Legislature(1995 - 1996)
03/22/1996 01:40 PM House FIN
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* first hearing in first committee of referral
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+ teleconferenced
= bill was previously heard/scheduled
HOUSE BILL NO. 325
"An Act authorizing suspension of payment of a portion
of the royalty due the state for initial production of
heavy oil from wells on the Arctic Slope."
1
REPRESENTATIVE JOE GREEN testified in support of HB 325. He
provided members with Amendment 1, 9-LS112\R.7 (Attachment
1).
Co-Chair Foster MOVED to adopt Amendment 1. Representative
Green observed that Amendment 1 is the result of a work
session with the Division of Oil and Gas and operators.
KEN BOYD, DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF
NATURAL RESOURCES provided members with a memorandum
summarizing Amendment 1 (Attachment 2). He noted that the
amendment clarifies the meaning of a "well". He pointed out
that the memorandum contains suggestions for amendments to
the legislation:
Amendment 2
(E) for purposes of calculating the first 500 barrels
per day of production from a well, production from dual
completions and other forms of multiple completions in
a well is to be added together and counted as
production from a single well.
Amendment 3
(f) for purposes of defining fieled costs in this
subparagraph, field costs include the costs
outlined in AS 38.05.180(f).
Co-Chair Hanley noted that the memorandum from Mr. Boyd,
includes other amendments to the legislation:
Amendment 4
Page 2, line 10
delete "finished goods"
insert "industrial commodities"
Amendment 5
Page 2, line 22
insert after "performed"
"at least once monthly"
Mr. Boyd discussed the substantive changes contained in
Amendment 1. He stated that the Amendment 1 clarifies what
a well is and what a well is not by inserting "for purposes
of this subparagraph, `actual initial drilling' does not
include plug-backs of existing wells, sidetracks from
existing wells, multi-lateral or dual completions of
existing wells, or sidetracks of redrilled wells,".
2
Mr. Boyd identified other substantive changes made by
Amendment 1:
Page 2, line 30
(2) by taking an exemption from the payment
of royalty under this subsection, the lessee
waives any right that the lessee might
otherwise have under its lease, unit
agreement, or other agreement with the State
to deduct, against royalty due the State, any
field costs associated with the production of
the heavy oil for which exemption is taken;
and
(3) in this subsection `heavy oil' means oil
having a weighted average equal to or less
than 20 degrees API gravity as the term API
gravity' is defined in AS 43.55.900.
Mr. Boyd stressed that the remainder of the amendment
provides for renumbering.
JON TILLINGHAST, ATTORNEY, OCCIDENTAL OIL AND GAS
CORPORATION (OXY) USA INC. discussed Amendment 1. He agreed
that the majority of the amendment renumbers sections. He
observed that Amendment 1 clarifies that the exemption only
applies to new wells and not to the redrilling of existing
wells.
Mr. Tillinghast observed that Amendment 1 clarifies that the
$15 dollar a barrel ceiling will be the "lessee's reported
royalty before any field cost deduction."
Mr. Tillinghast noted that the last substantive change made
by the amendment clarifies that any heavy oil field costs
that royalty is not paid on cannot be deducted against other
production.
Mr. Tillinghast discussed amendments suggested by Mr. Boyd
in Attachment 2. He observed that Amendment 2, with the
addition of subsection (e), would clarify that the
suspension would pertain to the total production of
individual pipes of a multiple completion well. He noted
that Amendment 3 would amend AS 38.05.180(f) to define field
costs. Amendment 4 by Mr. Boyd would make more accurate
reference to what it is that the producer price index
reports. He did not object to the first three amendments.
Amendment 5 would change the requirement for gravity tests
from quarterly to monthly. Mr. Tillinghast expressed
concern with this requirement. He noted that the burden of
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this amendment would be significant. He concluded that a
quarterly gravity test would be sufficient.
Mr. Boyd noted that flow tests are performed monthly. He
did not think the requirement to perform gravity tests
monthly would be onerous.
In response to a question by Representative Martin, Mr.
Tillinghast agreed that flow rates are continuously
monitored. He pointed out that API gravity tests are not
part of the existing testing and measuring system.
BRUCE POLICKY, EXPLORATION MANAGER, MILNE POINT, BRITISH
PETROLEUM explained that API gravity tests are performed in
a lab. Samples are removed manually from the well and taken
to a lab. He emphasized that this is labor intensive. The
labs are on site.
WILLIAM VANDYKE, PETROLEUM ENGINEER, DEPARTMENT OF NATURAL
RESOURCES stressed that marginal wells could change on a
monthly basis. He observed that other tests such as royalty
accounting and production accounting are done monthly.
Representative Green pointed out that the other tests
mentioned by Mr. Vandyke are metered and performed in the
field. He pointed out that API gravity tests would be more
costly.
There being NO OBJECTION, Amendment 1 was adopted.
Representative Brown discussed Amendment 3. She noted that
"field costs" are not defined in AS 38.05.180(f). Mr. Boyd
maintained that for the purpose of defining "field costs"
subsection (f) should be included in the legislation.
Discussion ensued regarding the wording of the amendment.
Mr. Tillinghast pointed out that AS 38.05.180(f) defines
lease or unit expenses. He suggested that the amendment be
amended to insert "those lease or unit expenses" and delete
"the costs". Representative Brown noted that the amendment
would clarify that these kinds of things are included.
Representative Therriault MOVED to adopt Amendment 2.
(E) for purposes of calculating the first 500 barrels
per day of production from a well, production from dual
completions and other forms of multiple completions in
a well is to be added together and counted as
production from a single well.
There being NO OBJECTION, it was so ordered.
Representative Therriault MOVED to adopt Amendment 3 as
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amended.
(f) for purposes of defining filed costs in this
subparagraph, field costs include those lease or
unit expenses outlined in AS 38.05.180(f).
There being NO OBJECTION, it was so ordered.
Representative Brown MOVED to adopt Amendment 4.
Page 2, line 10
delete "finished goods"
insert "industrial commodities"
There being NO OBJECTION, it was so ordered.
Co-Chair Hanley asked the expense of Amendment 5. Mr.
Policky stated that an API gravity test would cost $50
dollars a sample. The labor involved in obtaining the
sample would increase the cost.
Mr. Boyd suggested that monthly API gravity tests be
required for wells with a weighted average of 19 degree API
gravity or greater. Representative Martin spoke in support
of frequent sampling.
Representative Therriault MOVED to conceptually adopt
Amendment 5 to require monthly testing for wells having a
weighted average of 19 degrees API gravity or greater, and
to require quarterly tests on wells below 19 degrees API.
There being NO OBJECTION, it was so ordered.
Representative Brown referred to Attachment 2. She noted
that Mr. Boyd suggested that "reported royalty" be changed
to "actual royalty". Mr. VanDyke noted that adjusted
royalty reports are filed after the initial filing. He
stressed that if royalty adjustments push royalty over the
trigger point that royalty will be paid. He noted that
revisions are common.
Members discussed the wording for proposed Amendment 6.
Representative Brown asked if "adjusted" should be inserted.
Representative Brown MOVED to adopt Amendment 6:
Conceptually amend Amendment 1, page 1, line 14, after
"royalty" insert "as may be adjusted." There being NO
OBJECTION, it was so ordered.
Representative Brown provided members with Amendment 7, 9-
LS1122\R.5 (copy on file). Representative Brown MOVED to
adopt Amendment 7. Representative Mulder OBJECTED for
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purposes of discussion. Representative Brown stated that
there should be some period of time when the State is
guaranteed to get its base royalty. The amendment would
prevent a lessee from claiming or obtaining an additional
royalty adjustment on heavy oil production for 20 years
after an exemption is taken under the bill.
Mr. Tillinghast stressed that the Legislature is directly
setting state royalty policy through the enactment of HB
325. He stated that the amendment is consistent with this
approach.
Representative Navarre expressed concern that advances in
technology will result in greater savings to operators than
estimated. He noted that testimony showed a third of the
State's royalty will be forgiven under existing technology.
He stressed that if technology is enhanced the State will
give away a significantly larger percentage of its royalty
share.
(Tape Change, HFC 96-85, Side 2)
Representative Navarre concluded that using assumptions
provided by OXY that the operator will receive $1.177
billion dollars over five years from their investment. (172
wells X 300 barrels X $12.5 dollars per barrel X 365 days X
5 years.) He stressed that this would provide a 100 percent
return on their capital investment, plus interest, and $600
million dollars in field costs for the forty year life of
the field. He maintained that all the incentives are given
on the front end. He asserted that there will not be
incentive for additional investment in the wells to increase
production after the royalty holiday. He stated that
operators could receive $2.3 billion dollars based on 172
wells X 500 barrels X $15 dollars per barrel X 365 days X 5
years. He reiterated that there is a disincentive for
development after the first five years of a well.
Representative Green noted that if production is over 500
barrels a day royalty would be paid. He stated that the
purpose of this provision is to assure that the State
benefits from advances in technology.
Representative Navarre clarified that royalty would only be
paid on the incremental amount above 500 barrels a day. He
asked what is the break even point in OXY's profit margin.
He stressed the need to find a fair rate of return to
provide an incentive for development while protecting the
State's interest.
Representative Green emphasized that royalty would only be
forgiven on 10 percent of the available resource.
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Representative Navarre pointed out that OXY's presentation
used a 300 barrel a day average for their base economic
assumptions. He observed that the bill allows a production
average of 500 barrels a day. He suggested a field average
of 300 barrels a day for all wells.
Mr. Tillinghast disagreed with calculations by
Representative Navarre regarding profit margins. He
stressed that there will not be 172 producing wells in the
first year. He stated that there will only be 15 producing
wells in the first year and 30 producing wells in the second
year. He acknowledged that the State runs some risk in lost
revenues. He pointed out that the alternative is to take no
action and lose the resource. He maintained that a brief
royalty suspension minimizes the risk. He stressed that if
a reduced royalty was granted over the life of the field
that the risk would be for the full forty year field life.
Representative Navarre argued that his calculations are not
in error. He stressed that all 172 producing wells will
have 5 years of royalty holiday, regardless of when they are
drilled. He stated that he would support royalty reductions
to allow returns of 100 percent of the operator's
investment, interest and field costs. He emphasized that
the legislation provides the potential for greater profits.
Representative Brown stressed that the intent of Amendment 7
is to guarantee that the State receives the base royalty
amount estimated by OXY.
Representative Navarre questioned if an average well
production rate on a field wide basis would be an acceptable
compromise. Representative Green stressed that the rate
would only apply to the well seeking reduction. He
emphasized that higher gravity wells would not be included
in the calculations.
Representative Brown spoke in support of Amendment 7. She
maintained that the amendment is needed to ensure that the
promised benefits materialize over the life of the
agreement. She emphasized the need to guarantee that
operators do not receive additional reductions immediately
after the expiration of the royalty holiday.
Representative Navarre expressed concern that wells will be
shut in if additional investment is required after the
holiday expires. He concluded that operators could request
additional reductions from the Legislature.
Representative Navarre WITHDREW his objection to Amendment
7
7. Co-Chair Foster OBJECTED. A roll call vote was taken on
the MOTION to adopt Amendment 7.
IN FAVOR: Brown, Grussendorf, Navarre, Kelly, Kohring,
Parnell, Therriault, Hanley
OPPOSED: Mulder, Martin, Foster
The MOTION PASSED (8-3).
Representative Brown noted that BP and OXY had agreed to
supply the Division of Oil and Gas with information
supporting their assumptions. She questioned if this
material had been delivered and reviewed.
Mr. Boyd noted that the Division received some data from OXY
two weeks ago. No information was received from BP. He
observed that the Division's results differ slightly in some
instances. He maintained that assumptions for OXY should
not be applied for BP.
Mr. Policky stated that BP has 85 percent of the data
collected. He stated that BP would submit their data in the
next week.
In response to a question by Representative Brown, Mr. Boyd
noted that the legislation would apply to a number of
fields, including Kuparak, Endicott, West Sak and Prudhoe
Bay.
Mr. Tillinghast noted that heavy oil production in Prudhoe
Bay would be under the same provisions as Milne Point heavy
oil production. If a new well is drilled under the heavy
oil provision the royalty holiday would apply.
Representative Green noted that the heavy oil formation in
Prudhoe Bay is surrounded by water. The ability to confine
production to heavy oil will take a technological
breakthrough.
Representative Brown restated that the language on page 2,
lines 13 and 14 only pertains to new wells. Mr. Tillinghast
agreed that the legislation only applies to new wells.
Representative Navarre questioned the policy that the
legislation will implement. He asserted that a greater rate
of return on the first five years of the royalty holiday
does not mean that it will be reinvested into the life of
the field. He maintained that the
legislation almost guarantees that reinvestment will not
occur. He suggested that royalties could be forgiven at one
third of the well's value for the life of the well. He
alleged that the legislation creates an incentive to shut in
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wells. He asked if a royalty reduction on an annual basis
was considered.
Representative Green replied that if all wells were drilled
instantaneously there might be some justification for
Representative Navarre's suggestions. He emphasized that
wells are not drilled all at one time. He stressed that the
same capital is reinvested into additional wells. He
maintained that heavy oil production is a high risk venture.
He noted that two attempts have been made at production of
heavy oil. He pointed out that operators cannot leave it up
to speculation that the Commissioner will allow a royalty
reduction after the infrastructure has been developed.
There has to be security for development to occur.
Representative Brown stressed that the level of royalty
reduction needed to stimulate production has not been
determined. She suggested that the legislation be held
until data is available to determine the level of reduction
needed. She added that amendments to HB 207 should be
considered to allow the Commissioner to grant reductions on
heavy oil pools.
Co-Chair Foster MOVED to report CSHB 325 (FIN) out of
Committee with individual recommendations and with the
accompanying fiscal notes. Representative Navarre OBJECTED.
He pointed out that the economic assumptions are based on
the field's 8 percent owner, OXY. He suggested that
economics for the 92 percent operator will differ. He noted
that he would like to amend CSHB 325 (FIN); on page 2, line
1, delete "500" and insert "300". On page 2, line 14,
delete "2206" and insert "2002".
Co-Chair Foster WITHDREW his motion.
Representative Navarre MOVED to on page 2, line 1 to delete
"500" and insert "400". The amendment would provide that
the royalty holiday be given on the first 400 barrels of
daily production of heavy oil. Co-Chair Foster OBJECTED.
Representative Navarre maintained that 500 barrels a day
would provide an excessive profit margin. Mr. Tillinghast
stated that OXY's assumptions were based on a 430 barrels a
day production level. He stressed that 500 barrels a day
provides for an average of 430 barrels a day. He maintained
that the project would be sub-economic at 400 barrels a day.
Representative Navarre argued that testimony stated that
production rates for wells drilled at a later date are
higher. Mr. Tillinghast argued against the amendment. He
stressed that 500 barrels a day only just allows OXY to be
competitive.
A roll call vote was taken on the MOTION.
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IN FAVOR: Brown, Grussendorf, Navarre, Hanley
OPPOSED: Kelly, Kohring, Martin, Mulder, Parnell, Foster
Representative Therriault was absent from the vote.
The MOTION FAILED (4-6).
Representative Navarre MOVED to delete "2206" and insert
"2002" on page 2, line 14. He emphasized that the amendment
would anticipate a more accelerated rate in terms of
development.
Mr. Tillinghast observed that BP's development plan expands
nine years. He observed that later wells in the development
plan would be shut out of taking advantage of the
suspension. He noted that development is evaluated based on
the rate of return of the whole project. He maintained that
the rate of return for the whole project would be reduced.
He stressed that disincentive for later wells would be
created.
Representative Navarre suggested that development would have
to occur quicker. He acknowledged that the amendment may
require a small amount of additional risk in terms of the
capital investment. He maintained that the return would be
just as great.
(Tape Change, HFC 96-86, Side 1)
Representative Navarre noted that the Legislature could
revisit the issue prior to the sunset. He maintained that
the amendment would require that the issue be revisited when
more data is available.
A roll call vote was taken on the MOTION to delete "2006"
and insert "2002".
IN FAVOR: Brown, Grussendorf, Navarre
OPPOSED: Kelly, Kohring, Martin, Mulder, Parnell,
Therriault, Hanley
The MOTION FAILED (4-6).
Co-Chair Foster was absent from the vote.
Representative Mulder MOVED to report CSHB (FIN) out of
Committee with individual recommendations and with the
accompanying fiscal notes. Representative Navarre OBJECTED.
A roll call vote was taken on the MOTION.
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IN FAVOR: Kelly, Kohring, Martin, Mulder, Parnell, Foster,
Hanley
OPPOSED: Brown, Grussendorf, Navarre, Therriault
The MOTION PASSED (7-4).
CSHB 325 (FIN) was reported out of Committee with "no
recommendation" and with a fiscal impact note by the
Department of Revenue and with a fiscal impact note by the
Department of Natural Resources, dated 1/24/96.
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