Legislature(2005 - 2006)CAPITOL 124

01/26/2006 05:00 PM OIL & GAS

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05:08:47 PM Start
05:09:16 PM HB294
05:47:10 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Heard & Held
+= Bills Previously Heard/Scheduled TELECONFERENCED
HB 294-GAS EXPLORATION\DEVELOPMENT TAX CREDIT                                                                                 
CHAIR KOHRING announced that the  only order of business would be                                                               
HOUSE  BILL  NO.   294,  "An  Act  amending   and  extending  the                                                               
exploration  and  development  incentive  tax  credit  under  the                                                               
Alaska  Net Income  Tax Act  for operators  and working  interest                                                               
owners directly  engaged in the  exploration for  and development                                                               
of gas  for delivery  and sale  from a lease  or property  in the                                                               
state; providing for an effective  date by amending the effective                                                               
date  for  sec.  2,  ch.  61, SLA  2003;  and  providing  for  an                                                               
effective date."                                                                                                                
5:09:16 PM                                                                                                                    
SUE WRIGHT, Staff to Representative  Mike Chenault, House Finance                                                               
Committee,  Alaska  State   Legislature,  sponsor,  explained  on                                                               
behalf of  Representative Chenault,  that HB 294  is an  act that                                                               
amends and extends the exploration  and development incentive tax                                                               
credit  that was  originally enacted  in 2003  as House  Bill 61.                                                               
This tax  credit continues to  apply under the Alaska  Net Income                                                               
Tax  Act  for  operators  and working  interest  owners  directly                                                               
engaged in  the exploration for  and development of  natural gas,                                                               
primarily in  the Cook  Inlet area.   She informed  the committee                                                               
that  any natural  gas production  and supply  in the  Cook Inlet                                                               
area has been declining for a  number of years.  During that same                                                               
time, demand  has been increasing  steadily.  Therefore,  a sharp                                                               
increase in drilling to find  new reserves is drastically needed.                                                               
She stated  that the  original investment  tax credit  enacted in                                                               
2003, while  modestly successful in stimulating  new drilling and                                                               
development, needs to be made  a much more effective incentive in                                                               
order  for developers  to increase  capital spending  in a  large                                                               
manner.  These  changes will go a long way  toward achieving that                                                               
goal, and it will also increase employment.                                                                                     
5:10:55 PM                                                                                                                    
JOHN A.  BARNES, Manager, Alaska Production  Region, Marathon Oil                                                               
Company, stated  that Marathon  Oil Company is  in support  of HB
294.   He  informed  the committee  that  Marathon Oil  Company's                                                               
Alaska  operations are  focused  on the  Cook  Inlet natural  gas                                                               
industry.   Last year  [in 2005],  Marathon Oil  Company produced                                                               
and sold  about 68 billion cubic  feet (bcf) of natural  gas.  He                                                               
said   that  during   [2005],  Marathon   Oil  Company   sold  to                                                               
"essentially" every natural  gas market that was  available.  The                                                               
markets include:   ENSTAR Natural  Gas Company,  Chugach Electric                                                               
Association,  Inc.,  a  liquefied  natural  gas  (LNG)  plant  in                                                               
Nikiski, Tesoro  [Corporation], and Agrium  Inc.  He  stated that                                                               
the Marathon Oil  Company is committed to the  Cook Inlet natural                                                               
gas   market,  including   serving   its  long-term   contractual                                                               
commitments to  the local utilities  and seeking  other available                                                               
MR. BARNES reminded the committee  that in 2003, the  legislature                                                               
passed and the governor signed,  several bills that were directed                                                               
at  providing  incentives  for new  exploration  and  development                                                               
activities.  Marathon Oil Company  was particularly interested in                                                               
House Bill 61, which was  intended to incentivize exploration and                                                               
development of natural gas reserves,  specifically in Cook Inlet.                                                               
He stated that HB 294 will strengthen the incentives.                                                                           
5:12:46 PM                                                                                                                    
MR. BARNES said that one might  ask about the need to incentivize                                                               
natural  gas  development in  Cook  Inlet.    The answer  to  the                                                               
question  is  found  by  considering  the  long-term  decline  in                                                               
natural  gas reserves,  which  Cook Inlet  has  experienced.   He                                                               
stated that what must be  addressed is whether there is currently                                                               
sufficient  exploration   activity  to  arrest  the   decline  in                                                               
reserves, and not  whether the Cook Inlet is running  out of gas.                                                               
At  the current  minimal level  of Cook  Inlet exploration,  it's                                                               
unlikely that  Cook Inlet reserve  additions will  replace annual                                                               
production on  an ongoing basis.   As such, natural  gas reserves                                                               
are at risk of continual decline  in Cook Inlet.  He informed the                                                               
committee that  the net result  of not addressing the  issue will                                                               
be the loss of industries and associated jobs.                                                                                  
5:13:36 PM                                                                                                                    
MR. BARNES stated  that the lack of Cook Inlet  exploration is an                                                               
artifact of  the historic oversupply  of natural gas,  which kept                                                               
prices  well below  Lower  48  prices, which  created  a lack  of                                                               
incentive for  drilling.  Furthermore, regulatory  and permitting                                                               
hurdles  in   Alaska  have  played  roles   in  reducing  project                                                               
economies,   due  to   uncertainties  and   predictably  bringing                                                               
projects  online on  time and  within the  budget.   He announced                                                               
that  there  is,   however,  good  news.     Recently,  the  U.S.                                                               
Department  of  Energy  completed   a  report,  which  identified                                                               
significant potential  in Cook Inlet  for additional  gas through                                                               
infield reserve growth, new discoveries, and other gas sources.                                                                 
5:14:23 PM                                                                                                                    
MR.  BARNES   informed  the  committee   that  the   same  report                                                               
identifies  the  need  for significant  capital  expenditures  to                                                               
bring the gas  to market, including $500  million associated with                                                               
finding  and developing  infield reserve  growth of  1.4 trillion                                                               
cubic feet  (tcf).  An  expenditure of  $5 billion to  $6 billion                                                               
was associated with  exploration and development of 6  tcf to 8.5                                                               
tcf of resource.                                                                                                                
5:14:59 PM                                                                                                                    
MR. BARNES  stated that the [aforementioned]  targets represent a                                                               
significant opportunity  to reinvigorate  the Cook  Inlet natural                                                               
gas industry.   The net  result of developing the  reserves would                                                               
be additional  jobs, ongoing industrial  use of natural  gas, and                                                               
revenue  increases  to  the  State  of  Alaska  through  tax  and                                                               
5:15:24 PM                                                                                                                    
MR. BARNES posed the question:  how  will HB 294 help?  He stated                                                               
that Alaska projects are not  considered solely on their absolute                                                               
economic merit.   Companies are scrutinized on  a relative scale,                                                               
in  comparison  to other  opportunities  around  the world  where                                                               
people can invest.  The intent of  HB 294 is to level the playing                                                               
field  between  Alaska   opportunities  and  other  opportunities                                                               
around the  world.  He added  that HB 294 is  intended to provide                                                               
an incentive  to oil  and gas  development activities  through an                                                               
investment  tax credit.    Most importantly,  under  HB 294,  the                                                               
percentage of qualified  expenditures that could be  applied as a                                                               
credit to offset  future tax liabilities is increased  from 10 to                                                               
25 percent.                                                                                                                     
5:16:22 PM                                                                                                                    
MR. BARNES  added that timing  is "very important" on  Cook Inlet                                                               
development.   It  currently takes  an excess  of three  years to                                                               
bring any  potential Cook  Inlet discovery to  production.   If a                                                               
sufficiently   high  level   of  exploration   activity  can   be                                                               
stimulated,   there's   an   increased  probability   that   some                                                               
discoveries  may be  brought to  market sooner,  which ultimately                                                               
will benefit industries and consumers.                                                                                          
5:16:49 PM                                                                                                                    
MR. BARNES summarized that Marathon  Oil Company believes that HB
294 can  serve as  a stimulus to  enhance Cook  Inlet exploration                                                               
and development activities.                                                                                                     
5:17:00 PM                                                                                                                    
CHAIR KOHRING  opined that the  legislation that  the legislature                                                               
passed  in 2003  benefited the  industry, including  Marathon Oil                                                               
Company,  and  inquired  as  to what  the  justification  is  for                                                               
generously increasing the  tax credits as well as  taking out the                                                               
50 percent limitation.  He also  asked, "Why would that be needed                                                               
in light of the fact that [House Bill 61] has been successful?"                                                                 
5:17:31 PM                                                                                                                    
MR. BARNES  responded that the key  word is that [House  Bill 61]                                                               
has been  "moderately" successful.   If one looks at  the overall                                                               
level of activity  in Cook Inlet, he opined that  [House Bill 61]                                                               
hasn't  drawn  the  type of  exploration  that  would  ultimately                                                               
benefit the  State of  Alaska.   He added  that another  thing to                                                               
consider is  the multiplier  effect.  For  example, if  a company                                                               
receives $1 million in tax credit,  that implies it has spent $10                                                               
million in Alaska ultimately finding  and developing natural gas.                                                               
Then one would also have to  think about the development cost and                                                               
what the ultimate revenue to the  State of Alaska would be, which                                                               
is  dependent on  oil price.   He  stated that  through severance                                                               
tax, royalty, and  ad valorem tax, the multiplier  benefit to the                                                               
State of Alaska  is probably on the order of  the investment that                                                               
the  company makes.    The key  point  is that  for  every $1  of                                                               
credit,   $10  was   spent  in   Alaska,   making  an   important                                                               
contribution to Alaska commerce.                                                                                                
5:19:02 PM                                                                                                                    
CHAIR KOHRING noted  that money has also been  generated which is                                                               
in the  state treasury.  He  said that his understanding  is that                                                               
there's about $1.5 million, and that  for every dollar that is in                                                               
the  state treasury,  the industry  is spending  about ten  times                                                               
that.   Therefore, he opined that  there has been a  benefit from                                                               
[House Bill 61].   He expressed his concern  that the legislature                                                               
doesn't go  "too far"  in terms  of extending  "already generous"                                                               
provisions,  and  added  that  the  reasons  for  extensions  are                                                               
adequately justified.                                                                                                           
MR. BARNES expressed his understanding  of the need for the State                                                               
of Alaska to  determine the amount of stimulus  it deems required                                                               
to increase activity.                                                                                                           
5:19:53 PM                                                                                                                    
REPRESENTATIVE MCGUIRE  described another "incentive  bill" heard                                                               
by the  House Rules  Standing Committee.   She opined  that she's                                                               
leery of  eliminating the 50  percent requirement entirely.   She                                                               
also expressed her concern regarding  extending [the sunset date]                                                               
to 2024, and said that she  doesn't see any justification for it.                                                               
She opined that  a periodic checkpoint is  necessary.  Therefore,                                                               
she inquired about the reasoning behind the sunset date of 2024.                                                                
5:23:19 PM                                                                                                                    
MR. BARNES explained  that if the "tool" works, one  wants to try                                                               
to get to  the point where there is an  "ongoing span profile" of                                                               
Cook Inlet.  He opined that having  a sunset date of 2020 or 2024                                                               
offers  a stable  picture of  a reward  that could  be there  for                                                               
ongoing investment.   He informed  the committee  that currently,                                                               
Cook Inlet burns between 150-200 bcf of  gas per year.  If one is                                                               
able to find  and replace reserves at $1 per  thousand cubic feet                                                               
(mcf),  it  would  imply that  one  has  a  $200-million-per-year                                                               
capital program occurring  in Cook Inlet.  In order  to keep that                                                               
level of  activity going, one  has to create an  environment that                                                               
draws the capital in.  He  said that he doesn't know whether Cook                                                               
Inlet  will  ever achieve  the  degree  of sustainability  that's                                                               
5:26:39 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG  commented that a  tax credit of  up to                                                               
100  percent   would  allow  operators  to   execute  development                                                               
exploration without risk.                                                                                                       
5:27:49 PM                                                                                                                    
REPRESENTATIVE  SAMUELS  asked  for  examples of  other  tax  and                                                               
royalty systems  around the world  that the Marathon  Oil Company                                                               
deals with.                                                                                                                     
5:28:21 PM                                                                                                                    
MR.   BARNES  mentioned   production-sharing  agreements,   which                                                               
typically  occur  when  there's   a  higher  probability  of  the                                                               
resource base.   He also mentioned typical  royalty and severance                                                               
tax  approaches.   The U.S.  government  has implemented  royalty                                                               
reduction in an  attempt to stimulate deepwater  exploration.  He                                                               
said that Alaska is one of the  few states [in the U.S.] that has                                                               
implemented royalty reduction as an  incentive in the oil and gas                                                               
5:30:26 PM                                                                                                                    
JERRY McCUTCHEON opined that [HB  294] will not accomplish a lot.                                                               
He suggested  that a method  to spur  gas production would  be to                                                               
start taxing  leases on  which seismic  information has  not been                                                               
collected and/or  drilling has not  occurred.  He  also suggested                                                               
that if  an operator is  not drilling  on a lease,  he/she should                                                               
let another operator take over the  lease to begin drilling.  His                                                               
motto is, "drill it or lose it."                                                                                                
5:32:09 PM                                                                                                                    
REPRESENTATIVE SAMUELS,  referring to  page two  of [HB  294] and                                                               
line  five and  line eleven,  inquired about  the 25  percent for                                                               
qualified  services  in  the  state and  asked  whether  it's  an                                                               
operating tax credit also.                                                                                                      
MARK  GRABER,   Income  Audit  Manager,  Anchorage   Office,  Tax                                                               
Division, Department  of Revenue  (DOR), said  no, and  that it's                                                               
for capital expenditures  only; therefore, operating expenditures                                                               
wouldn't qualify.                                                                                                               
5:32:51 PM                                                                                                                    
REPRESENTATIVE SAMUELS quoted page 2,  lines 4-6, of HB 294 which                                                               
read, "10  percent of  the annual cost  incurred by  the taxpayer                                                               
for  qualified services  in the  state during  each tax  year for                                                               
which a credit  is allowable for a  qualified capital investment"                                                               
and asked what a qualified service would be.                                                                                    
MR.  GRABER  said that  he  can't  answer Representative  Samuels                                                               
question precisely.  He added that  the DOR has not performed any                                                               
audits on  the credits that have  been claimed.  He  conveyed his                                                               
understanding  that a  "qualified  service"  pertains to  seismic                                                               
work  and  to  the  types  of things  that  will  eventually  get                                                               
capitalized, as opposed to capital assets that are purchased.                                                                   
5:34:10 PM                                                                                                                    
REPRESENTATIVE SAMUELS clarified  that on page three,  there is a                                                               
definition of  "qualified capital investment", but  there isn't a                                                               
definition of "qualified service."                                                                                              
REPRESENTATIVE  GUTTENBERG  inquired  as  to  whether  there's  a                                                               
definition of "qualified service" in [Alaska Statutes].                                                                         
CHAIR KOHRING  asked whether he  would be correct in  saying that                                                               
Mr. Graber "wasn't aware" of what "qualified service" meant.                                                                    
MR. GRABER  confirmed "not precisely."   He added that  the first                                                               
credit showed  up in 2004, and  the DOR "really" hasn't  had time                                                               
to audit it yet.                                                                                                                
CHAIR  KOHRING   requested  that  the  DOR   identify  "qualified                                                               
service" in [Alaska Statute].                                                                                                   
5:34:57 PM                                                                                                                    
CHAIR KOHRING  inquired about  the number  of times  since [House                                                               
Bill 61]  was enacted,  that the credit  has actually  been taken                                                               
advantage of, and by which  companies other than the Marathon Oil                                                               
MR. GRABER  acknowledged that there  are two companies  that have                                                               
"taken" the credit.                                                                                                             
5:35:54 PM                                                                                                                    
CHAIR KOHRING asked whether it  appears as though [House Bill 61]                                                               
has been  effective in terms  of companies having interest  in it                                                               
and taking advantage of it.                                                                                                     
MR. GRABER  said that  he wasn't able  to answer  Chair Kohring's                                                               
5:37:12 PM                                                                                                                    
CHAIR  KOHRING indicated  that [HB  294]  might be  held over  in                                                               
order to address  some of the concerns of members.   He expressed                                                               
his support of the concept behind  [HB 294], and of the committee                                                               
doing   something    to   accelerate    additional   development,                                                               
particularly in the  Kenai Peninsula.  He opined  that House Bill                                                               
61  facilitated additional  development, and  that the  committee                                                               
should be able to "tweak"  [existing statute] in order to attract                                                               
more companies and therefore, more investment.                                                                                  
5:38:32 PM                                                                                                                    
CHAIR KOHRING  expressed an additional concern  that might result                                                               
in  having to  add  a provision  to [HB  294]  if necessary,  and                                                               
[Legislative Legal and  Research Services] would be  able to make                                                               
the decision.  He said his  concern is in regard to the potential                                                               
gas line,  "spurs," and any gas-related  infrastructure, since he                                                               
doesn't feel they  should be included in HB 294.   He opined that                                                               
the  State  of  Alaska  doesn't  want to  be  "too  generous"  to                                                               
companies that build  the gas line, with the  credit increased to                                                               
25 percent.   To "narrow  down" [HB  294], he said  his suggested                                                               
wording would  be, "The provisions  of this  act do not  apply to                                                               
cost   and   revenue   associated    with   gas   pipelines   and                                                               
infrastructure."   He added that  the Marathon Oil  Company seems                                                               
amenable to his suggestion.                                                                                                     
5:39:38 PM                                                                                                                    
MR. BARNES  said that  his initial thought  is whether  there are                                                               
concerns regarding  a North  Slope gas  line or  spur line.   The                                                               
intent  of [HB  294] is  for exploration  and development  of new                                                               
gas, south of  the Brooks Range.   He added that at  a high level                                                               
pass, there's  a possibility that a  gas line or spur  line would                                                               
be excluded, because  gas from the North Slope  is produced north                                                               
of the  Brooks Range.   He  said, "You're right,  there may  be a                                                               
need to  tweak and make  certain there's not  a gap there  in the                                                               
5:40:27 PM                                                                                                                    
REPRESENTATIVE   SAMUELS  asked   whether   [HB  294]   specifies                                                               
geographic location.                                                                                                            
REPRESENTATIVE GUTTENBERG answered, "68th parallel."                                                                            
5:40:52 PM                                                                                                                    
REPRESENTATIVE  SAMUELS  asked  if  the  DOR  has  conducted  any                                                               
economic modeling to establish how  much [money] would have to be                                                               
spent and  how much [gas]  would have to  be found, to  make [the                                                               
gas line] worthwhile.  He added,  "Not counting the impact on the                                                               
economy, but the impact on the state treasury."                                                                                 
5:41:28 PM                                                                                                                    
MR.  GRABER defined  "qualified services"  as, "Expenditures  for                                                               
labor, seismic,  and other services that  are directly applicable                                                               
to a  qualified capital  investment."   He added  that "qualified                                                               
services" does not include operating lease expenses.                                                                            
5:42:11 PM                                                                                                                    
CHAIR KOHRING requested that Mr.  Graber discuss the accompanying                                                               
fiscal note.                                                                                                                    
5:42:28 PM                                                                                                                    
MR.  GRABER  explained  that  [HB   294]  retains  the  following                                                               
characteristics:   only exploration  and development  outlays for                                                               
gas  wells qualify  for the  credit;  the credit  may be  applied                                                               
against the  taxpayers total  income tax  liability -  the credit                                                               
may  offset   tax  arising  from  oil   production  and  pipeline                                                               
activity,  as  well as  gas  exploration  and production;  unused                                                               
credits may be carried forward  to the subsequent five years; and                                                               
once  gas production  begins, additional  outlays  for the  field                                                               
cease to  accrue credits.  On  the other hand, he  explained that                                                               
[HB  294]   makes  four  significant  changes   to  current  law:                                                               
increases  the  amount of  the  credit  to  25 percent  [from  10                                                               
percent]  of  the  amount of  qualified  capital  investment  and                                                               
qualified services  spending; removes  the 50  percent limitation                                                               
on  the amount  of  credits  that can  apply  in  a single  year;                                                               
removes  the  "successful  efforts" requirement  that  developers                                                               
must find and deliver new gas  resources to market to qualify for                                                               
the credit;  and extends  the sunset date  of the  investment tax                                                               
credit from January 1, 2013, to January 1, 2020.                                                                                
5:44:32 PM                                                                                                                    
MR. GRABER  informed the  committee that in  the two  years since                                                               
the enactment  [of House  Bill 61],  the DOR  has seen  claims of                                                               
[$]6.3 million.  He added, "That relates to three fields."                                                                      
5:44:47 PM                                                                                                                    
MR.  GRABER  stated   that  the  rest  of  the   fiscal  note  is                                                               
essentially an economic analysis that he did not prepare.                                                                       
5:45:19 PM                                                                                                                    
CHERYL  L. NIENHUIS,  Petroleum Economist,  Tax Division,  Juneau                                                               
Office, Department of Revenue (DOR),  informed the committee that                                                               
some of  the language  in [HB 294  reflects language  in existing                                                               
statute].  She  said that from an economic  standpoint, the price                                                               
of  gas is  almost  as much  of  an incentive  as  a tax  credit.                                                               
Therefore, as  long as the price  of gas remains high,  it should                                                               
be a good incentive in addition to a tax credit.                                                                                
5:46:02 PM                                                                                                                    
CHAIR  KOHRING,  upon determining  that  no  one else  wished  to                                                               
testify on  HB 294,  announced the  closure of  public testimony.                                                               
He  noted that  the committee  is holding  [HB 294]  in order  to                                                               
address the  "50-50 split," the  extension [of the  sunset date],                                                               
the definition of  "qualified services," and the  concern of gas-                                                               
related  infrastructure.    He  reiterated  his  support  of  the                                                               
concept behind [HB 294].                                                                                                        

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