Legislature(2005 - 2006)HOUSE FINANCE 519
04/03/2006 01:30 PM House FINANCE
| Audio | Topic |
|---|---|
| Start | |
| HB488 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 488 | TELECONFERENCED | |
| + | TELECONFERENCED |
HOUSE FINANCE COMMITTEE
April 3, 2006
1:39 p.m.
CALL TO ORDER
Co-Chair Chenault called the House Finance Committee meeting
to order at 1:39:54 PM.
MEMBERS PRESENT
Representative Mike Chenault, Co-Chair
Representative Kevin Meyer, Co-Chair
Representative Bill Stoltze, Vice-Chair
Representative Richard Foster
Representative Mike Hawker
Representative Jim Holm
Representative Reggie Joule
Representative Mike Kelly
Representative Beth Kerttula
Representative Bruce Weyhrauch
MEMBERS ABSENT
Representative Carl Moses
ALSO PRESENT
Patrick Foley, Manager of Land and External Affairs,
Pioneer; Tom Dodds, President, Andex Resources; John Barnes,
Production Manager, Marathon Oil, Alaska.
PRESENT VIA TELECONFERENCE
Ken Thompson, Managing Director, Alaska Venture Capital
Group.
SUMMARY
HB 488
"An Act repealing the oil production tax and gas
production tax and providing for a production tax on
the net value of oil and gas; relating to the
relationship of the production tax to other taxes;
relating to the dates tax payments and surcharges are
due under AS 43.55; relating to interest on
overpayments under AS 43.55; relating to the treatment
of oil and gas production tax in a producer's
settlement with the royalty owner; relating to flared
gas, and to oil and gas used in the operation of a
lease or property, under AS 43.55; relating to the
prevailing value of oil or gas under AS 43.55;
providing for tax credits against the tax due under AS
43.55 for certain expenditures, losses, and surcharges;
relating to statements or other information required to
be filed with or furnished to the Department of
Revenue, and relating to the penalty for failure to
file certain reports, under AS 43.55; relating to the
powers of the Department of Revenue, and to the
disclosure of certain information required to be
furnished to the Department of Revenue, under AS 43.55;
relating to criminal penalties for violating conditions
governing access to and use of confidential information
relating to the oil and gas production tax; relating to
the deposit of money collected by the Department of
Revenue under AS 43.55; relating to the calculation of
the gross value at the point of production of oil or
gas; relating to the determination of the net value of
taxable oil and gas for purposes of a production tax on
the net value of oil and gas; relating to the
definitions of 'gas,' 'oil,' and certain other terms
for purposes of AS 43.55; making conforming amendments;
and providing for an effective date."
HB 488 was HEARD and HELD in Committee for further
consideration.
J. PATRICK FOLEY, MANAGER OF LAND AND EXTERNAL AFFAIRS,
PIONEER NATURAL RESOURCES ALASKA, INC., provided information
regarding Pioneer's position on the bill. He referenced the
company president, Ken Schoeffield, who was unable to attend
due to illness. Mr. Foley explained that his company began
business in 2003, and commented that they were one of the
types of companies that the State of Alaska had been
encouraging to do business. He stated that their portfolio
had grown to approximately 1.7 million gross acres, equaling
450 to 500 net acres. He illustrated their acreage position
on the North Slope and noted that ConocoPhillips was their
partner in exploration. The company has two wells in the
area currently, and is expecting to drill several more. He
noted their development project in Oooguruk, as well as
exploration wells in other locations south of Prudhoe Bay.
He noted that ConocoPhillips in Antigua operated their Artic
Fox drilling rig. He also mentioned their Cosmopolitan
project in Cook Inlet - a known resource discovered by Arco
originally. They maintain small working interest, with the
option to increase to a fifty percent working interest and
become the operator. This will be decided by the summer of
2006.
Mr. Foley discussed details of Oooguruk project, an offshore
development with 50 to 90 million barrels of recoverable oil
reserves, developed at a cost of $500 million and a peak
production projection of 15,000 to 20,000 barrels per day by
2010. He explained that if this were a simple North Slope
project, it would include no processing. Processing fees
were being discussed.
Mr. Foley described the project components, such as gravel
placement in the winter of 2006, equipment in the winter of
2007.
Representative Chenault asked how far from shore. Mr. Foley
observed that the island is eight miles from the Island and
is at a depth of 4.5 feet. The pipeline at its deepest
crosses 7.5 feet of water.
1:45:55 PM
Mr. Foley acknowledged the cost structure as being a
challenge, some of the highest in the world. He noted the
theory that the super sized fields had already been tapped,
meaning that smaller reservoirs would be developed. He noted
that the cycle times between discovery and production were
much longer here than in the lower 48. He observed that the
cycle time was shortened to 5 years in Oooguruk. He pointed
out that it is close to infrastructure and that work had
been done since its discovery in the 1970's.
Mr. Foley noted the investment uncertainty in Alaska,
pertaining not only to exploration but also to fiscal
circumstances.
1:48:25 PM
Mr. Foley commented that their initial reception from
Administration was welcoming. He expressed concern over how
to process smaller fields, and noted the willingness to
allow access to facilities for newer companies, providing
they were willing to pay processing fees. He noted the
State's fiscal policies, and noted that they were still
attractive compared to other places in the world. He
referenced conversations with the Governor's office, and
suggested that production taxes might come out to be nearly
zero considering other incentives.
1:50:35 PM
Mr. Foley maintained that Alaska needs to be competitive
with lower 48 and Canadian on-shore resource plays, which
target tight sands, coal bed methane, and shale. These types
of projects are low risk, low cost and are attracting
development. Many have lower tax rates.
1:51:57 PM
Mr. Foley concluded that this was the climate that attracted
his company to develop in Alaska. He reviewed the
Administration's original proposal with a 20 percent tax
rate and a 20 percent credit, concluding that they believed
it to be fair and balanced. He noted the tax/credit rate,
$73 million exemption, tradable credits and other modest
incentives for new exploration. Large companies that are
already paying a production tax can utilize the credit the
next month. A new entrant would have to wait to use the
credit, or sell them when their value had eroded. He
explained that the credits had market value, and that the
incentives allowed for no entrants and exploration, by
reducing the economic size field that can be explored.
Smaller, less productive fields would be economic. He
concluded that the Administration's proposal would encourage
new investment.
1:54:37 PM
Mr. Foley then commented on the proposed legislation. He
applauded the 20% tax rate, and cautioned raising the tax
rate, proposing that that it would reduce companies'
incentive to invest. He pointed out that if a development
existed, it would be in the State's best interest to have
multiple independent companies also investing.
1:56:12 PM
Mr. Foley cautioned that if the State wished to implement a
progressive tax, that they be careful in its method. He
referred to the relationship between oil price rise and
costs for exploration. He noted that costs for all
development related services had increased recently.
Pioneer's drilling cost doubled in Texas in 2005. He
concluded that the profit margin does correlate to the rise
in oil profits.
1:57:36 PM
Mr. Foley suggested that if a progressive tax rate were
implemented, it should be based upon profits, rather than a
simple tax rate. He suggested that to base the tax on
profits would make it unnecessarily complex. He noted that
all of the oil sold by his company would be sold as crude on
the west coast and encouraged the use of ANS price if
necessary.
1:59:09 PM
Mr. Foley noted that it was difficult to predict prices. He
concluded that if a price were accepted, there should be
some index to take inflation into account. He suggested that
excess could be taxed at a higher rate, but noted that
overtime that amount would be affected by inflation.
2:00:25 PM
Mr. Foley then discussed the idea of $12 million "start up"
credits to encourage new entrants. He noted that the House
had converted this concept to a $12 million credit, but
stated that it was similar to a profit exemption. He
suggested that this credit would give an independent company
the opportunity to cover start up costs without the benefit
of an existing infrastructure. He noted that his company had
26 employees housed in Alaska, and stated that it was
difficult to do business in the state without personnel who
actually understand the way things work here.
2:02:58 PM
Mr. Foley proposed that start up costs in the State were
high, and this exemption gave a chance to smaller companies.
He noted that implementing a severance tax would make
business difficult for these smaller companies.
2:03:59 PM
Mr. Foley discussed the importance of monitoring tax
credits. He pointed out that credits could be used in a
number of ways, whether held or sold at a discount. He noted
that the purchaser of credits would redeem its full value,
as well as the cost to the state. He referred to the
"refundable" credit of $10 million included in the bill, and
encouraged legislators to increase the amount. He observed
that if a new investor spent $100 million, that between a 20
percent credit and a 20 percent loss, $40 million in credits
would be generated. He reiterated that any number higher
than 10 would be beneficial.
2:06:21 PM
Mr. Foley then addressed Transitional Capital Recovery. He
noted that their cumulative investment since 2003 had been
$100 million, and expressed the need to be rewarded for this
investment. He noted that in this time, they had yet to
recoup their costs for development.
2:07:35 PM
Mr. Foley referenced the 26 employees of Pioneer in Alaska,
and suggested that the State should make it a priority to
convert all resources into revenue. He reiterated that the
20/20 proposal was balanced and fair, and urged that careful
consideration be given to raising the tax rate. He noted
that the start up credit seemed to have a sunset provision,
and encouraged that the credits be allowed to last in
perpetuity. He also referred to refundable credits, and
encouraged that these be implemented. Finally, he noted that
a Transition Capital look back was appropriate, especially
for smaller companies.
2:10:24 PM
Representative Kerttula asked how the PPT would play into
the royalty reduction already set forth. Mr. Foley responded
that Mr. Van Dyke discussed Pioneer's royalty reduction and
the effect of royalty reduction. He proposed that it
benefited the project, but pointed out that it would not
dramatically add to its success. He noted that the rates of
return were not actually at the rate previously discussed.
2:12:13 PM
Responding to another question by Representative Kerttula,
royalty reduction had not yet phased out, which would occur
linearly over four years.
2:13:01 PM
Representative Holm referred to earlier comments about the
regulatory process being a stumbling block to production,
and asked for clarification. He asked if the regulatory
process was as big a burden as the tax rate.
2:14:20 PM
Mr. Foley acknowledged that the resource should be
protected. However, he contrasted the difficulty in
regulatory climate between the North Slope and another
global location, and noted that it was dramatically higher
in the North Slope. He suggested that it required personnel
familiar with the system.
2:15:26 PM
Representative Holm asked how long it would take to permit a
well in the Gulf of Mexico. Mr. Foley noted that he knew
that Oooguruk began its regulatory process on an informal
basis, and it took one year to complete. He also noted that
many other projects took 4 to 5 years.
2:16:18 PM
Representative Holm observed that if the State considered
creating incentive for production, perhaps it might do well
to adjust the permitting process as a type of incentive. He
noted that perhaps if the permitting took an inordinate
amount of time, the price might decline before production.
2:17:34 PM
Mr. Foley noted his personal experience with the regulatory
process in the immediate infrastructure. He felt the process
worked relatively well and noted that an offshore project
was permitted in a year's time. He pointed out however that
more remote resources would require a more difficult
permitting process, and suggested that this might be
investigated.
2:18:40 PM
Vice-Chair Meyer referred to delays occurring on the
North Slope relating to environment. Mr. Foley confirmed
that most exploration work took place in the winter, and
noted the snow road concept in working with the Department
of Natural Resources, developing systems to facilitate work
in late November, a month earlier than historical trends. He
also noted that drilling might continue until the end of
April.
2:20:05 PM
Vice-Chair Meyer expressed appreciation for the smaller
companies like Pioneer, and asked how many wells were
drilled this year. Mr. Foley noted that in the past year,
nine explorations wells had been drilled, as compared to 3
this year. Vice-Chair Meyer asked how this compared to ten
year ago. Mr. Foley noted that he had worked in exploration
activities for the past twenty years, and conceded that
there might have been a time when there were as many as
eight wells drilled, compared to times when prices were low.
He asked legislators to consider whether six wells were
adequate, and suggested that incentives might increase the
number of wells.
2:22:18 PM
Vice-Chair Meyer stated his belief that double the amount of
wells would be more beneficial, and questioned why there
wasn't more exploration with a cost of $60 a barrel.
2:22:47 PM
Mr. Foley noted that to drill a well would cost
approximately $10 million, with a higher cost in more remote
locations. He also responded that smaller companies had
finite resources, in terms of equipment and personnel. He
noted that the fleet of drilling tools would increase over
time. He noted that other companies needed to first consider
whether it was worth their while to enter into business in
Alaska.
2:24:41 PM
Vice-Chair Meyer questioned whether the 20/20 proposal would
be adequate to attract smaller companies if the drilling
season was shorter in Alaska, and regulatory costs higher.
Mr. Foley confirmed that the 20/20 proposal was fair and
adequate (without progressivity), providing a modest
incentive over the current structure, and estimated that
other companies would come to the State. He emphasized that
it would enable small, marginal [fields] to be profitable,
by only a few percentage points increase in the rate of
return.
2:26:10 PM
Representative Weyhrauch asked how our drilling costs
compared to Texas. Mr. Foley noted that the costs were
significantly less in the lower 48 states; a $2 to $3
million well would be considered expensive. Representative
Weyhrauch asked how independents were affected by the use of
ANS. Mr. Foley pointed out that the barrels would be sold in
the west coast market. He noted that it was not as simple as
predicting an average $2 dollar difference; there have been
times when the spread between ANS and WTI has been great.
2:27:50 PM
Representative Weyhrauch observed that three major companies
were marketing and shipping from the west coast and wondered
whether it was better to separate out that the network using
ANS indexing to use WTI to game the system.
2:28:27 PM
Mr. Foley stated that a company like Pioneer had no ability
to "game" the system. He noted that it was not a transfer
price or accounting issue, but rather a real legitimate
sale.
2:28:58 PM
Representative Chenault referred to earlier comments and
asked how this might affect Cook Inlet. Mr. Foley stated
that Oooguruk was in a decision making process to conclude
in the summer. He noted that their company included analysis
of Oooguruk and Cosmopolitan in their portfolio. He stated
that if a project like Cosmopolitan were separated out, the
credits might prove more enticing. He thought that
Cosmopolitan may be found to be marginal and a slight shift
would make it profitable.
2:30:43 PM
Representative Chenault commented that some interest was
not only North Slope, but also Cook Inlet, and questioned
what incentives were available to bring smaller companies
into these areas.
2:31:31 PM
TOM DODDS, PRESIDENT, ANDEX RESOURCES, provided information
on HB 488. Andex has been invested in Alaska for
approximately 6 years. Andex is an exploration leader. He
observed that there has been little new exploration in
Alaska. They are currently working on a gas [exploration]
project of over 500,000 acres, which would flow to Anchorage
and Fairbanks. Andex tries to identify projects'
risk/return. Capital commitment for investment dollars is
huge. He acknowledged Alaska's high cost of operation. They
are ready to start drilling in Nenana, but are waiting to
see the results of HB 488. He observed increases in rent of
400 percent and 200 percent in steel. There are also
shortages of equipment and manpower, which were worsened by
the recent hurricanes.
2:38:06 PM
Mr. Dodds observed that they were unable to find partners
for the high risk Nenana project. Lower 48 companies were
not interested in coming to Alaska. Three Alaskan companies
were recruited as partners, none of which were normal oil
and gas companies. There is a big difference between their
company and others in the Cook Inlet and North Slope. They
are looking for high return investments. Exploration would
be affected under a PPT plan. He observed the lack of
infrastructure, but pointed out that Alaska has the
potential for giant new discoveries. It will take people in
the interior looking for these reserves. Daily production is
declining.
2:41:23 PM
Mr. Dodds expressed concern that under the PPT tax new
exploration would not come to Alaska. He observed that their
project is in a basin 300 miles from the nearest operations.
They are between Cook Inlet and the North Slope. Production
is approximately 7 to 8 years in the future. There is only a
three-month drilling season, which must occur before
breakup. He stressed that a pipeline must be put under a
river to reach Fairbanks at a cost of $150 million over 6 -
7 years, which the producers must finance. The project would
lower the cost of fuel in Fairbanks by half and open up
services in the interior.
2:44:05 PM
Mr. Dodds emphasized that they need long-term stability and
pointed to the raise in oil prices. The 6 - 1 ration between
oil and gas should be more like 9 or 10 to 1, and should be
stand alone commodities. The incentive with any tax increase
must be real. Without new investment incentives there will
be little to no new exploration. He projected that the oil
and gas assets of the state of Alaska will be depleted
without new exploration. Reserves must be replaced and
investment encouraged.
Alaska relies heavily on the oil and gas industry. Oil is
ageing but gas has a huge potential. He stressed that the
gas will be a depleting resource once it begins production
and emphasized the need for more exploration.
2:48:00 PM
Representative Holm observed that the project has been on
hold for several years. Mr. Dodds responded that they did
not anticipate drilling before the current year. They held
several public meetings. Contracts with their partners were
only signed two years ago. He continued to give details
regarding the project's timeline. He noted that the plan to
begin in the next year had been jeopardized by the
introduction of HB 488. Andex is looking at acquiring rigs.
He emphasized that the project is high risk.
2:51:25 PM
In response to a question by Representative Holm, Mr. Dodds
observed that the same rigs could be used for oil and gas,
but that size is the issue. The rigs must be light load so
that they can be broken down and brought across the river.
2:52:54 PM
KEN THOMPSON, MANAGING DIRECTOR, ALASKA VENTURE CAPITAL
GROUP (AVCG), testified via teleconference from prepared
comments. He stated that AVCG was an independent oil
exploration company with a focus on the North Slope of
Alaska. AVCG is a consortium of 15 independent oil and gas
companies and individuals from Kansas and me as an
owner/investor from Alaska. AVCG has a technical and
operational services' subsidiary company called Brooks Range
Petroleum, with offices in Anchorage. He also noted that he
is the former President of ARCO Alaska, Inc.
2:56:18 PM
Mr. Thompson continued his testimony.
AVCG has been very active in the past six North Slope
(NS) area wide lease sales and we have acquired over
160,000 acres of exploration leases in five exploration
prospect areas, including new acreage we acquired in
the recent March 1, 2006, NS lease sale. Our
exploration strategy is to explore in the central part
of the North Slope for fields in the 25-150+ million
barrels range, fields that may be too small for the
giant producers but fields that can be produced
profitably by smaller companies like ours. We believe
there are hundreds of millions if not billions of
barrels of oil left on the North Slope in smaller
fields of this size and these fields near
infrastructure can be brought on more quickly. Our
first exploration well in partnership with Pioneer
Natural Resources - the Cronus #1 about 10 miles
southwest of the large Kuparuk Field - completed
drilling last week but results remain confidential.
I don't understand all the dynamics of the past three
weeks in the legislature, but this I do know. The CS
for HB 488 needs to be greatly simplified and it needs
to move back closer to the Governor's proposal and the
original HB 488 draft if a win-win solution is to be
re-developed.
2:58:05 PM
I am an optimist and always have been. I personally
think there is still time to avoid a train wreck in
this complicated business of a major restructuring of
Alaska's petroleum taxation system…if the House Finance
Committee acts quickly. I, for one, have not given up
hope that there is a version - easier to understand and
to implement - that can be a win-win for both the State
and industry. I repeat that the current draft of CS HB
488 is not a win-win. There is a simpler and better
way, in my opinion, for the State to improve government
take while not dampening exploration and development
investment. Let me outline my suggestions for a win-win
and my suggestions for simplification.
2:58:51 PM
First, however, let me say that while I am Managing
Director of AVCG, our other owners disagree strongly
that any change should be made to the 20/20 PPT formula
proposed by the Governor. The 20% PPT tax rate and the
20% credit originally presented in the Governor's bill
should be the tax rate and credit enacted. The AVCG
owners representing 15 new exploration investors in
Alaska are concerned enough that the current system is
being revised after they have made almost $10 million
investment in North Slope leases and other costs and
are planning a 3-year $46 million exploration program
with our first well recently drilled. With reasonable
discovery success over the next 3 years in any of our
upcoming prospects, we could see development capital
spending at $500 million to $1 billion.
Quite honestly, the AVCG owners listened in disbelief
when I told them the production profits tax rate being
considered in the current CS to HB 488 draft could add
a "progressive surcharge" that could place an
additional 37.5% taxation of wellhead value by the
state at high oil prices on to the base PPT, the
State's 12.5-16.7% royalty, the ad valorem property
tax, the 3-9% corporate income tax, lease bonus bid
amounts, the ongoing annual lease rental amounts, and
the Federal income tax rates averaging 20-35% of
taxable income. It all adds up, and AVCG Owners are
saying, "enough is enough."
3:01:43 PM
Interestingly - and this is important - when I was
communicating the latest CS to HB 488 details to the
AVCG owners by teleconference and email recently, I
felt two overwhelming emotions. The first emotion was
discouragement. Under the original 20/20 proposal, I
was recommending to our owners that considering the
value of the tax credits, we could add a sixth
exploration well for every fifth well drilled
essentially at no cost to our company…this could lead
to additional discoveries and production for all of us.
This is good policy. However, in discussing the CS to
HB 488 with its much higher taxation at high oil
prices, I recommended to our owners that, in order to
pay potentially higher production taxes under the
surcharge concept, we sell our credits to other
companies and save the cash to literally offset our
higher taxes later. I suggested we not consider the
additional sixth exploration well any longer…the AVCG
owners concurred. This will result in potentially a new
oil field that will never be drilled and lower
production for all of us. This is bad policy. And this
is discouraging.
3:03:45 PM
But I also found interesting another strong emotion
during that teleconference which surprised me a great
deal. I felt embarrassment for the State of Alaska, and
I felt embarrassment as an Alaskan. Here I was, telling
a group of outside investors that recently put all of
their focus and personal exploration budgets on the
North Slope of Alaska, and now I was telling them that
Alaska was creating the most complex, confusing
production tax bill ever created since the disastrous
Federal windfall profits tax. And I was telling them
that Alaska was levying the highest tax rate and
government take in North America, much higher than the
other U.S. states where they invest. I was embarrassed
that the anger - or the mistrust - of the Big 3
producers and the Governor has resulted in the State
crossing the line between balancing State revenues and
attracting outside investment.
3:05:05 PM
Currently, the total Alaska and Federal governments'
take is just over 50%. The Governor's proposal moved
this to 53% or so then the original HB 488 moved the
government take closer to 55%. Then the CS to HB 488
boosted the government take close to 60% with its
"Progressivity Surcharge."
3:08:41 PM
My Personal Perspective
Now let me shift gears in my comments to you. Because I
could not get buy-in for any alternatives from the AVCG
owners except the 20/20 case, I have decided to speak
out alone. As an Alaskan, I am concerned and feel I
must try to share a personal perspective trying to
balance what is best for my continued involvement on
the North Slope in balance with how the State must
change its system to be competitive in the world and
realize more government share at high prices.
3:10:23 PM
I realize by stepping out like this, I could jeopardize
my management status with AVCG and perhaps even
jeopardize how I am viewed by the major oil companies
and my friends in the independent company sector. But I
have taken such personal risks in the past, and I don't
mind doing so again today to simply do what I think is
the right thing to do regardless of others' opinions.
So, let me turn my attention to what key changes I
would make to the CS of HB 488. Again, my views are not
supported by AVCG owners or others in industry; rather
they are my personal views.
Mr. Thompson noted that he is okay with the tax rate being
progressive, but stressed that it needed to be simplified.
He continued his testimony:
When the Governor's office first announced a 25% tax
rate then amended that to 20%, I could see the move by
legislators to somehow bridge the gap from 20% to 25%.
However, the approach used by the House Resources
Committee based on their outside consultants' work is
simply too complex and will be arduous to implement. I
think - and perhaps all of you think - the Federal tax
code is too complex….the changes to HB488 are also too
complex and will lead to different interpretation,
"gamesmanship" possibly by some companies because of
the unwieldy progressive tax structure formula, and
future costly lawsuits when the State disagrees with a
company's calculations. And the number of accountants
to keep track of these complexities on both sides will
balloon! I urge you to simplify, simplify,
simplify...yet still have some progression that
legislators seem set on.
3:12:20 PM
For my company which drills the smaller oil traps that
may add up, we do not have a lot of upside potential in
seeing these smaller fields grow much larger in
reserves over time in contrast to the giant Prudhoe Bay
and Kuparuk fields. So our main upside is in oil price
escalation to offset exploration risks and to offset
the cycles of oil prices downward, a reality over time
for any commodity. I find it disturbing - and
personally unfair - that the House Resources Committee
recommended a windfall profits tax, or "Progressivity
Surcharge", as high as an additional 37.5% of value in
addition to the base PPT.
3:13:20 PM
I found it so interesting to see the Econ1 consultants
and consultant Daniel Johnston saying the government
should take more and more at high prices when not one
member of the Resources Committee asked them a very
important question they should have been asked: "how
much are you investing in Alaska?" I was shocked to see
that these consultants, when calculating the future
revenues to the State at various escalating rates, used
the same oil production curves. In reality, less
capital will be spent by industry at exorbitant
production profits tax rates (tax rates above 25% when
coupled with all other payments such as royalty,
corporate income tax, ad valorem tax, lease costs and
rentals, etc.). With less capital spending, the
production curve will be lower…an increasingly higher
tax rate may not in the end yield the forecasted
revenues for the State.
3:14:29 PM
On a related note, our company plans to go into the
private or public equity markets to raise funds and
capital for any future development. Such equity
investors invest in the oil markets to be fully exposed
to crude price upside. When they look at investments
all over the world, and see that Alaska could tax at
much higher crude prices with a "Progressivity
Surcharge", they will place their capital elsewhere to
continue their exposure to higher crude prices in
investments without alternative taxing structures such
as the Lower 48 states, the Gulf of Mexico deep water
with royalty relief, the Canadian oil sands or other
countries. The consultants did not address this issue
that I face month in and month out…the private and
public equity markets and the desire for such investors
to fully benefit from upside commodity price swings
without hedging or excessive, escalated taxation at
high prices.
3:16:11 PM
I could not believe the consultants did not show
capital spending elasticity graphs from different
countries. They did the legislature a disservice by not
doing so. Their work showed a biased perspective in my
opinion; by getting the House Resources Committee to
adopt a complex progressive tax rate structure, or
windfall profits tax, the consultants may feel they
have been successful…but not one of these consultants
will be around to defend their views in the future when
capital spending does decline at exorbitantly high and
unfair tax rates above the 25% level.
3:16:49 PM
So, what is a simpler alternative? What is an
alternative to yield more revenues to the State with a
balance to attract increased investment? I have
followed the progression of the PPT and noted when
respected global consultant Pedro van Meurs recommended
a 25/20 formula, i.e. a 25% tax rate and a 20%
investment tax credit. Yet the Governor recommended a
20/20 formula with a 20% tax rate. Since that
controversial time a few weeks ago, it appears the
House Resources Committee and the Senate Resources
Committee have spent a lot of time trying to recapture
the perceived "lost revenue" from the Governor not
taxing at the 25% level. On the other hand, the
Governor does make a good case about increased cash
flow to producers and resultant increased capital
investment at the lower 20% tax rate level. But
consultants Econ1 and Daniel Johnston did get things
way off track by proposing too complex a solution to
bridge this gap and get even more…the complex
"Progressivity Surcharge." Having the PPT at higher
prices being a mixture of taxation of profits and a
separate incremental tax on incremental revenues is
unwieldy and an accounting nightmare.
Let me address a way to transition from the 20% tax
rate to the 25% tax rate without getting too
complicated.
3:19:50 PM
I suggest that the Finance Committee revise the bill to
keep the production profits tax simply that…a tax on
production profits, and not an underhanded way to
further burden gross revenues with a surcharge. A
simpler way getting the progressive rate from 20% to
25% without the surcharge treatment complexity is to
adopt a graduated PPT that does accomplish a higher
State take at higher prices, yet leaves a reasonable
producer take.
I recommend the following production profits tax
schedule as a suggested one to "simulate" revenue
results somewhere between the Governor's proposal and
the CS to HB 488 proposal. It is one that everyone
could easily understand and implement with the State
realizing upside at higher oil prices yet not too much
upside is taken away from explorers/producers for re-
investment:
Up to monthly average wellhead price of $50/barrel for a
company: PPT rate of 20%
When monthly average wellhead price is between $50-
75/barrel: PPT rate of 22.5%
When monthly average wellhead price exceeds $75/barrel:
PPT rate of 25%
By the way, if the State were to pass a complex,
unwieldy windfall profits tax like that one proposed by
Econ1 and favored by some on the Resources Committee
with escalating production profits tax rates or
surcharges, I predict Alaska will make the cover of the
industry-wide influential magazine "The Oil and Gas
Journal" and perhaps even a cover spot in the "Wall
Street Journal." And I don't mean this media coverage
in a positive way…I think all in industry will say the
State is taking advantage of industry at high prices.
Whether or not industry makes money or not and makes
good, solid returns is not the issue with such
extremes…the perceived fairness of taxation in a high
cost, remote area like Alaska is the issue. This will
discourage new entrants, in my opinion.
3:21:21 PM
I highly respect industry consultant Daniel Yergin who
has an excellent reputation among industry personnel
and government officials alike. In November, 2005, Mr.
Yergin said this about a windfall profits tax: "What a
windfall profits tax does is introduce a lot of
distortion. It reduces investment, it increases a sense
of political risk and it doesn't achieve the goal that
is intended…it will really lead to decreased supply."
I urge the Finance Committee to seriously consider this
simpler approach, and ask that you have the Department
of Revenue run the above case to compare the State
revenues to the Governor's proposal, to the current CS
to HB 488 proposal, and to the existing ELF severance
tax program. Please do away with the complex
"Progressivity Surcharge" and simplify, simplify,
simplify.
3:22:02 PM
(2) "Trigger Points" For Escalating PPT Should Not be
WTI But Wellhead Value
I do not think the "trigger point" that increases the
PPT tax rate from 20% should be based on West Texas
Intermediate (WTI) oil price as suggested by Econ 1 and
Daniel Johnston and by the House Resources Committee.
The "trigger point" should be when a company's average
realized wellhead price in Alaska exceeds $50 per
barrel. Some say lower, but I do think there is strong
merit that those who have invested and taken
exploration risk and exposure to low prices should be
able to benefit from increased profits at higher
prices…"share the pain, share the gain"…to this
$50/barrel wellhead level. However, I personally am
fine with the State increasing the PPT tax rate
eventually to a cap of 25% when wellhead prices exceed
$50/ barrel. Having said this, you need to know that I
do not know anyone else in industry who thinks this;
everyone I know continues to press the 20/20 formula.
3:23:34 PM
Why should the State tie the PPT calculation to a
company's realized wellhead price instead of to West
Texas Intermediate (WTI) price? In reality on the North
Slope, not one company sees WTI prices. Every crude oil
in Alaska is different in quality with viscous crude
receiving less and oil produced from wells farther away
from infrastructure receiving less wellhead value due
to higher shipping costs. Conversely, oil in the Cook
Inlet is close to actual refining or on the water to
ship out of state and thus realizes on average much
higher wellhead value than most North Slope crude oils,
a substantial plus to Cook Inlet operators who face
higher operating costs with maturing fields. Our
company's crude when discovered on the North Slope will
be farther west, and when we have to transport the oil
via the major producers' gathering system lines to TAPS
pump station #1, we will pay the majors a certain
tariff of $0.50-1.00/barrel or more, and a facility
processing fee of $3.00/barrel of more, giving us a
lower wellhead value for our crude while the major
producers make an additional profit on shipping in
their crude lines and processing. The majors further
make profits from tariffs for shipping down TAPS and in
their marine tankers.
3:24:26 PM
3) Reinstate The Transitional Deductible Allowance
Jumping immediately from the prior ELF severance tax to
the PPT formula overnight wreaks havoc with a company's
budgeting and their forecast of available cash flow for
near-term capital investment. While this does not have
a major impact on AVCG, I do greatly empathize with
ConocoPhillips, who is the largest investor and most
active explorer in Alaska, about having "look back"
investment credits. Part of the current oil production
bringing in much higher revenues to the State is due to
investment over the past few years. Interestingly, the
PPT will have the largest negative impact on
ConocoPhillips, particularly on their production from
the Kuparuk Field. ARCO used to own the ConocoPhillips
properties on the North Slope, and I am concerned with
the impact on Alaska's largest investor and most
successful explorer. A transition adjustment of some
sort is appropriate and is fair.
I recommend the Finance Committee re-institute the
original HB 488 compromise to a three-year staged and
tiered "look back"; while not as substantial as the
Governor's proposal, the House Resources Committee's
staged "look back" is fair and should be re-instated in
the bill. The cost recovery allowed should be 75% of
2005 expenditures, 50% of 2004 expenditures, and 25% of
2003 expenditures to be deductible as costs for near-
term PPT calculations as originally in HB 488.
3:26:22 PM
4) The $12 Million Tax Credit Standard Allowance
The Governor proposed a $73,000,000 annual allowance of
production profits that would not be taxed by the PPT,
essentially giving a $14.6 million tax credit per
company. The House Resources Committee revised this
downward to a $50,000,000 annual allowance as a
reasonable compromise, or a $10,000,000 tax credit. The
CS to HB 488 further proposed that this be changed to a
simple $12, 000,000 annual "standard tax credit
allowance" as a reasonable compromise.
This "standard deduction" is very important to a
startup company like AVCG/Brooks Range Petroleum trying
to establish a foothold in Alaska and someday
contribute substantial oil revenues to the State.
I recommend the Finance Committee endorse the
$12,000,000 tax credit allowance per company.
3:27:05 PM
5) Tax Credit Repurchase Program
As protection for explorers and new entrants to Alaska,
the CS to HB 488 devised a tax credit repurchasing
program for those credits a company earns on
expenditures up to $10,000,000 per year for investments
in exploration and/or lease purchases in Alaska.
This is important to explorers like AVCG who does not
yet have production revenues. Without such a repurchase
program, our company might be able to sell our annual
tax credits to one of the major producers but have to
accept only 90-95% on the dollar or less. On the other
hand, the State would not be giving up anything to
repurchase the credits at 100% of value because the
major producers would otherwise use the credits to
reduce their tax bill and reduce revenue to the State.
But using the State repurchase approach, the small
explorer could turn around and re-invest the State-
refunded credit into new leases, seismic or exploration
drilling.
I recommend the Finance Committee support the tax
credit repurchase program outlined in the CS to HB 488.
3:28:14 PM
6) Remote Exploration Tax Credit Extension
I thank the House Resources Committee for their
proposal in extending the SB 185 exploration tax
credits for the next 10 years.
I recommend that the Finance Committee also endorse
this proposal that will extend the 40% tax credit for
remote wildcat exploration wells more than 25 miles
from existing facilities.
3:29:01 PM
7) Effective Date
The State has made far more money at high prices than
anyone ever dreamed. The State has, in a way, already
received a rich windfall at high oil prices. The change
in the production profits tax is controversial in its
own right. I would not dare "pour salt in the wound" by
making the tax effective on April 1, 2006, but allow
the transition as originally planned to a July 1, 2006,
date. This will also give all of us time to hire
additional accountants to do the monthly, complex
filings!
I recommend that the Finance Committee amend the
effective date to July 1, 2006.
3:30:11 PM
Concluding Remarks
The above comments are my personal views offered with a
hope that there can be an eventual win-win solution to
this complex subject of the State realizing more
revenues at higher prices while attracting exploration
and development investors who can also realize upside
at higher prices. I do believe the House Finance
Committee can get things "back on track" and better
balanced.
Importantly, many - if not most - in industry would
disagree with some - if not all - my personal views
expressed above. But I do feel compelled to "tell it
like it is" from my perspective as an Alaskan who has
worked the Cook Inlet and the North Slope oil and gas
fields for over 12 years.
3:32:09 PM
Representative Kelly spoke to the complexity issue and asked
tying progressivity, would address simplicity.
Mr. Thompson responded that the system will be more complex
than our current system, and commended the House Resources
Committee for working with the industry and state agencies
to determine allowable and unallowable deductible expenses.
He felt that the progressivity formula proposed by
consultants created a more complex system than necessary. He
concluded that while the legislation is still more complex
than desirable, it was "livable".
At Ease: 3:35:44 PM
Reconvened: 3:38:12 PM
JOHN A. BARNES, P.E., ALASKA ASSET TEAM MANAGER, MARATHON
OIL COMPANY, testified regarding creating incentives in the
Cook Inlet. He noted that they focused solely on the natural
gas market. Mr. Barnes commented that the discussions on PPT
dealt with reaching tax parities with a world market, but
pointed out that world wide opportunities did not apply to
activities in Cook Inlet.
3:39:40 PM
Mr. Barnes commented on the Cook Inlet Gas Summary before
PPT and noted the declining reserves and production rates,
as well as high costs, and a difficult regulatory arena. He
gave the State a "D" in its permitting process. He also
noted the need for additional exploration and the historical
price differential.
3:41:41 PM
Mr. Barnes referred to a table outlining the results of Cook
Inlet Area wide Lease Sales. He noted that there had been an
increase in coal acres sold. Next he referred to a graph
illustrating the timeline of Cook Inlet Exploration, showing
that exploration had recently begun to increase again.
3:42:56 PM
Mr. Barnes then examined three different price markers:
Henry Hub, DOR PV and DNR Royalty Values. He concluded that
Cook Inlet received less for its product than other
locations. He also noted the extreme volatility, and
suggested that it was not a good indicator to determine
progressivity.
3:44:30 PM
Mr. Barnes discussed the future of supply, pointing out
Enstar as working well with the supply/demand market. He
compared average residential gas prices and noted that
prices had benefited from Cook Inlet resources.
3:46:03 PM
Mr. Barnes ran conceptual comparisons on an average well,
based on the CSHB 488 (RES).
3:46:42 PM
Mr. Barnes showed a slide illustrating a before tax
comparison for various states. He commented that Alaska
would realize a lower profit, unless there was price parity.
He commented that there was a disadvantage in the Cook
Inlet. Profit investment ratio of excess of 4; Alaska is
1.7, which accounts for poor investment.
3:48:05 PM
Mr. Barnes offered a comparative analysis as a means of
considering how companies decided whether to invest in Cook
Inlet as opposed to other areas. He noted that although
there was good land access, there remained the disadvantage
of high costs, permitting troubles, and price.
3:49:33 PM
Mr. Barnes proposed that there was nothing wrong with ELF
for Cook Inlet natural gas. He commented that a higher tax
rate would result in lower reserves. He suggested that there
would be a decline in exploration and development in that
area. He also noted that potential loss of jobs and volatile
costs to utility customers.
3:51:23 PM
Mr. Barnes analyzed the PPT for $4 Cook Inlet Gas. He
concluded that as compared to Henry Hub, a consumer would
see a fluctuation in Cook Inlet.
3:52:45 PM
In summary, Mr. Barnes suggested that legislators not link
Cook Inlet PPT to the volatile Henry Hub price, but rather
to the Department of Revenue Prevailing Value. He
recommended that incentives be prioritized, including some
kind of transitional investment credits. He concluded that
they did not support the CS as it stands, but rather a
movement back toward the bill in its original form. He
conceded that the currently proposed approach was very
complicated.
3:55:00 PM
Vice-Chair Meyer summarized that Marathon would like to see
an exemption from the PPT for Cook Inlet. Mr. Barnes agreed.
He added that there are multiple parameters that could be
used.
Vice-Chair Meyer concluded that Cook Inlet is working. He
stressed that Cook Inlet is a small percent of the state of
Alaska's oil and gas production. Mr. Barnes agreed and
estimated that it is approximately 20,000 barrels a day.
Total production is approximately equal to one month of
Prudhoe Bay.
3:57:47 PM
In response to a question by Representative Holm, Mr. Barnes
stressed that the transaction price should be the
transaction amount. Any tax structure with progressivity
should be driven by the transaction activity.
3:59:37 PM
Representative Holm asked if there is an ANS price for gas
and if not what would be an average price that makes sense.
Mr. Barnes noted that there is not a market price for gas
that makes sense. The value the State uses to assess royalty
settlements is the best marker. There is not a good market,
with daily gas trades.
4:01:19 PM
Representative Holm questioned if a greater price of gas
would encourage investment. Mr. Barnes responded that gas
prices are starting to rise. There are a series of gas
contracts in Cook Inlet tied to various market indexes.
There has been a transition to contracting for gas in the
Cook Inlet. He provided details of recent contracts. He
noted that the consumer would benefit if the activity level
de-linked the capital and push down prices.
4:03:25 PM
Representative Joule asked how much is exported. Mr. Barnes
noted that half the gas is exported; 40 percent of
Marathon's gas goes to the LNG plant.
4:04:15 PM
Representative Kelly referred to slide 14. Mr. Barnes
referred to the price curve on slide 7 and noted that prices
are curving up due to indexes in legacy contracts raising
prices and competition for capital by new contracts. The gap
is narrowing. He did not think it would narrow 100 percent
due to the volatility. He explained that slide 14 looks at
the price as linked to Henry Hub. The calculation of PPT has
two key points with flatting. All things are equal at 20
percent. As Henry Hub goes up, the curve climbs and the gas
gets transacted at $4. Consumers would see an impact for
contracts that pass the tax through. He concluded that the
prices would be unstable with the linkage to Henry Hub and
it would not make sense to implement. Representative Kelly
observed that it is linked to progressivity.
4:09:03 PM
In response to a question by Representative Kelly, Mr.
Barnes noted that as Henry Hub balances up and down,
progressivity is increased. Henry Hub is calculated on a
monthly basis. Representative Kelly summarized that the
volatility only occurs at the point of marriage between
Henry Hub and Cook Inlet prices due to the link with
progressivity.
Mr. Barnes returned to slide 14. The tax rate would be
changed due to progressivity even if the business has not
changed. He explained that business would not have changed,
but the tax would have increased.
ADJOURNMENT
The meeting was adjourned at 4:11 PM
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