Legislature(2005 - 2006)HOUSE FINANCE 519

03/04/2006 02:00 PM RESOURCES


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02:02:26 PM Start
02:03:07 PM HB488
04:08:06 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
-- Time Change --
+= HB 488 OIL AND GAS PRODUCTION TAX TELECONFERENCED
Heard & Held
Testimony by legislative consultant
Jim Eason
HB 488-OIL AND GAS PRODUCTION TAX                                                                                             
                                                                                                                                
2:03:07 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SAMUELS  announced that  the  first  order of  business                                                               
would  be  HOUSE  BILL  NO.   488,  "An  Act  repealing  the  oil                                                               
production  tax  and  gas  production tax  and  providing  for  a                                                               
production tax on  the net value of oil and  gas; relating to the                                                               
relationship of  the production tax  to other taxes;  relating to                                                               
the dates  tax payments  and surcharges are  due under  AS 43.55;                                                               
relating to interest on overpayments  under AS 43.55; relating to                                                               
the  treatment of  oil and  gas  production tax  in a  producer's                                                               
settlement with  the royalty owner;  relating to flared  gas, and                                                               
to oil  and gas  used in  the operation of  a lease  or property,                                                               
under AS  43.55; relating to the  prevailing value of oil  or gas                                                               
under AS  43.55; providing  for tax credits  against the  tax due                                                               
under AS 43.55 for certain  expenditures, losses, and surcharges;                                                               
relating to statements or other  information required to be filed                                                               
with or furnished  to the Department of Revenue,  and relating to                                                               
the penalty for failure to  file certain reports, under AS 43.55;                                                               
relating to the  powers of the Department of Revenue,  and to the                                                               
disclosure  of certain  information required  to be  furnished to                                                               
the Department of  Revenue, under AS 43.55;  relating to criminal                                                               
penalties for  violating conditions  governing access to  and use                                                               
of  confidential   information  relating  to  the   oil  and  gas                                                               
production tax;  relating to  the deposit  of money  collected by                                                               
the  Department  of  Revenue  under AS  43.55;  relating  to  the                                                               
calculation of the gross value at  the point of production of oil                                                               
or  gas;  relating to  the  determination  of  the net  value  of                                                               
taxable oil and  gas for purposes of a production  tax on the net                                                               
value  of oil  and gas;  relating  to the  definitions of  'gas,'                                                               
'oil,' and certain  other terms for purposes of  AS 43.55; making                                                               
conforming amendments; and providing for an effective date."                                                                    
                                                                                                                                
2:04:14 PM                                                                                                                    
                                                                                                                                
JIM EASON,  Consultant, Legislative  Budget and  Audit Committee,                                                               
said he  came to Alaska as  a petroleum geologist and  has worked                                                               
for  Conoco and  Arco, as  well as  the United  States Geological                                                               
Survey evaluating  off-shore acreage in  Alaska.  He  then worked                                                               
for  the  state  as  the  director for  the  predecessor  of  the                                                               
Division of  Oil and  Gas.   He has since  been a  consultant for                                                               
industry, governments,  and law firms.   He said there  have been                                                               
all sorts of mathematical issues, but  he wants to talk about his                                                               
perspective.    He has  seen  the  "quasi-legal side"  of  states                                                               
protecting their interests.                                                                                                     
                                                                                                                                
2:09:12 PM                                                                                                                    
                                                                                                                                
MR.  EASON  said there  are  geological  connections that  aren't                                                               
obvious "if  you are just going  to focus on the  economics."  He                                                               
said "the numbers you've been looking  at are wrong, but it's not                                                               
necessarily bad."  He noted  the geological risk of reduced large                                                               
discoveries, but there are new ideas and new technology.                                                                        
                                                                                                                                
MR. EASON said  Pedro van Meurs' report helps  evaluate "what the                                                               
numbers  mean."   The report  notes that  smaller fields  are the                                                               
main target  on the  North Slope,  and the  proposed profit-based                                                               
petroleum production  tax (PPT)  is primarily  a tax  on existing                                                               
production.   The  50 million-barrel  high-cost, low-productivity                                                               
case "is a  very important benchmark for  large producers because                                                               
this is a  fairly representative case of most  of the incremental                                                               
developments that may  take place on the North Slope.   This case                                                               
will therefore  see a significant improvement  over all economics                                                               
while on average there's no  increase in tax, assuming that large                                                               
companies maintain a  long-term price forecast in the  $25 to $30                                                               
range."    Mr.  Van  Meurs  is saying  there  is  geological  and                                                               
forecasting risks,  which is relatively minimal  because there is                                                               
history   there.       Undiscovered   resources    are   "totally                                                               
hypothetical."  Price forecasts are notoriously unreliable.                                                                     
                                                                                                                                
MR. EASON  said some wells  penetrate many  different reservoirs,                                                               
and a company  in Cook Inlet defined "well" to  take advantage of                                                               
the ELF.   He said most people assumed that  the accumulations in                                                               
Prudhoe  Bay were  part  of the  Prudhoe Bay  field,  and it  was                                                               
disaggregated.   He  reflected on  mistakes the  state made  when                                                               
beginning competitive oil and gas  lease sales.  An attorney, who                                                               
was provided by  the Western Oil and  Gas Association, influenced                                                               
these  decisions, causing  years of  litigation.   In 1977,  "the                                                               
words of  the lease finally  began to take on  real significance.                                                               
The  state's  first  royalty receipts  indicated  that  everybody                                                               
seemed to be paying royalties on a very different basis."                                                                       
                                                                                                                                
2:22:16 PM                                                                                                                    
                                                                                                                                
MR. EASON  spoke of the  issues around the leases,  including how                                                               
the  state  determines  the fair  and  reasonable  allowance  for                                                               
transportation.    He  said  litigation lasted  17  years.    For                                                               
Prudhoe Bay it was agreed that  "the state would pay a field cost                                                               
no matter what,  if it was in  kind or in value,  on a negotiated                                                               
amount."   The  settlement did  not provide  a mechanism  to look                                                               
back.   He said that  agreement is  still alive and  governs what                                                               
the state's  obligations are at  Prudhoe Bay, and the  state pays                                                               
"just about a dollar a  barrel."  There are some [indecipherable]                                                               
leases still there and are associated mostly with production.                                                                   
                                                                                                                                
MR. EASON  said that  while the case  was pending,  the producers                                                               
settled and produced the  Trans-Alaska Pipeline System Settlement                                                               
Methodology, and "for years and  years, everyone that I've talked                                                               
with who  does not  own a  piece of the  pipeline feels  that the                                                               
actual  settlement  values  on that  pipeline  are  prohibitively                                                               
expensive for  some companies to  produce on the North  Slope and                                                               
at a minimum, very costly."                                                                                                     
                                                                                                                                
MR. EASON said  the effects [of the methodology]  have grown over                                                               
time, and it is  a big impediment for some.  It  is the same with                                                               
facilities-access, he  noted.   He said, "By  the time  the early                                                               
90s  was  rolling around,  litigation  was  still going  on,  the                                                               
administration made a  decision to try to settle the  case on the                                                               
remaining issues  before the trial  date because the  climate had                                                               
really  gotten ripe."   The  litigation was  expensive, he  said.                                                               
Three  people were  selected to  meet with  the big  producers to                                                               
settle  the "simple  question"  of how  to value  the  oil.   The                                                               
agreement resulted in three  different settlement agreements with                                                               
Phillips   Alaska,   Inc.,   BP,  and   ExxonMobil   Corporation.                                                               
"Basically they looked  to a proxy for the lease  terms that they                                                               
had before  [indecipherable] value.   Those  are just  set aside,                                                               
and  the deal  was that  we created  a new  way of  valuing North                                                               
Slope oil."   He said the basic agreement looked  to the relative                                                               
movement of  the average prices  of the spot reported  prices for                                                               
[indecipherable].    "It  was  designed  so  they  would  try  to                                                               
replicate the  value...of ANS in  the market and  hopefully, with                                                               
the provisions that  were designed into it, continue  to do that,                                                               
continue  to produce  the same  economic  result."   He said  the                                                               
agreements  have been  in effect  since about  1992.   There have                                                               
been "a  number of re-openers"  and negotiations, he said.   Both                                                               
sides are happy, he opined.                                                                                                     
                                                                                                                                
MR. EASON added,  "The key is, without the  ability to compensate                                                               
if  your  decision  is  wrong,  you run  the  risk  of  a  really                                                               
disproportionate result."   He said the question of  the point of                                                               
production that was "so important  in the royalty litigation...is                                                               
an issue that  needs to be clear in both  parties' minds...how it                                                               
may  affect existing  production practices  but also  how it  may                                                               
translate to the major gas sale."                                                                                               
                                                                                                                                
MR.  EASON said  the state  anticipated major  gas sales  in 1980                                                               
during the  settlement agreement,  and there are  some provisions                                                               
that will  materialize over  time as  the project  moves forward.                                                               
The changes made in tax statutes  "change some of the things that                                                               
will have, or  be impacted by, the decisions  incorporated in any                                                               
agreements that affect those in the  future.  And we can't really                                                               
say much  about that other than  that right now."   Looking at HB
488,  there  is   a  new  definition  for   both  gas  processing                                                               
facilities and gas treatment facilities,  "and we have asked...to                                                               
get  some  greater  certainty  about  what  the  intent  and  the                                                               
interpretation of  some of these  features might be and  how that                                                               
may change over time."  He  stated that it is very important that                                                               
those   questions  be   answered   because   they  provide   some                                                               
uncertainty with potentially great significance.                                                                                
                                                                                                                                
MR.  EASON  said another  issue  is  the  breadth of  credit  and                                                               
deductions in HB 488.   The bill speaks to qualified expenditures                                                               
for exploration,  production, and  development, but no  one knows                                                               
what that is.   As it is  written, it could be argued  that it is                                                               
"everything and  anything that you can  imagine."  He said  he is                                                               
not alone in that thought.   He said smaller companies would like                                                               
those terms better defined, and  the state should know its future                                                               
exposure to  that.  He said  it will be time  consuming but worth                                                               
it, and  the hard  calls would  be "your  calls, obviously."   It                                                               
will  help  avoid ambiguity  and  give  an understanding  to  the                                                               
implications  of  this  decision.    He said  one  issue  is  the                                                               
question of  abandonment costs,  and the  state should  have some                                                               
sense of  what that  might be.   The  state will  be underwriting                                                               
these costs, which is a major change from today.                                                                                
                                                                                                                                
2:37:17 PM                                                                                                                    
                                                                                                                                
MR. EASON said the Department  of Revenue told the legislature it                                                               
has not included abandonment costs in  all its estimates.  He has                                                               
not seen any  estimate of the costs of abandoning  the Cook Inlet                                                               
platforms.  As an example of  a way Alaska could begin to examine                                                               
this  potential cost  to the  state, he  looked at  the costs  of                                                               
abandoning platforms on the California coast.                                                                                   
                                                                                                                                
REPRESENTATIVE  GUTTENBERG  asked  Mr.  Eason  about  abandonment                                                               
costs in  Prudhoe Bay.   He asked if he  is talking about  the "r                                                               
and r'  and what's been in  place since the original  leases.  He                                                               
asked if the past can be set aside as no longer valid.                                                                          
                                                                                                                                
MR. EASON asked  if he is referring to  the Trans-Alaska Pipeline                                                               
System.  He  said that "would stay just as  they are because it's                                                               
a  transportation.   Arguably you  can't  guarantee nobody  would                                                               
claim that, but I'm looking  upstream of the transportation.  But                                                               
including  the transportation-the  pipelines, the  flow stations,                                                               
all the things  upstream of that-I believe under  this bill would                                                               
be subject to your support in abandoning."                                                                                      
                                                                                                                                
REPRESENTATIVE GUTTENBERG  said, "So  it has to  be in  the bill,                                                               
otherwise it doesn't happen?"                                                                                                   
                                                                                                                                
MR. EASON said that is correct.                                                                                                 
                                                                                                                                
2:39:58 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE GATTO  said, "I  think he's  referring to  what we                                                               
call demobilization,  removal, and  rehabilitation."   That money                                                               
is supposed  to be set aside  for that eventual day  in an amount                                                               
sufficient to  make it all happen.   He asked if  new legislation                                                               
could eliminate that.                                                                                                           
                                                                                                                                
MR. EASON said he is talking  about field abandonment.  "I do not                                                               
believe anybody  has physically put  money aside for that.   They                                                               
are contemplating  it.  They  are in some fashion  accounting for                                                               
it."  He doubts  anybody has put money aside for it,  but it is a                                                               
known, and substantial, obligation.                                                                                             
                                                                                                                                
CO-CHAIR SAMUELS said it is just a future liability.                                                                            
                                                                                                                                
REPRESENTATIVE  GATTO said,  "I thought  it was  a nickel,  and I                                                               
think  the  only  thing  we're talking  about  was  removing  the                                                               
pipeline."  He still  wants to know if it is a  promise to pay or                                                               
is it money in the bank.                                                                                                        
                                                                                                                                
2:41:40 PM                                                                                                                    
                                                                                                                                
MR. EASON  said there is no  bank for the  money.  He said  it is                                                               
completely  separate from  the TAPS  and  upstream from  it.   It                                                               
would be  all the  wells that  have been  drilled, the  pads, and                                                               
whatever the  state requires.   Other agencies will play  a role,                                                               
including  the Fish  and Wildlife  Service and  the Environmental                                                               
Protection Agency.  "The question  is: who pays  for it?"   Under                                                               
existing law and existing leases,  the companies can deduct those                                                               
costs from their federal and  state corporate income taxes.  They                                                               
can't deduct  from the petroleum  tax, but will under  this bill.                                                               
He warned that there is an  exposure to allowing credit on top of                                                               
the deduction, even thought DOR has said that is not the intent.                                                                
                                                                                                                                
MR.  EASON  said  most  of  those costs  are  unknown.    The  23                                                               
platforms  that  will  be  abandoned   in  California  will  cost                                                               
anywhere from $10.29 million to $129  million.  It will cost more                                                               
in Alaska,  but not as  high as  the high estimate,  he surmised.                                                               
Under the net profit share leases,  the lessee pays a royalty and                                                               
is forced  to pay a  share the net  profits above that,  he said.                                                               
So  there  are  running  accounts for  those  leases  in  certain                                                               
fields.   Every  month and  year  the costs  are accumulated  and                                                               
carried forward,  "so at any point  in time you can  look and see                                                               
what  the  development account  balance  is  that's growing  with                                                               
interest."   That  gives an  indication for  two fields,  and the                                                               
estimated cost for  the Endicott field is about  $110 million, he                                                               
said.    The Northstar  field  has  a  $75 million  exposure  for                                                               
abandonment.     He  looked  at  the   applications  for  royalty                                                               
reductions, which  are confidential.   But the range  for royalty                                                               
applications  range  from  7-20  percent of  the  total  combined                                                               
facility and  well costs.  "Those  are very large numbers,  and I                                                               
think they  are large enough  that you should be  concerned about                                                               
trying to find out as much  as you can...[of] an estimate of what                                                               
those  costs might  be  spread across  all  the known  facilities                                                               
today."  It is significant, he opined.                                                                                          
                                                                                                                                
2:48:11 PM                                                                                                                    
                                                                                                                                
CO-CHAIR SAMUELS  noted the Mr.  Eason said small  companies want                                                               
cost recovery  definitions laid out  in statute, but it  has been                                                               
the large companies  requesting such from him.  He  added that if                                                               
it is  in statute,  the industry will  ask future  legislators to                                                               
change  it "and  into the  political  system we  go where  common                                                               
sense sometimes  doesn't quite bubble  to the top."   The benefit                                                               
of  putting it  in regulation  is the  bureaucrats can  speak the                                                               
same language,  but then the  industry complains about  the power                                                               
of the regulators, who are the  most qualified people to make the                                                               
determinations.  He asked for Mr. Eason's opinion.                                                                              
                                                                                                                                
2:49:51 PM                                                                                                                    
                                                                                                                                
MR.  EASON told  the committee  to prioritize  the policies  that                                                               
need the most clarification.  He  said to focus on costs that may                                                               
be  the greatest,  and  then define  or limit  those  costs.   He                                                               
suggested to  think of it  as a negotiation,  and it will  not be                                                               
unusual  to "split,  refine, qualify,  place sideboards."   There                                                               
could be  a limit  on the  percentage of  recovery that  tries to                                                               
measure the production  profile with its expected  revenue.  "The                                                               
worst possible  event you  would want is  to have  falling prices                                                               
when you didn't expect them,  really declining production because                                                               
the   fields   haven't  materialized,   and   a   bill  for   the                                                               
[indecipherable].   And  that's the  worst case...I  can remember                                                               
when, back  in the early 80s,  we were looking very  seriously at                                                               
statute to  make sure that we  had the statutory minimum  in case                                                               
the  prices  fell  below  the  field  costs  and  all  the  other                                                               
considerations  for the  state's royalty  oil.   So...those thing                                                               
can change very dramatically in very short order."                                                                              
                                                                                                                                
2:53:26 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE SEATON  surmise that Mr.  Eason is saying  is that                                                               
terms defined  in statute  need to  be modifiable  in regulation,                                                               
giving the  state more  flexibility but  more chance  of lawsuits                                                               
because people understand the terms differently.                                                                                
                                                                                                                                
2:53:59 PM                                                                                                                    
                                                                                                                                
MR. EASON said he would stop short  of calling for all of them in                                                               
statute.    He   suggested  defining  them  in   advance  by  the                                                               
department or  by consensus, "so that  there's an understanding."                                                               
He said  to identify  places where there  have been  problems and                                                               
fix them  or come to an  understanding.  He said  a working group                                                               
has been recommended for all of  the producers, and he noted that                                                               
the  Alaska Oil  and  Gas Association  may have  done  that.   He                                                               
stressed  that there  are broad  terms in  [HB 488]  that can  be                                                               
interpreted in costly ways, and he said to resolve those.                                                                       
                                                                                                                                
2:55:37 PM                                                                                                                    
                                                                                                                                
MR.  EASON  he said  there  was  some  language  in HB  488  with                                                               
historic themes.   He noted that when  negotiating agreements and                                                               
appeals, the state was urged to  resolve them by resorting to the                                                               
unit   operating  agreements   for  guidance   or  clarification.                                                               
Regarding  the  bill  he  said,  "anytime  I  see  a  legislative                                                               
directive   to  an   administrative  agency   that  they'll   use                                                               
'substantial  weight', I  know  that  somewhere there's  somebody                                                               
that's going to tell you what that  is, and it's likely to have a                                                               
different opinion between parties."   He added that the fact that                                                               
it's connected with an operating  agreement, again, "is sort of a                                                               
recurring theme.   You  may, as  a matter of  policy, want  to do                                                               
that if  you have more comfort  or exposure to them.   But...they                                                               
are  agreements among  the  working interest  owners  in a  unit.                                                               
They aren't agreements with the state.   The state has no control                                                               
over  the terms  and prove  them  or deny  them."   He said  some                                                               
things  that the  parties agree  to will  not be  in the  state's                                                               
interest.  There  are many operating agreements  and they differ,                                                               
he stated, and they are given to  the state as a courtesy and are                                                               
not  required.   The  agreements are  routinely  amended and  the                                                               
state often  doesn't have  the current agreement.   As  a royalty                                                               
owner  the state  needs  to  explore that  more,  he  said.   The                                                               
implications are unknown.                                                                                                       
                                                                                                                                
3:00:01 PM                                                                                                                    
                                                                                                                                
MR. EASON  said another recurrent  theme is adopting  the royalty                                                               
settlement agreement  values for determining value  for severance                                                               
taxes.  He noted that  three different settlement agreements were                                                               
negotiated in  resolving the oil phase  of Amerada Hess.   At any                                                               
point  in time  those numbers  usually were  different, he  said.                                                               
Sometimes  the calculation  of crude  is dramatically  different,                                                               
because one agreement  allows actual costs "and then  some."  "If                                                               
you start  thinking about which  one of  those you might  want to                                                               
use, there's  probably a  concern there...how  would you  do that                                                               
mechanically and why would you do that?"                                                                                        
                                                                                                                                
MR. EASON  said looking  back at the  performance of  the state's                                                               
royalty settlement  values against the severance  tax payments in                                                               
the first  ten years showed  consistent higher  average severance                                                               
tax value than  royalty settlement agreement value.   That number                                                               
has  grown larger  in the  last five  years, he  stated, with  an                                                               
average of  about $0.40  a barrel.   There is  a concern  that it                                                               
will grow.   Theoretically, the  department has the  authority to                                                               
consider  all  these things  for  indicators  of value,  and  the                                                               
effort to memorialize it in  statute raises a flag, because doing                                                               
that has produced a lower result.                                                                                               
                                                                                                                                
MR.  EASON said  the  royalty settlement  agreements provide  for                                                               
arbitration rather than litigation.   He spoke of his involvement                                                               
in  the agreements  and  DOR's role.   He  said  DOR enjoys  some                                                               
deference from the  courts.  The arbitration  proceedings for the                                                               
settlement  doesn't have  full  discovery  opportunities and  the                                                               
decision-making process is  much narrower.  He  said adopting the                                                               
royalty  settlement agreements  isn't clear  whether that  is the                                                               
fiscal  terms  only or  the  arbitration  option for  making  tax                                                               
decisions, which is a very different world with risk.                                                                           
                                                                                                                                
3:06:26 PM                                                                                                                    
                                                                                                                                
CO-CHAIR RAMRAS asked Mr. Eason  how the House Resources Standing                                                               
Committee was handling the legislative proceedings on HB 488.                                                                   
                                                                                                                                
3:08:12 PM                                                                                                                    
                                                                                                                                
MR.  EASON  said the  process  and  effort  is good,  and  Daniel                                                               
Johnston will  give the  committee his  sense of  the appropriate                                                               
way to go.                                                                                                                      
                                                                                                                                
CO-CHAIR RAMRAS asked about Mr. Eason's confidence in DOR.                                                                      
                                                                                                                                
MR. EASON  said he said  the DOR  people are qualified,  but "you                                                               
would  be  well-served to  have  as  many  eyes looking  at  this                                                               
problem as you  can."  He said  the bulk of the  expertise in the                                                               
state is in  DNR, which works every day with  every aspect of the                                                               
oil and gas industry.   He said to make sure  that DNR people are                                                               
complementing and consulting with DOR,  which he achieved when he                                                               
was the director of the Oil and Gas Division.                                                                                   
                                                                                                                                
3:12:57 PM                                                                                                                    
                                                                                                                                
CO-CHAIR RAMRAS  said there  are rumors that  "our guys"  are not                                                               
smart enough  to take  on "their guys,"  because the  best people                                                               
migrate to  the high paying  jobs in the  industry.  He  asked if                                                               
the  state can  handle  this task  or if  the  producers will  be                                                               
"high-fiving each other on their way out of town."                                                                              
                                                                                                                                
3:14:29 PM                                                                                                                    
                                                                                                                                
MR. EASON said he has met people  in the state who are as good as                                                               
anyone  in the  industry,  but  industry has  "more  of them  and                                                               
generally they  stay up longer  and start  earlier."  There  is a                                                               
built-in  competitive advantage  that goes  beyond intellect  and                                                               
talent.   He  said the  "resources were  always insufficient...to                                                               
assure you  that you were covering  all the bases."   The state's                                                               
work is precipitated by events out  of its control.  The industry                                                               
has the advantage of pursuing  specific programmatic agendas into                                                               
the future.                                                                                                                     
                                                                                                                                
REPRESENTATIVE   GARA   brought   up   the   royalty   settlement                                                               
methodology issue.  Section 20 of HB  488 comes up with a new way                                                               
of  assessing the  gross value  of oil  that will  be taxed.   He                                                               
asked if  the rewrite  raises the potential  to lose  millions or                                                               
billions  of dollars  compared to  current law.   He  asked if  a                                                               
producer will be  able to choose between two  tax methods, giving                                                               
them the opportunity to choose the lowest tax formula.                                                                          
                                                                                                                                
3:17:49 PM                                                                                                                    
                                                                                                                                
MR.  EASON  said the  PPT  is  based on  profits.    He said  the                                                               
producers have  always wanted both  royalty and tax  "using those                                                               
values."   Historically, "had  you done  that under  the existing                                                               
production tax gross system, you  would have lost money eight out                                                               
of the  last ten years that  the settlement has been  in effect."                                                               
In the last  five years, the state would have  lost more money-"a                                                               
big number."   He said the intent and exact  rules and procedures                                                               
are not clear.  "If you can find  out what that is you will get a                                                               
better sense of what  it might cost you."  He  added that all the                                                               
numbers are averages,  and "all we know at this  point is that on                                                               
the average the  royalty settlement values have  not performed as                                                               
well as the severance tax values under the existing system."                                                                    
                                                                                                                                
REPRESENTATIVE GARA asked, "If we  said 'no', we're just going to                                                               
go with how  we calculate the value under  current law...could we                                                               
do that  under the PPT?   Would it mesh  or do we have  to change                                                               
our definition of how we calculate the value?"                                                                                  
                                                                                                                                
MR. EASON said the way  values are calculated now, the department                                                               
has regulations  that they would  presumably follow.   "I believe                                                               
they have the  authority now, under regulations,  to make changes                                                               
in how they  value, and I presume they would  just continue to do                                                               
that...The flag that  is raised is why the emphasis  in this bill                                                               
to  reinforce that  option exclusive  of  others."   He said  the                                                               
concern is not knowing what  the operating agreements provide and                                                               
that  the state  can't affect  them, "but  you're being  asked in                                                               
this bill  to do something that  is-raises a question as  to why.                                                               
You're being  asked to say in  statute that the agency  must give                                                               
substantial weight to those."  He  asked what that weight is, and                                                               
said it will be resolved in law  or arbitration.  He asked if and                                                               
why operating agreements are intended  to be used since operating                                                               
agreements can be changed and are out of the state's control.                                                                   
                                                                                                                                
3:23:36 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  SEATON  mentioned  that allowable  costs  do  not                                                               
include headquarter operations.  If  there were two operators who                                                               
agreed  to  take off  $600  million  for headquarter  costs,  for                                                               
example,  "then   we  would  be  stuck   into  recognizing  those                                                               
headquarter costs as an allowable  deduction because we're giving                                                               
substantial weight to the operation agreement?"                                                                                 
                                                                                                                                
MR.  EASON said  the  if  statute doesn't  allow  that, "I  can't                                                               
believe that  they would  knowingly allow  it through  some other                                                               
mechanism."   He said the concern  is how far the  state wants to                                                               
go   regarding  the   costs  of   exploration,  production,   and                                                               
development.   It may be  a policy matter,  but he has  seen many                                                               
things suggested as allowable costs.   He noted that anyone doing                                                               
their income  tax tries to figure  out every [deduction].   It is                                                               
more  important  to  have protection  for  both  parties  without                                                               
unexpected  disadvantages to  either.   He  stressed getting  the                                                               
best information from many sources.                                                                                             
                                                                                                                                
REPRESENTATIVE  LEDOUX   asked  where  "substantial   weight"  is                                                               
defined.                                                                                                                        
                                                                                                                                
MR. EASON said it is not defined in HB 488, and it may vary.                                                                    
                                                                                                                                
REPRESENTATIVE LEDOUX asked if the courts defined it in Alaska.                                                                 
                                                                                                                                
MR. EASON said he doesn't know.                                                                                                 
                                                                                                                                
REPRESENTATIVE  CRAWFORD  said he  makes  a  great case  for  the                                                               
constitutional  requirement that  one  legislature  can't bind  a                                                               
future legislature.                                                                                                             
                                                                                                                                
3:30:50 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE KERTTULA  asked him to suggest  language regarding                                                               
the royalty settlement methodology and operating agreements.                                                                    
                                                                                                                                
MR. EASON said that is his intent.                                                                                              
                                                                                                                                
REPRESENTATIVE  GUTTENBERG said  Mr. Eason  is stressing  getting                                                               
the definitions  right.   It sounds like  the perception  is that                                                               
DOR is a backstop, and he asked  if it's possible to build in the                                                               
intent that if the call is close, "it goes to the home team."                                                                   
                                                                                                                                
MR. EASON said the attorneys will likely say no.                                                                                
                                                                                                                                
REPRESENTATIVE  COGHILL  said  he  heard  discussions  about  the                                                               
royalty  settlement methodology  and the  sharing of  profits and                                                               
where that fits for the  processing and treatment facilities.  It                                                               
will be  interesting "on  how we  set the areas."   He  asked for                                                               
help in understanding those parameters.                                                                                         
                                                                                                                                
MR. EASON said one important issue  on the royalty side is how to                                                               
define  the  point  of  production.     With  all  decisions  and                                                               
settlements,  the  legislature  corrected  that  for  the  future                                                               
leases, "they  just said you  can't do  that anymore.   You can't                                                               
issue a  lease that allows a  field cost."  There  are still many                                                               
out there, and the healthy majority  of the leases in Prudhoe Bay                                                               
are.  There  is already a field cost settlement  for oil and some                                                               
allowances for gas.   He said the Kuparuk original  area was also                                                               
"in the  deal."  There are  many leases that are  unclear, but it                                                               
is related  to how to define  point of production.   There is the                                                               
issue  of what  is merchantable,  which can  change depending  on                                                               
where you are.                                                                                                                  
                                                                                                                                
MR. EASON  said the  state can  write the  regulations "so  as to                                                               
move  in a  situation where  you are  going to  build facilities,                                                               
depending on how  the regs define the point of  production.  Some                                                               
facilities  potentially  will be  able  to  claim deductions  and                                                               
credits  under  this  bill,  and  some may  not  if  they  aren't                                                               
configured  in the  way that  takes advantage  of...I don't  mean                                                               
unfairly,  just  does  this  in   recognition  of  what  the  tax                                                               
consequences are."   He said there isn't much  gas being produced                                                               
now, but the hope  is for a major gas sale.   The decision on how                                                               
and  where to  place  those  facilities is  not  clear, he  said.                                                               
Because of  that uncertainty,  there is a  valid question  of how                                                               
much and  what pieces  the state  will assume  the responsibility                                                               
for carrying  those deductions and  credits.  It is  important to                                                               
determine  the intent  of the  parties  and what  is upstream  or                                                               
downstream relative to the pipeline.                                                                                            
                                                                                                                                
3:39:39 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  COGHILL  said,  "We're  going to  have  to  start                                                               
defining what  they can deduct."   He noted that the  movement of                                                               
gas and oil will be part of the discussion in that regard.                                                                      
                                                                                                                                
MR.  EASON  said the  processing  and  production facilities  can                                                               
change over  time.  Currently,  "you know that from  the wellhead                                                               
to the final product there's-you  can control where things happen                                                               
with the  technology."  He said  the Division of Oil  and Gas may                                                               
be able  to help.   He said the  issue has  been big in  the past                                                               
with large  consequences.  The state  will be faced with  a large                                                               
project, and the goal is to clarify the intent.                                                                                 
                                                                                                                                
3:41:30 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  LEDOUX said  rather  than incorporating  nebulous                                                               
phrases  into the  bill  such as  "operating  agreements will  be                                                               
given  substantial weight,"  why  not just  list  each item  that                                                               
would be  accepted as a reasonable  cost?  It is  better to argue                                                               
about it now than to argue in court for the next 15 years.                                                                      
                                                                                                                                
MR. EASON  stated that some  companies prefer this route,  and it                                                               
may not be the best solution but  is one solution.  He said he is                                                               
not the only one who thinks that it is important to do.                                                                         
                                                                                                                                
CO-CHAIR SAMUELS noted  that if the statute  misses something, it                                                               
will be difficult to change it.                                                                                                 
                                                                                                                                
REPRESENTATIVE WILSON spoke of abandonment  costs,  and asked Mr.                                                               
Eason if  he said the  legislature has  to be careful  because of                                                               
the credits with  no timeline.  "Would you suggest  that we put a                                                               
timeline on  the credits  so that we  don't inadvertently  end up                                                               
doing a  bigger portion  of that  abandonment cost  ourselves, or                                                               
did you say that maybe we should just look at a percentage?"                                                                    
                                                                                                                                
MR.  EASON  said there  are  two  policy  calls.   The  bill  now                                                               
includes   abandonment  costs   as   part   of  development   and                                                               
production,  so that  would mean  underwriting the  full cost  of                                                               
abandonment.  The state can  decide to underwrite a percentage of                                                               
those  costs or  decide to  only  allow new  developments.   Many                                                               
players entered  into projects years  ago with  an understanding,                                                               
he said.  But he stressed looking  at the numbers.  He noted that                                                               
the bill  is designed to  encourage exploration  and development,                                                               
but there  is nothing  intellectually wrong  with sharing  in the                                                               
costs of  abandonment.   It could  be done  based on  the volumes                                                               
produced, he said,  and there are many options  besides the bill,                                                               
which underwrites all those costs of  abandonment.  He said it is                                                               
important to know what those figures will be.                                                                                   
                                                                                                                                
3:47:40 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE COGHILL  asked for  an explanation  of arbitration                                                               
as set in the bill in terms of working on the definitions.                                                                      
                                                                                                                                
3:48:18 PM                                                                                                                    
                                                                                                                                
MR. EASON said  there is currently no  provision for arbitration.                                                               
He  said  producers have  wanted  to  substitute arbitration  for                                                               
litigation.  Some  arbitration is fast but not  all; sometimes it                                                               
takes a  year to pick an  arbitration panel, he said.   At times,                                                               
litigation  is better  for complex  issues.   Producers are  more                                                               
comfortable  with arbitration  because they  do a  lot of  it, he                                                               
stated, but they find themselves being sued a lot.                                                                              
                                                                                                                                
REPRESENTATIVE  COGHILL  said,  "Do   we  get  better  definition                                                               
through  litigation?   And  then  the  discovery issue,  is  that                                                               
because  you can  force proprietary  information to  come to  the                                                               
table through litigation against arbitration?"                                                                                  
                                                                                                                                
MR.  EASON said  he would  not  say that  litigation gave  better                                                               
clarification, generally.   He said some judges  resolve all your                                                               
concerns  and  others  raise  new ones.    Some  arbitrators  are                                                               
limited in their  decisions.  He said his experience  is that the                                                               
state  has   been  disadvantaged   by  the  relative   wealth  of                                                               
information  when it  comes  to a  dispute.   The  state has  the                                                               
reports and numbers  and a relatively imperfect sense  of why and                                                               
how, he added.   The producers don't have to  discover very much;                                                               
they have all the information.                                                                                                  
                                                                                                                                
REPRESENTATIVE  COGHILL noted  that the  state is  always on  the                                                               
defensive  in those  situations, but  with rule-making  the state                                                               
can be in the offensive position.                                                                                               
                                                                                                                                
REPRESENTATIVE SEATON asked  if the problem on  abandonment is an                                                               
incentive to shut down in marginal production.                                                                                  
                                                                                                                                
MR. EASON  said there  are probably many  ways to  evaluate that.                                                               
He  said the  cost of  continuing to  produce is  underwritten to                                                               
some  degree,  and  [allowing deductions  of  abandonment  costs]                                                               
could create different  outcomes.  He said  the fundamental issue                                                               
is figuring out how much  financial exposure the state might have                                                               
and making  a judgment at  that point.   He said  the legislature                                                               
doesn't have  enough information right  now to make  the decision                                                               
of underwriting those costs.                                                                                                    
                                                                                                                                
3:57:16 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  SEATON asked  about the  tax flow  being reduced,                                                               
and  giving the  industry an  allowance on  abandonment expenses,                                                               
and especially  credits.  A  future legislature may have  a small                                                               
flow  of cash  coming  in, and  it might  be  more important  for                                                               
future legislatures when the fields are declining, he surmised.                                                                 
                                                                                                                                
MR. EASON said  that is fair.  "You know  you've got these things                                                               
and you  know somebody's going to  have to abandon them,  and you                                                               
know that now it's not your problem, and tomorrow it will be."                                                                  
                                                                                                                                
REPRESENTATIVE LEDOUX suggested  fashioning an arbitration clause                                                               
to make discovery just as liberal as under litigation.                                                                          
                                                                                                                                
MR. EASON  said it  may be  possible if  there is  agreement, but                                                               
arbitration terms can't be dictated.   There is nothing in HB 488                                                               
that  directs the  parties to  arbitration.   It is  suggested by                                                               
other language, he said.  It is something that can be explored.                                                                 
                                                                                                                                
4:01:03 PM                                                                                                                    
                                                                                                                                
CO-CHAIR RAMRAS  spoke of previous testimony  that expressed that                                                               
indemnification should  not be excluded as  a cost.  He  asked if                                                               
the  bill is  excluding Alaska  micro-players and  if there  is a                                                               
special remedy for that.                                                                                                        
                                                                                                                                
MR. EASON  said helping Alaskan  companies is a legal  issue, but                                                               
it may  be able  to be  done creatively.   He said  helping small                                                               
companies, "is  a perennial question...You  have to  be sensitive                                                               
to it  but there's no  end of  things that people...can  think of                                                               
that they  need help with."   The state has a  commendable record                                                               
of   being  responsive   to  small   companies,  like   providing                                                               
exploration  licensing.    He said  that  people  have  revisited                                                               
bonding,  and  those  numbers  have   decreased.    He  spoke  of                                                               
exploration  credits,  and  noted   that  the  state  is  already                                                               
providing incentives on a limited basis.                                                                                        
                                                                                                                                
4:06:10 PM                                                                                                                    
                                                                                                                                
MR. EASON  said there  have been  companies and  individuals that                                                               
"were really playing above their  heads," and the state bears the                                                               
risk  by encouraging  small entities  without ending  up with  an                                                               
uncontrolled  spill and  no liability  or coverage.   There  is a                                                               
host of  things that can  happen, including litigation,  and this                                                               
business requires a certain level of underwriting.                                                                              
                                                                                                                                
4:07:07 PM                                                                                                                    
                                                                                                                                
[HB 488 was heard and held.]                                                                                                    

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