Legislature(1995 - 1996)
02/08/1996 01:37 PM House FIN
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE FINANCE COMMITTEE
February 8, 1996
1:37 P.M.
TAPE HFC 96-29, Side 1, #000 - end.
TAPE HFC 96-29, Side 2, #000 - end.
TAPE HFC 96-30, Side 1, #000 - end.
TAPE HFC 96-30, Side 2, #000 - 581.
CALL TO ORDER
Co-Chair Mark Hanley called the House Finance Committee
meeting to order at 1:37 p.m.
PRESENT
Co-Chair Hanley Representative Martin
Co-Chair Foster Representative Mulder
Representative Brown Representative Navarre
Representative Grussendorf Representative Parnell
Representative Kelly Representative Therriault
Representative Kohring
ALSO PRESENT
Representative Joe Green; Ken Boyd, Director, Division of
Oil and Gas, Department of Natural Resources; Ed Behm,
Occidental Oil and Gas Corporation (OXY) USA Inc.; Bruce
Policky, Exploration Manager, BP Exploration (Alaska) Inc.;
Charles Logsdon, Chief Petroleum Economist, Department of
Revenue; Bill Vandyke, Petroleum Engineer.
SUMMARY
HB 325 An Act authorizing suspension of payment of a
portion of the royalty due the state for initial
production of heavy oil from wells on the Arctic
Slope.
HB 325 was HELD in Committee for further
discussion.
HOUSE BILL NO. 325
"An Act authorizing suspension of payment of a portion
of the royalty due the state for initial production of
heavy oil from wells on the Arctic Slope."
REPRESENTATIVE JOE GREEN testified in support of HB 325. He
stated that the intent of the legislation is to find a way
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to make development of heavy oil on the North Slope
economical. He estimated that between 25 and 40 billion
barrels of heavy oil are entrapped. He noted that attempts
to economically produce heavy oil have not been successful.
He stressed that there are more reserves of heavy oil than
existed in the original Prudhoe Bay discovery. He
acknowledged that the heavy oil cannot be fully recovered.
Heavy oil is thick, low gravity oil which is not in a
consolidated reservoir. It moves up almost to the
permafrost level. Heavy oil is almost as thick as molasses.
Production problems are greater for heavy oil than for
"normal" oil. The royalty holiday would provide a holiday
or suspension from the royalty that would otherwise be paid
to the State. He maintained that the royalty holiday would
help operators over the economic hurdle in developing a
profitable method of extraction. He asserted that it
behooves the State to cooperate with developers. He
stressed that operators are hopeful that operating costs per
barrel can be reduced. He noted that wells drilled within
10 years would receive a holiday from the royalty for five
years. After that time the normal royalty amount would
resume. He compared HB 325 to HB 207. House Bill 207 was
adopted and became effective on 6/30/95. He reiterated that
under HB 325 royalties will be forgiven for five years.
House Bill 207 allows the Commissioner of the Department of
Natural Resources the discretion to forgive royalties. He
emphasized that there are other areas of the world where
heavy oil exists. He maintained that the State could miss
opportunities to develop reserves of heavy oil if action is
not taken.
KEN BOYD, DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF
NATURAL RESOURCES maintained that industry, the Legislature
and the Administration want to see Alaska's oil and gas
resources developed in an economically and environmentally
sound matter. He pointed out that the State will not
receive royalties for five years on wells drilled prior to
July 1, 2006. He noted that wells drilled in the year 2006
will be royalty free until the year 2011. He asserted that
there is no showing of need in HB 325. He emphasized that
the same terms apply to all operators. The grant is
automatic. He alleged that the terms of the bill were
selected without any economic analysis. He questioned why a
five year exemption, 500 barrels a day or a $15 dollar net
back were chosen. He stressed that companies have given no
assurance that fields would be drilled. He pointed out that
companies can shut down wells or apply for a reduction under
HB 207 at the end of five years. He maintained that HB 207
is the proper vehicle for developmental incentives because
it requires an economic analysis. He stressed that fields
can be transferred under HB 325. He acknowledged that HB
325 is more administratively difficult. He stated that he
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would work with the Committee if modification to HB 207 is
needed to specify that heavy oil is included. He reiterated
that HB 207 would be the best vehicle.
In response to a question by Representative Martin, Mr. Boyd
stated that he did not understand why the terms in HB 325
are necessary or are the only terms necessary. He
questioned if development is worth a zero royalty for five
years. He stressed that other options may be identified
with an economic analysis.
Representative Navarre asked if Mr. Boyd has presented
written arguments regarding HB 207. He noted Mr. Boyd's
expertise. He stated that he supported, in general, trying
to offer an incentive. He added that it is the
Legislature's responsibility to assure that there is ample
justification when dealing with the State's resources. Mr.
Boyd referred to a letter he wrote to Representative
Williams regarding the use of HB 207 for royalty relief for
heavy oil. (The letter was provided to the Committee later
in the meeting. See Attachment 3.) Co-Chair Hanley stated
that it would be helpful to review the letter. He noted
that questions have been raised by the Administration
regarding the use of HB 325 for royalty relief. He asked
that the letter as well as any other concerns or objections
and points that need to raised be provided to the Committee
in order to get the answers to the questions.
Representative Brown agreed that some incentive is
appropriate. She stated that the question is how the
incentive should be tailored to assure that the State does
not leave more on the table than is necessary. She stated
that the heart of the matter is the debate between the
Administration and the Legislature regarding royalty relief
for a specific situation as opposed to an across the board
suspension.
Representative Brown referred to "An Opportunity to Develop
Alaska's Heavy Oil Resources...," by British Petroleum (BP)
Exploration and Occidental Oil and Gas Corporation (OXY) USA
Inc., January 22, 1996 (copy on file). She quoted from page
25: "OXY seems the fairest candidate since, unlike other
North Slope producers, OXY's revenues from Schrader Bluff
production will come solely from wellhead revenues--OXY does
not share in significant downstream pipeline, tanker or
refinery profits." She asked if this analysis is accurate.
Mr. Boyd stated that he does not have the data to back up
their assumptions. She asked if the Department has asked to
see underlying production and cost data or other data to
have confidence that this is a reasonable starting point for
consideration of an incentive. Mr Boyd stated that he has
not requested the data. He noted that, even if data
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supported the claim that the terms are reasonable for OXY,
the terms would also apply for BP. He noted that CONOCO was
not able to develop the Milne Point field absent a royalty
reduction. The field was sold to BP. He noted that BP has
increased production by 25 percent and will eventually
increase production by 50 percent without royalty reduction.
He stressed that one company's economics is different from
another's.
Representative Brown asked what advantage pipeline owners
have over nonowners.
WILLIAM VANDYKE, PETROLEUM ENGINEER, DEPARTMENT OF NATURAL
RESOURCES responded to questions by Representative Brown.
He stated that the estimated advantage of the majority owner
is .50 cents to a dollar.
Representative Brown asked how much difference the royalty
rate makes in the face of price uncertainty. Mr. Boyd
stated that for a project that is truly on the edge that a
royalty reduction would be appropriate.
Representative Brown referenced appendix A, page 4, in the
report by OXY and BP. She noted that the report states that
OXY cannot apply for royalty reduction for these specific
leases. Mr. Boyd stated that HB 325 would override the
agreement cited in appendix A. He suggested that language
contained in HB 325 on page 1, line 6 stated that
"Notwithstanding any other provision of this section or any
provision in a lease, unit agreement, or other agreement
between a lessee and the state that establishes an
obligation to pay royalty on production..." would remove the
prior obligation.
Representative Brown asked how the provision would be
interpreted under HB 207. Mr. Boyd stated that it would
prohibit relief for the 9 percent share holder, OXY. The 91
percent share owner could apply for relief under HB 207. He
stressed that BP, the 91 percent partner, could share
royalty relief with their minority partner.
Representative Brown asked how long it would take a company
to go through the process outlined in HB 207. Mr. Boyd
answered three to six months. He suggested that the process
may move quicker if all the pieces were ready.
Representative Mulder asked what the State stands to loose
from HB 325. Mr. Boyd stated that $220.0 thousand dollars
per well would be lost per year. The number of wells that
would be drilled is unknown. He noted that the Department
of Revenue has a fiscal note that accompanies the
legislation.
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Representative Green clarified that there was a royalty
reduction at Milne Point. He added that Kuparuk is the
major oil reservoir at Milne Point. The Kuparuk reservoir
is not as viscous and shallow as the heavy oil addressed by
HB 325.
In referring to the Administration's preference for an
economic analysis Representative Green maintained that a car
buyer does not ask General Motors to show their balance
sheets to see exactly what the car costs before they make
their offer. He asserted that the operators have come
forward with their "sticker price." He questioned if the
State is willing to accept the loss of revenue to allow
proof in the field through royalty free pilot projects.
Representative Navarre asked the current oil head value.
Mr. Boyd responded that the current oil head value is $10.0
dollars a barrel. House Bill 325 allows an exemption from
payment of royalty to the portion of the value at the
wellhead, net of eligible field cost deductions.
Representative Navarre asked what the market value of the
oil would have to be in order to net $15.0 dollars a barrel.
He noted that the industry has stated that the price of oil
is one of the biggest determining factors in assessing
project feasibility.
CHARLES LOGSDON, CHIEF PETROLEUM ECONOMIST, DEPARTMENT OF
REVENUE stated that a net of $15.0 dollars would equate to a
market price of $21.50 dollars a barrel for heavy oil in
Milne Point.
Representative Navarre asked the justification for the
number and price per barrel used in HB 325.
Representative Martin expressed frustration with testimony
by the Administration. He summarized that the
Administration does not see a value in the approach taken by
HB 325. Mr. Boyd emphasized that the Administration does
not know what the right terms are. Representative Martin
questioned what the State needs to get the right answers.
Mr Boyd responded that the economics of the company are
needed. He questioned if the intent is to give BP and all
other companies the same break as OXY. Representative
Martin stated that "if it is a good resource to sell, and it
would help the State with our economic problems, and they
(oil companies) want to invest millions and millions and
hundreds of millions to prove that it is worth something,
please go get it." Mr. Boyd reminded Representative Martin
that the resource would be royalty free.
Representative Martin asked if the values used in HB 325 are
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not fair then what does the State think is fair. Mr. Boyd
responded that he did not know if the values are fair
because he has not seen the back-up economics to show if it
is fair or not. He added if it is fair "how can it be fair
for every company."
Co-Chair Hanley emphasized that "there needs to be a
determination based on the facility or well or field on
whether it is economic or not, based on some general
criteria, rather than looking at the net profits of a
company."
Representative Brown responded to comments by Representative
Green. She stressed that the exercise before the Committee
is not like buying a car. She maintained that legislators
act as trustees for the State's resources. She noted that
the State is the land owner. She added that the operators
have entered into contracts and agreed on contract terms to
develop these resources. She observed that it has become
apparent that those terms are not economic. She asserted
that it is appropriate to look at the individual specifics
of why the obligations agreed to cannot be fulfilled.
(Tape Change, HFC 96-29, Side 2)
Representative Brown questioned if a $15 dollar break is
appropriate for OXY, how much more of a break is being given
to other companies. She asked at what price, generally,
economic development could occur in the heavy oil sands.
Mr. Logsdon did not have a number available. He stressed
that the State has only recently obtained development plans
for the Schrader Bluff area.
Representative Therriault summarized that a determination
may be made based on a small operator's economics which may
not apply to larger operators. He suggested that the
legislation may be too broad.
Representative Kelly observed that the State is worrying
about the value of the customer as opposed to the value of
the product. He stated that the legislation will provide an
incentive for smaller producers. He spoke in support of
absorbing some of the breaks given to larger companies in
order to provide incentives to small producers.
Mr. Boyd responded that HB 207 is an opportunity for
companies of any size to apply for a royalty incentive. He
stressed that the most important thing the State can do is
to maintain a good lease sale program and get state lands
into the hands of those that want to develop them on a
regular basis. He maintained that the State has a good
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lease sale program. He added that the State is trying to
make the administrative and permitting process easier.
Representative Navarre assessed that most members of the
Committee are interested in offering necessary incentives.
He noted that the question is what level incentives should
take. He observed that the Economic Limit Factor (ELF) will
reduce the production tax to at or near zero. A royalty
holiday would limit the State's revenue to corporation tax.
He stated that "I'm looking for what level of incentive you
can offer and still generate the type of activity they want,
without going to what might be perceived, at some point, as
a windfall, if the price of oil is at the $15 dollar well
head value and the wells come in at 495 barrels each." He
estimated that at this rate of return the oil companies'
profit would be significant. He pointed out that this
revenue stream accrues to both the Permanent Fund and
General Fund. He stated that he is willing to agree that HB
207 might not always work and that perhaps something else
should be put in place. He stressed that justifications and
restraints should be in place to make sure it is a win/win
situation.
In response to a question by Co-Chair Hanley, Mr. Boyd
clarified that heavy oil production at Schrader Bluff is
currently at 3,000 barrels a day. Mr. Logsdon observed that
the state long range forecast includes an estimation for
increased heavy oil production. Heavy oil production values
in the fall forecast were based on estimations by BP that
Schrader Bluff production will peak at 45,000 barrels a day
by the year 2005. He stated that Schrader Bluff production
would generate revenues to the State of approximately $20.0
to $25.0 million dollars a year at peak.
In response to a question by Representative Martin, Mr. Boyd
emphasized that he would welcome as many companies into
Alaska as wish to come. He reiterated that HB 207 is
available for any size company to make its case. Mr. Boyd
acknowledged that heavy oil production should be encouraged.
He added that the State should look at what is the right
answer. He stated that "I don't think we make up numbers
and say that is the right answer and apply it to
everything." Representative Martin noted that the State has
not offered other data. Mr. Boyd stressed that the data
belongs to the oil companies. He did not specify what data
needs to be available. He noted that the State would do an
economic analysis under HB 207.
ED BEHM, HEAVY OIL TEAM LEADER, OCCIDENTAL OIL AND GAS
CORPORATION (OXY) USA INC. testified in support of HB 325.
He noted that OXY produces approximately 60,000 barrels a
day in their total U.S. operations. He pointed out that the
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Milne Point Unit alone could produce 60 to 65 thousand
barrels a day.
Mr. Behm provided members with charts used during his
testimony (Attachment 1). He noted that Milne Point is
OXY's largest domestic capital project. He stated that OXY
plans to spend $40 to $50 million dollars for capital growth
in Alaska. He noted that the Schrader Development
represents approximately half of the production potential in
the Milne Point Unit. He stated that without royalty
suspension the State anticipates revenues of $60.0 million
dollars from Schrader Bluff production. He stressed that
with royalty suspension the State could receive $425.0
million dollars through increased production. He observed
that OXY produces oil from the Sag River reservoir which
passes through the Schrader Bluff reservoir.
Mr. Behm stated that heavy oil is low gravity, thick oil
that produces slowly over a long period of time. Heavy Oil
is generally defined as crude oil with an API gravity of 20
degrees or less. He emphasized that production of heavy oil
is capital intensive. He observed that the federal
government is also considering incentives for heavy oil
production.
Mr. Behm stressed that ARCO invested $135 million dollars in
13 wells and related facilities for heavy oil. He observed
that ARCO spent $169 dollars a barrel in capital investment.
Mr. Behm demonstrated that 300 barrels a day is an average
production rate for a well drilling heavy oil. He stressed
that a 500 barrel a day suspension is necessary to assure an
average production rate of 300 barrels a day. He guessed
that 25 or 27 wells are currently producing. He emphasized
that since production began at Milne Point's Tract 14 the
level has remained constant.
Mr. Behm stated that OXY spent $126 million dollars on 22
wells with an average production rate of 275 barrels of oil
per day. He summarized that OXY's total investment amounts
to $9.30 dollars per barrel of oil. He suggested that
production costs can be further reduced.
Mr. Behm discussed the "hurdle rate" or minimum rate of
return necessary to justify capital investment. He noted
that the cost of capital, overhead, and risk must be
accounted for before profit can begin. He observed that
OXY's profit margin is 15 percent. Mr. Behm referred to a
portion of a report compiled by Arthur D. Little Inc.
contained in Attachment 1. He stressed that the report also
concluded that 15 percent is the minimal profit margin. He
stated that most projects do not exceed 35 percent.
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Mr. Behm reviewed heavy oil well economics based on the 5
best wells to date in Tract 14. He noted that the rate of
return was 12.8 percent. He summarized that this represents
a loss of $300.0 thousand dollars a well.
Mr. Behm concluded that HB 325 will offer an incentive to
develop more wells. He observed that similar incentives are
offered by other states. He maintained that incentives in
Texas have resulted in a 400 percent increase in the number
of wells drilled. He asserted that the additional economic
value generated for Texas is $12.0 billion dollars.
Mr. Behm asserted that the effect of royalty suspension on
Schrader Bluff economics to OXY would be a net cash profit
of $115.0 thousand dollars per well as opposed to a $307.0
thousand dollar loss per well without the suspension. He
clarified that the rate of return is based on the State's
spring forecast.
Mr. Behm stated that it would take a company 10 years to
recoup their capital investment in a heavy oil field. The
State would receive royalties after 5 years. He stressed
that there is no reason an oil company would walk away from
a long term profitable resource. He pointed out that OXY's
Alaska branch has a high reinvestment rate.
Representative Brown asked if OXY is willing to provide data
underlying costs and profitability levels to the Department
of Natural Resources so that analysis can be confirmed. Mr.
Behm replied that he would be willing to supply and discuss
their data with the Department. He asserted that heavy oil
projects need general incentives. He maintained that the
values used in HB 325 represent a reasonable number to "jump
start" these kinds of projects. He pointed out that HB 207
was designed to encourage marginal new projects. He
acknowledged that Schrader Bluff produces 3,000 barrels of
oil a day and is profitable. He emphasized that it is not
profitable enough to expand production.
Representative Brown noted that the State forgoes royalty in
the short run for a long run gain. She asked how the State
can assure that the long run gain will be realized. Mr.
Behm stressed that once a well is drilled and makes a profit
there is no reason to shut the well in. He added that well
performance is a matter of public record. Representative
Brown observed that a case could be presented in the future
for more reductions. Mr. Behm reiterated that the problem
is making a return to pay for the capital investment. He
stated that the company would have to prove that they are at
the economic limit for a HB 207 reduction. He stressed that
Schrader Bluff wells are not at economic limit. They could
not prove that the Schrader Bluff wells would have to be
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shut in since they are profitable. He restated that it
would not be profitable to drill new wells.
Representative Brown noted that companies are granted rights
for all the reservoirs in a unit. She asked why a
particular reservoir should be segregated from other more
profitable ones. Mr. Behm noted that companies are profit
driven.
(Tape Change, HFC 96-30, Side 1)
Mr. Behm summarized that HB 325 will stimulate new wells.
Representative Martin asked if the Division of Oil and Gas
has been given data from OXY. Mr. Behm noted that the
Department of Natural Resources has data on Tract 14 wells
from royalty settlement negotiations. He asserted that the
Department "would have the information if they wanted to
look at it." Mr. Behm stressed that disagreement occurs
over the speculation of future costs.
Representative Mulder asked what new technologies are on the
horizon that might make heavy oil more profitable to
develop. Mr. Behm noted that steam drives at close spacing
are used in California. He stressed that new technologies
are often expensive.
In response to a question by Representative Mulder, Mr. Behm
stated that he would not foresee additional new wells for
Schrader Bluff without the incentives.
Representative Mulder observed that legislators are mandated
to get the best deal possible. He asked how realistic are
estimates of revenues the State will realize from heavy oil
production after the five year holiday. Mr. Behm stated
that "if things continue the way I would envision then that
should be a logical outcome."
In response to a question by Representative Navarre, Mr.
Behm clarified that well production varies. New wells are
not necessarily higher producers.
Representative Navarre observed that ARCO's cost per barrel
of oil was $169 dollars. OXY reduced their production cost
to $9.30 dollars a barrel. He questioned how far technology
has advanced in the last 10 years and asked how far will
technology advance in the next 10 years in allowing for
better economics for heavy oil development. He observed
that any well drilled before the year 2006 would have the
benefit of technology developed up to that time. He pointed
out that the royalty incentive would allow a greater rate of
return. Representative Navarre suggested that the State may
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want to offer the royalty incentive for a five year period.
The issue could be revisited in the year 2001 to see if it
should be extended.
Representative Navarre asked if a holiday based on a rate of
return has been considered. Mr. Behm stated that a holiday
based on the rate of return would triple administrative
costs due to audit exercises.
Representative Navarre asked what the rate of return would
be with a $15 dollar well head value for a well producting
300 barrels a day. He asked what the capital cost recovery
would be with the five year holiday. Mr. Behm could not
respond, but agreed to provide data on the question.
Representative Brown asked if existing wells can be modified
for heavy oil production. Mr. Behm stated that some wells
could be modified but that they would not receive the
royalty incentive. He stated that it is not the intent, as
he understands it, to allow modified wells to qualify.
In response to a question by Representative Therriault, Mr.
Behm stated that redrilling the same well would not be
considered as a new well. He added that the well "is still
called the same thing. It is only granted a five year
holiday from initial investment."
Representative Brown referred to page 2, line 2. Co-Chair
Hanley noted that language in the legislation can be
tightened to clarify the intent of the Committee.
In response to a question by Representative Kelly, Mr. Behm
explained that a 5 percent royalty discount rate would
equate to a 5 year royalty suspension. He stressed that a 5
percent discount over the life of the well would result in a
greater loss of revenues to the State.
Representative Navarre asked the rate of return on existing
wells after capital costs. He questioned if the 300 barrels
per day average has improved in newer wells. Mr. Behm noted
that the average is improving. He stated that the last 10
wells are closer to 400 barrels a day. He noted that his
economics are based on a production level of 400 barrels a
day.
BRUCE POLICKY, EXPLORATION MANAGER, MILNE POINT, BRITISH
PETROLEUM spoke in support of HB 325. He provided members
with charts highlighting points of his overview (Attachment
2). He noted that the Milne Point Unit is the Northern most
production unit on the North Slope. It is located between
the Kuparuk and Prudhoe Bay units. British Petroleum
Exploration purchased the unit in 1994. There are
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approximately 26 billion barrels of heavy oil underlying
existing North Slope units. He noted that not all of the
oil is recoverable. The quality of the field varies. Page
3 of Attachment 2 shows Schrader Bluff Heavy Oil
Development. He noted that Tract 14 development only
represents approximately 1 percent of the total resource.
He summarized that in 1991 21 wells were drilled. There was
a high capital investment of $135 million dollars with a low
initial production rate which averaged 275 barrels per day.
He noted that new completion technology was tested. The
wells remain on production. He emphasized that commercial
development stopped in 1991.
Mr. Policky stated that BP noticed after the unit was
purchased that the unit was performing well without high
well decline. A demonstration project was initiated by BP
in 1994 and 1995. The objective of the program was to
demonstrate that a commercial project in the heavy oil
accumulation at Schrader Bluff could be economically
feasible. They attempted to increase production rates and
reduce development uncertainty. Fifteen million dollars
were spent in 1995 to drill six new wells. Three older
wells were recompleted. Drilling costs were reduced.
Operating expenses remained high. Submersible pumps were
used. Page 7 of Attachment 2 outlines technology used at
Schrader Bluff. He noted that heat trace is used to keep
wells from freezing. He observed that it costs $1.0 million
dollars to complete a well. He emphasized that completion
in other areas is only half as expensive.
Mr. Policky discussed international competition for capital
funding. He noted that there are more projects than funds
available. He stressed that cost reductions and increased
production are not enough to win funds without the addition
of development incentives. He emphasized that the addition
of development incentives will not guarantee that they will
be successful in competing for developmental funds. He
noted that the Department of Revenue's Fall Forecast
presupposes that BP will be successful in competing for
funds.
Mr. Policky reiterated that there are approximately 2
billion barrels of heavy oil in place at Schrader Bluff. He
estimated that 200 to 800 barrels could be recovered. He
maintained that the royalty holiday will:
* Reduce investment uncertainty;
* Encourage investment;
* Send a positive signal; and
* Accelerate the pace and increase the scope of
development.
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Mr. Mr. Policky stressed that heavy oil fields have a long
production life. He estimated that well production will
last 41 years. He profiled production on 230 wells drilled
over a nine year period. He estimated that 300 million
barrels would be recovered. Only 30 percent of the produced
oil would be royalty free. He stressed the importance of
maintaining development momentum. He emphasized that
anytime a project is deferred there is a potential for value
loss. He stated that ultimate recovery could be placed at
risk if the project is delayed.
Representative Martin questioned what information the
Department of Natural Resources would need from BP to be
comfortable with the values used in HB 325. Mr. Policky
stressed that the Schrader Bluff BP projects have not been
completed, but offered to share information gathered. He
restated that BP supports HB 325. He noted that BP has
spent $17.0 million dollars for Schrader Bluff production.
No more wells are budgeted. He stressed that heavy oil
development does not compete for capital funds without
additional incentives. He observed that new projects have
to be approved by the London Board of Directors. All of
BP's holdings compete for investment funds.
In response to a question by Representative Therriault, Mr.
Policky noted that BP is expanding handling capacity at
their central facility from 30,000 to 65,000 barrels a day.
He noted that the Kuparuk development will fill the
facility. To make room for heavy oil production the central
facility would have to be increased to 95,000 barrels of oil
or more. He emphasized that heavy oil production would have
to pay for the upgrade. Four or five new pads would be
needed. Some existing pads could be utilized.
(Tape Change, HFC 96-30, Side 1)
Mr. Policky clarified that the difference between the rate
of return needed by BP only differs a few percentage points
from those needed by OXY. Representative Brown asked if BP
would share information on a confidential basis. Mr.
Policky stated that he thought that BP would share
information with the Department of Natural Resources on a
confidential basis. Representative Brown noted that OXY
does not share downstream tanker, pipeline, or refinery
profits. Mr. Policky stated that there is a minor financial
benefit to the pipeline owner. Representative Brown
restated testimony estimating that the benefit to BP through
their pipeline ownership is between .50 cents and a dollar.
Mr. Policky did not know the value of the benefit to BP
through ownership of the pipeline.
Representative Brown asked at what price development of
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heavy oil would be economic for BP. Mr. Policky was unable
to answer. He emphasized uncertainties. He guessed that
the price would have to be 20 to 30 percent higher. He
maintained that a net well head value of $15.00 dollars per
barrel is reasonable.
Representative Navarre asked the expected rate of return on
BP's $15.0 million dollar investment. Mr. Policky stated
that the rate of return is low. He emphasized that risk
funds were incorporated. He observed that the wells are not
on production. He stated that it costs between $1.6 to $2.0
million dollars to drill and complete a well. He added that
surface facilities can run from $500.0 thousand dollars to
$1.0 million dollars a well.
Representative Brown referred to page 1, line 14. She asked
the eligible field cost deductions for Milne Point. Mr.
Policky responded that it is consistent with royalty
calculations to determine well head values for royalty
payments.
In response to a question by Representative Therriault, Mr.
Policky stated that production is limited at Milne Point by
the capacity of the central facility to handle production.
He noted that the well cost includes a flow line to a
gathering point, gravel, flow lines to the central facility,
and upgrades to the central facility.
In response to a question by Representative Green,
Representative Navarre clarified that he would like to know
if the current rate of return is less than the 15 percent
threshold identified as the minimum profit margin. He
questioned what level of capital investment can be
supported. He suggested that a credit could be given
against a percentage of the capital investment to throw
their economics over the 15 percent threshold. He
questioned if the well head value is at $15.0 dollars today
and the wells were producing at an average of 300 barrels a
day would the rate of return be above the 15 percent
threshold. Representative Green summarized that
Representative Navarre is looking for a rate of return on
the investment.
Mr. Policky observed that if well head prices are high for
heavy oil on the North Slope than they would be high for oil
production throughout the world. He noted that the same
capital allocations are in place for competition with other
world projects. Representative Navarre concluded that
higher incentives may need to be offered to win competition
for Alaska.
Representative Brown asked if projections by the Department
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of Revenue are accurate. Mr. Policky stated that the
projections are accurate if the project is approved. He
cautioned that the project has not been submitted for
approval. He stressed that there is no guarantee that the
project will be approved. He did not foresee development of
the project without adoption of the incentives in the near
future. He emphasized that all parties encounter a degree
of risk.
Representative Brown asked the Division of Oil and Gas to
take advantage of a willingness by the operators to share
additional information. She asked the Department to look
over the assumptions used in HB 325 based on the access of
information available.
Mr. Boyd maintained that the data available to the
Department is six years old. He stated that he needs to
know what to do with the data. He stressed that he could
work under HB 207 applications.
Co-Chair Hanley summarized that the Administration is
opposed to HB 325. He asked for the Administration's
opposition in writing. He noted that members were provided
with a letter from Mr. Boyd to Representative Williams,
dated 1/30/96 (Attachment 3). He requested that any
comments, criticisms or reasons opposing HB 325 be provided
as soon as possible in writing to allow a response from
industry.
Representative Brown asked the Department to complete an
analysis of the assumptions in HB 325 as if it were applied
to the mandates of HB 207 to determine if it is a reasonable
incentive. She asserted that the Division of Oil and Gas
has the necessary expertise and that industry
representatives have stated that the data is available.
Co-Chair Hanley summarized Representative Brown's question.
He concluded that the question is: Is an incentive
necessary to develop heavy oil based on economics? He
observed that if an incentive is necessary the Committee can
continue to debate the form it would take.
Representative Navarre noted that it would be helpful to
ascertain what type of incentive would be granted if the
field were applied to HB 207. He asked the Department's
suggestions for protecting the State's interest if HB 325 is
adopted.
Mr. Boyd referred to Attachment 3. Co-Chair Hanley added
that the Committee needs a written response from the
industry summarizing why HB 207 does not work. He requested
that any additional concerns, comments, or questions by Mr.
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Boyd be prepared by 2/13/96. Mr. Boyd responded that he
will comply with the request. He suggested that discussion
occur regarding what data is necessary to make a
determination.
Co-Chair Hanley reiterated that the Administration believes
that HB 207 is the appropriate vehicle. Mr. Boyd stated
that HB 207 is the mandate the Department was given under
law. Co-Chair Hanley pointed out that the Legislature makes
decisions on law. He questioned if HB 207 handles all the
situations that the Legislature is trying to address. He
asked Mr. Boyd to make suggestions for modification of HB
207 or other options if HB 207 will not handle heavy oil
incentives.
Representative Martin expressed concern that the legislation
not be delayed. Co-Chair Hanley assure him of the
Committee's intention to take action. Representative Brown
restated her request to have a party outside of the
operators to provide an analysis of the legislation.
Representative Navarre observed that information is needed
to make a competent decision. He pointed out that an asset
of the State is being discussed.
Mr. Behm maintained that data is available. He stressed
that HB 325 creates an advantage for companies to come to
the State of Alaska to develop heavy oil.
Representative Navarre expressed concern that the
legislation projects fifteen years. He observed that
technology has advanced in the last 10 years. He stressed
that advances in the next 10 years will change overall
economics.
ADJOURNMENT
The meeting adjourned at 4:15 p.m.
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