Legislature(2013 - 2014)BUTROVICH 205

02/15/2013 03:30 PM RESOURCES


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03:30:39 PM Start
03:32:08 PM SB21
04:17:06 PM Presentation: Pfc Energy
05:55:27 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
-- Teleconference <Invitation Only> --
+= SB 21 OIL AND GAS PRODUCTION TAX TELECONFERENCED
Heard & Held
PFC Energy
Bills Previously Heard/Scheduled
               SB  21-OIL AND GAS PRODUCTION TAX                                                                            
                                                                                                                                
CHAIR GIESSEL announced  SB 21 to be up for  consideration and to                                                               
start  the   Department  of  Revenue   would  walk   through  the                                                               
complexities of progressivity.                                                                                                  
                                                                                                                                
3:32:08 PM                                                                                                                    
MICHAEL  PAWLOWSKI,  Petroleum  Systems Advisor,  Office  of  the                                                               
Commissioner, Department  of Revenue (DOR), Juneau,  AK, said the                                                               
intent of  the presentation  was to give  members a  general walk                                                               
through of the actual mathematics  of how progressivity works and                                                               
then to  talk about some  of the  issues that the  department has                                                               
identified in  progressivity that  have caused concern.  He noted                                                               
that a  lot of  these issues  are about  the aggressivity  of the                                                               
progressivity,  specifically about  the math  of the  equation in                                                               
the current system.                                                                                                             
                                                                                                                                
He  said he  would  first  walk through  the  calculation of  the                                                               
production  tax   liability  and   then  second  how   the  basic                                                               
progressivity calculation works; and  finally go through what the                                                               
administration has  identified as some  of the problems  with it.                                                               
He  invited   Mr.  Stickel  to   walk  through   calculating  the                                                               
production tax liability.                                                                                                       
                                                                                                                                
3:34:06 PM                                                                                                                    
DAN  STICKEL, Assistant  Chief Economist,  Department of  Revenue                                                               
(DOR), Juneau,  AK, said  the basic calculation  of the  ACES tax                                                               
liability  is: production  tax value  times your  tax rate  minus                                                               
your  credits.  Production  tax  value is:  the  value  at  plant                                                               
production (volume  of oil  and gas  produced times  the wellhead                                                               
value).  In   calculating  the   wellhead  value   you  subtract:                                                               
transportation costs  to get it  to market, operating  (Opex) and                                                               
capital (Capex)  expenditures in  the year earned  in calculating                                                               
production tax value (the tax base).  The base rate is 25 percent                                                               
plus an  additional .4 percent for  every $1 per barrel  that the                                                               
production tax value exceeds $30/barrel  up to $92.50/barrel, and                                                               
then at  $92.50 that turns into  a .1 percent slope.  The credits                                                               
are  subtracted from  that (primarily  the 20  percent credit  on                                                               
capital  expenditures  as  well  as small  producer  credits  and                                                               
transitional credits).                                                                                                          
                                                                                                                                
MR. PAWLOWSKI said the progressivity  function itself is found in                                                               
AS  43.55.011(g). He  reiterated that  the progressivity  doesn't                                                               
begin  to  get  calculated  until production  tax  value  exceeds                                                               
$30/barrel of  oil (deducting transportation  costs). As  soon as                                                               
it goes past $30 a barrel,  the tax rate increases .4 percent per                                                               
$1 until the  production tax value exceeds  $92.50/barrel when it                                                               
flattens out. The  maximum tax rate of  the progressivity portion                                                               
is a 50 percent tax, which when  combined with the base tax is 75                                                               
percent. Progressivity itself  is calculated monthly and  it is a                                                               
single statewide calculation on all oil and gas revenues.                                                                       
                                                                                                                                
3:36:03 PM                                                                                                                    
SENATOR  MICCICHE  asked if  there  are  any eligible  transition                                                               
expenditures that are still in use.                                                                                             
                                                                                                                                
MR. PAWLOWSKI replied that he would  get back to him on that, but                                                               
he understood that those are repealed in SB 21.                                                                                 
                                                                                                                                
3:36:54 PM                                                                                                                    
SENATOR DYSON joined the committee.                                                                                             
                                                                                                                                
MR. PAWLOWSKI  said the  basic calculation as  it appears  in the                                                               
2012 Fall  Revenue Sources Book  begins with the  base assumption                                                               
of  170,262,000 barrels  of taxable  production (royalty  oil not                                                               
included). The  equation begins with  an ANS West Coast  price of                                                               
$109.61/barrel  as  forecast  by the  department.  Transportation                                                               
costs of $8.81/barrel are subtracted  from that, which results in                                                               
$100.80/barrel gross value at the  point of production (wellhead)                                                               
of. The  deductible lease expenditures  are subtracted  from that                                                               
to  arrive at  the production  tax  value. So,  the Fall  Revenue                                                               
Sources Book shows an operating  expenditure of $16.32/barrel and                                                               
a  capital expenditure  of $19.61/barrel,  for  a production  tax                                                               
value of  $64.87. The base tax  of 25 percent is  applied against                                                               
that  production tax  value. So  the base  production tax  in the                                                               
example  would  be  around $16.22/barrel.  Those  are  the  basic                                                               
numbers to begin to calculate the progressivity function.                                                                       
                                                                                                                                
Calculating   the   progressivity   function  begins   with   the                                                               
production  tax value  of  $64.87/barrel  minus the  $30/trigger,                                                               
which results in  a value of $34.87. Because  that production tax                                                               
is  less  than $92.50,  the  amount  of the  percentage  increase                                                               
applied  to  this number  is  .4  percent.  So, $34.87  times  .4                                                               
percent  is roughly  the equivalent  of 13.95  percent (therefore                                                               
the progressivity in  this example is 13.95  percent). This 13.95                                                               
progressive tax is  then applied to the production  tax value per                                                               
barrel  of  $64.87  (not  the $34.87).  So,  $64.87  times  13.95                                                               
percent   equals   $9.05/barrel;   therefore   the   $9.05/barrel                                                               
progressive tax  plus the 25  percent base tax of  $16.22 results                                                               
in a $25.27/barrel production tax  (before the credits are added)                                                               
multiplied by  the taxable  production results  in $4,302,000,000                                                               
in production tax revenue.                                                                                                      
                                                                                                                                
3:40:04 PM                                                                                                                    
SENATOR FRENCH  said it struck him  that for all the  wailing and                                                               
gnashing of  teeth about  progressivity it  accounts for  just $9                                                               
out  of  $109/barrel of  oil,  and  it  doesn't  appear to  be  a                                                               
dominant aspect of the taxation  system. He asked where the gross                                                               
value at point of production is on the North Slope.                                                                             
                                                                                                                                
MR.  STICKEL answered  that includes  all of  the netback  costs,                                                               
everything that  it takes to  get from  the unit boundary  to the                                                               
destinations:  the  feeder  pipelines,  TAPS  tariff  and  tinker                                                               
tariff.                                                                                                                         
                                                                                                                                
SENATOR FRENCH asked if it is  just upstream of the pipeline tie-                                                               
in or downstream of the  production facility. Do the feeder pipes                                                               
count between the production facility and the pipeline or no?                                                                   
                                                                                                                                
MR. STICKEL replied  that it depends on whether  it's a regulated                                                               
pipeline or if it's within a  unit boundary and he offered to get                                                               
a technical definition.                                                                                                         
                                                                                                                                
SENATOR  FRENCH   said  he  understood   that  it   is  basically                                                               
downstream of the production facility  (after everything has been                                                               
taken  out)  but  before  the  feeder pipe;  yet  it's  called  a                                                               
wellhead price.                                                                                                                 
                                                                                                                                
MR.  PAWLOWSKI  commented  that the  wellhead  is  generally  for                                                               
calculating  royalty.  There is  a  general  synergy between  the                                                               
point of production and the wellhead,  but they are not the exact                                                               
same number because of getting  different treatment under the tax                                                               
- particularly  when it comes  to the allowable  deductible costs                                                               
for a shipper that has an  affiliated ownership in the TAPS (that                                                               
gets a regulated treatment by the Department of Revenue).                                                                       
                                                                                                                                
3:42:23 PM                                                                                                                    
Some  of his  preliminary  observations  about the  progressivity                                                               
mechanism were:                                                                                                                 
                                                                                                                                
-It increases the  overall tax rate as  the overall profitability                                                               
rises.  The progressivity  in the  production tax  itself is  one                                                               
component   of  the   overall  fiscal   system.  After   that  is                                                               
calculated, then state  and federal income taxes  are also levied                                                               
on the remaining net profit of a barrel.                                                                                        
-Progressivity is company  specific and each company  will have a                                                               
different exposure because progressivity is sensitive to:                                                                       
     -the oil price                                                                                                             
     -spending                                                                                                                  
     -production                                                                                                                
-Progressivity is only one part  of what makes the overall system                                                               
progressive; it  is not a  factor at all  at low oil  prices ($30                                                               
net).  He   explained  that  the   combination  of   credits  and                                                               
progressivity  creates the  linear slope  that is  different than                                                               
the slope  in SB 21. They  don't want people to  forget about the                                                               
credits  while   talking  about  progressivity  in   the  overall                                                               
picture,  and   this  presentation  will  only   talk  about  the                                                               
progressivity.                                                                                                                  
                                                                                                                                
SENATOR DYSON commented that  progressivity isn't triggered until                                                               
you   get  $30   over  the   combination  of   Capex,  Opex   and                                                               
transportation costs, but once it  is triggered, it goes back all                                                               
the way to the Capex and Opex.                                                                                                  
                                                                                                                                
MR. PAWLOWSKI agreed  and added that it's important  to note that                                                               
in the  beginning of calculating the  progressivity, $64.87 minus                                                               
$30 gives  one a number that  is used to determine  the tax rate,                                                               
not  the  number  that  the  tax rate  is  applied  against.  The                                                               
production  tax value  is the  number against  which both  the 25                                                               
percent  base  tax  and  the progressive  tax  rate  are  applied                                                               
against.                                                                                                                        
                                                                                                                                
3:45:28 PM                                                                                                                    
Next Mr.  Pawlowski walked  them through  the sensitivity  of the                                                               
progressivity  function example  based  on the  same numbers  but                                                               
changing  one  number in  the  equation,  increasing the  capital                                                               
spending  by  $500  million.  In this  example,  the  exact  same                                                               
transportation costs results in the  same gross value at point of                                                               
production; the  deductible lease expenditures and  the operating                                                               
cost are  the same  at $16.32, which  raises the  Capex/barrel to                                                               
$22.55 dropping the  production value from $64.87  to $61.93. The                                                               
base  tax is  reduced from  the  previous example  by 25  percent                                                               
against  the   $61.93  which   results  in   $15.48.  Calculating                                                               
progressivity starts with $61.93/barrel  (instead of $64.87). So,                                                               
doing  the  same walkthrough:  $61.93  minus  $30 equals  $31.93.                                                               
Since that $31.93  is less than $92.50, that is  multiplied by .4                                                               
percent,  which  results  in  a progressive  tax  rate  of  12.77                                                               
percent, which  is applied  to the $61.93,  which results  in the                                                               
progressive  tax  of  $7.91/barrel.   So,  one  sees  as  capital                                                               
spending goes  up, the production  tax value has dropped,  as has                                                               
the corresponding calculation of the progressivity.                                                                             
                                                                                                                                
The combination of  the progressive tax and the  base tax results                                                               
in  $23.39/barrel  (before  credits) multiplied  by  the  taxable                                                               
production.    That   shows    state   revenues    declining   to                                                               
$3,983,000,000.  Therefore, in  looking at  the impact  just from                                                               
the  progressivity, of  spending $500  million in  capital, state                                                               
revenues went  down $319 million  before considering the  cost of                                                               
credits (similar to what Econ One presented earlier).                                                                           
                                                                                                                                
3:48:24 PM                                                                                                                    
He said the department's preliminary observations were:                                                                         
                                                                                                                                
-Progressivity  based  on  the net  production  tax  incentivizes                                                               
spending.                                                                                                                       
-The level of  the incentive depends on the price  of oil and the                                                               
cost structure of the investor  not the relative economics of the                                                               
project.  The $319  million is  a function  of the  operating and                                                               
capital costs  per barrel, the  price of  oil in the  market and,                                                               
therefore,  not   linked  directly  to  a   specific  project  or                                                               
improving the overall economics.                                                                                                
-The value of this deduction  often exceeds the credits. In other                                                               
words, when we  think of 20 percent of $500  million, what we see                                                               
is  really $100  million. So,  $500 million  in capital  spending                                                               
would accrue $100  million in credits; and in  this example, $319                                                               
million worth  of buy down  value in the  progressivity equation.                                                               
So, because  of the price of  the oil in the  cost structure, the                                                               
value of  the progressivity buying  down is actually  much higher                                                               
than the value of the credit.                                                                                                   
-This benefit  is only  available to  an incumbent  producer that                                                               
has  a tax  liability and  doesn't create  a level  playing field                                                               
with  new entrants  accounting for  the difference  in government                                                               
take levels for a new entrant versus an incumbent producer.                                                                     
                                                                                                                                
3:49:12 PM                                                                                                                    
SENATOR FRENCH said he would add  "in Alaska" to the first bullet                                                               
point,   "progressivity  based   on   the   net  production   tax                                                               
incentivizes spending  - in Alaska."  If that extra  $500 million                                                               
is spent overseas, then Alaska gets nothing.                                                                                    
                                                                                                                                
MR. PAWLOWSKI responded that Alaska  would get the additional tax                                                               
revenue of that spending going elsewhere.                                                                                       
                                                                                                                                
SENATOR FRENCH said  his only other point was  that Mr. Pawlowski                                                               
had selected the number of $500  million, but in reality which of                                                               
the oil companies  doing business in Alaska  would increase their                                                               
capital spending by that much.                                                                                                  
                                                                                                                                
MR.  PAWLOWSKI  replied  that  it  would be  easy  to  foresee  a                                                               
combination  of  companies  currently doing  business  in  Alaska                                                               
doing  it or  some of  the newer  entrants. He  thought it  was a                                                               
fairly reasonable number  and it was a round number  to use as an                                                               
example.                                                                                                                        
                                                                                                                                
SENATOR FRENCH asked  if he agreed that a  $500 million increased                                                               
in capital spending in one year would be a significant increase.                                                                
                                                                                                                                
MR. PAWLOWSKI answered absolutely.                                                                                              
                                                                                                                                
3:51:41 PM                                                                                                                    
SENATOR MICCICHE asked if the  small producer credit would offset                                                               
the benefit.                                                                                                                    
                                                                                                                                
MR. PAWLOWSKI answered  that it offers a definite  benefit to the                                                               
small  producers  at  $12  million/year,  but  one  that  is  not                                                               
commensurate to the scale of the upfront buy down.                                                                              
                                                                                                                                
SENATOR MICCICHE  said he thought  that would be almost  a direct                                                               
offset  for   the  small  quantities  the   small  producers  are                                                               
producing, but he could be wrong.                                                                                               
                                                                                                                                
MR. PAWLOWSKI offered  to work with him on the  economics of that                                                               
premise.  His  next  example  took  the  same  $500  million  but                                                               
decreased  the  oil  price  by   $10  (using  $99.61  instead  of                                                               
$109.61), the same  transportation costs, but the  gross value at                                                               
the point  of production is  lower ($90.80), because  of starting                                                               
from  lower  oil  prices;  the  same  operating  expenditures  of                                                               
$16.32/barrel and same capital  expenditures of $22.55/barrel and                                                               
that resulted  in a  production tax  value of  $51.93/barrel. The                                                               
base   tax  25   percent   would  be   $12.98.  Calculating   the                                                               
progressivity   from  that   $51.93,   minus   $30,  results   in                                                               
$21.93/barrel. Again,  since it's  below $92.50, $21.93  times .4                                                               
percent  results  in a  progressive  tax  rate of  8.77  percent;                                                               
$51.93  times  8.77  percent equals  approximately  $4.56/barrel.                                                               
Therefore,  the  $4.56,  plus  $12.98   base  tax  results  in  a                                                               
$17.54/barrel production  tax before  credits, multiplied  by the                                                               
taxable  production.  Running  the   same  equation  without  the                                                               
additional spending derives revenues of $3,265,000,000.                                                                         
                                                                                                                                
He explained that  one sees the benefit of the  deduction of that                                                               
additional $500  million in  spending at a  higher oil  price was                                                               
worth $319  million, but  the oil price  falling $10  reduced the                                                               
value of  that deduction to  $279 million. This  illustrates that                                                               
the value of  the deduction is largely dependent on  the price of                                                               
oil when the deduction occurs.                                                                                                  
                                                                                                                                
He observed:                                                                                                                    
-Since the  value of  a deduction  is dependent  on the  price of                                                               
oil,  it's very  difficult for  a company  to predict  its value,                                                               
especially  with long  lead time  projects. So,  if the  value of                                                               
one's benefit  depends entirely on the  price of oil in  the year                                                               
you happen to be spending the  capital, looking out 3-5 years for                                                               
an  investment is  a different  thing  than looking  at the  near                                                               
term, next year.  And given the degree to which  that benefit can                                                               
fluctuate,   that   is   a   fundamental   problem   within   the                                                               
progressivity structure.                                                                                                        
-The  reduction in  taxes  is  temporary, since  as  soon as  the                                                               
spending is done the tax rate rises back to the higher rate.                                                                    
-This  effect   can  potentially  create   misalignments  amongst                                                               
working interest owners  in the same field. For  instance, if one                                                               
working interest  owner is spending  and another isn't,  then the                                                               
value  of  the  incremental  spending to  that  company  that  is                                                               
already  spending  will  be  less  than to  the  one  that  isn't                                                               
(because  of where  they are  in their  progressivity equations).                                                               
Again, the  value is  based on  an equation  and not  the project                                                               
economics that they are all working on together.                                                                                
                                                                                                                                
3:56:25 PM                                                                                                                    
SENATOR FRENCH said  he knew the point he was  getting at, but he                                                               
must be really careful in  expressing it. Working interest owners                                                               
in the  same field have to  be aligned when they  make investment                                                               
decisions or they don't happen; Prudhoe Bay requires unanimity.                                                                 
                                                                                                                                
MR.  PAWLOWSKI said  he  appreciated  the clarification.  Because                                                               
unanimity is needed to move forward  in some of these fields, one                                                               
of the  participants may  be in  a different  tax place  than the                                                               
others, so there may be an  actual material benefit to one of the                                                               
working  interest owners  to wait  to harvest  that progressivity                                                               
benefit as  opposed to another. He  thought that was offset  to a                                                               
large degree by  how they actually can look at  the value of that                                                               
deduction in  planning out into  the future.  However,  for short                                                               
term there could  be a difference in the  working interest owners                                                               
for  the  maintenance  spending and  capital  infrastructure  and                                                               
those  types  of  things.  This  is  not  a  major  problem  with                                                               
progressivity  but  just  a  potential concern  that  he  saw  in                                                               
running through the scenario.                                                                                                   
                                                                                                                                
3:58:24 PM                                                                                                                    
SENATOR DYSON asked  why one of those companies  couldn't have an                                                               
opportunity  to increase  production significantly  with expenses                                                               
on their portion of the lease.                                                                                                  
                                                                                                                                
MR. PAWLOWSKI answered  that it goes back to  what Senator French                                                               
talked about; at  the margin things can be done  by an individual                                                               
company within a lease depending  on the actual structure of that                                                               
working interest in  the relationship of the  unit agreement, but                                                               
for  bigger decisions  having different  tax rates  with multiple                                                               
companies that  are all working  together can  potentially create                                                               
problems.                                                                                                                       
                                                                                                                                
SENATOR DYSON  asked if it's  not dependent  on what part  of the                                                               
field they own.                                                                                                                 
                                                                                                                                
MR.  PAWLOWSKI answered  no; their  individual  tax rates  depend                                                               
basically on  their overall activity  in Alaska not at  the field                                                               
level. So, in  that a company may have  different activities than                                                               
their other partners,  they will be in different  tax places, and                                                               
that creates an  interesting question of how  that actually works                                                               
in   practice  and   if  the   progressivity  creates   potential                                                               
misalignments.  He  said   the  administration  was  consistently                                                               
concerned  about where  the potential  misalignments  are in  the                                                               
current tax system.                                                                                                             
                                                                                                                                
SENATOR  DYSON said  he was  talking about  the different  leases                                                               
they own and whether or not they can produce more oil.                                                                          
                                                                                                                                
MR.  PAWLOWSKI said  he would  invite  Mr. Balash  to talk  about                                                               
actions within the units.                                                                                                       
                                                                                                                                
4:00:46 PM                                                                                                                    
JOE BALASH, Deputy Commissioner,  Department of Natural Resources                                                               
(DNR), said  that type of scenario  is one they may  have seen 15                                                               
years ago  with multiple  operators in the  same unit  at Prudhoe                                                               
Bay. But  after the merger  between BP and Arco  the operatorship                                                               
was  consolidated  into  the  hands  of  a  single  company.  His                                                               
understanding  of  how  the unit  operating  agreement  functions                                                               
between  the  owners  is  that  a  single  operator  carries  the                                                               
responsibility  of  the  day-to-day   business  and  then  brings                                                               
forward  projects  to  the  other  working  interest  owners  for                                                               
approval through the AFE process.                                                                                               
                                                                                                                                
4:01:45 PM                                                                                                                    
MR. PAWLOWSKI  made a  final observation that  the state  gives a                                                               
greater  incentive to  a company  spending money  at high  prices                                                               
than at lower  prices for the same expenditure -  the opposite of                                                               
what is  needed to  make projects  economic -  if you  are purely                                                               
looking  at it  from the  progressivity perspective  in terms  of                                                               
what the state is giving as a benefit.                                                                                          
                                                                                                                                
He   turned  to   another  example   of  what   happens  in   the                                                               
progressivity equation  when a  company cuts  its costs.  In this                                                               
example he  went back to  the $109.61/barrel (WC) and  instead of                                                               
increasing  spending he  cut spending  by $5/barrel.  So, $109.61                                                               
minus  the same  transportation costs  for a  gross value  at the                                                               
point  of  production  (GVPP)  of   $100.80.  The  same  Opex  of                                                               
$16.32/barrel  but this  time a  Capex of  $14.61 gives  a higher                                                               
production  tax   value  of  $69.87  than   the  initial  example                                                               
($64.87), but  all that  has changed  is the  $5 less  in capital                                                               
spending.  The base  tax goes  up to  $17.47 (25  percent against                                                               
$69.87 is more than 25 percent against $60.47).                                                                                 
                                                                                                                                
4:03:41 PM                                                                                                                    
In calculating  the progressivity,  he said  one starts  with the                                                               
production tax value  (PTV) of $69.87 minus $30  times .4 percent                                                               
resulting in a progressive tax  rate of 15.95 percent. Multiplied                                                               
against the  $69.87 results in  $11.14/barrel and adding  that to                                                               
the  base tax  results  in $28.61/barrel  production tax  (before                                                               
credits).                                                                                                                       
                                                                                                                                
Going back  to the first  example before  the $5 less  in capital                                                               
was spent; taxes were $25.27/barrel;  now they are $28.61/barrel.                                                               
Therefore, a reduction in capital  cost per barrel of $5 actually                                                               
leads to a  tax increase of $3.34/barrel.  With progressivity the                                                               
producer  keeps  $1.66  of  the   $5  in  cost  savings;  without                                                               
progressivity the  producer would  keep $3.75 of  the $5  in cost                                                               
savings.  The  purpose of  this  illustration  was to  show  that                                                               
cutting costs  and increasing  taxes can  lead to  distortions in                                                               
decision-making and behavior.                                                                                                   
                                                                                                                                
MR. PAWLOWSKI  said technology  allows one to  do the  same thing                                                               
cheaper, but with  progressivity that could actually  lead to tax                                                               
increases;  it's  just  the  nature of  the  mathematics  of  the                                                               
progressivity  itself.  It creates  the  same  effect as  cutting                                                               
costs  because   it  increases  the  production   tax  value  and                                                               
therefore, the progressive tax rate.                                                                                            
                                                                                                                                
He  said according  to the  administration's consultant,  similar                                                               
things that reduce  the production tax value reduce  the tax rate                                                               
and  there is  a  much  stronger incentive  to  keep costs  under                                                               
control without progressivity.                                                                                                  
                                                                                                                                
Next he  said Mr.  Stickel would walk  through what  happens when                                                               
there is a  major gas sale, which has been  talked about over the                                                               
years as "de-coupling."                                                                                                         
                                                                                                                                
4:05:51 PM                                                                                                                    
MR. STICKEL said  he picked a nice round number  for this example                                                               
of 1  bcf/gas/day at a price  of $8 and a  transportation cost of                                                               
$4.50/mmbtu.  On a  barrel of  oil equivalent  basis he  used the                                                               
ratio  of 6:1  oil  to gas  and this  would  just illustrate  one                                                               
potential set of  numbers for a gas sale to  show what the impact                                                               
of the gas sale is.                                                                                                             
                                                                                                                                
He explained that the average  price per barrel of oil equivalent                                                               
actually  drops  by  including  the  gas.  A  $48/barrel  of  oil                                                               
equivalent is the  gas destination value, and on a  barrel of oil                                                               
equivalent  basis,  the  transportation costs  increase  and  the                                                               
total  gross value  at  point  of production  per  barrel of  oil                                                               
equivalent  becomes  $79.79. With  the  same  per barrel  of  oil                                                               
equivalent  lease expenditures,  one's production  tax value  per                                                               
barrel of oil  equivalent under ACES drops to  $43.86 from $64.87                                                               
from  before  the  gas  sale;  the base  tax  (25  percent)  will                                                               
increase a little to $10.97.                                                                                                    
                                                                                                                                
4:08:10 PM                                                                                                                    
MR.  PAWLOWSKI  explained  that the  de-coupling  dilemma  was  a                                                               
problem that  was thoroughly discussed  in the  26th Legislature;                                                               
it  is  exacerbated  by   the  aggressive  net-based  progressive                                                               
function,  and it's  when a  high  value product  (light oil)  is                                                               
blended with  a low value  product (gas), because you  are moving                                                               
is  the blended  price  of the  two  commodities together,  which                                                               
walks through  the equation in the  relationship to progressivity                                                               
in the same way as a reduction in price would naturally.                                                                        
                                                                                                                                
Adding  the 1  bcf/gas/day (lower  value product)  to the  higher                                                               
value light  oil leads  to a  lower oil value  per barrel  of oil                                                               
equivalent  and functionally  reduces the  state revenues  before                                                               
credits from  $4,302,000,000 to $3,096,000,000. So,  bringing the                                                               
low value  gas on line  when you  have a net  based progressivity                                                               
reduces revenue  to the state.  The values are drug  down because                                                               
they are linked together.                                                                                                       
                                                                                                                                
4:09:42 PM                                                                                                                    
SENATOR MICCICHE referred to slide 17 with $109 ANS price.                                                                      
                                                                                                                                
MR. STICKEL  said they assumed  the $109  for the oil  being sold                                                               
and averaging  in the $8  per 1/btu gas; and  on a barrel  of oil                                                               
equivalent basis  the weighted average  price is $93.39.  The way                                                               
the ACES  tax works, if  you have a major  gas sale, that  gas is                                                               
converted  to  barrel  of  oil  equivalent  on  the  ratio  of  6                                                               
mmbtu/gas equal to 1 barrel of oil.                                                                                             
                                                                                                                                
MR.  PAWLOWSKI  said  what  they  see  happening  is  170,262,000                                                               
barrels   produced  at   $109.61/barrel;   then  they're   seeing                                                               
60,833,333 barrels of oil equivalent  produced at $48/barrel. So,                                                               
that lower  value gas blended  with the  higher value oil  is all                                                               
rolled together into  the net calculation which leads  to a lower                                                               
overall price for the total product stream.                                                                                     
                                                                                                                                
4:11:24 PM                                                                                                                    
SENATOR MICCICHE  asked why  transportation costs  go up  if they                                                               
are averaged together; it's a pretty substantial jump.                                                                          
                                                                                                                                
MR. PAWLOWSKI  replied because the cost  of moving the gas  is in                                                               
relationship to the  value of the gas much higher  than it is for                                                               
moving a  barrel of oil.  The tariffs  on any gas  pipeline would                                                               
generally  be much  higher  as  a portion  of  the  value of  the                                                               
product than  it is for moving  the liquid oil. In  this example,                                                               
they see transportation costs of  $4.50 on an $8/gas price versus                                                               
transportation costs of $8.81 for oil  on $109 price. It's just a                                                               
function of  it being much  more expensive  to move a  much lower                                                               
value product. And  when all of that rolls in  together, one sees                                                               
a  substantial  reduction  in  state  revenue  when  the  gas  is                                                               
produced alongside the  oil. That's because the  overall value of                                                               
all  of   it  has   been  brought  down   and  that   .4  percent                                                               
progressivity  moves  the total  value  down.  So rather  than  a                                                               
progressive tax  of 13.95 percent,  you move to a  regressive tax                                                               
of 5.55 percent.  And the tax rate drops  dramatically as opposed                                                               
to just producing the oil.                                                                                                      
                                                                                                                                
4:12:39 PM                                                                                                                    
His general  summary was that progressivity  is fundamentally not                                                               
simple, and that is because:                                                                                                    
-It  reduces the  cash  margin  per barrel  in  ways that  leaves                                                               
Alaska uncompetitive.  That is  where the  administration started                                                               
to look at the impacts of  progressivity. Once you are in the low                                                               
spending,  cash   generation  phase  of  these   long  life  time                                                               
projects, progressivity goes up.                                                                                                
-It is highly sensitive to  price, making it difficult to predict                                                               
for  the state  of  Alaska and  taxpayers. So  if  a taxpayer  is                                                               
looking  forward to  a  long term  investment,  any benefit  from                                                               
progressivity is  basically dependent  on what  the price  of oil                                                               
happens  to be  when that  investment is  made. It  may work  for                                                               
short term decisions, but not well for long ones.                                                                               
                                                                                                                                
SENATOR  BISHOP commented  that it  seems  that it  could take  a                                                               
common  sense approach  out  of when  a  producer would  actually                                                               
would want to do their front end  work to get more oil out of the                                                               
field, because  at high prices the  math doesn't work as  well as                                                               
at lower prices,  making it less advantageous to  develop a field                                                               
from the investor's perspective.                                                                                                
                                                                                                                                
MR. PAWLOWSKI  agreed and  added that the  higher prices  make it                                                               
worse than the  lower prices from the  investor's perspective. It                                                               
creates   misalignment  potentially   in  that   it  incentivizes                                                               
spending, because that short term  decision is easy to make under                                                               
the  progressive system.  The tax  rate is  changing monthly  not                                                               
annually and if an investor is looking  at a long term - 3-5 year                                                               
-Big spending investment, looking through  the lens of a tax rate                                                               
that is  changing monthly over  that entire time period  based on                                                               
oil prices which no one has any control over is not easy.                                                                       
-It creates  misalignments between working interest  owners based                                                               
on individual spending programs.                                                                                                
-It incentivizes  spending but  not necessarily  investments that                                                               
lead to production                                                                                                              
-It mutes the incentive to save costs or utilize technology.                                                                    
-It creates and exacerbates the de-coupling dilemma.                                                                            
                                                                                                                                
4:16:29 PM                                                                                                                    
SENATOR  MICCICHE  said  progressivity  exacerbates  it,  but  it                                                               
doesn't eliminate the  high cost of transportation  off the North                                                               
Slope.                                                                                                                          
                                                                                                                                
MR. PAWLOWSKI said that was correct.                                                                                            
                                                                                                                                
SENATOR  GIESSEL  thanked  Mr.  Pawlowski, Mr.  Stickel  and  Mr.                                                               
Balash.                                                                                                                         
                                                                                                                                
^Presentation: PFC Energy                                                                                                       
4:17:06 PM                                                                                                                    
CHAIR  GIESSEL  announced  the committee  would  next  hear  from                                                               
consultant  Janak  Mayer  with   PFC  Energy.  He  would  discuss                                                               
competitiveness and answer questions  that were submitted through                                                               
the  letter of  intent that  was written  by the  TAPS Throughput                                                               
Committee.  She  also mentioned  a  quote  from Jean  Colbert  an                                                               
economist and minister of finance  under King Louis XIV of France                                                               
in 1619,  that amused her:  "The art  of taxation consists  in so                                                               
plucking the  goose as to  get the  most feathers with  the least                                                               
hissing."                                                                                                                       
                                                                                                                                
4:18:00 PM                                                                                                                    
JANAK  MAYER, Upstream  Manager,  PFC Energy,  consultant to  the                                                               
Legislature on  oil and  gas taxation and  fiscal reform  for the                                                               
State of  Alaska, said that  PFC Energy consults  specifically in                                                               
the field of oil and gas.  They look at questions of above-ground                                                               
risk  in oil  and  gas operations  that covers  a  wide range  of                                                               
things from geopolitics to understanding  the dynamics of oil and                                                               
gas   markets,  supply   and  demand   in  different   countries,                                                               
commercial  strategies   of  major  national   and  international                                                               
companies,  and   questions  of  project  economics   and  fiscal                                                               
structures.                                                                                                                     
                                                                                                                                
4:19:50 PM                                                                                                                    
Putting things  in context,  Mr. Mayer  said he  would look  at a                                                               
couple of  very simple  sensitivities of  future cash  flows from                                                               
petroleum to the  State of Alaska that are  outside of government                                                               
take under  the fiscal system.  The biggest  one is the  price of                                                               
oil. For example  in a hypothetical world of a  steady $140 price                                                               
and looking  at the  current declining  forecast, revenue  to the                                                               
state from oil  and gas taxation could be as  high as $12 billion                                                               
a year or as  low as $2 billion. But a $60  price could create "a                                                               
massive variation that dwarfs everything  else that we might talk                                                               
about in terms of either  new production or fiscal systems change                                                               
or any of the rest."                                                                                                            
                                                                                                                                
SENATOR FRENCH asked if his state  take of at $140/barrel in 2022                                                               
figures were strictly ACES or royalty and everything else.                                                                      
                                                                                                                                
MR. MAYER answered they were the entire state take.                                                                             
                                                                                                                                
SENATOR  FRENCH  asked  him  to explain  his  comment  that  "the                                                               
potential  variation  is  even   greater  since  production  also                                                               
responds to price."                                                                                                             
                                                                                                                                
MR. MAYER  explained that this analysis  holds production steady,                                                               
but in  reality, production is  deeply respondent to price.  In a                                                               
low price environment  very few new projects  are economic, don't                                                               
get  sanctioned and  don't  go  ahead. Lots  of  things that  are                                                               
included  in the  current DOR  forecast  wouldn't go  ahead in  a                                                               
$60/barrel  sustained world:  wells become  non-economic earlier,                                                               
production  gets shut  in earlier  than it  would otherwise.  The                                                               
inverse  is true  in a  very high  price environment:  wells keep                                                               
producing longer,  it's worth investing  in new  liquids handling                                                               
capacity and other things that  currently constrain production in                                                               
a way that is not at  the moment. So, this already enormous range                                                               
of  future  revenues  is  much  greater  if  one  considers  that                                                               
production also responds to price.                                                                                              
                                                                                                                                
4:24:31 PM                                                                                                                    
He  said the  other  major  determinant is  the  level of  future                                                               
production  and   in  the  context   of  declining   North  Slope                                                               
production, the rate  of that decline. For  instance, rather than                                                               
the 6  percent decline forecast we  had only a 3  percent decline                                                               
or worse,  a 9  percent decline,  there is a  good $4  billion in                                                               
difference between those two possible 2022 worlds.                                                                              
                                                                                                                                
                                                                                                                                
SENATOR FRENCH  asked why he  started calculating  the production                                                               
at 2017, because  DOR forecasts a 2.6  percent production decline                                                               
between 2013 and 2014, 3.7 percent  between 2014 and 2015 and 3.6                                                               
percent decline  between 2015 and  2016, much lower  numbers than                                                               
he used. Aren't  the near numbers usually more  accurate than the                                                               
out numbers for production forecasts?                                                                                           
                                                                                                                                
MR.  MAYER  answered that  was  a  reasonable statement  but  the                                                               
furthest  out numbers  don't include  results  of exploration  or                                                               
other things,  which in  the right  price and  fiscal environment                                                               
might come  on line. The reason  he started at 2017  onward is by                                                               
thinking of this in the  purely hypothetical context if through a                                                               
fiscal change  it were possible  to stimulate new  production and                                                               
what  would be  a reasonable  timeframe  for that  to happen.  It                                                               
won't happen tomorrow, but it might happen by 2017.                                                                             
                                                                                                                                
4:27:06 PM                                                                                                                    
SENATOR FRENCH  commented that  as we  get out  that far  he just                                                               
wanted to  make sure we keep  our feathers in our  down comforter                                                               
and not in theirs.                                                                                                              
                                                                                                                                
MR. MAYER said he was thinking  about what sort of new production                                                               
would need to come  on line as a result of a  change to make back                                                               
lost revenue in the future.                                                                                                     
                                                                                                                                
4:28:48 PM                                                                                                                    
SENATOR  FRENCH  said  he  would  be  asking  for  these  numbers                                                               
constantly, because he  was very concerned about net  loss to the                                                               
state in reducing  oil taxes and he didn't know  that it could be                                                               
made up  given the time value  of money. You can  reduce taxes to                                                               
zero and  North Slope investment can  go crazy at the  same - and                                                               
the State of Alaska starves.                                                                                                    
                                                                                                                                
MR.  MAYER  said it's  the  most  the  important question  to  be                                                               
asking, but  unsatisfactorily there is  an enormous limit  to the                                                               
science, but  one can take the  science further than it  has been                                                               
taken so far.                                                                                                                   
                                                                                                                                
SENATOR  MICCICHE said  fiscal terms  can  artificially create  a                                                               
high or  low cost environment  and asked if he  considered fiscal                                                               
terms in creating his analysis.                                                                                                 
                                                                                                                                
MR. MAYER responded  that fiscal terms either  improve or detract                                                               
from  project economics  and that  is why  they were  having this                                                               
discussion;  and this  is a  hypothetical about  if the  proposed                                                               
change  was  sufficient  enough in  terms  of  improving  project                                                               
economics to  create substantial future production  and what that                                                               
might look like in terms current revenues.                                                                                      
                                                                                                                                
4:31:24 PM                                                                                                                    
Inherent to this  discussion is oil price. It's not  only the key                                                               
determinant of Alaska's future revenues,  it was in many ways the                                                               
substance of  the last presentation about  progressivity, because                                                               
Alaska currently  has a highly  progressive system  that responds                                                               
very  dramatically  to changes  in  oil  price. It  seemed  worth                                                               
presenting  a few  slides about  the question  of the  global oil                                                               
price environment  in the future and  if it will be  $200 or $60.                                                               
There  is  no such  thing  as  an  accurate oil  price  forecast,                                                               
because ultimately no  one knows, but they can  talk about trends                                                               
and the  major structural factors  shifting things in one  way or                                                               
another  that might  lead  to an  over  or under-supplied  global                                                               
trade market.                                                                                                                   
                                                                                                                                
It's  also of  relevance, Mr.  Mayer said,  because it  ties into                                                               
something  else that  is a  key  factor in  talking about  fiscal                                                               
systems,  which is  the biggest  shock of  the last  five or  ten                                                               
years: the dramatic  change in production in  North America. It's                                                               
relevant  both  because  the  fixed  royalty  is  relatively  low                                                               
particularly at  high price  jurisdictions in  the Lower  48 that                                                               
are key  competitors at  the moment  for investment  dollars, and                                                               
the  production  coming  from  that has  the  potential  to  have                                                               
significant impact on prices in  the future. In 2003 through 2005                                                               
dollars harvested  in North America were  reinvested elsewhere in                                                               
the world  (major international  companies in  Sub-Sahara Africa)                                                               
and paying back shareholders.                                                                                                   
                                                                                                                                
In the last recent couple  decades, suddenly, North America is an                                                               
overall investment  destination among  international oil  and gas                                                               
companies,   because   of   the   extraordinary   revolution   in                                                               
unconventional production  like the shale  play and oil  sands in                                                               
Canada, but not in Alaska.                                                                                                      
                                                                                                                                
4:35:51 PM                                                                                                                    
MR. MAYER explained  in the context of the overall  profile of US                                                               
oil production US over the  last more than half century (referred                                                               
to  by PFC  as the  Great American  Energy Reset)  was in  steady                                                               
decline since the  late 1960s. The extraordinary  reverse in that                                                               
trend came from the technological  revolution in shale production                                                               
combined with high oil prices. The  sorts of growth coming out of                                                               
the Lower 48  combined with what PFC sees coming  on line between                                                               
now and 2020 is really comparable  and greater than the growth in                                                               
production that occurred in the post war years.                                                                                 
                                                                                                                                
4:37:07 PM                                                                                                                    
SENATOR MICCICHE asked  if he knew the decline  rate generally in                                                               
US energy from 1984 until 2007/8.                                                                                               
                                                                                                                                
MR. MAYER answered  that he didn't have that  information. In the                                                               
context of  what this means  for future  oil prices in  the world                                                               
market for crude, demand comes  from final products, whether that                                                               
is in  the form of transportation  fuels or from being  in almost                                                               
every economic  good that  anyone uses,  and from  the refineries                                                               
ultimately.  How that  demand is  met could  be described  as two                                                               
buckets of  supply: all  of the supply  that comes  from non-OPEC                                                               
countries without a  say in the price versus  the large producing                                                               
countries that  coordinate output  through the auspices  of OPEC,                                                               
but  as a  result have  some degree  of say  in setting  what the                                                               
future price of oil will be.                                                                                                    
                                                                                                                                
4:39:21 PM                                                                                                                    
In looking  at the  structural factors in  the world  oil market,                                                               
Mr. Mayer  explained that first  one looks  at what is  coming on                                                               
line in  non-OPEC sources  over the  foreseeable future  and what                                                               
that means  for the OPEC  crude and  the sorts of  decisions that                                                               
OPEC  is going  to be  making, and  one sees  quite extraordinary                                                               
growth based on projects that  have been sanctioned and coming on                                                               
line over  the next decade and  more. That comes from  a range of                                                               
sources: a substantial  wedge is in oil shale, a  lot of which is                                                               
in North  America, and some oil  sands in Canada along  with less                                                               
obvious sources of growth in  natural gas liquids and condensates                                                               
that actually come from OPEC  producing countries but aren't part                                                               
of  OPEC (places  like  the  enormous fields  that  will soon  be                                                               
coming on  line in the deep  water Pre-salt off of  Brazil) and a                                                               
range of  sources of  new production coming  on line  between now                                                               
and 2020  and 2025, that  will create substantial  challenges for                                                               
OPEC as they look to coordinate and balance supply and demand.                                                                  
                                                                                                                                
SENATOR FRENCH asked him to  explain the subheading on slide that                                                               
says, "In the past production  not affected by price swings," and                                                               
why  that  isn't   a  contradiction  with  slide   2  saying  how                                                               
production also responds "deeply" to price.                                                                                     
                                                                                                                                
4:40:58 PM                                                                                                                    
MR.  MAYER  answered  that that  particular  subheading  was  put                                                               
together by an  oil markets colleague and he would  like to defer                                                               
that answer  to him. But in  part it's the balancing  function in                                                               
world oil market that the past  has not been a factor of non-OPEC                                                               
supply;  it's been  much more  a question  of delivery  policy by                                                               
OPEC-producing countries.  Those delivery decisions are  not made                                                               
on  project economics;  they're  made on  the  interests of  OPEC                                                               
producing countries  and are not  a function of whether  they can                                                               
economically produce but  rather what level of  revenue they need                                                               
to balance their budget's external deficit.                                                                                     
                                                                                                                                
SENATOR  DYSON  asked what  makes  the  makers  of the  chart  so                                                               
optimistic about biofuel growth.                                                                                                
                                                                                                                                
MR. MAYER  answered the  substantial growth one  sees so  far and                                                               
the   fact   that   biofuels  is   reaching   a   turning   point                                                               
technologically  speaking, and  moving  from corn  and soy  based                                                               
products  that have  relatively  limited net  energy value  after                                                               
accounting for the  fossil fuels that went into  creating them to                                                               
crops that don't compete with food crops from grass to algae.                                                                   
                                                                                                                                
4:44:27 PM                                                                                                                    
He said that  shale was a relatively small wedge  of the total in                                                               
rising non-OPEC  supply, but  to view  it in  the context  of the                                                               
traditional  role  of Saudi  Arabia  in  balancing the  world  by                                                               
either increasing or decreasing  production to meet certain price                                                               
level  goals,  shale oil  is  now  forecast  to reach  4  million                                                               
barrels by  the end  of the  decade, which  is almost  double the                                                               
last Saudi supply  swing. It's interesting to think  about in the                                                               
context of  shale as  a form of  production that  is particularly                                                               
respondent to oil price, because  it consists of drilling so many                                                               
relatively  small  low producing  wells  that  have high  initial                                                               
production and  decline very dramatically  - so that the  way one                                                               
maintains  shale production  is  by drilling  and drilling.  That                                                               
means that shale more than any  other resource is respondent in a                                                               
very short  timeframe to oil  pricing - because you  either drill                                                               
or you don't depending on whether  it's economic to do so or not.                                                               
In that sense, shale oil  production joins the ranks of potential                                                               
short   term  global   oil  supply/demand   balances  that   were                                                               
traditionally either  made up  of Saudi  Arabia producing  or not                                                               
producing  or things  like the  International LNG  Association or                                                               
the US Strategic Petroleum Reserves  stocks. PFC thinks that OPEC                                                               
has yet to  grasp the scale of  its impact on its role,  as it is                                                               
only  now  beginning  to  address   the  consequences  of  rising                                                               
production in Iraq.                                                                                                             
                                                                                                                                
4:46:25 PM                                                                                                                    
MR. MAYER  said that Iran  has recently decreased  its production                                                               
as  a result  of sanctions.  If that  is held  flat for  the next                                                               
several years and  looking at what will come on  line out of Iraq                                                               
over that  period and the  coming shock  of all the  new non-OPEC                                                               
supply  coming onto  the market  between now  and 2020,  means if                                                               
Saudi Arabia  were to  take its traditional  approach and  be the                                                               
country  (because it  has the  lowest cost  of production)  to be                                                               
able to  swing with demand and  absorb it all they  would have to                                                               
go from  producing 9 million  barrels/day to producing  5 million                                                               
barrels/day,  which is  hard  to see  how they  will  be able  to                                                               
economically  do so.  And if  they aren't,  that has  substantial                                                               
implications for  the direction of  crude prices between  now and                                                               
2025.                                                                                                                           
                                                                                                                                
4:47:52 PM                                                                                                                    
He related that  as US production has more impacts  on oil price,                                                               
particularly  shale,  that  also   in  many  ways  increases  the                                                               
volatility of where things could  head - both about the immediate                                                               
responsiveness  of  shale  production  to changes  in  the  price                                                               
signal but  also because  of how  easy it is  to be  disrupted in                                                               
some  ways, because  the very  steep decline  from an  individual                                                               
shale well  can be 50-60  percent in  the first year.  This means                                                               
one has  to keep drilling  and as  you keep drilling  the overall                                                               
decline in terms  of annual production gets  steadily steeper and                                                               
compounds. He  showed a slide of  the Bakken Shale by  vintage of                                                               
wells drilled that illustrated how  more wells have to be drilled                                                               
every year  in order  to keep the  production growing  along with                                                               
changes in things like the  price that can lead very dramatically                                                               
to  an  immediate change  in  production  in  a way  that  hasn't                                                               
necessarily been the case in the past.                                                                                          
                                                                                                                                
Someone  asked what  a breakeven  price for  shale production  in                                                               
Lower 48  is and the  short answer is  there is on  one breakeven                                                               
price for  shale production in the  Lower 48, and Mr.  Mayer said                                                               
there is an extraordinary variation.  The reason for that is that                                                               
while it generally costs about $8  million to drill a shale well,                                                               
what you  get for that  varies "massively" depending on  where in                                                               
the play you are drilling it  and the initial productivity of the                                                               
well that you get as a result.                                                                                                  
                                                                                                                                
MR. MAYER said if one separates  wells drilled - for instance, in                                                               
the Bakken  - into quintiles of  the most productive down  to the                                                               
least  productive, the  most productive  well it  makes sense  to                                                               
drill even at  $41 or $44 in  the Bakken if you  include the cost                                                               
of the  acreage that goes  with the  well. It doesn't  make sense                                                               
for the least productive until prices  are north of $126. That is                                                               
simply  a   function  of  the  enormous   variation  and  initial                                                               
productivity that comes with these wells.                                                                                       
                                                                                                                                
SENATOR  FRENCH said  they were  given  several presentations  on                                                               
Capex and Opex costs in the  Bakken and asked how this jibes with                                                               
the Opex and  Capex cost estimates of $21/barrel all  in in North                                                               
Dakota and the Bakken.                                                                                                          
                                                                                                                                
MR. MAYER  replied that these  are phrased in different  and more                                                               
granular terms, the more granular  terms being used to create his                                                               
estimate  of $8  million -  more or  less -  to drill  a well  at                                                               
certain fixed  and variable  costs to operate  it. He  also noted                                                               
that  this more  granular analysis  considered that  both acreage                                                               
and  royalty rates  vary dramatically  across the  plane of  well                                                               
productivity and  a highly productive,  highly economic  well can                                                               
support a royalty rate  of up to 18 percent in  the Bakken and up                                                               
to 25 percent in the Eagleford and premium costs for acreage.                                                                   
                                                                                                                                
A lower productivity  well can support acreage  costs and royalty                                                               
rates that  are much  lower than  that, because  no one  would be                                                               
willing to  pay them. That is  also the case at  Eagleford in the                                                               
context of fiscal  systems benchmarking, because a  lot of people                                                               
look at  reports of 25 percent  or higher royalty in  some of the                                                               
shale  plays  and   think  that  is  actually   quite  a  serious                                                               
government take. The comparison is  only partly fair because only                                                               
a very  limited number of  leases get signed with  royalty rates,                                                               
because only  a very limited number  of leases have the  sorts of                                                               
economics that can support them.                                                                                                
                                                                                                                                
SENATOR FRENCH said he wasn't  sure he understood that answer and                                                               
it sounds  like this is an  overly simplistic view -  to give him                                                               
one fixed Capex and Opex when  he sees a much broader range given                                                               
the productivity of the wells.                                                                                                  
                                                                                                                                
MR. MAYER  responded that there  is almost  no range on  the cost                                                               
front. It's  going to cost on  the order $7.5 million  to drill a                                                               
well  in  the  Eagleford  whether  or  not  it's  productive  and                                                               
operating costs will be similar.  But Senator French was right on                                                               
a  per  barrel  basis,  those  costs  being  greater  for  a  low                                                               
productivity well than for a  high productivity well, because the                                                               
barrels over  which those costs  are amortized  are substantially                                                               
different.  His analysis  took a  particular average,  probably a                                                               
second quintile well, and generalized it.                                                                                       
                                                                                                                                
4:54:37 PM                                                                                                                    
A third example  for a more marginal play where  you need to have                                                               
a first quintile  well at current prices to be  worth drilling is                                                               
the Granite Wash  in the Panhandle of Texas. What  this means for                                                               
future crude prices,  Mr. Mayer said they could  think about this                                                               
in terms of sources of  potential upside and sources of potential                                                               
downside.  On the  upside, strong  globally economic  growth will                                                               
obviously lead  to strong demand  and a  tightening supply/demand                                                               
balance  and upward  pressure on  prices;  similarly whether  the                                                               
various  geopolitical  events  could remove  substantial  barrels                                                               
from the  market (another Libya-type  event or  a confrontation);                                                               
lots of  things could lead to  enormous spikes in the  oil prices                                                               
and sustain prices that are higher.                                                                                             
                                                                                                                                
He said  there are also an  enormous number of downside  risks to                                                               
the  oil  price  outlook.  The "American  energy  reset"  was  an                                                               
enormous boom in US production  that is now supporting production                                                               
from most  of the  world's incredible  demand growth  and leaving                                                               
relatively  little   room  for   additional  growth   from  other                                                               
countries.  And  there is  probably  greater  likelihood at  this                                                               
point of  economic slowdown whether  because of  ongoing weakness                                                               
in  the Eurozone,  here in  the  US and  China than  there is  of                                                               
enormously robust  global growth (the  challenges he laid  out in                                                               
terms of the  difficulties ahead for OPEC's  traditional role and                                                               
what they do in the wake of all the new non-OPEC supply).                                                                       
                                                                                                                                
With specific relevance  to Alaska, Mr. Mayer said,  there is the                                                               
question of  if it will continue  to receive the premium  of WTI,                                                               
for instance, that  it has received for the last  couple of years                                                               
as WTI has traded at a  discount to Brent or could various things                                                               
combine to mean  that actually that US WTI  discount extends more                                                               
broadly  across the  country. There  are a  number of  things, at                                                               
least  in a  world  and in  the US  where  production growth  was                                                               
robust  enough that  it could  increasingly meet  its own  demand                                                               
that can cause that to be the case.                                                                                             
                                                                                                                                
SENATOR  BISHOP  asked  what  inflation in  Europe  does  to  oil                                                               
production.                                                                                                                     
                                                                                                                                
MR.  MAYER replied  that ultimately  economics of  oil production                                                               
are economics in real terms  rather than nominal terms. Inflation                                                               
may impact  the price in  which barrels are equated,  although US                                                               
inflation has a much bigger impact  on that than anything, but it                                                               
doesn't change  the fundamental  economics of  whether production                                                               
is economic  or not.  Demand affects price,  but that  is several                                                               
steps  removed   from  inflation  unless  one   gets  into  "very                                                               
difficult territory."                                                                                                           
                                                                                                                                
4:58:24 PM                                                                                                                    
Finally, in  response to  a particular question  he was  asked in                                                               
the other chamber,  but is relevant in thinking  about this, was:                                                               
What is  the potential  floor for  ANS West  Coast crude?  In the                                                               
short term,  you could see  prices in the $30/barrel  range. It's                                                               
not  absurd to  think about  where prices  have been  between May                                                               
2008 and now. A chart of  prices ordered highest to lowest showed                                                               
the  relative  lengths of  time  in  no particular  chronological                                                               
order that have been spent  at different price levels. Obviously,                                                               
on the  furthest right, dips  occurred around late  2008/09 where                                                               
price levels got down to the  $40s. Prices that low would require                                                               
substantial global oversupply like  a combination of OPEC getting                                                               
things completely  wrong in terms  of managing supply  and demand                                                               
and booming US production. And  the oil price wouldn't stay there                                                               
for  long, because  to begin  with,  as seen  from the  breakeven                                                               
prices on  shale, there is no  shale production that is  going to                                                               
be economic at those prices  and production would rapidly fall in                                                               
a short period of time.                                                                                                         
                                                                                                                                
In  the  medium  to  long   term,  assuming  the  US  remains  an                                                               
integrated part  of a global crude  oil market, it's hard  to see                                                               
crude  oil prices  go much  lower  than $70/barrel  as the  lower                                                               
possible limit to where crude oil prices could go.                                                                              
                                                                                                                                
5:01:33 PM                                                                                                                    
He said there five key problems with ACES:                                                                                      
-  One is  that overall  high levels  of government  take reduces                                                               
competitiveness for capital especially at high prices.                                                                          
- The  high marginal  tax rates  reduces incentives  for spending                                                               
control.                                                                                                                        
-  The  complexity  of  the   system  makes  meaningful  economic                                                               
analysis and comparison relatively difficult.                                                                                   
- There is  significant state exposure in  low price environments                                                               
at high-cost developments.                                                                                                      
-  The  impact  of  large-scale  gas  sales  have  a  substantial                                                               
potential impact on tax rates in  a way that seems like something                                                               
that one would design out of intention.                                                                                         
                                                                                                                                
5:03:21 PM                                                                                                                    
Benchmarks:                                                                                                                     
At  $80/bbl,  ACES is  at  the  highest  end of  government  take                                                               
compared to other  jurisdictions in the OECD or  anywhere else in                                                               
the  U.S.  in terms  of  conventional  production, although  it's                                                               
quite  possible unconventionals  might see  high government  take                                                               
solely because  of the relatively higher  cost structure compared                                                               
to  conventional  production  -  combined with  a  fixed  royalty                                                               
(which,  because it's  a  regressive regime,  means  that at  low                                                               
prices and high costs you can get high government take).                                                                        
                                                                                                                                
At $80/bbl for a new development  on a standalone basis (not part                                                               
of the overall  cash flow of an existing  producing company) ACES                                                               
is already  the second  highest level of  government in  the OECD                                                               
and  above the  average for  production sharing  contracts around                                                               
the world.  Testimony on the  question of progressivity  from the                                                               
department prior  to this presentation indicated  that government                                                               
take is  substantially lower for  an existing producer.  This has                                                               
been modeled  with two reasons for  that in mind: the  biggest is                                                               
the  question  of the  impact  of  being  able to  claim  capital                                                               
expenditures (in  this case just  capital expenditures  from base                                                               
production not  from new  development because  that is  not being                                                               
included) but against  your tax liability. Another  source of the                                                               
difference is  that consistent  with the  approach that  Econ One                                                               
takes, which is sensible, they  have included for new development                                                               
a 16.67  percent royalty rather  than the 12.5 percent,  which is                                                               
more common on  the base, and which accurately  reflects what one                                                               
sees in the actual data under ACES.                                                                                             
                                                                                                                                
SENATOR FRENCH asked  if any of his models take  into account the                                                               
effects  of  royalty  modifications   that  are  available  if  a                                                               
development is shown to be stressed financially.                                                                                
                                                                                                                                
MR. MAYER replied no; and  at $80/bbl most developments would not                                                               
have royalty relief.                                                                                                            
                                                                                                                                
SENATOR  FRENCH  said the  reason  they  don't see  much  royalty                                                               
relief  is   because  they  couldn't  demonstrate   any  economic                                                               
difficulty to the DNR - basically.                                                                                              
                                                                                                                                
MR.  MAYER replied  that  might be  the case.  This  is only  one                                                               
metric  among many  that  are  important as  a  way of  comparing                                                               
regimes for competitiveness where Alaska stands.                                                                                
                                                                                                                                
SENATOR FRENCH said he would probably  ask him to run some graphs                                                               
with royalty  relief, because it  might be instructive  for folks                                                               
to be able to  see how much you can move down  in take if royalty                                                               
relief is granted.                                                                                                              
                                                                                                                                
CHAIR GIESSEL  said Alaska doesn't  offer much royalty  relief in                                                               
reality.                                                                                                                        
                                                                                                                                
MR. MAYER  replied to the  extent that Alaska does  offer royalty                                                               
relief, it's not unique among  any jurisdictions in doing so, but                                                               
it's not  something that would be  very easy to model  since it's                                                               
more about  specific circumstances than something  one can easily                                                               
run through a model.                                                                                                            
                                                                                                                                
5:08:22 PM                                                                                                                    
MR. MAYER said  ACES at $100/bbl for a new  development and 16.67                                                               
percent royalty is substantially above  Norway and is the highest                                                               
in  the OECD  and  getting  into the  company  of countries  like                                                               
Angola,  Turkmenistan,  and  Azerbaijan. ACES  for  the  existing                                                               
producers  moves up  to  the  second highest  in  the OECD  after                                                               
Norway,  and is  approaching the  average for  production sharing                                                               
contracts regimes  around the world.  ACES for a  new development                                                               
is now close to Norway, but  only because Norway has moved up not                                                               
the  other way  around; for  an existing  producer second  in the                                                               
OECD behind  Norway and above  the overall average at  that price                                                               
level.                                                                                                                          
                                                                                                                                
5:09:03 PM                                                                                                                    
At  $120/bbl, ACES  for a  new  development is  close to  Norway,                                                               
again, but  only because Norway  has moved  up and not  the other                                                               
way around,  and for an existing  producer - again second  in the                                                               
OECD behind  Norway and above  the overall overage at  that price                                                               
level for production sharing contract regimes.                                                                                  
                                                                                                                                
5:09:40 PM                                                                                                                    
MR. MAYER  moved to  Senator French's  question about  net income                                                               
per barrel for  ConocoPhillips because they are  the only company                                                               
that splits  out Alaska as  a separate reporting region  and said                                                               
that these are not all  of ConocoPhillips reported categories (he                                                               
selected the  major ones and  particular ones for which  there is                                                               
more time series for a  backward look). The biggest comparison is                                                               
how much  higher the net income  per barrel in Alaska  is than it                                                               
is in the Lower 48 and  why ConocoPhillips is investing there and                                                               
not here. In answer to that he  said the net income per barrel in                                                               
Alaska  is  comparable   to  what  net  income   per  barrel  for                                                               
ConocoPhillips  is in  many other  parts  of the  world. But  the                                                               
first thing  to notice is that  the stacked bars add  up to total                                                               
revenue supporting  the categories  of income,  production taxes,                                                               
operating    costs,   depletion,    depreciation,   amortization,                                                               
exploration  expenses and  finally -  once all  those things  are                                                               
taken out - what's left is income per barrel for the producer.                                                                  
                                                                                                                                
So, the first  thing you notice is that the  biggest reason for a                                                               
difference  in net  income  per barrel  of  oil equivalent  (BOE)                                                               
between Alaska and  the Lower 48 for ConocoPhillips  is that they                                                               
get half of the  revenue from a BOE in the Lower  48 that they do                                                               
in  Alaska  and  the  reason   is  that  ConocoPhillips/Lower  48                                                               
production is  overwhelmingly gas  as opposed to  almost entirely                                                               
oil in  Alaska. That in turn  is a function of  various decisions                                                               
including  the  particularly  ill-fated   one  to  have  acquired                                                               
Burlington Resources in the middle  of the last decade and having                                                               
paid a premium  price at the top  of the gas price in  the U.S. -                                                               
seeing an  ongoing heavy demand for  gas and not seeing  what was                                                               
about  to come.  As a  result they  have a  very heavy  gas-based                                                               
portfolio that doesn't  produce a lot of revenue  for each barrel                                                               
of oil equivalent.                                                                                                              
                                                                                                                                
5:12:25 PM                                                                                                                    
This   comparison  tells   you  little   to  nothing   about  new                                                               
investment.  If  the question  is,  given  how much  greater  net                                                               
income  per barrel  is in  Alaska than  in the  Lower 48  and why                                                               
ConocoPhillips isn't  therefore doing more of  that, the question                                                               
is  doing  more  of  what. To  begin  with  ConocoPhillips  isn't                                                               
invested  in  the  Lower  48 because  the  senior  management  is                                                               
deranged and  wants to destroy  its value; it's because  they see                                                               
enormous opportunities  in liquid rich plays  that have economics                                                               
that  are  very   different  than  the  base   portfolio  of  gas                                                               
production.                                                                                                                     
                                                                                                                                
Similarly, if one  looks at their relatively high  net income per                                                               
BOE  in  Alaska and  asks  why  they  wouldn't want  more  mature                                                               
largely depreciated  assets that were  all paid for 20  years ago                                                               
and are now harvesting a nice  cash flow, there isn't any more of                                                               
that. And  by definition, mature  regions produce  income because                                                               
the costs were paid 30 years  ago and most of the depreciation is                                                               
gone and you  get relatively a lot of income  from them. But that                                                               
is  not  indicative  of  what   the  opportunities  are  for  new                                                               
investment in  new projects. Yes,  ConocoPhillips net  income per                                                               
BOE  is  relatively high  in  Alaska  versus  the Lower  48,  not                                                               
particularly  remarkable compared  to other  regions, and  not at                                                               
all indicative  of the question  of economics in  new investment,                                                               
which is  why they  are currently  investing enormous  amounts in                                                               
liquids or shale plays in the Lower 48 and less so here.                                                                        
                                                                                                                                
5:14:31 PM                                                                                                                    
SENATOR MICCICHE asked if he hadn't  been able to determine a way                                                               
to give them a comparison based  on barrel of oil (BO) as opposed                                                               
to BOE.                                                                                                                         
                                                                                                                                
MR.  MAYER  responded  if  one  is to  limit  one's  analysis  to                                                               
publically  available  data,  the  way  companies  report  is  by                                                               
revenue overall;  however, they  report production by  oil versus                                                               
gas. So, there  isn't a good way for publically  reported data to                                                               
split where the revenue comes from.                                                                                             
                                                                                                                                
SENATOR  MICCICHE said  the legislature  uses  these numbers  and                                                               
they are  displayed on  the paper as  though they  mean something                                                               
that they  should consider, and it  would be nice to  have apples                                                               
to apples for a comparison.                                                                                                     
                                                                                                                                
MR. MAYER replied  that this data comes from  a subscription set,                                                               
a  service  that  PFC  Energy   offers,  which  is  precisely  by                                                               
comparing international oil companies to  each other and it would                                                               
be  very  nice to  be  able  to  compare  apples to  apples,  but                                                               
unfortunately  the  nature  of  comparing  companies'  publically                                                               
reported data is  that it's very rarely possible and  you have to                                                               
make the best of what you can do.                                                                                               
                                                                                                                                
SENATOR  DYSON asked  when the  equipment in  a mature  field has                                                               
been depreciated  if the  owner can  write that  depreciation off                                                               
against their  income taxes along with  non-depreciated equipment                                                               
that got a huge deduction against their business taxes.                                                                         
                                                                                                                                
5:17:06 PM                                                                                                                    
MR.  MAYER  said  that  was   correct,  but  on  the  other  hand                                                               
depreciation  also   reduces  your   taxable  income,   which  is                                                               
ultimately  effectively the  same  as what  is  reported here  in                                                               
terms  of net  income  per  barrel. In  that  sense,  one of  the                                                               
reasons why  the Lower  48 looks  bad other  than the  much lower                                                               
revenue that is being received  is because there is substantially                                                               
more depreciation.                                                                                                              
                                                                                                                                
He  moved on  to  the question  of high  marginal  tax rates  and                                                               
incentives  for   spending  control.   To  look  simply   at  the                                                               
production tax  component of the  regime, ACES has  two different                                                               
steps of  progressivity: the  .4 percent  rate that  extends from                                                               
$30/barrel of  production tax  value to  the shallower  rate that                                                               
starts at $92.50/barrel of production  tax value. Because it's an                                                               
unbracketed system, every dollar  increase in the price increases                                                               
the  rate that  is  applied to  all of  the  previous dollars  of                                                               
production and  you get an  slightly counterintuitive spike  in a                                                               
very high marginal rate of tax  so that every dollar of oil price                                                               
increase very dramatically  increases your tax rate  to the point                                                               
that  the marginal  dollar between  $91/barrel of  production tax                                                               
value  and  $92/barrel of  production  tax  value essentially  is                                                               
taxed  at a  marginal  rate  that is  close  to  90 percent.  So,                                                               
movements along  the price curve  in either direction  from there                                                               
have a  dramatic impact on  the level of  tax that is  paid. That                                                               
means because production tax value is  not on the oil price, that                                                               
there  are various  ways of  moving along  that curve.  One is  a                                                               
change in  the oil price; another  is a change in  costs that can                                                               
be  deducted to  reduce production  tax value  per barrel,  which                                                               
lets one  shift down that steep  curve and into a  lower marginal                                                               
and average  rate of tax.  This point was particularly  well made                                                               
by  Econ One  in  their presentation  two days  ago  on slide  23                                                               
modeling additional  spending given  an initial  background level                                                               
of spending and  what that does to a producer's  tax liability in                                                               
different  oil price  environments and  how enormously  different                                                               
that impact is  at higher oil price environments,  such that when                                                               
you reach  $120/barrel that 95  percent, effectively on  an after                                                               
tax  basis,  has  been  essentially recouped  as  a  function  of                                                               
reduction in  tax. So  that, in  particular for  relatively small                                                               
limited term spending  (that can be financed from  the cash flows                                                               
of the  business unit) it doesn't  need to be evaluated  in terms                                                               
of performance in  a wide range of economic  environments and the                                                               
fundamental economics  of a  project, it's easy  to see  why this                                                               
can  provide a  significant  incentive  for undertaking  projects                                                               
that  one might  not otherwise  undertake if  one had  to finance                                                               
their cost.                                                                                                                     
                                                                                                                                
5:20:21 PM                                                                                                                    
SENATOR FRENCH  asked if he was  aware of any projects  on planet                                                               
earth  as  an  example  of   how  industry  is  taking  "perverse                                                               
incentives" and wasting money on the North Slope.                                                                               
                                                                                                                                
MR. MAYER replied no; it's much  easier to look at incentives. In                                                               
terms of  gold plating, a  good example  of a regime  designed to                                                               
encourage  gold  plating  spending was  a  particular  production                                                               
sharing contract in India that is  a subject of challenges by the                                                               
Indian  government. It  gets very  difficult even  at that  level                                                               
when there  is a particular  accusation to  get down to  say this                                                               
was  accurate spending  or not.  It's almost  never possible  for                                                               
governments  to identify  what was  reasonable spending  and what                                                               
wasn't, because they  don't have the resources or  capacity to do                                                               
so.  What can  be done  is try  to design  a regime  that doesn't                                                               
incentivize it in the first place.                                                                                              
                                                                                                                                
5:22:19 PM                                                                                                                    
SENATOR FRENCH  commented that  he was  afraid that  regime would                                                               
leave him without many feathers.                                                                                                
                                                                                                                                
MR.  MAYER  said  on  the  question of  complexity  and  why  the                                                               
economics of  new developments don't  that look fantastic  for an                                                               
existing  producer and  as a  result  why they're  not all  madly                                                               
investing  in every  opportunity that  they get,  one interesting                                                               
comparison is looking at a  new development on a standalone basis                                                               
versus   an   incremental   capacity  (50   million   barrel/day,                                                               
$16/barrel Capex) development - taking  the costs and revenues of                                                               
an  existing  base  producing  company,  layer  on  the  cost  of                                                               
revenues of the  new development, and run that  through the model                                                               
and get  the cash  flow results,  then compare  that to  the cash                                                               
flow  results from  just base  production and  subtract the  base                                                               
production  from the  combined and  look at  the difference.  His                                                               
charts looked  very similar to Econ  One charts in terms  of what                                                               
different metrics look  like on an incremental basis.  One sees a                                                               
small  significant  difference in  government  take,  but a  more                                                               
substantial  difference  in  present  value, but  then  there  is                                                               
enormous difference in internal rate  of return: the basic reason                                                               
being that  viewed on the  incremental basis when  you're looking                                                               
at the impact  of spending after tax what you're  looking is "buy                                                               
down" or  the ability of  spending to lower  the tax rate  on the                                                               
base  production.  Because  of  the  cash flows,  a  lot  of  the                                                               
spending is being returned in the  form of lower tax, despite the                                                               
fact  that  there may  be  high  government take  and  therefore,                                                               
relatively  little cash  flows from  the investment.  Overall you                                                               
can  get  a  high  internal  rate  of  return,  because  actually                                                               
engineering one  isn't very  difficult. You  just need  to reduce                                                               
the  initial  capital  to  a  point.  That  doesn't  mean  you're                                                               
creating a project with large  amounts of economic value; it just                                                               
means  that you're  on an  after tax  basis investing  relatively                                                               
little enough  that the  limited cash flows  you get  provide you                                                               
with a high internal rate of return.                                                                                            
                                                                                                                                
5:25:57 PM                                                                                                                    
SENATOR  FRENCH  asked if  this  was  the difference  between  an                                                               
incumbent producer and a new producer.                                                                                          
                                                                                                                                
MR. MAYER  replied yes.  The most important  thing about  this is                                                               
that incremental economics are important  for a range of reasons:                                                               
they are important to companies but  they are vital to the state,                                                               
because  from  the state's  perspective  it  really is  foregoing                                                               
revenue  compared to  what it  would  otherwise get  of the  high                                                               
level of  government take  under ACES  in return  for investment.                                                               
The question  is what it  gets for that.  And the reason  he says                                                               
incremental  analysis is  important  but not  the  only thing  is                                                               
because  it's absolutely  one  thing that  companies  look at  in                                                               
making investment decisions.                                                                                                    
                                                                                                                                
He  stressed that  oil companies  look  for two  things and  that                                                               
ultimately they are  in the business of putting  large amounts of                                                               
capital to  work in  order to  get large  amounts of  future cash                                                               
flow from  those large and  efficient investments. The  fact that                                                               
one  can engineer  a situation  where they  get a  great internal                                                               
rate of return  purely on an architect's basis  doesn't by itself                                                               
make  an  investment compelling  -  in  particular when  it  must                                                               
compete with a  whole range of other  projects internationally in                                                               
a portfolio.  Simply on  a standalone basis,  a project  needs to                                                               
make sense economically  and if it passes that  threshold and has                                                               
the  benefit of  buying down  your tax  rate, that  is great  and                                                               
probably  pushes it  forward in  the queue,  but the  fundamental                                                               
purpose of investing in a major  oil and gas project, of spending                                                               
more than $1 billion, is not  to purchase tax equity; it's to get                                                               
substantial  rewards  in return.  It's  also  an investment  that                                                               
needs  to work  over  decades and  over a  broad  range of  price                                                               
environments.  Whereas a  system like  ACES will  get one  absurd                                                               
rates  of return  (90 percent)  on an  incremental basis,  but it                                                               
will do  that as long  as the oil price  is exactly $120  for the                                                               
rest of the project life. But  that isn't the real world and not,                                                               
therefore, the way projects are evaluated.                                                                                      
                                                                                                                                
On the  one hand ACES  is a system  that on an  architect's basis                                                               
gives back a lot  of cash compared to the high  level of take the                                                               
system  is designed  for in  return  for spending,  but it's  not                                                               
clear  that  in  doing  so   it  substantially  incentivizes  new                                                               
production investment. It's  much easier to see how  in any given                                                               
year  one could  spend on  a particular  bit of  maintenance; one                                                               
isn't looking at  the 30 year economics. It's much  easier to see                                                               
how the effective  rate is an incentive for spending,  and by and                                                               
large what they have seen over  the last several years has been a                                                               
growth  in  spending but  not  a  growth  in spending  about  new                                                               
development.  And  he  thought the  question  of  the  difference                                                               
between standalone  versus incremental  analysis goes a  long way                                                               
to understanding that.                                                                                                          
                                                                                                                                
5:30:51 PM                                                                                                                    
Another  metric one  can  consider, a  really  important one,  is                                                               
return on  capital employed.  There is  almost no  more important                                                               
way  at  the  highest  possible  level  in  terms  of  how  large                                                               
international oil companies are viewed  by the market in terms of                                                               
their capability  than return on  capital employed as  an overall                                                               
measurement of efficiency  of how well management is  used. It is                                                               
a metric that is completely  unaffected by any of the architect's                                                               
benefits that come from buy  down. A $50-plus billion large scale                                                               
investment in a North Slope gas development is a good example.                                                                  
                                                                                                                                
5:33:25 PM                                                                                                                    
SENATOR  MICCICHE asked  if he  was saying  there is  very little                                                               
value given to  credits in overall evaluation of  projects in the                                                               
board room.                                                                                                                     
                                                                                                                                
MR.   MAYER   answered  that   much   more   impact  comes   from                                                               
progressivity and  buy down, but  they are  only one part  of the                                                               
picture. If  the fundamental standalone economics  of the project                                                               
don't make  sense, having  the state provide  credits to  make it                                                               
economic  won't   make  any  difference.  The   most  pessimistic                                                               
interpretation  one could  put  on  that is  the  idea of  Alaska                                                               
returning a lot of money that  would otherwise be taken in in the                                                               
form  of  revenue under  the  system  in  the hope  of  improving                                                               
economics of making investment in  new production more viable and                                                               
actually getting very little for doing so.                                                                                      
                                                                                                                                
5:35:56 PM                                                                                                                    
So,  drawing  from the  same  key  things  that have  driven  the                                                               
previous two  issues: high marginal rates  that reduce incentives                                                               
for  spending  control and  potentially  can  mean talking  cross                                                               
purposes  in   what  is  incentivizing  production   also  create                                                               
significant   exposure  for   the   state  both   in  low   price                                                               
environments and for  high cost developments. There  is no better                                                               
way of  explaining this than  the Econ  One slide he  had already                                                               
presented:  the  basic point  being  that  particularly with  the                                                               
highest cost possible developments,  on an incremental basis they                                                               
actually reduce the tax burden  for the company undertaking it by                                                               
more than  the value that they  create for the state  and in that                                                               
sense  the  state  is  improving  that  value,  at  least  on  an                                                               
incremental basis, to its own detriment.                                                                                        
                                                                                                                                
SENATOR  DYSON asked  where  it  says dollars  per  BOE what  the                                                               
dollars were.                                                                                                                   
                                                                                                                                
MR. MAYER  answered the  four charts  are all  measuring returns,                                                               
but to the  producer and the state in terms  of net present value                                                               
at a 12 percent discount rate per barrel of oil equivalent.                                                                     
                                                                                                                                
5:38:02 PM                                                                                                                    
SENATOR DYSON asked  if the dollars running up  the vertical axis                                                               
was money in the companies' pocket or the states'.                                                                              
                                                                                                                                
MR.  MAYER said  the top  two were  from the  perspective of  the                                                               
company (left is  an incumbent and on the right  a new producer).                                                               
The  bottom  axis is  the  crude  price  and  lateral axis  is  a                                                               
question of value.                                                                                                              
                                                                                                                                
SENATOR  FRENCH mentioned  that  in the  upper  left corner  ACES                                                               
significantly improves  the MPV  to an incumbent  producer versus                                                               
no production tax.                                                                                                              
                                                                                                                                
MR.  MAYER  said  that  was  correct,   but  it  does  so  on  an                                                               
incremental basis and it doesn't  change the underlying economics                                                               
of the project, and it does so at enormous cost to the state.                                                                   
                                                                                                                                
SENATOR FRENCH  asked if ExxonMobil, ConocoPhillips,  BP would be                                                               
subject to incremental economics.                                                                                               
                                                                                                                                
MR. MAYER  replied that was only  one way of viewing  the problem                                                               
and only one lens through which to screen economic opportunity.                                                                 
                                                                                                                                
SENATOR   FRENCH   said  that   investment   in   Alaska  is   up                                                               
substantially in  the last few years  and it's expected to  go up                                                               
again next  year according to  the DOR's Revenue Sources  Book by                                                               
about $500 million. That's a 37 percent increase!                                                                               
                                                                                                                                
MR. MAYER  referred him back  to his  comments about the  type of                                                               
spending that is occurring that  is going to maintaining existing                                                               
facilities.  That kind  of spending  can be  financed out  of the                                                               
cash flows  of existing  operations versus  spending that  has to                                                               
compete with an international portfolio  for capital and face the                                                               
numerous screens and hurdles one has to in order to do that.                                                                    
                                                                                                                                
SENATOR FRENCH said next year  capital spending would increase in                                                               
Alaska by 37 percent and asked if that was good.                                                                                
                                                                                                                                
MR. MAYER answered unless it's  spending to create new production                                                               
that is not necessarily the case.                                                                                               
                                                                                                                                
CHAIR  GIESSEL  remarked  that  Mr. Mayer  had  made  that  point                                                               
several times.                                                                                                                  
                                                                                                                                
SENATOR  FRENCH said  he wasn't  quite sure,  because he  already                                                               
said he is  unaware of spending on the North  Slope that is being                                                               
misdirected.  So,  he  has  to   believe  that  the  oil  company                                                               
investors are  spending money on  the North Slope  towards making                                                               
more production, but Mr. Mayer seems  to be resisting that and he                                                               
didn't know on what basis.                                                                                                      
                                                                                                                                
MR. MAYER  responded there  are a  couple of  reasons: this  is a                                                               
mature  basin  in  decline  and   one  where  the  major  capital                                                               
investments were  made to  last 20  years and  have substantially                                                               
outlived that. A lot of spending  needs to go on just to maintain                                                               
existing  production, and  one would  expect at  this point  in a                                                               
basin's  life to  see  rising expenses;  spending  like in  field                                                               
drilling  programs   and  things   that  don't   have  challenged                                                               
economics that are  profitable to do and are going  on today. The                                                               
question is  if one wants  to go beyond  that to actually  try to                                                               
turn  around production  decline, what  economics of  substantial                                                               
new investments  that have  to compete  in a  company's portfolio                                                               
for capital  look like, and  the answer to  that is they  are not                                                               
occurring now and when you  compare even incremental economics on                                                               
many counts except  for IRR they are  not necessarily competitive                                                               
with  other   regimes,  particularly   when  you  look   at  pure                                                               
standalone economics  of the projects.  In many cases  they don't                                                               
make a lot of sense.                                                                                                            
                                                                                                                                
SENATOR  FRENCH said  that was  an excellent  answer, but  he was                                                               
still curious  about the quality  of spending on the  North Slope                                                               
and how Mr.  Mayer was able to  tell him it's not  being spent on                                                               
things that will turn around the production decline.                                                                            
                                                                                                                                
5:44:02 PM                                                                                                                    
SENATOR  MICCICHE said  they  had asked  staff  to calculate  the                                                               
value of the  production that had been returned to  the state for                                                               
the checks  to new entrants  that had  returned 5 percent  of the                                                               
North  Slope  overall  production.   The  state  has  expended  a                                                               
significant amount of effort and  hundreds of millions of dollars                                                               
in trying  to create a  secondary producer  base that may  or may                                                               
not  result  in  investment  ever   that  results  in  additional                                                               
production.                                                                                                                     
                                                                                                                                
He wanted to make sure  they didn't continue focusing on spending                                                               
that is not related to production  and seemed very unlikely to be                                                               
related  to  significant  production  in the  future.  They  were                                                               
trying to collect  some data on what the state  has spent on very                                                               
tiny  increments  of new  production  and  said, "I  think  we're                                                               
upside down and I don't think it's a good way to do business."                                                                  
                                                                                                                                
MR. MAYER said  finally the whole idea because  production tax is                                                               
levied on a btu equivalent basis  (treats oil and gas as the same                                                               
thing based  on their  heat content) and  pulls them  together in                                                               
terms of  a company's  gross revenue  and production  value after                                                               
allowances, that  on a per barrel  basis large scale sale  of gas                                                               
has the ability to substantially  reduce production tax value and                                                               
is  a feature  that would  not have  come about  through intended                                                               
design.                                                                                                                         
                                                                                                                                
5:45:54 PM                                                                                                                    
To  address  these five  key  problems  he listed  the  available                                                               
solutions.                                                                                                                      
-Addressing the  overall high levels  of government take  that is                                                               
about  the base  rate  can be  tackled  by reducing,  bracketing,                                                               
capping or eliminating progressivity.                                                                                           
-In terms of  incentives for spending control  under marginal tax                                                               
rates,  one can  reduce, bracket,  or eliminate  progressivity or                                                               
reduce or eliminate credits.                                                                                                    
-In  terms of  complexity,  other than  the  question of  overall                                                               
simplifying the  system design, it  seems that what one  wants to                                                               
do is  to get rid  of a lot  of the interaction  of progressivity                                                               
with credits to  create a system that doesn't hand  back a lot of                                                               
cash  for  things  that   don't  actually  fundamentally  improve                                                               
project economics and  when it comes to the question  of the very                                                               
different  economics for  a  new  development, particularly  when                                                               
there is  no possibility of  incremental analysis to try  to even                                                               
out the disparity.                                                                                                              
-The question  of state  exposure in  low price  environments for                                                               
high-cost developments  reveals the  same sorts of  questions, in                                                               
particular  the question  of reducing,  eliminating  some or  all                                                               
credits. One can eliminate the  ability to claim the credits from                                                               
the  state treasury  and require  them  to be  taken from  future                                                               
production, and  there are various ways  if they are going  to be                                                               
carried  forward to  production that  one can  do that  by either                                                               
keeping their  value constant  or trying  to maintain  their time                                                               
value of money.                                                                                                                 
-In terms of the question of  large scale gas sales on tax rates,                                                               
some of the other solutions,  such as simply reducing, bracketing                                                               
or capping  the rate of progressivity,  don't do a lot  to change                                                               
this feature.  The things that  would get rid of  the de-coupling                                                               
problem are either  eliminating progressivity altogether, keeping                                                               
it in place  but on a gross  rather than a net  basis, or finding                                                               
some other way  like a gross revenue exclusion similar  to one in                                                               
SB 21, but a progressive one rather than a flat one.                                                                            
                                                                                                                                
5:50:41 PM                                                                                                                    
He said the solution SB  21 chooses is eliminating progressivity,                                                               
getting rid  of the capital  credit and making the  net operating                                                               
loss credit  one that is carried  forward to production in  a way                                                               
that tries  to maintain  its value,  and improving  economics for                                                               
new developments through the gross revenue exclusion.                                                                           
                                                                                                                                
Coming back  to the benchmarking  slides, Mr. Mayer said  that at                                                               
$80/barrel  (assuming  costs  in   the  new  development  for  an                                                               
existing producer  that are essentially  the cost  structure seen                                                               
in a mature  producing field at Prudhoe Bay), SB  21 is basically                                                               
about the same at $80/barrel as  ACES. It would be slightly worse                                                               
a little  bit lower because of  the effect of taking  the credits                                                               
away.                                                                                                                           
                                                                                                                                
Under SB  21, the new  development is the lowest  because despite                                                               
the impact  of taking the credits  away it has the  gross revenue                                                               
exclusion. So for an entirely  new development in an entirely new                                                               
producing  area  even  at  $80/barrel   from  a  government  take                                                               
perspective it's  substantially lower. That disparity  only grows                                                               
as one moves up through the  price deck until at $120/barrel, for                                                               
the existing  producer and the  new development is just  over the                                                               
63 percent  government take mark under  SB 21 - a  much more even                                                               
range between the two of them.                                                                                                  
                                                                                                                                
5:51:43 PM                                                                                                                    
What it  doesn't show  is that  the impact  of taking  the credit                                                               
away is the point  at which SB 21 goes from  being a tax increase                                                               
to a tax decrease and that  it can happen at very different price                                                               
levels depending on  the level of capital spending  that is going                                                               
on by  the company  involved. So, for  base production  with only                                                               
$10/barrel in Capex at anything  above $75/barrel it's a tax cut;                                                               
below  $75/barrel it's  a tax  increase.  This ties  back to  the                                                               
question of  a possible floor  price for  ANS West Coast  that he                                                               
started with.                                                                                                                   
                                                                                                                                
If one is  involved in a capital intensive new  project - whether                                                               
that's at  Point Thomson or  taking sanction  on a number  of new                                                               
projects - if  one is a smaller new producer,  still very much in                                                               
the development phase of an asset -  the price at which this is a                                                               
tax  increase   is  substantially  higher.  If   he  is  spending                                                               
$25/barrel   in  Capex,   then  it's   only  when   prices  reach                                                               
$110/barrel that this actually reduces government take.                                                                         
                                                                                                                                
SENATOR FRENCH  asked if an  established producer at  Prudhoe Bay                                                               
with  all  costs amortized  is  on  the red  line,  is  it a  tax                                                               
increase? But it's  a tax decrease at  anything above $80/barrel?                                                               
If you're  trying to  produce heavy oil  or shale  you're further                                                               
out  because of  higher prices  and it  doesn't get  to be  a tax                                                               
break until it gets to $110/barrel?                                                                                             
                                                                                                                                
MR.  MAYER  said  that  was   correct.  If  one  has  substantial                                                               
satellite developments  in Kuparuk  that are currently  going on,                                                               
those are also things that take one's capital spend above that                                                                  
to somewhere in the $15-20 range.                                                                                               
                                                                                                                                
SENATOR FRENCH asked if you are Great Bear looking at this, you                                                                 
go "oh oh."                                                                                                                     
                                                                                                                                
MR. MAYER answered yes at current prices and said that concluded                                                                
his presentation.                                                                                                               
                                                                                                                                
CHAIR GIESSEL thanked Mr. Mayer.                                                                                                
                                                                                                                                
[SB 21 was held in committee.]                                                                                                  

Document Name Date/Time Subjects
SB 21 Progressivity by DOR SRES 2013.02.15.pdf SRES 2/15/2013 3:30:00 PM
SB 21
SB 21 Fiscal System PFC Energy Mayer SRES 2013.02.15.pdf SRES 2/15/2013 3:30:00 PM
SB 21