Legislature(2003 - 2004)

05/14/2003 09:40 AM FIN

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= 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                                                            
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                                                            
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                                                            
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                                                            
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                                                            
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                                                            
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                                                            
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                                                            
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                                                            
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                                                            
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                                                            
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                                                            
Co-Chair Green commented  that the competition has changed from five                                                            
years  prior  and   that  the  State  must  adjust  accordingly   to                                                            
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                                                            
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.                                                                                                              

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