Legislature(2005 - 2006)HOUSE FINANCE 519
08/01/2006 10:00 AM House FINANCE
| Audio | Topic |
|---|---|
| Start | |
| HB3001 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB3001 | TELECONFERENCED | |
| + | TELECONFERENCED | ||
HOUSE BILL NO. 3001
"An Act relating to the production tax on oil and gas
and to conservation surcharges on oil; relating to
criminal penalties for violating conditions governing
access to and use of confidential information relating
to the production tax; amending the definition of 'gas'
as that definition applies in the Alaska Stranded Gas
Development Act; making conforming amendments; and
providing for an effective date."
Co-Chair Chenault said the Committee would continue
discussion on the Produce of Pay tax proposal as set forth
by the Administration on 7/31/06. He provided members with a
proposed work draft to HB 3001, labeled 24-GH2096\I,
Bullock, 8/1/06 (WORK DRAFT).
DR. PEDRO VAN MEURS, CONSULTANT, OFFICE OF THE GOVERNOR,
noted that he had distributed a graph entitled "Effect of a
Do Nothing Scenario Under Produce or Pay" (copy on file).
He explained how base production works relative to
production decline. As shown on the graph, a producer would
be in the 25% tax rate by 2010 in a "do nothing" scenario.
Co-Chair Meyer asked if the production curve included gas.
Dr. Van Meurs responded by saying the graph illustrates oil,
but the WORK DRAFT refers to both oil and gas.
10:26:06 AM
Co-Chair Meyer asked if, in 10 years when the gas pipeline
comes online, production decline would be offset with gas
production and henceforth reduce the overall tax. Dr. Van
Meurs, said that the additional production would be a
significant underpinning of the decline curve.
Co-Chair Chenault asked about IRS and taxation: Would there
be penalties involved similar to IRS or would there just be
interest that would be demanded on the underpayment versus
overpayment?
ROBYNN WILSON, DIRECTOR, DIVISION OF TAX, DEPARTMENT OF
REVENUE clarified how the tax payment and tax interest would
be dealt with. She noted that there would be no penalties,
there would just be interest owed.
10:28:40 AM
Representative Kelly asked why the 5 percent increases kick
in at 2012 and not sooner. Dr. Van Meurs explained the
concept of new production and the need for organization time
by some companies: approximately 5 years. He also discussed
the provision's goal to not discriminate against those
companies that need the time to organize. He opined that 5-
year's time is not unreasonable given the fact that there
are many companies already in production on the North Slope.
A 10-year timeframe has disadvantages because there is less
incentive.
10:32:44 AM
Ms. Wilson explained that the first four sections of the
WORK DRAFT remains the same and briefly explained that
Section 5 (AS 43.55.011) establishes the tax rate; Section 9
(AS 43.55.020) establishes payment rules; and the credit
provisions are in Section 13 (AS 43.55.023-025). The lease
expenditures in AS 43.55.160 were broken into 3 parts.
Ms. Wilson provided an overview of the WORK DRAFT. She
referenced page 3 and noted that the sections had been
reordered to provide a more readable format. Subsection (e)
will be what is established in (f). Section 5(f) is the
core of the bill, detailing the base rate and incremental
rate. Section 5(f)(2) identifies the rate applicable to base
production Section 5(f)(3) is the percentage rate applicable
to a producer's incremental production. Subparagraphs A, B
& C detail the increase in percentage rates.
10:40:01 AM
Ms. Wilson observed that Section 5(f)(4) establishes base
production. Section 5(f)(4)(A) provides the formula for
base production. She also noted that the rate increase would
be capped at 22.5% for the first 3 years. This ceiling rate
was established in order to provide companies the
opportunity to immediately increase production at a rate no
higher than 22.5%. This was identified on the matrix from
7/31 presentation.
She continued an explanation of Section 5(5), which
establishes that the production is calculated in BTU
equivalent barrels and that it cannot be less than zero.
This continues the rules for base production. Section 5(6)
deals with transferring of properties in 2005. The base
production transfers with the properties. This prevents
companies from transferring properties just to get a lower
tax rate.
10:42:20 AM
Ms. Wilson explained that page 4, Section 5(g) is the
progressivity language seen previously. Subsection (k),
lines 27 and 30 are blank. [L1] These are the elements of
progressivity still under discussion.
10:4 :59 AM
Ms. Wilson discussed Section 5. She noted that Section
(5)(h) is the second part of the progressivity provision.
She explained that the only change reflects an annual
calculation. There is no change of the concept in the WORK
DRAFT. Royalties originally contained in Section 5(f) were
moved to Subsection (i) with no changes. These subsections
are reordered to provide more clarity i.e., to subsections
with basic tax rate together the subsections with
progressivity and the private royalties. Section 5(j) deals
with Cook Inlet gas. Other than some clarifying language on
how to calculate the average there is no change to Section
5(k), which deals with Cook Inlet oil. She clarified that
there is no intended change to the gross value calculation.
A new subsection was added (Section 5(l)) to clarify what
happens when there is a lowering of the tax rate regarding
Cook Inlet oil & gas. This clarification is important
because the tax credits can only be used against the base
tax. The language outlines the ordering of the tax
deduction.
10:46:11 AM
Representative Kelly asked if the language changes the
effective rate for Cook Inlet. Ms. Wilson replied that
there is no change to Cook Inlet.
10:47:00 AM
Ms. Wilson described Section 5(o). There is improved
language regarding regulations for determining heating value
of the producer's gas. The language clarifies how BTU will
be calculated.
Section 7, addresses how the estimated installment payments
will be calculated. The producers will calculate their
expected tax on a monthly basis. The also section sets out
the calculations for the expected tax rate.
10:48:38 AM
Ms. Wilson observed that Section 7(B) (4) defines rules
regarding estimated tax payments having to do with private
royalties.
Language was included in Section 9 clarifying that the
producers shall refund the excess to private royalty owner
in accounting for the estimated tax payments:
If the total deductions of installment payments of
estimated tax for a calendar year exceed the actual tax
for that calendar year, the producer shall, before
April 1 of the following year, refund the excess to the
royalty owner.
The rest of the changes in Section 9 relate to tax liability
calculated in a calendar year rather than monthly.
Section 12, describes the interest rules applicable to the
estimated or installment payments due. Subsection (g) deals
with underpayment and subsection (h) relates to
overpayments. Interest is calculated from the due date of
the installment payment until such time as the payment is
made or March 31, whichever is earlier. The interest is
calculated under, Internal Revenue Service 6621 & 6622:
Determination of rate of interest (on file). This
particular interest only occurs for the period in which the
payment is outstanding, until March 31.
10:51:26 AM
Ms. Wilson observed that the Section 13, capex credits, was
reordered, but not changed. Page 13, line 4, subsection (b)
deals with the conversion of a loss into a credit, at 20%,
to be carried forward.
10:52:45 AM
Ms. Wilson referred to Section 13, amendment to 43.55.024 on
Page 17, line 13 and noted it contains the additional
nontransferable tax credit that was in 43.55.170. The
credit started as a deduction and was turned into a credit.
The WORK DRAFT brings the credits all into one section. New
area development credit reflects 6 million, which is the
annual total of 500,000 x 12 months. The exploration credits
in 43.55.025 remain the same.
Co-Chair Chenault asked why $6 million. Ms. Wilson
explained that the tax is based on the calendar year.
10:54:48 AM
Ms. Wilson noted that Section 25 (4.55.160) on Page 24, line
15, was divided into 3 sections: 43.55.160, determination of
production tax value; 43.55.165, lease expenditures; and
43.55.170, adjustments to lease expenditures. The WORK
DRAFT out specific regions: (A) North Slope; (B) the area
south of the Brooks Range that is not cook inlet; (C) Cook
Inlet oil; and (D) Cook Inlet gas. Paragraph 2 on line 13 is
the calculation of the production tax value for the
progressivity.
10:57:46 AM
Representative Paul Seaton asked distinction between the
taxes in A and B. Ms. Wilson clarified that there is no
difference between taxes. The difference comes into play
with the new area development credit, which only applies to
areas other than the North Slope and Cook Inlet. The value
is calculated separately in order to apply the net tax.
10:58:55 AM
Ms. Wilson pointed out key elements on page 27, to
43.55.165, which determines whether costs are lease
expenditures. The department shall consider, among other
factors, industry practices replaced: "shall a substantial
weight will be given to industry practice". Line 13 is the
calculation of tax value for progressivity. The department
shall consider industry standards but if it is on list it is
prohibited. Subsection (e) specifies the list the list of
prohibited expenses. This is reiterated in Line 19. The
intent remains with the language clearer.
11:01:14 AM
Ms. Wilson continued to review Section 25. An amendment to
43.55.165 on Page 29, line 22, paragraph (2) clarifies
intent to use a percentage of direct costs. She explained
that exceptions to lease expenditures in subsection (e); and
language to 43.55.170 on Page 32, assets and adjustments to
lease expenditures, remain the same. Expanded language in
43.55.180 requires the Department of Revenue to report to
the legislature on 2011. Language was changed to reflect
an annual tax return on Page 34, line 27: 43.55.201.
11:05:42 AM
Representative Seaton asked about the definition of oil and
gas in regards to taxing: at what point during production is
it gas and where is it liquid? [The question was held for
later discussion.]
11:07:33 AM
Representative Seaton asked about page 5, and asked for
calculation on progressivity. Ms. Wilson replied that there
would be monthly calculations, which would be triggered by
the provisions in subsection (h). The slope is determined by
subsection (g). In response to a question by Representative
Seaton, Ms. Wilson clarified that the goal is to calculate
the net equivalent per barrel. She explained that the value
for the month is divided by produced barrels to determine
the net amount per barrel, which would be compared to the
trigger point to determine progressivity.
11:09:52 AM
Representative Seaton asked for clarification on page 4,
line 20, specifically the language regarding monthly and
yearly calculations. Ms. Wilson replied that progressivity
is calculated on a monthly basis and is a calendar year
return. Representative Seaton asked if the progressivity is
known each month and has to be paid in that month; otherwise
would there be interest due on it. Ms. Wilson confirmed
that his explanation is correct.
11:11:35 AM
Co-Chair Meyer asked about the decline rate. He suggested
getting it could be a disincentive if it were not close to
the actual rate. He requested an opinion about the 5
percent rate.
11:12:40 AM
Dr. Van Meurs replied that the natural decline rate of the
"do nothing" scenario is 10% - 12% in a mature state. The 5
percent is not meant to match a do nothing scenario in order
to maintain a 22.5% percent. Companies would have to have
significant, on-going investment in order to prevent the
decline. He suggested ways to slow the decline. In setting
the decline rate, it is assumed that the industry has to
make considerable effort. The 5 percent decline rate is
very sensitive and has been tested.
11:16:31 AM
Co-Chair Meyer noted that the geology is different on each
field; some declines are preventable and some are not.
There is no perfect number. Dr. Van Muers reiterated
previous comments on the decline rate.
11:17:14 AM
Representative Kertula asked if the decline rate is known
for Prudhoe Bay or Kuparuk. Dr. Van Meurs said the
sensitivity analysis was not done on specific fields. The
blended rate is a corporate wide rate. Fields that have
less decline set the impact for fields that decline more.
The idea is to create a blended rate that is reasonable and
requires the industry to maintain a certain amount of
investment/production. Representative Kertula summarized
that it is more about the rate than the field. Dr. Van
Meurs agreed.
11:19:48 AM
REPRESENTATIVE LES GARA inquired about the variables of
geology and age of the field and the discrepancies this
might present with the proposed tax system. Dr. Van Meurs
said the geology of the fields vary greatly. During normal
decline, the decline can be modified through various means
of investment and reinvestments. He noted that the blended
rate is the component that encourages investment.
11:22:56AM
Representative Gara observed that no matter how poor an
investment is made, the rate of 22.5% would not go up for
2006, 2007, and 2008. He noted that the existing tax has
provided incentive for investment and yet most companies are
at zero percent production rate. He asked Mr. Van Meurs to
explain what seems to be a benefit to companies without an
adequate return to the State. Dr. Van Meurs responded that
the idea is to give companies some time to evaluate the
favorable economics from a reinvestment point of view of the
PPT bill. The goal is to increase production. The 3 year cap
allows for companies to reorganize based on the PPT concept
and create incremental production based on the new tax.
11:27:00 AM
Representative Gara posed another scenario pointing out that
there would not be incentives for a company with a field in
a low rate of decline, under the propose tax structure. He
referenced Page 3, and noted that if a company is not adding
production or investment their rates still stay the same for
the following 3 years. He expressed concern that companies
that have chosen for many years NOT to invest could continue
without penalty, with no additional gain for the State. A
gross revenue based system without tax credits would not
encourage reinvestments. He related that, from Alaska's
point of view, it is a negative effect when companies do not
reinvest. Dr. Van Muers reiterated that the purpose of PPT
is to encourage new investment and increase production in
Alaska to create the neutral benefit of good investment. It
attempts to change investment behavior. The POP is an
additional layer of protection for the State.
11:30:21 AM
Representative Seaton questioned why, if the base rate is
taxed at 75%, why the first year is it only 70%. Dr. Van
Meurs explained that analysis is based on a request from the
legislature to make sure the blended rate is 22.5%.
11:33:24 AM
Ms. Wilson referenced a handout from 7/31/06 (Copy on File).
Page 1 indicates the severance tax under the Produce or Pay
Plan (POP) and various PPT proposals at $60/bbl.
Representative Hawker was troubled with the conclusion of
the graph. He stated that the Department of Revenue curve
is not a declination curve. Ms. Wilson agreed to the source
of the numbers. The projections are based on forecasts of
production amounts and do not reflect the assumptions of
increased investment. It was presented as the model of all
other versions.
11:38:05 AM
Representative Hawker requested modeling on alternate
production scenarios. He noted that the graphs reflect the
potential of production that seems achievable. He said that
he would like to see modeling on a goal of production in
which to create incentive for companies to achieve.
11:39:28 AM
Representative Holm noted that there was no discussion
regarding the stranded oil. He asked what potential there
was regarding stranded oil. Dr. Van Meurs stated that the
Department of Revenue is concerned about the current
activity on the North Slope. He thought it could
potentially face a situation by 2007, that where it is no
longer economic to recover [stranded oil]. He maintained
that every reservoir can increase recovery if better
technology is applied. Recovering factors could range from
20-60%. It is in the interest of every jurisdiction to
maximize recovery. The Administration believes that the PPT
proposal would provide continuous stimulus to technology for
field recovery. At a certain point in time, the oil fields
would be abandoned. It is in the joint interest of the
State and industry to delay that timeline. A system based
on net achieves that objective better than a system that is
based on gross.
The Department has the ability to lower the rate of the
royalties. The royalty proposal is the ability of the
Department to lower the royalty in marginal situations and a
PPT based on net built in will help Alaska.
11:44:33 AM
Representative Holm stated that the graph does not indicate
the potential loss and gain. Dr. Van Meurs agreed, stating
that was not intentional. He believed the State would see
higher production with PPT.
11:46:49 AM
Ms. Wilson briefly overviewed the remaining graphs of the
handout: Page 2 @ $40/bbl & Page 3 @ $20/bbl. Page 4
provides the State take and the distribution of future cash
flows under status quo: Governor's bill, POP and various PPT
proposals from FY2007-2030. Page 5 indicates the cumulative
severance tax from 2007-2030, produce or POP and various PPT
proposals. Page 6 shows the government share with the
distribution of future cash flows under status quo: the
Governor's bill, POP and various PPT proposals. Page 7
illustrates the comparison of forecast production to a 5%
decline curve. In conclusion, Page 8 indicates the volume
weighted average blended tax rate, equaling 22.35%.
11:52:25 AM
Co-Chair Chenault asked if the numbers were off a bit. Ms.
Wilson commented that 2030 was the date chosen as the date
the TAPS would be more costly than of benefit to keep on.
11:53:16 AM
DAN DICKINSON, CONSULTANT, TAX DIVISION, DEPARTMENT OF
REVENUE, responded to Rep. Seaton's question. The notion of
gas to liquid would not affect the point of production. The
point of production determines getting it out of the ground.
The changing of gas to liquids is a manufacturing process.
Under current law, if there was such a plant, the cost would
be deductible and the energy would not be deductible. It
would be similar to a refining plant.
AT EASE: 11:55:27 AM
RECONVENE: 1:27:52 PM
KEN KONRAD, VICE PRESIDENT, ALASKA GAS, BRITISH PETROLEUM,
related that increased oil investment is critical to a gas
pipeline and the opposite is also true. When considering
greater production on the North Slope there are two factors
considered by the industry: cost and infrastructure. He
related how they were interdependent.
1:32:41 PM
Mr. Konrad observed that in 2006 there is 7.6% less oil
going thru TAPS than the year before. He noted that there
is an increase in awareness on all sides of the importance
of investment. The biggest risk to Alaska is the question
of attracting investment. He presented the perspective from
an investor's viewpoint.
1:34:31 PM
Mr. Konrad referred to a slide presentation called "Produce
or Pay Proposal" (copy on file.) He commented on the key
messages on page 2. He said the 20 percent PPT tax rate is
high and was only agreed upon in order to produce gas. This
tax structure will not maximize investment. He pointed out
that the new proposal is a significant increase in tax. The
structure recognizes the importance of production but is
simplistic and relies on unrealistic assumptions.
Mr. Konrad related that the incentive is better focused on
investment. A 5% decline rate does not reflect the current
North Slope reality. In conclusion he said retaining
progressivity makes it more difficult for Alaska to attract
the capital it needs.
1:39:06 PM
TOM WILLIAMS, SENIOR TAX COUNSEL, BRITISH PETROLEUM, stated
that the opening comments are a review of the original
proposal. He further explained why the tax rate is too high
and not in the best interests of Alaska. He opined that
Alaska could gain more money overall with a lower tax rate.
He stated that lower tax rate would stimulate more
investment/reinvestment.
1:42:37 PM
Mr. Williams explained that the structure on Page 5 is
simplistic. Production is an output; investment is an
input. Producers have control only over the investment and
can not forecast the production. The linkage of tax rate to
production introduces additional uncertainty and thus risk
for the investor. Added risk and uncertainty make
investments less attractive and will make Alaska less
attractive compared to its competitors. The POP structure
could work, but only if the numbers are right. Care must be
taken to avoid unintended consequences.
1:45:22 PM
Mr. Williams continued to review Page 6. He concluded that
the future North Slope will be different from the past.
Future production will become more and more challenging as
light oil targets become smaller and less economic and the
proportion of viscous oil increases. Future production from
known resources in existing fields will greatly exceed that
from exploration. Mr. Williams noted that the projection
from the Department of Natural Resources is 310.43 million
barrels a year for 2006. Production would represent just
over 3 billion barrels, calculated at a 10% decline over the
next fifty years. Of the seven and a half billion, more
than half is going to need to have new investment or attract
new investment. In response to a question by Representative
Holm, he observed that they risk leaving oil in the ground
if it is not economic to produce. He further noted that at a
12% decline rate, only 2.6 billion barrels of the light oil
would be recovered; and at 15% it would be recoverable at
just over 2 billion barrels.
Page 7 - Depicts a 6.5%-7% actual decline rate from 1992-
2006. Mr. Williams used the chart to show that a 5 percent
decline rate does not reflect current North Slope reality.
He furthered the point by adding that these are declines
that are occurring in spite the industry's efforts to add
new fields and get access to heavy oil.
1:48:57 PM
Mr. Williams reviewed Page 8 and emphasized that increasing
taxes on new oil is bad policy. He referenced Dr. Van Muers
handout page 11 noting different tax rates for different
levels of production. He felt the graph was wrong in that
the tax rate runs inversely to the economic robustness of
the production. He went on to say the easiest, least
expensive oil to produce is produced first. It is the
opinion of BP that a flat 15% PPT tax rate for all new oil
would be a step in the right direction. He observed on
1:53:35 PM
Mr. Williams observed, as outlined on Page 9, that lower
taxes means more investment, more production, more jobs,
more state revenue and a healthier economy in Alaska.
1:54:24 PM
Mr. Williams added that the structure does not provide for
equal treatment for those companies who have spent more than
5% to slow the decline. He gave an example of how a
newcomer would benefit unfairly. A second type of
discrimination relates to new sources of production. The
use of more fuel for production adds to the costs. An
exploration may take 10 years to come to production and will
be taxed unfairly because of the incremental tax rate. He
also felt that heavy oil exploration would not be treated
fairly.
2:01:43 PM
Mr. Williams made several points regarding investment as
contained on Page 11 - Recommendations Investment
Methodology:
· To tie the tax rate to reinvestment would be a more
direct investment. Investment is in the direct control
of industry.
· Increased production is the goal and increased
investment is the means.
· In addition to increased production, increased
investment benefits to the Alaskan economy, businesses
and creates jobs for Alaskans.
· A tax rate based on reinvestment reduces the
investor's risk. Gold plating can be prevented in a
straightforward fashion.
· Tax based upon investment creates a more level playing
field and may avoid unforeseen adverse consequences of
a decline-based tax rate.
Mr. Williams related his experience with this as a
commissioner. He explained how to limit gold plating.
2:06:38 PM
Mr. Williams addressed the concern regarding diluting of
investment incentive by increasing the tax as the investment
comes to fruition. He spoke of leveling the playing field to
get more production in the long run.
Mr. Williams made several points regarding Page 12 titled
Issues: Decline Methodology:
· A decline rate of at least 10 percent is required to
reflect current mature North Slope fields.
· A rolling five year historical average would provide a
more reasonable base than a single year base period.
· Given the period required to develop new barrels, an
increase on the tax rate on new oil creates a
disincentive.
· BP recommends that this built in tax increase be
eliminated.
· Progressivity makes it more difficult to attract the
additional capital Alaska needs. Progressivity should
be dropped or reduced to a much lower rate.
· Tax rates for new and old oil should be lowered to
ensure the blended tax rate is competitive with other
US and global provinces.
2:12:18 PM
Mr. Williams said a single reference year is not indicative
of mature field decline. The slide on Page 13 - North Slope
Field Decline Rates with Investment, depicts base production
five-year averages of Prudhoe, Kuparuk, Milne, Endicott, and
Point McIntire.
2:14:55 PM
Representative Hawker referred to the slide on declining
productivity. He recognized production decline as the
common enemy and problem to be addressed. He summarized the
industry's viewpoint that they will provide production if
they have the lower tax rate. Representative Hawker said
that the legislature is saying: give us production and we'll
give you the rate. He asked BP what the difference was.
Mr. Konrad stressed that economics not physics is at issue.
He noted that the only thing keeping oil in the ground is
economics. The industry does not see a way to 20 percent
based on the decline rate used relative to the actual rate.
Representative Hawker asked why Department of Revenue
analysis shows that this tax rate equalizes over time. He
questioned why if they have the ability to access the oil,
the tax structure doesn't work. Mr. Williams said the
industry has different expectations about production
forecasts. He recalled how ELF was designed and speculated
at a different outcome. Mr. Konrad repeated his concerns
about the 20 percent tax rate.
2:21:18 PM
Representative Hawker said the industry is rigid in their
position of the 20% PPT being the only economics that could
work. Mr. Konrad felt this was not what BP wanted to
communicate. He reiterated comments by Mr. Williams on
stimulating investment and what he feels were inaccurate
percentages and production rates to base the rate on.
Representative Hawker recalled all of the proposals and
asked if the industry would be happy with the original PPT
proposal with progressivity and a flat 25 percent rate. Mr.
Konrad estimated the actual rate would be between 25 and
22.5 percent rate. Representative Hawker then asked if they
would be happy with 22.5 percent and progressivity. Mr.
Konrad emphasized that they could and would prefer to invest
more under a lower rate.
2:24:23 PM
Representative Hawker observed that the House Finance
Committee has twice sponsored a 20/20 tax rate bill to the
floor that didn't pass. The House at this point is forced
to make a compromise. He maintained that the industry has
not shown a willingness to compromise.
Mr. Konrad replied that it would be possible for the
industry to bring something forward outlining an investment
incentive structure. Representative Hawker asked how the
legislature could convince the people to accept that
proposal.
2:27:22 PM
Mr. Williams spoke of possible compromises as he offered his
advice. He maintained that there are alternatives which
would be better than a flat rate
2:28:48 PM
AT-EASE: 2:28:48 PM
RECONVENE: 3:12:15 PM
Representative Holm related that the Committee has been told
that investments are not going into Prudhoe due to the
business models the individual companies pursue. He asked
why was investment flat in Prudhoe Bay when the ELF was in
such a position that there was a minimal tax for the
production of oil. He also asked for an explanation of the
word "over-incenting". He questioned what assurance the
State has that the oil industry would produce to the maximum
benefit of the people of Alaska.
3:15:09 PM
Mr. Konrad responded to the question about Prudhoe Bay
investments. He recalled that there were a number of
satellite investments that did not pay production tax;
production output/investment could be checked by looking at
the previous five years. He mentioned situations where
"over-incenting" created problems, but did not think that
these circumstances existed in Alaska. In response to
Representative Holm's comment about producing the oil too
quickly, Mr. Konrad maintained that even with 50 year
business plans there is still a large amount of oil,
particularly heavy oil, left in the ground.
Mr. Williams noted that when production is added to a field
it makes it larger. With the ELF formula, field size was the
dominant parameter in setting the rates. When the field was
increased, it raised the rate for the whole field. This was
the burden for the industry in the ELF system. He answered
the question regarding "over-incenting". He explained that
the term was used only in the narrow sense with regards to
gold plating. He spoke to the excess production issue and
gave another example of damage to the reservoir. He noted
that there are a number of variables during production and
that it is important not to waste energy in the process of
producing. He pointed out that the purpose of the Oil and
Gas Conservation Commission is to prevent this from
happening through regulation of field practices.
3:23:56 PM
Representative Holm asked where price and the value of the
commodity fit into the scheme. He suggested there should be
urgency to produce the higher valued commodity in the
currently producing, known field. Mr. Konrad agreed that
there is an enormous undeveloped resource base. He
emphasized that there is no risk of running out of oil; the
concern is rather running out of economic opportunities to
develop fields. He further noted that when production gets
too low the unit costs go up. He said this is a greater
concern for industry than running out of oil.
3:27:35 PM
Mr. Williams asserted that there is a lot of capital
investment in Prudhoe Bay. Wells are being drilled
horizontally through thin layers of rock on the edge of the
reservoir, which was made possible with new technology. He
concluded that there is a lot of activity in Prudhoe Bay,
but added that there are maintenance and repair challenges
associated with decline.
3:28:41 PM
Representative Kelly addressed the decline rate and asked if
establishing a production curve for each company would solve
the problem. Mr. Williams responded that it would be
impossible to administer and to tax. He related that there
are events that have an effect on production curves.
3:32:32 PM
Representative Kerttula asked about the Alaska Oil and Gas
Conservation Commission (AOGCC) and the 5 year set of data.
She requested this data. She mentioned a process that
entails a refutable presumption whereby industry could come
in and disprove the decline rate. Mr. Williams said that
if that idea were pursued that there should be clear
criteria on the basis that the determination be made.
3:34:38 PM
Representative Gara asked if production could be speeded up
with enough industry incentives. Mr. Williams said with
proper incentives, investments could be made to slow the
decline.
Representative Gara questioned whether this approach would
encourage companies to speed up production to reduce the tax
burden. Mr. Konrad replied that in an operational sense,
the company produces all they can. He emphasized that it
takes many years to make investments and increase
production. The price of oil does not determine production
level. Representative Gara asked about incentives contained
in the WORK DRAFT and asked if they would produce more in
order to get the lower tax rate. Mr. Konrad responded that
there is investment opportunity at all sites. Mr. Williams
added that towards the end of the field life when margins
are smaller, tax rates are higher, which means investments
are less. He gave an example of Prudhoe Bay in the past
when nothing was gained by incentives because they were
unable to produce more than 1.5 million barrels.
3:41:22 PM
Representative Hawker discussed the purpose of the decline
curve. He pointed out that it might be better termed as a
decline allowance. The point of the curve is a mechanism to
create an incentive for investment; if the decline curve
were actual, it would lose its purpose. He noted that the
BP charts suggest the decline should be at 10% to represent
current realities. Mr. Konrad replied that if nothing is
invested it would be far in excess of 10 percent, probably
around 15 percent. Representative Hawker asked if current
spending is inevitably a 10% decline curve. Mr. Konrad
replied that current spending is 7.6%. Representative
Hawker asked if BP was asking for a -4% differential.
Mr. Williams said yes: in the context of $2.5 billion tax
increase. Mr. Konrad said that if the goal is to
incentivize investment that is the way to do it.
Representative Hawker commented on the sensitivity data that
established the 5% rate. He further noted that this was a
compromise with those that felt it should be at 2 or 3%.
Mr. Williams said the industry suggests a base and looking
at the natural decline and then seeing what "new" production
is: production that results from new investment. He also
felt that the 10% rate would put current investors and new
investors on a more level playing field.
3:47:10 PM
Representative Hawker asked, on the matter of a level
playing field, why there was a concern if the new investor
gets taxed at 15% and companies spending on new investments
get 15%. Mr. Williams replied that BP spent $1 billion to
get from the natural harvest decline rate to the historic
decline rate of approximately 7%. He pointed out that the
$1 billion would be taxed at 22% or higher, compared to a
new field being taxed at 15%.
Representative Hawker referred to earlier testimony from BP
that spoke of reducing the decline to 3%, by doubling
investment. Mr. Williams said yes, he would stand by that
testimony. Representative Hawker said he is confused
because the 5% provides for a mechanism to buy down the rate
yet industry is not supportive of this concept. Mr. Konrad
said, as investors they do not see it that way into the
future.
3:52:49 PM
Mr. Williams reiterated comments on the discrepancy in
incremental rate between new investors and current
producers. Representative Hawker appealed for a compromise
to resolve the tax issue.
3:54:08 PM
Representative Kelly brought up the 3% decline rate and the
current decline and asked if it is correct. Mr. Williams
said it is a subtle point. Each investment decision stands
on its own merits. Each year there are unknown numbers that
will need to be justified at the blended rate.
Representative Kelly referred to 20 percent and said the
House is at 22.5 percent. Mr. Williams expressed
appreciation for the cap.
3:58:11 PM
BRIAN WENZEL, VICE PRESIDENT, FINANCE AND ADMINISTRATION,
CONOCOPHILLIPS, stated that his company does not support the
new WORK DRAFT for HB 3001. He said it puts a tax burden on
the industry. He spoke against the 22.5 percent tax. He
further noted that this system is not the $1 billion tax
increase originally proposed, which ConocoPhillips supports.
The original proposal provided a balance and a foundation
for an agreement for a gas pipeline contract, as well as
investment incentives, production growth, and employment.
He maintained that the current WORK DRAFT does not do that.
4:03:24 PM
Mr. Wenzel went on to say that the original bill
incentivized production. He said the POP punishes
production failure. There may be production shortfalls for
a number of reasons. The 15 percent tax rate is not an
incentive for exploration or for heavy oil.
4:06:14 PM
Mr. Wenzel said he was concerned that the WORK DRAFT further
exacerbates the difference between a production adding
project and a non production-adding project. Mr. Wenzel
maintained that all investment is good investment. He
commented that the work draft differentially hurts long-term
investors. He reiterated concerns regarding the 5% decline
curve.
4:08:12 PM
Mr. Wenzel referred to a chart entitled "North Slope
Production and Individual Field Decline Rates" (copy on
file.) He said the decline rate even with investment is
accelerating.
4:11:12 PM
Mr. Wenzel pointed to structural flaws with the system. He
questioned the rationale for 22.5 percent. He said Conoco
Phillips does not support the WORK DRAFT. They do support
seeking a linkage between a higher company reinvestment and
lower production tax.
4:13:19 PM
Mr. Wenzel said the focus should be on reinvestment. He
claimed that they already have motivation to produce from
their shareholders. He argued that the answer can be solved
with an investment-based system rather than a production
based system.
4:16:33 PM
Mr. Wenzel maintained that reinvestment creates more
economic development as well as state royalties. In
closing, ConocoPhillips urged reconsideration of the billion
dollars per year production increase proposal. He said it
is the easiest way to accelerate progress on the gas
pipeline. He urged there be a limit of the degree of
progressivity of any tax bill or an elimination of it all-
together.
4:18:52 PM
Representative Hawker asked why there a problem with
incenting it if they are producing. Mr. Wenzel replied that
there is inconsistencies in the proposed system from a
fiscal policy stand point. He reiterated the desire for an
investment approach rather than a production approach.
4:22:03 PM
Representative Hawker asked how the industry feels about a
claw-back with gold-plating limits to reward companies that
invest in Alaska oil and gas development. Under the ELF,
the tax rate drops to zero, which is maximum incentive, but
the State is not getting the desired results.
4:25:00 PM
In answer to Mr. Wenzel's question, Representative Hawker
explained where the 75-25 split originated. He explained
that a mathematical algorithm was created for the tax
system, at status quo, which would result in a blended rate
of 22.5 percent. The algorithm achieves the initial rate
which, because of the concept of incremental and base,
allows a means to determine, whether established production
goals have been achieved. From there the rate would increase
or decrease. Mr. Wenzel maintained that the same 22.5% could
be reached in another way, other than the 75-25.
Representative Hawker agreed it could be done at a 15-30 or
a 50-50 split and asked if that would be more acceptable.
Mr. Wentzel argued that whether than using an algorithm that
"appears to have some numbers that are acceptable" that he
would rather go after some fundamental numbers and talk
about the period of time to make those determinations of old
oil versus new oil to reaching the correct answer.
Representative Hawker stated that number was targeted to
something acceptable to the entire legislature. He
reinforced the need to get out of a legislative deadlock.
4:28:01 PM
Representative Seaton commented on investment and thought
that the testimony on the PPT credit of 20% with a tax rate
of 20% provided significant investment incentive. He asked
if the program needed to be modified to further stimulate
investment.
Mr. Wenzel responded that the original proposal provides
sufficient and significant incentives for investment.
ConocoPhillips is not opposed to the concept of drawing a
linkage between lower production tax rates and incentive
levels.
4:30:39 PM
Representative Kertula asked if there were provisions in the
bill that address a situation where a company purchases
another company, increasing production, but with no gain to
the State. Representative Hawker said yes, there are
provisions in the bill that address the issue.
4:31:28 PM
Representative Kelly asked Mr. Wentzel if the decline curve
was the main concern. Mr. Wentzel said that even if the
decline rate hit the target he would still have a problem
with the absolute level.
4:35:09 PM
Co-Chair Chenault asked what ConocoPhillips' plans are for
bringing heavy crude to market. He noted that there is a 5
or 6-year window for this development. He asked; if it were
not profitable to produce heavy oil at $74 a barrel, when it
would be profitable. Mr. Wenzel stated that the grace
period for that development is not long enough. He went on
to say that he felt there should be no sunset on incentives.
Co-Chair Chenault said the proposed system's intent is to
keep taxes low to incent the development of heavy oil.
In terms of heavy oil, it takes a long time to develop. He
commented on continually developing technology in order to
expedite the process of extraction. He stressed that the
state should encourage research and a lower investment risk
through advance technology and other areas that assist in
extraction.
4:39:27 PM
Representative Holm asked if they would not invest in Alaska
if they did not get incentives. Mr. Wenzel stated that they
would continue to do business in Alaska, but indicated that
it might not be at the maximum level. He said the State and
industry share mutual benefit of the resource.
4:41:03 PM
Representative Holm did not disagree. He pointed out that
Alaska owns the assets and they are leased. He questioned
if there should be a greater reward for owning those assets
when the value goes up. He noted the issues of the lease
agreements. Alaskans need a place at the table to state
their needs. He asserted that those that live in Alaska get
a negative impact when the price of oil is high; there
should be some benefit as the price increases.
Mr. Wenzel disagreed about the lease agreements. He
acknowledged that the State of Alaska sold the right to
extract the hydrocarbon to take to market subject to certain
conditions such as royalties, which is separate from the
State's taxing authority. He questioned whether the current
proposal further encourages investment in Alaska. The people
of Alaska receive the increase by the increased royalty
share. He further discussed changing of lease terms and the
challenges of that.
4:46:40 PM
Representative Hawker discussed the investment metric versus
metric production issue and the accompanying challenges. He
asked how much the State should subsidize investment under
the investment scheme.
Mr. Wenzel did not want to speculate on the issue. He felt
that if there were going to be a discussion it would be best
to bring in an economist to outline the variables.
4:50:11 PM
Representative Hawker addressed the problem the industry has
with the 25% rate. Investment is both productive and non
productive. He recommended an approach that establishes a
base tax rate of 25% with a buy-back on some combination of
investment and production. Mr. Wenzel stated that the idea
of combined incentive would be additionally complex.
Representative Hawker commented that there is already an
unlimited reward for investment. Mr. Wenzel did not dispute
that. He was willing to help evaluate other incentives but
did not view it as necessary.
4:54:55 PM
Representative Gara noted that under the current ELF system,
the effective tax rate is zero; how could a 20% tax rate
cause greater investment. Mr. Wenzel said that investment
would occur under the ELF and maintained that ConocoPhillips
is currently investing. Representative Gara asked if they
would invest more under the 20/20 than they are currently.
Mr. Wenzel could not guarantee that raising taxes would
result in projects Alaska.
4:59:27 PM
Representative Gara recalled earlier testimony, which stated
that a 25% tax rate is less than the world average. He
asked Mr. Wenzel if he is saying that if the tax stays at
25%, they are interested in investing in Alaska. Mr.
Wentzel said that investment is based on a number of
elements.
5:00:08 PM
Co-Chair Meyer MOVED to ADOPT the work draft to HB 3001,
labeled 24-GH2096\I, Bullock, 8/1/06. Representative Hawker
OBJECTED for a question. He asked if Mr. Mintz and
legislative legal had reviewed the bill. Co-Chair Chenault
replied it had been reviewed. Representative Hawker
WITHDREW his OBJECTION. There being NO further OBJECTION,
it was adopted.
5:02:17 PM
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