Legislature(2007 - 2008)BUTROVICH 205

10/30/2007 09:00 AM JUDICIARY


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Audio Topic
09:17:01 AM Start
09:17:36 AM SB2001
03:22:02 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+= SB2001 OIL & GAS TAX AMENDMENTS TELECONFERENCED
Heard & Held
Actual versus Reasonable Costs
Credit Buy-back Fund and
Appropriation Authority
Corrosion
-- Testimony <Invitation Only> --
                SB2001-OIL & GAS TAX AMENDMENTS                                                                             
                                                                                                                                
9:17:36 AM                                                                                                                    
CHAIR FRENCH announced  the consideration of SB  2001. Before the                                                               
committee was CSSB  2001(RES), labeled 25-GS0014\M. He  said a BP                                                               
representative   had  testified   yesterday  that   repealing  AS                                                               
43.55.165 (c) and  (d) would send a signal  that the commissioner                                                               
would no longer  have the discretion to allow or  require the use                                                               
of  billed or  billable costs.  He asked  Mr. Bullock  to discuss                                                               
joint interest  billings and the  repealer of two  subsections in                                                               
AS 43.55.165.                                                                                                                   
                                                                                                                                
9:18:33 AM                                                                                                                    
DONALD  BULLOCK, Counsel,  Legislative Affairs  Agency, said  any                                                               
time  you repeal  something it  raises  the question  of what  it                                                               
means. In  isolation, if you repeal  it, then there would  be the                                                               
implication that  you can't look  at that any more.  However, you                                                               
can't look  at the repealed  subsections of AS 43.55.165  (c) and                                                               
(d)  in isolation;  they're part  of a  larger bill.  Included in                                                               
this larger  bill is the  amendment to AS 43.55.165(a),  which is                                                               
in  Section  19 of  CSSB  2001(RES)  and  in  Section 56  of  the                                                               
governors bill (SB 2001).                                                                                                       
                                                                                                                                
MR.  BULLOCK  said  his  reading of  AS  43.55.165(a)  gives  the                                                               
department  the   discretion  to  determine  whether   costs  are                                                               
allowable under the standards that  are presented there (page 16,                                                               
line 2,  of CSSB 2001(RES)).  Costs must be incurred  upstream of                                                               
the  point of  production  for oil  and gas;  the  costs must  be                                                               
ordinary  and  necessary  costs  of  exploring,  developing,  and                                                               
producing; and  the exploring  costs must  be direct  costs. This                                                               
language doesn't  preclude the department  from looking  at those                                                               
costs. Perhaps the repeal puts less  emphasis on the use of those                                                               
costs,  "but  the  department's   given  the  discretion  in  the                                                               
amendment to  .165(a) to put whatever  is out there --  to see if                                                               
the costs meet the criteria that are established in .165(a)."                                                                   
                                                                                                                                
9:20:23 AM                                                                                                                    
CHAIR FRENCH said that the PPT  was enacted just one year ago and                                                               
in it  the commissioner  was granted authority  to look  at those                                                               
costs  in the  two subsections  that are  now being  repealed. It                                                               
isn't as if  the PPT has 20  years of fights in  court about what                                                               
costs are  allowed and what  aren't. So repealing it  wouldn't be                                                               
undoing a long standing practice.                                                                                               
                                                                                                                                
MR. BULLOCK  agreed and said  he didn't  believe an audit  of the                                                               
returns  that were  filed on  April 1  had been  completed. Under                                                               
current  law, the  department has  three years  to complete  that                                                               
audit. The legislature  can put on the  record the interpretation                                                               
that  the department  can continue  to consider  these things  in                                                               
determining the  ordinary and  necessary costs.  Alternatively, a                                                               
clearer message  in .165(a)  could say  that the  information the                                                               
department may look  at may include the type of  things that were                                                               
in (c) and (d), but he didn't think that was necessary.                                                                         
                                                                                                                                
9:22:32 AM                                                                                                                    
SENATOR THERRIAULT  asked if putting  something in  statute would                                                               
be harmful.                                                                                                                     
                                                                                                                                
MR. BULLOCK  replied that  putting it in  statute would  create a                                                               
lot of  appeals. If it  says "may consider" the  department would                                                               
be challenged  to say why it  didn't consider it or  give it more                                                               
weight. To  give the  department the  broadest discretion  to use                                                               
whatever  information  it  feels   is  relevant  to  support  its                                                               
assessment, it is best to leave it as the legislative record.                                                                   
                                                                                                                                
9:23:56 AM                                                                                                                    
JONATHAN IVERSEN,  Director, Tax Division, Department  of Revenue                                                               
(DOR) agreed with  Mr. Bullock. He said the  department still has                                                               
authority under its general powers  to require any information it                                                               
needs in  order to reach  a calculation  of the tax.  However, he                                                               
pointed out  that the reporting requirements  in section 16(f)(5)                                                               
of the  CS expressly reference  joint interest billings.  So, the                                                               
department can look at those.                                                                                                   
                                                                                                                                
In regard  to the repealer,  AS 43.55.165(c) and (d),  he pointed                                                               
out that  the department has  several concerns. One is  from Gary                                                               
Rogers, supervisor, of the Oil  and Gas Revenue Audit Section, on                                                               
an administrative standpoint that  starts with .165(c) posing the                                                               
question  of whether  the  taxpayer  has substantial  consistency                                                               
between the  joint interest billings  and the standards  that are                                                               
set forth  in the  statute and  the department's  regulations. If                                                               
the  department  makes a  finding  referring  to costs  that  are                                                               
billable  as   lease  expenditures  under  the   joint  operating                                                               
agreement,  AS 43.55.165(d)  takes that  a step  further by  also                                                               
posing  the  question  to  the department  of  whether  there  is                                                               
substantial  incentive and  ability to  effectively audit  by the                                                               
other  working  interest  owners. This  poses  an  administrative                                                               
problem because  the audit  is looking in  the past  to determine                                                               
whether there has been substantial  consistency and the incentive                                                               
and  ability  to  audit  to determine  the  future.  Also,  these                                                               
agreements  are  moving  targets. The  accounting  procedures  in                                                               
these  joint  interest  agreements  are not  set  in  stone.  The                                                               
department would  essentially be auditing the  agreement and then                                                               
auditing  the joint  interest audit.  This creates  a multi-track                                                               
administrative problem.                                                                                                         
                                                                                                                                
9:28:19 AM                                                                                                                    
SENATOR WIELECHOWSKI joined the hearing.                                                                                        
                                                                                                                                
9:28:50 AM                                                                                                                    
GARY  A. ROGERS,  CPA, Supervisor,  Production  Tax Audit  Group,                                                               
Department  of  Revenue, added  that  in  writing regulations  to                                                               
implement 165(c) and (d), he  is being asked to write regulations                                                               
that make  subjective judgments about  whether or not  Alaska has                                                               
industry  standards. He  hired  consultants who  came  up with  a                                                               
variety of  agreements on what "substantially  consistent" means,                                                               
and he decided  that rather than create  administrative fights in                                                               
the future,  he wanted to  publish the department's  own standard                                                               
of what  lease expenditures are. He  said that (d) also  asks the                                                               
auditors  or  the  regulation drafters  to  make  the  subjective                                                               
judgment  of what  is effective  auditing if  the joint  interest                                                               
parties are  auditing each  other. "How  do we  define effective?                                                               
How do we know that what  was effective in the past has continued                                                               
in the future?"  His division is put in the  position of auditing                                                               
their auditors rather than the tax returns.                                                                                     
                                                                                                                                
CHAIR FRENCH  noted that Senators  Stevens and Thomas  had joined                                                               
the meeting a while ago.                                                                                                        
                                                                                                                                
SENATOR  HUGGINS asked  if current  language allows,  but doesn't                                                               
require, the flexibility to look at the joint interest billings.                                                                
                                                                                                                                
MR. ROGERS replied  that is correct. Any  auditor, whether state,                                                               
federal or  independent, auditing oil and  gas lease expenditures                                                               
that are subject  to unit operating agreements would  look at the                                                               
joint interest billings and unit agreements.                                                                                    
                                                                                                                                
MR. IVERSEN  noted the  policy concern  of these  provisions. His                                                               
staff are  put in  a tenuous position  because they  haven't done                                                               
any  activity under  this section.  The concern  is shifting  the                                                               
determination of  what costs are  allowable to the  taxpayer. The                                                               
department  would be  moving  from  its normal  "trust-but-verify                                                               
perspective" to  a scenario  of the  taxpayers saying  "trust us,                                                               
but let us verify it ourselves," and particularly in .165(d).                                                                   
                                                                                                                                
He said  these sections also  reference the final  resolutions of                                                               
these claims that  are contested between the parties  to the unit                                                               
operating  and   joint  interest   agreements,  and   they  won't                                                               
necessarily  be  aligned  with   the  state's  interest.  Another                                                               
concern, he said, is a  potential gap between statutory standards                                                               
and  whatever "substantial  compliance"  means.  Because of  this                                                               
gap,  there can  be  another  gap as  to  how  this provision  is                                                               
administered  between taxpayers,  because  one  can't be  treated                                                               
differently than another.                                                                                                       
                                                                                                                                
9:33:27 AM                                                                                                                    
MR. IVERSEN  said ultimately this  concept sets another  layer of                                                               
ambiguity and shifts responsibility to  where it shouldn't be. He                                                               
stated  that the  responsibility should  lie with  the department                                                               
and that the additional language  should give him the affirmative                                                               
responsibility to  set forth in regulations  what allowable costs                                                               
are.                                                                                                                            
                                                                                                                                
CHAIR FRENCH  said it occurs to  him that since there  is no body                                                               
of  law and  precedent with  respect  to what  his practices  are                                                               
going to be, that at this stage  of the game, to repeal these two                                                               
permissive practices doesn't take away  his authority to use them                                                               
if he decides to. But it doesn't bind him to use them either.                                                                   
                                                                                                                                
SENATOR THERRIAULT asked if that is how the CS is written.                                                                      
                                                                                                                                
MR. BULLOCK replied yes.                                                                                                        
                                                                                                                                
9:34:44 AM                                                                                                                    
CHAIR  FRENCH  turned  to  the issue  of  corrosion  starting  at                                                               
section 21, AS 43.55.165(e) on page 19.                                                                                         
                                                                                                                                
MR. IVERSEN  said this provision  intends to hit the  same policy                                                               
objectives expressed in  SB 80 but with a different  take. It has                                                               
a different trigger point and  takes the auditor away from making                                                               
a  determination of  improper  maintenance  or negligence,  which                                                               
really  isn't  their  purview. Those  are  legal  or  engineering                                                               
issues.  The provision  refers  to  unscheduled interruptions  or                                                               
reductions  in  production  or  spills/releases  of  a  hazardous                                                               
substance.  The  costs  incurred  for repair  or  replacement  or                                                               
deferred  maintenance of  facilities,  equipment, and  structures                                                               
(with  a  carve-out  for  wells) would  be  excluded  from  lease                                                               
expenditures, which  means they would  be excluded from  both the                                                               
deductions credits. The reason for  the well carve-out is because                                                               
there  is a  greater  degree of  geologic uncertainty  associated                                                               
with wells. The end of the  section inserts a quasi force majeure                                                               
provision that is  the same as language  in CERCLA (Comprehensive                                                               
Environmental Response,  Compensation and Liability Act  of 1980)                                                               
-   that  basically   excludes  liability   for  the   repair  or                                                               
replacement  if  it was  necessary  due  to  an  act of  war,  an                                                               
unanticipated  grave  natural disaster,  or  some  other sort  of                                                               
inevitable phenomenon  -  as  long as  the effects of  that could                                                               
not have  been reasonably prevented  or was not  from intentional                                                               
or negligent  acts of  a third  party - as  long as  the operator                                                               
acted with due care.                                                                                                            
                                                                                                                                
9:38:45 AM                                                                                                                    
MR. IVERSEN said that (a), (b)  and (c) of this section delineate                                                               
what costs  include and the  meaning of hazardous  substance (oil                                                               
is  included). Replacement  includes renovation  and improvement.                                                               
He said  Pat Martindale from  Martindale Consulting  helped draft                                                               
this provision.                                                                                                                 
                                                                                                                                
9:40:43 AM                                                                                                                    
CHAIR FRENCH asked him about the corrosion provision in SB 2001.                                                                
                                                                                                                                
PAT  MARTINDALE,  Martindale   Consultants,  Oklahoma  City,  OK,                                                               
testifying  via teleconference,  gave his  background in  oil and                                                               
gas auditing.                                                                                                                   
                                                                                                                                
CHAIR FRENCH  asked if he  has had experience working  with these                                                               
types of  provisions that try  to exclude the deduction  of costs                                                               
that are due to unscheduled  interruptions or reductions in rates                                                               
of production due to problems with improper maintenance.                                                                        
                                                                                                                                
MR.  MARTINDALE  replied  that his  experience  is  working  with                                                               
industry  in  writing  language to  identify  [indecipherable]  …                                                               
productions cost statutes in the mid 1990s.                                                                                     
                                                                                                                                
CHAIR  FRENCH asked  him to  walk through  a couple  of scenarios                                                               
this provision would apply to.                                                                                                  
                                                                                                                                
9:45:36 AM                                                                                                                    
MR. MARTINDALE described a circumstance  where an oil company had                                                               
to  repair  or  replace  its  infrastructure  where  preventative                                                               
maintenance might have kept it from happening.                                                                                  
                                                                                                                                
9:47:16 AM                                                                                                                    
MR. IVERSEN clarified that Mr.  Martindale was involved with this                                                               
statute as an  advisor; he didn't draft the  provision itself. He                                                               
asked Mr. Martindale, because he  is a contract auditor, how this                                                               
would be audited.                                                                                                               
                                                                                                                                
MR. MARTINDALE explained that most  companies would capture costs                                                               
(repair  and replacement)  with work  order project  numbers. The                                                               
current  PPT  audits  would  target  each  of  the  projects  and                                                               
determine whether costs apply  appropriately for either operating                                                               
or capital expenditures.  The project would have  to be described                                                               
and  reviewed with  documentation.  Having  this provision  might                                                               
cause a taxpayer  to be reluctant to describe a  project, so some                                                               
work would  be required  to look at  the underlying  vouchers and                                                               
other documents to see if the project is legitimate.                                                                            
                                                                                                                                
9:51:41 AM                                                                                                                    
CHAIR FRENCH thanked  Mr. Martindale and went on to  the issue of                                                               
gas turbine  maintenance. The turbines are  frequently taken down                                                               
for maintenance,  and such a  problem would be difficult  to pick                                                               
up on.  He asked how  narrow an  application the language  is for                                                               
specific pieces of equipment, like the turbines.                                                                                
                                                                                                                                
9:52:56 AM                                                                                                                    
MR.  IVERSEN responded  that part  of this  question goes  to the                                                               
underlying  policy of  scheduled  proactive  maintenance that  is                                                               
linked to  a scheduled shutdown.  If a  turbine is replaced  on a                                                               
regularly  scheduled basis,  this provision  wouldn't pick  up on                                                               
that  - "it  wouldn't  even be  on the  radar  screen." It  would                                                               
exclude  the cost  of  repairing or  replacing  turbines from  an                                                               
unscheduled shutdown that is attributable  to a turbine that just                                                               
blows out. This is  a brighter line and broader than  in SB 80 in                                                               
terms of  the potential number of  events, but it gets  the state                                                               
out  of  a deeper  hole  in  the  sense  of actually  making  the                                                               
determinations and the  fights that are going  to ensue regarding                                                               
what is or isn't negligent.                                                                                                     
                                                                                                                                
CHAIR FRENCH asked  how the public would be able  to tell if such                                                               
costs have been deducted.                                                                                                       
                                                                                                                                
MR.  IVERSEN  directed the  committee  to  the monthly  reporting                                                               
requirements in  Section 16  of the  CS. Section  (f)(3) requires                                                               
reporting  of any  unscheduled interruption  or reduction  in the                                                               
rate of oil  or gas production. That would be  the first tip off.                                                               
A dip in  production would also be apparent to  him in looking at                                                               
regular production reports. That would  be questioned on an audit                                                               
and depending on the response it might be looked into deeper.                                                                   
                                                                                                                                
9:55:49 AM                                                                                                                    
MR. ROGERS concurred with Mr.  Martindale who said that a company                                                               
is normally going to establish  some sort of cost center, project                                                               
number, AFE, or work order number  to track costs related to some                                                               
sort  of  incident or  unscheduled  breakdown,  and the  auditors                                                               
would look at the backup documents for those.                                                                                   
                                                                                                                                
CHAIR FRENCH  pointed out  that those  work orders  wouldn't come                                                               
with flags on them.                                                                                                             
                                                                                                                                
MR. ROGERS said experienced auditors know what to look for.                                                                     
                                                                                                                                
9:57:25 AM                                                                                                                    
SENATOR WIELECHOWSKI  said the thing  that offends  most Alaskans                                                               
about  the North  Slope situation  is that  companies have  acted                                                               
negligently  and are  able to  deduct those  costs. This  is very                                                               
different than SB 80.                                                                                                           
                                                                                                                                
MR. IVERSEN replied  this is actually more of  a strict liability                                                               
type of statute and, in his mind, it is broader.                                                                                
                                                                                                                                
SENATOR WIELECHOWSKI said  the difference is if a  company on the                                                               
North Slope  has been  negligent for years  and then  schedules a                                                               
shut down to  fix that negligence, it can deduct  those costs and                                                               
essentially the people of Alaska end up paying for the repairs.                                                                 
                                                                                                                                
MR. IVERSEN replied if it's  part of their scheduled regime, then                                                               
that is correct.  Last year the incident was triggered  by a leak                                                               
and  wasn't part  of  a scheduled  maintenance  program. At  some                                                               
point the  state will  have to draw  the line as  to what  is not                                                               
related to an incident.                                                                                                         
                                                                                                                                
CHAIR FRENCH said he didn't know  if a body of historical records                                                               
existed that  would allow the  department to challenge  whether a                                                               
piece of maintenance has been scheduled or unscheduled.                                                                         
                                                                                                                                
MR.  IVERSEN answered  that the  trigger would  be the  shut down                                                               
with a dip in the production report.                                                                                            
                                                                                                                                
10:01:36 AM                                                                                                                   
CHAIR FRENCH  used the recent  BP spill  as an example  and asked                                                               
about spotting a leak and calling for a "scheduled" shut down.                                                                  
                                                                                                                                
MR.  IVERSEN  replied  that  the department  needs  to  keep  the                                                               
legislative  intent  in  mind  in   writing  the  regulation  for                                                               
scheduled maintenance. The scheduling has to be reasonable.                                                                     
                                                                                                                                
10:03:14 AM                                                                                                                   
SENATOR  HUGGINS posed  a  scenario of  installing  a valve  that                                                               
fails the following day that  causes an interruption and asked if                                                               
that would qualify.                                                                                                             
                                                                                                                                
MR. IVERSEN  replied yes,  but he  said he  was trying  to reduce                                                               
ambiguity and get out of those gray areas.                                                                                      
                                                                                                                                
CHAIR  FRENCH  wondered  how  removing  "unscheduled"  would  put                                                               
parameters on the meaning of what scheduled means.                                                                              
                                                                                                                                
MR.  IVERSEN  replied  that  the  issue  with  scheduling  versus                                                               
unscheduling goes to  the underlying policy of  setting some sort                                                               
of standard for pro-active maintenance to keep production going.                                                                
                                                                                                                                
10:06:13 AM                                                                                                                   
SENATOR THERRIAULT said that taking  a turbine down for scheduled                                                               
maintenance would cause  an interruption so he  didn't think that                                                               
word could be deleted.                                                                                                          
                                                                                                                                
CHAIR FRENCH agreed.                                                                                                            
                                                                                                                                
SENATOR  THERRIAULT asked  what  "irresistible" is  in the  force                                                               
majeure definition  of exceptional, inevitable,  and irresistible                                                               
character.                                                                                                                      
                                                                                                                                
MR. IVERSEN replied that those  terms are almost redundant and it                                                               
means something that  reasonably could not have  been prevented -                                                               
such as an earthquake.                                                                                                          
                                                                                                                                
CHAIR FRENCH said  he thought some eager lawyer  had just started                                                               
adding  adjectives  in  there.   On  natural  disasters,  though,                                                               
clearly a pipeline or a facility  ought to be able to withstand a                                                               
tremor, and  he asked  where one  would draw  the line  between a                                                               
tremor and an earthquake.                                                                                                       
                                                                                                                                
MR. IVERSEN said  that gets to the secondary  area, which becomes                                                               
an evidentiary  matter. He didn't  know enough  about earthquakes                                                               
to draw a  line at the point where a  tremor would inevitably rip                                                               
apart any pipeline no matter  how well constructed. This language                                                               
triggers times when the event is unforeseen.                                                                                    
                                                                                                                                
10:09:34 AM                                                                                                                   
CHAIR FRENCH said  it's his intention that  the facilities should                                                               
be built  to withstand the  terrible weather on the  North Slope,                                                               
like 70 mph winds and ice storms.                                                                                               
                                                                                                                                
MR. IVERSEN agreed.                                                                                                             
                                                                                                                                
SENATOR THERRIAULT  asked what "in  privity of contract  with" on                                                               
lines 29-30 means.                                                                                                              
                                                                                                                                
MR. IVERSEN said it means an oilfield contractor, for example.                                                                  
                                                                                                                                
SENATOR THERRIAULT  said last  year in  the Special  Committee on                                                               
Natural  Gas  that  he  offered  Amendment  9  and  part  of  the                                                               
discussion on it  was not only about the capital  costs, but what                                                               
happens to  operating costs in  a shut down.  At the time  it was                                                               
estimated that  375,000 barrels/day of production  would be lost.                                                               
If there  is a shutdown  in Prudhoe  Bay and half  the production                                                               
goes away, the fixed costs of  $1 million/day don't go away. Part                                                               
of it  gets attached  to every barrel  that gets  produced. Those                                                               
may double on  the remaining production. He  asked if disallowing                                                               
those  costs was  discussed. His  amendment suggested  that there                                                               
should be a way of disallowing them - maybe through regulations.                                                                
                                                                                                                                
10:13:19 AM                                                                                                                   
MR. IVERSEN said the express  topic of cost-per-barrel of capital                                                               
expenses wasn't discussed.                                                                                                      
                                                                                                                                
SENATOR THERRIAULT said they wouldn't be capital costs.                                                                         
                                                                                                                                
MR. IVERSON  said this provision  would exclude both  capital and                                                               
operating  expenses. So  he thought  perhaps additional  language                                                               
was needed.  He said this  language is  fairly broad in  that the                                                               
costs  are  going  to  be  those that  are  "in  response  to  or                                                               
otherwise associated with."                                                                                                     
                                                                                                                                
SENATOR THERRIAULT said his interpretation  is that this language                                                               
does not address those fixed costs.                                                                                             
                                                                                                                                
MR. IVERSEN said the legislature might want to clarify that.                                                                    
                                                                                                                                
10:15:30 AM                                                                                                                   
CHAIR FRENCH asked how this proposal treats well costs.                                                                         
                                                                                                                                
MR. IVERSEN  explained that the carve-out  for a well is  that it                                                               
would be the  costs incurred for repair,  replacement or deferred                                                               
maintenance of  the facility or  pipeline structure other  than a                                                               
well. It  is still  allowing the costs  that would  be associated                                                               
with wells, recognizing the uncertainty in drilling.                                                                            
                                                                                                                                
MR. ROGERS said  he would echo that comment. Lots  of things that                                                               
can't be anticipated can go wrong  "down-hole" in a well that you                                                               
really can't control or observe as with above surface equipment.                                                                
                                                                                                                                
10:16:56 AM                                                                                                                   
CHAIR   FRENCH  noted   that  AS   43.55.165(e)  has   a  general                                                               
prohibition  that  lease  expenditures   do  not  include  "costs                                                               
arising  from   fraud,  willful  misconduct,   gross  negligence,                                                               
violation of the  law, failure to comply with an  obligation or a                                                               
lease  permit or  license." If  drilling operations  get too  far                                                               
outside the bounds  of normal behavior, there is  a cutoff point,                                                               
but  in  general  well-drilling  costs can  be  deducted  whether                                                               
something goes wrong on the rig  floor or down-hole that causes a                                                               
problem in "the normal course of drilling operations."                                                                          
                                                                                                                                
MR.  IVERSEN  responded  that  is correct  to  the  extent  other                                                               
exclusion provisions would affect wells  and the normal course of                                                               
business stuff isn't going to be picked up here.                                                                                
                                                                                                                                
10:18:18 AM                                                                                                                   
CHAIR FRENCH said that administration could offer a rebuttal.                                                                   
                                                                                                                                
The committee took an at-ease from 10:18:35 AM to 10:39:14 AM.                                                                
                                                                                                                                
CHAIR FRENCH said the committee will hear from the industry.                                                                    
                                                                                                                                
10:39:37 AM                                                                                                                   
MARILYN  CROCKETT,   Executive  Director,  Alaska  Oil   and  Gas                                                               
Association  (AOGA) introduced  Mr.  Williams  who would  present                                                               
AOGA's testimony.                                                                                                               
                                                                                                                                
TOM WILLIAMS,  Chair, AOGA  Tax Committee,  said the  comments he                                                               
made yesterday  about the repeal  of Section AS  43.55.165(c) and                                                               
(d) were made for AOGA and not as a BP representative.                                                                          
                                                                                                                                
10:40:48 AM                                                                                                                   
He read the following testimony pertaining to corrosion:                                                                        
                                                                                                                                
     The  administration's  proposed  paragraph (19)  to  be                                                                    
     added to  AS 43.55.165(e) would, unless  a situation is                                                                    
     caused by  a "super"  force majeure, disallow  any cost                                                                    
     incurred  for  the   repair,  replacement  or  deferred                                                                    
     maintenance undertaken in  response to failure, problem                                                                    
     or event the results  in an unscheduled interruption of                                                                    
     or  reduction  in  the  oil or  gas  production  or  is                                                                    
     undertaken in  response to  or is  otherwise associated                                                                    
     with an  unpermiteed release of hazardous  substance of                                                                    
     gas.  Not  only  is  the   language  of  this  proposed                                                                    
     revision  ambitious and  likely to  lead to  additional                                                                    
     audit exceptions and disputes,  the entire provision is                                                                    
     unnecessary.                                                                                                               
                                                                                                                                
     The proposed  provision states that  otherwise ordinary                                                                    
     and  necessary, and  thus  deductible,  costs would  be                                                                    
     disallowed  if  the  Department of  Revenue  determines                                                                    
     such costs were  in response to a  'failure, problem or                                                                    
     event' that  results in an unscheduled  interruption or                                                                    
     reduction in  production. What constitutes  a 'failure,                                                                    
     problem or  event' and under  what standards  would any                                                                    
     of  those  be  determined?  Cost  associated  with  any                                                                    
     temporary, unforeseen shutdown  or minor interruptions,                                                                    
     regardless  how minor,  could now  be disallowed  by an                                                                    
     auditor  even   when  such  an  event   arises  despite                                                                    
     otherwise prudent and necessary business operations.                                                                       
                                                                                                                                
     Yet  the  issue  of  determining what  portion  of  any                                                                    
     maintenance costs  should be disallowed, if  related to                                                                    
     improper  maintenance or  production interruption,  was                                                                    
     thoroughly   debated    when   the    legislature   was                                                                    
     considering  the PPT  and again  in recent  legislative                                                                    
     sessions.  Each time  amendments  such as  the one  the                                                                    
     administration  is now  advocating  failed because  the                                                                    
     difficulties  with   such  subjective   standards  were                                                                    
     immediately  apparent. The  state turned  to Dr.  Pedro                                                                    
     van Meurs, an international  gas consultant retained by                                                                    
     the  state,  who  recommended  a  flat  30  cent/barrel                                                                    
     exclusion  from what  would otherwise  be a  producer's                                                                    
     capital portion  of its lease expenditures.  As Dr. van                                                                    
     Muers explained:                                                                                                           
                                                                                                                                
          It should be  noted that in most  oil and gas                                                                         
          fields,  assets  will  have  to  be  replaced                                                                         
          after the  technical life of such  assets has                                                                         
          expired.  Therefore,  such  replacements  are                                                                         
          reasonable  lease  expenditures and  required                                                                         
          to  protect  the  health and  safety  of  the                                                                         
          workers and to  protect then environment. The                                                                         
          US $0.30  per BTU equivalent barrel  is based                                                                         
          on  reasonable capital  maintenance costs  of                                                                         
          fields  for   which  I   have  (confidential)                                                                         
          information.                                                                                                          
                                                                                                                                
     Dr. van Meurs further testified that:                                                                                      
                                                                                                                                
          Maintenance  is  a reasonable  deduction  for                                                                         
          PPT;  but  it  is sometimes  hard  to  decide                                                                         
          which    expenditures    fall    into    that                                                                         
          classification. The  simplest solution  is to                                                                         
          take some  base expenditure that  really will                                                                         
            be replacement and over the next 20 - 30                                                                            
             disallow a modest floor of the capital                                                                             
          expenditures.                                                                                                         
                                                                                                                                
MR. WILLIAMS  said if you  assume that production is  250 million                                                               
barrels/year, which  is a little  less than  700,000 barrels/day,                                                               
the   30  cents   exclusion  comes   to   $75  million   (capital                                                               
expenditures that  collectively the  industry would incur  on the                                                               
Slope)  that will  be disallowed  from either  being deducted  or                                                               
giving rise to credits. He continued:                                                                                           
                                                                                                                                
     At  a 25  percent tax  rate, that  disallowance is  $75                                                                    
     million and  equates to $18.75 million.  The 20 percent                                                                    
     credit  on  that $75  million  equates  to another  $15                                                                    
     million.  That's  over  $33   million  a  year  of  tax                                                                    
     reduction  that   occurs  because   of  the   30  cents                                                                    
     disallowance.  Thirty cents  doesn't  sound like  much,                                                                    
     but  $33 million  a year  is  quite a  lot. That's  the                                                                    
     point. We  believe that  over time  that's, as  Dr. van                                                                    
     Meurs  believed,  that that's  going  to  more than  be                                                                    
     adequate  for  the  situations you  will  be  concerned                                                                    
     about.                                                                                                                     
                                                                                                                                
     So,  Dr.  van  Meurs' recommendation  was  adopted  and                                                                    
     became section  43.55.165(e)(18) of  the PPT.  The flat                                                                    
     30  cents  per  barrel   exclusion  sets  a  floor  for                                                                    
     maintenance costs  and avoids  the problems of  case by                                                                    
     case  decisions as  to whether  maintenance (repair  or                                                                    
     replacement)   is   required   because   equipment   or                                                                    
     facilities  have been  improperly maintained  or result                                                                    
     in   an   unscheduled   interruption.  To   adopt   the                                                                    
     administration's proposed  amendment while  leaving the                                                                    
     flat 30  cents per  barrel exclusion  in the  law would                                                                    
     result in a double disallowance  of the same costs. The                                                                    
     flat 30  cents exclusion also avoids  all questions and                                                                    
     disputes about which categories  of costs were incurred                                                                    
     due to  a triggering event  and are nondeductible  as a                                                                    
     result - and also disputes  about how much was incurred                                                                    
     in each cost category.                                                                                                     
                                                                                                                                
     Finally  the  30  cents per  barrel  exclusion  applies                                                                    
     every  year, whether  there is  a  triggering event  or                                                                    
     not. Over  time the 30  cents figure may well  prove to                                                                    
     be a  reasonably accurate approximation of  the average                                                                    
     amount of  costs that would  be disallowed  by auditing                                                                    
     and  verifying   exactly  which  cost   categories  are                                                                    
     disallowed under the proposal and  how much costs is in                                                                    
     each such  category. A  flat rate  disallowance greatly                                                                    
     furthers   the   goals   of  clarity,   certainty   and                                                                    
     efficiency  in  tax   administration,  enforcement  and                                                                    
     compliance. Paragraph  (19) in contrast  would undercut                                                                    
     each one.                                                                                                                  
                                                                                                                                
10:46:32 AM                                                                                                                   
SENATOR  WIELECHOWSKI  asked  what  it  cost  BP  to  repair  the                                                               
corrosion on the North Slope.                                                                                                   
                                                                                                                                
MS. CROCKETT cautioned  the committee that Mr.  Williams was here                                                               
on AOGA's behalf,  not on BP's. So, it's not  appropriate for him                                                               
to answer questions relating to his company's activities.                                                                       
                                                                                                                                
SENATOR WIELECHOWSKI said they were  trying to figure out if this                                                               
is a reasonable amount.                                                                                                         
                                                                                                                                
10:47:37 AM                                                                                                                   
MR. WILLIAMS  responded that AOGA doesn't  have information about                                                               
what oil  transit line  costs are  for Prudhoe  Bay. He  said the                                                               
committee  could   get  an  estimate  by   remembering  how  many                                                               
instances of  the type they  are concerned with and  they already                                                               
know that disallowed costs amounted  to $33 million/year. He said                                                               
AOGA doesn't have the information to answer the question.                                                                       
                                                                                                                                
CHAIR FRENCH  said they would  not go forward without  the answer                                                               
to the question,  because it is relevant to know  if the 30 cents                                                               
really captures  extraordinary events  that will take  place with                                                               
respect to  production. Those are  the things that  subsection 19                                                               
is trying to  address and he said, "Frankly the  oil spill on the                                                               
North Slope a year ago was one of them."                                                                                        
                                                                                                                                
10:50:25 AM                                                                                                                   
MR. WILLIAMS recalled that Mr.  Suttle's letter mentioned that BP                                                               
had a $13  million tax effect. Here they're looking  at a 30 cent                                                               
exclusion  that  totals a  third  of  a  billion over  a  10-year                                                               
period. He suggested that they get someone else to speak for BP.                                                                
                                                                                                                                
CHAIR  FRENCH  said  it's  important to  take  into  account  the                                                               
unavoidable event that is driving this provision.                                                                               
                                                                                                                                
10:52:51 AM                                                                                                                   
SENATOR THERRIAULT asked  if Mr. Suttle's number  was an estimate                                                               
of  the  tax  consequences  at  that time  or  the  ultimate  tax                                                               
consequence.                                                                                                                    
                                                                                                                                
MR. WILLIAMS said that it talked about the effects during 2006.                                                                 
                                                                                                                                
CHAIR FRENCH  asked if he had  to choose between the  language in                                                               
SB 80 and in SB 2001, which he would choose.                                                                                    
                                                                                                                                
10:54:08 AM                                                                                                                   
MS.  CROCKETT replied  that AOGA's  belief  is the  30 cents  per                                                               
barrel  provides the  protection  they are  looking  for and  the                                                               
language in both bills is not necessary.                                                                                        
                                                                                                                                
MR. WILLIAMS  said he would  have to  ask the tax  committee what                                                               
its preference was.                                                                                                             
                                                                                                                                
SENATOR THERRIAULT remarked that all  members would have to agree                                                               
because AOGA is a consensus organization.                                                                                       
                                                                                                                                
10:55:26 AM                                                                                                                   
MR. IVERSEN  agreed that  this adds another  item to  their audit                                                               
and that acts  of negligence are included in this  sort of strict                                                               
liability provision.  He pointed out  that there is  some dispute                                                               
regarding  what this  30 cent  provision covers.  Senator Wagoner                                                               
said it  was originally  intended to  bring the  tax closer  to a                                                               
gross system and statements have  been made that it's supposed to                                                               
cover regular maintenance.                                                                                                      
                                                                                                                                
CHAIR FRENCH asked his view of the 30 cents.                                                                                    
                                                                                                                                
MR.  IVERSEN replied  that it  seems  the discussions  originally                                                               
began with  Senator Wagoner asking  Dr. van Meurs  about bringing                                                               
the system  closer to  a gross  and hitting  costs that  would be                                                               
regular maintenance.  This would be  picking up a  different sort                                                               
of item than what either SB 80 or HB 2001 is addressing.                                                                        
                                                                                                                                
He  discussed the  30-cent  per  barrel exclusion.  It  is a  per                                                               
barrel  amount;  it  isn't  an  exclusion  that's  going  towards                                                               
negligence or unscheduled  interruptions. As production declines,                                                               
the 30-cent amount  the state gets declines. The  real tension is                                                               
if  it's declining  because of  poor  maintenance practices,  the                                                               
state actually gets  more money taken away because  it's based on                                                               
a per  barrel amount. The  way the calculation actually  works is                                                               
counter to the concept of covering these items.                                                                                 
                                                                                                                                
MR. IVERSEN also  pointed out that the  30-cent exclusion applies                                                               
to  everyone regardless  of  their behavior.  And  it's based  on                                                               
their  production; it's  not going  toward  negligence; it's  not                                                               
going  toward  improper  maintenance;   it's  not  going  towards                                                               
unscheduled shut downs  in production. "It's a  blanket that hits                                                               
everyone in the entire state."                                                                                                  
                                                                                                                                
CHAIR FRENCH said it's almost a gross tax floor.                                                                                
                                                                                                                                
10:59:43 AM                                                                                                                   
MR.  IVERSEN agreed.  With that  in mind,  the 30-cent  provision                                                               
compared  to SB  80  or  HB 2001  is  not  a double  disallowance                                                               
because they are hitting different  things. The 30-cent provision                                                               
does not further the policy  of promoting planned maintenance and                                                               
planned  shutdowns. Costs  associated  with deferred  maintenance                                                               
will  rise in  the future.  Under  the current  regime it's  $150                                                               
million,  but if  they want  to  stick with  the exclusion  (from                                                               
capital  costs),  it  could be  increased  to  include  operation                                                               
expenditures  as well  or maybe  a more  realistic assessment  of                                                               
what  costs are  - and  put  that 30  cents  up to  50 cents.  He                                                               
clarified that BP  is just one of several working  owners in that                                                               
unit, and its reported $13 million  tax effect is just a fraction                                                               
of the effect on the state.                                                                                                     
                                                                                                                                
11:04:11 AM                                                                                                                   
SENATOR WIELECHOWSKI  asked if  the state knows  the cost  of the                                                               
corrosion repairs.                                                                                                              
                                                                                                                                
MR. ROGERS replied it does not.                                                                                                 
                                                                                                                                
SENATOR  WIELECHOWSKI  asked if  he  has  authority to  get  that                                                               
information.                                                                                                                    
                                                                                                                                
MR. IVERSEN replied if the  department has a provision that makes                                                               
that a  tax effect by statute,  he could, at audit.  Otherwise he                                                               
can't. Without  language from SB 80  or SB 2001, the  state is on                                                               
thin ground.                                                                                                                    
                                                                                                                                
SENATOR WIELECHOWSKI  asked what the  loss to the state  was from                                                               
the other groups.                                                                                                               
                                                                                                                                
MR. ROGERS  answered that he  could look up the  working interest                                                               
owners' shares in the unit  operating agreements, and he recalled                                                               
that BP owns about 26 percent of Prudhoe Bay.                                                                                   
                                                                                                                                
SENATOR WIELECHOWSKI asked if the state lost about $50 million.                                                                 
                                                                                                                                
MR.  IVERSEN  replied  yes  -  for one  year.  The  expenses  are                                                               
supposed to span the course of  two years. So those repairs would                                                               
amount to about a $130 - $150 million tax impact to the state.                                                                  
                                                                                                                                
SENATOR WIELECHOWSKI  asked if  those costs  would be  covered if                                                               
the governor's section on this issue was passed.                                                                                
                                                                                                                                
MR. IVERSEN replied:                                                                                                            
                                                                                                                                
     To the  extent that any  of those costs  are associated                                                                    
     with  a  spill...or   an  unscheduled  interruption  in                                                                    
     production  and there  were those  as well,  then those                                                                    
     would be excluded.  At some point we will  have to draw                                                                    
     a line as to both in  time and scheduling as to how far                                                                    
     that goes....                                                                                                              
                                                                                                                                
SENATOR WIELECHOWSKI asked if the  state would be able to capture                                                               
more  of  the $150  million  loss  if  SB  80, which  includes  a                                                               
negligence standard, were to be passed.                                                                                         
                                                                                                                                
MR. IVERSEN  replied: "Since  there has been  a plea  of criminal                                                               
negligence, if there is a  negligence standard that we're looking                                                               
at, then  I would have  to look at  the actual plea  agreement to                                                               
determine  exactly  what  that  covers." One  of  the  things  he                                                               
wrestled  with is  that gross  negligence  is currently  excluded                                                               
under statute. But  the challenge with a  negligence decision, he                                                               
said, is if  BP decides to replace the  entire pipeline, deciding                                                               
what percentage of  that replacement would have  been done anyway                                                               
and what  percentage is actually  attributable to  negligence. He                                                               
opined that  the language  in Version  M is  tighter in  terms of                                                               
precluding an argument.                                                                                                         
                                                                                                                                
SENATOR  WIELECHOWSKI said  the  administration  supported SB  80                                                               
last year.                                                                                                                      
                                                                                                                                
11:11:42 AM                                                                                                                   
CHAIR FRENCH asked  Mr. Iversen to bring  the committee something                                                               
more  definitive on  the tax  consequences  of the  spill on  the                                                               
North Slope: what they are under  current law and what they would                                                               
be if SB 2001 passed.                                                                                                           
                                                                                                                                
MR.   IVERSEN  said   that  request   brings  up   a  couple   of                                                               
complications. The first  is that this is  under investigation by                                                               
the  Department of  Law (DOL),  so he  can't speculate  about the                                                               
actual damages. In addition, he  doesn't know what the costs are;                                                               
he only has heard what they might be.                                                                                           
                                                                                                                                
CHAIR FRENCH asked where the  $250 million to $300 million number                                                               
comes from.                                                                                                                     
                                                                                                                                
MR. IVERSEN  said they were  in articles  that came out  when the                                                               
incident happened.                                                                                                              
                                                                                                                                
SENATOR HUGGINS recalled that $250  million came out in Resources                                                               
along with an inflationary figure of  5 to 10 percent. He thought                                                               
BP was the source.                                                                                                              
                                                                                                                                
CHAIR FRENCH  went back to AS  43.55.165(e) on page 17  of the CS                                                               
that says  "costs arriving from  fraud, wilful  misconduct, gross                                                               
negligence, violation  of the  law or failure  to comply  with an                                                               
obligation under a lease." He  said BP's guilty plea is drop-dead                                                               
proof that any costs that arose  from that violation would not be                                                               
deductible. He asked if he was interpreting that too broadly.                                                                   
                                                                                                                                
MR. IVERSEN replied  on its face that would seem  to be the case,                                                               
but  he anticipated  an argument  that criminal  negligence isn't                                                               
the sort of violation of the law that they would be looking for.                                                                
                                                                                                                                
CHAIR  FRENCH responded  that  his lawyerly  sense  says that  he                                                               
could argue  that the  only cost that  arose from  that violation                                                               
was  the fine  paid,  not the  pipeline  replacement and  perhaps                                                               
that's why the language is needed.                                                                                              
                                                                                                                                
SENATOR WIELECHOWSKI  pointed out  that there's still  74 percent                                                               
from the other operators who didn't plead negligence.                                                                           
                                                                                                                                
SENATOR HUGGINS  asked Mr. Iversen  if this provision  is tighter                                                               
than SB 80.                                                                                                                     
                                                                                                                                
MR. IVERSEN replied yes.                                                                                                        
                                                                                                                                
SENATOR HUGGINS  asked him what  happens to the money  that comes                                                               
from the 30 cents/barrel provision.                                                                                             
                                                                                                                                
MR.  IVERSEN said  that provision  is an  express exclusion  from                                                               
lease  expenditures  under  AS   43.55.165(e).  That's  the  same                                                               
provision that sets exclusions for  things like gross negligence,                                                               
fraud, the provision  the Senator French mentioned  a few minutes                                                               
ago, violations of  law or lease expenditures, and  others. It is                                                               
30  cents/barrel of  capital  costs, "so  you  take your  taxable                                                               
production  … which  would  be rate  of  production less  royalty                                                               
barrels, multiply that  amount times 30 cents a  barrel, and then                                                               
you  exclude that  cost from  allowable  lease expenditures."  It                                                               
isn't money sitting in a fund.                                                                                                  
                                                                                                                                
SENATOR HUGGINS said  it is not to be used  for maintenance work,                                                               
and it is important to recognize it as a flat tax or revenue.                                                                   
                                                                                                                                
11:18:58 AM                                                                                                                   
CHAIR FRENCH said he read that  BP's costs to replace 16 miles of                                                               
pipe in  Prudhoe Bay have increased  slightly to as much  as $260                                                               
million.  So they  are  in the  ball park  with  respect to  cost                                                               
estimates or pipeline replacement on the North Slope.                                                                           
                                                                                                                                
MR. IVERSEN said the state is  losing the time value of money for                                                               
seven years - a substantially larger loss to the state.                                                                         
                                                                                                                                
The committee took an at-ease at 11:21:09 AM.                                                                                 
                                                                                                                                
11:22:01 AM                                                                                                                   
CHAIR FRENCH said  they would discuss the issue  of actual versus                                                               
reasonable, costs  and he asked  Mr. Burnett to discuss  the pool                                                               
the ACES bill envisions.                                                                                                        
                                                                                                                                
JERRY BURNETT,  Director, Administrative Services,  Department of                                                               
Revenue (DOR),  said the original  ACES proposal has  a provision                                                               
for setting up  a tax credit payment fund and  that was taken out                                                               
in Version  M. He referred  to the  chart of tax  credit payments                                                               
under the  current PPT and  under ACES.  He said there  are three                                                               
ways to pay  tax credits - one  is that a producer who  has a tax                                                               
liability gets a reduction in his  tax bill. Another is if he has                                                               
a  transferable  credit   (someone  who  does  not   have  a  tax                                                               
liability)  that can  be sold  to the  producer that  reduces the                                                               
producer's tax  bill. "So  it comes right  out of  the production                                                               
tax pool before that production tax goes to the general fund."                                                                  
                                                                                                                                
MR. BURNETT said a refundable  tax credit (whereby a company with                                                               
no tax liability to the State  of Alaska under the production tax                                                               
but with earned  credits under the PPT) could be  paid out of the                                                               
general fund through an appropriation.                                                                                          
                                                                                                                                
11:24:11 AM                                                                                                                   
MR.  BURNETT said  rather  than having  an  appropriation to  the                                                               
operating budget and then paying  the refundable tax credits, the                                                               
ACES proposal (Section 45 in the  original SB 2001) sets up a tax                                                               
credit fund  where an appropriation  is made from  the production                                                               
tax prior to it going to the general fund in a percentage.                                                                      
                                                                                                                                
11:25:31 AM                                                                                                                   
MR. BURNETT  said producer transferable  tax credits  are handled                                                               
exactly the  same as they  are under the current  PPT. Refundable                                                               
tax credits are  paid from a tax credit fund  that is funded from                                                               
the appropriation  of a percentage  of production  tax liability.                                                               
It  requires an  appropriation  into the  general  fund from  the                                                               
legislature each year, and then the  payments are made out of the                                                               
tax credit  fund without further  appropriation. This  means that                                                               
the  balance in  the fund  can be  carried forward;  the earnings                                                               
from the fund  stay in the fund  and the fund would  not be swept                                                               
into the CBR (Constitutional Budget  Reserve). It's not available                                                               
for appropriation  because amounts  in that  fund do  not require                                                               
further appropriation to be spent.                                                                                              
                                                                                                                                
CHAIR FRENCH said it seemed to be an unusual arrangement.                                                                       
                                                                                                                                
MR.  BURNETT said  it isn't  a unique  example and  the education                                                               
fund is similar example.                                                                                                        
                                                                                                                                
SENATOR THERRIAULT directed attention to page 30.                                                                               
                                                                                                                                
MR. BURNETT  said that was the  intent of the fund.  He explained                                                               
that a  concern with ACES  is that tax credits  aren't equitable,                                                               
and using  the tax credit fund  ensures that the funds  are there                                                               
and doesn't  compete with general fund  expenditures. The funding                                                               
mechanism allows the legislature to know what is going on.                                                                      
                                                                                                                                
11:31:44 AM                                                                                                                   
CHAIR FRENCH recognized Senate President Lyda Green.                                                                            
                                                                                                                                
SENATOR WIELECHOWSKI asked if he  thought this section would cost                                                               
$100 million.                                                                                                                   
                                                                                                                                
MR. BURNETT said it will not  cost the taxpayer anything, but the                                                               
credits  that are  in current  legislation will  cost about  $125                                                               
million and  he already has  a FY'08 authorization.  This section                                                               
would put about  $200 million into the fund  if the appropriation                                                               
bill also has a language  section conforming to it (incorporating                                                               
the money into  the fund). Other provisions in  ACES would likely                                                               
increase the  amount of credits that  needed to be paid  from the                                                               
fund beyond the $125 million.                                                                                                   
                                                                                                                                
SENATOR WIELECHOWSKI  asked how he  negotiates the price  for the                                                               
credits.                                                                                                                        
                                                                                                                                
MR. BURNETT replied that when  the state is paying refundable tax                                                               
credits it is  a 100 percent value, but a  transferable credit to                                                               
a producer  is a negotiated value  between the holder of  the tax                                                               
credit  certificate and  the  producer.  Testimony has  indicated                                                               
that to be in the 90  percent range. The department believes that                                                               
since producers  get 100 percent  of the value of  their credits,                                                               
there is  no advantage to  the state to  not give 100  percent of                                                               
the value of a credit to  a non-producer who could transfer it to                                                               
a producer and the producer would get 100 percent.                                                                              
                                                                                                                                
11:34:27 AM                                                                                                                   
CHAIR FRENCH asked him how much  would have to be appropriated to                                                               
the fund to get  it up and running and to  explain how it doesn't                                                               
get swept into the CBR.                                                                                                         
                                                                                                                                
MR. BURNETT  started with Section  (c), which assigns  10 percent                                                               
of the production  tax revenue when the price for  ANS West Coast                                                               
is  above $60  into the  credit fund.  That fund  would hold  the                                                               
money;  it  will  be  invested  by the  treasury  in  short  term                                                               
investments.  Tax credits  will  be  paid from  the  fund to  the                                                               
taxpayer when the division finishes auditing a tax application.                                                                 
                                                                                                                                
CHAIR FRENCH asked how they arrived at the 10 percent figure.                                                                   
                                                                                                                                
MR. BURNETT replied  that 10 percent was based on  an estimate by                                                               
the department's economist based on  what the likely value of tax                                                               
credits will  be relative  to production tax  over time.  This is                                                               
just  for those  who  have  no current  tax  liability and  small                                                               
amounts of production for that year.                                                                                            
                                                                                                                                
MR.  BURNETT estimated  that this  year  the fund  paid out  $125                                                               
million and left $75 million. He  said next year they were hoping                                                               
for $250  million in credits  because that means  more investment                                                               
is being done. He said it's not  expected to grow in a linear way                                                               
over time; it's  expected to be lumpy. This smoothes  the flow of                                                               
money out of  the production tax by taking a  percentage out each                                                               
year and  then the  fund is  able to  pay differing  amounts each                                                               
year  and the  rest  is carried  forward.  The legislature  could                                                               
decide  each  year to  stay  with  10  percent  or to  change  it                                                               
depending on how much is left in the fund.                                                                                      
                                                                                                                                
11:38:50 AM                                                                                                                   
CHAIR  FRENCH  asked  if  this  was a  guideline  rather  than  a                                                               
prescriptive  value   that  will  automatically  pop   up  in  an                                                               
appropriation bill.                                                                                                             
                                                                                                                                
MR.  BURNETT replied  that he  expected the  administration would                                                               
always  put  that  into  the  appropriation  bill  and  then  the                                                               
legislature would discuss it.                                                                                                   
                                                                                                                                
SENATOR  THERRIAULT said  he expected  the  Finance Committee  to                                                               
watch the balance.  He also pointed out that  this language gives                                                               
the department the  authorization to pay for  these credits only,                                                               
and it  wouldn't have access to  any other balance in  that fund.                                                               
The legislature does, however. Everyone agreed.                                                                                 
                                                                                                                                
SENATOR WIELECHOWSKI asked  if there would be a  market for these                                                               
tax credit certificates if the state declined to purchase them.                                                                 
                                                                                                                                
MR. BURNETT replied  that the state doesn't have an  option as to                                                               
whether  or not  to pay  the  different types  of credits  unless                                                               
there is  insufficient money  in the  fund. Remaining  amounts of                                                               
the  credits  that weren't  purchased  by  the state  because  of                                                               
insufficient funds  would be either  carried forward or  could be                                                               
transferred   to  another   taxpayer  who   had  sufficient   tax                                                               
liability. There  are limitations  on how  much one  could reduce                                                               
tax  liability through  transferable credits,  so there  could be                                                               
circumstances where it could only be carried forward.                                                                           
                                                                                                                                
SENATOR THERRIAULT noted that the  agency could ask for a general                                                               
fund  appropriation  the   next  year  or  ask  for   them  in  a                                                               
supplemental  budget to  pay  credits that  were  turned in  with                                                               
insufficient funds.                                                                                                             
                                                                                                                                
MR. BURNETT  replied yes,  but a  long period  of low  oil prices                                                               
could  lead to  insufficient  money  in the  fund  after lots  of                                                               
credits have been  paid out, and the legislature  might choose to                                                               
not spend the money on credits.                                                                                                 
                                                                                                                                
SENATOR   THERRIAULT  followed   up  on   Senator  Wielechowski's                                                               
question and  said even though  there is a private  sector market                                                               
mechanism, payment of these credits  ultimately always comes back                                                               
to the state treasury.                                                                                                          
                                                                                                                                
MR. BURNETT said yes.                                                                                                           
                                                                                                                                
SENATOR  WIELECHOWSKI asked  if the  state pays  interest to  the                                                               
credit holder if it doesn't turn in its credits for a few years.                                                                
                                                                                                                                
MR. BURNETT  replied no; it is  unlike a tax refund.  Tax credits                                                               
are not  ones that earn interest.  They are paid when  there is a                                                               
sufficient balance.                                                                                                             
                                                                                                                                
11:44:09 AM                                                                                                                   
CHAIR FRENCH  asked how  this would  work and  if the  fund would                                                               
fill up during FY'08 through an appropriation.                                                                                  
                                                                                                                                
MR. BURNETT  replied that the  state has outstanding  credits, so                                                               
it would  make sense to  request a supplemental  appropriation to                                                               
capitalize the  fund in 2008  - especially since the  revenues in                                                               
2008 should be sufficient.                                                                                                      
                                                                                                                                
CHAIR FRENCH  asked if  it is the  administration's plan  to both                                                               
capitalize the fund and spend it in the same year.                                                                              
                                                                                                                                
MR.  BURNETT  replied  yes,  but  the  fund  would  have  ongoing                                                               
capitalization and would fluctuate from year to year.                                                                           
                                                                                                                                
CHAIR FRENCH said it's not a slush fund.                                                                                        
                                                                                                                                
MR. BURNETT  agreed and  added that  a slush  fund would  have no                                                               
value  to the  department  or the  administration;  it's just  to                                                               
cushion  swings  in  income  from   year  to  year  and  to  have                                                               
sufficient funds to pay the credits each year.                                                                                  
                                                                                                                                
11:47:01 AM                                                                                                                   
CHAIR FRENCH asked how rapidly  declining oil prices would affect                                                               
the fund.                                                                                                                       
                                                                                                                                
MR.  BURNETT  replied that  language  in  the bill  requires  the                                                               
department  to  write  regulations  that determine  how  it  pays                                                               
credits in  a time when there  is an insufficient balance  in the                                                               
fund. It  could be a  case where  explorers are spending  a great                                                               
deal of capital  and so lots of money isn't  going into the fund.                                                               
He  said the  department is  thinking of  pro-rating the  credits                                                               
between the  various tax  certificate holders  and allow  them to                                                               
carry  them forward  into the  next year.  It could  be that  the                                                               
legislature will need to make a decision at some point.                                                                         
                                                                                                                                
CHAIR FRENCH asked by how much FY'07 estimates were off.                                                                        
                                                                                                                                
MR.  BURNETT replied  that the  department asked  for around  $25                                                               
million in the  supplemental budget and it ended  up paying about                                                               
$59  million in  credits.  Some  credits have  been  paid out  in                                                               
FY'08, but  not to the $25  million limit. He expected  that most                                                               
of the  credits would come after  the winter season and  with the                                                               
tax returns at the end of the  year. Tax returns come in in April                                                               
and they have 60 days to audit the credit application.                                                                          
                                                                                                                                
MR. ROGERS  clarified that under  this proposal that  is extended                                                               
to 120 days.                                                                                                                    
                                                                                                                                
11:52:34 AM                                                                                                                   
CHAIR  FRENCH referred  to SB  80 corrosion  elements inside  the                                                               
bill before them  [CSSB 2001(RES), version M] and  noted the memo                                                               
from Mr.  Bullock to  Senator Wagoner,  dated February  26, 2007,                                                               
relating to retroactivity.  Mr. Bullock opined that  it would not                                                               
violate ex  post facto laws  and it would  be legal to  look back                                                               
that far.                                                                                                                       
                                                                                                                                
The committee recessed from 11:53:53 AM until 1:31:32 PM.                                                                   
                                                                                                                                
CHAIR FRENCH called  the meeting back to order. He  said that Dr.                                                               
Scott  would address  transportation deductions  and that  he had                                                               
copies of the current law for the committee members.                                                                            
                                                                                                                                
ANTONY  SCOTT,  Commercial  Analyst,  Division of  Oil  and  Gas,                                                               
Department  of  Natural Resources  (DNR),  said  AS 43.55.150  is                                                               
about  transportation  deductions  which are  used  to  determine                                                               
gross value at  the point of production. He said  he would review                                                               
the  current  law,  some  of  its  problems  and  some  potential                                                               
remedies  for  determining   transportation  deductions  for  tax                                                               
purposes.  He  explained  that  gross   value  at  the  point  of                                                               
production  is  determined  by subtracting  reasonable  costs  of                                                               
transportation from  market prices.  The statute  says reasonable                                                               
costs  are  determined  to  be different  from  actual  costs  by                                                               
meeting three conditions.                                                                                                       
                                                                                                                                
CHAIR FRENCH  asked if this  calculation applies to  both royalty                                                               
oil and PPT payments.                                                                                                           
                                                                                                                                
MR. SCOTT  said he is  only talking  about PPT payments,  not how                                                               
transportation tariffs  are set for rate-making  purposes, and he                                                               
isn't suggesting the state can  do anything about what a pipeline                                                               
actually charges. He  was speaking to what  the legislature wants                                                               
to determine is the appropriate  transportation deduction for tax                                                               
purposes.  This  is  not  about  royalty  deductions,  which  are                                                               
determined by contract, either.                                                                                                 
                                                                                                                                
MR.  SCOTT  said under  the  current  PPT, reasonable  costs  are                                                               
deemed  to   be  the  actual  costs   unless  three  simultaneous                                                               
conditions hold.  The last condition, the  oil/gas transportation                                                               
method,  is  not  reasonable  in  view  of  existing  alternative                                                               
methods of  transportation and will  never be obtained.  The only                                                               
reasonable method of  transportation of gas or oil  off the North                                                               
Slope, for  example, is always going  to be by pipeline  - unless                                                               
the sea  ice melts. So  the third condition, which  would provide                                                               
an exception  to reasonable  costs being  actual costs,  is never                                                               
going to be obtained - they will always be actual costs.                                                                        
                                                                                                                                
1:36:50 PM                                                                                                                    
CHAIR FRENCH asked why that matters.                                                                                            
                                                                                                                                
MR. SCOTT replied  that the first condition  (which would suggest                                                               
that maybe  reasonable costs shouldn't  be actual costs)  is when                                                               
the parties to the transportation  of oil and gas are affiliated.                                                               
It's possible  that the price  paid doesn't  indicate appropriate                                                               
costs.  Affiliate  language   exists  elsewhere  for  determining                                                               
appropriate  lease  expenditures.  For instance,  the  production                                                               
wing  of  an integrated  oil  company  will  pay  a rate  to  the                                                               
transportation  subsidiary of  the same  integrated company.  But                                                               
because it's  affiliated, it may  not be reasonable.  He surmised                                                               
that  when the  statute  was initially  drafted, people  probably                                                               
thought the DOR should be able  to take a closer look. The second                                                               
condition is similar:  If the contract for  transportation of oil                                                               
or   gas  is   not   an  arms-length   transaction   or  is   not                                                               
representative of market value of that transportation.                                                                          
                                                                                                                                
1:39:03 PM                                                                                                                    
CHAIR  FRENCH said  the  first two  conditions  cause a  person's                                                               
eyebrows to be raised that the  correct rate is not being charged                                                               
and that they need to look deeper.                                                                                              
                                                                                                                                
MR. SCOTT agreed.                                                                                                               
                                                                                                                                
SENATOR HUGGINS said he believed  that an arms-length transaction                                                               
is a basic requirement for transportation for the affiliates.                                                                   
                                                                                                                                
MR. SCOTT responded with an  example supposing that BPXA owns 100                                                               
percent  the North  Star  field,  BPTA owns  the  North Star  oil                                                               
pipeline, and they transport 100  percent of BPXA's oil. Although                                                               
they  are separate  companies, they  are clearly  affiliates. One                                                               
could  at  least  argue  that  it  is  not  a  fully  arms-length                                                               
transaction  - although  legally they  are two  separate entities                                                               
and the parties  nominating oil on the pipeline  will be separate                                                               
people  from the  parties receiving  those nominations.  He added                                                               
that  the  pipeline  has  rules   to  insure  that  the  pipeline                                                               
personnel from BPTA do not  provide privileged information to the                                                               
shippers in BPXA.                                                                                                               
                                                                                                                                
SENATOR HUGGINS  said he  operates under  the assumption  that an                                                               
arms-length  transaction  is  one  of the  requirements  for  the                                                               
transportation.                                                                                                                 
                                                                                                                                
MR. SCOTT said that gets into the issue of what arms length is.                                                                 
                                                                                                                                
1:41:29 PM                                                                                                                    
CHAIR   FRENCH  doubts   it's   possible   to  have   arms-length                                                               
transactions between affiliates.                                                                                                
                                                                                                                                
SENATOR  WIELECHOWSKI  asked  where the  potential  for  conflict                                                               
between the  state and  producers is  on this  issue. Is  there a                                                               
concern that  actual costs are  not what reasonable  costs should                                                               
be? Is  the concern that  when they  set their tariff  they don't                                                               
get  taxed on  that  tariff?  Is there  a  concern from  anyone's                                                               
perspective that when the tax  is raised, the producers can raise                                                               
their tariff?                                                                                                                   
                                                                                                                                
MR.  SCOTT responded  that the  concern  is if  one affiliate  is                                                               
charging a rate to another affiliate  of the same company. At the                                                               
parent level,  the company doesn't  care about the  rate, because                                                               
it is  moving the money from  the left hand pocket  to the right.                                                               
But  there   is  a  substantial  tax   consequence,  because  the                                                               
transportation   deduction   is   a   tax   deduction.   If   the                                                               
transportation  tariff is  $1 too  high  (above reasonable  cost)                                                               
under PPT, the  state receives 22.5 cents less on  each barrel of                                                               
oil that is subject to tax.                                                                                                     
                                                                                                                                
1:44:34 PM                                                                                                                    
MR.  SCOTT  said   in  practice,  the  first  two   parts  of  AS                                                               
43.55.150(a) go  to circumstances that might  raise some eyebrows                                                               
about actual costs being reasonable. He advised:                                                                                
                                                                                                                                
     It might be  worth taking a second look,  but right now                                                                    
     in the  statute it's not  just that  you have to  be an                                                                    
     affiliate  or have  an arms-length  transaction, it  is                                                                    
     also the  case that  reasonable costs and  actual costs                                                                    
     cannot  be different  unless  there  is an  alternative                                                                    
     mode  of  transportation  - and  practically  speaking,                                                                    
     that's never the case.                                                                                                     
                                                                                                                                
MR. SCOTT said  that right now this statute  might remotely apply                                                               
to some circumstances in Cook Inlet, but he couldn't imagine it.                                                                
                                                                                                                                
SENATOR  THERRIAULT speculated  that other  basins where  perhaps                                                               
the oil could  be trucked wouldn't trigger the state  to impose a                                                               
reasonable rate because one or two wouldn't be satisfied.                                                                       
                                                                                                                                
1:47:11 PM                                                                                                                    
MR.  SCOTT said  that  is correct.  He supposed  a  case where  a                                                               
producer has chosen to truck the  oil to market and there is more                                                               
than one  trucking company,  but the  producer does  a sweetheart                                                               
deal with  one. If it  is not  an affiliate transaction  and even                                                               
though the one would charge less,  the state would be required to                                                               
pay the other rate. The state would have no recourse.                                                                           
                                                                                                                                
1:48:09 PM                                                                                                                    
SENATOR HUGGINS  reminded them  that they  would have  to discuss                                                               
the  treatment  of  different geographical  areas  based  on  the                                                               
different variables of developing.                                                                                              
                                                                                                                                
SENATOR THERRIAULT said  now they are focused on  the North Slope                                                               
with its developed transportation system.  But the state hopes to                                                               
find  resources in  other areas,  and the  committee should  make                                                               
sure this statute, which applies statewide, works statewide.                                                                    
                                                                                                                                
MR. SCOTT said transportation deductions  on oil pipelines in the                                                               
state have historically  been determined by rates  that have been                                                               
sanctioned by  regulatory bodies  - the Regulatory  Commission of                                                               
Alaska (RCA) or the Federal  Energy Regulatory Commission (FERC).                                                               
Historically  this  has been  the  basis  for saying  that's  the                                                               
transportation deduction.                                                                                                       
                                                                                                                                
1:49:35 PM                                                                                                                    
CHAIR FRENCH  asked how far  the transportation element  is meant                                                               
to carry.                                                                                                                       
                                                                                                                                
MR.  SCOTT replied  that transportation  can begin  downstream of                                                               
the point  of production.  Upstream of  the point  of production,                                                               
which is defined  for tax deduction purposes in  AS 43.55.920, is                                                               
not   considered   transportation.   Downstream   is   considered                                                               
transportation.  Moving oil  on TAPS  is transportation.  Prudhoe                                                               
Bay has oil  transit lines that are not  transportation; they are                                                               
field lines  that are considered to  be upstream of the  point of                                                               
production  because  the  oil  is not  metered  yet  for  custody                                                               
transfer.  In Prudhoe  Bay, transportation  begins downstream  of                                                               
Pump Station 1.                                                                                                                 
                                                                                                                                
CHAIR FRENCH asked if that is really the inlet valve to pump 1.                                                                 
                                                                                                                                
MR.  SCOTT  replied  yes  -  it is  metered  where  the  producer                                                               
transfers custody  at a flange to  TAPS. He said the  Alpine unit                                                               
has a similar  story in that the custody transfer  happens to the                                                               
Alpine  pipeline, which  is owned  by  a separate  transportation                                                               
company. At  that point, transportation begins.  Upstream of that                                                               
any of  the flow lines  within Alpine are not  transportation for                                                               
tax purposes.  Those are lease  expenditures (for  tax purposes).                                                               
"So  that custody  transfer meter  marks the  distinction between                                                               
whether   you're  upstream   of  the   point  of   production  or                                                               
downstream, and if you're downstream, it can be transportation."                                                                
                                                                                                                                
1:52:36 PM                                                                                                                    
CHAIR  FRENCH said  this  came  up yesterday,  and  he said  that                                                               
Kuparuk is more like the  Alpine scenario. Prudhoe Bay has feeder                                                               
lines that go into pump 1.                                                                                                      
                                                                                                                                
MR. SCOTT agreed and said North Star is the same thing.                                                                         
                                                                                                                                
CHAIR FRENCH asked how far downstream transportation goes.                                                                      
                                                                                                                                
MR.  SCOTT replied  that it  goes to  market. He  added that  the                                                               
Department of  Natural Resources (DNR) and  Department of Revenue                                                               
(DOR),  separately,  have  spent   an  enormous  amount  of  time                                                               
figuring out the reasonable cost of transportation for tankers.                                                                 
                                                                                                                                
SENATOR HUGGINS asked how much maritime costs are.                                                                              
                                                                                                                                
1:54:08 PM                                                                                                                    
MR. SCOTT replied  that those change for  different companies and                                                               
he  didn't  want  to  venture a  figure.  There  are  differences                                                               
between the  tanker transportation deduction for  royalty and for                                                               
tax, but it's in the range  of $1.50 to $2.00. DOR publishes what                                                               
the marine  transport deduction is  to the West Coast  for income                                                               
tax purposes.                                                                                                                   
                                                                                                                                
SENATOR THERRIAULT said  that was discussed last  year. Exxon was                                                               
the highest and the state is  trying to come to an agreement with                                                               
them on what fee should be paid - as a contractual dispute.                                                                     
                                                                                                                                
MR. SCOTT  said he would be  happy to get those  figures. He went                                                               
on to explain that historically  the transportation deduction for                                                               
tax purposes  has relied  on rates that  have been  sanctioned by                                                               
the  regulatory  bodies; however,  it  has  not resulted  from  a                                                               
regulatory determination.  This is  an important  distinction. If                                                               
you  have a  rate  which is  approved by  a  regulatory body,  in                                                               
general  those agencies  have a  requirement  to establish  rates                                                               
that are just and reasonable.  Historically, and it's usually the                                                               
case  within the  state, the  producers through  their affiliates                                                               
own transportation. Typically you see  a very close match between                                                               
ownership percentages in the  pipelines and ownership percentages                                                               
of the production which comes out of the fields.                                                                                
                                                                                                                                
He said because these integrated  companies are paying themselves                                                               
- moving money  from one pocket to the other  - they would prefer                                                               
a high  rate. Because the  higher the  rate, the lower  their tax                                                               
payments will  end up  being and the  lower the  royalty payments                                                               
will   be.  So   the   only  party   usually  complaining   about                                                               
transportation  deductions has  been  the state.  A dispute  will                                                               
occur  and  rate litigation  will  ensue.  Without exception  the                                                               
state  has  ultimately come  up  with  settlement agreements  for                                                               
those pipeline  tariffs. The regulatory agencies  have never said                                                               
that the  rates produced  by the  settlement agreements  are just                                                               
and reasonable  rates. Just and  reasonable is  a term of  art in                                                               
the regulatory  arena, which means historically  cost-based rates                                                               
- rates which reflect actual  costs of developing and operating a                                                               
pipeline including reasonable return on capital.                                                                                
                                                                                                                                
1:58:59 PM                                                                                                                    
CHAIR FRENCH  asked why the state  has not pursued this  claim to                                                               
the very end. Why has it  relied on settlement agreements when it                                                               
would  have gotten  a  better result  by  forcing the  regulatory                                                               
agency to come to a decision on what actual costs are?                                                                          
                                                                                                                                
MR. SCOTT  replied that  TAPS is  the really  big deal,  and when                                                               
those tariffs were  being litigated from 1977  through 1985 (when                                                               
the  state finally  settled), there  was significant  uncertainty                                                               
around methodology issues for pipeline  rate making. This applied                                                               
to  pipelines in  the  Lower  48 as  well.  It  was against  that                                                               
context  of  regulatory  uncertainty  that  the  state  made  the                                                               
determination  that it  had  no  comfort in  getting  to a  final                                                               
conclusion any  time soon. Another  ten years was  the prediction                                                               
at the time of the settlement.                                                                                                  
                                                                                                                                
He said the determination was made  that the state was better off                                                               
settling,  because it  might have  a potential  refund obligation                                                               
that  was  continually  accruing.  It  measured  in  billions  of                                                               
dollars. There are  a number of reasons why  it seemed reasonable                                                               
at the  time for the  state to settle  the TAPS dispute  when and                                                               
how it did.                                                                                                                     
                                                                                                                                
2:01:29 PM                                                                                                                    
MR. SCOTT said  his Master's thesis was on this  question, and he                                                               
never  opined whether  it was  good for  the state  or not.  Many                                                               
people think  that the state made  a mistake and others  think it                                                               
was the right thing to do.  Having settled TAPS, he said it could                                                               
be argued that the state got  used to not wanting to litigate any                                                               
more and  it now has  a framework for subsequent  settlements and                                                               
has long-term  settlement agreements. He assured  them that those                                                               
settlement  agreements did  not  say that  for  tax purposes  the                                                               
state  would  use the  tariff  numbers  that  came out  of  those                                                               
settlement  agreements.  Those  settlement  agreements  said  the                                                               
following:                                                                                                                      
                                                                                                                                
     Here is a methodology. It'll  determine a rate. So long                                                                    
     as the  rate each year that  the transportation company                                                                    
     files  is at  or below  that rate,  the state  will not                                                                    
     protest the  rate. That's what  the agreements  say. It                                                                    
     doesn't say  we're going to  use them for  tax purposes                                                                    
     or  royalty  purposes or  any  other  purpose for  that                                                                    
     matter....                                                                                                                 
                                                                                                                                
     Now, on the  royalty side, we have a  number of royalty                                                                    
     settlement agreements, which  make reference to various                                                                    
     transportation  rates, but  again, for  tax purposes  -                                                                    
     and so  we're bound  to the  extent that  our contracts                                                                    
     bind  us. But  for tax  purposes, when  coming up  with                                                                    
     appropriate  transportation  deductions,  you  are  not                                                                    
     similarly bound - just like  you're not bound on issues                                                                    
     relating  to corrosion....  You're  the policy  makers;                                                                    
     you  get  to decide  what's  an  appropriate course  of                                                                    
     action for deductions.                                                                                                     
                                                                                                                                
2:04:19 PM                                                                                                                    
SENATOR WIELECHOWSKI  asked if the  state has lost  money because                                                               
of the way the rates are set.                                                                                                   
                                                                                                                                
MR.  SCOTT replied  that  the  RCA was  host  to intrastate  rate                                                               
litigation  concerning rates  for  1977 through  2000 brought  by                                                               
Tesoro, an  instate refiner.  Tesoro thought  the rates  were too                                                               
high.  Eventually the  RCA "disgorged"  a 200-page  decision that                                                               
found that through 1996, TAPS  tariffs had collected $9.9 billion                                                               
too  much from  shippers. A  very large  percentage of  that $9.9                                                               
billion  was collected  from Exxon  Production  Company to  Exxon                                                               
Transportation  Company, but  given the  state's royalty  and tax                                                               
interests, the state  footed roughly 25 percent of the  bill - or                                                               
$2.5 billion.                                                                                                                   
                                                                                                                                
SENATOR HUGGINS asked who paid the remaining $7.7 billion.                                                                      
                                                                                                                                
MR. SCOTT replied  that the remainder of the  settlement would be                                                               
mainly  transfer payments  from  affiliates of  the pipeline.  In                                                               
other words BPXA paid BPTA too  much. "But since they were paying                                                               
themselves, it's neither here nor there."                                                                                       
                                                                                                                                
CHAIR FRENCH  commented, "We  don't care  except that  it reduces                                                               
our royalty and taxes."                                                                                                         
                                                                                                                                
2:07:17 PM                                                                                                                    
MR. SCOTT  repeated that  the vast majority  of the  remainder of                                                               
the  $7.7 billion  was  paid  by affiliates  of  the pipeline  to                                                               
itself. There were some independent shippers, but very few.                                                                     
                                                                                                                                
CHAIR FRENCH recognized Senator Thomas and Representative Buch.                                                                 
                                                                                                                                
SENATOR  WIELECHOWSKI  asked if  the  state  can recoup  that  $2                                                               
billion based on that RCA decision.                                                                                             
                                                                                                                                
MR. SCOTT replied no.                                                                                                           
                                                                                                                                
SENATOR THERRIAULT said  that four years were  being disputed and                                                               
the FERC decision  potentially goes back two or  three years. The                                                               
potential impact to the state treasury  if the RCA rate is upheld                                                               
is $800 million.                                                                                                                
                                                                                                                                
2:08:34 PM                                                                                                                    
MR.  SCOTT said  he  would  talk about  tax  impacts shortly.  He                                                               
explained that  in 2005,  rate litigation  at the  FERC commenced                                                               
with Anadarko and Tesoro as parties.  The state was also a party,                                                               
but  its complaint  had  to do  with  discrimination because  the                                                               
intrastate rates  were so much  lower than the  interstate rates.                                                               
Last May,  an administrative  law judge  for the  FERC determined                                                               
that  indeed  the  interstate  rates set  pursuant  to  the  TAPS                                                               
settlement  methodology with  the state  were much  too high  and                                                               
suggested that  the just and reasonable  rate (for transportation                                                               
on TAPS)  should be  about $2.00 rather  than $5.00.  That matter                                                               
was  appealed to  the FERC  as a  whole, but  he could  guarantee                                                               
that,  no matter  what the  result, the  FERC's decision  will be                                                               
appealed in the D.C. Circuit Court.                                                                                             
                                                                                                                                
SENATOR WIELECHOWSKI said losing this tax makes him angry.                                                                      
                                                                                                                                
MR. SCOTT  said the $2.2  billion figure from the  RCA's decision                                                               
is from the period of 1977 through 1996.                                                                                        
                                                                                                                                
SENATOR WIELECHOWSKI  asked if  the state could  do a  statute of                                                               
limitations retroactively to recoup that loss.                                                                                  
                                                                                                                                
2:10:53 PM                                                                                                                    
MR. SCOTT said he couldn't answer that.                                                                                         
                                                                                                                                
SENATOR WIELECHOWSKI remarked that was like stealing.                                                                           
                                                                                                                                
SENATOR THERRIAULT  reminded them that  it was only in  2005 that                                                               
the  state started  protesting,  and the  opportunity to  protest                                                               
previous years is lost.                                                                                                         
                                                                                                                                
MR. SCOTT said  that is correct. In essentially  all cases, until                                                               
recently,  regulatory bodies  have blessed  settlement agreements                                                               
that  the state  has struck  with industry  rather than  having a                                                               
fully-litigated  rate case  that eventually  came to  conclusion.                                                               
That  raises   some  issues  about   whether  actual   costs  are                                                               
reasonable,  and evidence  exists  that they  are unreasonable  -                                                               
given recent regulatory determinations of actual costs.                                                                         
                                                                                                                                
CHAIR FRENCH recognized the presence of Senator Hoffman.                                                                        
                                                                                                                                
2:12:19 PM                                                                                                                    
MR. SCOTT said  the first question he wanted to  raise is why the                                                               
state   bases  its   tax  policy   for  pipeline   transportation                                                               
deductions  on  pipeline  rate litigation.  For  royalty,  it  is                                                               
pretty much stuck doing so, but  for taxation, it is not. Tax for                                                               
transportation  deductions  is  a  sovereign  matter.  The  right                                                               
answer could be zero, he remarked,  and added that this is not an                                                               
unheard of measure. It's the legislature's call.                                                                                
                                                                                                                                
MR. SCOTT further elaborated:                                                                                                   
                                                                                                                                
     On  pipelines  transporting  federal  royalty,  if  the                                                                    
     pipeline  is   an  affiliate   of  the   producer,  MMS                                                                    
     (Minerals Management  Service) doesn't take  the tariff                                                                    
     rate as  the basis  for determining  the transportation                                                                    
     deduction, in  general. MMS  is the  federal equivalent                                                                    
     of  DNR for  the state.  So, under  their leases,  MMS,                                                                    
     says, 'We will give you  an actual and reasonable cost,                                                                    
     but we're  not going to  look to the  regulatory agency                                                                    
     to   determine   actual   and  reasonable   costs   for                                                                    
     transportation if  you don't have a  properly contested                                                                    
     rate  proceeding.' So,  if this  is not  an arms-length                                                                    
     transaction,  what  we do  is  we'll  say, 'Here  is  a                                                                    
     method, here's  what you'll use.  This is  the formula,                                                                    
     crank it through  the formula. The rate  that comes out                                                                    
     [is]   your  transportation   deduction.'  It   is  not                                                                    
     dissimilar, frankly,  from what  DOR - it's  actually a                                                                    
     little more formal. No, I  shouldn't say that. It's not                                                                    
     dissimilar    from   what    DOR   does    for   marine                                                                    
     transportation deductions....                                                                                              
                                                                                                                                
     There are some  reasons for the state  to avoid relying                                                                    
     on the  regulatory process in setting  tax value. First                                                                    
     of  all, as  we've  just been  talking about,  pipeline                                                                    
     litigation  can drag  on for  a considerable  period of                                                                    
     time and in the  meantime you're accruing balances that                                                                    
     may show  up as refunds  to the state treasury  and may                                                                    
     not,  but   you're  creating  uncertainty  as   to  the                                                                    
     ultimate  tax value  when you  rely  on litigation  for                                                                    
     determining tax value.                                                                                                     
                                                                                                                                
2:15:28 PM                                                                                                                    
CHAIR FRENCH  said his sense  is that the regulatory  process and                                                               
the litigation that is used from  that takes much longer than the                                                               
litigation process that ensues when you have a tax dispute.                                                                     
                                                                                                                                
MR. SCOTT said  that can be the  case. In a memo  to DNR, Spencer                                                               
Hosie said he  could resolve tax disputes in two  or three years.                                                               
Mr. Scott  said he hoped the  first stage of the  rate litigation                                                               
at the  FERC will be  concluded within  three years, but  then it                                                               
will  go to  the D.C.  Circuit Court;  more than  likely a  small                                                               
portion of it will be remanded back  to the FERC. It is a process                                                               
that can take  considerably longer than three years.  He said the                                                               
original Tesoro  protest with the  RCA was  in 1997 and  that was                                                               
not concluded  until 2005. That  decision is still not  final and                                                               
is before the Alaska Supreme Court right now.                                                                                   
                                                                                                                                
SENATOR  THERRIAULT  said it  took  RCA  five  years, but  it  is                                                               
evaluating  a  methodology  and  doing all  the  work.  Then  the                                                               
challenge  in   the  court  system  determines   whether  it  was                                                               
reasonable and not  arbitrary. So there is some  deference to the                                                               
agency's expertise.  One would expect  the agency function  to be                                                               
the longest.                                                                                                                    
                                                                                                                                
MR. SCOTT  agreed and  said the second  reason to  question using                                                               
the  regulatory process  to set  tax value  is that  absent arms-                                                               
length transactions with  commercially sophisticated parties like                                                               
Tesoro was  at the RCA  or like Anadarko  and Tesoro were  at the                                                               
FERC. Absent that kind of a  protest, it is at least questionable                                                               
whether you're  going to get  settlement results that are  a good                                                               
match to actual costs or reasonable costs.                                                                                      
                                                                                                                                
2:18:25 PM                                                                                                                    
MR.  SCOTT gave  an example.  Right now  the TAPS  transportation                                                               
deduction is about  $5.00. TAPS is one hose  with separate straws                                                               
within it  and each one has  a different tariff and  those bounce                                                               
around  from year  to year.  The RCA  determined that  costs were                                                               
actually around  $1.97. The FERC  law judge determined  they were                                                               
about $2.05. While the litigation  continues, the state continues                                                               
to allow $5.00  for a transportation deduction  for tax purposes.                                                               
If it  is the case  that TAPS deductions  are $3.00 too  high and                                                               
assuming  production is  760,000 barrels  per day  and production                                                               
tax rate  is 22.5  percent, it  would cost  the state  about $160                                                               
million per year.                                                                                                               
                                                                                                                                
2:21:12 PM                                                                                                                    
MR.  SCOTT  said   he  wanted  to  shift  focus   to  talk  about                                                               
transportation  deductions   for  gas  pipelines.  He   said  gas                                                               
pipelines are  typically built on  the basis of  negotiated rates                                                               
between shippers and pipelines, and  there is no scrutiny by FERC                                                               
as to whether it is a fair bargain.  In the case of a major North                                                               
Slope  gas pipeline,  if  the  producers end  up  owning the  gas                                                               
pipeline, they  can negotiate with themselves.  That could result                                                               
in a very  high negotiated rate because they could  use that rate                                                               
for determining  their deduction  for determining gross  value at                                                               
the point of  production for gas. Given the  current statute, the                                                               
state  wouldn't even  have a  regulatory forum  really to  go to,                                                               
practically  speaking, to  complain  about  this excessive,  non-                                                               
arms-length negotiated rate. The FERC doesn't care.                                                                             
                                                                                                                                
So,  why  would  the  state  want  to  set  its  tax  policy  for                                                               
transportation deductions on the  basis of a non-arms-length deal                                                               
that the state can't even  litigate before a regulatory body? The                                                               
state's experience  with TAPS suggests  that would be  unwise and                                                               
there is  no need to  do so. He said  this is an  opportunity for                                                               
the  state  to  reconsider   how  transportation  deductions  are                                                               
handled for determining gross value at the point of production.                                                                 
                                                                                                                                
2:23:56 PM                                                                                                                    
MR.  SCOTT said  the state  presently must  live with  it because                                                               
it's never the case that there  will be other reasonable modes of                                                               
transportation - so  the third condition in  AS 43.55.150(a) will                                                               
never  be met.  The DOR  could  follow MMS's  lead and  establish                                                               
regulations  given a  statutory change  to determine  appropriate                                                               
cost deductions  for non-arms-length transactions. But  the state                                                               
will  need to  be  careful  to deal  with  the circumstance  that                                                               
Anadarko  faces,  for  example.  Anadarko really  does  pay  TAPS                                                               
tariffs; it doesn't own a part  of the pipeline. A non-TAPS owner                                                               
that is not an affiliate may want to use their actual costs.                                                                    
                                                                                                                                
SENATOR  WIELECHOWSKI  asked the  impact  of  exploration on  the                                                               
North Slope when tariffs are so much higher than they should be.                                                                
                                                                                                                                
MR. SCOTT  said it is  not helpful. There  have been a  number of                                                               
presentations on how  the tax rate affects  the break-even point.                                                               
Those movements based on tax may  be well under that $3.00 swing.                                                               
It is a substantial difference.                                                                                                 
                                                                                                                                
2:26:36 PM                                                                                                                    
SENATOR WIELECHOWSKI  asked if tariffs  were down to  $2.00 would                                                               
that encourage exploration on the North Slope.                                                                                  
                                                                                                                                
MR. SCOTT said the short answer is no, and:                                                                                     
                                                                                                                                
     the  reason is  because the  state cannot,  through its                                                                    
     tax   policy,  determine   what  a   pipeline  actually                                                                    
     charges; so a third party  shipper right now faces TAPS                                                                    
     tariffs which are  arguably too high. They  have to pay                                                                    
     that tariff if  they want to get their  product off the                                                                    
     North  Slope.   What  you  choose  as   an  appropriate                                                                    
     transportation   deduction  for   tax  purposes   can't                                                                    
     directly affect  what the  pipeline charges  that third                                                                    
     party. What you  can do, and what you  clearly have the                                                                    
     power  to do,  is  affect  whether that  transportation                                                                    
     deduction  affects   the  state's  general   fund.  So,                                                                    
     through tax policy you can't  directly change the rate.                                                                    
     Through  tax   policy  you  can  directly   affect  the                                                                    
     transportation deduction.                                                                                                  
                                                                                                                                
SENATOR WIELECHOWSKI  asked if  the pipeline  owners have  to get                                                               
FERC approval on rates or if they charge whatever they want.                                                                    
                                                                                                                                
MR. SCOTT replied  that owners of a pipeline will  have to have a                                                               
tariff  on  file  with  the FERC,  for  example.  Absent  someone                                                               
complaining  about that  tariff, it  will be  allowed to  go into                                                               
effect. Protesting tariffs is an  extremely lengthy and expensive                                                               
process; it's  not something that  a company  undertakes lightly.                                                               
It would have  to have enough production to be  worth their while                                                               
on  a cost  benefit basis.  When Anadarko  and Tesoro  decided to                                                               
challenge TAPS tariffs at the  FERC, they needed approval for the                                                               
legal expenditures  that were going  to be entailed  because they                                                               
measured in  many millions of  dollars. Small, new  entrants will                                                               
not be inclined to do that.                                                                                                     
                                                                                                                                
2:29:17 PM                                                                                                                    
CHAIR FRENCH  went back  to the  Anadarko case  and asked  why it                                                               
wouldn't deduct the actual costs, since they are not affiliated.                                                                
                                                                                                                                
MR. SCOTT replied that changing "and"  to "or" will get the state                                                               
most of the way, if not all of  the way, to where it needs to go.                                                               
It won't capture  Anadarko, but they want to make  sure that when                                                               
DOR promulgated  regulations (after  changing "and" to  "or") for                                                               
setting appropriate transportation deductions  that it applies to                                                               
everyone whether  they are affiliated  or not. It's  probably not                                                               
necessary to do it in statute.                                                                                                  
                                                                                                                                
2:31:06 PM                                                                                                                    
SENATOR  THERRIAULT said  the actual  cost will  be a  legitimate                                                               
deduction for Anadarko or any other non-TAPS owner.                                                                             
                                                                                                                                
MR. SCOTT said that is right.  TAPS is the poster child, but this                                                               
change  could potentially  apply to  the other  pipelines and  it                                                               
makes a  difference. One needs  to look on a  case-by-case basis.                                                               
It is really about transportation deduction policy.                                                                             
                                                                                                                                
The committee took a recess from 2:33:05 PM to 2:52:53 PM.                                                                  
                                                                                                                                
CHAIR FRENCH called the meeting back  to order and said that they                                                               
would hear  a response to  the previous testimony from  Mr. Scott                                                               
about actual versus reasonable costs from AOGA.                                                                                 
                                                                                                                                
MARILYN CROCKET,  AOGA, said  she is not  planning to  respond to                                                               
the  previous  testimony.  She has  testimony  on  actual  versus                                                               
reasonable cost and the credit buy back.                                                                                        
                                                                                                                                
CHAIR FRENCH asked to start with the most recent topic.                                                                         
                                                                                                                                
2:54:07 PM                                                                                                                    
TOM WILLIAMS,  Chairman, AOGA  Tax Committee,  said the  issue of                                                               
actual versus reasonable  costs is real and was faced  by the DOR                                                               
when he  was director  of the Petroleum  Revenue Division  of DOR                                                               
(which is now  the Tax Division) from 1975 to  1979 and also when                                                               
he was  DOR commissioner from  1979 to  1982. Back then  the same                                                               
issue arose  in other  contexts. In  the context  of the  cost to                                                               
transport ANS crude  by marine tankers from Valdez  to markets on                                                               
the West  Coast, Hawaii, St. Croix  in the Virgin Islands  and to                                                               
the   U.S.  East   and  Gulf   Coasts,   the  respective   marine                                                               
transportation costs had to be  netted out or subtracted from the                                                               
market  value  of  the  ANS  delivered  at  each  outside  market                                                               
destination  in  order  to determine  the  corresponding  netback                                                               
value  of  that  oil  at  Valdez. From  the  Valdez  netback  the                                                               
pipeline transportation costs were further  netted out to get the                                                               
corresponding  netback in  the field  (which was  formally called                                                               
the  gross value  at the  point of  production in  production tax                                                               
statutes starting in mid-1977).                                                                                                 
                                                                                                                                
MR. WILLIAMS  said, from a  tax administrator's  perspective, the                                                               
advantage of  using reasonable costs  instead of actual  costs is                                                               
that you  don't have to audit  reasonable costs. You just  find a                                                               
publication  or other  recognized authority  that tells  you what                                                               
the reasonable costs are and the current market conditions.                                                                     
                                                                                                                                
For international  marine transportation there was  actually such                                                               
a  publication or  authority. He  said the  average freight  rate                                                               
assessment  (AFRA) was  published  by the  London Tanker  Brokers                                                               
Panel.  Those rates  were helpful  to DOR  to find  the delivered                                                               
cost to acquire comparable foreign  crude at a market destination                                                               
where  ANS was  also  going and  competing  against that  foreign                                                               
supply, but AFRA  didn't give them the reasonable  cost or market                                                               
value of  waterborne transportation in  Jones Act ships.  When he                                                               
first heard  about a  new U.S.  AFRA in 1978  he was  inclined to                                                               
consider using  it to  determine the  reasonable costs  for Jones                                                               
Act tanker  transportation from  Valdez to  the other  U.S. ports                                                               
where ANS was shipped - he  was very inclined until he discovered                                                               
that the  tanker fleet  for ANS would  dominate the  rates quoted                                                               
for this U.S. AFRA. In  other words, those quotes would basically                                                               
be the  same information he would  be getting - it  would be just                                                               
another source.  This illustrates  one of  the problems  of using                                                               
reasonable rates -  which is finding an  authoritative source you                                                               
can trust. Often times there  simply isn't one and sometimes they                                                               
go out of business or  become unreliable and inaccurate. The only                                                               
other way to  implement the reasonable cost approach  is to audit                                                               
the cost of everyone involved.                                                                                                  
                                                                                                                                
2:58:07 PM                                                                                                                    
MR. WILLIAMS said  this is the worst of all  possible worlds from                                                               
a tax administrator's perspective because  you have to do all the                                                               
auditing and  other work in an  actual cost system and  once that                                                               
is done there  are the further challenges of  proving to everyone                                                               
that  your reasonable  cost figures  are  accurate and  represent                                                               
market conditions. Given the  constraints of tax confidentiality,                                                               
he asked how cost information could  be used from one taxpayer to                                                               
show any other  taxpayer how reasonable cost  was determined. The                                                               
issue of  how one  taxpayer's information could  be used  to show                                                               
another taxpayer was solved in the statute enacted last year.                                                                   
                                                                                                                                
MR. WILLIAMS  said reasonable cost  figures will be badly  out of                                                               
date given that taxpayer information  from which the department's                                                               
figures  are derived  would have  to be  audited first  to insure                                                               
reliability. There would  be a tax that no  taxpayer could comply                                                               
with correctly  when due. It  would require numerous  filings and                                                               
refilings of  amended returns  by tax  payers as  reasonable cost                                                               
data was published or updated on  the basis of new audit results,                                                               
or it  would be a tax  whose correct amount cannot  be determined                                                               
at all until taxpayers are audited.  The challenge for DOR to set                                                               
up  and maintain  accurate records  of  each taxpayer's  payment,                                                               
corrections,  and  final  cost figures  would  be  enormous,  but                                                               
relying  on audits  is  the  only way  to  determine the  correct                                                               
amount of reasonable costs, and  that would amount to taxation by                                                               
audit instead of self reporting  and self assessment. It would be                                                               
difficult and inefficient to administer  a tax that supposedly is                                                               
self reported and self assessed. He continued:                                                                                  
                                                                                                                                
     Rather   than   taking   any   of   these   unappealing                                                                    
     alternatives, we  (DOR) opted in  1979 and 1980  to use                                                                    
     actual  transportation costs  as much  as we  could and                                                                    
     save ourselves these troubles.  From a taxpayer's point                                                                    
     of view - and I am now  putting my hat back on as chair                                                                    
     of  the  AOGA  Tax  Committee  -  the  reasonable  cost                                                                    
     approach  suffers  from  three major  problems.  First,                                                                    
     taxpayers only  know their own  business and  their own                                                                    
     actual costs. Anything different  from a taxpayer's own                                                                    
     actual costs cannot  be right in its  eyes, because the                                                                    
     actual costs are what they  are and the facts cannot be                                                                    
     different  from  what  they  are. It  is  a  rare  tax,                                                                    
     indeed, that  does not look  at the  actual performance                                                                    
     or  results  of  a   taxpayer's  business  or  business                                                                    
     related activities.                                                                                                        
                                                                                                                                
     3:00:45 PM                                                                                                               
     And as long as the tax  is taking such later items into                                                                    
     account, it  is fundamentally unsound to  ignore actual                                                                    
     costs or  similar actual results,  and to base  the tax                                                                    
     instead on some different cost  or result no matter how                                                                    
     reasonable  this  derivation  may  be.  Second,  unless                                                                    
     there is  some reliable and authoritative  source about                                                                    
     reasonable costs  under the current conditions  that is                                                                    
     available  to taxpayers  before their  tax returns  and                                                                    
     payments become due, it will  be impossible for them to                                                                    
     compute, report, and  pay the correct amount  of tax on                                                                    
     that due  date. In  the case  of operating  and capital                                                                    
     costs to  explore for, develop,  or produce oil  or gas                                                                    
     on the North Slope,  there is no reliable authoritative                                                                    
     source  available at  all, much  less one  that can  be                                                                    
     available  on  a timely  basis.  Here  you can  see  we                                                                    
     misunderstood  where the  concerns  seem to  be of  the                                                                    
     committee  on  this  subject. We  were  addressing  the                                                                    
     issue of  the upstream costs  in the field  rather than                                                                    
     downstream costs of the transportation.                                                                                    
                                                                                                                                
     Third,  if  DOR  would  be determining  the  amount  of                                                                    
     reasonable costs  to explore  for, develop,  or produce                                                                    
     oil  and  gas  on  the  North Slope  on  the  basis  of                                                                    
     taxpayers' verified and audited  actual costs for these                                                                    
     activities, it would still  be impossible for taxpayers                                                                    
     to report  and pay  the correct amount  of tax  when it                                                                    
     comes  due. In  addition,  the problems  of filing  and                                                                    
     refiling  amended   tax  returns   or  of   having  the                                                                    
     alternative  taxation   by  audit  will  be   about  as                                                                    
     difficult and  onerous for taxpayers  as they  would be                                                                    
     for tax administrators.                                                                                                    
                                                                                                                                
     It is  also worth  remembering that  to the  extent the                                                                    
     actual  lease  expenditures  can   be  based  on  joint                                                                    
     interest   billings   by    the   operator   to   other                                                                    
     participants in the operations,  the total actual costs                                                                    
     under  those  billings  will  be   the  same  for  each                                                                    
     participant with the only difference  being the size of                                                                    
     each one's  share of that  total. Even if DOR  were not                                                                    
     to rely on the audits  by non operating participants of                                                                    
     the  billings   to  ensure  that  those   billings  are                                                                    
     appropriate and accurate, it would  have to do only one                                                                    
     audit of each set of  billings by the operator. This is                                                                    
     the same set  for all the partners. And  that would be,                                                                    
     instead  then of  doing  completely independent  audits                                                                    
     for each  participant's actual costs. So,  using actual                                                                    
     costs could  prove to be significantly  less burdensome                                                                    
     for  DOR to  administer,  audit, and  enforce than  one                                                                    
     might first expect.                                                                                                        
                                                                                                                                
3:03:14 PM                                                                                                                    
SENATOR  WIELECHOWSKI   asked  if  his  testimony   represents  a                                                               
consensus view within AOGA including Anadarko.                                                                                  
                                                                                                                                
MR. WILLIAMS replied yes. "There was no dissent."                                                                               
                                                                                                                                
SENATOR THERRIAULT said Mr. Williams  indicated his testimony was                                                               
not  in  response  to  the previous  discussion,  but  rather  in                                                               
response to the upstream in-field reasonable cost discussion.                                                                   
                                                                                                                                
MR. WILLIAMS said yes, but  the anecdotal discussion about AOGA's                                                               
experience with tanker rates fits into the discussion.                                                                          
                                                                                                                                
CHAIR FRENCH asked if AOGA takes  a position on the proposal with                                                               
respect to  AS 43.55.150, to change  the final "and" to  an "or",                                                               
he would  give him further  opportunity to speak before  the bill                                                               
leaves committee.                                                                                                               
                                                                                                                                
3:05:13 PM                                                                                                                    
SENATOR  THERRIAULT asked  if the  gathering lines  on the  North                                                               
Slope are regulated or just negotiated.                                                                                         
                                                                                                                                
MR. WILLIAMS  replied that the  pipelines in the  fields, whether                                                               
they  are oil  transit  lines  or not,  upstream  of the  custody                                                               
transfer meter  are not regulated  and have not been  deducted in                                                               
getting  to the  gross value  at  the point  of production.  That                                                               
point of production is downstream.                                                                                              
                                                                                                                                
SENATOR  THERRIAULT asked  if the  discussion for  transportation                                                               
costs for tax purposes is only for the downstream stuff.                                                                        
                                                                                                                                
MR.  WILLIAMS said  yes. The  transportation costs  start at  the                                                               
custody transfer  meter where  it leaves the  unit and  goes into                                                               
the custody of the common carrier pipeline serving that field.                                                                  
                                                                                                                                
CHAIR FRENCH asked if AOGA had an opinion on a tax credit fund.                                                                 
                                                                                                                                
3:06:18 PM                                                                                                                    
MR. WILLIAMS replied that AOGA supports the concept of the state                                                                
buying back tax credit certificates and creating the fund to do                                                                 
so. Further he said.                                                                                                            
                                                                                                                                
     However, for this  system to work it  will be essential                                                                    
     that  future  legislatures  appropriate  the  necessary                                                                    
     money into the fund each  year. Otherwise the fund will                                                                    
     turn into an empty promise  for future investors. In as                                                                    
     much  as   the  topic  currently   under  consideration                                                                    
     includes appropriation authority  for credit buy backs,                                                                    
     AOGA  would  draw your  attention  to  a few  potential                                                                    
     issues relating to this portion of the topic.                                                                              
                                                                                                                                
     First,  might the  automatic inclusion  of earnings  on                                                                    
     the  fund   as  part  of  the   fund  without  specific                                                                    
     appropriations  of those  earnings back  into the  fund                                                                    
     each year  violate Alaska's  constitutional prohibition                                                                    
     against  dedicated  revenues?  If so,  what  might  the                                                                    
     legal  effect  be  of   AS  43.55.028(h)  stating  that                                                                    
     'Nothing in this section creates a dedicated fund?'                                                                        
                                                                                                                                
     With respect  to that  question, if  I may  depart from                                                                    
     the  testimony, I  think  that since  this  fund is  an                                                                    
     account in  the general fund, this  issue of dedication                                                                    
     might be moot  - as I understand it, because  it is not                                                                    
     an independent  thing like the University  of Alaska or                                                                    
     something like  that. But  if that's  the case  and the                                                                    
     earnings  sort of  automatically  are  there and  there                                                                    
     isn't an  appropriation, then could  they be  taken out                                                                    
     of  the treasury  without violating  the clause  in the                                                                    
     constitution requiring  an appropriation to  take money                                                                    
     out of  the treasury? The  fact that this  statute says                                                                    
     that they  are automatically in the  fund balance might                                                                    
     not   be   self   executing   because   it's   not   an                                                                    
     appropriation; so  you would have  to take care  in the                                                                    
     future to  make sure that in  addition to appropriating                                                                    
     the new  tax receipts, the  percentage of the  tax each                                                                    
     year,  that   you  would  also  be   appropriating  the                                                                    
     interest. There  might be an issue  otherwise about the                                                                    
     use   of  that   money   that  might   not  have   been                                                                    
     appropriated and that violates  Article 9, Section 13 -                                                                    
     or  it might.  I can't  give you  the legal  opinion on                                                                    
     that. Our concern is that it might.                                                                                        
                                                                                                                                
     3:09:07 PM                                                                                                               
     The second  question, which  is now  - might  the anti-                                                                    
     lapse provisions in AS  43.55.028(f), which states that                                                                    
     money in the fund at the  end of a fiscal year does not                                                                    
     lapse   and  remains   available  for   expenditure  in                                                                    
     successive  fiscal  years,  which includes  the  monies                                                                    
     appropriated to  it, does that more  properly belong in                                                                    
     a bill  making an appropriation  to the fund or  a bill                                                                    
     specifically  reappropriating the  money back  into the                                                                    
     fund, rather than in  this legislation establishing the                                                                    
     fund in the  first place. If so,  would AS 43.55.028(f)                                                                    
     violate   the  constitution's   one-subject  rule   for                                                                    
     legislation?  There  it  says: 'Every  bill  should  be                                                                    
     confined to  one subject unless it  is an appropriation                                                                    
     bill  or   one  codifying,  revising,   or  rearranging                                                                    
     existing  laws.  Bills   for  appropriations  shall  be                                                                    
     confined to appropriations.'                                                                                               
                                                                                                                                
     Although  representative of  some members  of the  AOGA                                                                    
     tax committee  may be attorneys,  the tax  committee is                                                                    
     not  authorized nor  qualified to  offer you  any legal                                                                    
     advice  or  opinion about  what  the  answers to  these                                                                    
     questions might  or might not  be. The most we  feel we                                                                    
     can  properly do  under the  circumstances is  to point                                                                    
     out  these potential  issues so  you  can get  whatever                                                                    
     professional legal advice you  may feel is necessary or                                                                    
     appropriate to  answer these  questions and  to revise,                                                                    
     if necessary or prudent,  these provisions of the bills                                                                    
     accordingly.  And I  would  add  here that  technically                                                                    
     these are  not in the bill  in the sense that  they are                                                                    
     not in  the committee substitute from  Resources, but I                                                                    
     discussed them because they are  on the agenda and it's                                                                    
     in the original bill.                                                                                                      
                                                                                                                                
     As I  close, Mr. Chairman,  I should mention  that AOGA                                                                    
     has prepared  a white paper  on aspects of  tax credits                                                                    
     since we're on  the subject sort of  tax credits, under                                                                    
     the  proposed  bill  that falls  outside  the  specific                                                                    
     scope of  the present topic.  In fact, the  white paper                                                                    
     covers the following topics:  the 50 percent limitation                                                                    
     on   credits  taken   the   first   year  for   capital                                                                    
     investments,  the  "TIE"  credits,  electric  ratepayer                                                                    
     benefits  from selling  tax  credits, and  conditioning                                                                    
     exploration tax  credits on  new requirements  to share                                                                    
     information.  We believe  the  committee members  might                                                                    
     find some or all of these  points to be of interest and                                                                    
       with your permission I would like to have that be                                                                        
     submitted as part of the record.                                                                                           
                                                                                                                                
CHAIR FRENCH responded he would be happy to take that in.                                                                       
                                                                                                                                
3:11:27 PM                                                                                                                    
SENATOR THERRIAULT  suggested that the drafter  had patterned the                                                               
language after  other sub-funds of  the general fund  that retain                                                               
their  interest and  it may  be worth  having the  legal division                                                               
look at  it. He didn't  think it would  create a problem.  If the                                                               
legislature in the  future did not go through  this separate fund                                                               
mechanism to  repay the  credits, that  doesn't mean  the credits                                                               
wouldn't  be honored.  Future legislatures  could have  different                                                               
ways of honoring the state's commitment.                                                                                        
                                                                                                                                
3:12:55 PM                                                                                                                    
JERRY  BURNETT,   Director,  Administrative   Services  Division,                                                               
Department of Revenue, said he  agreed with Mr. Williams that the                                                               
legislature would have  to appropriate the interest  each year in                                                               
order for the  department to be able to spend  it. The dedication                                                               
of funds issue  can be taken care of in  the annual appropriation                                                               
bill and it would be their intent to do it that way.                                                                            
                                                                                                                                
CHAIR FRENCH  asked about the  anti-lapse provisions being  in an                                                               
appropriation bill as opposed to this one.                                                                                      
                                                                                                                                
MR. BURNETT replied  that the intent of  this legislation clearly                                                               
can't deal with  appropriations, so he intended to  put the lapse                                                               
language in the appropriation bill.                                                                                             
                                                                                                                                
SENATOR THERRIAULT asked  if their main concern is  having a fund                                                               
that is not sweepable. Mr. Burnett replied yes.                                                                                 
                                                                                                                                
CHAIR FRENCH asked  Mr. Scott if he wanted to  respond to some of                                                               
the comments made with on transportation costs. He replied no.                                                                  
                                                                                                                                
3:14:53 PM                                                                                                                    
SENATOR  THERRIAULT asked  for producers  who are  owners of  the                                                               
means  of transportation,  if  the  state has  to  be careful  in                                                               
applying a reasonable  rate to all shippers because  some of them                                                               
actually pay that rate.                                                                                                         
                                                                                                                                
MR.  SCOTT  replied that  is  exactly  right.  So for  TAPS,  for                                                               
example, there are a number  of companies that have production on                                                               
the North  Slope who ship through  TAPS or sell to  other parties                                                               
who ship  through TAPS and  don't own  any interest in  TAPS. For                                                               
those  parties,  the  reasonable  costs really  should  be  their                                                               
actual costs because they really  do pay it. The primary function                                                               
of the  tariff for an affiliate  producer is to affect  their tax                                                               
and royalty distributions to the state.                                                                                         
                                                                                                                                
CHAIR  FRENCH said  he wanted  to hear  from a  producer with  no                                                               
interest in TAPS  before the committee takes final  action on the                                                               
proposed amendments. He said they would  next take up the cost of                                                               
the spill and how SB  2001 prohibits producers from deducting the                                                               
costs of unusual events from their production taxes.                                                                            
                                                                                                                                
3:17:16 PM                                                                                                                    
BERNARD HAJNY,  Manager, Production  Taxes and  Royalties Alaska,                                                               
BP Exploration  Alaska, testified that their  Prudhoe Bay manager                                                               
testified  that the  cost to  replace  the oil  transit lines  is                                                               
currently in the range of $250 million to $260 million.                                                                         
                                                                                                                                
CHAIR  FRENCH asked  if those  costs had  been spent  or will  be                                                               
spent or both.                                                                                                                  
                                                                                                                                
MR. HAJNY replied  that some will be spent in  calendar year 2007                                                               
and the remainder will be in 2008. That is the expected total.                                                                  
                                                                                                                                
3:19:20 PM                                                                                                                    
SENATOR WIELECHOWSKI  asked if that  cost was all incurred  by BP                                                               
or if other parties are participating.                                                                                          
                                                                                                                                
MR.  HAJNY  replied  that  expenditure  would  be  borne  by  the                                                               
operating unit with BP as the operator.                                                                                         
                                                                                                                                
SENATOR WIELECHOWSKI surmised the cost would be spread around.                                                                  
                                                                                                                                
MR. HAJNY replied yes.                                                                                                          
                                                                                                                                
SENATOR WIELECHOWSKI  asked if BP  intends to write off  the full                                                               
amount as a deduction under the current PPT.                                                                                    
                                                                                                                                
MR.  HAJNY referred  him  back  to Doug  Suttle's  letter to  the                                                               
legislature on February  15, 2007 where he  indicated BP intended                                                               
to  deduct  the  cost  of inspection,  business  resumption,  and                                                               
replacement of the oil transit lines.                                                                                           
                                                                                                                                
There being  no further  business to  come before  the committee,                                                               
the meeting was adjourned at 3:22:02 PM.                                                                                      

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