for each of the aforementioned
proposed changes. Drawing attention to slide 13, "MONTHLY GROSS
MIN CALCULATION: NEUTRAL OR TAX HIKE," he noted that the impact
of this proposed change would be either neutral or a tax hike
depending on the price environment and, in particular, depending
on volatility. A crude way of expressing it would be to say
"heads I win, tails it's a draw." The reason for that is best
understood by looking at the price environment in 2014 where for
most of the year prices were at or above $100 a barrel, but then
prices started to fall in the last quarter. Referring to the
chart on slide 13, he pointed out that the Alaska North Slope
West Coast (ANS WC) average annual price was about $98. He said
the expenses used in the chart are for the fiscal year rather
than the calendar year, but are still a decent representation.
He calculated that subtracting the average annual cost for
transport, opex, capex, 35 percent production tax, and Per-
Barrel Credit results in a net tax of $8.71 and a Gross Minimum
Tax of $3.49. So, in this case, the net tax of $8.71 is what
applies and therefore the gross liability per barrel is $8.71.
However, if these calculations are done on a monthly basis for
2014, the net tax would be applied for each of the first 10
months and the Gross Minimum Tax would be applied to each of the
last 2 months. In the last two months, the gross tax amount is
actually higher than the net tax amount. When the production
tax for each of the 12 months is then averaged, the average
production tax is $9.31 per barrel and when multiplied by the
number of taxable barrels on the North Slope it is roughly $100
million more. The way that $100 million is generated for the
state is simply by saying that rather than assessing this
annually, the state would assess this monthly and a company
would not get the benefit of that revenue smoothing across the
year. It would be like being taxed at the top tax rate in the
months where a company's income is highest even if on average
over the year the company's income was substantially lower than
that.
[HB 247 was held over.]
| Document Name | Date/Time | Subjects |
|---|---|---|
| HSE RES 2.25.16 enalytica Overview + North Slope February 2015.pdf |
HRES 2/25/2016 1:00:00 PM |