Legislature(2007 - 2008)BARNES 124

03/21/2007 01:00 PM RESOURCES


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01:07:08 PM Start
01:07:27 PM Presentation: Ncsl/usda
02:15:15 PM HB128
02:55:50 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Presentation: NCSL/USDA TELECONFERENCED
+= HB 128 OIL & GAS PRODUCTION TAX: EXPENDITURES TELECONFERENCED
Heard & Held
+ Bills Previously Heard/Scheduled TELECONFERENCED
HB 128-OIL & GAS PRODUCTION TAX: EXPENDITURES                                                                                 
                                                                                                                                
2:15:15 PM                                                                                                                    
                                                                                                                                
CO-CHAIR GATTO announced  that the final order  of business would                                                               
be  HOUSE BILL  NO.  128,  "An Act  relating  to allowable  lease                                                               
expenditures for  the purpose of  determining the  production tax                                                               
value  of  oil and  gas  for  the purposes  of  the  oil and  gas                                                               
production tax;  and providing for  an effective date."   [Before                                                               
the committee was CSHB 128(O&G).]                                                                                               
                                                                                                                                
The committee took an at-ease from 2:16 p.m. to 2:17 p.m.                                                                       
                                                                                                                                
2:18:35 PM                                                                                                                    
                                                                                                                                
KEVIN BANKS, Acting  Director, Division of Oil  & Gas, Department                                                               
of Natural Resources  (DNR), began by relating  DNR's support for                                                               
HB 128.  He  then turned to paragraph (19) [on  page 3, lines 19-                                                               
23] of  the legislation, which  suggests a new category  of costs                                                               
that  would   be  eliminated  from   a  potential   deduction  in                                                               
calculating  the petroleum  production profits  tax (PPT)  should                                                               
there  be   repair  or   replacement  or   improperly  maintained                                                               
property.                                                                                                                       
                                                                                                                                
2:20:11 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  GATTO  asked  if  DNR  has a  definition  of  the  term                                                               
"improper."                                                                                                                     
                                                                                                                                
MR.   BANKS  related   his  understanding   that  John   Iversen,                                                               
Department of  Revenue (DOR), has  been working  with Legislative                                                               
Legal and  Research Services,  himself, and  staff of  the Alaska                                                               
Oil  and Gas  Conservation  Commission (AOGCC)  to develop  clear                                                               
language.  Mr. Banks related his  belief that this is a provision                                                               
of the petroleum  production profits tax (PPT) that  would not be                                                               
used  very  frequently.   He  suspected  that  there could  be  a                                                               
situation  in which  an auditor  determines there  has been  some                                                               
kind of  failure, which  would indicate  that there's  a problem.                                                               
At  that point  the commissioner  of DOR,  under this  provision,                                                               
would be able  to consult with DNR,  the Conservation Commission,                                                               
or  the Department  of Environmental  Conservation (DEC)  and ask                                                               
whether  something  had  occurred  or  whether  the  failure  had                                                               
occurred   due   to   improper    maintenance.      After   those                                                               
conversations,  the  commissioner will  be  able  to assemble  an                                                               
opinion regarding whether  or not a facility  had been improperly                                                               
maintained.   At this point,  the commissioner of DOR  could take                                                               
it  or leave  it  as he  is  only tasked  with  taking such  into                                                               
consideration when  making a decision regarding  whether the cost                                                               
is deductible or not.    He highlighted that DNR is now embarking                                                               
on an  effort, as  a consequence  of the  events last  spring and                                                               
summer, to create the Petroleum  Systems Integrity Office (PSIO).                                                               
The  PSIO   will  be   responsible  for   collecting  information                                                               
regarding  how facilities  owned  and operated  by the  [state's]                                                               
lessees  are  being  maintained.    The PSIO  will  rely  on  the                                                               
internal controls  that the operators normally  use in scheduling                                                               
maintenance,  various   industry  standards,   as  well   as  the                                                               
operators' own internal controls for maintaining equipment.                                                                     
                                                                                                                                
2:24:47 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE   WILSON  related   her  understanding   that  the                                                               
department can already do what HB 128 says.                                                                                     
                                                                                                                                
2:25:14 PM                                                                                                                    
                                                                                                                                
MR. BANKS explained that [the  department], as the landlord, will                                                               
be  extending  the oversight  over  operations  conducted by  the                                                               
lessees.  The purpose of this  organization is not to provide, on                                                               
a  routine  basis,  information   that's  relevant  to  a  taxing                                                               
authority of  the state.   He clarified that [the  department] is                                                               
going  to assure  that the  facilities  in operation  in the  oil                                                               
field are  being taken  care of.   When  the commissioner  of DOR                                                               
comes to DNR and wants to  know whether or not equipment has been                                                               
maintained  appropriately.   Once [the  PSIO] is  up and  running                                                               
there  will be  evidence to  share to  answer the  aforementioned                                                               
question.   In  fact, he  suggested  that a  lessee knowing  that                                                               
potentially  the  cost of  maintenance  activities  might not  be                                                               
deductible  under taxes  may have  the incentive  to provide  the                                                               
PSIO with  information that they  have properly  maintained their                                                               
equipment.    The evidence  DNR  may  collect  would serve  as  a                                                               
benefit to establish  that the lessee or  taxpayer had legitimate                                                               
costs to be deducted.                                                                                                           
                                                                                                                                
2:27:05 PM                                                                                                                    
                                                                                                                                
CO-CHAIR GATTO  asked if this  requires a person on-site  or will                                                               
the poor maintenance  or nonmaintenance be based  on the evidence                                                               
of  a  leak, corrosion,  or  a  pipe shut  down.    He noted  his                                                               
understanding that there can be a  pipe shut down for a number of                                                               
reasons, none of  which are improper maintenance.   Therefore, he                                                               
questioned whether there  is a test that  would determine whether                                                               
there is  proper maintenance,  improper maintenance,  failure, et                                                               
cetera.                                                                                                                         
                                                                                                                                
MR. BANKS responded  that as part of the routine  function of the                                                               
PSIO, PSIO staff will examine  the records and documents provided                                                               
by the  lessees that  illustrate the  types of  maintenance plans                                                               
and  equipment replacement  planning  in place.    The PSIO  will                                                               
verify that the lessee did what it  said it would do.  There will                                                               
also be  occasional on-site inspections to  ensure that equipment                                                               
is  in place  that  the  lessees specify  and  meet the  standard                                                               
certification  expected in  the various  settings utilized.   The                                                               
idea,  he clarified,  is to  ensure nothing  happens.   Mr. Banks                                                               
emphasized  that  the PSIO  won't  pursue  a problem.    However,                                                               
pursuing a problem may be the  result of a tax audit that reveals                                                               
a   failure   due  to   improper   maintenance.     Under   those                                                               
circumstances, the commissioner of DOR  may request that DNR help                                                               
determine  whether [the  failure] was  caused by  an accident  or                                                               
gross  negligence   or  something  in  between,   which  is  what                                                               
paragraph (19)  attempts to  address.  At  that point  [the PSIO]                                                               
can turn to its records and information to establish that.                                                                      
                                                                                                                                
2:30:11 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE WILSON recalled that  the PPT legislation included                                                               
language  that would  cover the  existing situation.   Therefore,                                                               
she questioned whether, because  of regulations, BP's request for                                                               
a tax  credit could  be disallowed, if  the department  so chose.                                                               
She  expressed interest  in understanding  what HB  128 is  doing                                                               
that's different.                                                                                                               
                                                                                                                                
MR.   BANKS   replied   that  the   regulations   regarding   the                                                               
implementation   of  terms   like  improper   maintenance,  gross                                                               
negligence, and other  aspects of this particular  section of the                                                               
PPT is the responsibility of DOR.                                                                                               
                                                                                                                                
2:31:55 PM                                                                                                                    
                                                                                                                                
JONATHAN  IVERSEN,  Director,  Anchorage  Office,  Tax  Division,                                                               
Department  of  Revenue,   said  that  there  are   a  number  of                                                               
provisions in  the PPT already  that would be applicable  to this                                                               
sort  of repair  costs.   Although there  are a  number of  tools                                                               
under the  PPT to  exclude costs,  HB 128  would help  to clarify                                                               
whether  costs  attributable  to   improper  maintenance  can  be                                                               
excluded, in  the absence of  gross negligence.   The legislation                                                               
before the committee today makes it bulletproof, he opined.                                                                     
                                                                                                                                
2:33:20 PM                                                                                                                    
                                                                                                                                
ROBERT E. MINTZ, Attorney at  Law, Kirkpatrick & Lockhart Preston                                                               
Gates  Ellis LLP,  explained that  the  current law  has an  area                                                               
which is clear and an area that  isn't.  The area of existing law                                                               
that is clear is the exclusion  of costs due to gross negligence.                                                               
However, gross negligence  is a much narrower  category than what                                                               
this  legislation is  trying to  address,  which is  the lack  of                                                               
maintenance or improper maintenance.   The unclear portion is the                                                               
general  definition of  lease expenditures  or deductible  costs,                                                               
which  are ordinary,  necessary, and  direct costs  of exploring,                                                               
developing, or producing  oil and gas deposits.  He  said that in                                                               
interpreting  that general  definition, current  law directs  the                                                               
department to review typical industry  practices and standards in                                                               
the state  that are reflected in  the types of costs  that may be                                                               
billed  under  joint operating  agreements.    If the  department                                                               
reviewed this and determined that  improper maintenance costs are                                                               
typically  disallowed  by industry  practice,  then  it would  be                                                               
firmer ground to disallow them.   If the facts are otherwise, the                                                               
department would have  to rely on the  gross negligence standard.                                                               
Mr.  Mintz   specified  his  agreement  with   Mr.  Iversen  that                                                               
legislation is  appropriate if the  legislature is  interested in                                                               
making clear  that costs due  to lack of maintenance  or improper                                                               
maintenance should be excluded.                                                                                                 
                                                                                                                                
2:35:29 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE SEATON  related his  understanding that  Mr. Mintz                                                               
is  excluding  the  lease expenditure  portion  of  the  enrolled                                                               
version  of House  Bill  3001 on  page 28  [which  was passed  in                                                               
2006].  Under  that provision, there is another  fallback so that                                                               
if the other  producers within that lease don't  allow that those                                                               
deductions  were   legitimate  deductions   or  were   caused  by                                                               
negligence, then  the state automatically  doesn't allow  them as                                                               
well or can exclude those costs  as well.  Therefore, there seems                                                               
to  be gross  negligence  and  negligence as  seen  by the  other                                                               
owners on that  lease.  He questioned, "Can you  tell me then, in                                                               
reference  to  that,  where  is this  new  standard  of  improper                                                               
maintenance come from our standpoint  if the other owners of that                                                               
lease don't consider that the  improper maintenance was enough to                                                               
not  allow that  to be  deducted from  the operator's  costs that                                                               
they're  billing  them.   At  what  point  does our  standard  of                                                               
improper maintenance come in?"                                                                                                  
                                                                                                                                
2:37:26 PM                                                                                                                    
                                                                                                                                
MR. MINTZ stated  his agreement that if the costs  were in a unit                                                               
subject to  a unit  operating agreement  that the  department had                                                               
approved  or acquired  under  [AS 43.55].165(c)  or  (d) and  the                                                               
producers  disallow the  bill,  it would  be  disallowed for  tax                                                               
purposes  as  well.    He then  related  his  understanding  that                                                               
Representative Seaton  is proposing a  situation in which  HB 128                                                               
is passed, but there's a situation  in which the costs are billed                                                               
under an operating  agreement and the partners  don't dispute it,                                                               
they pay  it.  The  question is whether  the state would  have to                                                               
allow  it as  a  deduction, to  which the  answer  is no  because                                                               
subsections (c)  and (d)  specifically exclude  all of  the items                                                               
listed in subsection  (e).  He directed attention  to the lead-in                                                               
language to  subsection (c)(1) on  page 28 and  subsection (d)(1)                                                               
on  page 29  of House  Bill 3001.   The  language specifies  that                                                               
lease expenditures  that are  deductible are  the costs  that are                                                               
listed other  than items listed in  (e) of the section,  which is                                                               
the list of excluded items.                                                                                                     
                                                                                                                                
2:39:16 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE SEATON said:                                                                                                     
                                                                                                                                
     That's what I  was recognizing.  All  of these, whether                                                                    
     it's the  gross negligence  standard or the  ... strict                                                                    
     liability clause  of 16 if  there's a spill.   And then                                                                    
     we  have this  third fallback  that we're  just talking                                                                    
     about in lease expenditures.   If they're disallowed by                                                                    
     the  other  operators. ...  I  guess  if we're  talking                                                                    
     about  standards  of  the industry  and  we're  talking                                                                    
     about  standards that  are used,  ... is  your position                                                                    
     that the  other owners are going  to automatically roll                                                                    
     over for these big high  costs or you would expect them                                                                    
     to  roll-in and  pay a  good percentage  of these  high                                                                    
     costs if they attribute  them to negligent operation of                                                                    
     the  unit.   If that's  not the  case, then  what we're                                                                    
     talking about a  whole series that is  beyond what they                                                                    
     would disallow for negligence.  Is that correct?                                                                           
                                                                                                                                
MR. MINTZ  said he  wasn't sure  he could  predict how  the other                                                               
owners are going to behave.   However, he recalled that in one of                                                               
the early  hearings of  [House Bill  3001] a  representative from                                                               
ConocoPhillips Alaska,  Inc. (ConocoPhillips) discussed  that its                                                               
corporate  policy in  reference to  bills is  to challenge  bills                                                               
that they believe  are due to gross negligence or  the acts of an                                                               
imprudent operator.  He further  recalled that the ConocoPhillips                                                               
representative said  that a determination  had not yet  been made                                                               
as  to the  company's position  related to  the particular  costs                                                               
related to pipeline corrosion.                                                                                                  
                                                                                                                                
2:41:49 PM                                                                                                                    
                                                                                                                                
DON  BULLOCK, Attorney,  Legislative  Legal Counsel,  Legislative                                                               
Legal   and  Research   Services,  Legislative   Affairs  Agency,                                                               
explained that under the PPT  the producers are allowed to deduct                                                               
the  allowable  lease  expenditures  in  determining  their  tax.                                                               
Under the  22.5 percent tax rate  if there's a $1  deduction, the                                                               
state  shares  22.5 cents  of  the  cost.    In addition  to  the                                                               
deduction  allowed in  determining the  amount of  the tax  to be                                                               
paid,  there  is also  a  credit  for certain  qualified  capital                                                               
expenditures.    The   aforementioned  provides  [the  producers]                                                               
another 20  percent of their  qualified capital expenditure.   He                                                               
highlighted that  to be a  qualified capital expenditure,  it has                                                               
to  also  be an  allowable  lease  expenditure.   This  bill,  he                                                               
stated, presents  the question of  how much risk the  state wants                                                               
to be for certain costs.   Mr. Bullock then turned to negligence,                                                               
and  pointed out  that an  entity would  be negligent  because it                                                               
didn't  do what  was expected.   Therefore,  HB 128  requires the                                                               
commissioner  of  DOR  to  determine   what  is  good  oil  field                                                               
practice.  The legislation specifies  that certain deductions for                                                               
cost  will  be given,  but  a  certain  level of  performance  is                                                               
expected.   How much of  a deviation  from what's expected  to be                                                               
good oil  field practice will  be determined by  the commissioner                                                               
of DOR.                                                                                                                         
                                                                                                                                
MR. BULLOCK then  turned to the matter of depreciation.   The PPT                                                               
has  some aspects  of an  income tax  as it  starts with  a gross                                                               
value  at the  point of  production  and the  costs are  allowed.                                                               
However,   the  [costs]   are  all   expensed   and  there's   no                                                               
capitalization.  This means that  regular maintenance costs would                                                               
be deducted  over the  year as  they go,  but if  equipment isn't                                                               
maintained, then  there would be a  disproportionate deduction to                                                               
make  up.   Therefore,  if the  cost is  one  that could've  been                                                               
prevented, then the question with HB  128 is whether the state is                                                               
going to share in the cost  of something less than what the state                                                               
finds to be an acceptable standard.                                                                                             
                                                                                                                                
2:45:23 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  GATTO posed  a scenario  during which  the first  three                                                               
years there  are normal  maintenance costs of  one, one,  and one                                                               
for  a total  of three.   He  then posed  a scenario  in which  a                                                               
company doesn't  do maintenance until  the fourth year  when it's                                                               
four, which  would've been  normal.  In  such a  situation should                                                               
the  company be  penalized for  doing all  of its  maintenance in                                                               
year  four, or  should the  company  be penalized  for not  doing                                                               
maintenance during the first three years.                                                                                       
                                                                                                                                
MR. BULLOCK  explained that it's  the history of  the maintenance                                                               
as well as whether the  company should've done something in prior                                                               
years that later resulted in  extraordinary cost.  The [question]                                                               
is whether  the company  deviated from the  standard of  good oil                                                               
field practice.  This legislation  has the following two aspects:                                                               
it tells a  producer what level of performance  is expected, that                                                               
they  be consistent  with good  oil  field practice;  and if  the                                                               
producer  doesn't [follow  good oil  field practices],  the state                                                               
doesn't want to share in costs that could've been avoided.                                                                      
                                                                                                                                
2:46:33 PM                                                                                                                    
                                                                                                                                
CO-CHAIR GATTO posed a situation in  which in year four a company                                                               
only has  an expense  of three, and  asked whether  the companies                                                               
should  be rewarded  for  delaying maintenance  to  year four  or                                                               
should they be penalized for not doing one, one, and one.                                                                       
                                                                                                                                
MR. BULLOCK said,  "You do that in the forms  already in the bill                                                               
[by] giving  credit for  development of new  equipment.   That is                                                               
something  you  can  consider."    The narrow  scope  of  HB  128                                                               
addresses the  level of operation  that's expected for  the state                                                               
to share the cost.                                                                                                              
                                                                                                                                
2:47:14 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE SEATON  commented that  he is unclear  with regard                                                               
to the  standard for life  expectancy of  something.  He  posed a                                                               
situation in which  something has a life expectancy  of 20 years,                                                               
but in  the 22nd  year it  breaks and causes  the pipeline  to be                                                               
shut  down.   In  such  a  situation,  when  does the  amount  of                                                               
maintenance  and  something's useful  life  come  into play  with                                                               
regard to improper  maintenance and subparagraphs (B)  and (C) in                                                               
relation to a partial or complete shutdown.                                                                                     
                                                                                                                                
MR.  BULLOCK  opined that  the  aforementioned  is why  the  bill                                                               
sponsor asked the  commissioner of DOR to  determine the expected                                                               
standard.  Still,  it's logical to assume that toward  the end of                                                               
the useful life  of property, it would  require more maintenance.                                                               
He mentioned  the notion of  normal wear and tear  versus unusual                                                               
wear and tear.   He reminded the committee that  it's a matter of                                                               
what good oil  field practice requires after [the  useful life of                                                               
an item].   One option is to insert  presumption specifying clear                                                               
examples of  what should be  done.   He recalled that  during the                                                               
hearings  in the  House Special  Committee  on Oil  and Gas,  how                                                               
often  the inspection  pigs were  utilized was  mentioned.   As a                                                               
policy,  certain inspections  could  be required  in addition  to                                                               
good oil field practice.                                                                                                        
                                                                                                                                
2:49:33 PM                                                                                                                    
                                                                                                                                
CO-CHAIR GATTO  read lines 19-23  on page  3, and opined  it's an                                                               
almost impossible standard to meet.   He asked if there's any way                                                               
to get to an easy standard.                                                                                                     
                                                                                                                                
MR. BULLOCK said  that the committee is facing whether  this is a                                                               
high  standard or  merely the  expected standard.   The  state is                                                               
sharing  in  the  costs through  these  deductions  and  credits.                                                               
Therefore, it's  a policy determination  as to how  much latitude                                                               
the  committee  wants   to  allow.    He  pointed   out  that  AS                                                               
43.55.165(a)  discusses  ordinary  and   necessary  costs.    The                                                               
aforementioned  is  the rule  of  thumb.   Subsection  (e)  being                                                               
amended by HB 128 is where  the legislature decides how much risk                                                               
the state will take and what costs  will be shared as well as for                                                               
which  expenditures, through  leases  expenditures and  qualified                                                               
capital expenditures, a credit will be allowed.                                                                                 
                                                                                                                                
2:52:12 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  GATTO  recalled  that  the  $.30  was  inserted  for  a                                                               
specific maintenance reason.   He asked if it  would've helped to                                                               
have never had that $.30 cents or should it be higher.                                                                          
                                                                                                                                
MR. BULLOCK replied  that there may be different  reasons to have                                                               
the $.30.  One of the ironies  of the [$.30 provision] is that if                                                               
there are  malfunctions and declining  production and  the volume                                                               
decreased,  the   $.30  times  the  lower   volume  broadens  the                                                               
deduction that can be taken as it lowers the threshold.                                                                         
                                                                                                                                
2:53:19 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  SEATON expressed  concern  that most  all of  the                                                               
standards are  fairly firm,  save this one.   "The  industry," he                                                               
opined, "is  going to  have a  very hard  time pinning  down what                                                               
proactively is going to be  determined in retrospect if something                                                               
happens  ... to  have  been improper  maintenance."   He  further                                                               
opined that this  standard will depend more on  whether the state                                                               
is  running a  surplus or  deficit in  the budget.   The  earlier                                                               
suggestion  of   including  some  presumptions  might   help,  he                                                               
commented.  He  then turned attention to the language  on page 3,                                                               
line 19, where it says, "costs  or that portion of the costs" and                                                           
recalled that  one of  the commissioners  that would  be deciding                                                               
that didn't seem to know what that standard is.                                                                                 
                                                                                                                                
2:55:12 PM                                                                                                                    
                                                                                                                                
CO-CHAIR GATTO announced that this  Friday at 1:00, the committee                                                               
will  accept  testimony  on what  constitutes  proper  oil  field                                                               
practices.                                                                                                                      
                                                                                                                                
[HB 128 was held over.]                                                                                                         

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