Legislature(2005 - 2006)HOUSE FINANCE 519

04/09/2006 01:00 PM FINANCE


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01:11:32 PM Start
01:13:19 PM HB488
03:59:04 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+= HB 488 OIL AND GAS PRODUCTION TAX TELECONFERENCED
Heard & Held
-- Testimony <Invitation Only> --
Daniel Johnston, Legislative Consultant,
Daniel Johnston & Co. Inc.
+ Bills Previously Heard/Scheduled TELECONFERENCED
HOUSE BILL NO. 488                                                                                                            
                                                                                                                                
     An  Act  repealing  the   oil  production  tax  and  gas                                                                   
     production  tax and  providing for  a production  tax on                                                                   
     the  net  value   of  oil  and  gas;  relating   to  the                                                                   
     relationship  of  the  production  tax to  other  taxes;                                                                   
     relating to  the dates tax  payments and  surcharges are                                                                   
     due   under   AS   43.55;  relating   to   interest   on                                                                   
     overpayments under  AS 43.55; relating to  the treatment                                                                   
     of  oil   and  gas  production   tax  in   a  producer's                                                                   
     settlement  with the royalty  owner; relating  to flared                                                                   
     gas,  and to  oil and  gas used  in the  operation of  a                                                                   
     lease  or  property, under  AS  43.55; relating  to  the                                                                   
     prevailing  value   of  oil  or  gas  under   AS  43.55;                                                                   
     providing for  tax credits against the tax  due under AS                                                                   
     43.55 for certain expenditures,  losses, and surcharges;                                                                   
     relating to statements or  other information required to                                                                   
     be  filed  with  or  furnished   to  the  Department  of                                                                   
     Revenue,  and relating  to  the penalty  for failure  to                                                                   
     file certain  reports, under  AS 43.55; relating  to the                                                                   
     powers  of  the  Department   of  Revenue,  and  to  the                                                                   
     disclosure  of   certain  information  required   to  be                                                                   
     furnished to the Department  of Revenue, under AS 43.55;                                                                   
     relating to criminal penalties  for violating conditions                                                                   
     governing access to and use  of confidential information                                                                   
     relating to the oil and gas  production tax; relating to                                                                   
     the  deposit of  money collected  by  the Department  of                                                                   
     Revenue under  AS 43.55; relating to the  calculation of                                                                   
     the gross  value at  the point of  production of  oil or                                                                   
     gas; relating  to the determination of the  net value of                                                                   
     taxable oil and gas for purposes  of a production tax on                                                                   
     the  net  value   of  oil  and  gas;  relating   to  the                                                                   
     definitions  of 'gas,'  'oil,' and  certain other  terms                                                                   
     for purposes of AS 43.55;  making conforming amendments;                                                                   
     and providing for an effective date.                                                                                       
                                                                                                                                
1:13:19 PM                                                                                                                    
                                                                                                                                
DANIEL JOHNSTON,  LEGISLATIVE  CONSULTANT, DANIEL JOHNSTON  &                                                                   
COMPANY  INCORPORATE,  HANCOCK,  NEW  HAMPSHIRE,  provided  a                                                                   
handout to  Committee members,  titled - Further  Discussions                                                                   
of SB 305 & HB 488.  (Copy on File)                                                                                             
                                                                                                                                
                                                                                                                                
Mr.  Johnston  remarked  that  the oil  industry  is  working                                                                   
diligently to maintain their position  and enumerated threats                                                                   
received from the industry:                                                                                                     
                                                                                                                                
   · Investments will dry up with 25/20% proposal, including                                                                    
     the progressive features                                                                                                   
   · Alaska reputation will be seriously harmed                                                                                 
   · There may be no gas pipeline                                                                                               
   · Philanthropic donations would be at risk                                                                                   
                                                                                                                                
Mr.  Johnston  pointed  out  that  large  oil  companies  are                                                                   
fighting similar battles around  the planet.  It is important                                                                   
that Alaska understand why oil companies are fighting hard.                                                                     
                                                                                                                                
He  provided an  "independent  view", expecting  to  continue                                                                   
work for  the oil companies.   He stated that he  would never                                                                   
identify  the actual  profits  made by  the  companies.   Oil                                                                   
companies  in general  lost hundreds of  millions of  dollars                                                                   
before  the   1970's.    They   continued  to  pump   oil  in                                                                   
expectation that those prices would rise.                                                                                       
                                                                                                                                
1:22:23 PM                                                                                                                    
                                                                                                                                
Mr. Johnston suggested that times  like the present should be                                                                   
rather  glorious  for  the  State  of  Alaska,  however,  the                                                                   
current  system  is  regressive.   Oil  prices  could  easily                                                                   
continue to rise.                                                                                                               
                                                                                                                                
Page 2  of the handout provides  a comparison of  Alaska with                                                                   
peer  groups from  around  the world.    He recommended  that                                                                   
Alaska not  be compared to Kansas  or Colorado.   Alaska does                                                                   
have  problems but  the major  players would  rather be  here                                                                   
than any  other state.   There  are a  couple countries  that                                                                   
compare  to Alaska,  one  of which  is  Russia.   Russia  has                                                                   
fields  governed through  a royalty  tax system.   The  terms                                                                   
under that contract are so "tough"  that it would make Alaska                                                                   
look like  one of  the "finest  places on  the planet".   The                                                                   
Russian   terms  are   difficult   given   the  royalty   tax                                                                   
arrangement,  where  they expect  tariffs  at  $30 dollars  a                                                                   
barrel off the  top.  He pointed out that the  same producers                                                                   
in Alaska operate in Russia.                                                                                                    
                                                                                                                                
1:26:36 PM                                                                                                                    
                                                                                                                                
Mr. Johnston  took threats  being made  by the oil  companies                                                                   
with  a  "grain  of  salt",  pointing   out  their  continued                                                                   
involvement in those places.                                                                                                    
                                                                                                                                
Mr.  Johnston  referenced the  graph  on Page  2,  indicating                                                                   
government take from  oil prices from around the  world.  The                                                                   
graph demonstrates  that fiscal terms  could be priced  @ the                                                                   
$60  dollars  per barrel  price.    Moving  from $20  to  $60                                                                   
dollars per  barrel indicates a  90% profit.   Governments do                                                                   
not  change terms  in  that fashion  and  instead, the  graph                                                                   
indicates the upside  of barrel prices at each  rate.  Alaska                                                                   
is proposing only  a 5-percentage point increased  intake not                                                                   
30.                                                                                                                             
                                                                                                                                
1:29:56 PM                                                                                                                    
                                                                                                                                
Page 3  highlights the countries  that are progressive.   Mr.                                                                   
Johnston pointed  out that Azerbaijan has a  progressive rate                                                                   
throughout the range, with a system  rate of return featuring                                                                   
no royalty or cost recovery limit.   The world today captures                                                                   
rate of return features.  The  government takes are under the                                                                   
government contracts  and fluctuate; the kind  of option most                                                                   
governments  wish  they had.    Most systems  are  regressive                                                                   
systems, but that 20% have progressive features.                                                                                
                                                                                                                                
1:32:53 PM                                                                                                                    
                                                                                                                                
Mr. Johnston stated that the version  from the Senate Finance                                                                   
Committee does not destroy the State's reputation.                                                                              
                                                                                                                                
Page  4, China's  finance ministry  added  a 20%  tax with  a                                                                   
sliding scale for  prices above $40 dollars a  barrel a scale                                                                   
is  similar  to what  is  being  proposed  in Alaska  and  is                                                                   
referred  to  as a  windfall  profit  type-tax or  price  cap                                                                   
formula.    He  stressed  the  actions  taken  in  China  are                                                                   
"horrifying" to the oil companies.                                                                                              
                                                                                                                                
1:35:05 PM                                                                                                                    
                                                                                                                                
Pages  5 &  6:   Mr.  Johnston  commented  on a  response  he                                                                   
received  from  Dr.  Juan  Carlos  Boue,  Oxford  University,                                                                   
regarding the  question of  rigging the rules,  understanding                                                                   
the profitability  and prospects  of upstream oil  activities                                                                   
in the offshore  U.S. Gulf of Mexico.  It is  not unique that                                                                   
in  Alaska, oil  companies  have significant  power.   It  is                                                                   
frustrating for  governments, when those  companies operating                                                                   
in there,  rival the  power of  the government.   One  of the                                                                   
"worst situations"  exists in  Mexico with PEMEX  having "way                                                                   
too much control".                                                                                                              
                                                                                                                                
Mr. Johnston  referenced  the United Kingdom  (UK) North  Sea                                                                   
output maturing fields, often  put forward as a prime example                                                                   
of  the  power  of  a more  flexible  taxation  scheme.    He                                                                   
discussed  industry   and  taxation,  central   to  Alaskans.                                                                   
Increasing  the  government  take  is  another  name  for  an                                                                   
"effective tax rate".                                                                                                           
                                                                                                                                
1:40:04 PM                                                                                                                    
                                                                                                                                
British  Petroleum   (BP)  claims   that  after   1993,  they                                                                   
increased  their investment  in  the North  Sea.   They  were                                                                   
selective in their  choice of statistics and  focused only on                                                                   
what they  did; however, the  information points out  that in                                                                   
general,  investment  in  the   North  Sea  after  1993  that                                                                   
industry   did   not   increase   investment   activity   and                                                                   
development activity remained the same.                                                                                         
                                                                                                                                
1:40:48 PM                                                                                                                    
                                                                                                                                
Page    10   indicates    Norwegian   production    increased                                                                   
significantly  at  a time  when  they did  not  drop the  tax                                                                   
rates.   When  taxes did  drop in  1993, production  appeared                                                                   
that  the industry  was  responding  to an  anticipated  drop                                                                   
rate, that  was not the  case.  In  1968, the UK  allowed the                                                                   
equivalent of credits for exploration  drilling, which is why                                                                   
it increased  dramatically.   Taxes were  reduced but  it was                                                                   
moderate.   It is understood  that allowing credits,  reduces                                                                   
taxes.                                                                                                                          
                                                                                                                                
1:43:05 PM                                                                                                                    
                                                                                                                                
Page  10:    Mr. Johnston  continued  the  number  of  fields                                                                   
brought on line after 1993:                                                                                                     
                                                                                                                                
   · Andrew                                                                                                                     
   · Harding                                                                                                                    
   · Fionaven                                                                                                                   
   · Schiehallion                                                                                                               
   · Eastern Trough Area Project (ETAP)                                                                                         
                                                                                                                                
1:44:44 PM                                                                                                                    
                                                                                                                                
Page 11:   Mr.  Johnston spoke  to the Norwegian  development                                                                   
activity  before and  after  1993.   Taxes  were not  changed                                                                   
during  that period.   Oil companies  are threatening  Alaska                                                                   
with false hope and loss of the  gas pipeline, which does not                                                                   
fit with  information existing in  other parts of  the world.                                                                   
He reiterated that the Norwegian  exploration activity before                                                                   
and  after the  1993  huge tax  cuts.   He  recommended  that                                                                   
Alaska  demand  information  stating  that there  will  be  a                                                                   
severe  drop  in  economic  activity   through  the  proposed                                                                   
changes.    Enough  information  has  not  been  provided  to                                                                   
justify that conclusion.                                                                                                        
                                                                                                                                
1:46:12 PM                                                                                                                    
                                                                                                                                
Page 12:  Mr.  Johnston read an article from  the "Economist"                                                                   
              th                                                                                                                
dated March 16,   2006, which highlight that  new taxes would                                                                   
bump  a 10%  increase in  government  take.   At today's  oil                                                                   
price,  the impact  on  development would  be  minimal.   The                                                                   
danger  comes  when  prices  start to  slip.    Mr.  Johnston                                                                   
mentioned  the Wyoming  experience, which  is second  only to                                                                   
Alaska  in regard  to the  importance that  the oil  industry                                                                   
plays to  the economy  and is important  research to  what is                                                                   
happening in Alaska.                                                                                                            
                                                                                                                                
1:49:35 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston recommended  that information  provided by  the                                                                   
oil  industry should  be presented  more fairly,  emphasizing                                                                   
that those companies are "bullying"  Alaskans.  He offered to                                                                   
answer questions of the Committee.                                                                                              
                                                                                                                                
1:50:30 PM                                                                                                                    
                                                                                                                                
Co-Chair Meyer had  not recalled the comparison  of Alaska to                                                                   
Kansas  but had  heard a  comparison  to Texas  and the  Gulf                                                                   
shores.  He noted that in Texas,  drilling is allowed most of                                                                   
the  year   with  lower   drilling  costs.     Mr.   Johnston                                                                   
acknowledged comparisons  in states  throughout the U.S.   He                                                                   
was aware of the weather windows  as compared to Texas, given                                                                   
the permitting and low cost environment  there and thought it                                                                   
would  be more  appropriate to  compare such  places to  Cook                                                                   
Inlet.                                                                                                                          
                                                                                                                                
The  North Slope  consists 90%  - Prudhoe  Bay and  Kaparuck.                                                                   
Most  oil  tax action  does  not  involve exploration.    Mr.                                                                   
Johnston suggested  Alaska has not made enough  room made for                                                                   
smaller oil companies.  In order  to compete with places like                                                                   
Texas with  easier permitting, more  must than what  is being                                                                   
offered  in  the  proposed  legislation  must be  done.    He                                                                   
reiterated Russia is the best comparison.                                                                                       
                                                                                                                                
1:55:28 PM                                                                                                                    
                                                                                                                                
Co-Chair  Meyer  asked  which  parts  of  Russia  were  being                                                                   
compared.  He was hopeful to discover  more exploration sites                                                                   
and  in a  country  like Russia,  it  would  be difficult  to                                                                   
compete with those costs.  Mr.  Johnston advised that the big                                                                   
companies are  already in Alaska.   Russia does not  have the                                                                   
permitting   problems,   however,   many   more   bureaucracy                                                                   
concerns.   He  emphasized the  huge  advantages that  Alaska                                                                   
offers; the  conditions would have  to be glorious  in Russia                                                                   
to invest there rather than here.                                                                                               
                                                                                                                                
1:57:58 PM                                                                                                                    
                                                                                                                                
Co-Chair Meyer  thought that the potential for  larger fields                                                                   
would be better in Russia than  in Alaska.  He referenced the                                                                   
known oil accumulations on the  North Slope.  He asked if the                                                                   
Governor's proposal was enough  incentive to get at that oil.                                                                   
                                                                                                                                
1:58:58 PM                                                                                                                    
                                                                                                                                
Mr. Johnston  pointed out that  ConocoPhillips first  went to                                                                   
Russia in the 1990's, which has  been "a bit of a nightmare".                                                                   
To imply that Russia  has virtues that do not  exit in Alaska                                                                   
is untrue.   Heavy  oil hasn't changed  much over  the years.                                                                   
None  of  the proposals  before  the  Legislature  adequately                                                                   
address heavy  oil unless  oil prices stay  at $60  dollars a                                                                   
barrel.   The proposed  system attempts to  be all  things to                                                                   
those involved.                                                                                                                 
                                                                                                                                
2:01:11 PM                                                                                                                    
                                                                                                                                
In  response to  comments  by  Co-Chair Meyer,  Mr.  Johnston                                                                   
clarified  that he  does not  expect  prices to  stay at  $60                                                                   
dollars per barrel.                                                                                                             
                                                                                                                                
2:02:07 PM                                                                                                                    
                                                                                                                                
SENATOR GARY WILKEN recalled times  when oil was projected to                                                                   
stay below $20  dollars a barrel for decades.   He asked what                                                                   
part prospectivity plays for Alaska.                                                                                            
                                                                                                                                
2:03:46 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston advised  that  the issue  is  complex and  that                                                                   
treats  the National  Petroleum  Reserve-Alaska (NPRA)  areas                                                                   
separately from  the Alaska  National Wildlife Refuge  (ANWR)                                                                   
area.    He  mentioned  that   the  field  size  expectation,                                                                   
distribution  and prospectivity  are significantly  different                                                                   
in  those   areas.    Prospectivity  identifies   exploration                                                                   
activity; 80% of the current drama  discussions are not about                                                                   
exploration.                                                                                                                    
                                                                                                                                
Mr. Johnston  said the State will  be short changed  with the                                                                   
proposed plan.   He did not know how many more  alpine fields                                                                   
exist.   He recommended  designing terms  accommodate  to all                                                                   
situations for the two big fields.                                                                                              
                                                                                                                                
2:06:43 PM                                                                                                                    
                                                                                                                                
Senator Wilken asked to what degree  does prospectivity drive                                                                   
a project.  Mr. Johnston replied it is the major driver.                                                                        
                                                                                                                                
Senator  Wilken pointed  out comments  regarding  cataclysmic                                                                   
events assuming  a change.   At  the highlighted numbers,  it                                                                   
could mean  a $300 - $400  million dollar per year  to people                                                                   
of Alaska, a  4% increase to government take.   He questioned                                                                   
if 4% in government  take, could fuel the industry  to remove                                                                   
operations from Alaska.                                                                                                         
                                                                                                                                
2:09:43 PM                                                                                                                    
                                                                                                                                
Mr. Johnston said he has been  doing this kind of work for 25                                                                   
years and has never ever seen  statistics lowering indicating                                                                   
the  level of  activity  from  changes in  a  tax  rate.   He                                                                   
questioned how  ConocoPhillips could make the  statement that                                                                   
a 2% increase  in government-take would reduce  investment by                                                                   
20%.                                                                                                                            
                                                                                                                                
Mr. Johnston  noted the change  in the UK tax  rate, pointing                                                                   
out  that investment  remained  the same.    In Venezuela  on                                                                   
April  1,  2006,  new harsh  terms  were  declared  and  most                                                                   
companies agreed  to the terms and remained.   Increasing the                                                                   
government  take   by  3  -   4  percentage  points   is  not                                                                   
significant.   He  noted that  industry agreed  to the  terms                                                                   
offered by the Governor and he  concluded that the difference                                                                   
between  those numbers  and the  ones being  proposed is  not                                                                   
significant.                                                                                                                    
                                                                                                                                
2:14:06 PM                                                                                                                    
                                                                                                                                
Senator Wilken  stated that the  well-being for  Alaskans had                                                                   
not  been addressed.    He pointed  out  assertions that  Mr.                                                                   
Johnston does  not live in Alaska  & really does not  have an                                                                   
investment  in  Alaska.   He  inquired  why  Alaskans  should                                                                   
listen  to Mr. Johnston.     Mr. Johnston  observed that  his                                                                   
reputation  could  be judged  by  his statements  during  the                                                                   
Committee process  and maintained that he cares  deeply about                                                                   
what happens here.                                                                                                              
                                                                                                                                
2:17:10 PM                                                                                                                    
                                                                                                                                
Representative  Kerttula  expressed concern  with  statements                                                                   
that "we cannot separate out"  legacy fields from exploration                                                                   
in Cook  Inlet for  the heavy  oil.   Mr. Johnston  agreed it                                                                   
would be  better to separate them,  but did not think  it was                                                                   
feasible,  especially  within the  legislative  session.   He                                                                   
emphasized the vast differences.                                                                                                
                                                                                                                                
Representative   Kerttula  questioned   the  rough   boundary                                                                   
differences for  treating legacy fields from  exploration and                                                                   
heavy  oil.   Mr. Johnston  stated that  the differences  are                                                                   
dramatic.  In  the legacy fields alone, there  are production                                                                   
rates of decline.   The spectrum of exploration  could create                                                                   
an  additional  category  of reserve,  subject  to  different                                                                   
terms.   The  incentive for  exploration  could be  different                                                                   
with  higher risks.   Cook  Inlet  has its  own problems  and                                                                   
boundary conditions  such as the high water cut  over 90%.  A                                                                   
couple of platforms have been  abandoned in Cook Inlet, which                                                                   
is  discouraging, given  the number  of jobs  that exist;  he                                                                   
voiced concern with further withdrawals.                                                                                        
                                                                                                                                
2:21:10 PM                                                                                                                    
                                                                                                                                
SENATOR FRED DYSON  acknowledged the issue of  the high water                                                                   
cuts in Cook  Inlet.  He observed that the  Alaska Regulatory                                                                   
Commission (ARC)  allows for gas  discoveries but  that there                                                                   
is not much  of a market for  new gas.  There is  not an easy                                                                   
place to sell  new gas.  He  stated that Alaskans are  on the                                                                   
edge of encountering demand concerns  while looking at supply                                                                   
problems over 5 years.  The concern  is how to give incentive                                                                   
for more exploration and production in Cook Inlet.                                                                              
                                                                                                                                
2:23:32 PM                                                                                                                    
                                                                                                                                
Mr. Johnston  observed  that he  is not well  versed in  Cook                                                                   
Inlet gas  and hoped to explore  those issues in  the future.                                                                   
Senator Dyson  noted that  some of  the non-legacy  owners in                                                                   
Prudhoe  Bay  would  have  access  to  processing  facilities                                                                   
because they are bumping up against  their capacity to handle                                                                   
water.   He asked how could  short-term incentives  for those                                                                   
facilities to be expanded.                                                                                                      
                                                                                                                                
Mr. Johnston  noted that  one of  the founding principles  of                                                                   
the Administration's work is to  provide access to facilities                                                                   
and  the infrastructure  for small  producers.   In order  to                                                                   
provide facilities  for the bigger  producers, there  will be                                                                   
costs and it might  have to be a tariff or fee  of some sort.                                                                   
He did not have further information on the issue.                                                                               
                                                                                                                                
2:26:16 PM                                                                                                                    
                                                                                                                                
SENATOR   LYDA  GREEN   addressed   the  underlying   concern                                                                   
regarding the surety  of the 30-year window.   She questioned                                                                   
how other  entities balance these  situations.   Mr. Johnston                                                                   
advised  that  his position  had  not changed  regarding  the                                                                   
producers  need   for  certainty,  especially   in  light  of                                                                   
increases in the  steel prices.  He observed that  there is a                                                                   
range of possibilities for certainty  and maintained that one                                                                   
of  Alaska's  sovereign  rights  is  to  make  changes.    He                                                                   
stressed  that once  a change  is made, it  remains for  many                                                                   
years  and said  certainty must  have  a "value".   A  robust                                                                   
progressive system  is needed to address what  is requested &                                                                   
required.   He observed  how the  capital costs  for the  gas                                                                   
pipeline have  increased.   In similar situations,  producers                                                                   
have moved forward without certainty.                                                                                           
                                                                                                                                
2:31:24 PM                                                                                                                    
                                                                                                                                
Senator  Green inquired  where a cap  on progressivity  could                                                                   
fit.  Mr.  Johnston  noted  that  the  Chinese  capped  their                                                                   
progressivity at  $60 a barrel  with a tax  rate of 40%.   He                                                                   
acknowledged  that  progressivity  could  go  "to  far",  but                                                                   
questioned why capping the price,  which could allow everyone                                                                   
to share in the high prices of oil.                                                                                             
                                                                                                                                
2:32:53 PM                                                                                                                    
                                                                                                                                
Mr. Johnston  understood  the desire for  an incentive  based                                                                   
arrangement.  He  observed that an oil reserve  tax is fairly                                                                   
punitive  and  expressed  concern  with  the  approach.    He                                                                   
observed that there  are a number of situations  in which the                                                                   
government would  like to see the oil companies  move faster.                                                                   
Oil companies hold  the acreage and have a lot  of power.  He                                                                   
did know  what incentives  could be put  into a gas  pipeline                                                                   
contract  to assure  that  it goes  forward.   Companies  can                                                                   
delay  if they  feel abused  and  must be  unanimous to  move                                                                   
forward, which places Alaska at a disadvantage.                                                                                 
                                                                                                                                
2:38:02 PM                                                                                                                    
                                                                                                                                
Senator Dyson  asked if credits  could be structured  so that                                                                   
they can offset  to help achieve the pipeline.   Mr. Johnston                                                                   
had   not   considered   that,   but   thought   it   sounded                                                                   
"interesting".                                                                                                                  
                                                                                                                                
2:39:03 PM                                                                                                                    
                                                                                                                                
Vice  Chair  Stoltze  noted  that he  was  puzzled  with  the                                                                   
Governor's  20/20  proposal  and   asked  if  it  was  "usual                                                                   
dynamics"  for oil companies.   Mr.  Johnston thought  so and                                                                   
was surprised  by the  protection mechanisms  offered  by the                                                                   
industry.                                                                                                                       
                                                                                                                                
2:41:58 PM                                                                                                                    
                                                                                                                                
SENATOR DONNY  OLSON referenced  an article submitted  to the                                                                   
Senate  Finance Committee  (SFC) by the  Eastern Nova  Scotia                                                                   
Province, asking  for Mr.  Johnston's comments regarding  the                                                                   
stringent  tax structure  proposed.   Mr. Johnston  responded                                                                   
that he  had seen  the article,  which fascinated  him.   The                                                                   
last  time  he  was in  New  Foundland,  he  discussed  those                                                                   
concerns with the Prime Minister  and the circumstances there                                                                   
are similar to  Alaska.  The federal government  taxes at the                                                                   
federal  level, leaving  little  maneuvering  ability.   That                                                                   
providence  rivals  North  Slope   conditions  with  offshore                                                                   
icebergs and worse  conditions than the North Sea.   In order                                                                   
to work,  the area would have  had to bend further  than they                                                                   
are willing.  He could add no  any further information on the                                                                   
situation.                                                                                                                      
                                                                                                                                
2:44:27 PM                                                                                                                    
                                                                                                                                
Mr. Johnston acknowledged the  article was valid and the main                                                                   
purpose  article highlighted  that  "negotiations broke  down                                                                   
and oil  companies walked away".   He did not know  the terms                                                                   
or  conditions offered  under  the contract  and  recommended                                                                   
finding out more information regarding the circumstances.                                                                       
                                                                                                                                
2:45:36 PM                                                                                                                    
                                                                                                                                
Representative  Kelly inquired if  Mr. Johnston stuck  by his                                                                   
original  proposal.   Mr.  Johnston stated  that  he was  not                                                                   
comfortable with  the Governor's  20/20 or the  neutrality of                                                                   
that  proposal.   He noted  the amount  of lobbying  pressure                                                                   
occurring  during  the process;  lobbying  power  of the  oil                                                                   
companies  is substantial.   They  are  not going  to try  to                                                                   
resurrect  the process.   There  are many  dimensions to  the                                                                   
certainty.  He  voiced strong support for starting  at 25/20,                                                                   
attaching a progressivity scale.                                                                                                
                                                                                                                                
Representative  Kelly  asked if  Mr. Johnston  supported  the                                                                   
progressivity ratio  of 50/40.  Mr. Johnston  advised that he                                                                   
recommended the  start point be  about $25 dollars  a barrel.                                                                   
Most  producers  have  made  it   clear  that  they  are  not                                                                   
interested in major investments  at that price.  He said that                                                                   
$40 dollars a  barrel would be a significant  change and that                                                                   
he  was comfortable  with  that number.    Mr. Johnston  felt                                                                   
there was  room for negotiations  beginning at $40  dollars a                                                                   
barrel.                                                                                                                         
                                                                                                                                
2:51:33 PM                                                                                                                    
                                                                                                                                
Representative  Kelly  inquired  the  maximum  terms  of  the                                                                   
contract  that the  State of Alaska  should  consider.    Mr.                                                                   
Johnston claimed  that it would  be unfair to insist  on both                                                                   
certainty in  gas and oil.   A typical contract  is 25-years,                                                                   
which he said  was "unthinkable" & recommended  that 10-years                                                                   
was  more reasonable.    If the  State  leaves  money on  the                                                                   
table, the  oil companies  would not  fix it.   If the  State                                                                   
asks too much,  they have the power to change.   There should                                                                   
be certainty with regard to the  gas line as it will take 12-                                                                   
years before the State starts  producing.  To reach half-life                                                                   
of the gas will take 25-years.   He recommended that offering                                                                   
all equity  interest could help  and pointed out that  he has                                                                   
strongly lobbied for progressive terms on oil and now gas.                                                                      
                                                                                                                                
2:55:22 PM                                                                                                                    
                                                                                                                                
Representative  Kelly  addressed bottom  tax  concerns.   Mr.                                                                   
Johnston responded  that it should  not matter if it  went to                                                                   
zero, if  oil prices  fall below  $25 dollars  a barrel.   At                                                                   
zero, a severance  tax could be okay if a royalty  amount was                                                                   
included.  To a  large extent, it is an estimate  on what the                                                                   
expected prices of oil will be.   He did not think oil prices                                                                   
would  weaken  significantly  as  the pressure  seems  to  be                                                                   
moving upward.                                                                                                                  
                                                                                                                                
2:59:14 PM                                                                                                                    
                                                                                                                                
Representative  Kelly mentioned the  no-start date for  a gas                                                                   
contract.  Mr.  Johnston voiced concern regarding  a hard and                                                                   
firm  start date;  industry  has  proven that  mega  projects                                                                   
usually come  in over-budget  and never are  on time.   It is                                                                   
difficult  to  account  for  that.    Crafting  language  for                                                                   
something  new is  worrisome.   It  usually  takes ten  years                                                                   
before contract  language can appropriately  address possible                                                                   
outcomes.   He could  not offer  any alternatives  to a  firm                                                                   
start deadline.                                                                                                                 
                                                                                                                                
3:02:28 PM                                                                                                                    
                                                                                                                                
Representative  Kelly worried about  any contract  that would                                                                   
affect Alaska  for 15-years.   Mr. Johnston added  that there                                                                   
are  circumstances   governed  by  the  commerciality   of  a                                                                   
contract,  determining  if a  field  is viable  or  not.   He                                                                   
emphasized that  the option before  the Committee  presents a                                                                   
unique situation that might not be best for the State.                                                                          
                                                                                                                                
3:04:31 PM                                                                                                                    
                                                                                                                                
Representative  Kelly addressed  the  challenges of  pipeline                                                                   
in-fill and the gamble associated with that for Alaska.                                                                         
                                                                                                                                
3:06:15 PM                                                                                                                    
                                                                                                                                
Co-Chair Meyer appreciated  the 2 for 1 idea  coming from the                                                                   
Senate Resource  Committee (SRC).   Mr. Johnston  stated that                                                                   
his  first impulse  was negative  to  that idea.   The  House                                                                   
Resource  Committee  (HRC)  attempted to  determine  if  that                                                                   
result  would achieve  increased  investment.   The  2 for  1                                                                   
proposal could  help satisfy both conditions  of fairness and                                                                   
economic logic on investments  made during that time made and                                                                   
it  encourages the  original  investment  because it  enables                                                                   
recouped costs.                                                                                                                 
                                                                                                                                
3:08:21 PM                                                                                                                    
                                                                                                                                
Co-Chair Meyer commented that  the goal of the State, similar                                                                   
to that  of the oil companies,  is to maximize the  return to                                                                   
the  State's  shareholders.   He  asked  if the  goal  should                                                                   
rather  be getting  more out  of  declining existing  fields.                                                                   
Mr. Johnston  pointed out  a general  consensus that  "80% of                                                                   
the action"  is in existing fields.   The idea of  the demise                                                                   
of  exploration  is premature;  there  is virtue  in  further                                                                   
exploration.    He  thought, there  would  be  some  pleasant                                                                   
surprises.  Dollar for dollar,  the two big legacy fields and                                                                   
significant  accumulation of  heavy oil,  is where the  State                                                                   
should be  spending most of their  time; however, not  to the                                                                   
exclusion of exploration.                                                                                                       
                                                                                                                                
3:11:40 PM                                                                                                                    
                                                                                                                                
Co-Chair  Meyer  recommended  that the  issues  be  addressed                                                                   
separately.   Mr. Johnston stated  that during  his testimony                                                                   
            th                                                                                                                  
on  March  6,    the  tax  and  the  credits   were  directly                                                                   
discussed,   an  attempt   to   balance   the  existing   tax                                                                   
production.                                                                                                                     
                                                                                                                                
3:12:54 PM                                                                                                                    
                                                                                                                                
Co-Chair Meyer  questioned if larger oil companies  would opt                                                                   
to spend  their dollars in  Alaska or  the Gulf of  Mexico if                                                                   
Alaska chooses the  25/20 plan.  Mr. Johnston  stated that he                                                                   
could run  those numbers  to determine  the choice  including                                                                   
progressivity, reserves, cost rates and costs involved.                                                                         
                                                                                                                                
3:14:16 PM                                                                                                                    
                                                                                                                                
Co-Chair Meyer  recommended comparing  Alaska to Texas  & the                                                                   
Gulf  of  Mexico  rather  than   Russia.    He  thought  that                                                                   
opportunities for working year  round and tax rates were more                                                                   
favorable in Texas.                                                                                                             
                                                                                                                                
3:14:54 PM                                                                                                                    
                                                                                                                                
Representative Kerttula mentioned  negotiation considerations                                                                   
and  the  unlikelihood  of  a  low  side  and  worried  about                                                                   
incorporating  a "floor"  at  the  low side.    When she  had                                                                   
written  contracts, a  date certain  was  always included  to                                                                   
address delays.                                                                                                                 
                                                                                                                                
Mr.  Johnston responded  that  oil prices  falling below  $25                                                                   
dollars a barrel  could happen at the end of  exploration.  A                                                                   
mechanism must  be in place  to accommodate such  situations.                                                                   
The $9 a barrel  scenario happened in 1998, but  did not last                                                                   
long.   If that  happens again,  the State  and the  industry                                                                   
will need  to revisit the situation.   He continued,  a start                                                                   
date is a  difficult consideration and he could  not conceive                                                                   
of a hard date with all the uncertainties.                                                                                      
                                                                                                                                
3:19:13 PM                                                                                                                    
                                                                                                                                
Mr.  Johnston responded  to Representative  Kerttula that  he                                                                   
was  not able  to provide  a  single tax  rate  to cover  all                                                                   
fields and situations.                                                                                                          
                                                                                                                                
3:20:14 PM                                                                                                                    
                                                                                                                                
SENATOR BEN  STEVENS referred to the  graph on Page  9 of the                                                                   
handout.  He  observed that of the 10 largest  fields brought                                                                   
on line  during that time  (1980 - 2000),  8 were  in Norway.                                                                   
He thought  that the increase  in those fields  resulted from                                                                   
the  access  to resources.    They  were the  largest  fields                                                                   
outside of the Middle East during  that period.  He suggested                                                                   
that if Alaska's productions were  overlaid, those challenges                                                                   
could  become  obvious.   Mr.  Johnston  responded  that  the                                                                   
characterization  of the tax rate  impact the  United Kingdom                                                                   
(UK) was over simplified and not  correct.  He noted that the                                                                   
investment activity in Norway  and the production profile was                                                                   
dramatic and he believed that  exploration must have occurred                                                                   
earlier when  fiscal terms were  tough.  He pointed  out that                                                                   
the climate and the regulatory terms in Norway are severe.                                                                      
                                                                                                                                
3:24:25 PM                                                                                                                    
                                                                                                                                
Senator   Stevens   suggested   that   government-owned   oil                                                                   
companies were  doing the exploration.  Mr.  Johnston doubted                                                                   
that they were doing all or even most of the exploration.                                                                       
                                                                                                                                
3:25:20 PM                                                                                                                    
                                                                                                                                
Senator Stevens  referred to Page 3,  graph 2.  He  counted 9                                                                   
progressive systems  and 23  countries that have  production-                                                                   
share  agreements   and  4  with  service  agreements.     He                                                                   
concluded that  there appears to  be a small  percentage with                                                                   
progressivity,  including the  "R"  factor.   He was  curious                                                                   
about the terms of a production  sharing agreement, recalling                                                                   
that the  average  time of such  an agreement  was 23  years.                                                                   
Mr. Johnston responded  that 10 years would  be reasonable in                                                                   
the absence of a certainty clause.   If a change were made by                                                                   
the Legislature,  it would  be unthinkable  that it  could be                                                                   
reconsidered  sooner than 10  years.   He clarified  that the                                                                   
average  term of  a production  contract is  about 25  years.                                                                   
That does  not mean that the  fiscal terms cannot  be changed                                                                   
and noted that  contract terms have changed  worldwide.  Some                                                                   
of the production-sharing  contracts are more  stable, but he                                                                   
knew of no country that gave up their sovereignty.                                                                              
                                                                                                                                
3:30:07 PM                                                                                                                    
                                                                                                                                
Senator Stevens  questioned why statements  regarding onerous                                                                   
tax  increases &  their  impacts should  be  discarded.   Mr.                                                                   
Johnston disagreed  that the tax  rates being  discussed were                                                                   
onerous.  He observed that those  working in the industry are                                                                   
not as objective  as they should  be.  He pointed out  he had                                                                   
been given  a mandate  to be  "objective".   He stressed  his                                                                   
intent to  be objective and  to provide prospective  for both                                                                   
sides & advised that he was not  being onerous but attempting                                                                   
to protect those non-oil interests.                                                                                             
                                                                                                                                
Senator  Stevens continued,  the  decisions  being made  will                                                                   
impact the people of Alaska, who  should be listened to.  Mr.                                                                   
Johnston stressed that the process  has included all types of                                                                   
people and that  he had listened to testimony  from all sides                                                                   
to learn the process.   Industry is not the  only entity that                                                                   
needs to  have representation.   He maintained  that Alaskans                                                                   
want to  take care of the  oil industry "almost to  a fault",                                                                   
because no one wants to hurt Cook Inlet.                                                                                        
                                                                                                                                
3:36:12 PM                                                                                                                    
                                                                                                                                
SENATOR BERT STEADMAN stated that  the only way the State can                                                                   
really  know what  the  resource  is worth  is  to have  them                                                                   
withdrawn  and  re-bid.    He questioned  the  range  if  the                                                                   
resource  were  relinquished.     Mr.  Johnston  referred  to                                                                   
Indonesia where contracts were  relinquished and then re-bid.                                                                   
He   observed   that  after   30   years,  terms   had   been                                                                   
renegotiated.   It was  acknowledged that  if the  government                                                                   
had taken ownership at the end  of the contract, the industry                                                                   
would  have  stopped  production  5 years  before  the  terms                                                                   
ended; the result was a $60 million dollar bonus.                                                                               
                                                                                                                                
3:41:25 PM                                                                                                                    
                                                                                                                                
Senator Steadman assumed that  the government's take could be                                                                   
higher than  what currently is  on the table.   He understood                                                                   
that the intent  was to stimulate production  and exploration                                                                   
until the gas  line comes on.   The hope is to leave  some on                                                                   
the  table,  not driving  off  the  industry.   Mr.  Johnston                                                                   
maintained  that   there  is   stillroom  to  error   on  the                                                                   
conservative  side, although  it  is difficult  to know  what                                                                   
that  number is.   He  referred to  other markets,  observing                                                                   
that  there  have  never  been  prices  demonstrated  in  the                                                                   
1990's.   He  said that  many of  his friends  living in  the                                                                   
United Kingdom (UK)  believe that the terms  being offered in                                                                   
Alaska are "luke warm".                                                                                                         
                                                                                                                                
3:44:05 PM                                                                                                                    
                                                                                                                                
Representative  Kelly referred to  the prospective  price and                                                                   
asked  what sort  of  adjustment was  needed.   Mr.  Johnston                                                                   
explained  that  there  were two  dimensions  and  relatively                                                                   
speaking, prospectivity  has not changed a lot  as oil prices                                                                   
have.   Increase in oil  prices does not happen  immediately;                                                                   
it takes  a couple  of years of  drilling activity,  costs of                                                                   
services are increasing.                                                                                                        
                                                                                                                                
3:46:24 PM                                                                                                                    
                                                                                                                                
Representative    Kelly   commented    that   the    relative                                                                   
progressivity could  change little  and asked if  the numbers                                                                   
could be changed at a later date.   Mr. Johnston did not know                                                                   
the mechanisms  that exist to address royalty  reductions but                                                                   
believed  that someone  must  have the  authority  to do  it.                                                                   
Presently, there are no beneficiaries.                                                                                          
                                                                                                                                
Representative Kelly  spoke to the  fairness of the 2  for 1,                                                                   
derived  from a  base average  initial  investment and  asked                                                                   
about  the effective  date.   Mr.  Johnston  had not  thought                                                                   
about inserting  a threshold.  Regarding the  effective date,                                                                   
he  recommended that  it be  sooner  rather than  later.   He                                                                   
identified sense  of urgency  to fix a  "broken system".   He                                                                   
spoke to the amount of money that  the State would be loosing                                                                   
by  not  putting the  systems  in  place.   He  thought  that                                                                   
January 2006 might be an appropriate  start date and was open                                                                   
to discussion.                                                                                                                  
                                                                                                                                
3:52:22 PM                                                                                                                    
                                                                                                                                
Representative   Kerttula   asked    about   critical   audit                                                                   
functions.  Mr.  Johnston agreed it was a big  issue, stating                                                                   
that auditors  are  worth their  weight in  gold.  There  are                                                                   
many concerns about having profit-based  mechanisms in place.                                                                   
About 70%  of what  governments receive  in this world  comes                                                                   
from profit-based  mechanisms.   Most of  the means  by which                                                                   
governments insure  that the accounting is done  properly, is                                                                   
"field-proven" off  the shelf methods, often  done with great                                                                   
success.  He pointed out royalty  determination disputes.  He                                                                   
recommended that  it is important  to get the tax  rate right                                                                   
at the beginning when determining a correct structure.                                                                          
                                                                                                                                
3:54:45 PM                                                                                                                    
                                                                                                                                
Senator Dyson  noted his support for the  Governor's proposal                                                                   
and the blanket  credit for development work.  He  asked if a                                                                   
standard definition  had been  used.  Mr. Johnston  explained                                                                   
that with  the boundary conditions  placed on  the Department                                                                   
of Revenue, they  did what they had to do to  accommodate the                                                                   
situation within a single system and determined:                                                                                
                                                                                                                                
   · Tax Rates                                                                                                                  
   · Credit Systems                                                                                                             
   · Allowances                                                                                                                 
                                                                                                                                
Mr.  Johnston   recommended  a   system  to  cover   all  the                                                                   
structures.  For enhanced oil,  there are no well-established                                                                   
guidelines for what could be appropriate;  which is important                                                                   
to establish guidelines, as there  is a substantial amount of                                                                   
heavy oil in Alaska.                                                                                                            
                                                                                                                                
HB 488 was HELD in Committee for further consideration.                                                                         

Document Name Date/Time Subjects