Legislature(2017 - 2018)BUTROVICH 205
04/18/2017 02:00 PM Senate RESOURCES
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| Audio | Topic |
|---|---|
| Start | |
| HB111 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 111 | TELECONFERENCED | |
HB 111-OIL & GAS PRODUCTION TAX; PAYMENTS; CREDITS
2:00:36 PM
CHAIR GIESSEL announced the consideration of HB 111 [CSHB 111
(FIN)(EFD FLD)]. She said the Alaska Department of Revenue (DOR)
will conclude their presentation that addresses HB 111, titled
"New Sustainable Alaska Plan."
2:01:05 PM
KEN ALPER, Director, Tax Division, Alaska Department of Revenue,
Juneau, Alaska, continued the department's presentation on HB
111, "New Sustainable Alaska Plan," commencing with slide 24,
"Fiscal Analysis: Impact of North Slope Tax Rate Change, per one
barrel of taxable non-Gross Value Reduction (GVR) oil; FY18
costs per Fall 16 Revenue Sources Book (RSB)." He noted that the
previous meeting ended with the section in the department's
report that looked at how the bill's specific provisions worked,
and the report's next section shows how the bill's provisions
fit together. He addressed slide 24 and referenced a table that
compared "Status Quo Versus HB 111" at $60 and $120 per barrel
as follows:
Status Quo:
· Price $60/BBL $120/BBL
o Transport: $9.77 $9.77
o GVPP: $50.23 $110.23
o Lease Expenditures $33.64 $33.64
o PTV(net): $16.59 $76.59
o Tax at 35 pct.: $5.81 $26.81
o Per-BBL Credit: $8.00 $4.00
o Tax per Net: -$2.19 $22.81
o Minimum Tax: $2.01 $4.41
o Higher Of: $2.01 $22.81
o Tax as Pct. of Price: 3 pct. 19 pct.
o Tax as Pct. of GVPP: 4 pct. 21 pct.
o Tax at Pct. of PTV: 12 pct. 30 pct.
HB 111:
· Price $60/BBL $120/BBL
o Transport: $9.77 $9.77
o GVPP: $50.23 $110.23
o Lease Expenditures $33.64 $33.64
o PTV(net): $16.59 $76.59
o Tax at 25 pct.: $4.15 $19.15
o Surtax at 15 pct. $0.00 $2.49
o Tax per Net: $4.15 $21.64
o Minimum Tax: $2.01 $4.41
o Higher Of: $4.15 $21.64
o Tax as Pct. of Price: 7 pct. 18 pct.
o Tax as Pct. of GVPP: 8 pct. 20 pct.
o Tax at Pct. of PTV: 25 pct. 28 pct.
MR. ALPER detailed the table's first four lines for the "status
quo" and HB 111 tax calculations as follows:
· Cost of Transport (Transport):
o Pipeline-tariff plus "marine."
· Gross Value at the Point of Production (GVPP):
o Also known at the "wellhead value" upon which the
state's royalty is charged and any gross base; i.e.,
the minimum taxes charged.
· Lease Expenditures:
o Sum-total of operating and capital expenditures.
· Production Tax Value (PTV).
MR. ALPER addressed the "status quo" tax rate and pointed out
that when oil prices are cut in half the taxable net drops by
more than three quarters, just by the nature of the net-profits
tax. He pointed out that Alaska's highly elastic tax system is
the reason why the state's revenue went down by more than 90
percent when the price drop occurred, specifically the
production-tax revenue. He explained that the "status quo" tax
rate is 35 percent and the table's rates ranged between $5.81
and $26.81. He said at the lower oil price the per-barrel credit
is the "full" $8 and $4 at the higher price. He detailed the
"actual tax," (Tax per Net), at the lower oil price would be
negative or zero because the calculation cannot be below zero.
He added that the "actual tax" at the higher price of $22.81. He
summarized that the "minimum tax" of $2.01 is the tax that
governs at the lower oil price.
He addressed HB 111 and explained that by getting rid of the per
barrel credit and replacing it with the lower tax, everything in
the table is the same until the tax calculation at 25 percent
instead of 35 percent. He detailed that the tax calculation at
the lower oil price is $4.15 versus $2.01 in the "status quo"
calculation. He said, as Senator Stedman alluded in prior
testimony, that HB 111 moves the crossover point between gross
and net substantially to the left with the net system exhibiting
a wider range of prices. He pointed out that the tax calculation
table shows a substantial tax increase in the lower oil per
barrel price ranges. He emphasized that the tax is on a single
barrel of non-GVR taxable oil, also known as "royalty oil." He
disclosed that there are approximately 150 million barrels of
non-GVR taxable oil in a typical year.
He summarized that HB 111 would double the tax at the lower oil
prices; however, the tax rate is similar at higher oil prices,
within 5 percent of each other. He pointed out that a small tax
cut occurs at higher prices, something that could easily get
lost in the noise of the individual variation in per barrel
spending from one company to another.
2:06:53 PM
He addressed slide 25, a graph showing the "Fiscal Analysis:
Effective Tax Rates (Legacy/non-GVR oil)." He noted that in a
presentation at a prior meeting he had a similar slide that
compared effective tax rates and net operating loss (NOL) rates
for tax laws that encompassed "Alaska's Clear and Equitable
Share" (ACES), and SB 21. He specified that the same modeling
set is used in slide 25, but without the ACES comparison. He
detailed that the graph displayed the following:
· Status quo: (SB 21), blue curve on the chart.
· CSHB 111(RES): red curve on the chart.
· CSHB 111(FIN): green line on the chart.
MR. ALPER said as he noted in the similar slide that there is a
substantial difference between the effective tax rate, which
varies between 35 percent and then ramping down as the price
gets lower, currently the rate is 15 percent, and the rate at
which the state is giving benefit for a carried-forward loss,
it's also the rate of tax benefit the state gives for what
companies earn for their incremental spending; for example, if a
company, even a profitable company, spends another $1 million,
the company would get a $350000 tax reduction based on the
current tax code of 35 percent, even though the effective rate
is somewhat lower because of the impact from the per barrel
credit.
He said the red curve represented CSHB 111(RES) on the graph and
detailed as follows:
What the House Resource Committee did was interesting
in that it was a tax increase across the board between
that red curve that is the minimum tax to the left and
that jagged step to the right which is the reduction
in the per-barrel credit. But the other thing they did
was cut the carry-forward to 50 percent; what that
meant in practical terms was if you are carrying half
of your losses forward to use against the 35 percent
tax, that's the equivalent of a 17.5 percent NOL,
basically you are offsetting the 35 percent tax with
half of your spending.
He explained that the purpose of CSHB 111(RES), with equivalent
NOL, was to put the line in the middle of the tax range which it
does as shown on the graph where the dotted red line crosses
through the middle of the red curve rather than sitting above
which the blue curve does. However, the change created a serious
distortion between the money being spent on new projects by
incumbents versus companies that are investing for the first
time. He explained that an example of an "incumbent" is a
company that is profitable but is investing in a new project and
continues to get the 35 percent benefit whereas a company
investing in its future with their first project could only get
the 17.5 percent benefit.
MR. ALPER said the distortion from CSHB 111(RES) that was unfair
to newcomers was resolved in the House Finance Committee,
represented by the "green line" on the chart. He explained that
the green line is the effective tax curve of HB 111 with a 25
percent net tax in addition to a bracket-of-progressivity to the
right of $100 per barrel that closely tracks the effective tax
curve of SB 21 after $100 per barrel. He pointed out that there
is no dotted green line on the chart because there is no NOL
rate per se, because the carry-forwards are at the statutory tax
rate and the effective tax rate are the exact same thing because
there is no per barrel credit anymore. The value of those carry-
forwards is at the statutory tax rate where the companies will
get the value of whatever their tax rate is. He explained that
if the companies' tax is at lower prices with a 25 percent tax
with some expenditures carried forward from the past, then those
offset their taxes. He said if companies are further up the
chain and are paying a 30 percent rate, then they would get the
value of those carry-forwards at the 30 percent rate. He
asserted that the "useful alignment of math" noted in his
examples where the value given to loses and the value paid in
taxes are at the same rate, a distortion previously addressed in
testimony by Mr. Ruggiero.
SENATOR HUGHES referenced the chart on slide 25 regarding prices
between $50 and $80 per barrel. She remarked that there was
"quite an increase" between the green and blue lines. She
referenced an earlier slide from a previous meeting where the
governor's "four priority concerns" were addressed, specifically
that "The oil companies should participate as part of the
overall fiscal plan for Alaska." She asked, based on the "four
priority concerns," if the governor supports the current form of
the bill where taxes are increased at low prices.
2:11:20 PM
RANDALL HOFFBECK, Commissioner, Department of Revenue, Juneau,
AK, concurred that the governor for the last two years has felt
that everyone should participate at some level in balancing the
fiscal situation that the state is facing. He said the governor
has supported some level of increased revenue from the oil
industry as part of the plan. However, he does not endorse HB
111(FIN) or any other. He agreed with Director Alper that HB
111(FIN) contains a substantial tax increase at low oil prices.
He noted that the governor had proposed a one percent increase
in the gross tax rate which more closely aligns the difference
between the chart's "red" and "blue" lines. He opined that HB
111(FIN) tries to get the tax and credit rates in alignment and
then the decision point as to what the net effect is with the 25
percent rate. He pointed out that Director Alper said alignment
can be achieved without the level of tax increase proposed in HB
111(FIN). He emphasized that the governor addressed the idea
that there should be tax increases at some level with everybody
participating in the solution.
SENATOR HUGHES asked if any economic analysis was done on the
impact to the North Slope from the tax increase proposed in HB
111(FIN).
COMMISSIONER HOFFBECK replied that the industry has testified on
what they believed the impact would be. He noted that the
department has the capacity to do various full-life modeling on
the North Slope fields, but conceded that ascertaining the
industry's threshold point from a tax increase for a go/no-go
decision is not the kind of insight the department has.
SENATOR HUGHES commented that she has troubling "stomaching" the
tax increase from HB 111(FIN). She asserted that the state's
energy should be behind putting as much oil in the pipeline as
possible, especially when the state is in recession. She
remarked that HB 111(FIN) seems to be focused on the lower price
range that causes her grave concerns.
MR. ALPER addressed slide 25 and asked the committee to draw its
attention on the concept of reducing the state's liability
related to large, future investments. He opined that the larger
structural concept is the state's participation via the value of
the offsets of the carry-forwards where someone makes a large
investment that comes into future production at the 25-percent
rate; that is a more substantial and material savings for the
state than the specific issue of the tax increase in the short
term. He remarked that the structural changes that align the tax
and gets rid of the system's distortions are in some ways more
important than the tax increase and should be looked at
separately. He summarized as follows:
I think that there are structural fixes to the tax
system that could be done without raising taxes if the
will of the Senate and the committee is not to raise
taxes; but, because this version happens to raise
taxes shouldn't mean that you shouldn't look at some
of those other more technical fixes that are embedded
within this bill.
2:15:47 PM
CHAIR GIESSEL explained that the four goals when SB 21 was
written were that the tax be: fair, simple, durable, and
resulted in more production. She pointed out that during the
previous meeting the committee heard that the current oil tax is
working and is workable for companies. She added that the
thought was that the tax was durable as well. She pointed out
that the governor has said, "We've got some exposure here, we
need to protect the state from the tax credit exposures." She
added, "We certainly agree with that." She opined that HB
111(FIN), "goes far off the rails from that." She asserted that
the bill is an increase in tax rates under a current regime that
has resulted in more production, something that the committee
has concerns with. She pointed out that life-cycle modeling has
been mentioned by the department, but it has not been presented
to this committee or previous committees.
COMMISSIONER HOFFBECK responded that the department did a life-
cycle analysis in other committees, but the department received
criticism for not properly accounting for the timeframes between
initial exploration work and bringing things into production, so
the department decided not to include life-cycle analysis in its
presentation. He said the department would be happy to work with
the committee in presenting a life-cycle analysis, but conceded
that the department would be required to spend time with
industry participants that are developing the fields to make
sure the analysis is properly calibrated to accurately reflect
what is going on.
CHAIR GIESSEL replied that she appreciated the commissioner's
statement. She noted that Senator Wielechowski had commented in
an earlier meeting that the Legislature has never seen an oil
policy bill come from a legislator, that the bills have come
from the administration and that the administration has had a
consultant of its own who could do credible modeling.
SENATOR WIELECHOWSKI added that he too would like to see life-
cycle modeling on a variety of Prudhoe Bay's fields, both legacy
and new fields. He noted that Commissioner Hoffbeck had earlier
mentioned that he did not have an idea of what the "hurdle
rates" would be. He pointed out that department has established
hurdle rates, at least the Alaska Department of Natural
Resources (DNR) has established rates. He recollected that the
DNR has established hurdle rates that the industry uses at 15
percent and noted that he believed the "royalty relief" for
[Caelus Energy] to be 17.5 percent. He asked if the hurdle rate
he previously noted is a fair rate to be considered for the
life-cycle models, net present value, and the internal rates of
returns on the oil fields.
2:19:36 PM
COMMISSIONER HOFFBECK agreed that historically the 15 percent
hurdle rate is not unreasonable and is consistent with what has
been presented to the state in the past. He noted that the
department does not have information on lower hurdle-rates in a
low-return environment where there is concern by companies on
what their investments can earn versus past earnings. He added
that the department will never have information on what the
competing projects are in a company's portfolio and what hurdle
rates might trip a project.
MR. ALPER specified that the department's life-cycle model was
built on a similar life-cycle model from enalytica, the previous
consultants to the legislature. He disclosed that the department
discovered that the status quo appeared too weak for the rates
of return of a large field under current conditions. He revealed
that even $80 oil was not as economic as what the department
believed it to be and what the project sponsors have presented
them to be. He said the department thinks the primary reason for
the weak rates of return has to do with the timing of the
capital-spending curve. He surmised that a large project
probably is not as front-loaded in the assumptions of capital
spending as what the department shows, that the buildout is
slower. He emphasized that "when" the capital spending occurs
makes a big difference in a large project's rate of return. He
disclosed that the department was reluctant to change its
assumptions in the middle of the session because a track record
was established in hearings that was based on certain status quo
results. He conceded that the department's "starting point" may
be a little bit off in its impact analysis on the oil tax bills,
but stands behind its accuracy in how its modeling goes from "A
to B." He emphasized that the committee should not get hung up
on the specific rates of return in the result and suggested that
the focus be on the change in rates of returns between the
starting point and whatever a bill being introduced specifies.
SENATOR STEDMAN remarked that the current oil tax system has a
gross tax at some dollar amount and below, roughly high $60s or
$70 where below there is a gross tax and above is a net tax at
35 percent with credit mechanisms and other things going on. He
pointed out that the committee started the week with $1 billion
noted in production-tax value, also known as "profit oil," and
now the committee is told there is $2.2 billion or $2.3 billion
due to industry cost containment, increased production, oil
prices moving a little bit, and a few other changes; however,
the state has ended up with $1.2 billion or so in more profit
oil. He asked if there was any thought about what size the
profit oil should be before the state starts looking at changing
the mechanism from out of a gross tax into something else.
2:24:38 PM
MR. ALPER concurred with Senator Stedman that the state has
ended up with approximately $1.3 billion in divisible profits in
FY2017 due to the reasons he had given.
He addressed the graph on slide 25 and pointed out that the
minimum tax kicks in for the green line/CSHB 111(FIN) at $50 or
$52 a barrel and stays in the net tax for a wider range versus
the blue line/SB 21. He acknowledged Senator Hughes' question,
and said looking at structural change that reduces the state's
exposure without a tax increase was worth looking at. For
example, if the green line/CSHB 111(FIN) was lowered to 15
percent, what he described as a non-material tax increase, and
then the line would follow the blue line/SB 21 to the right. The
result is a revenue-neutral change that would still do the
important policy direction of reducing the state's exposure and
keeping the state in a net tax, albeit a 15 percent net tax, all
the way down to $55 a barrel or so. He emphasized that there are
several different ways to do this.
He noted that Mr. Ruggiero previously spent time talking about
how to ensure the entirety of the carry-forwards get monetizable
and the importance that the companies can use 100 percent of
their losses. He said the question is what tax rate should be
used for the carry-forwards.
SENATOR COGHILL asked if Mr. Alper has modeled the impact from
CSHB 111(FIN) on the effective tax rate where oil fields must be
separated for a loss, carry-forward credits change, and the tax
rate plus the investment strategy are affected.
MR. ALPER explained that a life-cycle model fundamentally
isolates a single oil field as a resource where "X" barrels are
in the ground, total capital spend is going to be, how the
capital is going to be spent, what the operations will look
like, and what the production will be. He specified that the
inherent default of the life-cycle model is that the costs are
contained in an oil field or ring-fenced. He detailed as
follows:
If there were not a ring-fence it would only get more
economical in the company's favor because it would
mean some of those carry-forwards would be able to be
monetizable in some way sooner than the model would
otherwise show, the model shows they can't get that
value until they come into production.
MR. ALPER noted that ring-fencing was addressed at a previous
meeting and he wanted to make sure the committee fully
understands what ring-fencing does and does not do. He detailed
as follows:
If a company has multiple projects in parallel, it
doesn't necessarily mean that they are all taxed
separately, especially if that is an encumberment
company who is otherwise profitable. If the company
does not have a negative cashflow for the year there
is no separation in between their different projects,
it is a single, unitary tax across the North Slope.
It's only when that company is in a loss circumstance
for the year which would be expected if a new company
was having a single, large project, for example. Then
those losses would get tied to that field so that they
can't be used until that field comes into production.
But the way the bill is written now, it does not
impact say if you have a company who has profit and
they are reinvesting a portion or even almost all of
that profit in a new field. There would be no
attachment of that spending with the new field.
SENATOR COGHILL said what the committee heard was that was a
"value call" and there is going to be less oil if there is the
inability to make a value call, something Alaska cannot afford.
He said the committee will have to look at the "value thing"
when going through the very complex oil structure.
2:29:57 PM
COMMISSIONER HOFFBECK disclosed that he had discussions with
producers regarding ring-fencing and they concurred with Senator
Coghill that the ability to monetize credits on a field earlier
makes their field development more economic in the long term. He
specified that the ring-fence idea was to make sure credits
stayed with an oil field and the credits would drive the field
into production. He noted that a softer ring-fence could be
considered that allowed investment transfer with a claw-back if
a field is not brought back into production. He opined that
ring-fencing is the simplest option, but conceded that "simple"
has collateral issues around it.
SENATOR STEDMAN pointed out that he did not receive an answer
regarding the size of the profit oil before a switch is
considered. He said at some point having a discussion on profit
oil would be nice because if there's virtually no profit oil
then there is nothing to cut up, no production tax value. He
explained that if the production tax value was sitting in
aggregate between $2 billion to $5 billion, at some point the
Legislature needs to consider when to trigger in and out of the
minimum-tax range.
He addressed ring-fencing and said the inability for a producer
to take a loss on a field, but pay taxes on gains seemed odd to
him. He said he is struggling with the concept of screening out
the ability to immediately deduct your losses where there is
production, asserting that the committee will have to work on
that concept. He remarked that he did not know if the department
supports the concern he pointed out, because the bill was
introduced from a colleague in the legislature.
2:33:14 PM
COMMISSIONER HOFFBECK addressed a statement made earlier in the
meeting regarding SB 21's "four pillars" and opined, "I think we
maybe didn't quite hit the simplicity pillar in SB 21." He said
one of the things that the state has in the current tax
structure is a blended gross tax/net tax that is the best of
both worlds as far as the state is concerned. He explained that
the state has a gross tax at the low oil prices, but setting a
gross tax across the entire spectrum of prices tends not to
capture the upside because the gross tax is set so high to
capture the upside that the tax would be onerous on the low
side. He said having the blended-tax structure for a minimum tax
at the low side and allowed to capture revenues at the high side
by switching to a net tax is an oil tax structure that is well
designed for the state's position. He concurred with Senator
Stedman that the question becomes where is the trigger point, a
question that the department is trying to answer.
MR. ALPER recounted a statement made by Mr. Ruggiero in an
earlier meeting where he expressed a fundamental issue with
anything tied to gross in the tax and viewed that as a
distortion in the system. He detailed that the history of the
gross was originally passed as part of the Petroleum Profits Tax
(PPT). He noted that Mr. Ruggiero questioned where the $25
figure comes from, why the tax is 4 percent only at prices above
$25 and why does it go to zero at $15 oil. He asserted that no
one is realistically contemplating $15 oil and specified that
minimum-tax triggers are tied to the annual average price, not
to a low point occurring in a fixed month. He believed that Mr.
Ruggiero would advocate for no minimum tax at all, but a
stronger net tax so that when there was a profit the state
received a more reasonable share while companies who were losing
money were not being penalized. He emphasized that nor he or the
governor were advocating what he surmised Mr. Ruggiero's
position is regarding a minimum tax. However, he stressed that
Mr. Ruggiero's argument has previously been made before the
committee this week.
2:35:35 PM
MR. ALPER addressed the graph on slide 26, "Fiscal Analysis:
Effective Tax Rates (New/Gross Value Reduction (GVR) Oil)." He
said slide 26 shows how the effective rate works on the GVR
eligible oil, the so called "new oil." He explained that the way
the per-barrel credit works with GVR-eligible oil is the tax can
go to zero, roughly below $70 oil, and then the impact is shown
on the graph from the reduced 35 percent of the adjusted
production tax value after the GVR with the $5 credit that shows
the curve going up. He expounded that the House Resource
Committee placed a hard floor at 4 percent, but was modified by
the House Finance Committee at 3.2 percent, the result is a tax
increase at low prices and a tax cut at high prices, something
noted earlier in the committee as "irrational." He opined that
that tax increase at low prices and a tax cut at high prices was
inadvertent, a mathematical byproduct of other decisions that
were made in formulating the bill.
He continued to analyze slide 26 as follows:
· On the right side is the lower tax rate, the 25
percent, while maintaining the $5 per barrel credit,
whereas the sliding-scale-per-barrel credit was
eliminated.
· There's a second jog at around $90 where the minimum
tax gives way to the net tax, then another jog at
around $105, that's where the progressive bracket
would come in.
He surmised that if the $5-per-barrel credit were eliminated,
the result would be much like non-GVR oil that is relatively
revenue neutral at higher prices, bringing the conversation back
to low prices, a realistic discussion to have should the floor
be hardened for GVR oil.
MR. ALPER acknowledged that GVR is inherently time limited,
something the committee knows because setting a time limit on
GVR was part of HB 247 that the Senate helped pass the previous
year. He remarked that having GVR may be helpful to a project's
bottom line for a zero tax for those three or seven years. He
conceded that having a bill raise prices at one price point and
lower at another price point is unusual.
He addressed a graph on slide 27, "Fiscal Analysis: Total
Production Tax Revenue (FY2019)." He pointed out that the graph
shows a triangular shaped wedge between the green line (CSHB
111(FIN) and the blue line (SB 21), occurring between $50 and
$100 area that shows the straighter 25 percent net tax leads to
a tax increase and then at higher prices a bit of a tax cut. He
noted that the lines in the graph can be adjusted and viewed
separately to show any structurally positive results that might
be made from simplification by avoiding the tax changes. He
pointed out that the graph shows the tax change of a few
hundred-million dollars when the state is only receiving $0.5
billion to $1.0 billion, but is more dramatic when oil is well
over $100-per barrel where the production tax might be $3
billion or $4 billion.
He addressed slides 28 and 29 regarding the Tax Division's four-
page fiscal note on the bill. He referenced slide 28, "Fiscal
Analysis: Fiscal Note Summary-Tax" as follows:
· The tax impact is concentrated in the $50 to $100 oil price
range:
o Difference between the current effective tax rates,
based on 35 percent of net less the per barrel credit,
and a flat 25 percent of net;
o "Crossover" between gross and net taxes moves
substantially lower, from about $75 to about $50.
· Comparably minor revenue impact at higher prices, actually
a small tax cut.
He summarized slide 28 as follows:
The tax impact is concentrated in that mid-price range
and that has to do with the elimination; it's
counterintuitive to some, we are reducing taxes and
therefore raising revenue. We are lowering the rate
from 35 percent to 25 percent, but getting rid of that
per-barrel credit; that means that flat 25 percent of
net and again, the crossover moving from roughly
$70/$75 to around $50, and then the smaller impact at
higher prices, and this was the choice made in the
other body as how to structure this tax.
MR. ALPER referenced slide 29: "Fiscal Analysis: Fiscal Note
Summary-Budget" as follows:
· Additional impact due to near-total elimination of cash
payments for tax credits (reduced spending):
o Long-term forecast for cash credits is $150
million/year; reduced to less than $20 million.
o Does not include what "would be" the liability for
possible future large projects.
o The associated projects don't come into production
during the fiscal note period.
He opined that the analysis on the budget is getting less focus.
He pointed out that one of the fundamental purposes of the bill
is to move the state away from the business of cash for tax
credits and the bill nearly eliminates that world. He detailed
that in the department's long-term forecast the credit
obligation as it accrues is estimated at $150 million per year.
He noted that before the passage of HB 247, the annual cash
credits of $150 million per year would have been $250 million
per year. He detailed that approximately $100 million in Cook
Inlet credits have fallen out of the mix; however, he emphasized
that the $150 million or the "old $250" are understated. He
explained that the only dollars in the forecast are the dollars
that are connected to barrels that are in the oil production
forecast. He added that a lot of things are not in the oil-
production forecast yet and if any fall into the forecast the
dollars associated with them will enter the forecast as well.
2:41:41 PM
SENATOR STEDMAN readdressed his question regarding how big the
production-tax value or profit oil is before the gross/net
switch-out. He suggested that a sensitivity analysis be done to
see where the new volume, price structure, and production-tax
value would be at the tipping point. He noted that the last time
a sensitivity analysis was done the price tripped-out at $70. He
recommended that FY2017 be used because a large portion of the
year has already elapsed. He estimated that the state has
approximately $2.2 billion to $2.3 billion in profit oil and
expected the number to be larger than $4 billion. He said he was
not saying the profit oil's change in size is good or bad, but
emphasized that the total focus should not be just on per
barrel, but to also look at the components, GVR, non-GVR, and
then to look at, "The whole can of soup as we put all of the
ingredients together and stir it up."
MR. ALPER noted that his presentation was put together prior to
the spring forecast and the department did not have the benefit
of being able to come out publicly with those numbers. He
admitted that a couple of things are going to move based on the
spring forecast. He suggested that a bit more of higher
production be "baked in" for the near term due to the inherent
staleness of the FY2018 and FY2019 production numbers.
2:43:40 PM
He readdressed slide 29 and pointed out that the bill does not
"completely" eliminate cash credits because cash credits exist
in the "Middle Earth," the region not in the Cook Inlet or the
North Slope. He disclosed that cash credits for middle-earth
include:
· NOL credit: 15 percent,
· Capital expenditure: 10 percent,
· Well drilling credit: 20 percent.
He explained that the credits amount to $20 million to $30
million in the near term and a little lower beyond that. He
reiterated that the credits do not include projects that might
get sanctioned in the future that could include hundreds of
millions of dollars in credit liability.
He disclosed that the other remaining cashable credit in the
system other than middle-earth is the refinery credit, which has
another three years left to a refinery capital improvement
credit against the corporate-income tax as well as the interior
gas utility has access to a gas storage credit should that
project come to fruition. He detailed that the credit for the
gas storage facility was modeled after the Cook Inlet Natural
Gas Storage Alaska (CINGSA) given to the underground storage
facility in Kenai that remains as a cashable credit. He
summarized that the passage of CSHB 111(FIN) would be the limit
of what remains for cashable credits.
SENATOR STEDMAN asked that the following be included in a
report:
Maybe if I could do the current FY2017 and then if I
could have it rerun at $5 on the per-barrel, like the
Senate had it initially on SB 21, and then $0 so we
could see the full gamut of how that number moves
around, and I'm not saying any of them is good or bad
or otherwise, I'd just like to know what it is.
MR. ALPER replied that the department will comply. He remarked
that the $8 credit will keep Alaska in the gross tax range, a
wider range of prices than anyone really contemplated. He opined
that the fact the state is still in a gross tax at $70 oil is
not what the Legislature expected when SB 21 passed. He pointed
out that if the Senate's version was used with the $5 credit,
the crossover point would be, "Somewhat to the left of the
graph."
2:46:01 PM
He referenced slide 30, "Fiscal Analysis: Fiscal Note Table-
Impact at Range of Prices." He addressed two subtotal lines in
the table: "Total Revenue Impact" and "Total Budget Impact." He
detailed that the subtotal lines have about 10 lines above them
that corresponds to an individual component of the bill that
shows individual impact at different price points at different
years with a price-point presumption of the fiscal forecast. He
disclosed that the official forecast price range for next year
is $54 and $60 the year beyond. He detailed that "Total Revenue
Impact" is how much more in taxes the state is expected to
receive and noted that the revenue amount will show up in the
department's online payment system as money in the bank to the
state. He explained that "Total Budget Impact" is the reduction
in the state's obligation for buying cash-tax credits and
reiterated that the long-term forecast is $150 million with a
90-percent reduction in the out-years with $15 million of
middle-earth credits and refinery credits. He pointed out that
"Total Fiscal Impact" is the total of both new money in the
treasury-the revenue side, and less to the appropriated budget
side.
He explained that the last three lines in the table show the
cumulative value of carried-forward-lease expenditures. He noted
that there is a small amount of carried-forward losses because
of major producers who might have had an operating loss in a
low-price year that are unable to getting cash credits; under
current law those get carried forward and are gradually getting
used up by the producers: $14 million for FY2018 and $0 beyond.
He detailed that the next line is the same concept with the
passage of the bill where producers are not get cash credits,
but everyone is accumulating carried-forward-lease expenditures
that grows to $225 million in FY2020 and $640 million in FY2027.
He specified that the carried-forward lease expenditure is a 25
percent tax; e.g., $900 million worth of carried-forward losses
would be $225 million (FY2020) and $2.5 billion worth of carried
forward losses would be $640 million (FY2027).
2:49:26 PM
SENATOR WIELECHOWSKI asked what the cost is to run a net-tax
system in terms of state employees and total dollars versus a
gross-tax system. He noted that Alaska has been told that it
operates one of the most complex tax structures in the world.
MR. ALPER recounted that the state's oil and gas production tax
division has been around since the 1970s and experienced a
ramping up of staff with the switch to a net tax in the late
2000s. He noted that industry-experienced "audit masters" were
added and paid higher than the traditional state-pay scale to
provide technical advice to help orchestrate the more complex
net-profits tax process. He summarized that the division is
comprised of five to seven employees and accounts for less than
$1 million to the state.
SENATOR WIELECHOWSKI asked if the division has enough people to
do the audits and what needs to be done.
MR. ALPER replied that the oil and gas group is proud of staying
ahead of the statute of limitations. He noted that the division
will ultimately be reviewing fewer credits, primarily due to
Cook Inlet cashable credits falling out of the work pool where
the staff will be freed up to assist with tax audits. He
disclosed that added staff will occur with corporate-income-tax
auditors, but additional staff has not been sought in the oil-
and-gas production group.
2:52:37 PM
He addressed slide 31, "Fiscal Analysis: Fiscal Note Table-
Impact at Range of Prices." He explained that the graphic slide
shows what happens from FY2018 to FY2027 if the price of oil
varies from the Fall 2016 Revenue Forecast, (FC). He pointed out
that at the $60/$80/$100 oil-price ranges show the impact from a
relatively dramatic 25 percent net tax overlaying the previous
tax which nets out to an annual $200 million to $400 million
increase in revenue. He said at the lower oil price range,
$20/$40, the graph shows more credit obligation for cash where
nearly everyone on the North Slope starts operating at a loss
and many of the companies are eligible for cash credits and the
state would have a large cash obligation as companies start
running up multi-hundred-million-dollar losses with eligibility
for a 35 percent NOL credit under status quo law. He noted that
lower oil prices equate to a budget impact and higher prices a
tax impact. He pointed out that at the $120 oil price the
"curves" crossover each other that results in a more revenue-
neutral bill at $120 and higher prices.
SENATOR WIELECHOWSKI recalled that the committee heard testimony
the previous day from a producer that claimed the bill was a
100-percent increase in taxes at $60-barrel oil. He calculated
that the tax increase was approximately $150 million. He asked
what the total government take was when royalties, corporate
income taxes and property taxes were considered.
MR. ALPER replied that he appreciated Senator Wielechowski's
inquiry to compare apples-to-apples. He pointed out that the
state does receive revenue when oil prices are low from
royalties, property taxes and corporate incomes taxes. He added
that doubling the state's production tax is just an increment on
top of one component in addition to the previously noted revenue
sources. He summarized that the state's approximate production
take in the near-term years is $1.5 billion; at $60 oil, the
state is looking at $150 million to $200 million increase, or a
10 to 15 percent increase in total oil and gas from the change.
2:56:32 PM
At ease
2:57:20 PM
RICH RUGGIERO, Managing Partner, Castle Gap Advisors, LLC,
Houston, Texas, addressed his overview titled "Petroleum Fiscal
Design CSHB 111."
CHRISTINA RUGGIERO, Advisor, Castle Gap Advisors, LLC, Houston,
Texas, introduced herself but did not provide testimony.
MR. RUGGIERO commended the committee members for keeping up with
the bill's iterations and noted that he had one major flaw in
his analysis due to inadvertently using an interim version of
the bill.
He noted that the committee had asked him for some final
observations and analogized that the Legislature's committees
responsible for oil and gas acts as the board of directors for
the state's oil interest. He opined that the committee members
should not be expected to know the intricacies of the day-to-day
operations, but to be advised on a routine basis of the key
aspects that represent the bulk of the revenues and profits. He
said he was saddened to see at the end of the session that
legislators acting as the "board of directors" were having to
ask basic questions about what is going on with the business
that is the "engine of the state." He asserted that information
should be made available early and regularly so that when
committee members are talking about making decisions on what
represents 70 to 80 percent of what drives the state that the
best information is available ahead of time for members to
better formulate their questions, to better understand how
things are going, and to better know how to make the decisions
that must be made.
CHAIR GIESSEL asked if Mr. Ruggiero could specify exactly what
information he was referring to.
MR. RUGGIERO addressed slide 4, "Alaska's Priorities - The
Current Challenge." He noted that his observations and
suggestions will come from a "30000-foot view" and not
necessarily down to the fiscal-type numbers that Commissioner
Hoffbeck and Mr. Alper previously provided.
He asserted that the state has drivers that it is currently
dealing with: money into the state and the looming cashable
credit issue, and making sure whatever the state does that it
does not in any way significantly damage the long-term ability
to fill the Trans Alaska Pipeline System (TAPS) with more oil.
3:01:17 PM
SENATOR WIELECHOWSKI remarked that Mr. Ruggiero said two
different things: revenue to the state, and filling TAPS. He
said the state can give the oil away and probably fill TAPS, but
that does not fulfill the state's need to get revenue. He asked
Mr. Ruggiero if he agreed that a balance is required between
revenue and giving huge tax breaks to get more oil into the
pipeline.
MR. RUGGIERO replied that when he made his statement the state
has a short-term driver due to the cashable credits and the long
term to fill TAPS. He asserted that in no way did he want to
imply that the state should fill TAPS just for the sake of
filling TAPS. He specified that the state has an asset that it
has licensed out to others to develop and the state needs to
receive some value for that. He said the constant challenge the
Legislature has is determining the state's fair share over time
as opposed to how much the state leaves the producers for their
development effort and risk taken. He set forth that TAPS is
going to be filled where it makes sense for all parties
involved.
MR. RUGGIERO referenced slide 5, "Observations from Prior
Testimony" as follows:
· We see a common understanding of the overarching strategic
drivers:
o More oil to fill TAPS.
o State cannot afford to pay cashable credits.
o Some go further to see the need for increased state
revenues today.
· Cashable credits:
o Our experience in other regimes is that the producers
have mechanisms that allow full recovery of their
costs.
o Industry in their testimony all agree that they need
the right to fully recover their costs.
o All mentioned that the current system, which includes
per-barrel credits and a gross-minimum tax, results in
carry-forward NOLs not producing the same tax saving
benefit as the cashable credits; i.e., the "Lost
NOLs."
He explained that there comes a time and level in TAPS where the
producers cannot operate the pipeline any further, and what the
state does not want to do is push the producers too close to
that level and find out that the operational level was higher
than what was previously thought. He said the state should want
to take steps now and always to make sure it is doing the things
to put more oil into TAPS and with that whatever is the state's
fair share in doing so.
He addressed cashable credits, disclosing that he has worked
with over two-dozen oil regimes and noted that everyone has a
mechanism that allows the producer to fully recover their costs
and to do so in a way that allows them to achieve the expected
tax benefit. He analogized that if he is allowed deductions on
his personal income tax that he gets the value of the deductions
without an alternative minimum tax (AMT) sneaking in. He noted
that the AMT on one's personal taxes takes away the value of the
deductions; in a way, the state's per-barrel credits and minimum
gross tax acts like an AMT to the producers where the producers
do not end up getting what they thought because their deductions
and credits are taken away. He said his AMT analogy puts a
picture to what might happen when producers do their economics
on getting full value for deducting loses as they move forward,
likening the change to the cashable credits to the "loss or
wasted NOL" in that producers are not getting what they might
expect to be the same value or tax savings from having spent the
money and then being able to deduct the cost of that money.
3:05:10 PM
MR. RUGGIERO referenced slide 7, "Observations and Suggestions:
Overall" as follows:
· Alaska has an overall complex system for administering
energy taxation:
o This has likely led to the frequency of change.
o Functional interdependencies make even a small fix
difficult at best.
· Too many items tied to price versus profitability or unit
profitability:
o The ever-changing world of energy and the resultant
price and cost structures will ensure the original
intent can't be maintained for very long.
o Need to try and make things as self-correcting as
possible.
· Over the last decade the hundreds of billions spent in
countries and states with higher non-producer take than
Alaska should cause a greater focus on aspects other than
the rate to make Alaska as competitive as possible for
investment capital.
· Coming up with a simple system to generate the expected
state revenues is not that difficult, but dealing with all
the nuances will take time to make sure all constituencies
are heard, and all issues addressed.
He opined that Alaska has one of the most complex systems that
he has ever dealt which he believes leads to the frequency of
change due to many functional interdependencies that make small
changes difficult. He explained that either there are so many
interconnected levers that trying to change one leads to
changing others, or an unintended consequence impacts something
that is thought to not need change.
He added that part of the frequency of change is also due to
having a lot of mechanisms tied to price instead of
profitability. He noted that in a previous meeting he questioned
how and why the state had a zero-gross tax at $15 and 4 percent
at $25; at the time, the costs were at $15 total-all-in and the
state likely was putting in a gross-minimum tax at zero when the
producers did not have any profit in moving forward. He added
that there were probably fewer players and fewer units in
different divisible property interests; however, he asked if the
oil tax is doing what the Legislature intended it to do at the
time SB 21 passed and is the state getting the intended value.
MR. RUGGIERO noted that the state also has barrel credits if it
so chooses to keep them that are tied to prices; however, the
intent in doing barrel credits was an expected profitability
level at each of those prices at the time the Legislature did SB
21. He said the one thing that we know is cost will change and
will change often at the price of oil changes, which means
whatever was the philosophy or the intent behind the Legislature
putting in the per-barrel credit tied to oil prices is not the
situation today or in the future. He added that much like the
minimum-gross tax when initially set, the state now has negative
progressivity in its system and is not realizing exactly what it
intended when the tax was passed.
He emphasized that tying a lot of things to fixed things like
price does not in any way inform as to what that means to the
company, how profitable they are, or what they need to do with
their business in time. He said there are a lot of things going
on that are going to bring the state's oil prices and issues
associated with it back to the Legislature to again make another
fix.
3:08:24 PM
He remarked that he is not surprised, but a little disappointed
that in the ten years of showing the Legislature that the
marginal-tax rate is not informative as to where people invest
their money and the discussion continues today. He said people
continue to come before the Legislature saying either the state
is or is not competitive based on the marginal-tax rate,
something that is not true because an investment call cannot be
made based solely off marginal-tax rate. He pointed out that
hundreds of billions have been spent in countries with marginal-
tax rates that are worse than Alaska, something that should
inform the Legislature that tax rate did not make the decision
for the companies where to invest, that there must be something
else, a point that gets into the totality of the state's fiscal
system. He emphasized that, "It's not just the rate."
He said when asked if increasing the tax rate is better or
worse, he is going to say it depends, not because he is a
consultant, but that changing the tax rate really does depend.
He addressed what other regimes are doing and referenced North
Dakota (ND). He disclosed that ND took away tax credits on new
wells in addition to 18-month and 24-month exemptions; however,
their tax rate did not change. He said people will insinuate
that ND did not increase or reduce their taxes, but ND did
increase their taxes. He detailed as follows:
They actually did increase their taxes in the last two
years, quite considerably; but, you won't see it
because it doesn't show up in the headline rate and it
won't move their position on that relative curve
because they still have severance, and they have ad
valorem property tax when added to the royalty. When
added to the royalty it's going to plot out the same
as government take.
MR. RUGGIERO said the Legislature must dig deep. He emphasized
that his intent is to provide information and bring an education
so that committee members can ask tougher questions as to why
hundreds of billion get spent in the other countries. He pointed
out that committee members can look at the annual reports for
the state's three biggest producers and see the countries where
they will be spending their money in the next three to five
years. He pointed out that a lot of the countries listed in the
producers' annual reports have worse marginal-tax rates than the
purported rate in Alaska. He summarized as follows:
That's one message you can tell that I'm passionate
about and that we really make sure you get all of the
information you need to make your decision.
3:11:20 PM
He asserted that the state can come up with a simpler system. He
opined that the Legislature cannot handle all the nuances and
things that come up in a short period of time; however, coming
up with a system that at the macro level delivers the same
revenue at the same oil prices can easily be done.
SENATOR COGHILL remarked that he tends to agree with Mr.
Ruggiero on the marginal-tax rate; however, he noted that
producers have said there are variables that they have to deal
with that includes the tax rate, effects of the tax rate, and
the credits. He said the producers make their point on
investment strategy because of Alaska's place in geography, the
state's service industry that can help them, permitting
challenges, and time to production. He opined that producers see
their win on the effective tax rate as the key element for their
decision point. He asked Mr. Ruggiero to expound on his emphasis
that there is more than the tax rate.
MR. RUGGIERO agreed that there is more to it than the tax rate.
He pointed out that people have come before the committee and
said the tax rate is the issue, but suggested that where the
producers are spending their capital should be examined. He
remarked that if tax rate was the issue then the producers
should not be investing in those countries that have marginal-
tax rates worse than Alaska's. He explained that companies
consider a "locational premium" due geopolitical issues, cost
probabilities based on prior project difficulties, and all sorts
of variables in deciding; however, he conceded that if nothing
else changes and the state raises its tax rate, the economics
run by the companies will get worse for Alaska. He pointed out
that the constant in the oil industry is change and very rarely
does one walk into a situation where all things stay equal.
SENATOR COGHILL explained that the state has a range of economic
realities for producers to work in and the intent in the gross-
to-net tax regime was to diversify the investment field. He
conceded that the Legislature went a little too far in cash
because the state now is in a place where it cannot afford to
invest as previously advertised, which means the Legislature is
going to have to "shift gears." He pointed out that the current
tax regime did have an impact on having a diversified field;
however, it also brought its own problem with it and a whole
different set of economics that hit the state's very complex
system. He concurred that previous testimony has emphasized that
the state's economics "will go south fast" if the tax rate is
increased.
3:16:11 PM
SENATOR WIELECHOWSKI noted that at a previous committee meeting
he asked producers to suggest the economics that the state
should look at; for example, net present value or internal rate
of return. He said he did not get an answer, but noted that one
producer suggested to, "Look at the results and you've got more
oil." He asked if more oil is a metric that should be looked at
or if not, what are the metrics that the state should look at in
determining whether a system is going to put more oil in the
pipeline and provide a fair amount of revenue to the state.
MR. RUGGIERO explained that companies will restate their
strategy during down-price times that includes the type of
projects they are looking for to, "Put into the hopper of
consideration." He said, "Once you get projects in that hopper,
it's just standard economics." He pointed out that each company
has their "little twist" on how they look at a project's upside,
downside and sensitivities. He said companies have their
corporate price-deck and inflation-deck, which is not
necessarily the prices and inflation that is going to be used
even if DOR comes back with a full-life-cycle model for the
committee. He emphasized that during his 40 years in the
industry that what companies look at are going to be different,
but what has not changed is they all look at a project's
economics. He said what he has seen grow more important in
making projects more likely is identifying where are the risks
and what tools are within a regime to mitigate those risks.
SENATOR WIELECHOWSKI asked if Mr. Ruggiero has models that can
compute the internal rates of return and net present value for
hypothetical projects in Prudhoe Bay or Kuparuk.
MR. RUGGIERO replied yes, that standard-project-economic models
are easy and have been done for many regimes. He said all the
different nuances within the Alaska system can be modeled.
SENATOR WIELECHOWSKI asked if Mr. Ruggiero can share his models
with the committee.
MR. RUGGIERO disclosed that he had shared some models with the
other body; however, they complained that his results were
wrong, but he found out that changes were made to his model. He
said he would work with the Senate in providing models for the
Legislative Budget and Audit Committee.
3:19:58 PM
SENATOR MEYER agreed that tax rate alone is not a determining
factor on whether a producer invests in Alaska versus projects
elsewhere. He expressed that Alaska has a lot of factors that
work against the state that must be factored in as well; for
example, transportation costs, supplier costs, climate costs,
permitting costs, potential lawsuit delays, lack of roads on the
North Slope, etc. He asked to confirm that the state's tax rate
has to be less when its regional factors are considered.
MR. RUGGIERO reiterated to look at the countries that have a
worse marginal-tax rate than Alaska; many have extreme
logistical issues as far as distance for market, tough
geopolitical regimes, and higher cost associated with offshore
development that are upfront as opposed to ND where costs can be
spread out over ten years with gradual drilling. He pointed out
that a lot of things that Senator Meyer brought up are present
in much the same level of costs in other regimes that have worse
rates than Alaska that big companies invest in. He explained
that project analysis uses costs for a specific location,
expected costs, economics based off expectations, the inflation,
and a company's price-deck; after that is when risk factors are
considered. He added that how good a company's group is at
estimating cost is considered, what has been their estimation
track record that results in either a plus/minus of 10 percent
or 50 percent possibility. He remarked that if he has been
somewhere and operated for 40 years that he would have a pretty
good handle on what the costs are going to be. He pointed out
that the locations with worse tax rates are new entries for some
companies whereas Alaska has companies that have been in the
state for a long time and ought to have a good handle on
permitting and their economics versus investment somewhere else.
3:23:22 PM
SENATOR MEYER addressed testimony during a previous meeting that
changing the state's production-tax code 7 times in the last 12
years makes it hard to be accurate. He opined that whatever the
Legislature does that the production-tax code be done right and
left alone.
MR. RUGGIERO replied that changing the tax code multiple times
does not change the amount of time to get a permit or what a
company's cost structure is. He surmised that Senator Meyer was
intimating that the items he brought up made it more difficult
to decide on Alaska; however, those items are not impacted by
the changes in the tax. He guessed that Senator Meyer wanted to
bring up Alaska's tax change impact on the overall economics
presented to a company's management regarding what they thought
they were going to get and then what they were actually being
delivered, something that he agreed changes and is something
that the state has to deal with as in any other regime that
makes multiple changes to their tax; however, in no way should
that change a company's confidence level in the time it takes to
get something done and the cost that it takes to get something
done.
CHAIR GIESSEL noted that the state's appropriation for its
cashable-credit program has been vetoed for the last two years,
something that she remarked as kind of unpredictable or unstable
that would change a company's perception in terms of risks. She
disclosed that many companies with discoveries have said they
lost potential partners due to Alaska's 35 percent tax and
complex tax structure. She asked to verify that Mr. Ruggiero is
saying that the level of tax does not matter, and that Alaska is
more attractive than regimes with higher taxes. She remarked
that she is not quite sure what Mr. Ruggiero is saying.
3:25:41 PM
MR. RUGGIERO specified that his point was a matter of education
where a lot of people draw a bright line with "competitive" on
one side and "noncompetitive" on the other, a pronouncement that
he believes cannot be made by someone in the industry who
understands the intricacies on how the different regimes work.
He asserted that if analysis was that easy then all the money
would go to where it says "competitive" and no money would have
gone to the "noncompetitive;" that's not how it works. He said
his point was not to rely on the one metric of "competitive" or
"noncompetitive." He expressed that what Chair Giessel addressed
are the things that Senator Meyer was trying to bring up
regarding the unpredictable nature of what Alaska's economics
are going to be. He noted that he responded to Senator
Wielechowski that investment decisions are based on economics
plus the risk profile. He explained that if a regime is
unpredictable as to what a company is going to pay then that
adds a level of risk that will likely find some form within
their economics to put that risk in. He noted that some
companies will put a locational risk premium that compares net
present value at higher levels as well. He concurred that the
things Chair Giessel brought up will negatively impact a
project's risk; however, it is a matter of how individual
companies put that risk into their decision making in deciding
how much that risk really impacts projects going forward or not.
3:28:11 PM
He referenced slide 8, "Observations and Suggestions: Overall"
as follows:
· As a Legislature, if you want to be able to make changes
that are most responsive to achieving goals and to be
durable over time you need real and timely data.
· The "Flaw of Averages" would suggest that working with
estimates or averages will likely continue to result in a
less than effective structure for all parties.
· Complexity in Alaska is further exasperated by the common
ownerships of wells, fields, plants, pipers, ships, etc.;
given some of those are regulated entities and subject of
numerous past litigations, it will be difficult for parts
of industry to come forward.
· Need to find a mechanism to get good data and information.
He addressed the first bullet point on slide 8 that to make
responsive changes the Legislature has got to have the real data
and the best data with the best prediction of not only what is
happening now, but what has happened over the few years and what
is anticipated to happen over the next few that follow.
MR. RUGGIERO explained that what the committee gets from DOR,
people like himself and others is noted in the second bullet
point regarding "The Flaw of Averages" where everything is done
"average;" however, when running averages, as Mr. Alper
mentioned earlier, it is very easy to get highly different
economic results from multiple profiles. He noted that his
models encompass: three, five or seven-year lead-ins; if
applicable, big expiration spikes; an appraisal in the early
years and then study; and accelerated/non-accelerated recovery.
He summarized that to be able to give the committee an informed
opinion the state should base its knowledge that it only has
three or four major things that can come on in the next five
years and to build around those with the knowledge of what they
are and not to some generalities.
3:30:08 PM
SENATOR WIELECHOWSKI asked how Alaska would compare on the risk
profile to countries with higher government-tax rates,
nationalized assets, and civil strife like Libya, Venezuela,
Russia, Iraq, and Iran.
MR. RUGGIERO replied that he cannot say whether Alaska is better
or worse. He explained that regimes are ranked based on various
items that change over time such as the government in place, the
need of national oil company, or the size of a regime's
petroleum fund. He said a company looks at a series of
parameters, what to mitigate, and portfolio mix regarding living
with higher risk in a region relative to long-term-strategic
goals. He admitted that he cannot rank all countries and say,
"Alaska sits here," because then he would be just as guilty as
someone picking a marginal-tax rate and telling Alaska where it
ranks.
SENATOR HUGHES asked if Alaska's risk has increased due to the
state making 7 changes in 12 years and the governor vetoing
cashable credits the last 2 years.
MR. RUGGIERO answered that if one of the goals is to attract new
players and new oil to the pipeline, then the state's perceived
risk has probably increased.
He addressed the third and fourth bullet points in slide 8. He
explained that there are a small number of overall players that
are involved throughout the "value chain" in the gathering,
processing plants, pipelines, and in the ships; some of those
are regulated entities and care must be taken in dealing with
regulated entities for litigious reasons. He remarked that the
"intertwining" in Alaska and the state's complex tax code
creates one of the most complex workings along the value-chain
where the limited players worry about how certain information
can be used against them. He said the Legislature must think as
the "board of directors" how to get the needed information while
understanding the complexities that exist in the system.
3:34:41 PM
MR. RUGGIERO referenced slide 9, "HB 111 Review and Comments" as
follows:
· HB 111 perceptions, understandings, and dialogue have all
changed immensely since we began advising the Legislature.
· Effective Tax Rate graphs:
o CSHB 111(RES),
o CSHB 111(FIN).
He addressed the graph on CSHB 111(RES) versus the "status quo"
and noted that small changes occur around $70/$80 when per-
barrel credits start at a different, lower rate and the major
change occurrs at $120 when the per-barrel credits disappear;
however, the graph shows no difference between the two curves at
$150/$160.
He pointed out that the graph depicting CSHB 111(FIN) shows a
substantial tax and revenue increase in the $70/$80 a barrel
price range with the plus/minus around the "zero line" and the
curves do equate as the oil prices increase further out. He
disclosed that the numbers he used in the graphs were rounded
with the assumption that all oil was at one cost structure, one
royalty structure, etc.
3:37:05 PM
SENATOR MEYER concurred that CSHB 111(FIN) is a substantial tax
increase with the tax flattening out with the current code as
prices get higher. He opined that CSHB 111(FIN) seems backwards
where taxes are raised on oil companies where they are making
less money, but not raised when the oil companies are making a
lot of money.
MR. RUGGIERO pointed out that governments are entities that are
highly dependent on their oi revenue to run their state or their
government and there will always be discussion on how to get
more when prices are down. He said he has seen a lot of entities
that are oil revenue dependent do things that would appear to be
counter intuitive at low prices because regimes that do not have
a large reserve to call upon have to get revenue in the low-
price environment. He remarked that whether CSHB 111(FIN) makes
sense is up to the Legislature to decide. He agreed that the tax
increase in CSHB 111(FIN) is substantial and the committee must
decide whether the increase is the right or wrong thing to do.
SENATOR MEYER remarked that the oil industry is often referred
to as "our partner" and "sticking it to your partner" does not
seem right when times are tough. He said the state is highly
dependent on the one industry and raising the tax rate when the
industry is making less money would discourage investment in the
state and new investors or new producers will consider investing
elsewhere like Texas, a state with a more diversified economy.
He asked Mr. Ruggiero if his statement is correct to say.
MR. RUGGIERO replied that the increased tax rate would factor
into a company's risk assessment. He surmised that a company
would consider whether to work somewhere where oil represents 75
to 80 percent of a government's income or 5 percent, a scenario
that would indicate what to expect in the coming years with
taxes when oil prices go way up or down.
SENATOR MEYER remarked that Alaska's dependence on the oil
industry adds another higher-risk factor to the state.
MR. RUGGIERO concurred.
3:40:21 PM
He referenced slide 10, "Ring-Fencing" as follows:
· State Concern:
o Paying, through tax savings or credits, without actual
new hydrocarbons flowing to market.
· Operator Concern:
o The need to separate costs:
1. Between various projects using common facilities.
2. Possibility between oil and gas.
· Suggested Solution:
o For an existing unit or field on production business
as usual with any NOL created being used to offset
future segment taxable income.
o For a new field or unit, direct cost associated with a
potential new development will be calculated and held
until commercial production is established; one that
occurs then all NOLs for that new entity will be
available to be used in the taxpayer's segment return.
MR. RUGGIERO said two concerns have been brought up regarding
ring-fencing and both are equally valid. He specified that the
credits offered by the state, the cashable aspect and the rest,
accomplished its goal by attracting new players. He pointed out
that this year there are names of possibly new fields of the
size that were never talked about 6 to 10 years ago. He noted
that the state's concern regarding the idea of ring-fencing is
that the state would be paying either through the credits or in
an oil mechanism for no barrels associated with the money, a
valid concern. He explained that from the operator's perspective
the belief is ring-fencing immediately creates an accounting
nightmare that triples the complexity for the audit process five
or six years down-the-road due to oil field and possible common-
facility separation.
He opined that ring-fencing is one of those things that the
concerns from both sides be addressed and then ask, "Do I have a
mechanism that can solve that?" He suggested for an existing
unit or field that when prices fall, or costs are high that in a
year they, "Have it in the well, it is getting used right now on
costs, it spreads across whatever that segment tax return that
they are doing." He recommended that if the state is really
concerned about not getting new hydrocarbons for a new field or
unit to only deal with the direct cost before there is a barrel
of production so there is no worry about joint facilities and
separation, and to allow all those to be deducted against the
current operations wherever they are at because if they are
joint, that means they are already being used and are already
being deducted somewhere. He asserted that he dismisses all the
ring-fencing noise about having to separating all the different
costs into different categories and just say costs are allocated
until commercial production is established and the [NOLs] can be
used by whichever taxpayer has them for their consolidated-
segment return. He noted that new players will obviously have to
wait until they have revenues for carried-forward NOLS, etc. He
added that an existing player that farmed into the unit or
bought into the unit get to use the credits in their returns,
but not until there is commercial production. He summarized that
there are some simple things that can be done that he believes
satisfies the concerns on both sides and does not create an
administrative or cost accounting burden.
3:43:33 PM
SENATOR VON IMHOF asked to confirm that HB 111(FIN) puts ring-
fencing on a new field where any cost associated with the field
must remain with that field. She noted that Director Alper said
earlier that one of the fears is to have a company come in and
purchase the new field's well and apply the new field's credits
somewhere else, a fear that was behind the ring-fencing
provision.
MR. RUGGIERO replied that Senator von Imhof's characterization
is right in stating the state's concern. He concurred that the
state does not want to pay for cost that does not result in
placing more hydrocarbons into the pipeline. He reiterated that
there are simple ways to address all the concerns and then
constructing something that matches all those concerns.
SENATOR VON IMHOF expressed her worry that the ring-fencing
provision may have unintended consequences; for example, a
company that spends several years trying to develop a particular
well, cannot sell to another company who could possibly utilize
the wells loses and fund further development from their other
producing wells. She continued as follows:
What I worry is that it is a business concept, your
basic economic business concept. I think that we are
looking at one hat, we are looking at the revenue to
the state-hat and we are not looking at the greater
economic impact-hat; that's what I worry. So, I guess
I wonder if we can have a conversation about if
there's other mechanisms that could address the fears
that have been presented by Director Alper.
MR. RUGGIERO commented that what Senator von Imhof brought up is
why CSHB 111(RES) had what was called the dry-hole credit. He
pointed out that Senator von Imhof presented two scenarios, the
first one was people legitimately trying to explore with the
intent of finding something and developing it, spend money, but
do not find anything that could be commercially developed; in
that case, CSHB 111(RES) said if the company paid all its
service companies and has given back its lease to the state,
then the company's credits will be paid back. He explained that
the second scenario is where someone else can buy a new field
under development, get the NOLs and use the NOLs when the first
barrel of commercial oil starts coming up.
CHAIR GIESSEL asked if the dry-hole credit has worked elsewhere.
MR. RUGGIERO explained that a company usually suffers the cost
of a dry hole and moves on, it's the cost of exploration;
however, Alaska created a credit program to attract new players
and additional exploration.
CHAIR GIESSEL said one of the things that she wrestles with is
how much should the state be supporting companies that come to
Alaska where "wildcatters" drill a dry hole and the state pays
them. She affirmed that the state wrestles with paying for
drilling dry holes, especially in the fiscal time that Alaska is
in.
MR. RUGGIERO speculated that a lot of exploration and drilling
activity that took place would not have happened without the
credits. He said there was a lot of discussion on what Alaska
can do to overcome the exact things that Senator Meyer brought
up as the "givens" for Alaska. He conceded that the Legislature
can talk about making decisions on a one-of-item basis, but he
asserted that the state must look at its tax code, "as a whole."
CHAIR GIESSEL pointed out that there is also a question of
picking winners and losers, and inviting companies up that do
not have the competencies to develop in the state's complex
environment. She added that the state also has seismic credits
and noted that seismic data is foundational for choosing whether
to buy a lease or not. She admitted that there are a lot of
factors that come into play.
SENATOR VON IMHOF remarked that she has a big issue with ring-
fencing. She expressed that she understood Mr. Ruggiero's
explanation, but explained that she looked at ring-fencing in
the economic sense that businesses or companies need to recoup
the dry holes utilizing their whole business model to stick with
it and keep drilling until they find the glory-hole. She
asserted that not allowing the costs to be recouped will result
in the dry holes sitting abandoned. She set forth that ring-
fencing will not allow the state to get the intended consequence
which is more development. She summarized that for an economic-
hat, ring-fencing is not the answer because it is too narrow of
a parameter.
3:51:53 PM
MR. RUGGIERO disclosed that one of the first things many regimes
do in a license round is to put in a prequalification process
for bidding. He noted that during his time in the oil industry
that more effort was put into the qualification process versus
the bid process; however, he noted that there are great
explorers that are not operators and placing a qualifying
condition might discourage true explorers who are great at
finding oil, but are not interested in oil development. He
suggested that legislators not act too quickly in excluding a
subset of companies from the state that can work on various
things.
MR. RUGGIERO referenced slide 11, "Transparency" as follows:
· Oil and Gas Industry:
o Royalty and taxes paid towards Alaska's economic
engine.
o Issues related to oil and gas should be top priority
for the Legislature.
· Key data and information not readily supplied to each
legislator.
· Suggested Actions:
o Alaska Oil and Gas Statistics Book:
ƒPhysical and online "book."
ƒGas statistics should be published and reviewed
by DNR and Alaska Oil and Gas Conservation
Commission (AOGCC) no later than the first week
of the legislative session.
ƒContains historical and projected curves or
charts of production, spending, projects, jobs,
wells, seismic, license rounds, etc.
ƒInformation should be broken down to the lowest
level of granularity as possible.
o Pre-session Workshop:
ƒGo over the current state of the global energy
picture with multiple views on:
· Supply,
· Demand,
· Pricing,
· Emerging Technology,
· Industry Disrupters,
· LNG Market,
· Impact all might have on activity in
Alaska's energy sector.
He addressed "transparency" and suggested that the Legislature
needs to have both a physical and online book that every
legislator gets at the beginning of the legislative session. He
pointed out that oil represents the bulk of Alaska's economic
engine and legislators need to be up to date with the "latest
and the greatest" of whatever is going on, what has happened and
what is planned in the near-future. He emphasized that
legislators need to see the book before the session starts. He
suggested early in the session that the DNR and AOGCC the
provide informative data to the Legislature rather than the
Department of Revenue due to confidentiality issues. He added
that those new to the Legislature or individuals that want a
deep-dive into oil should have a pre-session workshop on non-
Alaska topics that address competitive curves, what other
regimes are doing, current and future oil prices, the supply and
demand picture, and technologies emerging that might disrupt
crude oil. He asserted that the book and a briefing from DNR and
AOGCC will bring the entire legislative body, Alaska's "board of
directors for oil," up to speed and current with everything that
is going on so that legislators are not asking for basic data on
the state's business during the session's last weeks.
CHAIR GIESSEL pointed out that the Legislature has the Oil and
Gas Competitiveness Review Board (O&G CRB) that was established
as part of SB 21. She disclosed that the Legislature did not
fund O&G CRB, which creates a challenge. She revealed that the
Cook Inlet's tax regime was changed, and their annual report was
due at the beginning of the session, but the task was not
accomplished on time. She asserted that the Legislature needs to
fund O&G CRB, but noted that Mr. Ruggiero's recommendation was
appreciated.
MR. RUGGIERO disclosed that he had reviewed the 2015 report
which provided extensive background information about
prospectivity, but suggested that receiving two or three
different views as to what is going on in the world of oil and
gas is always useful. He reiterated that the diverse dialog will
provide legislators with a good sense of what the state is up
against rather than talking about billions of dollars at the
last minute.
He referenced slide 12, "Gross Value Reduction (GVR)" as
follows:
· The GVR can be viewed as an uplift to current costs as it
serves to reduce the Production Tax Value just as current
cost do.
· Uplift graph.
· This is a progressive-tax-reduction tool that grows with
price.
· Do not see why the extra 10 percent is needed to bring a
project on stream. The availability of the 20-percent. GVR
with royalty-relief should be sufficient.
MR. RUGGIERO explained that CSHB 111(FIN) talks about the
elimination of the extra 10 percent of the GVR, one of two
things that he will provide a different perspective on. He
detailed that he explained GVR in terms of operating-expense
uplift because the GVR reduction comes in as a subtraction in
the same place as the operating and capital expense, so the
state's per-barrel-expense deduction. He said his GVR
perspective was done because the discussion with committee
members has addressed NOLs and uplifts in the eight-percent
range.
He addressed the "GVR Uplift of Operating Expense (OPEX) and
Capital Expenditure (CAPEX)" graph on slide 12. He pointed out
that at $60 Alaska North Slope West Coast (ANSWC) Oil Price per
barrel with the 20 percent GVR would be the equivalent of a 30
percent uplift on the OPEX, which means without the GVR the same
tax would be paid with a 30 percent higher OPEX. He noted that
the 30 percent line showed at $60 per barrel the uplift would be
nearly 50 percent.
He remarked that his perspective is interesting because "gross"
is usually thought of as a regressive tax where it gets worse as
the price goes down; however, from the state's perspective it
gets worse as the price goes up because as the price goes up the
gross value of the point of production goes up and the value
continues to grow. He pointed out that the graph on slide 12
shows that around $110 and $120 per barrel that the impact of
the 30-percent GVR is the same as if the producers could deduct
their expenses twice over. He said given the deduction that is
allowed from just the 20 percent that he does not see the need
for the extra 10 percent to be successful and economic. He
remarked that the extra 10 percent is an expensive aspect of the
tax code.
SENATOR STEDMAN asked Mr. Ruggiero's if his use of the word
"expensive" was from the viewpoint of the state.
MR. RUGGIERO answered yes.
SENATOR STEDMAN remarked that GVR has been looked at and noted
that some members have voiced their concerns while others have
like it a lot. He said Mr. Ruggiero's GVR perspective is an
interesting way of presenting GVR in a different context and is
easier to understand its impact versus running a math model. He
opined as follows:
Conceptually when you take a gross value and throw it
against a net, you have a big impact. Just by
definition it is scary.
MR. RUGGIERO replied as follows:
You will also see I've put the per-barrel credits in a
different aspect. When you keep talking about $5 and
$8-per-barrel it seems like a really small and
innocuous number, but we'll see later on what the
impact of that is as well.
4:01:42 PM
He referenced slide 13, "Tax Rate and Per Barrel Credits" as
follows:
· To create a durable structure, a simplified system needs to
be put in place when time allows.
· As previously recommended, Castle Gap would go with a
stepped or bracketed-net system that would have the various
steps based on unit profitability:
o Low initial rate to mimic low taxes for Cook Inlet and
other projects like heavy oil.
o Can progressively go higher as unit profitability
grows.
o Self corrects for changing price and cost
environments.
He noted that CSHB 111(FIN) lowers the tax rate and eliminates
the per barrel credits. He reiterated that Castle Gap Advisors
recommends that the state can create a simplified system that
gets rid of a lot of the different moving parts and lessens the
chance of unintended consequences. He pointed out that the tax
can be based on many things including profitability or unit
profitability, which means the tax self corrects and the
Legislature would not have to come back and fix it as often. He
conceded that nuances must be considered to make sure an
operator or operation is not singled out unnecessarily for a tax
that is onerous from an economic standpoint.
4:02:40 PM
He referenced slide 14, "Put the Barrel Credits in Perspective"
as follows:
· Table assumption: 500000 Barrels a Day (BOPD), $10
Transportation and Shipping (T&S), $30 Costs:
o $55, $65, $75 per-barrel-market price.
o All values rounded and in $Billion:
$55 $65 $75
Market Value 10.0 11.9 13.7
T&S 1.8 1.8 1.8
Royalty 1.0 1.3 1.5
Costs 5.5 5.5 5.5
Tax Value 1.7 3.3 4.9
Tax @ 35 pct. 0.6 1.2 1.7
Per Barrel Credits 1.4 1.4 1.4
Gross Minimum Tax 0.3 0.4 0.5
· Alaska is in a gross-minimum tax world until somewhere
around $75-per-barrel and even this may move higher as
costs rise with the rise in the price of oil.
MR. RUGGIERO said slide 14 puts per barrel credits in
perspective as he had previously done with GVR. He noted that at
$55-per-barrel, the taxable value to producers is $1.7 billion
at the current 35 percent tax rate the tax would be $600
million; however, rather than seeing the per-barrel credit on a
per-barrel basis at $8, the table shows the per-barrel credit at
$1.4 billion. He explained that his intent was to show committee
members the comparison between taxable value and the tax owed.
He pointed out that at $55, $65 and $75 per barrel, with costs
being held constant, that the per barrel credits and the use of
the gross-minimum tax are greater than the tax that would be
owed. He noted that his last bullet point says that even if oil
prices start to come up the cost structure is going to come up
as well and at the current barrel-credits structure the state is
likely going to stay in a minimum-tax-controlled world for quite
some time. He summarized that the table on slide 14 shows that
the state being in a minimum-tax world for a long time is
significant and remarked that he was not sure that everybody
knows how large the numbers are.
4:05:16 PM
SENATOR STEDMAN commented as follows:
I think in the current fiscal year the per barrel
credit total is somewhere around $1.2 billion, so
these numbers aren't quite that wacky as far as a
general reference as far as where we are at in this
fiscal year, so it's a sizable amount of money.
These credits don't roll forward if they are not used,
they drop away, but they have a huge impact of holding
us in this minimum tax range which goes to the earlier
questions that I've asked as far as at what production
tax value or how big is the size of the profit oil
before we are out of the minimum tax structure that
these per barrels hold in them, I'm expecting that to
be north of $4 billion.
SENATOR VON IMHOF thanked Mr. Ruggiero for the information
provided on slide 14. She pointed out that "royalty" was noted
on the table, something that she had not seen before. She asked
if "royalty" was included when determining the taxable value.
MR. RUGGIERO explained his calculation as follows:
I've had this discussion 15 times since I've been
here, in the end you pay your tax on taxable barrels.
I happen to use "royalty" in a way that says, "If I am
looking at the market, the market is the market value
of all the barrels if you actually do the subtraction
the way I've got."
He said everyone tells him that he has it wrong, but when he
does the math the actual dollars come out the same, but the
taxable value he gets is the taxable value everybody else gets,
a mathematical perspective that is a little different.
4:07:50 PM
He referenced slide 15, "Review: Timing of Cost Recovery is
Critical" as follows:
· Presented on Saturday, four different recovery scenarios
that yielded significantly different economic results,
[Internal Rate of Return (IRR), Net Present Value (NPV),
Net Operating Loss (NOL)]:
o Accelerated: 20-pct. IRR $27-NPV(10)
o Depreciated: 14 pct. $14
o Cashable: 27 pct. $46
o 50 pct. reduction: 6 pct. -$12
· In this simple example there is considerable difference in
economics between the "accelerated" and the "cashable"
versions.
· Our modeling for a new North Slope field shows a gap of
three percent to four-percent IRR difference between
"cashable" credits, (assuming being paid when earned),
versus any form of CF NOL recovery.
MR. RUGGIERO summarized that there was a substantial difference
in economics between even the "accelerated" and the "cashable."
He said a thought was to apply some uplift to the "cashables"
and allow them to be recovered on an accelerated basis to bridge
the gap; however, Castle Gap's modeling shows that there is
about a three or four-percent IRR gap at various prices. He said
a tighter modeling field was run at flat, nominal pricing that
exhibited the gap. He said slide 16 continues the modeling
explanation.
He referenced slide 16, "Created a Full Lifecycle Model" as
follows:
· Model ran on a possible North Slope new field:
o $10 billion total CAPEX, roughly $6 billion before
first production.
o $9 billion in total OPEX.
o 40-year project life.
o 1-billion barrels produced.
o Average 12.5 percent royalty.
· Run with 35-percent tax and credits as well as 25-percent
tax and no credits.
4:09:07 PM
He referenced slide 17, "Cashable Credits" as follows:
· New and existing producers were encouraged by the
possibility of receiving early cash return for their
investments toward bringing new hydrocarbons into
production.
· [Current practice is to pay a maximum of $70 million per
taxpayer per year, CSHB 111(FIN) to pay a maximum of $35
million per taxpayer per year.]
· For a new, large North Slope field that has a maximum CF
NOL of $5 billion:
o If converted to credits at 35 percent would take 50
years to get paid back.
o If converted to credits at 25 percent would take 35
years to get paid back.
o Both options would suffer from significant lost time
value of money.
MR. RUGGIERO explained that slide 17 erroneously showed in the
second bullet point that "current practice" is to pay a maximum
of $35 million, but the correct amount is $70 million per year.
He noted that he used $35 million in his calculation where 35 to
50 years was required to get it back, at $70 million it was 17
to 25 years just to recover if the producers are force convert
to credits that the state is not going to buy any more, and the
state waits for the producers to recover them each year going
forward. He summarized that the modeling shows in both options
that there would be a significant loss of value due to the time
value of money to the people subject to it.
4:10:38 PM
He referenced slide 18, "Bridging the Gap - Project Internal
Rate of Return (IRR)" as follows:
· Type project run to compare immediately cashable credits
"cashable" against current structure with CF NOL "wasted,"
current structure with NOLs 100 percent effective "useful,"
and cashable credits recovered at a maximum of $35 million
per year (35 per year).
· Even with considerable uplift, the rate of return gap does
not close much at all; you can however, use uplift to
equate cash flows.
· ["Project IRR" graph shows: wasted, useful, cashable, 35
per year projections; the range on the left is 0 to 40
percent; oil prices on the bottom go from $50 to $160 per
barrel.]
He detailed that the top line in the graph is the rate of return
if there were cashable credits where once a producer incurs the
cost they would file and get paid the cashable credit the next
year.
He said the next two lines in the graph identify: "wasted" blue-
line, and "useful" red-line. He explained that that Castle Gap
too a look at what they called the "wasted" NOL version as
follows:
I used my NOLs to take my production tax value down to
zero, not withstanding that I may have barrel credits
or a minimum tax to be paid.
He explained that "wasted" NOL goes to what Castle Gap presented
at their presentation on the previous Saturday. He disclosed
that Castle Group created a model to address wasted-NOL
recovery. He noted that the red line on the graph is designated
as "useful" and explained that the line gets marginally better
on rate of return, but the reason why "useful" does not get a
lot better and bridge the gap to the "cashable" line is due to a
span from year 7 to year 27 for NOL recover to make them used
and useful. He noted that changes will occur at various price
levels, but his focus was on the $70 to $90 a barrel range, a
range forecasted for the foreseeable future that pushes the NOLs
far out that even though the producers ultimately do get to
recover them and gain a big benefit on the cashflow into the
project, the producers get very little benefit to the rate of
return or the net present value discounted to today because the
recovery and getting the full-tax benefit is so far out into the
future that it does not impact present numbers.
MR. RUGGIERO said the line on the bottom of the graph is the
current IRR situation for only deducting $35 million a year. He
said the line gets a little better with an annual $70-million
deduction, but the noticeable gap exists. He summarized that
there is not much difference between "used" and "useful," 100
percent or some of the loss. He noted that there is a huge step
up to the "cashable" and a huge step down to, "I defer payment
and I only pay so much a year." He added that if there are
multiple partners involved that receive multiple payments, then
changes will occur and there will be some variations.
He said the other aspect of the Project IRR model is the top
line could be used as a surrogate for an incumbent that has
significant income for writing off without ring-fencing, a noted
issue by Senator von Imhof. He detailed that if two players get
involved and one is a new player with no other income, they at
best do the red-line or blue-line in the middle. He said an
existing incumbent player would roughly realize the top line
because as soon as they incur it, they would be able to write it
off against current income. He explained that the two-player
scenario would create in the tight field that he is running a
three to four-percent IRR advantage to people who are current
producers with enough taxable income to write it off.
4:14:24 PM
SENATOR VON IMHOF commented that Mr. Ruggiero's statement was
fair. She conceded that the Legislature was making the tax more
difficult and asked if there could be a mechanism that gets the
lines closer together as in if a legacy producer purchased a
credit where they could use 80 percent as a write off versus
going into the actual field.
MR. RUGGIERO replied that Castle Gap ran their model and
detailed as follows:
My intuition before I actually ran it was that there's
probably some amount of uplift that I could bridge the
gap on the return. I put up to 100 percent uplift and
I can't bridge the gap on the return and that's
because I just keep moving whatever NOLs there are
further and further into the future. When you use 10
or 15-percent discounting it's not worth anything
today, it makes a huge impact on cashflow and they
make a whole lot of money, but they don't make it for
20 or 30 years and the state then would be giving that
up.
He said he did not try any other mechanism to see how to bridge
the gap, but asserted that it comes down to a philosophy of what
the state is trying to keep people whole on. He said his comment
goes back to the fundamental question Senator Wielechowski asked
earlier on which metric to use in the decision making. He
continued as follows.
I would almost say that both IRRs and net-present-
value discounting to using it, what carries more
weight or how would they look at the fact that I may
get 20 percent more cashflow but I'm going to get 3
points less on the IRR than my partner.
He summarized that there are many different things that could be
looked at, but conceded that he had just finished the model and
did not run all the cases without knowing what some of the
issues are to tell committee members what a recommended solution
would be.
4:16:53 PM
He referenced slide 19, "Project Rerun at 25 Percent Tax and No
Credits" as follows:
· Note that the curves for NOLs and Optimized NOLs are almost
identical.
· The only difference is the impact of the gross-minimum tax
in about four years.
· The gap between cash now and deduction later is still
significant.
· [Project IRR graph with the lines noted as on slide 18.]
MR. RUGGIERO detailed that the plot on slide 19 was based on
CSHB 111(FIN) and run at the 25-percent tax and no credits. He
noted that there is no influence of the per-barrel credits,
causing lost NOLs. The result is the "wasted" and "useful"
curves almost lie on top of each other, the gap to the slow-pay
credits gets smaller, but the gap to the "cashable" remains
quite large. He summarized as follows:
Again, this is back to my simple four-square example
of different ways of cost recovery, this is just
because they get it while they are actually spending;
they are actually getting value for that spending and
it's in years one, two, three and four that that is so
important in the economics that is overwhelms
everything.
4:17:58 PM
He referenced slide 20, "Lost NOLs" as follows:
· The large North Slope type field was run, across a range of
flat nominal pricing, under the current structure (assuming
CF of NOLs) and under the structure proposed by CSHB
111(FIN), (25-percent tax rate with no credits).
· The removal of the per-barrel credits greatly reduces the
amount of "Lost NOLs."
· ["Lost NOLS under Current and CSHB 111(FIN)" graph
illustrated on slide 20 with lines plotted for "Hard Floor
Plus Per Barrel Credits" and "Hard Floor."]
He reiterated that his intent is to keep putting things in a
different perspective and noted that slide 20 provides analysis
that is based off runs from the two-previous slides which shows
how much NOL is lost. He explained that "lost NOL" means no tax-
savings benefit for the producer was generated.
He detailed that the graph has two curves, the top curve is the
"current" run off that has the sliding scale per barrel, the
hard floor, and a 35 percent rate. The bottom curve is CSHB
111(FIN) that has the 25 percent rate and no per barrel credits.
He noted that all were run on a non-GVR basis. He provided an
overview of the existing structure as follows:
Literally what it is saying is under the existing at
$50 a barrel "flat" for the life of the project, I
spent $6 billion before first production and I got
zero value for my NOLs because there's so much in the
per-barrel credits and the minimum tax that my write-
off of my cost changes my tax to zero. Then as you
see, as the price goes up you get a compounding
effect, you are getting more revenue which creates
more taxable value. Then as the price goes
incrementally beyond $80 the per barrel credits start
coming down, so that's why you see an acceleration of
the slope of the curve as it goes up in price.
MR. RUGGIERO provided analysis under CSHB 111(FIN), adding that
a producer would not do a project in a $50 world, but ran the
plot across the price range and detailed as follows:
The amount of lost NOLs falls by two thirds, falls
from $6 billion to $2 billion, and that curve, it's
fairly shallow as you go out, and what you get is it's
just this gross minimum that you keep hitting as you
go forward with this to how much NOL is lost as you
move on.
He summarized as follows:
Again, just trying to put into perspective when you
are looking at some of the issues with respect to the
various mechanisms that are being suggested to be
changed in [CSHB 111(FIN)] is how this is impacting
other aspects of the operation and the value both to
the producer and cost or value to the state.
4:21:12 PM
SENATOR VON IMHOF noted that different colors where used for the
lines in slides 18, 19 and 20. She asked that Mr. Ruggiero
clarify the line-color comparison between the three graphs.
MR. RUGGIERO specified as follows:
The best way to say this is these two curves on slide
20 represent the "blue" or the "wasted" scenario
because what I wanted to do is I want to see how much
of the NOL is wasted with the per-barrel credits and
without the per-barrel credits, both with the hard
floor.
He added that the tax rate changes at higher prices and the tax
amount becomes equal around $120 to $130, the point where DOR
just showed the committee where CSHB 111(FIN) tends to have the
same marginal tax rate at the state's current structure once oil
gets to higher prices.
SENATOR VON IMHOF remarked that one would look at slide 20 and
say, "Well, with the lower tax rate and no credits, NOLs are
more useful, with the gray line."
MR. RUGGIERO answered exactly.
SENATOR VON IMHOF replied that the problem the committee has
heard is making the NOLs useful. She commented as follows:
Is there a way to change the NOL structure and make it
to some degree net-neutral within a range to both the
state and to the oil producers?
MR. RUGGIERO replied that he understood Senator von Imhof's
concern. He said to keep the "whole" in mind and detailed as
follows:
What I was trying to do was to point out you've got
all these pieces and if you look at them in isolation
is just understand how much impact they can have. We
then talked about the the interdependencies and this
whole concept of the lost NOLs, the interdependencies
of different aspects that you may try and change
something; for example, this committee may suggest
something that lowers the peak in that bottom curve,
but then what does it do to other aspects? What does
it do to current production for the legacy-players?
What does it do to new projects coming on? Does it
help one and impede the other? I'm just trying to make
sure you stay aware that as you change these different
pieces we keep the whole in mind and always look at
the whole and then test the little different things
that we can do in each of these different aspects of
the code.
But you are exactly right, you can't concentrate on
just one area and ignore what it does in the other; in
fact, you just made my point that I've been trying to
make is changing the NOLs and fixing that, "Well, that
just exasperated the tax or if I change the tax, it
may not keep new players whole." You may never get
those new projects and now you have just violated your
first goals which is get more oil into the pipeline.
So, it all has to be looked at as a whole and that's
why it makes it more important that what we use as
examples are more closely related to the type of
projects and things that you could have coming on then
the averages that even I'm using, because I'm just
using rounded, average, typical type projects and
numbers because I don't have anything that looks like
the profiles of what you have as a possibility right
now.
4:27:14 PM
CHAIR GIESSEL addressed slide 20 and inquired if there were more
lost NOLs because the per-barrel credits must be taken first.
MR. RUGGIERO explained that his understanding is the credits are
taken after the NOLs and the obligation is to use the NOLs until
a zero-tax value is created, which then the per-barrel credits
would themselves have taken it.
He referenced slide 14 to exemplify the issue as follows:
I would have to subtract it if the tax section, to
come down to the tax, and that would reduce the
taxable value and you see the tax as it is right now
comes to 0.6, so I would reduce that to zero and yet,
I had the per-barrel credits which could have covered
anything that I was owed. So, that meant any NOLs that
I would use in this example, the $0.6 billion that I
would use would be lost because the per-barrel credits
were big enough to have wiped out my tax. Again, I go
to the next year, my tax would have been $1.2 billion,
so if I use my NOLs to drop that down to zero, I would
have covered it with my per barrel credits. So, it is
a bit of the sequencing because I have to use the NOLs
first to go down to a zero-production-tax value.
4:29:04 PM
He referenced slide 21, "Optimizing Model Results" as follows:
· Indicative profiles of timing of investment and production
are necessary to understand the impact of your fiscal
system (and proposed changes) on state revenue and producer
economics.
He detailed that slide 21 timely emphasizes what he just said.
He noted that Chair Giessel asked the question about what is
really the impact and how does it work. He explained as follows:
This goes back to my whole thing of you really need to
understand how what you are looking to do will impact
the key things which are those major projects you have
on the horizon which could bring, as I've heard, "A
couple hundred thousand extra barrels a day" into the
pipeline and would keep it going for another couple of
decades beyond where it might not go if it doesn't get
this extra production.
Again, if you're going to start looking at exactly
what happens to NOLs, exactly how some of these people
are impacted, and when I say exactly I mean close
enough in the ballpark then us sitting here guessing
as to what the size of something is or how much time
it is going to take, or what is the oil production
curve really going to look like, is actually having
enough information to get it close enough not because
I'm going to say, "I can get you screwed down to here
to exactly a 15 IRR or a NPV 10 of a billion ought to
be enough value coming in," it's not to do that, it's
to make sure that the shape of things that the
mechanism that you choose to put into place or change
or not change are responsive to what's actually going
to come. You're not a state that's got a hundred
different things that can happen over the next five
years, you're a state that's only got a handful of
things that can happen over the next five years.
CHAIR GIESSEL stated that she appreciated Mr. Ruggiero's
emphasis on new projects and pointed out that "new projects" was
the focus of SB 21. She noted that new projects take many years
and emphasized that there must be a balance with the legacy
players who are currently keeping the pipeline functioning.
MR. RUGGIERO explained that there are two sides, the mathematics
and the practical. He said in a practical sense you do not do
things for "new" that hurt the "legacy," the intent is to find
something that helps everybody in the business; however, if
there is some suffering that "legacy" has to do, they have to
realize that when the "new" comes on, as he noted in the
previous Saturday's meeting, there is anywhere between $5
billion to $50 billion more for the state and a like number for
producers to keep the fields going.
SENATOR WIELECHOWSKI opined that there is a need for two
separate tax structures or something that recognizes the very
high cost for the new fields because the new producers are so
much more economically challenged than the legacy fields. He
said moving forward he would urge committee members to keeping
the legacy fields profitable with incentives focused on the new
producers and the new fields.
SENATOR VON IMHOF asked if there is a way to just stop short of
production-value tax by taking an NOL and allowing the per-
barrel credit to "take that last bit" to make it zero so a
little bit of the NOL is left on the table and allow the per-
barrel credit to that "last bite" to help salvage some of the
NOL.
MR. RUGGIERO replied that slides 18 and 19 is exactly what
Senator von Imhof's query addresses regarding the difference
between the "wasted" and the "useful" curves. He explained that
he had written within his routine that says, "Only use enough of
the NOL that when I then apply the per-barrel credits it equals
out the minimum tax." He noted that when he originally built his
model that he questioned from a practical standpoint why NOLs
should be used that do not have to be used. He disclosed that
the model had to be modified to take all the NOLS to get the PTV
to zero.
| Document Name | Date/Time | Subjects |
|---|---|---|
| AGENDA - 4 - 18 -17.pdf |
SRES 4/18/2017 2:00:00 PM |
|
| HB111 - DOR Presentation - 4.14.17.pdf |
SRES 4/18/2017 2:00:00 PM |
HB 111 |
| HB 111- Castle Gap Evaluation of Fiscal Impacts - 4 - 17 - 17.pdf |
SRES 4/18/2017 2:00:00 PM |
HB 111 |