Legislature(2005 - 2006)HOUSE FINANCE 519

03/06/2006 12:30 PM FINANCE


Download Mp3. <- Right click and save file as

Audio Topic
12:38:00 PM Start
12:38:06 PM HB488
03:16:01 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Joint with House Resources
Presentation on HB488 - OIL AND GAS
PRODUCTION TAX - by Legislative
Consultant Daniel Johnston
DANIEL JOHNSTON,  LEGISLATIVE  CONSULTANT, DANIEL JOHNSTON  &                                                                   
CO., Inc., referred throughout  his presentation to a handout                                                                   
entitled  "Alaska's Proposed  Production Tax  - PPT  20/20/%"                                                                   
(copy on file),  which analyzes issues related to  SB 305 and                                                                   
HB 488.   He explained the services he  provides: consulting,                                                                   
teaching, and  expert witness  work.  The  past 15  years his                                                                   
work  has been  equally  divided  between oil  companies  and                                                                   
government  work.   He  shared that  his  philosophy is  that                                                                   
mineral  resources are a  gift from  God and  this work  is a                                                                   
sacred trust.                                                                                                                   
                                                                                                                                
Mr.  Johnston   shared  his  mandate  in  the   analysis  and                                                                   
discussion of  PPT 20/20%.  He  stated an objective  to share                                                                   
analysis, research,  discussion and recommendations,  to help                                                                   
design a fair production tax system,  and to avoid a punitive                                                                   
arrangement.   He opined  that future  generations would  ask                                                                   
questions about  the design, negotiations, and  management of                                                                   
this policy.                                                                                                                    
                                                                                                                                
Mr. Johnston pointed  out that on page 5 of his  handout is a                                                                   
disclaimer about some of the restrictions  and limitations of                                                                   
his presentation.  He noted the  report should be viewed as a                                                                   
preliminary indication of things  that will be addressed when                                                                   
there is more time.                                                                                                             
                                                                                                                                
12:47:21 PM                                                                                                                   
                                                                                                                                
Mr. Johnston shared  conclusions that Alaska  has every right                                                                   
to change  its  current regressive,  inefficient tax  system.                                                                   
The  new system  should increase  revenues to  the state  and                                                                   
enhance  exploration  activity.   Those  objectives  are  not                                                                   
mutually exclusive.  Increasing  taxes on existing production                                                                   
is relatively  inelastic.  Proposed  incentives can  work and                                                                   
there is solid justification for having credits.                                                                                
                                                                                                                                
Mr. Johnston  related that  the new system  would be  a well-                                                                   
designed,  modern  system  that   is  flexible,  progressive,                                                                   
simple, and transparent.   Trying to craft one  system to fit                                                                   
all situations  in Alaska may  be impossible.   The producers                                                                   
want "fiscal certainty".                                                                                                        
                                                                                                                                
12:53:41 PM                                                                                                                   
                                                                                                                                
Mr. Johnston discussed the debate  regarding government take.                                                                   
With the  gas pipeline project,  a government  take statistic                                                                   
is much less meaningful.   It is time to address  this issue.                                                                   
Crafting  language to  avoid "leakage"  deserves  appropriate                                                                   
terms on the front end.  He suggested  that Alaska should get                                                                   
the deal right  the first time.  There are  several issues of                                                                   
critical importance:  relinquishment  provisions, abandonment                                                                   
provisions   such   as   site   restoration,   cleanup,   and                                                                   
dismantlement,  and  the  proposed  "linkage"  with  the  gas                                                                   
pipeline deal, which is risky.                                                                                                  
                                                                                                                                
12:55:36 PM                                                                                                                   
                                                                                                                                
Mr.  Johnston   related  other   perspectives  on   ELF;  the                                                                   
alignment of interests  is not good because the  tax is based                                                                   
on  production not  profits.   He  referenced the  Indonesian                                                                   
story and its fiscal device where  the oil companies had five                                                                   
years  of royalty-free  living,  which resulted  in a  strong                                                                   
incentive for  the oil companies  to produce the  oil quickly                                                                   
and to obtain  separate field status.  He  discussed problems                                                                   
with separate field  status.  He shared the  California story                                                                   
where the  state lost  in two ways:  lower royalty  and lower                                                                   
taxes.   He suggested that with  new elements it  often takes                                                                   
10 years.                                                                                                                       
                                                                                                                                
Mr. Johnston  discussed what criteria  should be used  if the                                                                   
system  is going  to  be changed.    He emphasized  that  the                                                                   
system must  be progressive.   When comparing times  with low                                                                   
and high oil prices, with progressive  systems the government                                                                   
take increased  on an  average of  10 percent.    The  system                                                                   
must have a fair division of profits,  have no unhealthy dis-                                                                   
incentives,  and be  simple and  transparent.   One  critical                                                                   
issue centers  on whether  or not  raising or lowering  taxes                                                                   
has  an  effect  on  investment  activity  in  the  petroleum                                                                   
sector.   He opined that  the proposed  PPT system, as  it is                                                                   
currently designed, would not be a problem.                                                                                     
                                                                                                                                
1:01:31 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston  spoke to  the  uniqueness of  Alaska's  needs.                                                                   
There  are boundary  conditions  and  high costs  with  being                                                                   
land-locked.   There  are high  transportation  costs.   High                                                                   
costs  exist  in  the  Arctic,   and  there  are  field  size                                                                   
distribution expectations relative  to Arctic conditions.  He                                                                   
opined that  exploration in  northern Alaska  is not  a place                                                                   
that most of the major oil companies  would be interested in.                                                                   
The fields  are not big enough  to attract a large  amount of                                                                   
capital.   Independent  oil  companies  may express  interest                                                                   
there.                                                                                                                          
                                                                                                                                
Mr.  Johnston referred  to page  11  as the  balance sheet  -                                                                   
things to  consider about fiscal  system analysis  and design                                                                   
relating  to prospectivity  and contract  terms.  He  pointed                                                                   
out the importance of expected  field size distributions, the                                                                   
petrophysical  characteristics  of  the  rock,  the  delivery                                                                   
rates  of  an  oil well,  estimated  success  rates,  if  the                                                                   
province is  gas or oil prone,  and the quality  and quantity                                                                   
of the  oil or gas.   Other factors are exploration  drilling                                                                   
costs and  costs after  the discovery  is made.   Exploration                                                                   
drilling  is more  expensive.   He  discussed  transportation                                                                   
costs, water depth, climate, and political risks.                                                                               
                                                                                                                                
Mr. Johnston highlighted contract  terms as the other side of                                                                   
the equation.   He pointed out  that government take,  one of                                                                   
the elements, has weaknesses.   One country's government take                                                                   
may  have  better  terms  than another's.    There  are  many                                                                   
factors  regarding  government   take,  some  with  immediate                                                                   
implications.  The most important  is the limit to the number                                                                   
of barrels.                                                                                                                     
                                                                                                                                
Mr. Johnston  related  that the  type of tax  system is  very                                                                   
important to oil companies.  Most  provinces with the kind of                                                                   
field size  distribution Alaska  has, use  production-sharing                                                                   
contracts, which  have some  implications unfavorable  to oil                                                                   
companies.     Most  companies   would  prefer  royalty   tax                                                                   
arrangements.  Work programs,  seismic data, and drilling are                                                                   
important   contract  terms.     In   the  area  of   timing,                                                                   
relinquishment, and guarantees,  Alaska distinguishes itself.                                                                   
Unlike in  many parts of  the world,  Alaska is able  to hold                                                                   
onto   substantial  acreage,   which   may  weaken   Alaska's                                                                   
bargaining  position and  is something  to  consider for  the                                                                   
future.                                                                                                                         
                                                                                                                                
Mr. Johnston stated that royalty  rates are average in Alaska                                                                   
by world standards.   By changing the severance tax  to a PPT                                                                   
as  proposed, the  royalty  is  reduced to  12  percent.   He                                                                   
suggested  that 20  percent is  an  acceptable royalty  rate.                                                                   
"Entitlement"  is   the  number  of  barrels   a  company  is                                                                   
physically, legally able to lift  and report to shareholders.                                                                   
He  defined "ringfencing"  as  an important  issue  regarding                                                                   
trading credits.   The PPT  proposal is outstanding  in terms                                                                   
of  ringfencing.    Alaska  does not  qualify  as  high  risk                                                                   
regarding  "Crypto" taxes.   Contract  stability  is an  area                                                                   
worth  looking  closely at.    "Allocation strategy"  is  the                                                                   
method of allocating  licenses to the oil companies.   Alaska                                                                   
uses area-wide  leasing, which is painless to  oil companies.                                                                   
There are a variety of issues where Alaska has advantages.                                                                      
                                                                                                                                
1:12:32 PM                                                                                                                    
                                                                                                                                
Mr. Johnston related that comparing  Alaska to an appropriate                                                                   
peer group  is important.   He  took issue  with some  of the                                                                   
peer  groups  that  have  been  mentioned  so  far  in  other                                                                   
presentations.   The proposed  PPT is  trying to  accommodate                                                                   
the legacy assets  in Prudhoe Bay and Kuparek,  and in Arctic                                                                   
Frontier  explorations, which  are vastly  different.   It is                                                                   
difficult to find a peer group with a similar situation.                                                                        
                                                                                                                                
The United  Kingdom is not a  good example of  an appropriate                                                                   
peer  group for  Alaska.   It  has a  government  take of  50                                                                   
percent, but  also a  government take of  75 percent  for the                                                                   
old  legacy fields.    Picking  a peer  group  that fits  the                                                                   
exploration  of  Alaska's  legacy  fields  is  quite  another                                                                   
matter.   Angola  falls  into  the same  category  with a  75                                                                   
percent government take.  He suggested  that there is work to                                                                   
be done to provide better examples  of peer groups because of                                                                   
the bi-modal distribution quality found in Alaska.                                                                              
                                                                                                                                
Mr.   Johnston  mentioned   that  another   problem  is   how                                                                   
government  take is  calculated.   He  referred  to the  Wood                                                                   
Mackenzie Report  from 2004, which  excludes one of  the four                                                                   
main means  by which  governments  "get a piece  of the  pie"                                                                   
called government participation.   The government can take up                                                                   
a working  interest in  a commercial  oil company  discovery,                                                                   
called a  risk-free government carry.   Oil companies  do not                                                                   
like  this form  of government  participation  because it  is                                                                   
inefficient  for them.   The Wood  Mackenzie Report  excludes                                                                   
this in  their analysis.   He suggested  a hearing  with Wood                                                                   
Mackenzie in attendance.  If the  government take is factored                                                                   
in worldwide, 5 percentage points  would be added to the Wood                                                                   
Mackenzie  Report because  Alaska  does  not have  government                                                                   
participation.                                                                                                                  
                                                                                                                                
1:19:03 PM                                                                                                                    
                                                                                                                                
Mr. Johnston discussed  if increasing tax rates  would reduce                                                                   
investment in Alaska and result  in job loss, as implied in a                                                                   
presentation last  week.  He pointed out that  the PPT system                                                                   
is designed to  both take and give.  He referred  to page 14,                                                                   
a BP  graph of  production  tax vs.  the tax rate  in the  UK                                                                   
sector of the North  Sea.  He argued that the  graph is not a                                                                   
fair representation  of what the  result of lowering  the tax                                                                   
rate would be.   He pointed out that the government  take was                                                                   
around 85 percent  until 1993 when it dropped  to 33 percent,                                                                   
a  dramatic  reduction.   The  graph  shows  that  investment                                                                   
increased at this point, but it  does not show prior years of                                                                   
extensive exploration,  which would have  affected investment                                                                   
increases.                                                                                                                      
                                                                                                                                
Mr. Johnston showed,  on page 15, that the  actual investment                                                                   
activity  in the  UK  contradicts  the idea  that  production                                                                   
after  1993 was  strongly influenced  by  the tax  reduction.                                                                   
The  graph   depicts,   by  year,  the   royalty  rate,   the                                                                   
supplementary  petroleum  duty,  the petroleum  revenue  tax,                                                                   
corporate tax, and  marginal tax rate on old  and new fields.                                                                   
The term marginal take and government  take are the same, but                                                                   
statistics  vary  by  report,  depending on  who  writes  the                                                                   
report.  He  highlighted annual expenditures  for exploration                                                                   
and development  throughout  the years  1974-2005.  He  noted                                                                   
that  in  the  1980's,  the  UK   sector  of  the  North  Sea                                                                   
instituted a policy  similar to that which is  being proposed                                                                   
in Alaska  - a credit  system.  He referred  to it as  a two-                                                                   
dimensional  change that  kept the  investment activity  very                                                                   
high.  He suggested  that the graph is a bit  misleading.  He                                                                   
referred to the BP presentation  and a disaster in 1988, when                                                                   
many were killed and the industry  had to spend an extra five                                                                   
billion pounds  over five years.  Exploration  drilling after                                                                   
1993 decreased.  He suggested  that the committee obtain more                                                                   
information on this topic.                                                                                                      
                                                                                                                                
1:24:37 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston  referred  to page  16,  UK  drilling  activity                                                                   
history.   It  confirms the  fallacy  of the  claim that  the                                                                   
reduction  of government take  from around  85 percent  to 33                                                                   
percent  enhanced  investment activity  in  the  UK in  1993.                                                                   
Exploratory drilling was quite  high in the 80's.  He related                                                                   
that the North Sea was maturing at this time, also.                                                                             
                                                                                                                                
1:25:47 PM                                                                                                                    
                                                                                                                                
Mr. Johnston  referred to  the "risk vs.  reward" in  the PPT                                                                   
credit plan on  page 17.  He spoke in favor  of a credit plan                                                                   
that would allow companies direct  credits that could be sold                                                                   
or  traded.   He  provided as  an  example,  grass roots  oil                                                                   
exploration in Indonesia.  He  explained the process for cost                                                                   
recovery and how  much the government would pay  for dry hole                                                                   
costs.     Countries   would  take  the   risk  because   new                                                                   
discoveries are  profitable.  Norway is the  best comparison;                                                                   
it partly  justifies the high government  take.  It  is a new                                                                   
system so it is too early to tell.                                                                                              
                                                                                                                                
Mr. Johnston  mentioned that  in the  1980's, the UK's  North                                                                   
System government  take was 85  percent.  He maintained  that                                                                   
in  the  North  Sea  you could  not  take  advantage  of  the                                                                   
"credit" unless  there was sufficient  new production.   This                                                                   
illustrates that  these credits  work, and the  industry will                                                                   
find  a  way  to  "soak  it  all  up".    Canada's  Petroleum                                                                   
Incentive  Payments  (PIP) Grants  is  another  example of  a                                                                   
credit plan  that worked.  They  only risked 20 cents  on the                                                                   
dollar.   The Alaska's  PPT proposal  risks  39 cents on  the                                                                   
dollar   and  could  go   lower  in   order  to   incentivize                                                                   
exploration, and the government take could be higher.                                                                           
                                                                                                                                
1:32:09 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston  summarized  the  key fiscal  elements  of  PPT                                                                   
20/20%.   The PPT  rate is 20  percent, and  the PPT  base is                                                                   
company   cash   flow,   which  is   greater   than   capital                                                                   
expenditures.   The  tax credit  rate is 20  percent and  tax                                                                   
credit base is  capital expenditures.  TLCF  or Net Operating                                                                   
Loss is another component of PPT.   Mr. Johnston recalled two                                                                   
quotes by  Dr. Van Meurs:   "Negative  Cash flow can  also be                                                                   
converted  into a  tax credit  by taking the  20 percent  tax                                                                   
value of these  yearly losses."   "A loss in any year  can be                                                                   
converted into a tax credit by taking the 25% tax value."                                                                       
                                                                                                                                
Mr.  Johnston reported  that  the base  allowance  rate is  a                                                                   
standard  deduction of  $73 million,  and the base  allowance                                                                   
base  is  the same  as  the  PPT base  "deductible"  for  PPT                                                                   
calculation  purposes.    The transition  provision  is  past                                                                   
capital  expenditures from  July  2001 to  June  2006, to  be                                                                   
amortized over 6 years and deductible for tax purposes.                                                                         
                                                                                                                                
1:36:47 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston  summarized  the  key fiscal  elements  of  PPT                                                                   
20/20%.  The proposed structure  shifts some of the risk from                                                                   
the industry to the State of Alaska.  The shift is multi-                                                                       
dimensional.  By shifting the  tax base from "net production"                                                                   
to "profits"  it takes  some of  the risk  away from  the oil                                                                   
companies  and puts  the burden  on  the government.   It  is                                                                   
sometimes   called  a   "proxy   for  profits"   because   no                                                                   
depreciation is required.  The  shift applies a 20% credit on                                                                   
capital expenditures  and allows  credits to  be traded.   He                                                                   
addressed  the $73  million allowance  and noted  that it  is                                                                   
difficult  and awkward.   It is  difficult  to design a  one-                                                                   
size-fits-all  system.   He said  he  is still  uncomfortable                                                                   
with it.  PPT also has no ringfence.                                                                                            
                                                                                                                                
Mr. Johnston  addressed the "lookback"  provision.   He noted                                                                   
that there is a  fairness issue.  He suggested  that it would                                                                   
be politically difficult  to sell to the public  and deserves                                                                   
further consideration.                                                                                                          
                                                                                                                                
1:40:18 PM                                                                                                                    
                                                                                                                                
Mr. Johnston briefly mentioned,  on page 21, the hierarchy of                                                                   
arithmetic one  would expect in any given  accounting period.                                                                   
He provided  information  about government  take on page  22,                                                                   
depicting a simple royalty/tax  system with a 15% royalty and                                                                   
a  50% tax.   He  described several  scenarios  to explain  a                                                                   
regressive fiscal system.  Column  C can be viewed in several                                                                   
ways, as  the difference between  $20 per barrel and  $60 per                                                                   
barrel,  or  windfall  profits.    Marginal  government  take                                                                   
assumes that there are no costs.                                                                                                
                                                                                                                                
1:43:39 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston explained  the  variations  on government  take                                                                   
calculations  on   page  23.     This  scenario   involves  a                                                                   
royalty/tax  system with  a 15%  royalty and  a 50% tax,  but                                                                   
also  a  30%  government  participation  element,  which  Mr.                                                                   
Johnston   included  in   all   calculations,   as  did   the                                                                   
administration.   He mentioned  Azerbaijan as a  country that                                                                   
deals with government participation  "heads up" from day one.                                                                   
He  agreed  with   Dr.  Van  Meurs  with  his   treatment  of                                                                   
Azerbaijan.     He   mentioned   that   contractor  take   is                                                                   
significantly  different in  each  scenario.   Much money  is                                                                   
involved and  a mistake could be  very costly.  He  noted the                                                                   
similarities  between Azerbaijan  and  Alaska's proposed  PPT                                                                   
system.                                                                                                                         
                                                                                                                                
1:47:25 PM                                                                                                                    
                                                                                                                                
Page  24  depicts  the  definition   of  the  Wood  Mackenzie                                                                   
treatment of  government participation.   In calculating  the                                                                   
government take,  all elements of  the fiscal regime  such as                                                                   
royalty,  income  tax,  production  sharing  contract  profit                                                                   
shares,  and additional  profits  taxes  have been  included.                                                                   
Cash  flow that  would be  derived  by the  government, or  a                                                                   
national oil  company having an  equity interest in  a field,                                                                   
was  not included.    He referred  to  it as  the  government                                                                   
participation controversy.                                                                                                      
                                                                                                                                
1:48:15 PM                                                                                                                    
                                                                                                                                
Mr. Johnston referenced  page 26, take calculations  with and                                                                   
without factoring in participation.   The examples show for a                                                                   
"world  average"  system  with  government  participation  of                                                                   
13.5%,  which  should  be  close to  world  average  for  all                                                                   
systems,  and   how  different   the  take  statistics   look                                                                   
regarding government participation.   The graph on page 27 is                                                                   
a reproduction  of a  graph from  Conoco Phillips  indicating                                                                   
four  cost/tax scenarios.   The  lines  shift up  by 5%  when                                                                   
including  government  participation.    Countries  are  more                                                                   
likely to  have government participation  when the  costs are                                                                   
low and the tax is high.                                                                                                        
                                                                                                                                
The credit  system would  make it appear  that the  costs are                                                                   
lower  and that  they would  not have  to put  the amount  up                                                                   
front, but that was already factored in.                                                                                        
                                                                                                                                
Representative Kapsner asked for  further explanation of page                                                                   
27.                                                                                                                             
                                                                                                                                
1:51:21 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston   explained  that   the  graph  indicates   the                                                                   
government take on the left scale  relative to the costs in a                                                                   
given country.   He spoke  to countries with  high government                                                                   
take and  low cost.   When there  are high  costs there  is a                                                                   
downward trend, as shown by the  scale on the right.  In this                                                                   
case, the  government take  is artificially  off by 5%.   The                                                                   
credit system  makes it appear  that costs could  be reduced,                                                                   
which makes Alaska look less "painful".                                                                                         
                                                                                                                                
1:53:05 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston  continued  by   highlighting  pages  28-30  on                                                                   
government  participation.  The  government participation  at                                                                   
30% could cause  financial pain for oil companies.   He noted                                                                   
the financial "painometer" on page 30.                                                                                          
                                                                                                                                
Page  31  highlights  efficiency and  flexibility  in  fiscal                                                                   
design systems.   A  flexible system  can accommodate  a wide                                                                   
variety of  circumstances such  as high and  low prices.   An                                                                   
efficient system gets  a fair share for the  government.  The                                                                   
theory is that  a progressive system will be  more stable and                                                                   
prices will triple.                                                                                                             
                                                                                                                                
Page 32  is a graph  that shows  a typical regressive  system                                                                   
and  regressive  signature.    When  systems  are  evaluated,                                                                   
several different field sizes  are shown, and three different                                                                   
cost assumptions  and three price scenarios  are evaluated to                                                                   
show the  government take.   As profitability  increases, the                                                                   
government take declines.  Government  take for such a system                                                                   
would be approximately 65%.                                                                                                     
                                                                                                                                
1:55:36 PM                                                                                                                    
                                                                                                                                
Mr.   Johnston  highlighted,   on  page   33,  the   regional                                                                   
distribution of  petroleum fiscal systems.   He addressed the                                                                   
highlighted box:                                                                                                                
*    ROR systems                                                                                                                
*    "R" Factor                                                                                                                 
*    +Price-based formulas                                                                                                      
These  systems are  the systems  that are most  likely  to be                                                                   
progressive.    The rate-of-return-systems  have  some  heavy                                                                   
baggage.                                                                                                                        
                                                                                                                                
1:57:28 PM                                                                                                                    
                                                                                                                                
Mr.   Johnston  addressed   page   39,  indicating   industry                                                                   
statistics.     Page  40  highlights  the  weakness   of  the                                                                   
government take statistic, which  is not a perfect statistic.                                                                   
It is  important to  know the strengths  and weaknesses.   It                                                                   
does  not  adequately  capture signature  bonuses,  does  not                                                                   
address  the  "how"  of  government  take,  says  nothing  of                                                                   
timing, and  the scope of  the material  is too narrow  as it                                                                   
does  not indicate  benefits such  as jobs.   The  government                                                                   
take  statistic  also says  nothing  of ringfencing,  or  the                                                                   
ability  to tax  deduct costs  incurred in  one area  against                                                                   
other  license   areas.    It   does  not  measure   contract                                                                   
stability, nor  account for reserve/lifting  entitlements and                                                                   
ownership.   It does not  differentiate between  diverse work                                                                   
program  provisions, and  crypto  taxes  don't get  captured.                                                                   
Finally,  the government  take statistic  is not relevant  in                                                                   
some   important   situations   such   as   exploration   and                                                                   
development.                                                                                                                    
                                                                                                                                
2:01:10 PM                                                                                                                    
                                                                                                                                
Mr. Johnston  stated that  Alaska is  low on the  painometer.                                                                   
He spoke  to government risk  and said  that Alaska is  not a                                                                   
risky place on  the planet.  He referenced  the statistics on                                                                   
page 42.   He addressed  the difference  between oil  and gas                                                                   
exploration.  Gas  discoveries are not nearly  as valuable as                                                                   
oil discoveries for the same volume of reservoir rock.                                                                          
                                                                                                                                
Mr. Johnston  highlighted statistics  from various  companies                                                                   
regarding deepwater  projects on page  43.   He said  that 72                                                                   
of the  systems were regressive,  23 were progressive,  and 5                                                                   
were neutral.   He pointed  out the 5  points of  increase on                                                                   
government take.                                                                                                                
                                                                                                                                
2:03:30 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston spoke  of international  petroleum  exploration                                                                   
and contracts as shown on the  graph on page 44.  It is close                                                                   
to  a  statistically   significant  sampling.     It  is  not                                                                   
appropriate for  Alaska because of North  Slope requirements.                                                                   
He cautioned  members to be  wary of a  graph like this.   He                                                                   
pointed  out that government  participation,  as seen  in the                                                                   
left  hand  column,  is  factored  in.   On  either  side  of                                                                   
Azerbaijan   are    two   countries   with    no   government                                                                   
participation                                                                                                                   
                                                                                                                                
The graph  on page 45 is based  on cash flow analysis.   Most                                                                   
systems are regressive and government  take has dropped some.                                                                   
The left side shows government  take increases in progressive                                                                   
systems.   On  page 46,  graph 3  is not  conclusive, but  it                                                                   
depicts what  has happened to  the government take in  the UK                                                                   
during  the last  five years.   It  is not  appropriate as  a                                                                   
comparison  to Alaska's  legacy fields.   He  said he had  to                                                                   
mention  that the  government take  in the  North Sea was  75                                                                   
percent, but he warned the members to be careful.                                                                               
                                                                                                                                
Mr.  Johnston also  warned against  page  47, graph  #4.   He                                                                   
hoped to  assist in determining  what a fair share  would be.                                                                   
He asked  what kind  of terms would  yield the same  economic                                                                   
benefit  at $60  per  barrel that  was  obtained  at $20  per                                                                   
barrel.   He  referred to  the  article about  Libya and  the                                                                   
company's bid terms, which are consistent with the graph.                                                                       
                                                                                                                                
2:09:34 PM                                                                                                                    
                                                                                                                                
Mr. Johnston  spoke to  contract duration.   He said  he does                                                                   
not believe  that contracts  should last  about 50-60  years.                                                                   
He clarified  that most  contracts are  much shorter  and are                                                                   
two-dimensional: exploration years and production years.                                                                        
                                                                                                                                
Mr. Johnston  looked at  the graph on  page 51, the  expected                                                                   
value  theory  or  risk  analysis.   He  showed  how  rewards                                                                   
balance the risks.  He analyzed  the estimated probability of                                                                   
success.  Credits  are now structured in such a  way that the                                                                   
average field size is lower and risks are lowered by half.                                                                      
                                                                                                                                
Mr.  Johnston contradicted  BP's  presentation from  February                                                                   
28, 2006  on the proposed  PPT.   He highlighted  Sonangol to                                                                   
explain that  if non-associated  natural gas is  found, there                                                                   
are  re-opener  clauses  in  place.    "Always"  is  not  the                                                                   
appropriate word.                                                                                                               
                                                                                                                                
2:15:54 PM                                                                                                                    
                                                                                                                                
Mr. Johnston defined ringfencing on page 53.                                                                                    
                                                                                                                                
Co-Chair Samuels  asked about  the $73  million figure.   Mr.                                                                   
Johnston responded  that it won't work for  many companies in                                                                   
this state and needs to be replaced by something.                                                                               
                                                                                                                                
Representative  Gatto asked  about  the relationship  between                                                                   
"backing in" and  getting a royalty.  Mr.  Johnston responded                                                                   
that they are not the same in  the industry's language.  From                                                                   
a financial point of view, they  are similar because when the                                                                   
government  receives a  royalty the oil  companies have  paid                                                                   
for everything  right up to the  point of production  and the                                                                   
government gets something that they did not pay for.                                                                            
                                                                                                                                
Representative  Gatto referred  to page 20  and asked  if the                                                                   
lookback should  be layered  80/60 and  then 40/20/0,  or not                                                                   
even considered.   Mr. Johnston replied that it  is a complex                                                                   
issue dealing with how far back  to go, and with fairness and                                                                   
expectations.   The  issue is  that Alaskans  are behind  and                                                                   
have  not been  receiving  their  due.   He  said  he is  not                                                                   
comfortable with  elements of the  lookback and is  not happy                                                                   
just saying five years.                                                                                                         
                                                                                                                                
2:20:15 PM                                                                                                                    
                                                                                                                                
Co-Chair  Ramras  asked  how   long  Mr.  Johnston  would  be                                                                   
available.    He asked for  the optimum rate: 25/20  or 20/20                                                                   
or something  else.   Mr. Johnston replied  that he  has only                                                                   
two  weeks available  in the  next few  months.   He said  he                                                                   
would be  in Juneau for  two more days.   He opined  that the                                                                   
system that  is chosen must  be progressive because  it would                                                                   
be stable and dignified.   The terms must be  designed now in                                                                   
order  to  be  stable and  comfortable.    He  mentioned  the                                                                   
problem  of Cook  Inlet being  so different  than the  legacy                                                                   
fields.    Representative  Ramras  suggested  excluding  Cook                                                                   
Inlet.   Mr. Johnston suggested  he is not happy  with 20/20.                                                                   
He hesitated  to state  numbers.   Many sliding scales  don't                                                                   
work well.   It is nearly  impossible to predict a  rate with                                                                   
Cook  Inlet involved.   Representative  Ramras  asked how  it                                                                   
would  be  to  deal  with everything  but  Cook  Inlet.    He                                                                   
wondered what  would happen if exploration costs  are several                                                                   
points  higher than  the tax  rate.   Mr.  Johnston said  the                                                                   
system should  accommodate a wide  variety of oil  prices and                                                                   
encourage exploration.  He said  he would like to see greater                                                                   
credits  for exploration.   It  has  to be  decided how  much                                                                   
exploration is wanted.                                                                                                          
                                                                                                                                
2:26:51 PM                                                                                                                    
                                                                                                                                
Representative  LeDoux asked  Mr. Johnston  to state  his own                                                                   
opinion about  what system  would bring  the most money  into                                                                   
Alaska.    Mr.  Johnston responded  he  would  structure  the                                                                   
system  to   segregate  different  provinces   and  different                                                                   
classes of  investors.  Representative  LeDoux asked  if that                                                                   
is illegal.  Mr. Johnston suggested it could be fixed.                                                                          
                                                                                                                                
2:29:14 PM                                                                                                                    
                                                                                                                                
Representative  Kapsner addressed  the topic  of tax  credits                                                                   
and asked if the  focus should be on exploration  costs or on                                                                   
fields already  explored.   Mr. Johnston  replied that  it is                                                                   
good to  ask what  needs to  be incentivized.   He  suggested                                                                   
that  companies  explore  within  their own  fields.    Pilot                                                                   
studies  would  qualify  for  exploratory  investments.    He                                                                   
listed,  in order,  how investment  dollars  could be  spent:                                                                   
first  in  existing   fields,  then  in   exploration  within                                                                   
existing  fields,  and  finally in  wildcatting  or  frontier                                                                   
exploration.                                                                                                                    
                                                                                                                                
2:31:45 PM                                                                                                                    
                                                                                                                                
Representative  Holm  asked  how   strong  the  legislature's                                                                   
bargaining  position  is  in  light  of  the  fact  that  the                                                                   
legislature does  not negotiate  the contracts.   He wondered                                                                   
how much control the legislature  has over "whether they lift                                                                   
or  don't  lift".    Mr.  Johnston  replied  that  it  is  an                                                                   
uncomfortable   question.     The  legislature's   bargaining                                                                   
position  is  more  a function  of  just  how  much  strength                                                                   
Alaskans have,  and not quite  as much  a function of  who is                                                                   
doing  the negotiating.   He  defined bargaining  power as  a                                                                   
combination  of the  legislature's  and the  administration's                                                                   
bargaining  power.   This issue  is  one of  the most  widely                                                                   
published  subjects in  the world.    Mineral resources,  and                                                                   
especially oil  revenues, contribute greatly to  the nation's                                                                   
budget.  He  mentioned the strength of the  lobbying power of                                                                   
the  oil companies.   He  opined that  Alaska is  not in  the                                                                   
strongest  position he  has ever seen.   Representative  Holm                                                                   
asked  about walking  away from  the negotiation  table.   He                                                                   
said he is uncomfortable not knowing  where the line is.  Mr.                                                                   
Johnston pointed  out that the  problem is that  walking away                                                                   
would lead to more loss of money to the state.                                                                                  
                                                                                                                                
2:35:12 PM                                                                                                                    
                                                                                                                                
Representative  Holm  asked  about   the  difference  between                                                                   
giving a  check, rather  than giving a  credit, and  which is                                                                   
better  to  do.    Mr.  Johnston   responded  that  they  are                                                                   
virtually  identical.   The credits proposed  could  be sold,                                                                   
which is tantamount to getting a check.                                                                                         
                                                                                                                                
Representative   Seaton  asked   about   the  complexity   of                                                                   
combining oil and gas in the PPT  system.  He wondered if gas                                                                   
should be  taken out  of the mix  or left  in.  Mr.  Johnston                                                                   
replied that it  is premature for him to say  because he does                                                                   
not  know  enough  about  it.    PPT  will  influence  future                                                                   
exploration  of gas  because gas  discoveries  bring in  less                                                                   
money.   He  suggested providing  additional gas  exploration                                                                   
incentives.     The  credit  system  needs   more  attention.                                                                   
Representative  Seaton  requested  future  feedback  on  this                                                                   
consideration.                                                                                                                  
                                                                                                                                
2:38:43 PM                                                                                                                    
                                                                                                                                
Representative Kelly  asked about tax and  credit sensitivity                                                                   
on  the profit  side  overshadowed  by  the credit  side,  by                                                                   
possibly ten  times.  If  that is the  case, he  wondered how                                                                   
the credit side  could be fine-tuned.  Mr.  Johnston said the                                                                   
working number  is five to  one.  It is  the tax that  is the                                                                   
most  sensitive.    Representative   Kelly  agreed  that  the                                                                   
progressive  system  is  the  way  to  go,  but  asked  about                                                                   
providing a  safety net, such as  ELF, so it does  not bottom                                                                   
out.   Mr. Johnston  thought Alaska  would be protected,  but                                                                   
that  a number  should be  determined  so it  would never  do                                                                   
worse than  what ELF yielded.   He suggested  calculating the                                                                   
tax in two ways:  calculate ELF and the new PPT  and take the                                                                   
higher of the two.                                                                                                              
                                                                                                                                
Representative  Kelly  asked about  boundary  concerns.   Mr.                                                                   
Johnston  said the  biggest boundary  condition is  one-size-                                                                   
fits-all.   He referred  to Dr.  Van Meurs' presentation  and                                                                   
stated  that  a  credit  system   is  necessary,  and  it  is                                                                   
important  to get  the  tax right,  also.    He continued  to                                                                   
explain that  Cook Inlet could  not sustain a tax  increase -                                                                   
73  percent   is  an  attempt   to  separate   the  different                                                                   
provinces.  He remained skeptical.                                                                                              
                                                                                                                                
2:44:50 PM                                                                                                                    
                                                                                                                                
Representative  Kerttula asked if  any other countries  group                                                                   
all  of the  credits together  up front,  all at  once.   Mr.                                                                   
Johnston  said no.    She asked  if incentives  are  allowed,                                                                   
should  the legacy  and newer  fields be broken  apart.   Mr.                                                                   
Johnston replied  yes, but  that has its  problems, too.   He                                                                   
related  problems in  Pakistan and Algeria  - offshore  terms                                                                   
and  onshore terms.   Representative  Kerttula  asked if  any                                                                   
countries allow dollar  for dollar credits -  gas against oil                                                                   
or any other mineral.  Mr. Johnston  said that many countries                                                                   
allow "credits  to cross the  fence".  When governments  have                                                                   
different  terms  for  gas,  the  statistics  show  that  the                                                                   
government take  is about 67-70  percent.  The  world average                                                                   
government take  for oil, as  reported by Wood  Mackenzie, is                                                                   
71 percent  and for gas, 61  percent.  There are  problems if                                                                   
the tax system is not the same for both oil and gas.                                                                            
                                                                                                                                
2:48:39 PM                                                                                                                    
                                                                                                                                
Representative Olson asked how  to address both the companies                                                                   
in  Cook Inlet  and  those up  on the  slope.   Mr.  Johnston                                                                   
responded  that in the  80's many  companies invested  at $60                                                                   
per barrel.  He related the pain  felt at $40 per barrel.  He                                                                   
suggested  that  exploration  should be  encouraged.    North                                                                   
Slope producers  are smiling  now, but in  the 80's  and 90's                                                                   
exploration was discouraging.                                                                                                   
                                                                                                                                
2:50:32 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  ETHAN  BERKOWITZ  asked about  elasticity  of                                                                   
production  for legacy  fields.   He  asked  Mr. Johnston  to                                                                   
quantify an  increase in  tax rates and  how it would  affect                                                                   
production decisions.   He wondered  if legacy  fields should                                                                   
be treated  differently.  Mr.  Johnston said he  was speaking                                                                   
about the elasticity  of investment, relative  to fluctuation                                                                   
in taxes.  Research  and experience has shown that  it is not                                                                   
extremely elastic,  but when the  tax was dropped from  85 to                                                                   
30, investment  activity in dollars  really slowed down.   He                                                                   
noted that the three years prior  to 1993 and the three years                                                                   
after, there  were a few more  wells drilled, but  the change                                                                   
was only  3 percent.   If taxes  are raised  there will  be a                                                                   
change in production  on the North Slope.  It  is a tradeoff.                                                                   
The  question is  what  would be  reasonable.   He  suggested                                                                   
increasing taxes would be beneficial.                                                                                           
                                                                                                                                
2:54:18 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE NORM  ROKEBERG asked about the  variability of                                                                   
different provinces.   He wondered about  making distinctions                                                                   
between  fields.    He  noted  possible  legal  issues.    He                                                                   
wondered if  legal issues  are taken care  of, what  an ideal                                                                   
structure  would  look like.    He  also inquired  about  tax                                                                   
credits for  heavy oil.   Mr. Johnston noted  the flexibility                                                                   
surrounding  a heavy  oil field,  and the means  by which  to                                                                   
reduce the royalty.   He deemed it appropriated  to provide a                                                                   
means of fiscal  relief.  He suggested Alaska  seek that kind                                                                   
of flexibility  on an area-wide  basis.  He spoke  in support                                                                   
of such an idea.                                                                                                                
                                                                                                                                
2:57:51 PM                                                                                                                    
                                                                                                                                
Representative   Gatto   referred   to   predictability   and                                                                   
durability  in   earlier  presentations.  He  asked   if  PPT                                                                   
provides for  those more than  ELF.  Mr. Johnston  said those                                                                   
terms  go  beyond contract  terms  to  stability  provisions,                                                                   
which are very predictable and durable, but high risk.                                                                          
                                                                                                                                
2:59:48 PM                                                                                                                    
                                                                                                                                
Co-Chair Ramras asked  for an opinion on number  ratios.  Mr.                                                                   
Johnston  related   the  question  to  predictability.     He                                                                   
suggested  a  sliding  scale based  on  prices,  which  would                                                                   
influence a production-based tax.                                                                                               
                                                                                                                                
3:01:54 PM                                                                                                                    
                                                                                                                                
Co-Chair  Samuels  noted that  there  is auditing  of  fields                                                                   
around the  world.  He asked  about cost recovery  and "games                                                                   
playing".   Mr. Johnston  replied  that it  is a huge  issue.                                                                   
Many companies  have a strong  incentive to keep  costs down.                                                                   
If they keep costs  down, they get to keep a  percentage, say                                                                   
41  percent.   59  cents  on a  dollar  is a  high  incentive                                                                   
compared  to  Indonesia  where it  is  only  15 cents.    One                                                                   
practice  is  to procure  a  vendor  for goods  and  services                                                                   
through a bidding process.  He  addressed cheating and how it                                                                   
is  measured.   He  mentioned severe  penalties,  AFE in  the                                                                   
budget  process, and working  industry  partners, as  ways to                                                                   
provide  transparency.   One  difficulty  for governments  is                                                                   
administrative overhead charges,  which are more difficult to                                                                   
measure.                                                                                                                        
                                                                                                                                
3:07:15 PM                                                                                                                    
                                                                                                                                
Representative Seaton  asked about the $73  million allowance                                                                   
and  how it  was constructed.    He wondered  if a  different                                                                   
formulation would work.  Mr. Johnston  replied that there was                                                                   
a bit of art involved by Dr. Van  Meurs when constructing the                                                                   
formula.   $40 per  barrel, times 5,000  per day,  equals $73                                                                   
million.   But that allowance  is applied against  cash flow,                                                                   
not gross revenues.  He suggested  that the number 5,000 is a                                                                   
realty  check.   He  said  he  is not  comfortable  with  $73                                                                   
million, but it worked for Cook Inlet companies.                                                                                
                                                                                                                                
3:10:09 PM                                                                                                                    
                                                                                                                                
Representative Seaton  wondered about progressivity  based on                                                                   
a  production  model,  rather  than a  profits  model.    Mr.                                                                   
Johnston  said he preferred  that levies  are profits  based.                                                                   
Under the  proposed system,  with a  sliding scale,  if there                                                                   
were a  tax rate change, the  credit rate would  also change.                                                                   
It would  be regressive.   Representative Seaton asked  if it                                                                   
is necessary  to have  the change  in credit.   Mr.  Johnston                                                                   
said it would  take another formula to accommodate  that.  It                                                                   
would cause more problems.                                                                                                      
                                                                                                                                
3:13:03 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE LES  GARA requested a range of  fair tax rates                                                                   
on  the legacy  fields.   Mr.  Johnston  replied  that he  is                                                                   
uncomfortable  answering that  question.   At $20 per  barrel                                                                   
the producers would  be feeling pain; at $60 it  would not be                                                                   
so bad.  He suggested that a sliding  scale would accommodate                                                                   
the  down  side and  the  up side.    The  take should  be  a                                                                   
function  of  a  flexible  sliding  scale  and  require  some                                                                   
modeling.  He stated comfort with a flexible system.                                                                            
                                                                                                                                
3:16:01 PM                                                                                                                    
                                                                                                                                
Representative  Rokeberg  referred   to  an  earlier  comment                                                                   
regarding a progressive  system, and reverting to  ELF if the                                                                   
price drops.  He voiced concern  with that idea.  He wondered                                                                   
if other  countries do that.   He also  asked about  the "two                                                                   
knives"  system.   Mr.  Johnston replied  that  there is  "no                                                                   
going back"  language in some  sliding scales.   The "knives"                                                                   
terminology  came from  Kazakhstan, which  has three  sliding                                                                   
scales.                                                                                                                         
                                                                                                                                
He summarized  that he would  not want  to see a  system with                                                                   
maximum  flexibility because  "if  you want  to  go the  full                                                                   
distance  with a  truly progressive  system", the  government                                                                   
take is  greatly reduced.   He  emphasized  that he does  not                                                                   
want  to see  Alaska under  worse circumstances.   A  sliding                                                                   
scale  has a  high likelihood  for unforeseen  circumstances.                                                                   
He suggested  that if  PPT drops down  below what  would have                                                                   
been  earned  under ELF,  reverting  to  ELF is  better  than                                                                   
nothing.                                                                                                                        
                                                                                                                                

Document Name Date/Time Subjects