Legislature(2021 - 2022)BUTROVICH 205

02/10/2021 03:30 PM RESOURCES

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Audio Topic
03:34:11 PM Start
03:34:52 PM SB61
04:48:22 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
*+ SB 61 OIL/GAS LEASE:DNR MODIFY NET PROFIT SHARE TELECONFERENCED
Heard & Held
-- Invited & Public Testimony --
**Streamed live on AKL.tv**
        SB 61-OIL/GAS LEASE: DNR MODIFY NET PROFIT SHARE                                                                    
                                                                                                                                
3:34:52 PM                                                                                                                    
CHAIR REVAK  announced the  consideration of  Senate Bill  61 "An                                                               
Act authorizing  the commissioner of natural  resources to modify                                                               
a net profit share lease."                                                                                                      
                                                                                                                                
He  noted that  the Department  of Natural  Resources (DNR)  will                                                               
provide a presentation  on Senate Bill 61  (SB 61)Oil/Gas  Lease:                                                               
DNR Modifying Net Profit Shares.                                                                                                
                                                                                                                                
3:35:45 PM                                                                                                                    
JHONNY  MEZA,  Commercial  Manager,  Division  of  Oil  and  Gas,                                                               
Department of Natural Resources,  Anchorage, Alaska, explained SB
61  would modify  certain aspects  of the  existing statutes  for                                                               
royalty modifications.                                                                                                          
                                                                                                                                
He addressed  slide 2, Outline,  noting the department's  goal is                                                               
to provide  the committee  with a brief  description of  what net                                                               
profit share leases (NPSLs) are, and  where they are on the North                                                               
Slope.                                                                                                                          
                                                                                                                                
MR. MEZA  detailed in section  2 of his overview,  the department                                                               
explain its  rationale for proposing  that the ability  to modify                                                               
NPSLs and  all the changes  present in  the bill; section  3, the                                                               
department will provide another  view of the modification process                                                               
for royalty and how its  proposed changes will reflect within it;                                                               
and   section  4,   contains   appendices   with  more   detailed                                                               
information.                                                                                                                    
                                                                                                                                
3:37:31 PM                                                                                                                    
He referenced  slides 3 and 4  regarding an overview of  NPSL. He                                                               
explained by statute,  the DNR commissioner has  the authority to                                                               
issue oil  and gas leases  via competitive bidding. In  doing so,                                                               
the commissioner  has a series  of lease sale  methods available,                                                               
allowing  the offer  of different  types of  oil and  gas leases.                                                               
Most frequently,  the leases  that the state  offers have  only a                                                               
royalty  component as  a revenue  source in  its role  as lessor.                                                               
However, in some  cases in the North Slope, DNR  has also offered                                                               
other leases which in addition  to royalty, also have a provision                                                               
for net profit sharingthese are NPSLs.                                                                                          
                                                                                                                                
MR. MEZA said prior to delving  into the definition of net profit                                                               
sharing,  the  department  will   first  highlight  a  couple  of                                                               
differences in  royalty revenue and  net profit share  revenue to                                                               
help illustrate the [net profit sharing] concept.                                                                               
                                                                                                                                
3:38:40 PM                                                                                                                    
He explained  royalty revenue  begins with  commercial production                                                               
based on  gross revenue.  There is  a subtle  distinction between                                                               
the  royalty value  and the  proceeds that  the lessee  receives.                                                               
However,   royalty  valuation   calculation  does   not  consider                                                               
exploration,   development,  operating,   processing,  or   other                                                               
production costs.  On the other hand,  for a NPSL the  sharing of                                                               
net profits  only occurs when  the lease  is set to  have reached                                                               
the payout  stage. This is the  stage at which the  lease recoups                                                               
exploration and development costs  allocated to the lease through                                                               
revenues  and net  operating costs  associated with  a particular                                                               
lease.                                                                                                                          
                                                                                                                                
MR. MEZA detailed  with the beginning of activities  in the lease                                                               
viability   associated    with   exploration    and   development                                                               
activities,  some of  those costs  will be  allocated to  the net                                                               
profit  sharing.  Since  there   is  no  productiontherefore   no                                                               
revenuesthe   cumulative balance  of costs  associated to  a NPSL                                                               
will continue  to accumulate and  the department keeps  a balance                                                               
of such costs. Some of  the [cost balance] erodes when production                                                               
and revenue  occurs until  full costs  recovery via  revenues and                                                               
net  operating costs;  at that  point when  the balance  is fully                                                               
eroded, the department then says  the NPSL has reached the payout                                                               
stage. Net  profits occurs when  any amount exceeds  the recovery                                                               
of development costs  at which point the lessee pays  the state a                                                               
share of  the net  profits pursuant to  the share  established in                                                               
the leasethe net profit share.                                                                                                  
                                                                                                                                
3:41:29 PM                                                                                                                    
He  noted a  map  of the  North  Slope in  slide  5 that  depicts                                                               
existing oil and gas units  with existing NPSL units highlighted                                                                
26 units. He explained an oil and  gas unit contains a set of oil                                                               
and  gas leases.  Oil  and gas  units are  at  times composed  of                                                               
leases with only a royalty  component and other times with NPSLs                                                                
which contain both royalty and a net profit-sharing provision.                                                                  
                                                                                                                                
MR. MEZA  detailed the  NPSLs are  in seven  unitsnoting  various                                                               
units from west to east on the map as follows:                                                                                  
                                                                                                                                
   • Colville River Unit                                                                                                        
   • Oooguruk Unit                                                                                                              
   • Kuparuk River Unit                                                                                                         
   • Milne Point                                                                                                                
   • Duck Island Unit                                                                                                           
   • Point Thomson                                                                                                              
                                                                                                                                
MR. MEZA said  the NPSLs were issued in the  late 1970s and early                                                               
1980s, most  offered with a  fixed royalty  rate and a  fixed net                                                               
profit sharing rate.  In other cases, the net profit  share was a                                                               
bid  variable  with   values  as  high  as  79   percent  for  an                                                               
[inaudible] NPSL in Duck Island, or  93 percent for a NPSL in the                                                               
Northstar unit.                                                                                                                 
                                                                                                                                
He explained  the reason why  the department does not  show NPSLs                                                               
for the  Northstar unit in the  map is due to  legislative action                                                               
in 1996  that transformed five  NPSLs in the Northstar  unit into                                                               
leases  with only  a royalty  componentfurther  explanation  will                                                               
occur later in  the presentation to exemplify one  of the reasons                                                               
for proposing SB 61.                                                                                                            
                                                                                                                                
MR. MEZA noted the NPSLs which  have reached the payoff stage are                                                               
in Colville River, Oooguruk, Milne  Point, and Duck Island units.                                                               
The  net profit  share revenue  has been  an important  source of                                                               
additional revenue to the state,  and the largest contributors of                                                               
such additional revenue  are in the NPSLs in the  Duck Island and                                                               
Milne Point  unitsaccounting  for  approximately $1  billion. The                                                               
total revenue coming from NPSLs amount to close to $1.2 billion.                                                                
                                                                                                                                
3:44:25 PM                                                                                                                    
CHAIR REVAK asked him of the  26 active NPSLs on the North Slope,                                                               
how many  does he anticipate  needing to  change and what  is the                                                               
need to change now.                                                                                                             
                                                                                                                                
MR. MEZA replied,  the department has prepared  information as to                                                               
the need for  proposing SB 61. The department  cannot guess which                                                               
NPSLs  will submit  applications. The  following slide  will show                                                               
information the department thinks warrants the proposed change.                                                                 
                                                                                                                                
CHAIR REVAK asked him to confirm  that he said some NPSLs were as                                                               
high as 90 percent.                                                                                                             
                                                                                                                                
MR. MEZA answered yes. He noted  the Northstar unit offered DNR a                                                               
NPSL  that  contained  the  net   profit  share  at  the  bidding                                                               
variable. The successful bidder for  that lease sale submitted an                                                               
offer for  93 percent  of the net  profit share.  The legislature                                                               
modified  those  NPSLs in  1996including   the  93 percent  share                                                               
rateto only contain a royalty component.                                                                                        
                                                                                                                                
3:46:26 PM                                                                                                                    
MR. MEZA  addressed slides 6  and 7  regarding why to  allow NPSL                                                               
modification. He said one of the  reasons for why DNR believes SB
61  will provide  benefits to  the state  is that  the department                                                               
believes  [NPSL   modification]  will  increase   production  for                                                               
otherwise uneconomic sources.                                                                                                   
                                                                                                                                
He  detailed the  current statute  for  royalty modification,  AS                                                               
38.05.180(j), enables the DNR commissioner  to modify the royalty                                                               
rates   under   specific   scenariosdiscussed    later   in   the                                                               
presentationwith   the objective  to  encourage production  which                                                               
would  otherwise  remain  uneconomic   in  the  absence  of  such                                                               
modificationthe   modification  process  discussed later  in  the                                                               
presentation. However,  there is a  possibility that even  with a                                                               
royalty modification, such production could remain uneconomic.                                                                  
                                                                                                                                
3:48:30 PM                                                                                                                    
SENATOR  VON  IMHOF  noted  he   mentioned  on  slide  7,  "Under                                                               
circumstances,  even with  royalty modification  is possible  for                                                               
continuing." She asked  him if DNR has  done royalty modification                                                               
in the past and what were the results.                                                                                          
                                                                                                                                
MR. MEZA answered  yes. He explained he  believed the legislature                                                               
enacted  the  royalty  modification  statute  in  1995  and  then                                                               
amended  the  statute  in  2003. The  state  has  received  eight                                                               
applications for  royalty modification with two  denied and three                                                               
withdrawn.                                                                                                                      
                                                                                                                                
CHAIR  REVAK  asked  Mr.  Meza  to  provide  the  committee  with                                                               
information  on how  the royalty  modifications  have done  since                                                               
their approval.                                                                                                                 
                                                                                                                                
MR. MEZA answered yes.                                                                                                          
                                                                                                                                
CHAIR REVAK asked  Mr. Meza if the royalty  modification ended in                                                               
2003.                                                                                                                           
                                                                                                                                
MR.  MEZA  answered no.  He  specified  he said  the  legislature                                                               
amended the statute in 2003.                                                                                                    
                                                                                                                                
CHAIR  REVAK  asked  him  when   the  last  royalty  modification                                                               
occurred.                                                                                                                       
                                                                                                                                
MR. MEZA answered  the last application that DNR  received was in                                                               
2014 for the Oooguruk unit.                                                                                                     
                                                                                                                                
SENATOR VON IMHOF  addressed the last bullet point on  slide 7 as                                                               
follows:                                                                                                                        
                                                                                                                                
     This would result in additional royalties, net profit                                                                      
     share, taxes, etc. that the state would not otherwise                                                                      
     receive.                                                                                                                   
                                                                                                                                
She said  she assumed the  royalty modifications resulted  in net                                                               
profit shared, taxes, etcetera. She  asked him how much money the                                                               
state made that  they would not otherwise  have madeassuming  the                                                               
three   applications   received  approvalwithout    the   royalty                                                               
modification.                                                                                                                   
                                                                                                                                
MR.  MEZA answered  yes. He  said  the department  will have  the                                                               
information available to committee members.                                                                                     
                                                                                                                                
3:51:30 PM                                                                                                                    
SENATOR  BISHOP  asked  him  if   there  was  some  royalty  rate                                                               
modification discussed  for the [Nuna Development]  as well after                                                               
2014.                                                                                                                           
                                                                                                                                
MR. MEZA  answered yes.  He noted  he referred  to the  Nuna case                                                               
earlier  in   his  presentation.   The  department   received  an                                                               
application in 2014 for royalty  modification for the development                                                               
of the Nuna prospect residing in the Oooguruk unit.                                                                             
                                                                                                                                
SENATOR  STEVENS noted  the department's  proposal is  a tradeoff                                                               
where the state receives less but  extends the life of the field.                                                               
He  asked him  what  the advantage  to the  state  is with  their                                                               
proposal.                                                                                                                       
                                                                                                                                
MR.  MEZA explained  applications for  royalty modifications  and                                                               
net  profit  share  modificationsproposed    in  SB  61does   not                                                               
automatically   translate  into   an  approval.   The  department                                                               
performs  a  full  review  process   that  entails  a  review  of                                                               
technical and commercial information  by the applicant. According                                                               
to statute,  the applicant  needs to  provide a  convincingly and                                                               
clear  showing that  the project  is not  economic and  therefore                                                               
will not occur without the modification.                                                                                        
                                                                                                                                
3:54:35 PM                                                                                                                    
CHAIR REVAK asked  him to explain in the simplest  terms what the                                                               
state is  trying to achieve by  modifying a lease and  under what                                                               
circumstances. He said his understanding  is modifying a lease is                                                               
due to a lease not being  economic given the amount of net profit                                                               
the state would take for the company to drill more oil.                                                                         
                                                                                                                                
MR. MEZA answered when the  department references to a project or                                                               
production being economic  or not economic, what  they are trying                                                               
to do is influence the  lessee's investment decision by modifying                                                               
either royalty  or net profit  share because investment  will not                                                               
occur  without modification.  However,  the  department does  not                                                               
guarantee modification results in profitability.                                                                                
                                                                                                                                
He noted later  in his presentation he will refer  to one measure                                                               
of profitability  that the department uses  oftenthe  net present                                                               
valuewhich  is a comparison of the  cost and revenue of a project                                                               
in simple terms.                                                                                                                
                                                                                                                                
3:56:36 PM                                                                                                                    
CHAIR REVAK  announced Senator Micciche has  joined the committee                                                               
meeting.                                                                                                                        
                                                                                                                                
SENATOR  KIEHL remarked  many committee  members as  well as  the                                                               
presenter  are experts  in  the oil  and gas  field.  He said  he                                                               
requires a more basic explanation.                                                                                              
                                                                                                                                
He asked  Mr. Meza what  the difference is  between a NPSL  and a                                                               
royalty lease, and how net  profit share differs from the state's                                                               
production tax which  is also based on net profits.  He noted the                                                               
difficulty in getting  his head around the notion  that, "Once we                                                               
are into net  profits, something that is not economic,  how is it                                                               
not economic if you are making a profit?"                                                                                       
                                                                                                                                
CHAIR  REVAK  suggested  to  Mr.  Meza  to  start  out  with  the                                                               
difference  between the  royalties  and the  net  profits in  the                                                               
simplest of terms.                                                                                                              
                                                                                                                                
3:58:16 PM                                                                                                                    
MR. MEZA explained  the department uses the term  "net profit" in                                                               
the context of both NPSLs  and production taxes. The department's                                                               
hope during  the presentation is  to explain the  key differences                                                               
between  "net profits"  in  the  context of  NPSLs  and how  that                                                               
differs from  "project profitability" from the  standpoint of the                                                               
lessee.  One  key  aspect illustrating  the  distinction  is  not                                                               
considering certain  costs for profit determination  under a NPSL                                                               
context  versus a  company's  profitability  determination for  a                                                               
project.                                                                                                                        
                                                                                                                                
He said other  examples of other costs not  considered for profit                                                               
sharing leases  includes an allowance  for overhead and  a return                                                               
on  cost  not  recouped  based  on the  prime  rateoil   and  gas                                                               
companies require a return much higher than the prime rate.                                                                     
                                                                                                                                
CHAIR REVAK asked  Senator Kiehl if Mr.  Meza's explanation helps                                                               
him.                                                                                                                            
                                                                                                                                
SENATOR  KIEHL answered  Mr. Meza's  response is  a start  and he                                                               
likely has some of the answers built into his presentation.                                                                     
                                                                                                                                
4:00:54 PM                                                                                                                    
MR. MEZA said slide 8  references the second reason for purposing                                                               
SB  61,  which  is  to  provide  DNR  with  additional,  valuable                                                               
flexibility  for  modifying  the  existing  royalty  modification                                                               
statute  and  the  proposed modification  of  net  profit-sharing                                                               
rates.                                                                                                                          
                                                                                                                                
He detailed the current royalty  modification statute enables the                                                               
DNR  commissioner  to  modify the  royalty  rate  under  specific                                                               
scenarios to  encourage production  which would  otherwise remain                                                               
uneconomicthe department will later define via example.                                                                         
                                                                                                                                
He said  the department believes  SB 61 importantly  provides the                                                               
DNR commissioner with the ability  to modify not just royalty but                                                               
net profit share  as well. For example, in the  review process of                                                               
an application  for modification, the  state may find that  it is                                                               
in  its best  interest to  modify net  profit sharing  instead of                                                               
royaltythe   department has  prepared  a draft  to exemplify  the                                                               
particular case.                                                                                                                
                                                                                                                                
He explained if only modifying net  profit share helps to make an                                                               
uneconomic production come to fruition,  then the state would not                                                               
have to  defer its royalty  revenue becauseas   previously noted                                                                
they receive  concurrent payment with  production. Alternatively,                                                               
the state may find that a  blended structure of NPSLs and royalty                                                               
modification  could be  in  the best  interest  rather than  just                                                               
using one modification.                                                                                                         
                                                                                                                                
He noted the current statute  for royalty modification allows the                                                               
commissioner  to  increase or  decrease  the  royalty rate  which                                                               
could allow for  the possibility of recovery  of forgone revenue.                                                               
Also, SB 61 includes net profit share as another variable.                                                                      
                                                                                                                                
4:03:59 PM                                                                                                                    
He explained  slide 9 provides  a hypothetical graph of  what the                                                               
department  means  for  a  project  trying  to  develop  economic                                                               
production.                                                                                                                     
                                                                                                                                
MR.  MEZA  reiterated SB  61  has  the objective  of  encouraging                                                               
economic  production  and  provides   the  state  with  valuable,                                                               
additional  modification  flexibility  if  the  department  finds                                                               
modification is in the project's best interest.                                                                                 
                                                                                                                                
He  referenced the  economic model  that provides  two production                                                               
scenarios for a hypothetical project.  One graph defines a set of                                                               
leases with one  containing royalty and the other  with NPLS, the                                                               
second  graph  with all  NPLSpreviously   noted  to contain  both                                                               
royalty and  a net  profit share component.  The graphs  show one                                                               
measure of  profitability for a  company in terms of  net present                                                               
value.  The  graphs  represent   the  lessee's  expectations  via                                                               
production, price, and cost  variables. The evaluation determines                                                               
whether a project is economic and warrants investment.                                                                          
                                                                                                                                
[He detailed  various economic  and uneconomic  project scenarios                                                               
shown on the graphs.]                                                                                                           
                                                                                                                                
He  noted  under the  existing  modification  framework, the  DNR                                                               
commissioner  can  only modify  the  royalty  rates to  encourage                                                               
production which otherwise would remain economic.                                                                               
                                                                                                                                
He   reiterated  when   evaluating  modification   requests,  the                                                               
department's goal  is not to  guarantee project  profitability or                                                               
to provide  more than  necessary profitability.  The modification                                                               
goal is  to improve  the chances  for project  profitability, but                                                               
only to the point necessary  to impact the investment decision by                                                               
the lesseeone   circumstance includes using the  net profit share                                                               
instead of the royalty rate.                                                                                                    
                                                                                                                                
4:08:20 PM                                                                                                                    
SENATOR  KIEHL asked  him what  discount rate  the department  is                                                               
using in their  analysis, noting he mentioned  prime rate earlier                                                               
and that companies  use a significantly higher rate.  He said the                                                               
discount rate used for a net  present value analysis makes a huge                                                               
difference.                                                                                                                     
                                                                                                                                
MR.  MEZA answered  the department  does not  use a  set discount                                                               
rate. The department first looks  at economic profitability for a                                                               
project from  the company's perspective  to evaluate  whether the                                                               
company   will  make   an  investment   decision.  However,   the                                                               
department  realizes there  are  different types  of North  Slope                                                               
operators,  some  are  financially   stronger  with  a  worldwide                                                               
project  portfolio,  and some  have  different  types of  project                                                               
investment in  their portfolios.  The department uses  a "prudent                                                               
operator's"  standpoint  for  determining whether  a  project  is                                                               
economic.                                                                                                                       
                                                                                                                                
SENATOR MICCICHE  asked him to  confirm that the  combined relief                                                               
of royalty  modification and NPSLwith   a minimum of  10 percent                                                                
could possibly  stop the abandonment of  unprofitable production.                                                               
Anything back  to the state  above that unprofitable line  is far                                                               
more   beneficial  to   the  State   of  Alaska   than  abandoned                                                               
production.                                                                                                                     
                                                                                                                                
MR. MEZA answered yes, the  department encourages production that                                                               
would  otherwise  remain  uneconomic  and not  come  to  fruition                                                               
without the modification.                                                                                                       
                                                                                                                                
He  reiterated  the  department's  goal is  not  to  guarantee  a                                                               
certain  profit  level or  profit  under  all circumstances,  but                                                               
rather to influence the investment decision by the applicant.                                                                   
                                                                                                                                
4:11:27 PM                                                                                                                    
SENATOR  KIEHL asked  him how  the department  sets the  "prudent                                                               
operator" standard. He noted an  oil business might say a prudent                                                               
operator is not  going to make less than a  very high number, but                                                               
a state  revenue department might  be interested in a  much lower                                                               
number.  He inquired  if the  department determines  the standard                                                               
via regulation or "are we to trust one another."                                                                                
                                                                                                                                
MR. MEZA  answered what he  meant by the term  "prudent operator"                                                               
is  from   an  economic   standpoint.  DNR   considers  different                                                               
scenarios in its  review process as well as  the opportunity cost                                                               
for the state.                                                                                                                  
                                                                                                                                
He explained if  DNR were to hypothetically  deny an application,                                                               
the department  would consider the  state's opportunity  cost for                                                               
not  sanctioning  a project  via  waiting  for another  operator,                                                               
market conditions or technology  improvements, or for a different                                                               
project configuration.                                                                                                          
                                                                                                                                
He summarized  DNR is always  comparing its opportunity  cost and                                                               
revenue  benefit that  could occur  with the  modification versus                                                               
the  revenues that  might or  might not  occur in  the future  by                                                               
delaying a project.                                                                                                             
                                                                                                                                
4:13:28 PM                                                                                                                    
CHAIR  REVAK asked  him to  confirm that  DNR currently  does not                                                               
have  the ability  to negotiate  NPSLs and  the department  feels                                                               
having  the  ability  to negotiate  under  certain  circumstances                                                               
would be a greater benefit to the state.                                                                                        
                                                                                                                                
MR. MEZA answered  yes. He noted a NPSL  modification occurred in                                                               
1996   for  the   Northstar  unit,   but  the   process  entailed                                                               
legislation. SB  61 would provide  the DNR commissioner  with the                                                               
authority to modify royalties and net profit share rates.                                                                       
                                                                                                                                
CHAIR  REVAK   asked  him  how   many  NPSLs  are   currently  in                                                               
production.                                                                                                                     
                                                                                                                                
MR. MEZA  referenced the map  on slide  5 and detailed  the units                                                               
that currently have NPSLs in production as follows:                                                                             
                                                                                                                                
   • Colville River                                                                                                             
   • Oooguruk                                                                                                                   
   • Nikaitchuq                                                                                                                 
   • Milne Point                                                                                                                
   • Dick Island                                                                                                                
   • Northstar                                                                                                                  
        o Originally had NPSL.                                                                                                  
        o Applicant sanctioned modification and project is                                                                      
          producing.                                                                                                            
                                                                                                                                
4:15:37 PM                                                                                                                    
CHAIR REVAK asked him how many NPSLs are not in production.                                                                     
                                                                                                                                
MR. MEZA  answered the  Point Thomson unit  is producing  but not                                                               
associating its production to NPSL.                                                                                             
                                                                                                                                
SENATOR  BISHOP asked  him  if  he is  talking  about having  the                                                               
ability  to  modify  existing   production,  new  projects  going                                                               
forward, or both.                                                                                                               
                                                                                                                                
MR.  MEZA  answered  royalty   modification  under  the  existing                                                               
statute  and NPSLs  under SB  61  can only  occur under  specific                                                               
scenarios described by the  statuteadditional  detail provided in                                                               
the next slide.                                                                                                                 
                                                                                                                                
SENATOR STEVENS  noted Judge  Sharon Gleasonformer   state judge,                                                               
now a  federal judgemade   a decision  on the  issue of  how much                                                               
money from the [Trans-Alaska Pipeline  System (TAPS)] taxes would                                                               
go to communities. Judge Gleason  stated that oil will be flowing                                                               
from Prudhoe Bay for the next 50  to 100 years. He said he thinks                                                               
Judge Gleason was  saying that sometimes it is best  to leave oil                                                               
in the  ground because  in the  future the oil  might be  of more                                                               
value to the state.                                                                                                             
                                                                                                                                
SENATOR STEVENS said  he is truly concerned if  the department is                                                               
truly looking with a 50-to-100-year  view of the oil industry for                                                               
the state,  or is  the department just  looking at  the immediate                                                               
production of oil.                                                                                                              
                                                                                                                                
4:18:18 PM                                                                                                                    
MR. MEZA answered the DNR review  process looks at both short and                                                               
long-term  effects  from  modification for  existing  and  future                                                               
production. He  noted Alaska built a  pipeline infrastructure not                                                               
for one unit,  but for the benefit of other  types of development                                                               
throughout the North Slope.                                                                                                     
                                                                                                                                
SENATOR MICCICHE noted NPSLs ranged from  30 to 79 percent in the                                                               
1970s  and 1980s.  However, the  department's request  via SB  61                                                               
could drop the NPSL percentage amount to 10 percent.                                                                            
                                                                                                                                
He  asked him  if the  department  is thinking  of utilizing  the                                                               
practice as  combined relief between  royalty and the need  for a                                                               
lower  NPSL  to make  economic  sense,  and does  the  department                                                               
envision the 10 percent minimum is something realistic.                                                                         
                                                                                                                                
4:20:36 PM                                                                                                                    
MR. MEZA  replied the department  is not proposing to  reduce the                                                               
net profit  share to  the 10  percent level, but  for a  floor to                                                               
exist  under  which modifications  cannot  go  beyond should  the                                                               
department consider  modification in  the interest of  the state.                                                               
Just  because the  department has  a  minimum does  not mean  the                                                               
department will go  to the minimum, and the same  applies for the                                                               
existing statute of royalty  modification, which contains minimum                                                               
levels of royalties.  The department in its review  does not have                                                               
the intent to necessarily go to  the minimum, but the decision to                                                               
modify the  rate is based  incentivizing the  investment decision                                                               
by the applicant.                                                                                                               
                                                                                                                                
He referenced the  graph from the economic model on  slide 9 that                                                               
contains a  hypothetical scenario  of combined relief.  The right                                                               
graph  on  slide  9 illustrates  the  possibility  that  separate                                                               
royalty and NPSL  modification may not be large  enough to change                                                               
the  decision from  no  investment to  investment.  DNR may  find                                                               
under  certain  circumstances  the   need  for  combined  relief.                                                               
However, the department  does not mean it will go  all the way up                                                               
to provide the  greatest profitability to a project,  but only to                                                               
the point where  the applicant acts on  conducting its investment                                                               
decision.                                                                                                                       
                                                                                                                                
SENATOR MICCICHE  noted he will  follow up later in  the overview                                                               
regarding questions  on modifications if  a well ends  up looking                                                               
borderline profitable and  there is combined relief  and then the                                                               
profitability becomes remarkably successful later.                                                                              
                                                                                                                                
4:23:31 PM                                                                                                                    
MR.  MEZA  said slide  10  describes  the  third section  of  the                                                               
department's  presentation   which  addresses  the   process  for                                                               
modification that  currently exists,  and how  SB 61  proposes to                                                               
modify the process.                                                                                                             
                                                                                                                                
He explained SB  61 will amend the  existing royalty modification                                                               
statute to provide authority to  modify the net profit share with                                                               
a  goal of  encouraging production  which would  otherwise remain                                                               
uneconomic.                                                                                                                     
                                                                                                                                
He  noted the  department is  providing a  third reason  to allow                                                               
NPSL  modification  by streamlining  the  process.  In 1996,  DNR                                                               
presented a proposal to the  legislature for modifying four NPSLs                                                               
in the Northstar unit. The  offered NPSLs included the net profit                                                               
share rate  as the  [inaudible] variable;  the highest  bidder in                                                               
that lease  sale offered  a net  profit share rate  in a  NPSL as                                                               
high as 93 percent.                                                                                                             
                                                                                                                                
He said  DNR is proposing via  SB 61 to authorize  the department                                                               
to modify the net profit share  to streamline the NPSL process in                                                               
conjunction with  the existing statute  that allows  royalty rate                                                               
modification. Also,  the department  will publish and  report the                                                               
proposed  net  profit  share modification  decision  for  royalty                                                               
modification  through a  best practice  interest  finding to  the                                                               
Legislative Budget and Audit Committee.                                                                                         
                                                                                                                                
4:26:10 PM                                                                                                                    
SENATOR  KIEHL  asked  him what  currently  requires  legislative                                                               
approval,  what  simply  requires reporting  to  the  legislature                                                               
under the status quo, and how that would change.                                                                                
                                                                                                                                
MR. MEZA explained  under the existing statute  which allows only                                                               
for  royalty modification,  the  departmentonce   it receives  an                                                               
application  for  modification  of  royaltyperforms   its  review                                                               
process and if the department  finds that granting a modification                                                               
of royalty is  in the best interest of the  state, the department                                                               
publishes  a best  interest finding  allowing for  public comment                                                               
and offers  a presentation  to the  Legislative Budget  and Audit                                                               
Committee; the SB 61 proposal  tries to include the modifications                                                               
for net profit  share in this process while  maintaining the same                                                               
review  process,  the  same  publication  of  the  best  interest                                                               
finding, and offers to make presentations to the legislature.                                                                   
                                                                                                                                
SENATOR  KIEHL asked  him why  the  Northstar unit  modifications                                                               
required legislative action.                                                                                                    
                                                                                                                                
MR.  MEZA answered  at that  timeand  currentlythe   statute does                                                               
not allow  the DNR  commissioner to modify  net profit  share. In                                                               
1996, the lessee  reached out to the department which  led to the                                                               
legislature  receiving  tentatively   negotiated  terms  for  the                                                               
proposed NPSL modification.                                                                                                     
                                                                                                                                
4:28:21 PM                                                                                                                    
CHAIR REVAK summarized  SB 61 seeks to solve the  very problem he                                                               
noted. He  said the  committee has asked  for details  related to                                                               
those conducted NPSLs and how they have worked so far.                                                                          
                                                                                                                                
MR. MEZA  explained slide 12  addresses the third section  in the                                                               
presentation  that  covers   the  current  modification  process                                                                
information  the   committee  previously  askedand   how   SB  61                                                               
proposes the process.                                                                                                           
                                                                                                                                
He explained under  the current statute the  commissioner has the                                                               
authority   to  modify   royalty  rates.   SB  61   proposes  the                                                               
commissioner would also  have the authority to  modify net profit                                                               
share  rates with  the objective  to  encourage production  which                                                               
would otherwise remain uneconomic.                                                                                              
                                                                                                                                
He said  the department  is also  proposing to  ask for  a fourth                                                               
scenario   for   applicant  eligibility   regarding   incremental                                                               
production  for producing  pools which  need significant  capital                                                               
expenditures.                                                                                                                   
                                                                                                                                
He added SB  61 proposes to clarify a potential  ambiguity in the                                                               
criteria for  one of the  scenarios for  modification eligibility                                                               
in  test production  [during exploration]  would not  necessarily                                                               
disqualify an applicant.                                                                                                        
                                                                                                                                
SENATOR BISHOP asked him what the test production cutoff is.                                                                    
                                                                                                                                
MR. MEZA answered he will cover the topic in slide 14.                                                                          
                                                                                                                                
4:31:12 PM                                                                                                                    
He  said  slide  13  addresseswithin  the  same  context  of  the                                                               
modification   processthe    current   and  proposed   types   of                                                               
modifications.  Currently  the  royalty modification  contains  a                                                               
minimum  floor of  5 percent  and 3  percent under  corresponding                                                               
scenariosnoted   on  slide  14.  SB 61  would  also  establish  a                                                               
minimum net  profit share rate of  10 percent; the intent  is not                                                               
necessarily to go  there, but to have a minimum  under which does                                                               
not allow the department to offer for modification.                                                                             
                                                                                                                                
MR. MEZA explained consistent  with existing statutewhich  allows                                                               
for a sliding  scale mechanism to vary royalty  rate according to                                                               
price, production, or  other measureSB  61 proposes  that the net                                                               
profit  share also  is subject  to the  sliding scale  mechanism.                                                               
Also,   the  bill   would  include   a   provision  for   certain                                                               
circumstances where  the state  could recapture  forgone revenues                                                               
from the  beginning of  the project  by participating  in outside                                                               
price movement or other types of variables.                                                                                     
                                                                                                                                
4:33:11 PM                                                                                                                    
He said slide 14 provides  more details on scenarios for eligible                                                               
modification  applications.  He  reiterated SB  61  proposes  the                                                               
consideration for both royalty and  net profit share modification                                                               
for  the three  existing scenarios  in the  statute, but  also to                                                               
include a fourth scenario.                                                                                                      
                                                                                                                                
He explained in the first  scenario, the pool under consideration                                                               
has  not yet  produced  and would  need  modification for  future                                                               
production to occur economically.  The scenario has one condition                                                               
in that  the field or  pool has  not yet previously  produced for                                                               
sale. He  noted the scenario  has a potential  ambiguity referred                                                               
to earlier  in the overview that  SB 61 is trying  to address and                                                               
clarify.                                                                                                                        
                                                                                                                                
He  noted in  the development  stage of  a given  project as  the                                                               
company  starts  its appraisal  stage  and  drilling some  wells,                                                               
naturally  some of  its  resource  will flow  to  the ground  and                                                               
tested  for  quality  and pressure  information.  The  department                                                               
wants to clarify  that such a test production  scenario would not                                                               
necessarily  disqualify a  potential  applicant  that is  seeking                                                               
modification.  Also, to  provide  clarity,  the term  "commercial                                                               
production" will  refer to  production after  project sanctioning                                                               
for a pool not having produced before.                                                                                          
                                                                                                                                
4:35:29 PM                                                                                                                    
He  explained  the  second  scenario on  slide  14  references  a                                                               
situation  where  production  already   exists,  but  with  lower                                                               
production  levels, high  operating costs,  or lower  prices that                                                               
makes  abandonment expectations  likely; for  this case,  royalty                                                               
modification   or  the   proposed  NPSL   may  prevent   existing                                                               
production from becoming uneconomic.                                                                                            
                                                                                                                                
                                                                                                                                
MR.  MEZA said  in  the third  scenario,  production has  already                                                               
ceased,  and wells  are likely  shutting.  The idea  is that  the                                                               
modification of royalties or NPSL  may bring that production back                                                               
online.                                                                                                                         
                                                                                                                                
He explained in the proposed  fourth scenario, production already                                                               
existslike   in the  second scenariobut   the key  distinction is                                                               
that the  production and  review is  incremental to  the existing                                                               
one where  it only  comes to  fruition after  significant capital                                                               
investment.  However,   such  incremental  investment   would  be                                                               
uneconomic   unless   royalty   modification  or   NPSL   occurs.                                                               
Incremental  investment examples  include  expansion of  existing                                                               
pools, additional drilling pads,  enhanced oil recovery projects,                                                               
etcetera. He  noted the additional production  decision addresses                                                               
both short term and long-term impact perspectives.                                                                              
                                                                                                                                
4:37:36 PM                                                                                                                    
CHAIR  REVAK  asked  him  to  explain  how  the  proposed  fourth                                                               
scenario  of  incremental  production  differs  from  the  second                                                               
scenario.  He  inquired whether  the  second  scenario would  not                                                               
suffice for what the state needs.                                                                                               
                                                                                                                                
MR. MEZA  replied his  question allows him  to highlight  the key                                                               
distinction  between  the second  and  fourth  scenarios. In  the                                                               
second scenario  when the department refers  to rising per-barrel                                                               
costs,  the department  refers  to costs  the  lessee is  already                                                               
incurring. However,  the costs  in the  fourth scenario  have not                                                               
occurred   and  are   under  evaluation   to  bring   incremental                                                               
production into  existencea  key distinction. To  qualify for the                                                               
second  scenario, the  lessee  would have  to  first incur  their                                                               
costs, but more likely the lessee  would not do so if they deemed                                                               
the project as uneconomic.                                                                                                      
                                                                                                                                
4:39:10 PM                                                                                                                    
He addressed  slide 15 regarding the  decision-making process for                                                               
royalty  and  net  profit  share modification.  SB  61  does  not                                                               
propose  to change  the  modification  process, applicants  still                                                               
need  to  provide  a  clear and  convincing  showing  that  their                                                               
application meets the statutory requirements.                                                                                   
                                                                                                                                
He explained  the bar for standard  of proof is much  higher when                                                               
compared to other  types of DNR applications.  The applicant must                                                               
show a clear and convincing case  at a higher degree of certainty                                                               
for  their   claim  that  production  is   not  economic  without                                                               
modifications. The applicant needs  to provide abundant technical                                                               
and financial informationheld confidential upon request.                                                                        
                                                                                                                                
MR. MEZA added  DNR retains the ability to  require applicants to                                                               
pay for  each application  to allow the  department to  reach out                                                               
for  consulting work  to assist  in specific  areas of  technical                                                               
information that the  department may not have  the expertise. The                                                               
department  will  keep the  same  process  of publishing  a  best                                                               
interest finding and offering a presentation to the legislature.                                                                
                                                                                                                                
He noted  even if DNR  grants the modification,  the modification                                                               
will contain  a series of  conditions and provisions  intended to                                                               
prevent any  deviation of the  claims made by the  applicant with                                                               
respect   to   the   proposed  project's   timeline,   investment                                                               
expenditures, and  application conditions.  Application approval                                                                
currently   in   statuterequires    authorization  by   the   DNR                                                               
commissioner.                                                                                                                   
                                                                                                                                
4:42:05 PM                                                                                                                    
SENATOR MICCICHE addressed new production  and asked him if there                                                               
is a  claw-back adjustment that the  department can automatically                                                               
initiate  to  a more  traditional  royalty  production tax  if  a                                                               
project  ends  up being  enormously  more  productive than  first                                                               
thought in the original negotiation and modification.                                                                           
                                                                                                                                
MR. MEZA answered yesnoting  slide  13 referenced a sliding scale                                                               
mechanism  to  provide for  a  lower  or  higher value  than  the                                                               
original  value stipulated  in the  lease contractthe   state may                                                               
find in its  review process that a claw-back provision  is in its                                                               
best interest if an outside case were to occur.                                                                                 
                                                                                                                                
SENATOR  MICCICHE asked  him to  clarify  that he  does not  mean                                                               
within the  ranges of NPSL  or royalty  relief, but he  is saying                                                               
the  department  could  convert  to  a  traditional  royalty  and                                                               
production tax.                                                                                                                 
                                                                                                                                
MR. MEZA  explained when the  department refers  to modification,                                                               
the  department is  referring in  the context  of changes  in the                                                               
royalty rate, changes  in the net profit share,  or a combination                                                               
if  the department  finds it  is in  its best  interest; however,                                                               
nothing about production tax.                                                                                                   
                                                                                                                                
4:45:13 PM                                                                                                                    
SENATOR KIEHL  asked him if  the state  should prove not  to have                                                               
had the  best information  when the  negotiation happened  in the                                                               
first place, could the state  come in and initiate a modification                                                               
to raise the net profit share or royalty.                                                                                       
                                                                                                                                
MR. MEZA answered  the department would consider  such a scenario                                                               
of recapture of  what the department granted  initially through a                                                               
provision  within  the  initial   modification  decision  if  the                                                               
department deemed  the modification requires granting  within the                                                               
series of conditions.                                                                                                           
                                                                                                                                
SENATOR  KIEHL stated  he thinks  the answer  to the  question he                                                               
asked  is  "no." However,  the  department's  hope is  to  always                                                               
foresee all scenarios with a modification.                                                                                      
                                                                                                                                
He noted  to Chair  Revak that he  requires some  additional help                                                               
and basic  understanding before the  bill comes back. He  said he                                                               
will  reach  out to  the  department  to better  understand  what                                                               
information  the department  has  access to,  how the  department                                                               
performs some of  its analysis, what information  is available to                                                               
the public, and  what information is available  to legislators to                                                               
help him analyze  whether the bill is something  that makes sense                                                               
to the state going forward with.                                                                                                
                                                                                                                                
CHAIR REVAK concurred and noted  the committee will hear the bill                                                               
in  the  future  via  additional   people,  receive  a  sectional                                                               
analysis, and  get more informational  briefings. He  thanked Mr.                                                               
Meza for his presentation.                                                                                                      
                                                                                                                                
[CHAIR REVAK held SB 61 held in committee.]                                                                                     

Document Name Date/Time Subjects
SB 61 Sectional Analysis version A 2.2.2021.pdf SRES 2/10/2021 3:30:00 PM
SB 61
SB 61 Sponsor Statement 1.28.2021.pdf SRES 2/10/2021 3:30:00 PM
SB 61
SB 61 DNR One-Pager 2-5-21.pdf SRES 2/10/2021 3:30:00 PM
SB 61
SB61 DNR NPSL Presentation 2-10-21.pdf SRES 2/10/2021 3:30:00 PM
SB 61