Legislature(2011 - 2012)HOUSE FINANCE 519

03/17/2011 08:00 AM FINANCE

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08:05:30 AM Start
08:05:38 AM HB110
10:24:25 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Heard & Held
Tax Credits, Additional Discussion
Dept. of Revenue
+ Bills Previously Heard/Scheduled TELECONFERENCED
HOUSE BILL NO. 110                                                                                                            
     "An  Act relating  to the  interest rate  applicable to                                                                    
     certain amounts due for fees,  taxes, and payments made                                                                    
     and property  delivered to  the Department  of Revenue;                                                                    
     relating  to  the  oil and  gas  production  tax  rate;                                                                    
     relating to  monthly installment payments  of estimated                                                                    
     oil and  gas production  tax; relating  to oil  and gas                                                                    
     production  tax   credits  for   certain  expenditures,                                                                    
     including  qualified capital  credits for  exploration,                                                                    
     development,   and   production;    relating   to   the                                                                    
     limitation  on assessment  of  oil  and gas  production                                                                    
     taxes;  relating to  the determination  of oil  and gas                                                                    
     production  tax values;  making conforming  amendments;                                                                    
     and providing for an effective date."                                                                                      
8:05:38 AM                                                                                                                    
BRYAN   BUTCHER,   COMMISSIONER,  DEPARTMENT   OF   REVENUE,                                                                    
explained that  the presentation would be  about tax credits                                                                    
as related  to HB  110. He  stated that  tax credits  were a                                                                    
substantial part of the legislation.                                                                                            
Co-Chair Stoltze  appreciated the prompt  communications the                                                                    
committee had been receiving from the department.                                                                               
LENNIE  DEES,  AUDIT  MASTER, TAX  DIVISION,  DEPARTMENT  OF                                                                    
REVENUE, provided  an overview  of his credentials  and work                                                                    
experience,  including a  degree in  accounting and  twenty-                                                                    
four years of  experience in the oil and  gas industry, both                                                                    
in  the natural  gas pipeline  sector and  upstream oil  and                                                                    
gas.  He noted  that  he  had been  with  the Department  of                                                                    
Revenue  (DOR)  since 2008,  right  after  Alaska Clear  and                                                                    
Equal Share (ACES) came into effect.                                                                                            
Mr. Dees offered a  PowerPoint presentation, "Production Tax                                                                    
Credits, March  17, 2011"  (copy on file).  He began  with a                                                                    
list of the  seven different types of  tax credits allowable                                                                    
under  the Alaska  oil and  gas production  tax statute  (AS                                                                    
43.55) on "Types of Production Tax Credits" (Slide 3):                                                                          
     Credits  which may  taken  against  oil and  production                                                                    
     taxes include:                                                                                                             
        · Capital Expenditure Credits                                                                                           
        · Alternative Tax Credits for Oil and Gas                                                                               
        · Net Operating Loss ("NOL") Carry Forward Credits                                                                      
        · Transitional   Investment    Expenditure   ("TIE")                                                                    
        · Additional Nontransferable Tax Credits                                                                                
        · Well Lease Expenditures Credit                                                                                        
        · Cook Inlet Jack-up Rig Credit                                                                                         
8:10:14 AM                                                                                                                    
Mr. Dees  noted that  the next slide  provided a  history of                                                                    
when the various tax credits  were created, illustrated with                                                                    
comparative timelines on Slide  4, "Timelines for Production                                                                    
Tax Credits."  [NOTE: only the  types of credits  are listed                                                                    
below, not the timelines, which can be found on the slide.]                                                                     
     43.55.023(a) QCE and (b) CFAL credits                                                                                      
     43.55.023(l) 40% Well Lease Exp (CI)                                                                                       
     43.55.023(i) TIE credits (PPT)                                                                                             
     43.55.023(i) TIE credits (ACES)                                                                                            
     43.55.024(a) New Area Development credit                                                                                   
     43.55.024(c) small producer credit                                                                                         
     43.55.025(20%/40%) credit for exploration                                                                                  
     43.55.025(30%/40%) credit for exploration                                                                                  
     43.55.025(l) Cook Inlet Jack-up Rig credit                                                                                 
Mr. Dees highlighted that the  earliest credit enacted under                                                                    
AS  43.55  was  the  alternative  credit  for  oil  and  gas                                                                    
exploration; the  credit was  enacted in  2003. Most  of the                                                                    
other credits came  into being with the  passage the passage                                                                    
of  the petroleum  production tax  (PPT),  starting with  AS                                                                    
43.55.023(a),  the  qualified  capital  expenditure  credits                                                                    
(QCE) and  AS 43.55.023(b), the carried-forward  annual loss                                                                    
(CFAL)  credits; the  two came  into effect  April 1,  2006.                                                                    
Initially  the credits  were 20  percent  each; during  PPT,                                                                    
credits taken  under the particular  statute could  be taken                                                                    
by  a taxpayer  in  their  entirety in  the  year they  were                                                                    
earned.  The  provision  was  changed  by  ACES  so  that  a                                                                    
taxpayer could  only take  50 percent of  the credit  in the                                                                    
year it was earned; the other  50 percent had to be taken in                                                                    
later years.                                                                                                                    
Mr. Dees  continued that the  next credit enacted  under PPT                                                                    
was   the   transitional  investment   [expenditure]   (TIE)                                                                    
credits.  Initially, the  credit was  for expenditures  that                                                                    
companies had made in the  five-year period between April 1,                                                                    
2001 through March 31, 2006;  if the particular expenditures                                                                    
would have been QCEs after  April 1, 2006, the company would                                                                    
have  been  able  to  get   20  percent  of  the  particular                                                                    
expenditures as a credit. However,  each year the credit was                                                                    
going  to  be  limited  by   the  amount  of  the  company's                                                                    
expenditures  during   that  particular  year.   The  credit                                                                    
changed under ACES and was  only available to companies that                                                                    
did  not  have  production  prior to  January  1,  2008,  or                                                                    
companies that were already producing before 2006 and 2007.                                                                     
Mr. Dees  turned to  the next credit  that came  into effect                                                                    
under PPT,  the AS 43.55.024 non-transferrable  tax credits.                                                                    
There were two  credits under the section. One  was the new-                                                                    
area  development  credit, a  $6  million  credit for  those                                                                    
companies producing  oil and gas  outside of Cook  Inlet and                                                                    
the North Slope above 68  degrees north latitude. The credit                                                                    
could  only be  taken against  a tax  liability and  was not                                                                    
transferrable or  useable in a  succeeding year.  The credit                                                                    
was available to  a company each year and had  a sunset date                                                                    
of 2016.                                                                                                                        
8:13:36 AM                                                                                                                    
Mr.  Dees  described  the next  credit  available  under  AS                                                                    
43.55.024(c), the small producer  credit, with a $12 million                                                                    
credit for companies producing less  than 50,000 barrels per                                                                    
day of  oil and  gas (BTU equivalent).  The credit  was pro-                                                                    
rated down  to zero at  100,000 barrels per day,  could only                                                                    
be  used against  a tax  liability, could  not be  converted                                                                    
into  cash,  transferred  to  another  taxpayer  or  carried                                                                    
forward, and the expiration date was 2016.                                                                                      
Mr.  Dees  informed  the committee  that  the  AS  43.55.025                                                                    
credit came  into being prior  to PPT and was  revised under                                                                    
ACES for activities  after June 30, 2008;  the credit became                                                                    
a 30 or  40 percent tax credit (it initially  had been 20 or                                                                    
40 percent).  The credit amount  was dependant on  where the                                                                    
activity  took place;  the activity  had to  be at  least 25                                                                    
miles outside the  boundary of a unit on the  North Slope or                                                                    
10 miles  outside the boundary  of a  unit in Cook  Inlet. A                                                                    
well drilled  under the  credit had to  be three  miles away                                                                    
from an existing well.                                                                                                          
Mr. Dees  directed attention to  the two tax  credits passed                                                                    
by the legislature  in the prior year: the  40 percent well-                                                                    
lease expenditure credit under  AS 43.55.023(l) and the Cook                                                                    
Inlet Jack-up  Rig Credit under  AS 43.55.025(l).  The well-                                                                    
lease  expenditure  credit  was 40  percent  for  well-lease                                                                    
expenditures   (well-lease   costs   considered   intangible                                                                    
drilling and  development costs, as defined  by the Internal                                                                    
Revenue  Code). He  noted that  in the  drilling of  a well,                                                                    
between  75  and  85  percent of  the  drilling  costs  were                                                                    
typically  considered  to  be intangible;  intangible  costs                                                                    
were costs of items without  a salvage value. The credit was                                                                    
currently only available in areas  south of 68 degrees north                                                                    
latitude and  became effective  for expenditures  after July                                                                    
1, 2010.                                                                                                                        
8:17:07 AM                                                                                                                    
Mr. Dees  provided details about  the last credit,  the Cook                                                                    
Inlet Jack-up Rig Credit; the credit  was for 100, 90, or 80                                                                    
percent of  the first  $25 million  for companies  using the                                                                    
same  jack-up rig  that targeted  a  particular zone  within                                                                    
Cook Inlet,  the pre-tertiary zone.  He noted that  to date,                                                                    
there  was  not  a  jack-up  rig  in  Cook  Inlet,  but  the                                                                    
department anticipated that there would soon be one.                                                                            
Representative Gara  referred to  prior discussion  that the                                                                    
credits were  too liberal  and concerns  that the  state was                                                                    
giving  away  so many  credits  that  companies were  "gold-                                                                    
plating." Some  had talked about limiting  credits to things                                                                    
like exploration wells and development  wells. He pointed to                                                                    
the 20  and 40  percent credits  listed for  exploration (20                                                                    
percent inside  a field  and 30 and  40 percent  for further                                                                    
away). He  asked whether the  credits covered every  sort of                                                                    
tangible   capital  expenditure   besides  development   and                                                                    
exploration  wells.  He  wondered whether  there  were  some                                                                    
Mr.  Dees  responded  that   exploration  credits  under  AS                                                                    
43.55.023(a)(2) and  under AS 43.55.025  had a  very limited                                                                    
scope as  to the  activity that  would qualify.  The credits                                                                    
could  only  be  used  for activities  associated  with  the                                                                    
drilling  of   an  exploration  well  or   a  geological  or                                                                    
geophysical  (G&G) activity  such  as a  seismic shoot.  The                                                                    
scope was  very limited and  the purchase of  vehicles would                                                                    
not be allowed.  The credit that would  include all tangible                                                                    
purchases (like  the truck) would be  the AS 43.55.023(a)(1)                                                                    
credit,  the  qualified   capital  expenditure  credit;  the                                                                    
expenditures  that qualified  for that  credit were  a broad                                                                    
definition of what a capital  expenditure was under Internal                                                                    
Revenue  Code  26  U.S.C.  The credit  would  apply  to  the                                                                    
purchase  of equipment,  vehicles,  and  the improvement  of                                                                    
buildings,  in addition  to the  drilling of  wells and  the                                                                    
construction of facilities.                                                                                                     
8:20:52 AM                                                                                                                    
Representative  Gara  referred  to  the  20  to  40  percent                                                                    
capital  exploration credit  (limited  to more  exploration-                                                                    
related activities).  He thought there was  also the broader                                                                    
AS 43.55.023(a) credit. He asked  why the 20 percent capital                                                                    
exploration credit  was needed if  a broad array  of credits                                                                    
was available under the first one.                                                                                              
Mr. Dees answered that the  capital exploration credit under                                                                    
AS  43.55.023(a)(2)  was   typically  for  those  particular                                                                    
exploration well  or G&G activities  that occurred  within a                                                                    
unit, so they would not qualify  for the 30 to 40 percent AS                                                                    
43.55.025 credit  for outside the  unit; it would  be within                                                                    
the  20-mile limit  or within  the 3-mile  distance from  an                                                                    
existing well. The purpose was  to allow for those companies                                                                    
currently  producing and  conducting exploration  activities                                                                    
in the vicinity of their  unit. He noted that another reason                                                                    
for the separation was that  there was a requirement for the                                                                    
company to  submit information to the  Department of Natural                                                                    
Resources (DNR) for  the types of activities  related to the                                                                    
credits, in addition to the exploration wells.                                                                                  
Representative  Doogan requested  that the  common names  of                                                                    
the tax  credits be used  in the discussion rather  than the                                                                    
numerical   statute   designations   in  order   to   better                                                                    
understand the references.                                                                                                      
8:23:18 AM                                                                                                                    
Vice-chair Fairclough  queried the reporting  mechanisms for                                                                    
credits  in  totality.  She  referred   to  grids  that  the                                                                    
committee had  seen, with companies  that were  drilling and                                                                    
permitting in  various years (provided  by Roger Marks  in a                                                                    
prior presentation).  She asked whether there  was a summary                                                                    
of  what credits  were being  accessed, the  amounts of  the                                                                    
credits, and the companies using the credits.                                                                                   
Mr.  Dees  answered that  the  reporting  mechanism for  the                                                                    
companies taking the credits off  the top of tax liabilities                                                                    
was  the annual  true-up based  on the  projected forecasted                                                                    
capital  expenditures. He  noted that  throughout the  year,                                                                    
the  companies  made  installment   payments  based  on  the                                                                    
projected  forecasts  and  took credits  against  their  tax                                                                    
liability based on  the projections. At the end  of the year                                                                    
when  the companies  did  the true-up  (on  March 31),  they                                                                    
submitted information to DOR  about the capital expenditures                                                                    
amounts  that  led  to  the   credits  taken  against  their                                                                    
liability. At  that point,  the department  did not  get the                                                                    
detail; the invoice-level details  on the expenditures would                                                                    
not be  acquired until  the audit.  The companies  that were                                                                    
not  producers and  did not  have a  tax liability  and were                                                                    
simply coming  to the department to  apply for transferrable                                                                    
tax  credit  certificates  had to  submit  (along  with  the                                                                    
application)  sufficient detail  to  support  the amount  of                                                                    
expenditures for  the credits claimed. For  the AS 43.55.023                                                                    
QCE credits and for the  annual loss credits, the department                                                                    
did  a due-diligence  review of  the detail.  He noted  that                                                                    
there had been occasions  when claims were disallowed. After                                                                    
issuing  the certificate,  the  department maintained  audit                                                                    
rights to  go back later  and do  a more thorough  review of                                                                    
the   expenditures.   When   companies   applied   for   the                                                                    
exploration credits under  Section AS 43.55.025 (alternative                                                                    
credit  for oil  and gas  exploration), they  had to  submit                                                                    
sufficient detail,  and DOR  conducted a  full audit  of the                                                                    
claims prior to issuance of a certificate.                                                                                      
8:26:52 AM                                                                                                                    
Mr.  Dees continued  that for  the  transferable tax  credit                                                                    
certificates, DOR would  have either done a full  audit or a                                                                    
review of  the information,  so there  would be  more detail                                                                    
about what types  of expenditures there were  and where they                                                                    
were incurred. He  added that the credits  taken against the                                                                    
tax liabilities  would follow when the  company's tax return                                                                    
was audited.                                                                                                                    
Vice-chair Fairclough  agreed that the  procedures described                                                                    
met  government and  general accounting  standards. For  the                                                                    
credits just listed, she wanted  a break-out per year of how                                                                    
much money had been given away  or invested in Alaska by the                                                                    
entity asking  for the credit.  She wanted the  committee to                                                                    
be  able  to  see   whether  the  recommendations  from  the                                                                    
administration matched  with what the legislature  wanted to                                                                    
accomplish.  She  wanted  to   know  who  had  accessed  the                                                                    
credits.  She  understood  there  was  a  six-year  auditing                                                                    
backlog. She  wanted to  know who  the "winners  and losers"                                                                    
were in order to understand who the state was backing.                                                                          
Commissioner Butcher  responded that  DOR would be  happy to                                                                    
put the  information together for  the committee.  He warned                                                                    
that there  were confidentiality  issues related to  the tax                                                                    
returns of individual companies;  the department was limited                                                                    
regarding a breakdown by company.                                                                                               
Vice-chair Fairclough stated that she  did not want to break                                                                    
confidentiality. She  felt the  legislature should  still be                                                                    
able to  see how many  dollars were applied per  category in                                                                    
order to  analyze which credits were  working. She commented                                                                    
that  the  information  should   be  available  to  the  tax                                                                    
division through  an accounting system query.  She asked how                                                                    
the department would access the information requested.                                                                          
8:30:34 AM                                                                                                                    
Commissioner Butcher replied that  DOR would provide as much                                                                    
detail  as  possible.  He  noted  that  the  department  was                                                                    
somewhat hampered  by its current  accounting system;  a new                                                                    
data-base  would be  able to  produce  the information  more                                                                    
quickly. He pointed out that  DOR was currently working with                                                                    
the   Department  of   Administration   (DOA)   on  a   more                                                                    
comprehensive  review   of  what   was  needed   related  to                                                                    
Vice-chair Fairclough clarified that  to get the information                                                                    
the  department  had  to   look  through  actual  paperwork.                                                                    
Commissioner Butcher answered "pretty much yes."                                                                                
Co-Chair Stoltze  asked that the  report of  the information                                                                    
requested use the common names of the tax credits.                                                                              
Representative  Hawker   addressed  a  "mischaracterization"                                                                    
made  of Mr.  Marks's presentation  about credits  and gold-                                                                    
plating. He stated that gold-plating  was the result of high                                                                    
tax rates and not of the existence of credits.                                                                                  
Co-Chair Stoltze  noted that there  would be  a presentation                                                                    
by Mr. Marks.                                                                                                                   
Representative  Wilson  understood  that  credits  could  be                                                                    
detailed until  full audits  had been  done. She  asked what                                                                    
was happening  to credits if  full audits had not  been done                                                                    
since 2006.                                                                                                                     
Mr. Dees  answered that the  credits had been taken  off the                                                                    
top  of the  tax liabilities.  As  long as  the audits  were                                                                    
completed  within the  assessment periods,  adjustments made                                                                    
through the  audits would be  assessed to the  taxpayer with                                                                    
interest.  The credits  would not  be in  a holding  pattern                                                                    
because the statute allowed the  taxpayer to take the credit                                                                    
off the top of the liability.                                                                                                   
Representative Wilson referred  to the information requested                                                                    
by Vice-chair Fairclough. She asked  how the committee could                                                                    
know  which one  of the  companies could  come back  and say                                                                    
which credit was not allowed without the information.                                                                           
Mr. Dees agreed.                                                                                                                
Representative  Wilson  asked  whether   a  model  could  be                                                                    
produced that would  show what most companies  would do (tax                                                                    
liability  and types  of  credits normally  used  for a  new                                                                    
operation)  to  compare the  numbers  of  new producers  and                                                                    
longer-term ones.                                                                                                               
Mr. Dees thought the model could be done.                                                                                       
8:34:26 AM                                                                                                                    
Commissioner  Butcher offered  to work  with DNR  to provide                                                                    
the information for the committee.                                                                                              
Representative Wilson wanted to know the bottom line.                                                                           
Co-Chair Stoltze  referred to  a Seinfeld  episode reference                                                                    
to "write-offs."                                                                                                                
Co-Chair   Thomas  asked   whether   work-over  wells   were                                                                    
available for credits.                                                                                                          
Mr. Dees  replied that it  depended; not all  workovers were                                                                    
"capital"  in nature.  He did  know  that a  portion of  the                                                                    
allowable   credit   under   the   40   percent   well-lease                                                                    
expenditure credit  referred to work-overs as  being part of                                                                    
the  activity  allowable.  However,  the  costs  had  to  be                                                                    
intangible drilling  and development  costs. A  work-over to                                                                    
increase the efficiency or through-put  of a well could be a                                                                    
capital activity;  a repair job  to get  a well back  to its                                                                    
normal production would  not apply. He noted  that the issue                                                                    
would be a challenge for auditors.                                                                                              
Co-Chair Thomas  pointed out  that there  had been  over 500                                                                    
work-over  wells the  previous year  alone. He  thought that                                                                    
giving tax  credits where they  were not due  without audits                                                                    
would mean  the state  was operating "blind."  He questioned                                                                    
whether  tax  credits  would   be  allowed  for  exploratory                                                                    
drilling and development of oil  too far from infrastructure                                                                    
to deliver the oil.                                                                                                             
Mr. Dees  replied that  activity on  state land  meeting the                                                                    
distance  requirements   from  units  and  wells   would  be                                                                    
Co-Chair Thomas  thought the activity would  only be allowed                                                                    
if the oil was put into the pipe.                                                                                               
8:37:56 AM                                                                                                                    
Commissioner  Butcher believed  the  incentive of  including                                                                    
all  possibilities  was  meant  to  encourage  companies  to                                                                    
explore in new  areas and not be penalized  twice if nothing                                                                    
was found (no oil and no credits).                                                                                              
Vice-chair Fairclough  asked whether  taxpayers historically                                                                    
tended to over- or under-report  credits if the result meant                                                                    
there would be penalties.                                                                                                       
Mr.  Dees opined  that  taxpayers did  not  over- or  under-                                                                    
report   intentionally;  he   believed  companies   reported                                                                    
expenditures  they  believed  they  were  eligible  for.  He                                                                    
stated that  he had not come  across a situation in  which a                                                                    
company  had  intentionally  over-  or  under-reported.  The                                                                    
department  had had  disagreements  with interpretations  of                                                                    
how types  of expenditures fit  a particular credit,  but he                                                                    
did not think the claims were deliberate.                                                                                       
Vice-chair  Fairclough  asked  whether  audits  historically                                                                    
resulted in  more taxpayers receiving additional  credits or                                                                    
Mr. Dees replied that typically,  audits had resulted in the                                                                    
state trying to get money back from taxpayers.                                                                                  
Vice-chair Fairclough  asked whether the  taxpayers received                                                                    
a penalty and were charged interest.                                                                                            
Mr. Dees  replied that as  long as the filings  were timely,                                                                    
the taxpayer did not get a  penalty. He added that there was                                                                    
interest attached to an assessment.                                                                                             
Representative Doogan  queried the  status of  the completed                                                                    
Mr.   Dees   answered  that   the   2006   PPT  audits   had                                                                    
substantially  been  completed  and  the work  on  the  2007                                                                    
audits had been started. He  added that the 2006 audits were                                                                    
still under  the three-year  statute; the  assessment period                                                                    
for those audits expired March 31, 2010.                                                                                        
8:41:35 AM                                                                                                                    
Mr. Dees continued  that the assessment period  for the 2007                                                                    
audits would expire March 31, 2014.                                                                                             
Representative Doogan  asked whether  the audits  were under                                                                    
the  current  tax  system  and  not  the  proposed  one.  He                                                                    
wondered what would happen if the system were "backed up."                                                                      
Mr.  Dees  replied that  the  timeline  would be  two  years                                                                    
sooner.  He  believed  the  department   would  be  able  to                                                                    
accomplish  the task.  The 2007  audits  would be  completed                                                                    
sometime in the current calendar year.                                                                                          
Representative Doogan  asked how  the proposed  new deadline                                                                    
would affect the situation.                                                                                                     
Mr.  Dees  replied  that  under  the  four-year  statute  of                                                                    
limitation, the 2007 tax filings  were filed March 31, 2008;                                                                    
the  statute of  limitation  would be  March  31, 2012.  The                                                                    
particular section  of the  bill was  scheduled to  start in                                                                    
2014, which he thought would  provide the opportunity to get                                                                    
more current on the audits.                                                                                                     
Commissioner   Butcher  added   that   the  most   difficult                                                                    
transition  for the  auditors was  from the  net tax  to the                                                                    
gross tax,  which took place  in the 2006 audits  just done;                                                                    
until then,  DOR was working  off the gross and  not looking                                                                    
at everything that  could be taken off  what was potentially                                                                    
paid in taxes. He pointed  out that the particular provision                                                                    
was taken out in the  House Resources Committee; the current                                                                    
version of the bill was back to the six years.                                                                                  
Representative  Doogan  questioned  forwarding a  bill  that                                                                    
would cause a lot more  paperwork just because it would mean                                                                    
a lot more money for the industry.                                                                                              
8:45:01 AM                                                                                                                    
Mr. Dees  spoke to  the ways credits  could be  redeemed. He                                                                    
directed  attention to  Slide  6,  "Credits Applied  Against                                                                    
Production Tax Liability":                                                                                                      
     Credits may be redeemed in two ways:                                                                                       
     (1) All Credits may be applied against production tax                                                                      
        · Capital Expenditure and Capital Exploration                                                                           
          Credits split  over two years (except  south of 68                                                                    
          degree North latitude - eff. July 1, 2010)                                                                            
        · NOL, TIE, Small Producer and Alternative Tax                                                                          
          Credits  for Oil  and Gas  Exploration may  all be                                                                    
          applied  against  tax  liability  in  total  in  a                                                                    
          single year                                                                                                           
     (2) Some Credits may be converted into a transferable                                                                      
     Tax Credit Certificate                                                                                                     
        · Capital Expenditure, Capital Exploration, NOL,                                                                        
          and  Alternative  Tax  Credits  for  Oil  and  Gas                                                                    
          Exploration are convertible to tax certificates                                                                       
        · Capital Expenditure, Capital Exploration and NOL                                                                      
          Tax Credit  Certificates must be applied  over two                                                                    
          years (except  south of 68 degrees  North latitude                                                                    
          - passed 2010)                                                                                                        
        · Alternative Tax Credits for Oil and Gas                                                                               
          Exploration  Certificates can  be  used in  single                                                                    
Mr.  Dees   detailed  that  the   credits  converted   to  a                                                                    
transferable tax credit certificate  could be either sold to                                                                    
another taxpayer or sold back to the state for cash.                                                                            
Mr.  Dees turned  to a  chart  on Slide  7, "Production  Tax                                                                    
Credits Applied  Against Tax  Liability (Fiscal  Year)" with                                                                    
historical and projected information  related to tax credits                                                                    
applied against  tax liabilities  since 2006. He  noted that                                                                    
the  credit   most  used  by   taxpayers  was   the  capital                                                                    
expenditure  credit. He  pointed  to the  TIE credit,  which                                                                    
went away for  most taxpayers effective at the  end of 2007;                                                                    
the 2008 number represented data  for the last six months of                                                                    
2007 (part of  fiscal year 2008). There had been  use of the                                                                    
small producer credits; there  were some taxpayers producing                                                                    
less than the  100,000 barrels per day required  for the use                                                                    
of  the  credit.  The exploration  credits  have  also  been                                                                    
applied in some situations.                                                                                                     
Representative  Doogan thought  the  current law  stipulated                                                                    
that  some of  the credits  had  to be  applied in  two-year                                                                    
segments.  He wondered  how  a person  could  tell when  the                                                                    
credits were applied as opposed to when they were earned.                                                                       
Mr. Dees responded  that the information would  be mostly on                                                                    
the  capital credit  expenditure line;  the major  producers                                                                    
use  the credit  the  most  and it  was  limited  to the  50                                                                    
percent split.  Under PPT, 100  percent of the  credits were                                                                    
used in the year they were  earned, but beginning in 2008 to                                                                    
2010, there was  a lag; 50 percent of one  year's credit and                                                                    
50 percent of  the previous year's credit were  used. He did                                                                    
not  think the  numbers  would provide  the answer,  because                                                                    
there were variant levels of  capital expenditure. He stated                                                                    
that  the numbers  on the  chart would  suggest that  as the                                                                    
amount  of  the  credits  went up,  the  underlying  capital                                                                    
expenditures giving rise to the  credits increased for those                                                                    
Representative   Doogan   thought   that  the   number   was                                                                    
increasing because of the popularity  of the credits; on the                                                                    
other side,  the state's liability  was increasing  in terms                                                                    
of having to pay the credits.                                                                                                   
8:49:40 AM                                                                                                                    
Mr. Dees clarified that the  question related to the state's                                                                    
liability  referred  to the  actual  credits  the state  was                                                                    
paying  out in  cash.  He  stated that  the  two  had to  be                                                                    
separated.  The credits  were  not the  ones  the state  was                                                                    
paying out  in cash, but  were the credits resulting  from a                                                                    
company  spending an  amount in  capital  expenditures in  a                                                                    
given year and taking 20  percent against the liability; the                                                                    
amount would never come to  the state treasury. For example,                                                                    
there would  be a check for  $280 million to the  state on a                                                                    
tax liability of $300 million.  He was trying to account for                                                                    
the  fact that  although the  amounts  did not  come to  the                                                                    
state's  treasury, the  amounts represented  the benefit  to                                                                    
the  companies  from  making the  capital  expenditures.  He                                                                    
added that an upcoming slide  would show the state's payout,                                                                    
which was related to a different group of taxpayers.                                                                            
Representative   Doogan  apologized   for  using   the  word                                                                    
"liability" with  an accountant.  He surmised  that overall,                                                                    
the  credits seemed  to be  costing  the state  increasingly                                                                    
more  each  year.  He  asked   whether  the  increase  would                                                                    
Mr. Dees  replied that  the ascending  curve on  the credits                                                                    
(especially the  capital expenditure credit line)  had to be                                                                    
directly tied to the amount  of capital expenditures made by                                                                    
companies. He said the  numbers would increase corresponding                                                                    
to the  increase of capital  expenditures by  the companies.                                                                    
He  noted  that  a  later  slide  would  show  what  capital                                                                    
expenditures had  done over  the last  few years.  He stated                                                                    
that  there   was  a  direct  correlation   to  the  capital                                                                    
expenditures made  by a company. The  numbers would continue                                                                    
to  rise  if  the  capital expenditures  continued  to  rise                                                                    
because the numbers  would be 20 percent of  a higher number                                                                    
(unless the credit laws changed).                                                                                               
8:53:09 AM                                                                                                                    
Co-Chair Thomas asked whether there  had been an increase in                                                                    
oil  production  with  the tax  credits.  He  suggested  the                                                                    
credits  should  be  abolished  if there  had  not  been  an                                                                    
Representative  Edgmon  referred  to  a slide  from  a  past                                                                    
presentation  by   Mr.  Seamount   that  had   depicted  the                                                                    
precipitous  drop in  exploration activity  in 2010  and the                                                                    
years  before that.  He asked  why  the capital  expenditure                                                                    
credit number seemed to be going  up and how that related to                                                                    
the information from the previous presentation.                                                                                 
Mr.  Dees answered  that exploration  activity would  not be                                                                    
reflected in  the numbers  listed in  the credits.  He noted                                                                    
that there would  be a slide further on  in the presentation                                                                    
that was  more in line  with Mr. Seamount's numbers  and the                                                                    
drop.  He  stressed that  there  was  always a  lag  between                                                                    
activities that were occurring and  the request for credits;                                                                    
the two did not necessarily happen in the same year.                                                                            
Representative  Edgmon  recalled  earlier  information  that                                                                    
there  were basically  three  types  of wells:  exploration,                                                                    
development,  and service  wells. He  was having  difficulty                                                                    
making a  connection between  earlier presentations  and the                                                                    
numbers Mr.  Dees was  presenting, particularly  the numbers                                                                    
under capital expenditure credits. He  had read in the press                                                                    
that the state  had issued $3 billion worth  of credits over                                                                    
the past few years.                                                                                                             
Mr. Dees  pointed out  that the $3  billion referred  to was                                                                    
inclusive  of  the  numbers  on Slide  7,  plus  numbers  on                                                                    
another  slide.  He  added  that  most  of  the  exploration                                                                    
activity was being conducted by  companies that did not have                                                                    
a production  tax liability. The  numbers on the  slide were                                                                    
from companies that were paying  a production tax liability.                                                                    
The credits  that had been  claimed against  the liabilities                                                                    
were  depicted. He  explained there  would be  another slide                                                                    
showing  information  from companies  that  did  not have  a                                                                    
production tax liability.                                                                                                       
Representative  Edgmon   asked  whether  the   credits  were                                                                    
working  for smaller  companies and  not working  for larger                                                                    
Mr.  Dees  responded  that  he   could  not  say  that;  all                                                                    
companies were taking advantage  of the credits available to                                                                    
them. Companies  were incurring  expenditures and  doing the                                                                    
activities that  generated the credits.  He did not  know if                                                                    
the  companies would  be doing  the  work if  they were  not                                                                    
getting some benefit.                                                                                                           
8:58:29 AM                                                                                                                    
Representative    Gara    apologized    for    an    earlier                                                                    
misunderstanding  about Mr.  Marks's statements  about gold-                                                                    
plating. He  explained that  he had  not intended  to change                                                                    
anything said  before. He stated  that "your words  on gold-                                                                    
plating would be your words  on gold-plating." He thought if                                                                    
the  gold-plating  argument  was  that  the  combination  of                                                                    
deductions and credits put together  were lucrative, then it                                                                    
sounded more like what it was than what he had said.                                                                            
Representative  Gara recalled  previous  discussion about  a                                                                    
four-year statute of limitations.  He thought the PPT audits                                                                    
from 2006  were done  "just in  the nick  of time"  if there                                                                    
were a  four-year statute of  limitations. He  thought there                                                                    
were currently a lot more  taxpayers and people claiming tax                                                                    
credits, and a  greater need for audits.  The department had                                                                    
gone from a time when it  could barely do the audits in four                                                                    
years (with  fewer companies)  to a proposal  to do  them in                                                                    
four years for more companies.  He asked how many additional                                                                    
companies were filing credit and tax returns.                                                                                   
Mr. Dees responded  that the 2006 audits  had been completed                                                                    
in 2010, one year before the  four years would have been up;                                                                    
the 2006  audits would have been  due in 2011 had  they been                                                                    
on  the four-year  statute of  limitations. The  audits were                                                                    
completed  a year  earlier than  the statute  stipulated. As                                                                    
far as the  credits were concerned, the  credits applied for                                                                    
with the department received a  due-diligence review (like a                                                                    
"light  audit") prior  to issuance  of the  credits. A  full                                                                    
audit  was done  for  the exploration  credits up-front,  so                                                                    
there  was  no danger  of  running  out  of the  statute  of                                                                    
limitations  for the  exploration credits.  For most  of the                                                                    
companies  for which  the department  did the  due-diligence                                                                    
review, there would be a  determination about the need for a                                                                    
full audit;  there had  not been a  need to-date.  He stated                                                                    
that  the  department  was  current with  most  of  the  tax                                                                    
credits,  except  for  the  ones  that  were  taken  on  tax                                                                    
liabilities. He stated that the  number of taxpayers had not                                                                    
substantially increased.                                                                                                        
Representative Gara  asked for the number  of taxpayers that                                                                    
would  have  to  be  audited, compared  to  2006.  Mr.  Dees                                                                    
offered to get the information to him at a later time.                                                                          
Representative  Gara asked  whether  the presentation  would                                                                    
cover operation expenses.                                                                                                       
9:02:12 AM                                                                                                                    
Mr. Dees replied  that most of the credits were  issued as a                                                                    
result of capital expenditures. He  noted that the only time                                                                    
operation  expenditures came  into  the  credit picture  was                                                                    
when they  were part of the  expenditures that led to  a net                                                                    
operating loss credit.  He added that he did not  plan to go                                                                    
into operating expenditures.                                                                                                    
Representative Gara  referred to a November  30, 2010 Juneau                                                                    
Empire  article  in  which  the   commissioner  of  DOR  had                                                                    
estimated that operation-only  capital expenditures had been                                                                    
$4.7 billion  the prior  year. The  numbers for  the current                                                                    
year were  expected to be  $5.1 billion, and  the projection                                                                    
for the  following year was  $5.5 billion. He  estimated the                                                                    
number represented an increase of  about 8 percent per year.                                                                    
He asked whether the numbers cited were correct.                                                                                
Commissioner  Butcher responded  that  he did  not have  the                                                                    
information referred  to but acknowledged  there had  been a                                                                    
slow  increase   in  spending   in  operating   and  capital                                                                    
expenditures,  which was  one of  the issues  DOR had  begun                                                                    
researching.   The  industry   had  communicated   that  the                                                                    
expenses  replaced things  in a  mature field  and were  not                                                                    
exploration related.  He stated that  DOR did not  have that                                                                    
kind  of information,  although  it had  since learned  that                                                                    
asking for more  detail was allowed in  the statutes through                                                                    
regulations. He noted that the  department had not requested                                                                    
the information  previously but it  intended to  include the                                                                    
legislature as the information was  developed. He offered to                                                                    
get information about the capital  and operating expenses by                                                                    
Representative  Guttenberg referred  to  testimony that  the                                                                    
taxpayers  were  taking advantage  of  all  the tax  credits                                                                    
available to them.  He asked whether any of  the tax credits                                                                    
qualified   as  gold-plating.   He   wondered  whether   the                                                                    
companies  were spending  additional  money  because it  was                                                                    
available to them.                                                                                                              
Mr.  Dees replied  that he  did not  know whether  companies                                                                    
were gold-plating.                                                                                                              
Representative  Guttenberg  pointed  to the  top  line  (for                                                                    
capital  expenditure credits)  on Slide  7 ("Production  Tax                                                                    
Credits Applied  Against Tax Liability"), and  asked how the                                                                    
increase from  2006 to  2011 related  to oil  production. He                                                                    
wondered whether there was a correlation.                                                                                       
Mr. Dees  responded that  at the present  time, DOR  did not                                                                    
have  information to  correlate the  two, as  the department                                                                    
did not  get information  about how companies  were spending                                                                    
the  money.  He  noted  that the  department  was  going  to                                                                    
request the categories of expenditures.                                                                                         
9:06:15 AM                                                                                                                    
Mr.  Dees directed  attention  to  "Transferable Tax  Credit                                                                    
Certificates" (Slide 9):                                                                                                        
     Companies may also claim tax credits by applying for a                                                                     
     Transferable Tax Credit Certificate (TTCC)                                                                                 
        · Available to companies (explorers) with no tax                                                                        
         liability to which credits can be applied                                                                              
        · Tax Credit Certificates under 43.55.023(a) and                                                                        
          (b)  must  be  split  or applied  over  two  years                                                                    
          (except credits  issued for  expenditures incurred                                                                    
          south of 68 degrees  North latitude effective July                                                                    
          1, 2010)                                                                                                              
        · May be transferred to another taxpayer or cashed                                                                      
          with the state                                                                                                        
Mr. Dees  detailed that the  certificates were  available to                                                                    
all  companies, even  those with  production tax  liability.                                                                    
However,  most companies  preferred to  take the  credit off                                                                    
the top of  their tax bill. He  emphasized that transferable                                                                    
tax credit  certificates were especially important  to those                                                                    
companies or  explorers with no  tax liability to  which the                                                                    
credit  could  be  applied (for  various  reasons),  as  the                                                                    
certificates could  be sold to  other companies or  could be                                                                    
sold back to the state.                                                                                                         
Mr. Dees  continued that tax credit  certificates were split                                                                    
in two when issued, because they  had to be applied or split                                                                    
over two years.  He added that the  prior year's legislation                                                                    
made  it so  that  effective July  1, expenditures  incurred                                                                    
south of  68 degrees north  latitude could be issued  in one                                                                    
Mr.  Dees next  discussed "Production  Tax Credits  Under AS                                                                    
43.55  Claimed by  FY ($M)"  (Slide 10).  He noted  that the                                                                    
previous slide had shown the  tax credits that were directly                                                                    
applied against  tax liabilities;  Slide 10  represented all                                                                    
the requests  for tax credit certificates  received over the                                                                    
years  by DOR  from various  explorers or  companies without                                                                    
tax  credit certificates.  He pointed  out  that an  earlier                                                                    
version  of the  slide had  a different  amount in  2008 for                                                                    
exploration  AS 43.55.025  credits,  but the  net amount  of                                                                    
credits issued would not be changed.                                                                                            
Mr. Dees continued  that Slide 10 represented  what had been                                                                    
requested by  tax payers  or explorers.  He noted  there had                                                                    
been  a  trend  related  to  exploration  activity;  the  AS                                                                    
43.55.025 numbers increased  in FY 2008, came  down a little                                                                    
in  FY 2009,  and then  had a  big increase  in FY  2010. He                                                                    
emphasized  that fiscal  years  were  depicted; he  stressed                                                                    
that the  period for drilling  a well (the  drilling season)                                                                    
on  the North  Slope was  typically between  October of  one                                                                    
year through March of the  next year. Accordingly, the $99.5                                                                    
(million) number  in 2010 did  not mean that there  was that                                                                    
much  activity in  the  state; it  just  reflected when  the                                                                    
particular applications  were submitted  to DOR  for credit.                                                                    
Most of the  activity that was related to  the $99.9 million                                                                    
occurred during the exploration  season from October of 2008                                                                    
through  March of  2009; in  the fall  of 2008,  exploration                                                                    
activity was  high and  there had been  a large  increase in                                                                    
oil prices.  Six months after  the exploration  activity was                                                                    
over,   the  companies   were  required   to  submit   their                                                                    
applications for the AS 43.55.025  claims. The $99.5 million                                                                    
figure represented  claims that were submitted  in September                                                                    
of 2009 (which was part of FY 2010).                                                                                            
9:11:02 AM                                                                                                                    
Representative  Guttenberg surmised  that  the AS  43.55.025                                                                    
credits in  2010 reflected expenditures  that had  been made                                                                    
because of the increased price of oil.                                                                                          
Mr.  Dees responded  that  the  number reflected  activities                                                                    
that had  occurred during the  drilling season  beginning in                                                                    
October  2008  and  completed  in   March  2009;  after  the                                                                    
drilling season  was over,  the companies  had to  apply for                                                                    
the AS 43.55.025 credit within  six months for the completed                                                                    
exploration  activities. Generally,  around September  every                                                                    
year  (when there  was a  lot  of activity),  DOR would  get                                                                    
inundated with  a lot  of applications  for wells  that were                                                                    
drilled  the previous  season. He  had  hoped to  illustrate                                                                    
that even though  the chart indicated the year  2010, it did                                                                    
not mean that  the activity had occurred in  2010. The chart                                                                    
showed  when the  applications  were  received for  activity                                                                    
that occurred in a previous drilling season.                                                                                    
Representative  Guttenberg asked  whether  DOR was  finished                                                                    
processing companies that had applied for credits in 2011.                                                                      
Mr.  Dees  replied  that the  department  had  not  finished                                                                    
processing the  applications, as  FY 2011 went  through June                                                                    
30 of 2011. He provided  an example related to dates between                                                                    
October 2010 and March 2011;  there was only one application                                                                    
for $2.4  million, which indicated  that there had  not been                                                                    
much exploration  activity at the  end of 2009.  He believed                                                                    
the  numbers  would correspond  to  a  chart that  had  been                                                                    
presented by  Mr. Seamount. He  underlined that there  was a                                                                    
lag  between the  exploration activity  and the  application                                                                    
for the credit.                                                                                                                 
Representative Doogan  opined that the chart  was confusing.                                                                    
He thought the  chart seemed to say that up  until 2011 (for                                                                    
which  there were  no  numbers) things  were  going well  in                                                                    
terms of  exploration, and that  it would not be  known what                                                                    
would happen in  FY 2011 until the process  was complete. He                                                                    
thought  the  explanation of  the  chart  just provided  had                                                                    
communicated something very different.  He asked Mr. Dees to                                                                    
rework Slide  10, because  it did not  match what  was being                                                                    
reported by the testifier.                                                                                                      
Mr. Dees  clarified that  there was a  lag between  when the                                                                    
activities  occurred and  when DOR  got the  application for                                                                    
the credit.  For example, for  a drilling season  that began                                                                    
at the  end of  2009 and  went through  the spring  of 2010,                                                                    
under  the statute,  the company  had six  months after  the                                                                    
exploration activity was completed to  file for a tax credit                                                                    
certificate.  In September  of 2009,  DOR had  only received                                                                    
one  application  for  exploration  activity  totaling  $2.4                                                                    
million; his interpretation of that  was that there had been                                                                    
very little  exploration activity  going on in  the drilling                                                                    
season that preceded the application.                                                                                           
Representative  Doogan asked  when Mr.  Dees would  know how                                                                    
accurate the $2.4 million number was.                                                                                           
9:16:47 AM                                                                                                                    
Mr. Dees replied that the  numbers (on Slide 10) represented                                                                    
applications received  through January  4, 2011;  the number                                                                    
was accurate  through the listed  date only.  The department                                                                    
had not received additional AS 43.55.025 applications.                                                                          
Representative  Doogan  wondered  when DOR  would  have  the                                                                    
final number.  Mr. Dees replied that  at the end of  FY 2011                                                                    
(June 30,  2011), he would  update the chart to  include all                                                                    
the applications received through that date.                                                                                    
Representative  Wilson  wondered   whether  there  had  been                                                                    
applications  received between  January  4  and the  current                                                                    
date (March 17).                                                                                                                
Mr.  Dees  responded  that   typically  the  department  was                                                                    
inundated with year-end applications  during the period that                                                                    
it received  the annual true-up.  He noted that there  was a                                                                    
statutory requirement  that everyone  doing business  in the                                                                    
state that was incurring  lease expenditures or expenditures                                                                    
for  which they  would apply  for credit  had to  submit the                                                                    
information   to  DOR   by  March   31.  He   expected  that                                                                    
applications would  be coming in;  he thought most  would be                                                                    
received by March 31.                                                                                                           
Representative Wilson suggested using  the same deadline for                                                                    
each  year to  be able  see  a comparable  true-up over  the                                                                    
years. She wondered whether the information was available.                                                                      
Commissioner Butcher replied  that DOR would try  to get the                                                                    
information   to   the   committee.  He   noted   that   the                                                                    
presentation showed all  tax credits that had come  in up to                                                                    
the date it was prepared.                                                                                                       
Representative Wilson did not  believe that the presentation                                                                    
reflected  the information  stated.  She wanted  to see  the                                                                    
numbers based on the same date every year.                                                                                      
9:20:25 AM                                                                                                                    
Mr. Dees  pointed out  that the slide  did reflect  the same                                                                    
date each year, June 30 of  each year. Since it was not June                                                                    
30 yet in the current year,  he had provided the fiscal year                                                                    
numbers to-date.                                                                                                                
Representative  Wilson wanted  the  numbers  to reflect  the                                                                    
calendar year, since  the decision would be  made before the                                                                    
end  of the  current  fiscal  year. She  wanted  to see  the                                                                    
numbers  yearly to  see whether  the  numbers had  decreased                                                                    
during the current year.                                                                                                        
Mr.  Dees   clarified  that   DOR  typically   received  the                                                                    
exploration  claims in  September, within  six months  after                                                                    
the  October  through March  drilling  season.  Most of  the                                                                    
$99.5 (million)  number reflected claims that  were received                                                                    
in September  of 2009 (for  FY 2010).  In FY 2011,  the $2.4                                                                    
(million) was  all that was  received in September  of 2010.                                                                    
The same  period was somewhat reflected.  He emphasized that                                                                    
the  numbers illustrated  that  there had  been  a lot  less                                                                    
exploration activity in the drilling period.                                                                                    
Representative Wilson asked what  DOR expected to receive by                                                                    
March 31. Mr.  Dees responded that he did not  expect to get                                                                    
many exploration claims, if any.                                                                                                
Vice-chair Fairclough  thought DOR  had given  the committee                                                                    
what  was   needed  from  an  accounting   perspective,  but                                                                    
observed that  the committee was  trying to get to  a policy                                                                    
9:24:00 AM                                                                                                                    
Co-Chair   Stoltze  believed   Commissioner  Butcher   would                                                                    
provide the policy perspective.                                                                                                 
Representative  Gara  hoped  to draw  conclusions  from  the                                                                    
numbers  on   Slide  10.  He   summarized  that   the  years                                                                    
represented were ACES years. In  2010, the state paid almost                                                                    
$100 million in exploration credits  and in 2011, the number                                                                    
was   significantly  smaller.   He   wondered  whether   the                                                                    
fluctuations  reflected  the  change   in  oil  prices.  For                                                                    
example,  in 2008,  the price  reached $140  per barrel  and                                                                    
then went down  to $30 per barrel in 2009.  He asked whether                                                                    
there  was  a  correlation   between  different  prices  and                                                                    
different results for the different years.                                                                                      
Mr. Dees  did not know  whether there was a  correlation. He                                                                    
suspected that  companies would tend to  explore more during                                                                    
the period of higher prices.                                                                                                    
Co-Chair Stoltze  asked whether the subject  of the question                                                                    
asked reflected Mr. Dees' area of expertise.                                                                                    
Mr. Dees replied that it did not.                                                                                               
Commissioner  Butcher  replied  that  the  answer  could  be                                                                    
obtained from  companies that made  the decisions.  He added                                                                    
that  he could  reply  to questions  about  price and  other                                                                    
issues,  but ultimately  the  companies  made the  decisions                                                                    
about whether or  not to explore and the  criteria they used                                                                    
when making the decisions.                                                                                                      
Representative Gara  pointed to the small  2011 number ($2.4                                                                    
million).  From  a policy  perspective,  he  wanted as  much                                                                    
input as possible from the  government proposing the oil tax                                                                    
and not from the companies that wanted the change.                                                                              
Co-Chair  Stoltze emphasized  that  there  was a  separation                                                                    
between the two, and that was the problem.                                                                                      
Representative Gara referred to  testimony that reflected an                                                                    
expectation of one  real exploration well in  2011. He noted                                                                    
that  the current  presentation  had  helped him  understand                                                                    
that there was  a lag between the numbers and  the years the                                                                    
exploration  wells  were done.  He  wanted  to know  whether                                                                    
there  was only  one well  for  2011 or  whether that  could                                                                    
change  between  the  current date  and  June.  He  wondered                                                                    
whether the $2.4 million figure was from 2010 and not 2011.                                                                     
Commissioner Butcher  replied that  DOR got  the information                                                                    
about the  one well in  2011 from DNR  and not DOR  data. He                                                                    
had asked DNR whether there  was an expectation of more than                                                                    
one well and DNR had replied no.                                                                                                
9:27:54 AM                                                                                                                    
Representative Neuman  referred to the statutes.  He queried                                                                    
how the  numbers for new  exploration should  be understood,                                                                    
related  to   AS  43.55.023(b)  providing   for  exploration                                                                    
credits for new well exploration.                                                                                               
Mr.  Dees   replied  that  AS   43.55.023(b)  was   not  for                                                                    
exploration  wells, but  was the  net operating  loss carry-                                                                    
Mr. Dees believed there was  confusion being expressed about                                                                    
dates.  He  stated that  the  year  2011  did not  mean  the                                                                    
calendar year  2011, but the  fiscal year beginning  on July                                                                    
1,  2010. In  each of  the years  discussed, the  dates were                                                                    
between July  1 of  one year  and June  30 of  the following                                                                    
year. He  was trying  to reflect what  had been  received by                                                                    
DOR in  terms of  claims for  incurred expenditures,  not in                                                                    
terms of credits that had actually been issued.                                                                                 
Mr. Dees turned to the  next chart, "Transferable Tax Credit                                                                    
Certificate  Activity by  Fiscal Year  ($M)" (Slide  11). He                                                                    
emphasized  that  the  chart  showed  the  transferable  tax                                                                    
credit certificates  that were issued each  fiscal year, how                                                                    
much the department had refunded  to the taxpayers, how much                                                                    
the  taxpayers  had either  transferred  or  applied to  tax                                                                    
liabilities, and the balance as of a given date.                                                                                
Mr.  Dees  directed  attention  to  "Cash  Refunds  History"                                                                    
(Slide 13):                                                                                                                     
     Cash Refunds Governed by AS 43.55.028:                                                                                     
        · To cash must be usable against tax liability                                                                          
        · Must show subsequent (24 months) QCEs or lease                                                                        
          bids equal to cash sought (repealed in 2010)                                                                          
        · Have a zero tax owed in current and past years                                                                        
        · Have no more than 50,000 BOE/d                                                                                        
Mr. Dees  reviewed the attributes  of cash refunds  in Slide                                                                    
13, "Cash Refunds History":                                                                                                     
     Cash Refunds Governed by AS 43.55.028:                                                                                     
        · To cash must be usable against tax liability                                                                          
        · Must show subsequent (24 months) QCEs or lease                                                                        
          bids equal to cash sought (repealed in 2010)                                                                          
        · Have a zero tax owed in current and past years                                                                        
        · Have no more than 50,000 BOE/d                                                                                        
Mr. Dees spoke to Slide 14  ("Oil and Gas Tax Credit Fund"),                                                                    
a history  of the fund  that had been appropriated  in order                                                                    
to pay the transferable tax credit certificates:                                                                                
     Oil & Gas Tax Credit Fund                                                                                                  
     Appropriations                     $ 904 M                                                                                 
     Tax Credit Purchases (TC Fund)     (772) M                                                                                 
     Tax Credit Purchases (GF)           (79) M                                                                                 
     Interest Earned                       22 M                                                                               
     Balance                            $  75 M                                                                                 
9:32:10 AM                                                                                                                    
Mr. Dees concluded with Slide  15 ("Impact of Production Tax                                                                    
Credits Total State Stimulus") with  a bar graph depicting a                                                                    
combination  of the  credits taken  against tax  liabilities                                                                    
and the actual  cash paid out by fiscal year.  He noted that                                                                    
2011 and 2012  were estimated numbers for  what was expected                                                                    
to occur by the end of the fiscal year.                                                                                         
Vice-chair Fairclough  acknowledged that  the administration                                                                    
was providing  data for  a body  that was  trying to  make a                                                                    
policy decision. She voiced concerns  about a statement made                                                                    
related to  legacy fields or  large producers  receiving tax                                                                    
credits. She  felt the committee  was being told  that there                                                                    
was  no different  benefit in  the tax-credit  structure for                                                                    
legacy fields  versus for the  explorers that the  state was                                                                    
trying to incentivize through ACES.                                                                                             
Mr. Dees  replied that  there was  no difference  other than                                                                    
the  40  percent   well-lease  expenditures  for  well-lease                                                                    
expenditures  north of  68 degrees  north  latitude and  the                                                                    
Cook Inlet Jack-up Rig Credit.  Otherwise, the same benefits                                                                    
would accrue  to the  legacy fields; they  would get  an oil                                                                    
credit if  they happened  to get  into a  net-operating loss                                                                    
situation.  They  would get  the  same  20 percent  capital-                                                                    
expenditure credit and the exploration  credits if they were                                                                    
doing the appropriate types of activities.                                                                                      
Vice-chair  Fairclough  thought  Mr. Dees  was  providing  a                                                                    
technical response;  from a  policy perspective,  she wanted                                                                    
to  differentiate   that  the  legislature  was   trying  to                                                                    
incentivize   smaller  exploration   and  smaller   drilling                                                                    
through  ACES. She  did not  think that  everyone had  equal                                                                    
access related to  tax credits. The slide made  it look like                                                                    
that was not happening.                                                                                                         
Vice-chair  Fairclough  spoke  to concerns  about  jobs  for                                                                    
Alaskans.  She  thought jobs  were  being  decreased on  the                                                                    
North  Slope,   specifically  in  the  legacy   fields.  She                                                                    
wondered  whether there  was additional  information related                                                                    
to tax credits that she had not yet heard.                                                                                      
9:36:37 AM                                                                                                                    
BRUCE TANGEMAN, DEPUTY  COMMISSIONER, DEPARTMENT OF REVENUE,                                                                    
explained  that Mr.  Dees was  describing the  technical way                                                                    
the tax credits were being  used. The credits were available                                                                    
and  in  statute, and  companies  were  taking advantage  of                                                                    
them.  He  pointed to  testimony  from  companies that  were                                                                    
enthusiastic about  the tax-credit system already  in place,                                                                    
like  Great   Bear  Petroleum.  He  emphasized   that  those                                                                    
companies were not  yet close to production.  The other side                                                                    
of the  equation was the  progressivity on the tax  when the                                                                    
companies started producing. He  noted previous testimony in                                                                    
the House  Resources Committee by  a company that  was close                                                                    
to  production;   up  until  that  point,   they  had  taken                                                                    
advantage  of  the  tax  system,  but  progressivity  was  a                                                                    
disincentive  once  they  were  looking  at  production.  He                                                                    
stated that  all of  the provisions in  ACES were  not being                                                                    
thrown  out, just  the  progressivity  component, which  the                                                                    
department  viewed as  a serious  problem on  the production                                                                    
side of the equation.                                                                                                           
Representative  Doogan  referred  to   Slide  15.  He  asked                                                                    
whether  the  graph  meant  to  communicate  that  in  2012,                                                                    
approximately half of the tax  credits were going to the big                                                                    
three  companies  and the  other  half  to the  smaller  oil                                                                    
Mr. Dees responded  that he was correct; a  little over half                                                                    
was projected as going to  companies applying tax credits to                                                                    
their  tax  liability.  He   clarified  that  the  companies                                                                    
represented were more than just the "big three."                                                                                
Representative  Doogan  asked  whether  the  representatives                                                                    
from DOR at the testifier's table had written the bill.                                                                         
Commissioner Butcher  responded "yes,  we did; the  three of                                                                    
us primarily, as  well as Joe Balash from  the Department of                                                                    
Natural    Resources."    [Commissioner   Butcher,    Deputy                                                                    
Commissioner Tangeman, and Mr.  Dees were at the testifier's                                                                    
Representative  Doogan asked  whether the  ideas behind  the                                                                    
bill and the approach to it were theirs.                                                                                        
Commissioner  Butcher answered  "yes." He  noted that  there                                                                    
had  been many  conversations with  the industry  discussing                                                                    
what  individual  companies  would  see  as  incentives  and                                                                    
"game-changers," as DOR did not  operate in a vacuum. He did                                                                    
not  think  there  would  be  a  point  to  coming  up  with                                                                    
legislation that would not work.  He acknowledged that there                                                                    
had  been  "a  lot  of conversations"  [with  industry]  but                                                                    
ultimately, when the bill came  out in January, they did not                                                                    
see it before anyone else.                                                                                                      
Representative  Doogan asked  whether "conversations"  meant                                                                    
Commissioner  Butcher  responded  that there  were  meetings                                                                    
with members of the industry.                                                                                                   
Representative Doogan asked whether  the meetings were about                                                                    
the bill.                                                                                                                       
Commissioner Butcher  replied that the meetings  were to get                                                                    
input from  the industry  on what industry  felt could  be a                                                                    
"game  changer." He  reported  that industry  was not  happy                                                                    
with all parts of the bill,  as had been heard in testimony;                                                                    
those were not things that had been discussed.                                                                                  
9:40:54 AM                                                                                                                    
Representative  Edgmon  referred  to the  subject  of  gold-                                                                    
plating  brought up  in the  detailed presentation  by Roger                                                                    
Marks,  who had  25 years  with  the department  as well  as                                                                    
extensive  experience  on the  subject.  He  stated that  he                                                                    
could not  tell from  comments by  the DOR  senior officials                                                                    
and   the  auditor   whether  there   was  gold-plating   by                                                                    
companies.  He was  troubled by  the discrepancy  and wanted                                                                    
assurance that someone  had a better idea of  what was going                                                                    
on with tax credits.                                                                                                            
Mr. Tangeman replied that the  department had stated that it                                                                    
had gone  from gross to  net just in  2006 and had  done the                                                                    
audit for 2006. He believed Mr.  Dees had stated that he had                                                                    
not seen  gold-plating taking  place in  the audit  that was                                                                    
substantially completed. He noted that  DOR was in the midst                                                                    
of auditing 2007  and that new information  going from gross                                                                    
to net would be available.                                                                                                      
Commissioner Butcher  pointed out that the  department would                                                                    
never  have the  staff  to address  the  kinds of  questions                                                                    
raised during  the presentation by  Mr. Marks  (related, for                                                                    
example, to the  decisions to buy different  kinds of trucks                                                                    
because  of   possible  incentives).   He  added   that  the                                                                    
department was looking for signs  of gold-plating insofar as                                                                    
the existing audit staff could.                                                                                                 
9:44:14 AM                                                                                                                    
Representative  Edgmon thought  there  was still  a big  gap                                                                    
between  what  the committee  was  being  told and  how  the                                                                    
information  was  being   substantiated  by  the  department                                                                    
through  the   auditing  process.   He  stressed   that  the                                                                    
legislature  would  have to  make  a  major policy  decision                                                                    
based on information from audits,  which were lagging behind                                                                    
the real-time activity. He expressed  confusion about how to                                                                    
substantiate his decision.                                                                                                      
Co-Chair Stoltze  interjected that  there was a  "great deal                                                                    
of  subjectivity"  in the  whole  area  of gold-plating.  He                                                                    
asked for further comment by the department.                                                                                    
Commissioner   Butcher   agreed   that   the   subject   was                                                                    
tremendously subjective.  He thought  the group  could spend                                                                    
an hour debating whether there could  be a need by a company                                                                    
for a  nicer truck; he  thought it  all depended on  how the                                                                    
issue was being looked at.  He argued that whether there was                                                                    
overreaching by  a company was  very difficult to  sort out,                                                                    
other than through an audit.                                                                                                    
Co-Chair Thomas  referred to a television  "reality" show in                                                                    
which someone shot seven times  at a caribou; he thought the                                                                    
legislature was at  shot three on the  discussed subject. He                                                                    
pointed to  people who thought  the state had gone  back and                                                                    
forth  from taking  too much  to  giving away  too much.  He                                                                    
wondered  whether the  administration had  a goal  or a  cap                                                                    
related to how much it wanted  to give back to the industry,                                                                    
so that the  legislature could get the bill  right and shoot                                                                    
the caribou once and for all.                                                                                                   
Commissioner Butcher  responded that the  administration had                                                                    
considered what  it called the "zone  of reasonableness." He                                                                    
argued  that   when  dealing  with  progressivity   and  tax                                                                    
credits,  the  numbers  changed;  there would  never  be  an                                                                    
"exact  sweet spot."  Regarding progressivity,  for example,                                                                    
when  the  department   considered  the  difference  between                                                                    
changing  progressivity  from   a  0.4  to  a   0.3  or  0.2                                                                    
[percent], or  considered brackets as a  different approach,                                                                    
it would  run the  numbers through  a model  to try  and see                                                                    
where it  evened out at  different prices. He  stressed that                                                                    
the  department  was trying  to  find  where the  state  was                                                                    
continuing to  get its  fair share  while still  allowing an                                                                    
oil company  (particularly when oil  prices were  higher) to                                                                    
get   a  little   more   to   incentivize  exploration   and                                                                    
production.  He  believed a  tax  bill  would always  be  an                                                                    
inexact science.                                                                                                                
Co-Chair Thomas  agreed; he pointed  out that with  ACES, no                                                                    
one had imagined oil could reach  the high prices it did. He                                                                    
wanted to assure the public  that functioning programs would                                                                    
continue to receive state funding.                                                                                              
Co-Chair  Stoltze  recommended  not spending  so  much  time                                                                    
arguing over  how the  profits would be  split that  the job                                                                    
never got started.                                                                                                              
9:49:12 AM                                                                                                                    
Representative  Gara stated  that  he was  disturbed by  the                                                                    
lack  of  information  on  the  bill.  He  referred  to  DOR                                                                    
information published  in the Juneau Empire  that investment                                                                    
spending on the  North Slope was increasing  about 8 percent                                                                    
each year  over the past  four years. He pointed  to another                                                                    
statement by DOR in the  Juneau Empire in December 2010 that                                                                    
had the  answer to a  question the testifiers from  DOR were                                                                    
now saying  they did not  have an  answer to; the  quote was                                                                    
that the increase  in capital spending was not  driven by an                                                                    
increase in  maintenance costs but  primarily driven  by new                                                                    
projects  coming  on  line.  He   asked  whether  the  prior                                                                    
commissioner was able to answer  the question [in the Juneau                                                                    
Empire] because  he had  information Commission  Butcher did                                                                    
not have.                                                                                                                       
Commissioner Butcher  replied that  he had  not been  in the                                                                    
room  with the  prior commissioner  [when the  statement was                                                                    
made] and  he did not  know what information he  was looking                                                                    
at and what  evaluation he was making  from the information.                                                                    
He   reported   that   in  the   few   months   prior,   his                                                                    
administration had considered what  the decline curve looked                                                                    
like, the lack  of exploration wells, and had  tried to make                                                                    
connections  about where  the credits  were.  He added  that                                                                    
there  was  not a  lot  of  activity  expected in  the  near                                                                    
future; he did not see  much exploration or fields that were                                                                    
ready to go.                                                                                                                    
Representative  Gara  asked why  there  was  not a  proposal                                                                    
directing the  state to enhance exploration  and development                                                                    
credits if the state was  trying to get more exploration. He                                                                    
thought testimony by Mr. Marks  had led the committee to the                                                                    
conclusion  that  the state  was  spending  money (about  $1                                                                    
billion  each  year) on  things  it  perhaps should  not  be                                                                    
spending  money  on.  He asked  whether  the  administration                                                                    
would  consider  starting  over  with  the  legislation  and                                                                    
focusing on  things that were  wanted, such as a  credit for                                                                    
processing facilities  so that  companies could  develop the                                                                    
smaller  fields,  or  a  credit that  would  be  better  for                                                                    
exploration, or for development wells.                                                                                          
Commissioner Butcher responded that  they had spoken to many                                                                    
independent companies  that had  come to Alaska  in response                                                                    
to tax credits passed in  ACES. He noted the companies would                                                                    
be testifying about  the issue. He believed  the credits had                                                                    
made the companies interested in  Alaska, but there had been                                                                    
challenges with negotiations related  to the production. The                                                                    
department  believed  more  than incentivizing  credits  was                                                                    
needed, because ultimately  the tax paid over  many years on                                                                    
a  producing field  did not  add up  to much  more than  the                                                                    
credits on the front end.  Credits might bring companies in,                                                                    
but the measure  would only be half-effective if  it did not                                                                    
result in production through TAPS.                                                                                              
9:53:57 AM                                                                                                                    
Representative Gara referred  to questions by Representative                                                                    
Doogan  about  who the  administration  had  worked with  in                                                                    
writing the bill. He asked  which companies were involved in                                                                    
the   meetings.   He   asked    whether   Exxon,   BP,   and                                                                    
ConocoPhillips were involved in the meetings.                                                                                   
Commissioner Butcher  responded that the  administration had                                                                    
had  meetings  with   ConocoPhillips,  BP,  Exxon,  Chevron,                                                                    
Armstrong,  Pioneer,   and  with  virtually   every  company                                                                    
operating in the  state. Everyone on the state  team was not                                                                    
in each  meeting, but between  them, the  administration had                                                                    
touched base  with as many  companies as possible to  get as                                                                    
much input as  possible. He did not think there  was a point                                                                    
to creating  a bill  to incentivize  private-sector decision                                                                    
making without input about what potentially might work.                                                                         
Co-Chair Stoltze interjected that  there had recently been a                                                                    
statement  in a  newsletter  that industry  had written  the                                                                    
Representative Gara  was not concerned  about who  wrote the                                                                    
bill  but about  who  had influenced  it.  He asked  whether                                                                    
members of the companies  had requested the major provisions                                                                    
in  the bill,  including  reducing  progressivity and  going                                                                    
from monthly to annual taxation.                                                                                                
Commissioner  Butcher  replied   that  the  discussions  had                                                                    
covered  many  topics,  not   specific  requests.  From  the                                                                    
beginning, conversations with members  of the companies were                                                                    
about doing  something with  progressivity, as  the governor                                                                    
had raised  the issue  months earlier; the  governor thought                                                                    
progressivity  was  inhibiting exploration  and  development                                                                    
production on the North Slope.                                                                                                  
Representative  Costello  noted   that  she  considered  the                                                                    
constitution when thinking about  the state's resources, and                                                                    
quoted that  it was  the "policy of  the state  to encourage                                                                    
the  settlement  of its  land  and  the development  of  its                                                                    
resources  by  making them  available  for  the maximum  use                                                                    
consistent  with   the  public  interest."   She  questioned                                                                    
whether it was in the interest  of the public to develop and                                                                    
produce the state's oil.                                                                                                        
Commissioner Butcher  responded that  he believed it  was in                                                                    
the best interest  of the state to develop  its resources in                                                                    
an environmentally safe manner.                                                                                                 
9:57:05 AM                                                                                                                    
Representative  Costello  pointed  out that  production  was                                                                    
declining.  She queried  the purpose  of  tax incentives  in                                                                    
Mr. Dees replied that although  it was not explicitly stated                                                                    
in statute, the credits  were intended to provide incentives                                                                    
for companies  to spend money  in a  way that would  lead to                                                                    
more oil  and gas production.  He noted that no  outcome was                                                                    
explicitly tied  to whether or  not a credit was  given, but                                                                    
he  thought it  was implied  that if  someone spent  capital                                                                    
dollars  to  drill wells,  the  result  would be  to  either                                                                    
maintain or increase the amount of oil and gas production.                                                                      
Representative  Costello  continued   that  exploration  and                                                                    
development were  two separate processes and  that the state                                                                    
was willing  to take a  significant amount of the  risk. She                                                                    
recalled information  given that  a low percentage  of wells                                                                    
drilled resulted  in oil. She  argued that the  state should                                                                    
be  willing  to  take  the  risk at  the  beginning  of  the                                                                    
exploration  process  for  the   long-term  benefit  of  the                                                                    
public.  However, it  seemed that  the result  had not  been                                                                    
production. She  asked what the state  was incentivizing and                                                                    
whether it was incentivizing the right things.                                                                                  
Mr. Tangeman  replied that Mr.  Dees was  very knowledgeable                                                                    
about tax  credits and  how they  were implemented,  but the                                                                    
question  related  to setting  policy.  He  agreed that  the                                                                    
credits  had  gotten  the  state to  a  certain  point;  new                                                                    
companies  were exploring.  However,  there  was a  distinct                                                                    
break between  exploration on the  one hand,  and production                                                                    
and throughput on the other,  which had raised the concerns.                                                                    
At high  oil prices, people  were interested in  looking for                                                                    
oil,  but there  was  still not  an  increase in  production                                                                    
comparable  to  other areas  in  the  world (such  as  North                                                                    
Representative Costello asked whether  the bill would change                                                                    
the base tax rate.                                                                                                              
Mr. Tangeman replied in the negative.                                                                                           
Representative  Costello   likened  the  situation   to  two                                                                    
different things on  either end of a balancing  toy called a                                                                    
seesaw.  On  one  side,  there   were  the  tax  credits  or                                                                    
incentives; on the other side  was progressivity. She wanted                                                                    
to achieve  a balance, so  that too much activity  would not                                                                    
be incentivized  on one  side. She  queried the  balance the                                                                    
state was  trying to achieve between  incentives offered and                                                                    
the tax rates the companies would pay.                                                                                          
Mr.  Tangeman answered  that the  bill would  only make  one                                                                    
change to  the tax  credit side, because  the administration                                                                    
believed that  the tax credits  already in place  were being                                                                    
used  and were  effective. The  proposal was  to go  from 20                                                                    
percent to  40 percent. He noted  that the bulk of  the bill                                                                    
would address  the progressivity  side; everything  else was                                                                    
10:03:01 AM                                                                                                                   
Representative Costello  queried the  value of  the resource                                                                    
in the  ground that the  state wanted to  incentivize enough                                                                    
to get to production.                                                                                                           
Mr. Tangeman  referred to earlier "optimistic"  testimony by                                                                    
the  Alaska  Oil  and Gas  Conservation  Commission  (AOGCC)                                                                    
regarding the amount  of oil present in the  state. He noted                                                                    
that  the  state  was  assisting  industry  with  short-term                                                                    
expenses through the  tax credits in order to  get the long-                                                                    
term value of  the oil. He did not think  the department was                                                                    
the expert on the amount of  the resource, but AOGCC was; he                                                                    
did  believe  there was  enough  oil  for the  pipeline  for                                                                    
decades to come.                                                                                                                
Commissioner Butcher  added that the value  was certainly in                                                                    
the hundreds of billions of dollars.                                                                                            
Representative Doogan  stated that he  wanted a list  of the                                                                    
meetings that were held related  to the bill by Commissioner                                                                    
Butcher,  any of  the  people  at the  table,  any of  their                                                                    
predecessors,  and  anybody  in the  governor's  office.  He                                                                    
wanted to  know when they met  and who was at  the meetings.                                                                    
He  understood  that  somebody   might  offer  a  privileged                                                                    
defense regarding the  contents of the meetings;  he was not                                                                    
asking for  that. He wanted  to know who  the administration                                                                    
had spoken to and when.                                                                                                         
Commissioner  Butcher  replied  that   he  would  relay  the                                                                    
request  to   the  governor's   office.  He   asked  whether                                                                    
Representative  Doogan   also  wanted   a  list   of  Native                                                                    
Corporations. He  stated that the  group involved  was broad                                                                    
and not  limited to just a  handful of folks that  they were                                                                    
eliciting opinions from.                                                                                                        
Representative  Doogan  stated  that  he wanted  a  list  of                                                                    
everybody involved. He wanted to  know who was talked to and                                                                    
when they were talked to.                                                                                                       
10:06:01 AM                                                                                                                   
AT EASE                                                                                                                         
10:14:35 AM                                                                                                                   
Representative Doogan  wondered whether the  committee would                                                                    
receive something in writing based on the presentation.                                                                         
ROGER MARKS, LEGISLATIVE  CONSULTANT, LEGISLATIVE BUDGET AND                                                                    
AUDIT COMMITTEE, provided a brief  summary of his background                                                                    
experience. He had  been a petroleum economist  with the Tax                                                                    
Division at DOR before retiring in  2008. He had spent a lot                                                                    
of time  analyzing the production  tax and had some  role in                                                                    
designing both the statutes and the regulations.                                                                                
Mr. Marks presented an overview  on the intent and design of                                                                    
PPT  and ACES,  particularly  the  relationship between  the                                                                    
credit rates  and tax rates and  how it was all  intended to                                                                    
fit together.                                                                                                                   
Mr. Marks reported  that PPT was designed in 2006  to do two                                                                    
main things.  The first was  to increase taxes;  most people                                                                    
realized that the  economic limit factor (ELF)  had not been                                                                    
working properly. The second goal  of PPT was to incentivize                                                                    
new investment.  A two-pronged system was  designed to reach                                                                    
the  goals. Exploration  and new  development would  get the                                                                    
credits, and  production would  pay the  tax. The  cycle was                                                                    
supposed  to work  with  a credit  system;  an entity  could                                                                    
convert losses  to a credit.  For example, under  ACES, $100                                                                    
million  in  exploration  costs would  convert  into  a  $25                                                                    
million  carry-forward   loss  and  a  20   percent  credit,                                                                    
totaling $45 million in credit.                                                                                                 
Mr.  Marks explained  that the  credit system  was important                                                                    
because  in exploration  economics, the  main thing  driving                                                                    
the outcome was  the probability of success and  the cost of                                                                    
drilling  the  well.  He emphasized  that  the  failure  leg                                                                    
carried more  weight if  there were a  90 percent  chance of                                                                    
coming  up with  a  dry hole.  He noted  that  a 90  percent                                                                    
chance of  failure was not  an unreasonable number.  Part of                                                                    
the  goal in  designing  the credit  structure  was for  the                                                                    
state to  assume a  share of  the failure risk  as a  way of                                                                    
incentivizing exploration.                                                                                                      
Mr. Marks  continued that  new field-development  costs were                                                                    
mostly on the  front end. The goal  was "backend-loading the                                                                    
tax," which meant reducing the  cost to the developer on the                                                                    
front  end of  the  project  to increase  the  value of  the                                                                    
project on the net present-value  basis. He pointed out that                                                                    
the  described structure  was used  all over  the world  and                                                                    
that  accelerated appreciation  was one  example. The  state                                                                    
had  a credit  system  that would  give  the producers  more                                                                    
money on the front end and get it back on the tail end.                                                                         
10:19:18 AM                                                                                                                   
Mr. Marks explained that the  system contained was a balance                                                                    
between  the tax  rate  and  the credit  rate  to make  sure                                                                    
things worked  right. He stated  that his judgment  was that                                                                    
ACES had created a distortion  in the balance. Currently, he                                                                    
felt  the  state  had  a   great  system  for  incentivizing                                                                    
exploration. For example, the  government assumed 45 percent                                                                    
of  the dry-hole  risk.  In addition,  costs  for state  and                                                                    
federal corporate income tax could  be deducted, which added                                                                    
up to  the government  assuming 70  percent of  the dry-hole                                                                    
risk,  a  great  incentive. However,  exploration  economics                                                                    
(given  a 90  percent chance  of  failure and  a 10  percent                                                                    
chance of  success) meant that  taxes were not  relevant for                                                                    
an entity  in the  exploration phase. Costs  and probability                                                                    
of success were the drivers.                                                                                                    
Mr. Marks  used the analogy of  a scene in the  movie "Butch                                                                    
Cassidy  and the  Sundance Kid."  The characters  were being                                                                    
chased by the law and came to  the edge of a cliff; they had                                                                    
to jump into a river. Sundance  said to Butch, "I don't know                                                                    
how to  swim." Butch answered,  "Don't worry, the  fall will                                                                    
probably  kill you."  During exploration,  the taxes  do not                                                                    
matter that  much, because when  coming up dry,  there would                                                                    
be no taxes to pay.                                                                                                             
Mr.  Marks believed  the current  credit system  worked well                                                                    
for exploration.  The tax was  designed so that  taxes would                                                                    
be  paid if  a company  found oil.  However, currently,  the                                                                    
exploration  incentives were  so  good  the companies  found                                                                    
oil, began to  produce, and then looked at the  tax rate and                                                                    
things slowed down as the  impact of paying the taxes became                                                                    
real.   He   believed   the   current   disconnect   between                                                                    
exploration  and production  was  a problem  that was  built                                                                    
into the structure of ACES.                                                                                                     
Mr.  Marks emphasized  that the  credit  system was  strong,                                                                    
with taxes  that were not too  high or too low;  the problem                                                                    
was the high taxes.                                                                                                             
Mr. Marks  addressed Representative Edgmon's  question about                                                                    
gold-plating. He  did not  believe that  even a  very strong                                                                    
audit  could tell  that  a company  had  purchased a  better                                                                    
truck  than it  needed to.  He thought  the solution  to the                                                                    
gold-plating problem  was to have  a tax structure  that did                                                                    
not  incentivize such  spending. He  noted the  main element                                                                    
contributing to  gold-plating was  high marginal  tax rates,                                                                    
under  which  the  tax  rate  and  net  value  dropped  with                                                                    
additional  costs.  He  estimated  the  credits  contributed                                                                    
perhaps  20 to  25  percent  to the  problem,  but the  main                                                                    
driver for gold-plating  was high marginal tax  rates at oil                                                                    
high prices.                                                                                                                    
HB  110  was  HEARD  and   HELD  in  committee  for  further                                                                    
Co-Chair Stoltze reviewed upcoming presentations.                                                                               
10:24:25 AM                                                                                                                   

Document Name Date/Time Subjects
HB110 HFIN DOR Production Tax Credits 0317.pdf HFIN 3/17/2011 8:00:00 AM
HB 110