Legislature(2007 - 2008)

11/06/2007 11:23 AM FIN


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11:23:10 AM Start
11:23:47 AM SB2001
04:21:15 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
SENATE BILL NO. 2001                                                                                                          
                                                                                                                                
     "An Act  relating to the production  tax on oil and  gas and                                                               
     to conservation surcharges on oil;  relating to the issuance                                                               
     of  advisory   bulletins  and  the  disclosure   of  certain                                                               
     information relating  to the production tax  and the sharing                                                               
     between  agencies of  certain  information  relating to  the                                                               
     production  tax and  to  oil  and gas  or  gas only  leases;                                                               
     amending  the State  Personnel Act  to place  in the  exempt                                                               
     service  certain  state  oil  and  gas  auditors  and  their                                                               
     immediate  supervisors;  establishing  an oil  and  gas  tax                                                               
     credit  fund   and  authorizing  payment  from   that  fund;                                                               
     providing for  retroactive application of  certain statutory                                                               
     and regulatory provisions relating  to the production tax on                                                               
     oil  and  gas and  conservation  surcharges  on oil;  making                                                               
     conforming  amendments;  and   providing  for  an  effective                                                               
     date."                                                                                                                     
                                                                                                                                
11:23:47 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman said the subject  for the meeting would be lease                                                               
expenditures, allowable deductions and  how they effect operating                                                               
and  capital  expenditures.   These  expenditures  are  "upstream                                                               
costs".                                                                                                                         
                                                                                                                                
11:24:56 AM                                                                                                                   
                                                                                                                                
JON IVERSON,  DIRECTOR, DIVISION  OF TAX, DEPARTMENT  OF REVENUE,                                                               
provided  a brief  overview  of the  current  PPT provisions.  He                                                               
specifically  addressed  lease  expenditures  outlined  under  AS                                                               
43.55.165 and  explained that  under PPT  the upstream  costs are                                                               
known  as  "lease expenditures":  items  that  are deductible  in                                                               
reaching the production tax value.  Upstream costs are made up of                                                               
capital  expenditures and  operating  expenditures. He  clarified                                                               
that  because   capital  expenditures  are  a   subset  of  lease                                                               
expenditures,  the   qualified  capital  expenditures   used  for                                                               
purposes  of  receiving  the credit  under  "lease  expenditures"                                                               
would not be allowed as a qualifying capital credit.                                                                            
                                                                                                                                
Mr. Iverson stated  that AS 43.55.165 sets  forth what determines                                                               
allowable  lease   expenditures.  These  are  the   ordinary  and                                                               
necessary  costs incurred  upstream to  the point  of production;                                                               
the direct  costs of  exploring, developing  or producing  oil or                                                               
gas.   When determining  what is  an allowable  lease expenditure                                                               
the Department  applies typical industry standards  and practices                                                               
in  billing costs  between companies  (unit agreements)  and also                                                               
the net profit  share lease regulations.  [This  criterion is set                                                               
forth  under   statute.]    Direct  costs   are  deductable  when                                                               
incurred, rather  than depreciated,  under current law.   Capital                                                               
costs,  under federal  regulations, are  assets that  last longer                                                               
and have a  useful life, longer than a year.   Under PPT, capital                                                               
expenditures are  allowed to be  expended when  incurred, thereby                                                               
not  depreciated.   Allowance for  overhead is  set forth  in the                                                               
statute and is set as a percentage of direct costs.                                                                             
                                                                                                                                
11:28:29 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman asked how capital  costs are handled for federal                                                               
tax reporting purposes because they  are still tax deductable and                                                               
depreciated.   Mr. Iverson explained that,  generally, items that                                                               
are considered  a capital expenditure are  depreciated. The value                                                               
of the asset  would be recovered as a tax  calculation over time.                                                               
PPT allows deductions in the year in which the costs occurred.                                                                  
                                                                                                                                
Co-Chair Stedman clarified  that a capital item will  show up, if                                                               
it  is  on  a  ten-year  schedule, nine  years  post  PPT,  as  a                                                               
deduction in a federal tax  return and concluded that federal tax                                                               
treatment would not be affected. Mr. Iverson agreed.                                                                            
                                                                                                                                
Mr. Iverson  explained that  overhead is set  as a  percentage of                                                               
direct costs.   He further clarified that specific  costs such as                                                               
lobbying,  advertising, etc.,  are not  significant, in  terms of                                                               
how  they effect  the  tax calculation.  He  maintained that  the                                                               
overhead allowance is a percentage of direct costs.                                                                             
                                                                                                                                
11:30:38 AM                                                                                                                   
                                                                                                                                
Mr. Iverson outlined the current  law regarding two provisions AS                                                               
43.55.165(c)  and   (d),  costs   billed  under   unit  operating                                                               
agreements.    He noted  this  would  be discussed  further  when                                                               
addressing SB 2001.  The PPT  statute sets forth what is excluded                                                               
from  lease  expenditures.  He  noted that  in  addition  to  the                                                               
general structure  of what is allowable,  specific exclusions are                                                               
established in AS  43.55.165(e)(18).  When a cost  is excluded as                                                               
a lease expenditure, it is not allowed as a deduction.                                                                          
                                                                                                                                
11:32:24 AM                                                                                                                   
                                                                                                                                
Senator Huggins asked  if health clubs were  allowable write offs                                                               
in PPT  or any other state  tax. Mr. Iverson noted  they were not                                                               
and clarified  that fringe  benefits, such  as health  clubs, are                                                               
overhead costs,  which is  set as a  percentage of  direct costs.                                                               
The state only audits for direct costs.                                                                                         
                                                                                                                                
Senator  Huggins asked  for the  percentage of  direct costs  for                                                               
overhead.  Mr.  Iverson answered that the percentages  are set in                                                               
regulation  15 AAC  55.270: three  percent of  non-overhead lease                                                               
expenditures  that are  qualified capital  expenditures and  nine                                                               
percent  of   direct  lease   expenditures  that   are  operating                                                               
expenditures.                                                                                                                   
                                                                                                                                
11:34:03 AM                                                                                                                   
                                                                                                                                
Mr. Iverson  added that there  is a provision under  AS 43.55.170                                                               
that  establishes   adjustments  to  lease   expenditures.  These                                                               
generally occur in instances where  something has been claimed as                                                               
a  lease  expenditure  in  a  prior  period  and  when  there  is                                                               
recoupment cost.                                                                                                                
                                                                                                                                
Mr. Iverson  addressed SB  2001 noting  that the  first provision                                                               
sets forth  an affirmative provision that  would allow Department                                                               
of  Revenue (DOR),  by  regulation, to  set  out allowable  lease                                                               
expenditures.  He explained  that  PPT established  a very  broad                                                               
base  of allowable  costs with  a number  of exclusions.  The new                                                               
provision  establishes  a  narrower   base  of  what  is  allowed                                                               
initially.    The intent  is  to  improved clarity  and  decrease                                                               
future litigation by delineating allowable expenditures.                                                                        
                                                                                                                                
11:36:38 AM                                                                                                                   
                                                                                                                                
Mr.  Iverson  referred  back  to  AS  43.55.165(c)  and  (d)  and                                                               
explained the  difficulty of implementing these  sections from an                                                               
administrative perspective, as well  as policy perspective. There                                                               
are two  primary drivers behind PPT  provision: an administrative                                                               
side  and a  policy side.   He  explained that  AS 43.55.165  (c)                                                               
provides  that  if the  Department  of  Revenue (DOR)  makes  the                                                               
finding   that  parts   of  a   unit   operating  agreement   are                                                               
substantially  consistent  with  general  standard  of  allowable                                                               
lease  expenditures,  then  the Department  would  authorize  the                                                               
producer  to treat,  as its  lease expenditures,  the costs  that                                                               
would be billable under the  operating agreement.  Alaska Statute                                                               
43.55.165 (d)  takes the provision  further; it  establishes that                                                               
costs   billed  under   the  agreement   are  allowed   as  lease                                                               
expenditures   if  DOR   makes   the   finding  of   "substantial                                                               
consistency" and  at least one  working interest owner in  a unit                                                               
has the substantial ability and is effectively auditing.                                                                        
                                                                                                                                
Mr.   Iverson  said   the  administrative   concern  is   one  of                                                               
implementation.    The  Department  of   Revenue  would  have  to                                                               
carefully track  the unit operating  agreements and the  terms of                                                               
those agreements.  Those agreements  are "moving targets" and the                                                               
accounting procedures are often in flux.   This also sets forth a                                                               
subjective  finding where  a determination  needs to  be made  of                                                               
what is  "substantially consistent" with the  regulations and the                                                               
statutes.   He maintained that  it is a  grey area of  whether or                                                               
not to  accept joint  audit findings  based on  this "effectively                                                               
auditing criteria".  Ultimately, it  means a multi track audit as                                                               
opposed to  auditing what  costs were billed.  The audit  that is                                                               
incurred by the  joint interest owners, as well  as the operating                                                               
agreement, would require  auditing.  He concluded  that this sets                                                               
up a multilinear  track of confusion.  He  added that substantial                                                               
compliance  with standards  set forth  in the  statute is  not in                                                               
precise correspondence with the statute  and the regulations.  As                                                               
a result,  a variance could be  allowed between what a  tax payer                                                               
is claiming and what is  actually allowed in statute. Under these                                                               
circumstances,   some  producers   could   be  treated   somewhat                                                               
differently as to what is actually deducted.                                                                                    
                                                                                                                                
Mr. Iverson  maintain that the previously  discussed concerns are                                                               
the reasons  the Department supports  the repeal of  AS 43.55.165                                                               
(c) and (d).                                                                                                                    
                                                                                                                                
11:39:20 AM                                                                                                                   
                                                                                                                                
Mr.  Iverson further  noted that  there is  imprecision regarding                                                               
cost allowances under the agreements.   As a policy matter, there                                                               
is  concern   regarding  a  shift  in   responsibility  from  the                                                               
Department  to the  tax  payer, for  determining  what costs  are                                                               
allowed as lease  expenditures.  He asserted  that the Department                                                               
is  not comfortable  with  the  shift and  does  not  feel it  is                                                               
appropriate.    These  determinations  put the  Department  in  a                                                               
difficult position  of having to  use an agreement that  had been                                                               
formulated in the past to predict  the future.  He clarified with                                                               
an example  of looking at  an operating agreement  and attempting                                                               
to  discern  whether  the   companies  are  continuously  staying                                                               
"substantially consistent" with the standards  set for the in the                                                               
statute.                                                                                                                        
                                                                                                                                
Mr. Iverson noted  the added provision in ACES  for the exclusion                                                               
of   costs  incurred   for  repair,   replacement,  or   deferred                                                               
maintenance on a facility undertaken  in response to a failure of                                                               
an  unscheduled "disruption  in production",  spill or  hazardous                                                               
substance  event.  The  Department   feels  that  "disruption  in                                                               
production"  is   a  more  usable  and   workable  standard  than                                                               
"improper   maintenance".     The  provision   proposed  by   the                                                               
Department provides  for the Department  to assess  whether there                                                               
was  an "unscheduled  disruption in  production".   He maintained                                                               
that  determining "unscheduled  disruption  of  production" is  a                                                               
more objective filing.                                                                                                          
                                                                                                                                
Mr. Iverson said,  within the provision, costs are  allowed to be                                                               
deducted if  the costs  were the result  of something  that could                                                               
not have  been prevented by  the taxpayers  such as acts  of war,                                                               
God, etc.                                                                                                                       
                                                                                                                                
11:43:01 AM                                                                                                                   
                                                                                                                                
Mr.  Iverson added  that  there  is an  exclusion  for the  costs                                                               
incurred to  construct, operate, or  acquire a refinery  or crude                                                               
topping plant. If  the crude oil topping plant is  on or near the                                                               
premises of  the property,  and the plant  is creating  a product                                                               
used on the  lease, the difference (the value  of the improvement                                                               
to the  product itself)  would be  considered an  allowable lease                                                               
expenditure. He explained that the  amount allowed as expenditure                                                               
is the difference  of fair market value and  the prevailing value                                                               
of the crude.                                                                                                                   
                                                                                                                                
Senator  Huggins  emphasized  concerns regarding  the  safety  of                                                               
transporting  fuel.   He  said  he is  interested  in looking  at                                                               
feasible  alternatives  that  allow  the state  to  partner  with                                                               
companies to  support topping plants. Mr.  Iverson responded that                                                               
the Department  has studied the  issue and assumed results  to be                                                               
forthcoming.                                                                                                                    
                                                                                                                                
Senator Huggins reminded  Mr. Iverson that Senate  Finance is the                                                               
last  committee  of  referral  and  stressed  the  importance  of                                                               
receiving the information in a timely manner.                                                                                   
                                                                                                                                
11:44:55 AM                                                                                                                   
                                                                                                                                
Co-Chair  Stedman  added that  there  was  limited time  for  the                                                               
special session  and for the  information to be  forthcoming. Mr.                                                               
Iverson understood.                                                                                                             
                                                                                                                                
Co-Chair Stedman  requested that  the Administration  bring forth                                                               
any current  cost estimates to  the treasury  as a result  of the                                                               
shutdown (corrosion issue).                                                                                                     
                                                                                                                                
Mr. Iverson clarified that only  the information disclosed by the                                                               
industry  can be  discussed.  He added  that  currently there  is                                                               
information under investigation that could not be revealed.                                                                     
                                                                                                                                
11:46:41 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman understood that there  could be costs claimed by                                                               
industry from the shutdown. Costs  that survive the audit process                                                               
may  be the  same  or substantially  different  depending on  how                                                               
tight the disallowable costs language is.                                                                                       
                                                                                                                                
Mr. Iverson agreed and believed  the amendment the Administration                                                               
proposed  regarding  the  exclusion   of  costs  associated  with                                                               
unscheduled shut downs, would tighten the language.                                                                             
                                                                                                                                
Mr. Iverson  noted that  there are items  in CSSB  2001(JUD) that                                                               
cause  the department  concern.  The language  allows only  lease                                                               
expenditures incurred  in the state.  He also said  the insertion                                                               
of language  regarding the exclusion from  lease expenditures due                                                               
to unscheduled  disruptions in production is  problematic because                                                               
it means the Department has to determine "improper maintenance".                                                                
                                                                                                                                
He concluded his presentation and asked for questions.                                                                          
                                                                                                                                
11:48:35 AM                                                                                                                   
                                                                                                                                
Co-Chair  Hoffman felt  the problem  with the  ACES language  was                                                               
that   it  was   not   definitive  enough.   He   asked  if   the                                                               
Administration agreed with that.                                                                                                
                                                                                                                                
Mr. Iverson said he would ask  the Administration how to make the                                                               
language tighter.  He emphasized  that the proposed  language was                                                               
the product of much consultative thought and effort.                                                                            
                                                                                                                                
Senator  Thomas stated  that he  felt the  "improper maintenance"                                                               
language was good.                                                                                                              
                                                                                                                                
11:50:36 AM                                                                                                                   
                                                                                                                                
GARY ROGERS,  PRODUCTION AUDIT MANAGER, TAX  DIVISION, DEPARTMENT                                                               
OF  REVENUE, referenced  language  in SCSSB  2001  and said  that                                                               
determining "indirect costs"  is the main audit  challenge.  Unit                                                               
operating  agreements in  Alaska  typically  allow more  indirect                                                               
costs to  be charged as  direct costs than  in other states.   He                                                               
noted the various  warehouses around the state.   In other states                                                               
a warehouse  would be considered an  indirect cost.  He  asked if                                                               
these are  the things under  the proposed language that  would be                                                               
excluded.   He asked how a  "direct cost" and an  "indirect cost"                                                               
would  be  defined for  auditing  purposes.   He  emphasized  the                                                               
importance  of  providing  clarity   around  the  language.    He                                                               
maintained that these terms would  be the reason for future audit                                                               
disputes.                                                                                                                       
                                                                                                                                
11:53:22 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman  asked how corporations attempting  to synergize                                                               
engineering  and  administrative duties  out  of  state would  be                                                               
treated in terms of allowable costs.                                                                                            
                                                                                                                                
Mr.  Rogers said  the normal  practice is  that engineers  charge                                                               
their  time   to  a  specific   project  which  is   more  easily                                                               
determinable.  He said  the  cost of  shared  facilities such  as                                                               
warehouses,  freight,  shipping,  and fringe  benefits  are  more                                                               
ambiguous.                                                                                                                      
                                                                                                                                
11:55:55 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman observed that due to  lack of labor force in the                                                               
Pacific Northwest  and in Canada,  as well  as some parts  of the                                                               
U.S., it is highly likely  engineering and drafting would be done                                                               
in India.   He asked if  the current language would  impact those                                                               
costs directly.                                                                                                                 
                                                                                                                                
Mr. Rogers  replied that  if there are  no clear  regulations for                                                               
indirect   costs,  different   auditors/lawyers  could   come  to                                                               
different conclusions on what are indirect costs.                                                                               
                                                                                                                                
11:57:03 AM                                                                                                                   
                                                                                                                                
Senator Elton  inquired if there is  language in any of  the bill                                                               
versions  that makes  it easier  or harder  to draft  regulations                                                               
that  would   clarify  the  issue.  He   further  emphasized  the                                                               
difficulty  of drafting  legislation  outlining specific  details                                                               
such as whether a warehouse is a direct or indirect cost.                                                                       
                                                                                                                                
Mr.  Rogers said  the Administration's  proposal that  repeals AS                                                               
43.55.165  (c)  and  (d),  and  the  added  amended  language  AS                                                               
43.55.165  (a) and  (b),  which allows  the  Department to  write                                                               
regulations while  considering unit operating agreements  and net                                                               
profit share lease  regulations, would work.  He  felt this would                                                               
be adequate  to address the issue.                                                                                              
                                                                                                                                
Senator  Elton asked  if there  was language  in the  any of  the                                                               
committee substitutes that does not work.                                                                                       
                                                                                                                                
Mr. Rogers emphasized  that the current language  in AS 43.55.165                                                               
(e) 22, CSSB  2001 JUD, "other indirect costs",  caused him great                                                               
concern as an auditor.                                                                                                          
                                                                                                                                
11:58:44 AM                                                                                                                   
                                                                                                                                
Senator Huggins asked Mr. Iverson to elaborate on his concerns.                                                                 
                                                                                                                                
Mr. Iverson clarified that there  may be other issues in addition                                                               
to  the   concern  about  the  ambiguity   of  "indirect  costs".                                                               
Delineation  of allowable  lease  expenditures  being only  costs                                                               
"incurred within the state" is  problematic as an audit issue. He                                                               
explained that  there are not  always resources  available within                                                               
Alaska  to  take  care  of   regular  costs  of  exploration  and                                                               
development. He provided  an example. Though a  seismic shoot may                                                               
be done  in Alaska, it may  be exported to Alberta  for analysis.                                                               
He  observed  that  the  language  in  ACES  regarding  "improper                                                               
maintenance" provides  a clearer  definition of  how to  meet the                                                               
policy objective than that outlined in SB 80.                                                                                   
                                                                                                                                
12:01:14 PM                                                                                                                   
                                                                                                                                
Senator  Huggins emphasized  the  reality that  only  a few  days                                                               
remained for  the special session  and the importance  of getting                                                               
the language correct.                                                                                                           
                                                                                                                                
Senator Thomas  asked if the  language "unscheduled  reduction in                                                               
production" would necessitate a determination of cause.                                                                         
                                                                                                                                
Mr. Iverson  explained that  the language  is a  strict liability                                                               
provision  so  a  determination  of  negligence  or  whether  the                                                               
facility has  been improperly maintained  is not  required. Costs                                                               
are excluded  if they are incurred  in response to an  event that                                                               
results in  an unscheduled interruption  of production.  The area                                                               
of  production  is   a  more  familiar  area   as  production  is                                                               
monitored, which  makes the interruption  in service  more easily                                                               
determinable. He noted that one of  the provision of ACES is that                                                               
any  "unscheduled   interruptions  in  production"  have   to  be                                                               
reported. He  maintained the provision also  encourages scheduled                                                               
and planned maintenance.  The  provision provides clarity in that                                                               
the reports would support a deductable cost of maintenance.                                                                     
                                                                                                                                
12:04:09 PM                                                                                                                   
                                                                                                                                
Senator  Thomas referred  to a  comment  by Mr.  Rogers who  said                                                               
there  was  too  much  subjectivity  in  the  language  regarding                                                               
"indirect  costs".    He  specifically noted  the  example  of  a                                                               
producer who  owns a warehouse  used for production in  the state                                                               
and whether it would be allowed as a deduction.                                                                                 
                                                                                                                                
Mr. Iverson deferred to Mr. Rogers.                                                                                             
                                                                                                                                
12:05:00 PM                                                                                                                   
                                                                                                                                
Mr. Rogers affirmed the audit  issue. He reiterated difficulty of                                                               
determining  the  costs  of warehouses  for  two  reasons.  These                                                               
facilities save companies on shipping  costs, which are generally                                                               
considered  a direct  cost. The  other  issue is  that, based  on                                                               
industry  standards,  the  warehouse  facilities  are  considered                                                               
indirect costs. He went on to  say that within the unit operating                                                               
agreement, the costs are considered  direct costs.  He maintained                                                               
that such ambiguity will result in a dispute.                                                                                   
                                                                                                                                
Senator Elton  said he struggles  with this  issue.  He  posed an                                                               
example  of a  "pig  run  thru a  line"  that detected  corrosion                                                               
problems before  a spill occurred,  but those  corrosion problems                                                               
could be attributed  to a lack of proper  maintenance or deferred                                                               
maintenance.   At that point  maintenance could be  scheduled, or                                                               
it may  occur before  there was  a spill or  an event  that would                                                               
trigger unscheduled maintenance.  It  seems as though the problem                                                               
with the  language in the  Governor's bill  is that all  of those                                                               
decisions that  had been made for  a period of years  that led to                                                               
the discovery  of the corrosion,  still cost  the state.   In the                                                               
example, someone  was able to  schedule maintenance  before there                                                               
was an event.  Senator Elton  maintained that that was not right.                                                               
In both cases, whether there was  a spill event that triggers the                                                               
maintenance  or   not,  decisions  made  for   years  before  the                                                               
discovery of  a problem  led to  that cost.   He did  not believe                                                               
that tax should be credited against the company's taxes.                                                                        
                                                                                                                                
12:08:06 PM                                                                                                                   
                                                                                                                                
Mr. Iverson acknowledged  that Senator Elton had  a valid concern                                                               
and that there is a concern  with "scheduling".  He felt this was                                                               
something  that   needed  to  be  addressed   in  regulation.  He                                                               
maintained that  though there  are still  some concerns  with the                                                               
language  in ACES,  it  provides more  clarity  than the  current                                                               
language.                                                                                                                       
                                                                                                                                
Co-Chair Stedman asked if members had questions for Mr. Mintz.                                                                  
                                                                                                                                
RECESS:        12:09:11 PM                                                                                                    
RECONVENED:    1:50:47 PM                                                                                                     
                                                                                                                                
Co-Chair Stedman continued the  discussion of lease expenditures,                                                               
allowable  deductions, and  the impact  on operating  and capital                                                               
expenditures.                                                                                                                   
                                                                                                                                
1:52:11 PM                                                                                                                    
                                                                                                                                
PATRICK  GALVIN, COMMISSIONER,  DEPARTMENT OF  REVENUE, spoke  to                                                               
the concerns of the legislature  and the Department's position on                                                               
those  concerns.   He addressed  lease expenditures  included and                                                               
excluded.    He  identified  changes   in  the  "corrosion  fix",                                                               
subsection 19, in  the original bill, page 44,  beginning on line                                                               
27.  The  primary  change  in the  Judiciary  Committee  was  the                                                               
inclusion of  language from SB  80. He clarified that  the intent                                                               
of  SB  80   was  to  ensure  that  costs   associated  with  the                                                               
replacement  of improperly  maintained  equipment  should not  be                                                               
deductible.   The   Department    recognized   the   difficulties                                                               
associated with  the ability to  implement the language of  SB 80                                                               
because it dealt with a  standard that was improperly maintained,                                                               
according  to industry  practices. When  attempting to  craft the                                                               
language for  ACES, the Department  worked closely  with auditors                                                               
within  the  Department,  as  well as  with  consultants  in  the                                                               
auditing field.   He maintained that what  developed was language                                                               
that would  identify an  event which would  prompt an  auditor to                                                               
look more closely  at specific expenditures to  determine if they                                                               
were acceptable.                                                                                                                
                                                                                                                                
1:55:55 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin  explained that  if there is  an interruption                                                               
of flow  caused by improper  maintenance, then that would  act as                                                               
trigger  for  looking  at  costs associated  with  a  repair.  He                                                               
maintained that the  language in the original  bill would provide                                                               
greater clarity for the standard.  The Senate Judiciary Committee                                                               
added  a  more  subjective standard  of  "improperly  maintained"                                                               
equipment, which would  not be deductible.  He  felt the language                                                               
creates a more complicated and difficult administrative burden.                                                                 
                                                                                                                                
1:57:08 PM                                                                                                                    
                                                                                                                                
Senator Elton  countered that  there are  many events  that would                                                               
not be  covered by the  suggested language. He  provided examples                                                               
and maintained  that things  could be addressed  by a  company to                                                               
preclude  an interruption  of service.  Under  the ACES  language                                                               
costs  would be  deductable even  if  a company  was careless  in                                                               
responding to  concerns that ultimately cause  an interruption in                                                               
production.                                                                                                                     
                                                                                                                                
Commissioner Galvin recognized that the  language is a trade off.                                                               
When  a standard  is established  due to  an association  with an                                                               
event such as  an unplanned interruption, things  will be missed;                                                               
some  costs  will  be  excluded   when  the  result  of  properly                                                               
maintained equipment breaks down  unexpectedly.  He indicated the                                                               
question was  not whether the  provision could result in  more or                                                               
less  costs  because  that  is  uncertain.    He  maintained  the                                                               
provision could be implemented in  a way to provide auditors with                                                               
a  clearer direction.  He  further claimed  that  the ability  to                                                               
prove  "improper maintenance"  would  require additional  outside                                                               
information,  whereas  "interruption  is production"  is  a  more                                                               
easily determinable factor.                                                                                                     
                                                                                                                                
2:01:04 PM                                                                                                                    
                                                                                                                                
Senator  Elton provided  other  examples  maintaining his  point.                                                               
The Commissioner reiterated that  under the ACES provisions there                                                               
may be some inequity on both sides.                                                                                             
                                                                                                                                
2:03:19 PM                                                                                                                    
                                                                                                                                
Co-Chair Stedman asked the  Commissioner about his communications                                                               
with  the  industry  regarding  deductions  associated  with  the                                                               
shutdown.                                                                                                                       
                                                                                                                                
Commissioner Galvin  said he had not  received enough information                                                               
to quantify  what costs  are associated with  the shutdown  or to                                                               
determine whether the  costs would be covered  under one standard                                                               
or  another.   The  Department  has   asked  for   more  detailed                                                               
information in order to make those determinations.                                                                              
                                                                                                                                
Co-Chair Stedman said  that many were surprised  at the magnitude                                                               
of  the  repairs due  to  the  shutdown.  He pointed  to  British                                                               
Petroleum's  20f  filing  projected  cost  of  $550  million  for                                                               
integrity  management.   He asked  the Commissioner  if this  had                                                               
been factored into the analysis and  what impact it would have on                                                               
the treasury.                                                                                                                   
                                                                                                                                
Commissioner Galvin informed the  committee that the $550 million                                                               
had been  factored into the  production forecasting numbers.   He                                                               
added  that  the  expense  for   integrity  management  had  been                                                               
reflected  in  future cost  expectations.  He  said the  industry                                                               
stated that  the integrity management  cost piece is  expected to                                                               
remain in place for the long term.                                                                                              
                                                                                                                                
2:06:43 PM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman asked  if  the $550  million  was an  aggregate                                                               
amount  or   specific  to  one  company.     Commissioner  Galvin                                                               
responded  that  he  could  not   be  certain,  but  the  numbers                                                               
generally  used  for  projections  are an  aggregate  number.  He                                                               
further noted that what is not  known is how much this commitment                                                               
to  infrastructure  will affect  investment  in  other areas.  He                                                               
maintained  that  this  is  why  the state  needs  to  provide  a                                                               
forecast as it relates to the expectations of expenditures.                                                                     
                                                                                                                                
2:08:47 PM                                                                                                                    
                                                                                                                                
Co-Chair Stedman asked how long  it would take before information                                                               
could  be  provided  to  the legislature,  if  the  language  was                                                               
approved.                                                                                                                       
                                                                                                                                
Commissioner Galvin hoped  that with the passage of  the bill and                                                               
implementation  of the  requirements, the  next revenue  forecast                                                               
would be  available in the  spring, before the budget  process is                                                               
complete.                                                                                                                       
                                                                                                                                
2:09:52 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin expressed concern  with language in CSSB 2001                                                               
(JUD)  regarding "costs  incurred within  the state".  He pointed                                                               
out  the difficulty  in auditing  and provided  an example.  If a                                                               
piece of equipment is manufactured  elsewhere and is delivered to                                                               
Alaska  to use  in production,  it is  difficult to  determine at                                                               
what point it is "incurred in the state".                                                                                       
                                                                                                                                
Commissioner Galvin  noted the second  aspect of  concern relates                                                               
to  tax  code  in  Alaska.  He  emphasized  the  Administration's                                                               
support of any  effort to provide jobs located  within the state,                                                               
associated with  North Slope production.   He maintained  that he                                                               
did  not feel  it appropriate  to establish  that within  the tax                                                               
code.   He maintained that  a more appropriate standard  would be                                                               
to  allow for  deductable  costs related  to "production"  within                                                               
Alaska.                                                                                                                         
                                                                                                                                
2:13:14 PM                                                                                                                    
                                                                                                                                
Senator  Huggins  asked the  Commissioner  if  he felt  that  the                                                               
language was punitive.                                                                                                          
                                                                                                                                
Commissioner Galvin responded that  the issue under discussion is                                                               
not  punitive,  but he  maintained  that  that Administration  is                                                               
concerned with the overall "package" that is produced.                                                                          
                                                                                                                                
Senator Huggins asked for clarification  of what the Commissioner                                                               
meant when he said "messaging of our tax code".                                                                                 
                                                                                                                                
Commissioner Galvin  emphasized the importance of  the entire tax                                                               
package  and the  ability  to  provide a  fair  share while  also                                                               
attracting oil  investment. In doing  so the tax package  must be                                                               
balanced with both concerns.                                                                                                    
                                                                                                                                
2:15:37 PM                                                                                                                    
                                                                                                                                
Senator Huggins  explained his expectations of  the Department to                                                               
do its best to implement the  law within its means and ability to                                                               
do so.   He  asked the  Commissioner if  that expectation  was an                                                               
accurate expectation.                                                                                                           
                                                                                                                                
Commissioner Galvin responded in the affirmative.                                                                               
                                                                                                                                
Commissioner Galvin drew attention  to changes in CSSB 2001(JUD),                                                               
page  41, regarding  allowable  deductions  definitions. He  said                                                               
that some of  the changes are good  clarification, whereas others                                                               
cause some  confusion.  With regard  to the language, on  line 6,                                                               
(i),   "for  properties   on  which   oil  and   gas  development                                                               
exploration, development,  or production", he clarified  that all                                                               
credits  and  deductions  had  to  be  related  to  oil  and  gas                                                               
development.   He added that  the language is in  some provisions                                                               
and not  in others.   {He maintained  the inconsistency  gave the                                                               
negative inference  that the other  provisions are  not similarly                                                               
required to be  related to oil and gas development.}  He felt the                                                               
language should be removed.                                                                                                     
                                                                                                                                
Commissioner  Galvin addressed  joint  interest billings,  noting                                                               
changes on  page 41 of CSSB  2001(JUD).  He explained  that it is                                                               
the  lead into  the section  that provides  authorization to  the                                                               
Department to use  join interest billings as a  method to provide                                                               
structure  to the  audit and  identify appropriate  expenditures.                                                               
On  line  25,  language  changed   from  "shall"  to  "may".  The                                                               
Administration supported the change.                                                                                            
                                                                                                                                
2:19:04 PM                                                                                                                    
                                                                                                                                
Commissioner    Galvin    discussed   exclusions    from    lease                                                               
expenditures. He  addressed added language  on page 42,  line 23,                                                               
CSSB 2001(JUD):  "violation of law,  or failure to comply with an                                                               
obligation under a lease, permit,  or license issued by the state                                                               
or federal  government." He said  the language could be  added to                                                               
the  section dealing  with  the corrosion  issue.   The  language                                                               
addresses  concerns  regarding  the corrosion  issue,  which  are                                                               
outlined on page 44, line 27.                                                                                                   
                                                                                                                                
2:21:43 PM                                                                                                                    
                                                                                                                                
Commissioner  Galvin   addressed  an  issue  that   he  said  had                                                               
continually surfaced in both the  public and the legislative body                                                               
regarding  expenses associated  with lobbying,  advertising, etc.                                                               
He explained  that the expenses  are not deductable as  they have                                                               
to  be  directly associated  with  production,  but there  is  no                                                               
language in  current statutes  that specifically  said that.   He                                                               
said on  page 42, section  59, AS 43.55.165.(e) 8,  adds specific                                                               
language.   He  further pointed  out that  the language  that was                                                               
deleted  is  superfluous.   Both  changes  are supported  by  the                                                               
Administration.                                                                                                                 
                                                                                                                                
2:23:41 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin  reported that page  43, line 6,  section 12,                                                               
was rewritten.  The Department was comfortable  with the rewrite.                                                               
The intention behind  the language is to ensure that  if there is                                                               
an internal transfer  with costs associated, then  there needs to                                                               
be a justification  reported for the amount claimed  to make sure                                                               
it is  of fair  market value.   The  onus is  on the  taxpayer to                                                               
assign fair market value to the expense.                                                                                        
                                                                                                                                
Co-Chair  Stedman  asked  the Commissioner  to  address  indirect                                                               
costs,  page 46,  line  4.   Commissioner  Galvin explained  that                                                               
lines 1-4 were  added in the Senate Judiciary  Committee. He felt                                                               
that  the language  in subsection  (21) was  an overstatement  of                                                               
what needs  to be excluded  from costs.   In subsection  (22), he                                                               
felt  it was  redundant  because  it states  the  inverse of  the                                                               
positive statement that "only direct  costs" are related. He said                                                               
the  reference  to  overhead  can  cause some  confusion.      He                                                               
reiterated  that overhead  is addressed  in  regulations: of  the                                                               
direct   costs,  3%   is  allowed   for   overhead  for   capital                                                               
expenditures, 9% for operating costs.                                                                                           
                                                                                                                                
Co-Chair Stedman asked if the  Commissioner would like to comment                                                               
on the topping plant issue.                                                                                                     
                                                                                                                                
2:29:38 PM                                                                                                                    
                                                                                                                                
Commissioner  Galvin  said  the   new  subsection  (20)  in  CSSB                                                               
2001(JUD),  page 45,  line 21  is the  language from  ACES.   The                                                               
topping  plant  issue  relates   to  an  investment  decision  by                                                               
ConocoPhillips to  pursue a topping  plant for low  sulfur diesel                                                               
located on  the North  Slope. The  company is  required to  use a                                                               
particular  low  sulpher  diesel  under  current  law.  There  is                                                               
ambiguity in the  current law as to whether  the manufacturing of                                                               
diesel  and the  building of  a refinery  is directly  related to                                                               
production  and  exploration.    In  the  Department's  analysis,                                                               
diesel is  a supply  issue. The  company needs to  have it  as an                                                               
item for  fuel to run equipment.   Because the companies  have an                                                               
option  to  purchase  the  fuel or  can  manufacture  the  diesel                                                               
themselves,  the  determination  was  made  that  building  of  a                                                               
refinery  should not  be  a  deductable cost.  He  said that  the                                                               
language recommended  by the Department  is their policy  call in                                                               
that the  cost for building a  plant should not be  deductable or                                                               
available for  a credit.   He  said there  are estimates  of $300                                                               
million  to build  a refinery  which would  represent a  $100-150                                                               
million impact  to the treasury, if  the expense is allowed  as a                                                               
deduction.  He  emphasized that the Department felt it  is not an                                                               
appropriate  deduction  and  should  not be  associated  with  or                                                               
subsidized through a production tax.                                                                                            
                                                                                                                                
Senator Huggins  underlined that  there is a  mandate to  use the                                                               
low  sulfur  diesel  fuel  and   emphasized  the  validity  of  a                                                               
company's  desire  to  build  a  plant.    He  said  it  was  his                                                               
understanding that  if the Department  did not  support something                                                               
they  would  provide  other  options  for  addressing  particular                                                               
concerns.                                                                                                                       
                                                                                                                                
Commissioner  Galvin  acknowledged  there were  some  discussions                                                               
regarding  the  fuel being  trucked  versus  the opportunity  for                                                               
companies  to build  their own  plants to  avoid the  trucking of                                                               
fuel.   He said DOR  has had  discussions with the  Department of                                                               
Transportation and  Public Facilities (DOTPF). A  report had been                                                               
generated from the associated concerns.                                                                                         
                                                                                                                                
Senator Huggins said  he saw the report. He went  on to highlight                                                               
the  safety  concerns  with  trucking  fuel.  He  emphasized  the                                                               
importance of  looking at the  issue and the  potential tradeoffs                                                               
regarding safety.                                                                                                               
                                                                                                                                
AT EASE:       2:37:01 PM                                                                                                     
RECONVENED:    4:12:48 PM                                                                                                     
                                                                                                                                
Co-Chair   Stedman  said   he  would   get   feedback  from   the                                                               
Commissioner.                                                                                                                   
                                                                                                                                
4:13:12 PM                                                                                                                    
                                                                                                                                
Commissioner Galvin  said that,  in summary, regarding  the lease                                                               
expenditure language, the corrosion  issue can satisfy most needs                                                               
with existing  language. He added that  expanding the description                                                               
of what costs  are going to be excluded, due  to criminal conduct                                                               
or "failure to  comply" with a lease  requirement, in combination                                                               
with  original language,  was a  good solution  to the  corrosion                                                               
issue. With regards to the  definition of what lease expenditures                                                               
are going to be excluded,  the language regarding costs "incurred                                                               
within  the state"  is too  broad.   With regards  to what  lease                                                               
expenditures are  provided, that  can be  tightened up  from CSSB                                                               
2001(JUD). Other than the  mentioned suggestion, the Commissioner                                                               
felt that  the bill was  a good  mix of clarifications  from what                                                               
was in ACES.                                                                                                                    
                                                                                                                                
Senator  Elton   assumed  the  Administration  would   have  some                                                               
proposed language on those issues.                                                                                              
                                                                                                                                
Commissioner  Galvin  affirmed  that  and said  he  would  submit                                                               
language to the chairman.                                                                                                       
                                                                                                                                
4:14:54 PM                                                                                                                    
                                                                                                                                
Co-Chair   Stedman   noted   that   he  would   work   with   the                                                               
Administration regarding  new or  additional language  that would                                                               
be acceptable to all parties.                                                                                                   
                                                                                                                                
Co-Chair  Stedman  asked if  the  Administration  had a  targeted                                                               
range of government take other than what is provided in ACES.                                                                   
                                                                                                                                
Commissioner  Galvin said  the issue  of government  take is  one                                                               
step  removed   from  the  primary   balance  of   ensuring  that                                                               
investment  opportunities in  Alaska are  protected. He  said the                                                               
target share should be comparable  to Alaska's peers, such as the                                                               
United Kingdom and Norway.                                                                                                      
                                                                                                                                
Commissioner Galvin noted  that he had the  original ACES metric,                                                               
which had  been requested, available for  the Committee. Co-Chair                                                               
Stedman  assured   the  Commissioner   that  he  would   get  the                                                               
information to the committee members.                                                                                           
                                                                                                                                
4:17:47 PM                                                                                                                    
                                                                                                                                
SB   2001  was   heard  and   HELD  in   Committee  for   further                                                               
consideration.                                                                                                                  
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
The meeting was adjourned at 4:21:15 PM.                                                                                        

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