Legislature(1995 - 1996)

03/06/1996 03:40 PM RES

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= 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           
 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              
 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                      
 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.                                                           

Document Name Date/Time Subjects