Legislature(2011 - 2012)BARNES 124

02/09/2011 01:00 PM RESOURCES

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01:01:11 PM Start
01:01:55 PM Presentation(s): History of Oil Taxes in Alaska
03:02:54 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
"The History of Oil Taxes in Alaska," by
Roger Marks, LB&A Consultant
      PRESENTATION(S):  The History of Oil Taxes in Alaska                                                                  
           [Contains discussion of HB 17 and HB 110]                                                                            
1:01:55 PM                                                                                                                    
CO-CHAIR FEIGE  announced that  the only order  of business  is a                                                               
presentation  on the  history of  oil  taxes in  Alaska by  Roger                                                               
Marks.  He pointed out that  Mr. Marks is especially qualified to                                                               
give this presentation because his  career has spanned the entire                                                               
history of oil taxation in Alaska.                                                                                              
1:02:48 PM                                                                                                                    
ROGER MARKS,  Economist, Logsdon & Associates,  Consultant to the                                                               
Legislative Budget  and Audit Committee,  first noted  that prior                                                               
to entering  private practice  two years ago  he was  a petroleum                                                               
economist  with  the Department  of  Revenue,  Tax Division,  for                                                               
about 25 years.   Much of his time with  the department was spent                                                               
analyzing the production tax and  he had some involvement in many                                                               
of the  events that he  is talking about  today.  He  pointed out                                                               
that for some of the events  he is discussing there is no written                                                               
record of the details, so  his descriptions reflect a combination                                                               
of his recollections  and the many conversations he  has had with                                                               
lots of  people over the years.   He cautioned that  other people                                                               
could have  different recollections and interpretations  of those                                                               
MR.  MARKS specified  that  his talk  concentrates  on the  North                                                               
Slope.   The two  major forces of  production and  price flavored                                                               
the events  of the  past 34  years.  Flow  of Alaska  North Slope                                                               
(ANS) crude  oil through the Trans-Alaska  Pipeline System (TAPS)                                                               
started in 1977 (slide  2).  This flow peaked in  1988 at about 2                                                               
million barrels  a day and has  been declining ever since.   Cook                                                               
Inlet,  also an  important part  of Alaska  oil and  gas history,                                                               
started in 1958  with the Swanson River field.   Cook Inlet [oil]                                                               
production peaked  in 1970  at about 200,000  barrels and  is now                                                               
down to just 10,000 barrels a  day.  Gas production in Cook Inlet                                                               
peaked at about  2 billion cubic feet a day  during the 1990s and                                                               
since then has been at about three-fourths of that level.                                                                       
1:05:17 PM                                                                                                                    
MR. MARKS pointed out that while  the bumps in price between 1977                                                               
and  1997  (slide 3)  do  not  look like  much  on  the graph,  a                                                               
difference of $5 a  barrel back then was a huge  deal in terms of                                                               
state  revenues.    Notable  past   events  are  the  1979  Iraqi                                                               
Revolution, the 1986 oil price crash  to about $6 per barrel when                                                               
the Organization of Petroleum  Exporting Countries (OPEC) flooded                                                               
the  market  to enforce  some  market  discipline, and  the  1990                                                               
[Persian] Gulf War.  Since 1998  prices have been climbing due to                                                               
a combination  of increased world demand  and the end of  the era                                                               
of  cheap oil.   Every  new barrel  of oil  produced now  is more                                                               
expensive to produce.  Alaska,  he noted, has been very fortunate                                                               
that  the  decline in  its  production  has  been offset  by  the                                                               
concurrent increase in oil price.                                                                                               
MR. MARKS defined  the production, or severance, tax as  a tax on                                                               
producing  or severing  a non-renewable  resource from  the state                                                               
(slide  4).   Authorized  in  AS 43.55  and  administered by  the                                                               
Department of  Revenue (DOR), the  tax applies to  all production                                                               
in the state, including onshore  state land, state land extending                                                               
three miles  offshore, and federal  onshore acreage, such  as any                                                               
production from the National  Petroleum Reserve-Alaska (NPR-A) or                                                               
the Arctic  National Wildlife Refuge  (ANWR).  Production  tax is                                                               
not   payable  on   the  public   (state  and   federal)  royalty                                                               
production.   Most  state leases  have  a royalty  of about  one-                                                               
eighth,  so the  production tax  is  only payable  on the  seven-                                                               
eighths that is non-royalty.                                                                                                    
1:07:33 PM                                                                                                                    
MR. MARKS  discussed the  three other  elements of  state revenue                                                               
that  Alaska receives  from petroleum:   royalties,  oil and  gas                                                               
property  tax,   and  state  corporate  income   tax  (slide  5).                                                               
Royalties are  not a tax,  but rather the state  ownership share.                                                               
Administered  by  the  Department  of  Natural  Resources  (DNR),                                                               
royalties  are based  on gross  production.   The gross  value of                                                               
production  is the  value before  subtracting  the operating  and                                                               
capital costs  to produce it.   Most  royalty rates on  the North                                                               
Slope are 12.5 percent; however,  some leases have a higher rate,                                                               
some  have a  lower rate,  some  are subject  to a  sliding-scale                                                               
royalty where  the royalty rate  fluctuates with the  price, some                                                               
have profit  shares on top  of the  fixed royalty rate,  and some                                                               
are subject  to royalty relief.   Royalty relief may  be received                                                               
by some  fields that apply to  DNR, and is often  received in the                                                               
beginning years of the project to  make it economic.  The royalty                                                               
terms are  dictated by the lease  and are determined at  the time                                                               
of the lease  sale.  The lease term is  considered a contract; it                                                               
is not determined by statute.                                                                                                   
1:08:59 PM                                                                                                                    
MR.  MARKS explained  that  the property  tax is  20  mills or  2                                                               
percent of  assessed oil and  gas production property  located in                                                               
the  state.     For  oil  and  gas  property   located  within  a                                                               
municipality or  borough, the borough  or municipality  keeps the                                                               
amount  of property  tax  generated  up to  its  mill rate,  even                                                               
though  the tax  is administered  by the  state.   For properties                                                               
outside a  municipality or  borough, the entire  tax goes  to the                                                               
state at the 20 mill rate.                                                                                                      
MR. MARKS explained  that Alaska's state corporate  income tax is                                                               
9.4  percent of  apportioned  income.   Apportioned  income to  a                                                               
state is  based on the  amount of a company's  property, payroll,                                                               
and  sales in  that  state relative  to the  rest  of the  world.                                                               
Alaska  has modified  apportionment which  is based  on property,                                                               
production, and sales.  He noted  that in addition to these state                                                               
taxes, the producers  also pay a federal corporate  income tax at                                                               
nominal rates of 35 percent of that.                                                                                            
1:12:01 PM                                                                                                                    
MR. MARKS  reviewed the Department of  Revenue's forecasted state                                                               
petroleum revenues  for Fiscal Year  2011 (slide 6).   Predicated                                                               
on a forecasted  ANS price of $78 per barrel,  DOR is forecasting                                                               
$5.3  billion in  general  fund  revenues.   About  half of  that                                                               
total, $2.6 billion,  is from the severance tax,  $2.2 billion is                                                               
from  the royalty,  $104 million  is from  the property  tax, and                                                               
$445 million  is from the state  corporate income tax.   He noted                                                               
that  for  acreages leased  prior  to  1979,  25 percent  of  the                                                               
royalty goes  to the  permanent fund;  for acreages  leased after                                                               
1979, 50 percent of the royalty goes to the permanent fund.                                                                     
MR. MARKS defined  "market price" as the price  that Alaska North                                                               
Slope  (ANS) crude  oil sells  for on  the West  Coast, which  is                                                               
currently a  little over $90 a  barrel (slide 7).   "Gross value"                                                               
(also  called  "wellhead  value")  is market  price  less  marine                                                               
shipping cost and TAPS tariff.   The current marine shipping cost                                                               
is a little  over $2 and the  TAPS tariff is over $4  for a total                                                               
of  $6 to  be  subtracted.   The  gross value  is  the basis  for                                                               
royalties and it was the basis  for the severance tax until 2006.                                                               
Technically, the  gross value is  at the  point where the  oil is                                                               
first accurately  metered and  measured as  it leaves  the lease.                                                               
"Downstream" is  anything that  happens from  the gross  value at                                                               
the point  of production towards  the market.  "Upstream"  is the                                                               
operating and capital  cost to produce the oil.   The "net value"                                                               
is  the gross  value less  the production  operating and  capital                                                               
costs and less the exploration  costs.  In the current production                                                               
tax, the term used for net income is "production tax value."                                                                    
1:14:43 PM                                                                                                                    
MR.  MARKS illustrated  how the  net  value per  barrel would  be                                                               
calculated (slide 8).  At a  market price of $90 per barrel, less                                                               
a marine shipping cost  of $2 per barrel and a  TAPS tariff of $4                                                               
per barrel,  the gross value is  $84 per barrel.   This $84 would                                                               
be the basis  for the royalty.  For Prudhoe  Bay this gross value                                                               
is at Pump Station 1; other  fields have pipelines to get the oil                                                               
to  Pump  Station 1,  so  these  fields pay  additional  pipeline                                                               
tariffs that  are subtracted to get  to their gross values.    To                                                               
arrive  at  the  net  value   the  capital  production  cost  and                                                               
operating production  cost, which  DOR estimates  respectively at                                                               
$12  and $11  per barrel  for FY  2011, are  subtracted from  the                                                               
gross value.  This results in a  net value of $61 per barrel at a                                                               
$90 market price.                                                                                                               
MR. MARKS  highlighted the  four tax  regimes that  have occurred                                                               
since 1977  when the North  Slope began operating.   The Economic                                                               
Limit Factor  (ELF) was in  place from 1977-1989, a  modified ELF                                                               
was in place  from 1989-2006, the Petroleum  Production Tax (PPT)                                                               
[also  known as  the Production  Profits Tax]  was in  place from                                                               
2006-2007,  and the  current Alaska's  Clear and  Equitable Share                                                               
(ACES) tax  law has been  in effect  since 2007.   However, there                                                               
are places in current law where ELF still lives on.                                                                             
1:16:27 PM                                                                                                                    
MR. MARKS  reviewed how the  production tax was  calculated prior                                                               
to the  start of  Prudhoe Bay  in 1977 and  which Cook  Inlet was                                                               
subject to (slide 10).  The  production tax was levied on a well-                                                               
by-well basis.   The first 300  barrels per day was  taxed at the                                                               
higher of 5 percent of gross value  or $.17 per barrel.  The next                                                               
700 barrels was  taxed at the higher of 6  percent of gross value                                                               
or $.20  per barrel.  Any  production over 1,000 barrels  per day                                                               
was taxed at  8 percent of gross  value or $.27 per  barrel.  The                                                               
cents per barrel was indexed for inflation every year.                                                                          
MR. MARKS  said it was known  prior to 1977 that  Prudhoe Bay was                                                               
going to be a big deal and  therefore it made sense to re-look at                                                               
the  tax given  that Prudhoe  Bay  would be  different than  Cook                                                               
Inlet.   The  Department of  Revenue commenced  a study  and made                                                               
recommendations for  what it believed  an appropriate  tax, which                                                               
became known  as the  Economic Limit  Factor (ELF).   As  a field                                                               
nears  the end  of  its life  a  point is  reached  at which  the                                                               
operating royalty and taxes exceed  the revenues (slide 11).  The                                                               
philosophy  behind ELF  was that  the  burden of  tax should  not                                                               
cause a field  to shut down when it reaches  this economic limit.                                                               
Thus,  ELF was  designed  to  scale down  the  production tax  as                                                               
production  declined over  the life  of the  field, with  the tax                                                               
becoming  $0  at the  point  of  economic  limit.   The  proposed                                                               
legislation  would have  required  a monthly  calculation of  the                                                               
number of barrels  needed at that month's oil price  to cover the                                                               
operating  cost,  and  those  would  be tax  free  to  cover  the                                                               
operating costs at the economic  limit.  However, the legislature                                                               
instead passed  a bill  that provided for  the first  300 barrels                                                               
per well per day to be tax free.                                                                                                
1:19:34 PM                                                                                                                    
MR.  MARKS explained  that under  the original  ELF formula,  the                                                               
percentage of  production greater than  300 barrels per  well per                                                               
day was  the percentage that paid  the tax; it was  computed on a                                                               
field-wide basis (slide  12).  For example, if  a field's average                                                               
production was  1,000 barrels, 300  would be divided by  1,000 to                                                               
arrive at 0.3.   Subtracting 0.3 from 1.0 would  arrive at an ELF                                                               
of  0.7.   The 0.7  was  multiplied by  the nominal  tax rate  to                                                               
arrive at  the effective tax rate.   When a field  declined to an                                                               
average of 300  barrels per well per  day, the ELF was  0 and the                                                               
tax was  0 (slide 13).   Or, put another  way, the ELF was  a 300                                                               
barrel standard  deduction.  He noted  that there was also  a gas                                                               
ELF under which  3,000 million cubic feet (MCF) per  well per day                                                               
was tax free.                                                                                                                   
1:21:18 PM                                                                                                                    
MR.  MARKS  pointed out  that  the  Cook  Inlet wells  had  lower                                                               
productivity than  the North Slope  wells and this  lower average                                                               
productivity  resulted  in a  higher  tax  rate.   Therefore,  an                                                               
exponent  was added  to the  ELF to  provide a  tax break  to the                                                               
older Cook Inlet wells (slide 14).                                                                                              
MR.  MARKS outlined  how  the ELF  was applied  (slide  15).   He                                                               
reiterated that  the ELF  is a  fraction between 0  and 1  and is                                                               
calculated on the  average of all productivity in  a given field.                                                               
Between 1977  and 1981, the  ELF was  applied to the  nominal tax                                                               
rate, which  was 12.25 percent  of gross.   Thus, if the  ELF was                                                               
0.5 percent, the  effective tax rate would be  6.125 percent (0.5                                                               
times 12.25).  The nominal tax rate for gas was 10 percent.                                                                     
MR.  MARKS recounted  that between  1981 and  1989, changes  were                                                               
made  to  the  ELF  in  association with  changes  in  the  state                                                               
corporate income  tax.   The ELF  was kept  the same  but changes                                                               
were made to  how it would operate and to  the nominal tax rates.                                                               
Those changes affected how the corporate income tax works today.                                                                
1:23:21 PM                                                                                                                    
MR. MARKS returned to slide  5 to elaborate, explaining that most                                                               
states  do not  have  oil and  therefore  their corporate  income                                                               
taxes  use the  apportionment factors  of property,  payroll, and                                                               
sales.   Alaska was using  these same apportionment  factors when                                                               
the North Slope  first opened.  However, this  method created two                                                               
problems  for Alaska.    The first  was that  when  a company  is                                                               
relatively  more profitable  in  a state  per  unit of  property,                                                               
sales, or payroll, that income gets  drawn out of the state under                                                               
apportionment.  If a company  is relatively less profitable, more                                                               
income gets  drawn into the state.   With the startup  of Prudhoe                                                               
Bay,  the producers'  Alaska  operations  became very  profitable                                                               
relative to the  rest of the world.  The  second problem was that                                                               
the sales  factor was very low  because most of the  oil was sold                                                               
in the  Lower 48.   These two  factors resulted in  the corporate                                                               
income  tax being  very low.   To  fix these  problems the  state                                                               
changed the income tax to  separate accounting, which ring fenced                                                               
Alaska as itself and measured net  income based only on what goes                                                               
on in the  state, thus causing the corporate income  tax to go up                                                               
several hundred million dollars.                                                                                                
1:26:35 PM                                                                                                                    
MR.  MARKS related  that the  producers sued  the state  claiming                                                               
that Alaska's separate accounting  resulted in double counting of                                                               
income between  what would be taxed  in Alaska and what  would be                                                               
taxed  in  other states.    The  producers further  claimed  that                                                               
separate  accounting  was  discriminatory  because  the  separate                                                               
accounting only applied to the oil  industry in the state.  While                                                               
the state  eventually won the case  in the U.S. Supreme  Court in                                                               
the late 1980s, it did not know  for sure in the early 1980s that                                                               
it would  do so and  a very  large liability was  accruing should                                                               
the state  lose the case.   To hedge its bets,  the state changed                                                               
the corporate  income tax to  modified apportionment  by swapping                                                               
the payroll factor for the  production factor.  Since Prudhoe Bay                                                               
was  so prolific,  using production  as  an apportionment  factor                                                               
would draw  in a lot  more worldwide  income.  He  recalled being                                                               
told  anecdotally that  producers  had  indicated in  discussions                                                               
that  they   would  not   find  modified   apportionment  legally                                                               
MR.  MARKS  explained  that going  from  separate  accounting  to                                                               
modified  apportionment  would  result  in the  state  taking  an                                                               
income hit  on the corporate  income tax  (slide 15).   To offset                                                               
this, the state  made changes to the severance tax  in 1981.  The                                                               
changes  were expected  to be  approximately revenue  neutral and                                                               
were therefore like buying insurance in  case of a bad outcome in                                                               
the U.S.  Supreme Court.   One change  consisted of  applying the                                                               
nominal rate  of 12.25 percent  of gross  to only the  first five                                                               
years of  a field  and thereafter  the nominal  rate would  be 15                                                               
percent.  Another  change, applicable to the first 10  years of a                                                               
field, was  the "rounding rule" in  which the ELF was  rounded up                                                               
to 1.0 if it was greater  than 0.7.  This rounding rule, however,                                                               
created a  time bomb that went  off when Prudhoe Bay  had its 10-                                                               
year anniversary.                                                                                                               
1:29:24 PM                                                                                                                    
MR. MARKS,  in response  to Co-Chair Seaton,  said that  prior to                                                               
PPT the  taxes were based  on gross, so  [during the era  of ELF]                                                               
the state  did not  have a  very good idea  of what  the upstream                                                               
capital and  operating costs were  and subsequently what  the net                                                               
value was.  At oil prices  of $15-$20 per barrel during this era,                                                               
he said  his educated  guess is that  upstream costs  during that                                                               
time were probably in the range  of $5-$10 per barrel, so the net                                                               
value would probably have been $5-$10  per barrel.  He offered to                                                               
get back to members with further information.                                                                                   
1:31:12 PM                                                                                                                    
MR. MARKS returned to his  presentation and outlined the problems                                                               
with the first ELF (slide 16).   One problem was that 300 barrels                                                               
was very arbitrary  for covering operating costs  at the economic                                                               
limit,  because at  an oil  price  of $5  per barrel  a lot  more                                                               
barrels would  be needed to  cover operating costs than  would be                                                               
needed at  a price  of $20.   Additionally,  the 300  barrels was                                                               
fairly generous in  terms of covering operating costs.   A second                                                               
problem was that  every time a well was drilled  the average well                                                               
productivity  went down.   A  third problem  was that  oil fields                                                               
naturally decline in  production, so even if the  number of wells                                                               
remained  the  same  the  well   productivity  declined.    Thus,                                                               
drilling  more wells  and  natural field  decline  resulted in  a                                                               
constant reduction of the effective  tax rate, regardless of what                                                               
was going on with price.                                                                                                        
MR. MARKS  stated that  another problem with  ELF was  that under                                                               
some circumstances  wells could be  drilled for no  other purpose                                                               
than to  drive down a  company's tax rate.   He said he  does not                                                               
know  whether  producers were  really  doing  that, but  the  ELF                                                               
effect  had  to be  part  of  the  equation when  producers  were                                                               
evaluating  their  after-tax  drilling programs.    For  example,                                                               
there were  a few years where  the ELF for the  Kuparuk field was                                                               
at 0.69.  The rounding rule  would have made it very advantageous                                                               
to  keep  the Kuparuk  field  below  0.7  to  provide a  big  tax                                                               
1:33:54 PM                                                                                                                    
MR. MARKS  reported that  a convergence  of problems  occurred in                                                               
the late  1980s (slide  17).   First was the  oil price  crash of                                                               
1986 in which  the price declined to about $6  per barrel and did                                                               
not  recover  much  by  1987  or  1988.    Second  was  declining                                                               
production,  which coupled  with  low oil  prices affected  state                                                               
revenues  a lot.   Third  was the  declining ELF  along with  the                                                               
declining tax  rate.   Then, in 1987,  the 10-year  rounding rule                                                               
for Prudhoe  Bay kicked  in.   He elaborated  on the  Prudhoe Bay                                                               
rounding rule problem  by turning to slide 22,  which depicts the                                                               
total average production for all  fields on the North Slope under                                                               
the economic  limit factor  from 1978  to just  beyond 2003.   He                                                               
explained that well  productivity from the Prudhoe  Bay field was                                                               
very  high -  just under  0.95 -  at the  field's start  in 1977.                                                               
When the Kuparuk  field started in 1981 the ELF  average dipped a                                                               
little bit.   Then, after the  rounding rule began, the  ELF went                                                               
way up.   The 10-year  rounding rule  for Prudhoe Bay  expired in                                                               
1987, resulting in a huge drop  in Prudhoe Bay's ELF and creation                                                               
of the time bomb previously  mentioned.  The weighted average ELF                                                               
for the North Slope dropped from  about 0.94 to about 0.78, which                                                               
was worth about $200 million [per year].                                                                                        
MR. MARKS, in response to  Co-Chair Feige, clarified that the 10-                                                               
year rounding rule  began in 1981.   For the first 10  years of a                                                               
field, this  rule provided that if  the ELF was greater  than 0.7                                                               
it would  be rounded up to  1.0.  So, instead  of multiplying the                                                               
nominal rate by 70 percent, it was multiplied by 100 percent.                                                                   
1:36:04 PM                                                                                                                    
MR. MARKS related that at the  time the rounding rule was put in,                                                               
people understood that  there was going to be a  big problem when                                                               
the  Prudhoe Bay  field  hit 10  years.   He  read the  following                                                               
statement made by then-Governor Hammond in 1981:                                                                                
     As  far as  the possible  revenue effects  in 1988  and                                                                    
     beyond, I  have full confidence  in the ability  of the                                                                    
     legislature  to  deal  at the  time  with  whatever  is                                                                    
     required to  retain the state's  fair share of  our oil                                                                    
1:37:01 PM                                                                                                                    
MR. MARKS stated  that in 1987 then-Governor  Cowper began trying                                                               
to  change the  ELF  system  (slide 17).    Many  of the  state's                                                               
economists,  himself included,  encouraged the  scrapping of  ELF                                                               
and the adoption of a net  tax.  Hugh Malone, DOR commissioner at                                                               
the time, understood  the ELF problem and why a  net tax would be                                                               
preferable,  but  it  was  Commissioner  Malone's  judgment  that                                                               
changing  from a  gross  to a  net system  would  create so  much                                                               
confusion that it was  better to keep with the ELF  form as a way                                                               
of minimizing chaos.   The ELF form was modified  to bring in the                                                               
new  element of  field  size in  addition  to well  productivity.                                                               
Field  size  would be  another  proxy  for profitability  because                                                               
bigger fields are  generally more profitable.   The bigger fields                                                               
would  pay more,  the smaller  fields  would pay  less, and  this                                                               
would bring in  more revenue as well as  encourage development of                                                               
small  fields.   Under ELF  II [1989-2006],  fields with  greater                                                               
than 150,000 barrels per day  would have relatively less than 300                                                               
barrels  tax  free per  well  per  day  and fields  smaller  than                                                               
150,000  barrels  a  day  would have  relatively  more  tax  free                                                               
barrels.   A  proposal in  1987 did  not pass  and neither  did a                                                               
proposal in 1988.   The third proposal (slide 18)  passed by only                                                               
one or two votes on the last day  of session in 1989.  He offered                                                               
his  opinion that  had the  Exxon Valdez  oil spill  not occurred                                                               
this third proposal would not have passed.                                                                                      
1:40:19 PM                                                                                                                    
MR. MARKS illustrated  how the amount of ELF II  depended on both                                                               
the daily field productivity and  the well productivity, with the                                                               
ELF  rising  correspondingly  higher with  increased  field  size                                                               
(slide  19). Applying  ELF  II  to the  15  percent nominal  rate                                                               
increased  state revenue  by about  $300 million  per year,  thus                                                               
bringing the  ELF back  to where  it was prior  to 1988  when the                                                               
rounding rule kicked in.   However, he continued, it is important                                                               
to  look at  what happened  with small  fields under  ELF II.   A                                                               
5,000-barrel-a-day field  had no  ELF and paid  no tax  no matter                                                               
what its  well productivity.  A  20,000-barrel-a-day field, which                                                               
is a  hefty field  size for  North Slope  standards, paid  no ELF                                                               
when the field average per well  per day was below 2,000 barrels.                                                               
Under  ELF  II, only  three  fields  on  the  North Slope  had  a                                                               
positive ELF - Prudhoe, Kuparuk,  and Endicott.  The other fields                                                               
had no ELF and paid no tax, which caused problems later on.                                                                     
1:42:16 PM                                                                                                                    
MR. MARKS  explained that while ELF  II got things back  to where                                                               
they were  prior to  its passage  in 1989,  the same  problem re-                                                               
occurred.    Field  size  and   well  productivity  continued  to                                                               
decline, again resulting in a  decline of the tax rate regardless                                                               
of  what   else  was   happening.     Another  problem   was  the                                                               
proliferation of  field satellites (slide  20).  When ELF  II was                                                               
passed in  1989, five wells were  operating on the North  Slope -                                                               
Prudhoe,  Kuparuk, Milne  Point, Lisburne,  and Endicott.   After                                                               
passage of  ELF II,  industry came to  the state  concerned about                                                               
the satellite  development that it  was going to be  starting up.                                                               
Satellites  are small  fields developed  in association  with the                                                               
main field and they share drilling and processing facilities.                                                                   
1:44:18 PM                                                                                                                    
MR. MARKS further  explained that a provision since  the start of                                                               
ELF I  allowed the  [Department of  Revenue] to  aggregate fields                                                               
for  determining  the  ELF  if  it found  that  the  fields  were                                                               
economically interdependent.  Aggregating  fields under ELF I was                                                               
not a  big deal and did  not affect taxes because  the fields had                                                               
approximately  the same  well  productivity.   But  under ELF  II                                                               
aggregating  fields was  a big  deal  because of  the field  size                                                               
factor.  Industry was concerned  that if the department exercised                                                               
its authority  to aggregate the  fields it would make  the fields                                                               
uneconomic either by  the high taxes that would  ensue or because                                                               
new facilities would have to  be built to avoid being aggregated.                                                               
Governor Cowper said the intent of  ELF II was to encourage small                                                               
fields, so  the department drafted  regulations that  would allow                                                               
it  to give  advance  rulings  to the  producers  that would  not                                                               
aggregate fields under certain conditions.                                                                                      
1:45:30 PM                                                                                                                    
MR.   MARKS  outlined   the  four   basic  conditions   in  these                                                               
regulations  under which  the department  could give  an advanced                                                               
ruling not to aggregate (slide 21):   1) if the shared facilities                                                               
reduced costs, 2) if the  advanced ruling enhanced the likelihood                                                               
of development,  3) if  oil from each  field could  be accurately                                                               
measured, and  4) if  the shared facilities  was the  only factor                                                               
making  the  fields  interdependent.   The  department  carefully                                                               
studied  the  requests  it  received   and  granted  several  for                                                               
satellite development  configurations.  A little  before the year                                                               
2000, the  department received a  request for an  advanced ruling                                                               
for Prudhoe  Bay to  not aggregate six  new satellites  that were                                                               
under  development.   By  this  time,  however, the  department's                                                               
understanding  of  satellite  development   was  evolving.    One                                                               
particular aspect  disturbing the department was  the practice of                                                               
"back  out" and  how it  created  a new  dimension regarding  the                                                               
meaning  of  interdependence  under   Condition  4.    Mr.  Marks                                                               
elaborated that  all oil fields have  gas that comes up  with the                                                               
oil.   The unit's processing  facility separates the gas  and the                                                               
gas is then injected back into  the well; so, as a field matures,                                                               
more and more  gas comes up with the oil.   However, a processing                                                               
facility can  handle only  so much gas  depending upon  its size.                                                               
Therefore, to  handle the high gas  to oil situation of  an older                                                               
field, oil  from the  high-gas field was  throttled back  and oil                                                               
that had less gas was brought in from another field.                                                                            
1:49:05 PM                                                                                                                    
MR. MARKS  noted that while  the statute gave the  department the                                                               
authority to  aggregate fields if those  fields were economically                                                               
interdependent,  the  statute   did  not  define  interdependent.                                                               
After  mulling   over  this  problem   for  several   years,  the                                                               
Department of Revenue  and the Department of Law came  up with an                                                               
interpretation  of  interdependent  that meant  the  Prudhoe  Bay                                                               
satellites and  main Prudhoe Bay  field should be  aggregated for                                                               
ELF purposes.   In 2005, then-Governor  Frank Murkowski concurred                                                               
with the  departments and aggregated  the six satellites  and the                                                               
main  field.   However, fields  that had  already been  given the                                                               
advanced rulings  were not touched  because the thought  was that                                                               
those  fields had  been developed  under a  good-faith agreement.                                                               
The 2005 aggregation decision raised  the Prudhoe Bay field size,                                                               
causing the main  field's ELF to go  up from 0.8 to  0.9, and the                                                               
ELF for the satellite fields went  from 0 to 0.9, which was worth                                                               
about $150 million.   He said he believes that  decision is still                                                               
being challenged in court.                                                                                                      
1:50:54 PM                                                                                                                    
CO-CHAIR SEATON understood the definition  of satellite fields to                                                               
be reservoirs  that are  at different  vertical depths  under the                                                               
same drilling platform.                                                                                                         
MR. MARKS  expounded on  what is  meant by field.   Units  are an                                                               
administrative  concept  for  how   leases  are  managed  by  the                                                               
Department of  Natural Resources.   A unit generally  consists of                                                               
several  accumulations  that  are   under  some  sort  of  common                                                               
management  system.   For  example,  the  big Kuparuk  field  was                                                               
started in 1981  and then some other fields -  Tarn, Tabasco, and                                                               
Meltwater -  were found near  it.  Technically, these  fields are                                                               
called participating areas; they  are a distinct oil accumulation                                                               
not in  any pressure communication  with any  other accumulation.                                                               
A unit  consists of  several of these  participating areas.   The                                                               
main  field  is a  participating  area  with these  other  fields                                                               
sharing the  same drill  pad and  same processing  facilities, so                                                               
there is some integration to how they are operated and managed.                                                                 
1:53:17 PM                                                                                                                    
MR. MARKS pointed out that while  the ELF for the North Slope had                                                               
an uptick  in 2005 when Prudhoe  Bay was aggregated, the  ELF had                                                               
been  steadily declining  over the  previous  decade (slide  22).                                                               
Many people were concerned about  this decline and deemed the ELF                                                               
broken.  The Kuparuk field was  seen as the poster child for "the                                                               
ELF is  broken" because  by 2005 its  well productivity  was very                                                               
close to 300  barrels per day.  Thus, Kuparuk's  ELF was about to                                                               
become zero even  though its production of  about 130,000 barrels                                                               
per day made it one of North America's largest fields.                                                                          
1:54:25 PM                                                                                                                    
MR. MARKS  related that the  ELF was  done away with  through the                                                               
1998 Stranded  Gas Development Act  (SGDA) (slide 23).   The SGDA                                                               
set out  to get a  gas line by  way of giving  the administration                                                               
the authority  to negotiate with  the producers a tax  system for                                                               
gas.   Once  that  system was  negotiated  it was  to  be put  in                                                               
contract  rather  than statute  so  that  there would  be  fiscal                                                               
stability.   Negotiations started in  2004 but stalled  about two                                                               
years later  because producers wanted  fiscal stability  for oil.                                                               
Wanting  fiscal stability  for oil  was not  frivolous, he  said,                                                               
because producers feared  that if the state  later became unhappy                                                               
with the gas contract, the state would  be able to take it out of                                                               
the producers'  hide on oil,  given that the  companies producing                                                               
gas were  the same companies producing  oil.  Since the  SGDA did                                                               
not authorize  fiscal stability for oil,  Governor Murkowski said                                                               
the  state  would  give  that  stability but  the  ELF  would  be                                                               
replaced with a  new oil tax system.  Governor  Murkowski asked a                                                               
consultant,  Dr. Pedro  van Meurs,  to design  an oil  tax system                                                               
that  would protect  Alaska's  interests  and be  internationally                                                               
competitive.  Dr.  van Meurs designed an oil  tax proposal called                                                               
the  petroleum  production tax  (PPT),  which  was based  on  net                                                               
income  rather  than  gross  income.   This  proposal,  a  public                                                               
document published on 2/14/06, recommended  a 25 percent tax rate                                                               
and  a 20  percent  credit rate  on  capital cost.    It did  not                                                               
include any  progressivity because Dr.  van Meurs was  looking to                                                               
make  the  system  internationally   competitive  and  the  other                                                               
jurisdictions  that  Alaska  was  competing  with  did  not  have                                                               
progressivity.  Additionally, Dr. van  Meurs proposed a system of                                                               
credits  associated with  production tax  that the  state largely                                                               
still has.                                                                                                                      
1:57:53 PM                                                                                                                    
MR. MARKS  said the Murkowski  Administration's position  when it                                                               
began negotiations with  producers was a 25 percent  tax rate and                                                               
a 20 percent credit rate.   What came out of the negotiations was                                                               
a 20 percent  tax rate and a  20 percent tax credit,  which was a                                                               
sizeable  tax  increase  over  the  ELF.    Arm-in-arm  with  the                                                               
producers, the  administration then went to  the legislature with                                                               
this proposed  oil tax system and  proposal to amend the  SGDA to                                                               
allow  fiscal  stability  for  oil.    The  legislature  was  not                                                               
supportive of  the gas  deal that  the administration  had struck                                                               
with the  producers, so  the legislature  took that  proposal and                                                               
used  it as  a  starting  point for  amending  the severance  tax                                                               
statute and  getting rid  of the ELF.   The  [Production] Profits                                                               
Tax (PPT)  [also known as  Petroleum Production Tax], a  net tax,                                                               
was adopted  in 2006.  Most  every economist believes that  a net                                                               
system  is a  much more  efficient way  to tax  than gross.   One                                                               
reason why  relates to production costs.   A barrel of  light oil                                                               
on the  North Slope might  cost $10 per  barrel to produce  and a                                                               
barrel of heavy  oil might cost $30.  Under  a gross system, they                                                               
would  pay  the same  amount  of  tax,  but  a net  system  would                                                               
recognize that  difference.  Another  reason why is that  under a                                                               
net system costs  can be deducted, but under a  gross system they                                                               
cannot.  In 2006 the  administration recognized that the pipeline                                                               
was running  in excess of 60  percent empty.  A  net system would                                                               
be in  the state's best  interest because a company  could reduce                                                               
its taxes by investing in  Alaska and deducting the cost, whereas                                                               
under  a gross  system the  profits would  be taken  and invested                                                               
elsewhere where they can be deducted.                                                                                           
2:01:00 PM                                                                                                                    
MR. MARKS  explained that the  legislature made two  main changes                                                               
to the  administration's "20/20  proposal" when  it came  up with                                                               
the  PPT.   First, the  tax rate  was raised  to 22.5  percent of                                                               
production  tax  value,  also  called   net  value.    Second,  a                                                               
progressivity  element was  added.   Progressivity was  triggered                                                               
when the net value exceeded $40  a barrel, at which point the net                                                               
value was multiplied  by .25 percent.  The term  for how fast the                                                               
tax rate  increases as value  goes up is  called the slope.   The                                                               
net  value is  determined by  subtracting the  transportation and                                                               
operating costs,  which average  $29 per  barrel in  Alaska, from                                                               
the price received per barrel.  For  example, at a price of $90 a                                                               
barrel the net value per barrel is $61.                                                                                         
2:03:32 PM                                                                                                                    
[A  brief at-ease  was taken  to correct  an error  discovered on                                                               
slide 24 -  the progressivity rate was incorrectly  shown as 7.75                                                               
percent, the correct rate was determined to be 5.25 percent.]                                                                   
2:03:41 PM                                                                                                                    
MR. MARKS continued with his  aforementioned example, noting that                                                               
the  progressivity is  calculated  by subtracting  $40 from  $61,                                                               
multiplying that  by .0025, arriving  at a progressivity  of 5.25                                                               
percent.   That 5.25 percent  is added  to the 22.5  percent base                                                               
rate to  arrive at a  total tax rate of  27.75 percent.   The $61                                                               
net value  is multiplied by 27.75  percent to arrive at  a tax of                                                               
$16.93 per barrel.                                                                                                              
MR. MARKS  noted that  the progressivity under  PPT peaked  at 25                                                               
percent.   Along  with  this was  another  provision for  capital                                                               
costs.  The PPT was being  debated in the legislature at the same                                                               
time that  there was a  big corrosion  spill on the  North Slope,                                                               
which caused  concern that deductions  should not be  allowed for                                                               
maintenance that  should have  been done.   As  a result,  $.30 a                                                               
barrel  was  subtracted from  capital  costs  for what  could  be                                                               
deducted  as a  sort  of  maintenance provision.    The PPT  also                                                               
established credits,  but those  were not  changed much  by ACES.                                                               
Additionally,  a floor  was  put  in, with  the  floor being  the                                                               
higher of 4 percent of gross or the PPT.                                                                                        
2:05:59 PM                                                                                                                    
MR. MARKS illustrated the .25  percent slope of the severance tax                                                               
rate under  PPT at various net  values per barrel (slide  25) and                                                               
the  PPT severance  tax  per  barrel at  various  net values  per                                                               
barrel  (slide 26).    He said  it was  decided  that Cook  Inlet                                                               
should stay at the  ELF that was in place in  April 2006 when the                                                               
PPT went into  effect, which is also the case  under current law.                                                               
So, Cook  Inlet oil pays zero  ELF, zero tax, and  Cook Inlet gas                                                               
pays $.17 per million cubic feet  (MCF) in production tax.  Under                                                               
current law those provisions stay in place until 2022.                                                                          
2:07:48 PM                                                                                                                    
MR. MARKS discussed the three  main problems with PPT (slide 27).                                                               
First, because the  state had previously been under  a gross tax,                                                               
the Department of  Revenue did not have a clear  idea of what the                                                               
deductible costs would  be.  So, while PPT was  under debate, the                                                               
department had to estimate those  costs in the absence of perfect                                                               
information.    Second,  even if the  department had  had perfect                                                               
information,  incredible   cost  inflation  took  place   in  the                                                               
petroleum sector  in 2007,  the first  year that  the PPT  was in                                                               
effect, resulting  in much less  revenue than had  been expected.                                                               
Based on oil prices at the  time, the estimate had been for about                                                               
$1.1 billion more  in production tax but only  about $0.3 billion                                                               
more came in, a difference of  about $800,000 million.  The third                                                               
problem was  what he  calls "VECO taint".   Evidence  arose after                                                               
the  2006  session  that  some   votes  for  PPT  may  have  been                                                               
influenced by inappropriate  relationships with VECO Corporation,                                                               
which caused  a lack  of confidence in  what had  happened during                                                               
the 2006 legislative session.                                                                                                   
2:09:18 PM                                                                                                                    
MR. MARKS  related that after  her 2006 election,  Governor Palin                                                               
decided to look  at oil taxes free of the  taint.  She introduced                                                               
a new production tax, Alaska's  Clear and Equitable Share (ACES),                                                               
which proposed to  increase the tax rate to 25  percent, drop the                                                               
progressivity trigger  to $30, and  drop the  progressivity slope                                                               
from .25 percent to .2 percent.                                                                                                 
CO-CHAIR SEATON understood that some  of the new wells drilled by                                                               
BP under  PPT were  paid off in  90 days.   He asked  whether Mr.                                                               
Marks  recalls this  as being  another  part of  the impetus  for                                                               
changing PPT.                                                                                                                   
MR.  MARKS replied  he does  not, but  that different  people may                                                               
have different recollections that may be absolutely valid.                                                                      
2:11:10 PM                                                                                                                    
MR. MARKS  pointed out that  in its 2007 session  the legislature                                                               
made  one major  change to  the Palin  Administration's proposal.                                                               
The  base rate  was increased  to 25  percent [as  proposed], the                                                               
trigger  was  dropped  to  $30  [as  proposed],  but  instead  of                                                               
reducing the  slope from .25 to  .2 [as proposed], the  slope was                                                               
increased to .4 percent.   Noting that ACES operated exactly like                                                               
PPT, he  used his  previous example  of a $90  price and  $61 net                                                               
value per barrel to calculate  the tax under ACES:  progressivity                                                               
is calculated  by subtracting $30  from $61, multiplying  that by                                                               
.004,  arriving at  a progressivity  of 12.4  percent; that  12.4                                                               
percent  is added  to the  25 percent  base rate  to arrive  at a                                                               
total tax rate of 37.4 percent;  [the $61 net value is multiplied                                                               
by 37.4 percent to arrive at a  tax of $22.81 per barrel.]  Under                                                               
current ACES  law, the  progressivity slope  drops to  .1 percent                                                               
when the  progressivity reaches  50 percent,  which is  at $92.50                                                               
net.  He noted that some changes were also made to the credits.                                                                 
2:12:59 PM                                                                                                                    
MR. MARKS  compared the ACES  and PPT severance tax  rates (slide                                                               
29).  Under  ACES, progressivity is triggered at  $30 compared to                                                               
$40 under  PPT; ACES has  a steeper  slope [.4 percent]  than PPT                                                               
[.25 percent];  under ACES,  when the net  value per  barrel hits                                                               
$92.50, the slope drops from .4  to .1 percent, but under PPT the                                                               
severance tax rate  peaked at 50 percent and  then remained flat.                                                               
Comparing  the ACES  and PPT  severance taxes  per barrel  (slide                                                               
30), he  reported that  when oil prices  averaged about  $100 per                                                               
barrel in  2008, ACES brought in  about $2 billion more  than PPT                                                               
would have.                                                                                                                     
MR. MARKS reiterated that the  ELF provisions for Cook Inlet were                                                               
kept in  ACES.   Additionally, a new  provision in  ACES provides                                                               
that any gas used in-state for  fuel, meaning fuel used for space                                                               
heat or power production, is also  subject to the April 2006 Cook                                                               
Inlet ELF of $.17 per MCF, which grandfathers out in 2022.                                                                      
2:14:27 PM                                                                                                                    
MR. MARKS compared the ELF, PPT,  and ACES severance tax rates as                                                               
a percent  of net under  various Alaska North Slope  (ANS) market                                                               
prices  based on  a cost  of $29  [slide 31]  and a  cost of  $39                                                               
[slide 32].  On a percent of gross  the ELF is just flat:  if ELF                                                               
was  still in  effect right  now and  DOR figures  are used,  the                                                               
weighted average  ELF would be  about .37, which  when multiplied                                                               
by a 15  percent tax rate comes  out to an effective  tax rate of                                                               
5.5 percent  of gross flat.   He explained  that as prices  go up                                                               
the net is a  higher percent of gross, so when  a flat percent of                                                               
gross is put on  a net basis, it is a  decreasing percent of net,                                                               
which is  why the  ELF curve  slopes downward on  the graph.   He                                                               
interjected that this  is also how royalties currently  work:  as                                                               
prices go up, the royalty, which  is 12 percent of gross, becomes                                                               
a smaller percent of net.                                                                                                       
2:16:32 PM                                                                                                                    
MR. MARKS  noted that on  slides 31 and  32 the ANS  market price                                                               
begins at  $50 per barrel.   However, at ANS market  prices below                                                               
$50  the ELF  severance tax  gets "weird"  [supplemental slides].                                                               
He reiterated  that the ELF  is based on  gross and gross  is the                                                               
difference between  market price  and transportation  cost, which                                                               
in Alaska is  about $6.  Until  oil prices reach $6,  there is no                                                               
gross  value, so  ELF  is zero.   However,  even  though the  ELF                                                               
becomes positive  at a  price of  $6, the  ELF curve  is negative                                                               
when calculated  as a  percent of  net because  the net  value is                                                               
negative  until a  price of  $29  a barrel  is reached.   When  a                                                               
positive  net value  is reached  at $29  a barrel,  the ELF  then                                                               
shoots  up because  a positive  value  is divided  by a  positive                                                               
value.  In response to  Co-Chair Seaton, Mr. Marks confirmed that                                                               
if this ELF was expressed as  actual money paid, the ELF would be                                                               
2:19:44 PM                                                                                                                    
MR.  MARKS added  that he  did not  have time  to make  models of                                                               
another dimension of ELF, PPT, and  ACES, which is that they have                                                               
"higher of" provisions.  For PPT and  ACES, it is the higher of 4                                                               
percent of gross or the PPT  calculation, and under ELF there was                                                               
also  a minimum  tax  of  $.80 per  barrel.    Regarding the  two                                                               
supplemental slides, he  added that the ELF spikes at  a price of                                                               
just over $39 a  barrel because it is a tax  based on gross which                                                               
is a  very, very  high percentage  of net, and  this is  why most                                                               
economists believe that taxes based on gross are not efficient.                                                                 
2:21:11 PM                                                                                                                    
MR. MARKS  reviewed the credits,  many of  which came out  of Dr.                                                               
van  Meurs' recommendations  and which  still exist  today (slide                                                               
33).  One is the 20 percent  credit on capital costs.  Another is                                                               
a 40 percent well lease  expenditure credit for areas outside the                                                               
North  Slope;  these credits  are  directly  related to  drilling                                                               
wells and were put into law  last year.  Governor Parnell's bill,                                                               
HB 110, proposes to expand that  40 percent credit to include the                                                               
North  Slope.   There  are exploration  credits  ranging from  20                                                               
percent to  40 percent  depending on the  location of  the bottom                                                               
hole in  the exploration well  and depending on whether  the well                                                               
is inside or outside  of an existing unit or how  far the well is                                                               
from an  existing unit.    There is a  credit of $12  million for                                                               
companies that produce less than  50,000 barrels per day and that                                                               
have enough  offsetting income.   Last year some  very aggressive                                                               
credits were  added for  the first three  parties to  explore the                                                               
Cook  Inlet pre-Tertiary  zone with  a  jack-up rig.   The  first                                                               
party will  receive a 100 percent  credit up to $25  million, the                                                               
second  party  will receive  a  90  percent  credit up  to  $22.5                                                               
million, and  the third party  will receive an 80  percent credit                                                               
up to  $20 million.  If  there is any commercial  production as a                                                               
result of  this exploration, 50  percent of the credit  will have                                                               
to be  re-paid.  There is  no double-dipping on the  credits - an                                                               
expenditure  used for  claiming  one credit  cannot  be used  for                                                               
claiming a second credit.                                                                                                       
2:23:42 PM                                                                                                                    
MR.  MARKS  noted  that  a  company unable  to  use  all  of  its                                                               
deductions  because  of a  net  operating  loss can  convert  its                                                               
unused deductions  at 25 percent to  a credit (slide 34).   There                                                               
is a floor of zero of the  tax, so a company that cannot monetize                                                               
its credits  because it is down  to zero tax can  either keep the                                                               
credit until it has sufficient  offsetting income or can sell its                                                               
credits  to other  taxpayers.   When selling  credits, a  company                                                               
will always  get less  than 100 percent  on the  dollar; however,                                                               
under an ACES provision for  companies producing less than 50,000                                                               
barrels a day, the state will buy the credit.                                                                                   
REPRESENTATIVE  GARDNER,  referencing  a previous  Department  of                                                               
Revenue presentation  before the  committee, understood  that the                                                               
small  company   credit  and  another  $6   million  credit  were                                                               
cumulative.  She asked whether that is an exception to the rule.                                                                
MR. MARKS  replied correct,  an additional  $6 million  credit is                                                               
available  to anyone,  not just  small  companies, for  producing                                                               
either non-North Slope or non-Cook  Inlet.  Because it expires in                                                               
2016, he said he  doubts that the credit will ever  be used.  The                                                               
credits of  $12 million and  $6 million are  use-or-lose credits,                                                               
so if  a company does not  have offsetting income in  the year it                                                               
earns the credit, the credit cannot be carried over.                                                                            
MR. MARKS  concluded his presentation  by reporting  that between                                                               
1977 and  Fiscal Year 2010  a total  of $40 billion  in severance                                                               
tax has been collected from across the state (slide 37).                                                                        
2:25:53 PM                                                                                                                    
The committee took an at-ease from 2:25 p.m. to 2:29 p.m.                                                                       
2:29:50 PM                                                                                                                    
CO-CHAIR SEATON requested  Mr. Marks to tell where  the figure of                                                               
$12 million came from and how it was arrived at.                                                                                
MR. MARKS responded that the $12  million credit is a second area                                                               
where ELF lives on.  When Dr.  van Meurs was designing the PPT he                                                               
understood  that  there  were some  projects  under  development,                                                               
small fields,  that would have had  a zero ELF and  companies had                                                               
started developing these fields assuming  they would be under ELF                                                               
and have  a zero tax.   This provision was  put in so  that small                                                               
development would continue  to have a zero  tax; additionally, it                                                               
would create  an incentive for  small companies to  produce small                                                               
fields.  Dr.  van Meurs arrived at the $12  million by looking at                                                               
the amount  of oil these  fields would  produce and the  price of                                                               
oil, which was $45 a barrel at that  time.  He then backed in the                                                               
amount of  credit a company would  need to bring the  tax to zero                                                               
under PPT,  and that was $12  million.  Quite frankly,  he added,                                                               
another reason  for putting in  this credit was to  get political                                                               
support  for  the  PPT  from  small  companies  during  the  2006                                                               
CO-CHAIR SEATON expanded  on Mr. Marks' response,  saying that it                                                               
was looked at as $60 million  in deduction, so that for the first                                                               
$60  million of  production from  a field  the company  would not                                                               
have a  tax.   This was later  converted at 20  percent to  a tax                                                               
credit of $12 million because that was easier to implement.                                                                     
MR. MARKS concurred.                                                                                                            
2:32:20 PM                                                                                                                    
REPRESENTATIVE HERRON,  saying he understands why  the credits of                                                               
$12 million and $6 million were  needed to get buy-in for passing                                                               
the  PPT, asked  whether it  is important  to maintain  these two                                                               
credits or to increase the amounts.                                                                                             
MR. MARKS answered that he would say  it is for small fields.  He                                                               
clarified  that  it is  not  really  small  fields, it  is  small                                                               
companies.  Getting  into new areas gets into  really high costs,                                                               
and  these   credits  create  additional  incentives   for  small                                                               
companies  to come  in.   Additionally, the  biggest risk  takers                                                               
around the world are the small companies.   As a way to get small                                                               
companies into Alaska, to get  bigger risk taking, it probably is                                                               
a good feature to retain as a  way to encourage a wider number of                                                               
views as to what is geologically attractive.                                                                                    
2:33:59 PM                                                                                                                    
REPRESENTATIVE HERRON  inquired whether it would  have a profound                                                               
effect on the taxes if the state  was to figure out how to value-                                                               
add the  resource, which in  this case is  oil.  For  example, if                                                               
the oil  was refined in  the state and then  left the state  as a                                                               
refined product,  would the severance  tax, the tax on  that oil,                                                               
be significantly different?                                                                                                     
MR. MARKS replied that what gives  value to the oil is its market                                                               
price.  The value  of what comes out of the  ground is its market                                                               
price less  its cost, and  that is the tax  base.  When  value is                                                               
added, cost is  added, and while there is a  little bit of profit                                                               
on that, the basic feedstock  that goes into a refinery basically                                                               
reflects the value of the oil  which is being taxed, which is how                                                               
the severance tax is based.  As  a feedstock to a refinery, it is                                                               
the same thing - it is the value of the oil.                                                                                    
REPRESENTATIVE  HERRON  expressed  his frustration  that  [a  raw                                                               
resource has more value than  a finished product]; for example, a                                                               
log exported  from the  state in  the round  has more  value than                                                               
manufacturing that  log into  lumber in  the state  and exporting                                                               
that finished lumber.                                                                                                           
CO-CHAIR FEIGE  suggested looking at  what kind of  credits could                                                               
be given for in-state use.                                                                                                      
2:36:46 PM                                                                                                                    
REPRESENTATIVE  MUNOZ,  regarding   the  PPT  progressivity  that                                                               
kicked  in at  $40  profit  per barrel,  asked  whether that  tax                                                               
applied to the full profit or just to the profit over $40.                                                                      
MR. MARKS directed  attention to slide 24 and  explained that for                                                               
this example  the total PPT  tax rate with progressivity  and the                                                               
base  rate  is  27.75  percent.   He  said  it  is  important  to                                                               
understand why  there is discussion  about the high  marginal tax                                                               
rate  under ACES.   Under  ACES, progressivity  starts when  [the                                                               
profit]   goes  above   $30,  at   which  point   [12.4]  percent                                                               
[progressivity] is added to the  25 percent [base rate] to arrive                                                               
at [a  total tax rate] of  37.4 percent.  This  37.4 percent does                                                               
not apply  to the thirty-first dollar,  it goes all the  way back                                                               
to the  very first dollar and  applies to every single  dollar of                                                               
value, and  this is the  genesis of  the argument by  some people                                                               
that ACES has  high marginal tax rates.  In  further response, he                                                               
confirmed that this same method was used under PPT.                                                                             
2:38:48 PM                                                                                                                    
REPRESENTATIVE MUNOZ  understood that  Prudhoe Bay,  Kuparuk, and                                                               
Endicott were the only fields that paid under the ELF factor.                                                                   
MR. MARKS responded after it passed in 1989 (indisc.)....                                                                       
REPRESENTATIVE  MUNOZ requested  Mr. Marks  to explain  again why                                                               
the Kuparuk field was the poster child for a broken ELF.                                                                        
MR.  MARKS answered  that the  ELF  was going  down, down,  down.                                                               
Between 2000 to  2005 or so, Kuparuk was  producing about 130,000                                                               
barrels a day at  very healthy prices at the time  of $40 to $50.                                                               
Despite being one of the largest  fields in North America, it was                                                               
paying just  about zero tax  because of the ELF  calculation, and                                                               
that is  what he means by  the poster child  of a broken ELF  - a                                                               
very, very economically healthy field was paying no tax.                                                                        
REPRESENTATIVE MUNOZ  asked whether the changing  of Alaska's tax                                                               
regime  4  times in  25  years  would  be considered  erratic  or                                                               
unusual as compared to other oil provinces in the world.                                                                        
MR. MARKS replied  that most oil companies  generally expect that                                                               
an oil tax will change about every 10 years.                                                                                    
2:40:46 PM                                                                                                                    
CO-CHAIR FEIGE  noted that  the committee is  trying to  put more                                                               
oil in the pipe, so  in its immediate deliberations the committee                                                               
is not necessarily looking at how  much money the state is making                                                               
or how much  profit the oil companies are making.   The objective                                                               
is to structure  HB 110 in the  best way for putting  more oil in                                                               
the pipe.   All  kinds of different  development could  happen on                                                               
the  North Slope  -  new fields  adjacent  to currently  unitized                                                               
areas; development within each unitized  area; different kinds of                                                               
oil  such  as  heavy,  viscous,  and  source  rock;  and  tapping                                                               
individual  fault blocks  using directional  drilling.   He asked                                                               
Mr. Marks to provide his opinion  on the best way to structure HB                                                               
110 to encourage companies to put more oil in the pipe.                                                                         
2:42:08 PM                                                                                                                    
MR. MARKS responded that under  the progressivity structure, when                                                               
the price goes up  $1, the tax rate is drawn  up for every single                                                               
dollar below  that.   The concept  of marginal  tax rate  is that                                                               
when the price of oil goes  up $1, what percentage of that dollar                                                               
goes  to government?   Progressivity  is an  absolutely fine  and                                                               
straight-forward philosophy  that at lower  income a  company can                                                               
afford  to pay  less, so  there is  a lower  rate, and  at higher                                                               
income a  company can afford  to pay more,  so there is  a higher                                                               
rate.  In  his judgment, the progressivity  structure within ACES                                                               
is seriously  dysfunctional because  of the way  it works.   When                                                               
the value goes up from $89 to $90,  not only does the tax rate on                                                               
the ninetieth  dollar go  up, the  tax rate  on all  the previous                                                               
dollars of value is  drawn up as well.  That is  what is called a                                                               
high marginal  tax rate,  and it  can exceed  90 percent  at high                                                               
prices.   This  is  a problem  because when  a  company looks  at                                                               
developing  a prospect  it looks  at the  expected price.   Since                                                               
prices are  very volatile and  hard to forecast, a  company looks                                                               
at what is going to happen under  a range of prices and there are                                                               
now  non-frivolous oil  price forecasts  that go  up to  $200 per                                                               
barrel by 2020.   Most people expect that more  things can happen                                                               
to make prices go up in the  future than down.  So when companies                                                               
look  at their  price  forecasts and  how things  work   under  a                                                               
variety of prices,  what happens on the high side  of high prices                                                               
can be  very important  to their outcome  because if  high prices                                                               
materialize they can make a lot of money.                                                                                       
2:44:49 PM                                                                                                                    
MR. MARKS  pointed out that  the high  marginal tax rate  of ACES                                                               
caps upside potential  because as price goes up  the marginal tax                                                               
rate gets higher and higher to  the point where not much money is                                                               
being  made by  the  company anymore.   From  what  he can  tell,                                                               
Alaska, at  high prices,  has the highest  marginal tax  rates in                                                               
the  world,   and  he  believes   this  makes   Alaska  seriously                                                               
uncompetitive.  Evidence  for this is Department  of Revenue data                                                               
that shows  only three  exploration wells drilled  in 2010  - the                                                               
smallest number of exploration wells  since 1988 when prices were                                                               
$8 a barrel, which he thinks is a problem.                                                                                      
2:46:08 PM                                                                                                                    
MR. MARKS said  he believes that the PPT was  as dysfunctional on                                                               
the  upside  as  ACES  because  it  had  the  same  progressivity                                                               
structure.  A  comparison of Department of  Revenue or Department                                                               
of Natural  Resources production  forecasts made in  2006, before                                                               
PPT, with  current forecasts for the  years 2010 to 2020  shows a                                                               
reduction of hundreds and hundreds  of millions of barrels.  This                                                               
reduction  is not  because a  field that  was thought  would come                                                               
online did not  materialize; it is for basically  the same fields                                                               
- the  core fields of Prudhoe  Bay, Kuparuk, and Alpine.   Eighty                                                               
to ninety  percent of  the oil  in the  forecasts is  forecast to                                                               
come from these core  fields because there is a lot  of oil to be                                                               
developed from them.   While ACES and PPT may  not be 100 percent                                                               
of the  cause for this  reduction, he  believes they are  a major                                                               
contributing factor.                                                                                                            
2:47:15 PM                                                                                                                    
MR. MARKS stated this could  be fixed by fixing the progressivity                                                               
structure.   The bracketing proposed  by HB  17 and HB  110 would                                                               
provide  for an  incremental tax  paid on  an incremental  value,                                                               
which  lowers the  marginal tax  rates and  is how  progressivity                                                               
universally works around  the world.  He has spent  a lot of time                                                               
on  this and  nowhere  else in  the world  has  he encountered  a                                                               
progressivity structure  like the one in  PPT or ACES, be  it oil                                                               
or non-oil.   He said  his judgment is to  go to a  bracketed tax                                                               
structure  and to  use international  competitiveness to  come up                                                               
with comparable marginal tax rates.   He added that he thinks the                                                               
current  credit  system   is  very  strong  and   very  good  for                                                               
encouraging development,  so he would  not focus on  the credits.                                                               
Credits coupled  with deducting costs are  significant incentives                                                               
for  developing,  but  the  high tax  rates  dwarf  anything  the                                                               
credits do.  In his  judgment, fixing the progressivity structure                                                               
will put more barrels in the pipeline.                                                                                          
2:49:00 PM                                                                                                                    
CO-CHAIR FEIGE  noted that under  the current system  the capital                                                               
costs  are  reported  as  one item  and  include  operations  and                                                               
maintenance as  well as exploration.   He asked whether  there is                                                               
any  advantage  to  having companies  report  those  exploration,                                                               
operations, and  maintenance costs separately and  then adjusting                                                               
the credit  structure to apply  to either  side of that,  such as                                                               
favoring more  exploration and development versus  operations and                                                               
MR. MARKS answered  that it is all production because,  in a way,                                                               
even maintaining things is production.   Encouraging producers to                                                               
maintain their fields is wanted and  the credits do that as well.                                                               
He  reiterated that  he thinks  the current  credit structure  is                                                               
strong and he  would focus on the  progressivity structure rather                                                               
than the credits.                                                                                                               
REPRESENTATIVE FOSTER noted that  the taxes for individual people                                                               
are based on  incremental taxation for the  incremental value and                                                               
do not  go retroactive to the  first dollar that a  person makes.                                                               
He understood this to be the point that Mr. Marks is making.                                                                    
MR. MARKS replied  exactly; what is proposed in HB  17 and HB 110                                                               
mirrors the Internal Revenue Service (IRS) tax booklet.                                                                         
MR. MARKS, in response to Co-Chair  Feige, said the IRS does have                                                               
progressivity, and it is bracketed.                                                                                             
2:52:00 PM                                                                                                                    
CO-CHAIR SEATON, referring to slide  31, asked what is the effort                                                               
being undertaken by  an oil company to have the  ANS market price                                                               
change  from  $90 a  barrel,  where  the  tax  rate is  about  36                                                               
percent, to $125 a barrel, where the  tax rate is 50 percent.  In                                                               
response to  Mr. Marks,  he noted  that the  state is  charging a                                                               
severance tax  for a non-renewable  resource that is  being taken                                                               
out  of the  state.   In further  response to  Mr. Marks,  he re-                                                               
phrased his  question by asking what  is a company doing  that it                                                               
should keep basically most all  of that profit difference between                                                               
$90 and $125 instead of having significant progressivity.                                                                       
2:54:18 PM                                                                                                                    
MR. MARKS allowed  that even under ACES the  producers are making                                                               
a lot of money, but the question  is how much more money can they                                                               
make somewhere else.  At  the corporate level corporations have a                                                               
finite amount of  capital.  In today's age  of globalization this                                                               
capital is very fluid and an  oil company can put capital lots of                                                               
places.   For example, ConocoPhillips  has presence in  more than                                                               
30 countries  and can choose to  put its money where  it will get                                                               
the most  for that money,  which is why looking  at international                                                               
competitiveness is  key.  One  would think  that as prices  go up                                                               
production would go up, [but  in Alaska] the production forecasts                                                               
have dropped between 2006 and now.   He said he truly believes it                                                               
is very  possible that because  of ACES,  when the price  goes up                                                               
the  schism between  Alaska's tax  and international  competitive                                                               
tax rate  widens.  The  higher the  prices the more  capital gets                                                               
diverted from  Alaska to  elsewhere, so  at higher  prices Alaska                                                               
gets less oil.                                                                                                                  
2:56:02 PM                                                                                                                    
CO-CHAIR SEATON understood  Mr. Marks to be  saying the companies                                                               
do not do anything to change the price from $90 to $120.                                                                        
MR. MARKS responded that they do not.                                                                                           
CO-CHAIR SEATON surmised  that Mr. Marks is saying  the state can                                                               
expect the  companies to continue removing  their investment from                                                               
oil in  Alaska to gas, which  legislators are being told  is very                                                               
unprofitable.   For  example, ConocoPhillips  has  a much  higher                                                               
percentage of profit coming from  its Alaska investment than from                                                               
its  international investments,  which are  gas investments;  yet                                                               
ConocoPhillips is going  to take its capital from  Alaska and put                                                               
it in  those gas  projects because  of the  marginal tax  rate in                                                               
Alaska, even though its percentage  increase in profits in Alaska                                                               
is much larger than it is internationally.                                                                                      
MR. MARKS answered that ConocoPhillips  is an oil and gas company                                                               
with interests all around the  world; worldwide it produces about                                                               
50 percent  oil and  50 percent  gas.   It can  invest in  oil in                                                               
Alaska  or elsewhere  and if  it can  earn more  profit elsewhere                                                               
than it  can in  Alaska, it will  go elsewhere.   That is  why he                                                               
believes Alaskans  should be very  concerned about how  the state                                                               
competes.   Fair value for  oil is  no different than  fair price                                                               
for  a  loaf of  bread.    Fair is  what  can  be received  in  a                                                               
competitive environment and  as an economist this is  how he sees                                                               
fair share,  although others  might see it  differently.   In his                                                               
opinion, if  Alaska thinks it is  entitled to more than  that, it                                                               
might end up in a not-very-good place.                                                                                          
2:59:08 PM                                                                                                                    
REPRESENTATIVE HERRON  observed that  current law stair  steps up                                                               
to  a  certain  value  and  then  progressivity  takes  off;  the                                                               
proposed  legislation stair  steps to  a certain  value and  then                                                               
goes flat.   He said  he is unsure  whether he supports  it being                                                               
flat at around  $100 because he thinks it should  stair step down                                                               
to encourage oil development and  production.  In response to Mr.                                                               
Marks, he confirmed he is meaning  that it should stair step down                                                               
at high prices because more money  is needed back in the state to                                                               
fill the pipeline.                                                                                                              
MR. MARKS replied  that the state's interests  must be protected,                                                               
too.  Looking  at the international environment, he  said he does                                                               
not think  that stair stepping  down at  high prices needs  to be                                                               
done  to be  competitive.   Under  these bills  the marginal  tax                                                               
rates peak  at about 75  percent, which means the  producers walk                                                               
away with 25  percent of incremental value.  At  high prices that                                                               
seems to be the  lay of the land.  He added  that the perfect tax                                                               
could   be  passed   this  year,   but  that   the  international                                                               
environment  must be  continually monitored  to stay  competitive                                                               
because that is what life in the age of globalization is.                                                                       

Document Name Date/Time Subjects
History of Alaskas Oil Gas Production Tax - Roger Marks 2.9.2011.pdf HRES 2/9/2011 1:00:00 PM
Additional ELF Graphs - Roger Marks Presentation.pdf HRES 2/9/2011 1:00:00 PM