Legislature(2003 - 2004)
05/14/2003 09:40 AM FIN
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
CS FOR SENATE BILL NO. 185(RES) "An Act providing for a reduction of royalty on certain oil produced from Cook Inlet submerged land." This was the second hearing for this bill in the Senate Finance Committee. Co-Chair Wilken directed attention to a draft committee substitute. Senator Taylor moved for adoption of CS SB 185, 23-LS0926\S, as a working document. Co-Chair Wilken objected for an explanation. DAN DICKINSON, Director, Tax Division, Department of Revenue, detailed the changes in the committee substitute. He stated this legislation relates to an oil and gas exploration tax credit. He noted the committee substitute provides that this credit could be taken any time after July 1, 2004. He clarified that although credits could be accrued for expenses occurred before that date, the credit could not be received until FY 04. He indicated the credit is either 20 percent or 40 percent. Mr. Dickinson spoke of the expenses that qualify for the credit and pointed out they must be incurred between July 1, 2003 and July 1, 2007. He stated this would encourage exploration during this time period. He furthered that the committee substitute "created a very narrow base of just those expenses traditionally associated with exploration." He asserted that and once a well is successful, the State would stop "recovering the cost", because it is assumed that a producer would continue development. Mr. Dickinson pointed out an error with in the committee substitute in that the practice of "cementing" qualifies for the credit on page 6, line 16, however is disallowed on line 20. He recommended deleting "cementing" from line 20, as the expense should be allowable. Mr. Dickinson next noted that if wells or work on wells has already been committed to the State as a plan of development, the credit could not be taken. He remarked this is to prevent producers from delaying activities. Mr. Dickinson stated that the 20 percent credit would apply to exploration that is done more than three miles from a preexisting well. He characterized this as small accumulations that would be close to current infrastructure and in which development would progress rapidly. He pointed out the three-mile requirement was changed from the location of the "blow holes", as specified in Version "Q" adopted at the previous hearing, to the location of the "bottom holes." He also noted that the specification of "preexisting" was inserted in the committee substitute Version "S" to allow developers to pursue additional exploration near other areas explored utilizing the proposed credit. He stated this would allow developers to utilize a single drilling pad and would cover a "drilling pad". Mr. Dickinson next described the wildcat exploration activities that would qualify for a 40 percent credit, which he compared to the recent Alpine discovery. He explained that these activities must occur at least 25 miles from a lease boundary, or infrastructure. He clarified these explorations could be located within 25 miles from another wildcat location. He also noted that seismic exploration would also qualify for the 40 percent credit. Mr. Dickinson outlined the procedure whereby information learned during these exploration activities would be submitted to the Department of Natural Resources and then made public after a period of ten years. He stated this would provide opportunity for explorers to develop their discoveries and also allow others to "build on that knowledge base" after ten years has passed. Co-Chair Green asked if ten years is the standard length of time in which to make this information available to the public. Mr. Dickinson replied it is standard in some places, although the time period is two years in other areas. He surmised the existing Department tax credit program has not been utilized because of the two-year period. Senator Taylor asked the benefit to the State for the ten year time period. He noted the exploration credit would be valid for four years and suggested the proprietary information should be made public after four years as well. Mr. Dickinson responded that the ten-year provision would benefit the State in that commercial transactions in areas near these drilling sites should not be interrupted because of proprietary information gleaned from the exploration activities. Senator Taylor expressed concern over the "vast amount of acreage" the State has leased, upon which no activity has occurred for "an extensive period of time". Mr. Dickinson understood the leases have a seven-year term and the contracts require a plan for development. Senator Taylor asked whether the terms of the lease agreements are enforces and if the State has terminated leases for lack of development. Co-Chair Wilken directed the witness to complete his explanation of the committee substitute. Mr. Dickinson noted that credits earned by a company that does not have a production tax liability, could be transferred or sold. He informed that a market exists for these credit certificates and that this provision would encourage "nontraditional" and independent explorers. Senator Hoffman asked the difference between transfer, convey and sell, as related to the certificates. Mr. Dickinson responded this is legal terminology to cover the situations in which a company could utilize the credit earned by a subsidiary. Mr. Dickinson continued that the committee substitute also contains a provision allowing the purchaser of a certificate to pay less than the full value of the credit, yet receive the full credit from the State. He explained this is to maintain the value of the certificates for the explorers and to provide incentive for explorers. Mr. Dickinson indicated other language in the committee substitute addresses confidentiality and definitions. Co-Chair Wilken moved for adoption of CS SB 185, 23-LS0926\S, as a working draft. The committee substitute, Version "S" was ADOPTED without objection. Amendment #1: This amendment deletes "cementing" from page 6 line 20 in Section 3 of the committee substitute. The amended language of Sec.43.55.025 (b)(3) reads as follows. (b) may not be for testing, stimulation, or completion costs; administration, supervision, engineering, or lease operating costs; geological or management costs; community relations or environmental costs; bonuses, taxes, or other payments to governments related to the well; or other costs that are generally recognized as indirect costs or financing costs; and Co-Chair Green moved for adoption. There was no objection and the amendment was ADOPTED. Senator Taylor restated his earlier question relating to maintenance of leases, acknowledging the subject is not directly related to this legislation. He asked the number of exploratory wells were drilled three years prior when the price of oil was $8.56 per barrel. Mr. Dickinson informed of the disappointment to the Department that when the prices were "covered" in 1999 and 2000, similar recovery in exploration did not occur. He relayed the theory that the higher prices of the past three years have been a "bubble" sustained for "various reasons" rather than due to a "fundamental shift in the underlying price." Therefore, he stated projects were evaluated based on a per barrel price of $14.00, despite the actual prices of ten dollars higher. MARK MYERS, Director, Division of Oil and Gas, Department of Natural Resources furthered that seven exploration drills have occurred on the North Slope over the past year, as well as "quite a bit of activity" in Cook Inlet. He informed that companies base expenditures on a production forecast and therefore plan several years in advance and he detailed the statistical methods utilized to determine exploration activities. Senator Taylor asked why this program was not done four or five years ago. Mr. Meyers answered, "The state of Alaska's oil industry has been in tremendous flux, largely due to the massive mergers and acquisitions." He explained that it would have been difficult for the large companies to invest in exploration in the midst of merging with other companies. Debate continued between Senator Taylor and Mr. Myers relating to the reserves not under exploration or development. Mr. Myers assured that no large known reserves were idle. He told of exploration activities underway across the State facilitated by a licensing program. Senator B. Stevens asked whether an explorer retains rights to seismic data submitted to the Department of Natural Resources after it has sold the tax credit certificate earned from activities at the claim in which the information was generated. Mr. Myers responded that the State would be required to maintain the confidentiality of this data for ten years. He furthered that any other company wishing to obtain this data must purchase it through the explorer. Senator B. Stevens clarified that the explorer could sell both the tax credit and the data collected. Mr. Myers affirmed. Senator B. Stevens asked whether this occurs often. Mr. Myers stated that most seismic data "shot" is not collected for speculation purposes and explained the existing practices of sharing and selling data. Senator B. Stevens asked whether a party could "shoot" seismic data in an area it does not own a lease on. Mr. Myers replied that seismic shot on State land is done by permit, independent of ownership of mineral rights. He stated that issuance of such permits is common practice for the Department. Senator Hoffman asked whether this legislation would apply to the National Petroleum Reserve - Alaska (NPR-A). Mr. Dickinson replied it would. Senator Hoffman asked the importance to this bill of the provisions relating to the sale, transfer and conveyance of the tax credits, and the consequences of deleting the provisions. Mr. Dickinson stressed the intent to not create this credit only for parties with current tax liabilities. He listed four companies with current tax liabilities and stated the goal is to encourage exploration to additional entities. Senator Hoffman asked if other states allow these sales and transfers and whether the credits are discounted according to the sale price of the credit. Mr. Dickinson understood that in other locations in the world where this practice is employed, purchasers are allowed to retain the full value. He remarked the intent is to protect the interest of the explorers. Senator Hoffman suggested the matter should be considered from the best interest of the State. Mr. Dickinson expressed the purpose is to promote exploration and to generate revenue from income taxes once the oil is produced. Senator Taylor clarified testimony that the oil industry is basing exploration decisions on a model based on a price of approximately $14.50 per barrel. Mr. Dickinson responded that $14.00 is the "stress price", i.e. "the low end price in the cycle". He stated this is one factor utilized by industry, although the companies have complex models. Mr. Meyers furthered the models vary by company and would be a "netted back price". He listed factors considered in determining exploration and production activities, including differential in transportation cost, whether the oil would be sold interstate or intrastate, pipeline tariffs, incremental facilities costs, whether existing infrastructure would be available, the commercial arrangement for infrastructure, potential productivity rates of the reservoir, etc. Senator Taylor commented on the large profits of oil companies and the need for those funds to be reinvested in Alaska. While he supported providing $500 million of anticipated revenue to induce additional exploration, he questioned the amount of revenue the State would receive, given the testimony regarding the "bubble" in oil prices. He predicted that significant exploration would occur as a result of the tax incentives but that actual production would not. KEVIN TABLER, Land and Government Affairs Manager, Union Oil Company, testified via teleconference from an offnet location to express disappointment that concerns he expressed to the Committee at the previous hearing were not addressed in the committee substitute. He pointed out that this bill initially related to royalty reduction necessary for continuation of exploration and infrastructure in the Cook Inlet area, and that the committee substitute adds another component at significant expense that could subsequently jeopardize the original provision. He emphasized the new provision relates to activities in the North Slope but would not benefit activities in Cook Inlet. Mr. Tabler spoke of wells drilled in the 1960s and 1970 that did not contain oil but could contain natural gas and were ranked as wildcat exploration. He stated that these are located close to existing infrastructure and would therefore not qualify for the tax credit, although there is no guarantee they contain natural gas. He spoke of the current shortage of natural gas. He suggested a provision to clarify the intent for increased production, as the current language of the bill provides no incentive for independent explorers operating in Cook Inlet. Mr. Tabler proposed amending Section 3, Sec. 43.55.025 (c)(2), on pages 6, line 30 through page 7, line 4 of the committee substitute to read as follows. (2) be for an exploration well that is located and drilled in such a manner that the bottom hole is located not less than three miles away from the bottom hole of an abandoned oil or gas well certified by the AOGCC [Alaska Oil and Gas Conservation Commission] as capable of producing from the same formation in the exploration well; SFC 03 # 94, Side B 10:27 AM Mr. Tabler continued this would allow parties to explore for gas in areas that had been explored for oil. He spoke to the different formations and horizons of oil and gas exploration. He remarked the proposed amendment would allow drilling utilizing the existing infrastructure, as intended by the original version of the bill. Mr. Meyers addressed the proposed amendment, noting the "many different flavors of oil exploration", including "rank wildcats", located far from infrastructure and with little geologic data and increased risk. He stated that with increased known data available, the exploration risk generally decreases. He titled areas within existing production as "extension explorations", noting these typically have significantly more data than the rank wildcat explorations. Co-Chair Wilken asked if the Department favors or opposes the suggested amendment. Mr. Meyers replied that the matter needs further discussion and the Department would oppose the amendment until that time. He remarked that the fiscal note would be difficult to quantify, although it would be in a significantly larger amount based on the number of wells that would qualify. He admitted he was unaware of the relationship of AOGCC certification to exploration risk. STEVE PORTER, Deputy Commissioner, Department of Revenue, testified that if this if bill passes, the Department would review the impacts to Cook Inlet. Mr. Tabler remained concerned recalling HB 207, of 1995, relating to royalty reduction in Cook Inlet. He asserted the final version incorporated the North Slope and subsequently, "made that bill unusable for us and unworkable." He reiterated the current bill could fail to pass as a result of the increased fiscal note cost. He understood the comments about exploration risk, but disagreed with the Department. He supported the concept proposed in the committee substitute, but warned that it does not apply equably to both "oil provinces". Co-Chair Wilken applauded the witness's presentation of arguments. He assured that before this bill could pass into law, additional opportunities would be available to address the witness's concerns. He furthered that the Department has committed to review the matter. Senator Bunde added that dry holes incur a substantial cost and would be a considerable risk. Mr. Tabler affirmed. He spoke of "pleading for capital" to drill those wells. Senator Hoffman asked if the July 1, 2007 deadline for this legislation would be in effect if the Alaska National Wildlife Reserve (ANWR) were opened for oil exploration before that date. Mr. Dickinson answered the credits would still apply. Senator Hoffman asked whether the provision of this bill should apply to potential activities in ANWR. Mr. Dickinson responded the intent is to encourage drilling presently and that the legislature could extend the provisions to apply to ANWR. Senator Hoffman noted that it is known that considerable oil reserves exist in ANWR, and that the State is depending upon an opening. Senator Hoffman referenced the spreadsheet detailing the cost of exploration and asked about oil development occurring in the other countries listed and the incentives offered in those locations. He expressed the need for a benchmark. Mr. Dickinson replied that exploration is one factor and that development, transportation, and marketing are also factors. He stated that each fiscal regime is different in the incentives offered. Senator Hoffman asked what areas exploration is concentrated. Mr. Dickinson listed areas in the former Soviet Union, noting that although there have been difficulties these areas offer the most enticing incentives. Co-Chair Wilken appreciated the Committee discussion on this issue. Senator Taylor offered a motion to report the committee substitute, Version "S", as amended, from Committee with individual recommendations and new fiscal notes. Senator Taylor then objected to his motion to comment that this legislation is "very brave" on the part of the Murkowski Administration to deny $100 million to the general fund each year for the next four years and provide that as an investment for future administrations and future legislatures that hopefully would realize a return. Senator Taylor removed his objection. Co-Chair Wilken pointed out the maximum exposure is $100 million annually and would not be realized until FY 05. He shared Senator Taylor's concern, but clarified that $400 million is not the correct amount of lost revenues because of increased production revenues. Co-Chair Green commented that the competition has changed from five years prior and that the State must adjust accordingly to participate. Co-Chair Wilken added that with regard to oil exploration, Alaska "is sitting still while others are leapfrogging ahead of us with exploration credits." Senator Hoffman concurred with the comments, but expressed concern th that this is monumental legislation considered in the 114 day of the legislative session. He asked why this bill was not introduced two months ago, given that the governor campaigned about resource development. He was unsure that he had adequate time to consider the ramifications, whether this would benefit the State and whether it would actually result in increased exploration activities. He asserted that the Committee has a responsibility to fully consider matters, and he questioned whether moving this legislation He remarked that despite his concerns, he would not object to this bill moving from Committee. Co-Chair Wilken countered that legislation should have been introduced two years ago. He informed that he became aware four weeks ago that this legislation was being prepared. He surmised that the Administration has researched the matter and understands the importance and the risks and benefits. He asserted, "finally we have a governor that has the courage to bring this to this table because the prior governor did not." Without objection, CS SB 185 (FIN) MOVED from Committee with a fiscal noted dated 5/11/03 for $107,900 from the Department of Revenue, and a zero fiscal note dated 5/9/03 from the Department of Natural Resources.