Legislature(1995 - 1996)
03/06/1996 03:40 PM RES
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
SB 112 DISCOVERY ROYALTY CREDIT CHAIRMAN LEMAN called the Senate Resources Committee meeting to order at 3:40 p.m. and announced SB 112 to be up for consideration. ANNETTE KREITZER, staff to the Senate Resources Committee, explained the proposed committee substitute. She said she worked with the Division of Oil and Gas and with industry to come up with another phrase for the terms "in commercial quantities and in a geologic structure" regarding their current relevance and that is reflected in the committee substitute. The current meaning of discovery royalty connotes drilling activity, even production and the original law was instituted to encourage new development and that's reflected with the inclusion of discovery royalty in the exploration licensing program. There is a change from 10 years to primary or initial term of lease to retain the discovery aspect of the royalty reduction - that it's not a long term provision, but is meant to reward discoveries of new pools. SENATOR TAYLOR moved to adopt the committee substitute to SB 112 for purposes of discussion. There were no objections and it was so ordered. Number 100 BILL STEWART, President, Stewart Petroleum Co., said he has approximately 26 years of oil and gas industry experience in Alaska. Their company is a small Alaska based independent company in Alaska. Their primary interest within Alaska is Cook Inlet Basin and their current production averages almost 5,000 barrels per day. Total production since start-up in 1993 has exceeded 2 million barrels. Their project is small by industry standards in Alaska, although it would be sizeable almost anywhere else. Investment to date exceeds $50 million. Taxes and royalties paid thusfar to the State of Alaska total approximately $3.2 million. They employ 15 - 60 Alaskans depending on activity and they do business at all times possible with Alaskan vendors and service companies who employ Alaskans. However, the operation is on the marginal side due to its remoteness and high operating costs per barrel and chronically low oil prices in Cook Inlet. MR. STEWART said that about 60 wells have been drilled in Alaska by independents including the first well in Alaska (in 1898). He said that SB 112, if enacted, would reestablish a discovery royalty program and he thought it would result in implementation of more aggressive development schedules by the operators than otherwise would have taken place. Encouragement is needed from government with natural obstacles such as weather conditions and remoteness; the man made obstacles include a regulatory system which is improving, but is still filled with road blocks to development. The man made obstacles are the tougher ones resulting in high costs. SB 112 with certain modifications would provide part of the needed encouragement for renewed industry activity in Cook Inlet Basin, at least from the independents. Much of the bill deals with leasing matters not related to discovery royalty. The language that does relate to discovery royalty, in his opinion, falls short in a couple of respects. First, reduced royalty for the primary term only is not much of a benefit. Recent leases in Cook Inlet have been issued for primary terms of seven years rather than the usual 10 and finding oil takes time. Geological studies and field work, often seasonal, integration of geological and geophysical data for prospect delineation, selection of bottom hole objective, well planning, permitting, drilling rig arrangements, acquisition of supplies, and actual drilling are among the activities involved - not to mention huge amounts of money and luck in finding oil. He didn't have a precise study at hand, but he thought that most of the discoveries in Alaska were made in the last few years of the primary term of the oil and gas lease involved or more often during the term extended by unitization. While SB 112 is a good concept, the time limitation in large part removes the benefit, he said. Second, unless the act is retroactive, the applicability provision will exclude all currently issued leases. Those leases which are most ready for development will not receive the benefit of reduced royalty. Operators can only look at future leases and lease sales which may or may not occur. At the risk of obvious self-service, it's appropriate to have an effective date that picks up west McArthur River and Sunfish, the two wells that got the second wave of exploration going - around January 1, 1991. The McArthur River development would definitely continue at a more rapid pace with quicker recovery of capital and expansion of activities there. Other activities in Cook Inlet Basin could commence earlier, like at Anchor Point. He proposed reinstatement of the original 10 year program which would apply to discoveries made after January 1, 1991 effective upon date of discovery. Previous royalty payments paid subsequent to such discovery date which exceed the five percent royalty will constitute a credit against future royalty payments. Suggested language is attached to his testimony which he is handing out. The suggested language applies only to Cook Inlet Basin as a means of revitalizing Alaska's oldest petroleum producing province. Number 260 SENATOR LINCOLN asked him to comment on the phrase "The payment of royalty under this paragraph is authorized only to the holder of the lease who first files." MR. STEWART responded that would be the operator who discovered and that mechanism is already in place, for example, they filed on their discovery well verification of a well capable of producing in commercial quantities (a finding issued from DNR). SENATOR LEMAN said it was his intent to do all he could to help encourage independents like him to explore and be successful. MR. STEWART thanked him and said he was in touch with quite a few independents who are waiting to see what is going to happen here. SENATOR TAYLOR asked what the dollar downside would be to the State of Alaska with the reduction. He asked if it was 7 1/2 percent. MR. STEWART answered yes and it would be hard to estimate without knowing the extent of the find and oil prices at the time. He said it would stimulate activity and the State would be well ahead in the long term. SENATOR FRANK asked how many leases Prudhoe Bay has. MR. STEWART answered that he didn't know that, but there are 1,700 wells involved. SENATOR FRANK said there is no chance that we would give away a royalty on a huge field, because it would require many leases only the first of which would have the reduction. MR. STEWART said that was correct. SENATOR TAYLOR noted that the language was written so that it would encompass the oil or gas within a pool and the pool is defined somewhat broadly. MR. STEWART responded that logically a pool would extend beyond the lease. He thought that a well capable of producing in commercial quantities should establish discovery. The "pool" takes years to define. SENATOR TAYLOR said they might need a redefinition of "pool" as it impacts the royalty question. MR. STEWART thought the language used in the early '60s was adequate. SENATOR LEMAN said it was his understanding that there were some challenges to the definition of discovery used in the '60s and that's part of the reason the royalty reduction was withdrawn. The other reason was that Prudhoe Bay was just discovered and the legislature thought they didn't need it. Number 370 KEN BOYD, Director, Division of Oil and Gas, said he thought the committee substitute was an improvement over the original bill, but he thought there were still several problems. The first one is "first discovery" is not properly defined and this has resulted in quite a number of law suits. There is no guidance in determining the amount and type of data you might need, the size of the pool, or any standards of productability. As a technical point, the bill seems to conflict with AS 30.05.180 (f) (4), page 3, line 7, which seems to beg the question of a discovery royalty on leases that carry royalty. The term of the lease is not clear to either mean the whole term of the lease or the primary term of the lease. The major problem he has is with the large and unintentional economic impact this bill may have. You get about $275,000 in reduction per well per year, so for a 10-year term that would be $2,700,000. Leases can have more than one well. For 10 wells there would be $27 million roughly in forgiven royalty over that period of time. The problem is that this could happen without ever adding an incremental barrel of oil because you can drill in Kuparek and have a perfectly good Kuparek producer, but then make a "discovery" in the shallow part of the well. Here there is no standard; it doesn't have to be produced or anything else. So if you discover it on that lease, then that entire lease and all the production that comes from it is subject to a five percent royalty. In the example he's using, that comes out to $27 million. He thought a better way to do it, if you're looking for new discoveries, is to have the royalty reduction apply to the newly discovered horizon. In other words, you have incremental production that was discovered being given a five percent royalty, but not that oil that is on the lease and which is perhaps very well known. Number 440 SENATOR LEMAN noted that Mr. Stewart's suggestions only applied to Cook Inlet for discoveries made after January 1, 1991. MR. BOYD responded that it depends on what benefits you are actually achieving by it. There are royalty reductions in HB 207 ADJUSTMENTS TO OIL AND GAS ROYALTIES which gives the opportunity for royalty reductions, even prospectively, for newly discovered, delineated fields. There is also a Cook Inlet type provision that provides for three percent royalty for extending the life of a field. He hadn't thought of Cook Inlet in particular. He thought you could still run some of the numbers, although they would probably be smaller. If it comes from a lease, all you have to do is make a small discovery; it doesn't have to be producible, just something different, and then all the production from that lease gets the five percent royalty. He didn't think that was the intention of the bill. SENATOR LEMAN said that was not his intention and asked for his help with language so that that doesn't happen. MR. BOYD said he would be glad to help. SENATOR TAYLOR said he was particularly concerned with the definition of geologic structure or pool and some definition so that a mere strike of a small amount in a new area might not open up the entire field for the discovery benefit. MR. BOYD replied that with some hesitation he would be pleased to try and help, but he related a true story when years ago the then Attorney General Wilson Condon and his assistant Jeff Lowsenfeld asked themselves the same question. They went on a tour of the U.S. interviewing people and wrote a seven volume, 2,000 page tome addressing those points. He hoped those volumes could help them with the definitions. Number 490 SENATOR PEARCE said she didn't think they dealt with first discovery last year, but asked if they didn't sufficiently define pool in those discussions concerning SB 207. MR. BOYD replied that although they got a definition, he is not sure it works here. He thought it worked better in the original bill, because it begs the question if a pool is defined by the OGC is a separate entity, how big is that entity. He used the example of Kuparek where a new discovery might be found because it might be a separate little piece of Kuparek that's in a separate pool in an adjacent lease, by this definition. SENATOR FRANK asked what the difference between a pool and a field was. MR. BOYD answered a field may contain several pools, but a pool is a separate entity unto itself. KATHRYN THOMAS, Kenai Peninsula businesswoman, said her small construction and trucking business is located there. The majority of their revenue is earned from the oil and gas industry in Kenai. Because of their age, many of the producing wells in their area are not very profitable. This has resulted in Cook Inlet wells being shut in. The loss of steady good paying jobs and the accompanying buying power is felt throughout her community as evidenced by the empty store fronts and slack economy. They have not been able to stimulate a commitment for additional exploration investment. SB 112 provides this opportunity. MS. THOMAS said a discovery royalty in the Cook Inlet Basin would be one of the most exciting prospects they have had to offer resource developers in many years. Exploration work provides high paying jobs and relies heavily on the support services that her community's small businesses can provide. She said this bill has been discussed with North Peninsula Chamber members and Kenai Chamber members, with Mayor Williams of Kenai and Mayor Gilman of the Kenai Peninsula Borough. The key components of the bill's merits show a value to the stimulation of the Kenai Peninsula economy that everyone agrees on. SENATOR LEMAN said they would work on this draft and have it before the committee soon.