Legislature(2005 - 2006)HOUSE FINANCE 519

07/27/2006 10:00 AM House FINANCE


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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ HB3003 OIL AND GAS TAXES/ADJUSTMENTS/ELF TELECONFERENCED
Heard & Held
-- Testimony <Invitation Only> --
+ Bills Previously Heard/Scheduled TELECONFERENCED
+= HB3001 OIL/GAS PROD. TAX TELECONFERENCED
Heard & Held
+= HB3004 OIL AND GAS TAX TELECONFERENCED
Heard & Held
                                                                                                                              
 Presentation by AOGA and AOGCC on HB 3001, HB 3003, HB 3004                                                                  
                                                                                                                                
JUDY   BRADY,  EXECUTIVE   DIRECTOR,  ALASKA   OIL  AND   GAS                                                                   
ASSOCIATION (AOGA),  stated that all three bills  raise taxes                                                                   
on the oil and gas industry, but are very different.                                                                            
                                                                                                                                
Ms. Brady highlighted  the changes and policy  issues of each                                                                   
piece of legislation.  She read as follows (copy on file):                                                                      
                                                                                                                                
NB 3003  and HB 3004 are  tax bills introduced for  the first                                                                   
time in  this special  session. Both  proposed bills  go back                                                                   
to the present  production tax - and add some  new twists, in                                                                   
order to  increase taxes; HB  3004 adds complications  to the                                                                   
present  tax  system,  and  raises  policy  issues  that  are                                                                   
arguably outside  the call of this special  session; both are                                                                   
strictly tax  increases on  the gross  production at  a level                                                                   
that  fails  to  address  the critical  need  for  Alaska  to                                                                   
attract  new  investment at  the  same  time as  the  state's                                                                   
share in oil revenues increases.                                                                                                
                                                                                                                                
You have  heard us say many  times that declining  production                                                                   
is the  eight hundred pound  gorilla in Alaska's  future. Tax                                                                   
legislation   must  be   configured   to   attract  the   new                                                                   
investment necessary  to increase production.  Incentives for                                                                   
new  investment and  reasonable  tax rates  that keep  Alaska                                                                   
competitive  with like oil  and gas regions  must be  part of                                                                   
the package.  Any legislation  that overreaches on  tax rates                                                                   
or  neglects real  world incentives  will simply  be a  black                                                                   
hole that leaves  Alaska as a backwater in  worldwide oil and                                                                   
gas regions.                                                                                                                    
                                                                                                                                
There are  now l4  days left  in this  special session  - and                                                                   
four  tax bills  on the  table. HB  3003 and  HB 3004  you've                                                                   
just been  hearing. HB 3005 was  introduced two days  ago. We                                                                   
understand  two other bills  are being  drafted. Of  the four                                                                   
tax  bills presently  on the  table,  only one  has been  the                                                                   
subject of  long and intense review  and scrutiny -  and that                                                                   
is HB  3001, the  Petroleum Production  Tax legislation.  The                                                                   
PPT  legislation was  the  subject of  hundreds  of hours  of                                                                   
hearings  in the  last legislative  session and  in the  last                                                                   
special  session.  It  has been  reviewed  and  critiqued  by                                                                   
consultants  hired  by the  legislature,  the  administration                                                                   
and the  oil and  gas companies  affected. The parameters  of                                                                   
this legislation are well understood.                                                                                           
                                                                                                                                
We ask  you to consider focusing  the remaining days  in this                                                                   
special  session on  reviewing,  finalizing  and adopting  HB
3001. The fact  of the matter is that developing  clear, fair                                                                   
tax  legislation   that  both  incentivizes   investment  and                                                                   
brings  a larger  share of  revenue  to the  state is  rocket                                                                   
science.  Those  of you  who  have  spent hundreds  of  hours                                                                   
trying  to  develop fair,  equitable  legislation,  are  well                                                                   
aware of  this fact.  Rocket science takes  time and  so does                                                                   
tax legislation.  The legislature  has spent  that time  on a                                                                   
new approach  for oil production tax  in Alaska - a  tax that                                                                   
reflects real  production economics.  A tax that  substitutes                                                                   
real cost  figures for the  proxy Economic Limit  Factor. The                                                                   
promise is  that this  tax will  increase revenues  to Alaska                                                                   
by over  one billion dollars a  year. The promise is  that in                                                                   
addition  to  increased  revenues,   this  tax  will  provide                                                                   
incentives  for new  investments  for the  new production  so                                                                   
desperately needed.                                                                                                             
                                                                                                                                
AOGA Supports HB 3001 - Governor's PPT                                                                                          
   • Even though  many of our  members remain  concerned that                                                                   
     the  increased level  of state  take  reflected in  this                                                                   
     bill will result  in reduced investment in  Alaska. This                                                                   
     bill would raise  taxes on the industry over  $1 billion                                                                   
     a year at $60/bbl.                                                                                                         
   • There continues  to be  a sense  of astonishment  in oil                                                                   
     and gas financial circles about  this agreement to a tax                                                                   
     increase of this size.                                                                                                     
   • And would raise total government take to around 60%.                                                                       
   • "Government take"  - royalty; production  tax, corporate                                                                   
     income tax; property tax, federal taxes                                                                                    
   • What do "costs"  have to do  with it - costs  have to be                                                                   
     counted either  directly or as  a proxy to  conserve oil                                                                   
     in the ground in maturing fields                                                                                           
   • PPT more accurately reflects true production economics                                                                     
   • The  balance  in   the  PPT  is  the  higher   tax  rate                                                                   
     counterbalanced by the reinvestment incentive.                                                                             
   • The balance  is essential -  throughout the  hearings on                                                                   
     PPT  there have  been  references  to countries  with  a                                                                   
     "higher"  government take  than  Alaska -  as Pedro  Van                                                                   
     Muers and  other consultants  have pointed out,  many of                                                                   
     those   countries  either   have  government-owned   oil                                                                   
     companies or are using production  sharing contracts. In                                                                   
     both cases the  governments take a bigger  share of risk                                                                   
     for a bigger share of profits.                                                                                             
   • Some  policy  makers  seem  to  be  frozen  between  the                                                                   
     concepts of "risk"  and "profits". They want  a lot more                                                                   
     of the share  of the profits; they don't  want any share                                                                   
     of the risk.                                                                                                               
   • This one-sided "two for me -  one for you" won't work in                                                                   
     the  worldwide competitive  market.  Under those  terms,                                                                   
     Alaska's  won't even  place for  new  investment in  any                                                                   
     serious way.                                                                                                               
                                                                                                                                
Gross Versus  Net tax -  Criticisms of  a net system  seem to                                                                   
be  based on  a misunderstanding  of how  the present  system                                                                   
works and how the PPT would work.                                                                                               
                                                                                                                                
   • The ELF in the  current system is a proxy  for costs. So                                                                   
     in that  sense the  current system  is  a form of  "net"                                                                   
     tax.  The PPT  simply  substitutes  real costs  for  the                                                                   
     proxy.                                                                                                                     
   • Some  legislators have  expressed the  concern that  the                                                                   
     state does  not have  the capability  to determine  real                                                                   
     costs. However, the state currently  audits the costs in                                                                   
     the netback in a lot of detail.                                                                                            
   • Operating and capital costs are  in our state income tax                                                                   
     return and property tax renderings.                                                                                        
                                                                                                                                
11:19:22 AM                                                                                                                   
                                                                                                                                
MIKE  HURLEY,  CONOCOPHILLIPS   ALASKA,  CHAIR  OF  AOGA  TAX                                                                   
COMMITTEE, spoke to auditing.   Every return filed by the oil                                                                   
companies is  audited.  The  audit assessments over  the past                                                                   
several years  have been  within 2%  for what is  anticipated                                                                   
payment.  He reiterated that it is a 100% audit.                                                                                
                                                                                                                                
11:21:04 AM                                                                                                                   
                                                                                                                                
Ms. Brady  said she knew that  the Department of  Revenue has                                                                   
the capability to audit.  She  addressed previous court cases                                                                   
surrounding   the  production   tax  and  prevailing   value.                                                                   
Currently,  the state  has been through  all necessary  steps                                                                   
for a net production tax.                                                                                                       
                                                                                                                                
Ms. Brady continued with her presentation:                                                                                      
                                                                                                                                
AOGA Does Not Support either HB 3003 or HB 3004                                                                                 
   • These   bills  are   simply   tax  increases   with   no                                                                   
     counterbalance                                                                                                             
   • No re-investment incentives, do  nothing to stem decline                                                                   
     or encourage  investment, there's  no structural  change                                                                   
     in the risk sharing.                                                                                                       
   • With HB  3003 ELF disappears  so there's  no recognition                                                                   
     of costs at all.                                                                                                           
                                                                                                                                
   • HB 3004  is a band-aid  approach -  a higher  rate, with                                                                   
     much  more  complexity.  It  seemed  puzzling  that  the                                                                   
     sponsor  spent so  much of  his  time providing  figures                                                                   
     about the industries profits, yet was proposing a tax                                                                      
     that has nothing to do with the profits.                                                                                   
                                                                                                                                
Oil and Gas Tax Legislation Is Not a Game of Texas Hold 'Em                                                                     
                                                                                                                                
   • Whether it is political one-ups-man-ship during an                                                                         
     election  year -  or real  belief that  Alaska does  not                                                                   
     have to be  competitive to attract new investment  - the                                                                   
     bidding up  of how much the  state of Alaska  can "make"                                                                   
     or "take" from oil production  is going to lose the game                                                                   
     for all of us.                                                                                                             
                                                                                                                                
The end game for  oil and gas tax legislation  can be about a                                                                   
higher  return for  the state  of Alaska  but must  recognize                                                                   
the need for  incentives that foster additional  investment -                                                                   
bottom line -  It is about increasing production  and keeping                                                                   
Alaska competitive.                                                                                                             
                                                                                                                                
The  pipeline  is  only  half  full.   This  must  be  turned                                                                   
around.                                                                                                                         
                                                                                                                                
11:25:22 AM                                                                                                                   
                                                                                                                                
Mr. Hurley addressed  access.  He maintained  that access has                                                                   
not been denied.                                                                                                                
                                                                                                                                
11:26:18 AM                                                                                                                   
                                                                                                                                
REPRESENTATIVE LES  GARA commented on  the access issue.   He                                                                   
asked if ConocoPhillips'  facilities had been  made available                                                                   
to  small  producers.   Mr.  Hurley  replied that  a  company                                                                   
called Windstar  made use  of ConocoPhillips' facilities  but                                                                   
came up with  a dry hole.   He stated that there has  been no                                                                   
production loss.                                                                                                                
                                                                                                                                
Representative  Gara  clarified  that  no  other  independent                                                                   
company has been able to produce  oil through ConocoPhillips'                                                                   
facilities.                                                                                                                     
                                                                                                                                
11:27:58 AM                                                                                                                   
                                                                                                                                
Representative Gara wondered why,  in spite of an increase in                                                                   
profits, exploration and investment  have not increased.  Ms.                                                                   
Brady replied that in the years  when the oil company profits                                                                   
increased,  so   did  the  state's.     As  far   as  further                                                                   
investment,  ConocoPhillips  is  investing  "big  time"  this                                                                   
year.  There are more wells being  drilled.  She did not know                                                                   
the  investment  figures,  but thought  all  investments  had                                                                   
increased.   Exploration  doubled  during  that time  period.                                                                   
There  is  money going  to  investors  in dividends  and  the                                                                   
Alaska  Permanent Fund  benefits  from that;  there is  money                                                                   
going  to  investment;  and  there will  be  more  buy  outs.                                                                   
Analysts look at  the reserves, which need to  be explored or                                                                   
bought.                                                                                                                         
                                                                                                                                
11:31:32 AM                                                                                                                   
                                                                                                                                
Co-Chair Meyer commented  on the only common  ground found in                                                                   
the net versus gross debate, which  is to increase investment                                                                   
and production.   He asked  if the net  would help  meet that                                                                   
objective better.   Ms. Brady replied it would;  net is based                                                                   
on profit.  Net only, without  incentives, would not work and                                                                   
would be  dangerous.  Under  the net  tax, the state  takes a                                                                   
bigger  risk through the  incentives,  and the companies  can                                                                   
afford to  take less profit at  the top.  She  concluded that                                                                   
she prefers the net.                                                                                                            
                                                                                                                                
Co-Chair Meyer  asked how  to attract  more oil companies  to                                                                   
Alaska.   Ms. Brady  replied that  the fiscal  system is  the                                                                   
only thing  that the  government can control.   Shell  Oil is                                                                   
coming back  into Alaska and  other companies are  showing an                                                                   
interest.  The state needs a big find.                                                                                          
                                                                                                                                
11:34:57 AM                                                                                                                   
                                                                                                                                
Co-Chair Meyer  asked if AOGA  represented all  oil companies                                                                   
in  Alaska.   Ms. Brady  replied  that it  represents all  18                                                                   
companies.                                                                                                                      
                                                                                                                                
11:35:21 AM                                                                                                                   
                                                                                                                                
Co-Chair Chenault  addressed a question about  Prudhoe Bay to                                                                   
Mr. Hurley.   He wondered what  paper work would  be required                                                                   
to allow for "gaming"  of the system.  He did  not envision a                                                                   
scenario  that the  auditors  could not  work  through.   The                                                                   
state  can audit for  any detail  and the  level of  auditing                                                                   
would be a choice made by the state and the legislature.                                                                        
                                                                                                                                
Co-Chair  Chenault speculated  that it  would take all  three                                                                   
companies  to successfully  "game" the  state.   If that  was                                                                   
done there could be jail time  and fines.  Mr. Hurley agreed.                                                                   
Co-Chair   Chenault  thought   that  there  were   protective                                                                   
mechanisms in place.                                                                                                            
                                                                                                                                
11:39:09 AM                                                                                                                   
                                                                                                                                
Representative  Kerttula  stated  it wouldn't  be  collusion;                                                                   
there  could  be  disagreements   with  the  state  over  the                                                                   
rightful  costs, which  could  result in  court  cases.   Mr.                                                                   
Hurley recalled that there was  a past case settled regarding                                                                   
tax costs.   Representative Kerttula added that  she has been                                                                   
involved in tariff cases regarding  disagreements.  She spoke                                                                   
to her history in the Department  of Law.  She disagreed with                                                                   
the usage of "fraud".                                                                                                           
                                                                                                                                
Mr.  Hurley  noted  that  AOGA   submitted  comments  on  the                                                                   
Governor's  PPT bill  requesting clarity  on excluded  costs.                                                                   
There are concerns by the companies.                                                                                            
                                                                                                                                
11:41:23 AM                                                                                                                   
                                                                                                                                
Representative  Kerttula  foresaw  problems with  costs  when                                                                   
giving substantial weight to the  agreements.  She encouraged                                                                   
that a standard  be established.  She emphasized  it is not a                                                                   
collusion situation.                                                                                                            
                                                                                                                                
11:42:28 AM                                                                                                                   
                                                                                                                                
Ms. Brady pointed out that there  is competition on the North                                                                   
Slope.  Each company thinks their  way is the best.  Over the                                                                   
past  40 years,  the state  has  had access  to the  disputed                                                                   
information.  Many issues have  already been worked out.  Mr.                                                                   
Hurley pointed out  grouping of costs, with 3  to 4 different                                                                   
conceptual models:                                                                                                              
                                                                                                                                
*    Inter-company billing                                                                                                      
*    IRS reference to ordinary and necessary                                                                                    
*    DNR regulations for net profit sharing exclusions                                                                          
                                                                                                                                
11:45:42 AM                                                                                                                   
                                                                                                                                
CATHY   FOERSTER,   COMMISSIONER,    ALASKA   OIL   AND   GAS                                                                   
CONSERVATION  COMMISSION  (AOGCC),  read  from  her  prepared                                                                   
testimony (copy on file.)                                                                                                       
                                                                                                                                
     Before  proceeding,  I want  to  disclose  to you  that,                                                                   
     immediately prior  to serving on the AOGCC,  I worked as                                                                   
     an engineering  consultant and, as such,  I participated                                                                   
     in  preparing  the  "North   Slope  of  Alaska  Facility                                                                   
     Sharing Study" performed  by Petrotechnical Resources of                                                                   
     Alaska  for   the  Division  of  Oil  and   Gas  of  the                                                                   
     Department  of  Natural   Resources.  I  discussed  this                                                                   
     participation  with the  other  AOGCC commissioners  and                                                                   
     they agreed  that this did  not represent a  conflict of                                                                   
     interest.   However,  I   did  want   to  disclose   the                                                                   
     information to you.                                                                                                        
                                                                                                                                
     The AOGCC  recognizes the  need to enable  new operators                                                                   
     to  acquire  reasonable   access  to  existing  facility                                                                   
     infrastructure.                                                                                                            
                                                                                                                                
     If the  Legislature adopts  HB 3004,  the AOGCC  will do                                                                   
     our best  to implement it.   That said, there are  a few                                                                   
     challenges to implementing  this bill as it is currently                                                                   
     written  and,   if  you'll  bear  with   some  technical                                                                   
     description  from me, I'll  explain what those  are with                                                                   
     some suggested ways around them.                                                                                           
                                                                                                                                
     The  bill requires  working interest  owners to  provide                                                                   
     access to  production or  other facilities "only  if the                                                                   
     commission finds  that the facility has  excess capacity                                                                   
     and  that  directing  the   working  interest  owner  to                                                                   
     provide  access by or  for the  benefit of others  would                                                                   
     not materially interfere  with the owner's paramount use                                                                   
     of the facility."  The AOGCC has two concerns  with this                                                                   
     wording.                                                                                                                   
                                                                                                                                
     First, there  will never be  excess capacity in  the oil                                                                   
     production facilities that this bill is targeting.                                                                         
                                                                                                                                
11:49:52 AM                                                                                                                   
                                                                                                                                
Representative  Gara related  that  he does  not dispute  the                                                                   
excess capacity  issue.   The question  is if new  facilities                                                                   
should be expanded and the costs charged to the company.                                                                        
                                                                                                                                
Ms. Foerster explained  the capacity design by  providing the                                                                   
history of oil,  gas, and water in various fields.   She used                                                                   
the example  of expanded facilities  and no excess  capacity.                                                                   
The  gas and  water continue  to  increase, but  not all  oil                                                                   
produced can fit into the facility,  which becomes a problem.                                                                   
She showed a hypothetical situation  where Tarn comes in with                                                                   
10,000 barrels and  where that same amount must  be taken out                                                                   
to provide room.  Each well takes  a priority ranking and the                                                                   
bottom wells  get "backed  out".   There is  no cost  at this                                                                   
point to get into the facility.                                                                                                 
                                                                                                                                
11:57:16 AM                                                                                                                   
                                                                                                                                
Ms. Foerster discussed  how a new player with  10,000 barrels                                                                   
of oil would  enter the market, backing out  9,000 barrels of                                                                   
water and 1,000  barrels of water.  The cost to  get in would                                                                   
be the sum  of lost revenue and  profit.  The costs  are very                                                                   
clearly spelled  out in the DNR  study.  The lost  area costs                                                                   
are debatable.   The third issue concerns what  a fair profit                                                                   
would be.  Negotiation would have to take place.                                                                                
                                                                                                                                
12:00:59 PM                                                                                                                   
                                                                                                                                
Co-Chair  Meyer asked  if  the process  would  scare off  new                                                                   
producers.   Ms.  Foerster said  her opinion  is that  people                                                                   
assume  that there  is a monopoly  going on.   She  suggested                                                                   
talking to Windstar who negotiated with ConocoPhillips.                                                                         
                                                                                                                                
Co-Chair  Meyer commented  that  that was  a dry  hole.   Ms.                                                                   
Foerster  maintained that  the negotiation  process was  held                                                                   
and was valuable.                                                                                                               
                                                                                                                                
12:03:19 PM                                                                                                                   
                                                                                                                                
Ms. Foerster continued to read from her handout:                                                                                
                                                                                                                                
     Even  if  we get  past  the "excess  capacity"  wording,                                                                   
     there  is  a  second  complication.  Since  the  owner's                                                                   
     paramount  use  of  the  facility  is  to  separate  the                                                                   
     associated gas  and water from  their oil, any  back out                                                                   
     for   another  operator   would  interfere  with   their                                                                   
     "paramount use of the facility."                                                                                           
                                                                                                                                
     Supposing that we work our  way past these two concerns,                                                                   
     let's next take a look at the fiscal impact.                                                                               
                                                                                                                                
     First, a primary  role here is a rate-setting  role, and                                                                   
     the  AOGCC  has  no  staffing   or  experience  in  rate                                                                   
     setting.  Therefore, to take  on this rate-setting  role                                                                   
     we  would   have  to   hire  accountants  and/or   other                                                                   
     financial expertise.   Second, we would  need someone on                                                                   
     staff   who  understands   and   can  oversee   facility                                                                   
     optimization;  we  currently have  no  one  on staff  to                                                                   
     perform that function.                                                                                                     
                                                                                                                                
12:05:02 PM                                                                                                                   
                                                                                                                                
     We have  one final concern  with placing  this authority                                                                   
     within  the  AOGCC.  And   that  is  the  potential  for                                                                   
     conflict with  the AOGCC's  role implementing the  Oil &                                                                   
     Gas  Conservation Act.  The commission  is charged  with                                                                   
     preventing  waste, ensuring  greater ultimate  recovery,                                                                   
     protecting  correlative  rights, and  protecting  ground                                                                   
     waters.  Decisions under  this bill  may be in  conflict                                                                   
     with  the commission's responsibility  to prevent  waste                                                                   
     of  hydrocarbon resources  and  ensure greater  ultimate                                                                   
     recovery. For  example, granting access to  a production                                                                   
     facility for one WIO's high-oil-rate  well may result in                                                                   
     the permanent  loss of oil  from the WIO  whose marginal                                                                   
     well is backed out of the facility.                                                                                        
                                                                                                                                
     Our recommendation  would be  to give this  rate-setting                                                                   
     responsibility  to either  a new  or an existing  agency                                                                   
     that is intended as a rate-setting agency.                                                                                 
                                                                                                                                
     I want  to conclude  by reiterating  what I said  first:                                                                   
     The AOGCC  recognizes the  need to enable  new operators                                                                   
     to  acquire  reasonable   access  to  existing  facility                                                                   
     infrastructure,  and if the Legislature adopts  HB 3004,                                                                   
     the AOGCC will do our best to implement it.                                                                                
                                                                                                                                
12:07:05 PM                                                                                                                   
                                                                                                                                
Co-Chair Chenault suggested Representative Gara and AOGCC                                                                       
meet to discuss the issues and work out their differences.                                                                      

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