Legislature(1995 - 1996)
03/09/1995 01:18 PM O&G
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
HOUSE SPECIAL COMMITTEE ON OIL AND GAS March 9, 1995 1:18 p.m. MEMBERS PRESENT Representative Norman Rokeberg, Chairman Representative Scott Ogan, Vice-Chairman Representative Gary Davis Representative Bill Williams Representative Tom Brice Representative David Finkelstein MEMBERS ABSENT Representative Bettye Davis OTHER MEMBERS PRESENT Representative Mike Navarre Representative Joe Green COMMITTEE CALENDAR *HB 207: "An Act relating to adjustments to royalty reserved to the state to encourage otherwise uneconomic production of oil and gas; relating to the depositing of royalties and royalty sale proceeds in the Alaska permanent fund; and providing for an effective date." HEARD AND HELD H0&G - 03/09/95 *HB 209: "An Act relating to the authority of the commissioner of natural resources to allow reductions of royalty on oil and gas leases; and providing for an effective date." SCHEDULED BUT NOT HEARD (* First public hearing) WITNESS REGISTER JOHN SHIVELY, Commissioner Department of Natural Resources 400 Willoughby Avenue Juneau, AK 99810 Telephone: (907) 465-2400 POSITION STATEMENT: Supported HB 207 PATRICK COUGHLIN, Assistant Attorney General Oil, Gas and Mining Section Department of Law 1031 West 4th Avenue Anchorage, AK 99501 Telephone: (907) 269-5255 POSITION STATEMENT: Supported HB 207 BILL VAN DYKE Division of Oil and Gas Department of Natural Resources 3601 C Street, Suite 1380 Anchorage, AK 99501 Telephone: (907) 762-2550 POSITION STATEMENT: Supported HB 207 PREVIOUS ACTION BILL: HB 207 SHORT TITLE: ADJUSTMENTS TO OIL AND GAS ROYALTIES SPONSOR(S): RULES BY REQUEST OF THE GOVERNOR JRN-DATE JRN-PG ACTION 02/27/95 501 (H) READ THE FIRST TIME - REFERRAL(S) 02/27/95 501 (H) OIL & GAS, RESOURCES, FINANCE 02/27/95 501 (H) FISCAL NOTE (DNR) 02/27/95 501 (H) 2 ZERO FISCAL NOTES (DNR, REV) 02/27/95 501 (H) GOVERNOR'S TRANSMITTAL LETTER 03/08/95 665 (H) CORRECTED FISCAL NOTE (DNR) No. 3 03/09/95 (H) O&G AT 12:00 PM CAPITOL 17 BILL: HB 209 SHORT TITLE: OIL & GAS ROYALTY REDUCTION SPONSOR(S): REPRESENTATIVE(S) GREEN, Rokeberg JRN-DATE JRN-PG ACTION 02/27/95 503 (H) READ THE FIRST TIME - REFERRAL(S) 02/27/95 503 (H) OIL & GAS, RESOURCES, FINANCE 03/01/95 551 (H) COSPONSOR(S): ROKEBERG 03/09/95 (H) O&G AT 12:00 PM CAPITOL 17 ACTION NARRATIVE TAPE 95-8, SIDE A Number 000 CHAIRMAN NORMAN ROKEBERG called the House Special Committee on Oil and Gas meeting to order at 1:18 p.m. Members present were Representatives Rokeberg, Ogan, G. Davis and Williams. Chairman Rokeberg declared a quorum was present. Chairman Rokeberg Chairman Rokeberg announced that although HB 207 and HB 209 were scheduled, the committee would only hear HB 207 due to time constraints. HO&G - 03/09/95 HB 207 - ADJUSTMENTS TO OIL AND GAS ROYALTIES HB 207, Sponsored by Rules by request of the Governor was before the committee. CHAIRMAN ROKEBERG welcomed Commissioner Shively and his staff members. Number 027 CHAIRMAN ROKEBERG stated to the members of the committee and all who were in attendance, he was glad to have received this bill from the Governor. He then mentioned he thought this particular bill marked a watershed event in the relationship between the state and the petroleum industry. He said this will be the most important legislation considered by the legislature this session. He then stated he was pleased the Governor saw fit to bring this bill forward. He then asked Commissioner Shively to begin his testimony. Number 043 JOHN SHIVELY, Commissioner, Department of Natural Resources, stated he would like to make some opening comments and then would answer questions from the committee. He mentioned there were three staff members with him and they were in attendance to provide him with any needed information. COMMISSIONER SHIVELY thanked the Chairman for his kind comments about this legislation, and stated they were pleased to be able to bring it forward. He then mentioned he thought all of the people in the room were concerned about how the oil industry, in Alaska, is faring with regards to the rest of the world. In order for us to continue to have a healthy industry we need to understand what is going on throughout the world which is one of the reasons the Governor is in London this week. This legislation starts us on the road to address how we can be competitive in the world climate. He told the members he wished to discuss what this world climate is, and what it is not. Commissioner Shively stated, what they are doing is a technical re-write of the existing law. He stated this is not a new law, they are taking existing legislation and changing it to make it more workable. He then mentioned one of the more significant changes is the commissioner already has the authority to reduce royalties on fields which have been abandoned, or fields which are about to be shut-in; this allows the commissioner to reduce the royalties for new fields. He stated, this was the most significant change. He then mentioned the state has lived for a long time off of Prudhoe Bay and Kaparuk, both of which are large fields, and off of some of the smaller fields. But as the industry starts to go out into new frontiers, we are looking at smaller and smaller fields. Therefore, some of the assumptions which work in some situations may not work in others. COMMISSIONER SHIVELY then mentioned the legislation makes the language, which gives the commissioner the discretion, more explicit and more workable. Commissioner Shively then stated, this is not the final answer as to how we can provide incentives to the oil and gas industry. He said, he thinks there are other roads, and some other additional legislation. He stated it was his decision, at this point, given the newness of the Administration, that this is something we can do this year. However, the Governor has appointed the Oil and Gas Policy Council, and one of their responsibilities is to look at other methods of providing incentives for oil development, and for a healthy oil industry. He then stated they consider this to be just the first step. COMMISSIONER SHIVELY said at this time he would like to talk about a few parts of the legislation which have caused people some concern. He stated there has been some concern over the amount of discretion which the commissioner is apparently granted by this legislation. In response to this concern, Commissioner Shively stated this was discretion which the Office of the Commissioner already has. He stated, right now he can reduce royalties on fields which are about to be shut-in, or abandoned. This is really not something new to the office. He stated, however, in order for him to make a decision to reduce a royalty, he has to find clear and convincing evidence. This means the situation must warrant the reduction. Not only that, even if the situation warrants the reduction, he must be sure it is in the best interest of the state. He then stated, for example, there could be a field which warrants the royalty reduction, but this may not be in the best interest of the state. These are two hurdles which the commissioner must go across. He then stated the other thing this legislation does in regards to the commissioners discretion, which he believes is an improvement, is it allows the commissioner to look at what Commissioner Shively considers to be the three prongs of any decision about the economics of an oil field. Those are the costs of development, the volume of oil in the field, and the price of oil. He stated those are not static prongs of any decision, the cost in some ways may be the most stable. He said but when technology changes, even costs can significantly change. Certainly price can have significant changes and even volume can encourage changes. He said this law allows the commissioner to look at the situation and if the current economic assumptions warrant a royalty reduction, grant it; but also provide that if those economic assumptions change, the state gets more money. Indeed, the state could end up with higher royalties than we are currently entitled to under certain circumstances. Commissioner Shively then mentioned this does allow the commissioner more flexibility than the office currently has. COMMISSIONER SHIVELY explained another issue which was discussed is the non-appealability of the applicant. The reason this provision was included is the applicant is coming to the state and asking for a favor. The applicant made an assumption, at one point, that they could develop fields under the lease and royalty provisions we have had, and now they are making another assumption. We feel the decision should rest with the commissioner, and his decision should be the end of the issue. Commissioner Shively then mentioned he was not a fan of litigation. He stated it was a waste of public resources. At this time, he stated this was just the first step in trying to build a partnership between the state, the industry, the legislature, and the communities which are involved in the oil industry. Commissioner Shively then expressed his appreciation to the representatives of the oil industries who worked with the Administration to develop this legislation. Number 192 CHAIRMAN ROKEBERG thanked Commissioner Shively for his testimony. He then stated, for the record, Representative Tom Brice joined the committee at 1:20 p.m. He also mentioned Representative Joe Green was present in the committee room and invited him to join the members at the committee table. Number 202 CHAIRMAN ROKEBERG stated he would first like to discuss a point on which there was some confusion. This was the genesis for the insertion of Section 1 in the statute which relates to the permanent fund. He stated there have been some discussions between the staff relating to why this was put into the legislation, and as he understood at the genesis of this, there was a concern of some possible constitutional challenges to the statute if this wasn't in there. He stated there were also concerns about public perception. Chairman Rokeberg stated he had requested a legal opinion from legislative counsel, which is in the packets distributed to the members, that says there is no foundation for a legal challenge. He then asked if Mr. Coughlin could comment on this matter so the committee could move forward. Number 222 COMMISSIONER SHIVELY stated he was prepared to comment. He continued by saying he couldn't tell the members there was no basis from which someone couldn't argue. He then stated they believe there is no constitutional requirement stating you can't go below the floor of the permanent fund contribution. Number 231 PATRICK COUGHLIN, Assistant Attorney General, Oil, Gas and Mining Section, Department of Law then added to the testimony by stating the Attorney General's opinion is that there is no constitutional requirement making the permanent fund whole as provided for in the bill. Number 236 CHAIRMAN ROKEBERG stated, as he understood it, this is a new feature which adds two things: It makes an exception for the permanent fund, yet doesn't maintain the status quo. He then mentioned the status quo would be without Section 1 in the legislation. CHAIRMAN ROKEBERG then asked the members of the committee if they had any questions on that particular issue. Hearing none, he said he would like to focus on the process of this procedure. He explained one of the issues which interests him are the problems revolving around the delineation of what a field is, and the definition of "a field." He then said he was wondering if it would be in the best interest of this legislation to define a field. Number 257 COMMISSIONER SHIVELY said he doesn't believe they need to define "a field." There are a variety of different possibilities which can occur. He then stated the leases are in the shape of squares or rectangles which have nothing to do with geography. When we lease an area, it is very difficult to determine what is under the ground. There may be one big oil field or several little pockets of oil. We think there are opportunities, as this legislation is written, to look at the horizons in oil development. However, you still need to take into account other developments under that lease. For example, if you have part of a field which is already developed and there is discussion about developing another horizon then the kind of investment which has already been made under the lease, how they will use those facilities. All those factors need to be taken into account. We think we can do this under the proposed legislation as it currently stands. He then stated Mr. Bill Van Dyke could elaborate more clearly on those issues. Number 278 CHAIRMAN ROKEBERG said he was looking at some of the record from the Conoco application and finding from 1990. He said it was his understanding that what is defined as a field can be vertically separated within the unit. Therefore, if you have a horizon which goes beyond the unit there could be some difficulties. He then stated you could define a field under this statue as a horizon notwithstanding whether it was inside the unit or not. Commissioner Shively stated he would allow Mr. Bill Van Dyke to respond to that point. Number 290 BILL VAN DYKE said the Chairman was correct. Under the Conoco application there was a considerable amount of discussion as to what the definition of a field was. The existing statute refers to total investment in the field, and so we had to address total investment in the field. This particular legislation would take out the reference to total investment. He then stated, under the proposed legislation they would look at individual horizons. He then stated they would not look at individual horizons under leases where the horizon was not delineated. He then mentioned they would want to know the volume, areal extent, and productivity of any of the reservoirs which we have applications for royalty releases pending. If it is not delineated it is not going to be eligible for the reduction. Number 309 CHAIRMEN ROKEBERG asked Mr. Van Dyke if the word "delineated" was a specific term of art. Chairman Rokeberg mentioned he wanted to be clear on this because the term "delineated" appears in the legislation on page 2, line 28. In other words, do we need to define this term to help you out? It seems to me there has been a lot of energy spent, in the past, trying to define what a field is. It therefore, seems if we can define the term in this statute we can go on to bigger and better things. Number 318 MR. VAN DYKE stated when you start creating definitions in the statute they can sometimes cause as many problems as they were designed to fix. He stated they think they know how the phrase will be applied. It may vary from field to field. As soon as you start listening to long sets of standards, it is really opened up to challenge again. He then stated there is a need to know what you are looking at, in terms of expected costs and production. This is why the term "delineated" is in the legislation. Number 330 REPRESENTATIVE GARY DAVIS stated there has been some good explanations on this subject. He then asked if an application for a royalty reduction were to be put in, it could be for a delineated field which could encompass a number of tracts? Representative G. Davis was told that was correct. Representative G. Davis then asked if the application upon approval would designate tracts, and probably a field also, or would it just be tracts? Number 340 COMMISSIONER SHIVELY stated what usually happens when you have more than one lease involved is they ask for a unit. So the unit defines which leases you have and then the field itself is delineated within those leases by the exploratory drilling that takes place. Number 345 REPRESENTATIVE G. DAVIS stated he did have some concern about this topic. He asked if this is was a royalty reduction curve would be allowed, and then anything outside of this would be another application? Number 350 COMMISSIONER SHIVELY stated they have to be able to understand, for example, let's say you have six leases but they have delineated oil under only four of them, if we don't think the field is delineated under the other two, then there is no royalty reduction on those leases. Someday the company might go out and do some additional drilling, but until they do, we wouldn't give them the reduction even if those leases were already in the unit. Number 356 CHAIRMAN ROKEBERG read a passage out of the Conoco decision which says that department's definition of "field" states, "Is similar to that used by the Alaska Oil and Gas Conservation Commission (AOGCC) in that it considers multiple, vertically separated pools or reservoirs underlying the same lease or leases in a single field." He then said the impression he receives from this is, you can have different horizons within a unitized field. He then stated the question becomes, for example, if Westsak isn't part of the Kaparuk unitization, you would have two different horizons within one unit. Number 369 COMMISSIONER SHIVELY stated he feels the legislation, as drafted, would allow us to deal with Westsak as a delineated field and give them a royalty reduction without reducing the royalty on the Kaparuk field. Number 375 CHAIRMAN ROKEBERG said his concern was that in the past, there has been an historical denial in the reduction. He stated that he is concerned about this. Number 377 COMMISSIONER SHIVELY stated he was not the commissioner when that occurred, and mentioned Mr. Coughlin may be able to explain this situation. Number 380 MR. COUGHLIN said the issue in the Conoco litigation was what did "field" mean under the terms of the statute. Conoco argued where there were two horizons, you could only look at one horizon which constituted the field. He then stated at this particular time, they had not gone into production on Schrader Bluff's horizon, they were producing on Kaparuk. He then stated Conoco claimed the only thing which could be looked at to determine the reduction was the Kaparuk horizon, and that the Department of Natural Resources (DNR) could not consider the lower horizon as part of the total investment of the field. He then stated, the position of the DNR was that you needed to look at the fact that both horizons were using the same facilities to produce. We believe in this particular situation, the definition which the DNR adopted, which is every horizon which might underlay a lease, would grant the commissioner the discretion to grant a reduction to one horizon and not the other. In making this decision, the commissioner has to look at the whole horizon because the economics on one horizon effects the overall economics of the field. Number 404 COMMISSIONER SHIVELY then said, if you were dealing with a horizon with a small amount of oil underneath a larger pool of oil presently being produced, if you just looked at the smaller pool of oil you would be able to say it definitely needs a royalty reduction, but if you combine it with the investment which is already made in the other field it may not. He then stated you must look at all of the horizons under a lease even if you end up treating some of them differently. Number 414 REPRESENTATIVE TOM BRICE said as far as administrative procedures are concerned, he has noticed there wasn't a strong delineation in the Governor's bill about the equity within the ability to re-negotiate a lease. For example, you have a producing well which is a whatever percent royalty which is locked in, yet to bring on line another well of the same quality would require a substantially lower rate. He asked if there is going to be any administrative ability to re-negotiate those leases, if necessary. Number 427 COMMISSIONER SHIVELY stated there would not be that ability in the middle of the contract. If the company has made the economic decision to produce, they are to proceed. However, if they come to the department and state they intend to shut-in or abandon the field then there would be an opportunity to renegotiate. They would then have to prove the royalty reduction is essential to keeping the field operating. Number 435 REPRESENTATIVE BRICE asked the commissioner to explain the process of proving a reduction that is necessary and how long it takes. Number 436 COMMISSIONER SHIVELY said he did not know how long the process takes, but stated his best guess was about three to four months. He then said there are two ways this could be done which is if the division has the staff time available, or if the legislation provides for the division to ask the industry to pay for an independent assessment. Number 443 CHAIRMAN ROKEBERG said his concern at this time is, as he understands the process, on the edges of certain units there can be non-reducible oil or hydrocarbons like the Prudhoe Bay tarmacs. He then stated the committee would be willing to help the department if this were to become a problem. Chairman Rokeberg then stated his approach to this problem is, the more decisions the legislature can take away from the commissioner, the easier the job of the commissioner will become. This would be building a fence around the commissioner's discretion. Number 458 COMMISSIONER SHIVELY stated he understood the points being made by the Chairman, and said he is willing to discuss those problems. He then mentioned this is not an easy situation. Oil fields, horizons and geography are all different. The current legislation is designed to allow the commissioner to look at all of these factors with maximum flexibility to decide whether the royalty reduction is justified. He then stated his willingness to work with the legislature on the language, and intent of the bill. Number 468 CHAIRMAN ROKEBERG mentioned the Westsak field springs out as being a problematic. You may want to take some of these definitions, in terms of looking at unitization, as the foundation of your decision of what a field is. Number 471 COMMISSIONER SHIVELY said he doesn't feel it stands in the way, but it doesn't necessarily mean we are always going to agree with the industry. He then said this was the problem with Conoco. The department did not agree with what the industry is asking for. He then said this is the problem with these kinds of decisions, you have two competing interests in the economic development interests, and protecting the assets of the people to make sure we get our fair return. In the Conoco case, they made a judgment in which the request was not appropriate in terms of our responsibility to protect the assets of the state. Number 480 CHAIRMAN ROKEBERG asked the members if they had any further questions on this topic. Number 481 REPRESENTATIVE G. DAVIS noticed the Commissioner would send a copy of his findings to every member of the legislature. He recommended they simply let the legislature know there is a report available and if we wanted the report, each individual legislator could request one. Number 495 CHAIRMAN ROKEBERG stated he has mentioned to the members he has discussed with Commissioner Shively, the possibility of setting up a "triad" style of decision making with the Attorney General's Office and the Commissioner of Revenue. He then asked for Commissioner Shivley's input on the issue. Number 500 COMMISSIONER SHIVELY said, clearly, legislation can provide whatever checks and balances the legislature feels is appropriate. He said there has been several things discussed, one of those things is whether or not two other commissioners should be responsible for accepting or rejecting the decision. The Royalty Board has been discussed as another option, and a third option was the AOGCC. He then stated this was really a policy call. Commissioner Shively said they basically believe the Executive Branch is responsible for making decisions, you could develop as many steps in the decision making process as you want but one of the problems the government has as we look at bringing the cost of government down, is taking some of these steps out. Commissioner Shively mentioned they don't want to take so many steps out as to damage the public process. He then stated there is a lot of redundancy in how the state makes its decisions, and he believe this would be redundant. Number 515 CHAIRMAN ROKEBERG noted Representative David Finkelstein joined the committee at 1:30, and acknowledged the presence of Representative Mike Navarre in the committee room. Number 518 REPRESENTATIVE BILL WILLIAMS stated he too dislikes going to court to solve these issues. He stated it is easier to work out the issues among the parties involved. Representative Williams then stated he would like to discuss the non-appealable issue further, and how this body can communicate with the commissioner. Number 525 COMMISSIONER SHIVELY asked if the question was in terms of why they think this concept works. Number 526 REPRESENTATIVE WILLIAMS responded by asking how would it work. Number 527 COMMISSIONER SHIVELY said it is really designed to look at the applicants. For example, lets say oil company "A" comes in and makes a request for a reduction in the royalty. The request is reviewed, the commissioner makes a decision either not to reduce it as much as the oil company wants, or not to reduce it at all. This language says this is the final point in the process, and would not allow them to go to court. This, however, does not prevent constitutional challenges to the concept, but it does keep the process within the department. Number 539 REPRESENTATIVE WILLIAMS asked if the legislature disagrees with the Commissioner and how could we act. Number 539 COMMISSIONER SHIVELY then commented we are dealing with a situation where the oil industry came in, made a bid on leases, they knew the conditions when they made those bids. They were willing to say they would pay a certain amount of money. We recognize the fact that situations can change, so this bill allows us to make changes which we think are warranted. This is really our decision due to the fact the companies have already agreed to play by a certain set of rules. If we decide not to do them a favor by changing the rules, all we are saying is they must play by the same rules they agreed to when they entered the agreement. Number 546 REPRESENTATIVE SCOTT OGAN noticed there was a fiscal note stating one person would be hired. He asked if this would be a petroleum engineer. Number 547 COMMISSIONER SHIVELY stated the new person would be an engineer. Number 552 REPRESENTATIVE OGAN asked if there was a fee built in this for making a royalty application. Number 553 COMMISSIONER SHIVELY stated there is no current fee. He then stated the department can make the company pay for an independent evaluation if the department does not have the resources to deal with an evaluation of this type. The department will then take the information provided by the independent company, and make the decision to grant or refuse the reduction. Number 564 REPRESENTATIVE OGAN asked if any other incentive programs currently requires a fee to process applications. Commissioner Shively responded no. Representative Ogan referred to Section 2, page 3, line 9 of HB 207 and explained the bill says, "The commissioner may require the lessee to pay the costs of a third party contractor." He asked if this was a good idea. Number 571 COMMISSIONER SHIVELY responded by asked stating if the Representative wanted the language to read, "If a third party contractor is required, the commissioner shall require the company to pay." Commissioner Shively said this would be fine, but noted currently it is under his discretion. He then said this is something they intend to do. Number 577 REPRESENTATIVE OGAN then mentioned he didn't believe there would be a problem making that change. He said he had heard some concerns about the confidentiality issue. He asked Commissioner Shively if he would be against allowing the oil company to participate in the selection of a third party, if one was needed. Number 579 CHAIRMAN ROKEBERG stated he has had some concern over the confidentiality issue. He asked the Commissioner Shively if he would be opposed to allowing an oil company to participate in the selection of a third party. Number 588 COMMISSIONER SHIVELY stated he would allow the company to have an opportunity to veto the selection of a third party if there are good reasons. He did, however, express some concern with allowing the oil company to choose their own third party. Commissioner Shively mentioned the philosophy behind the legislation. He said this a new era between the state and the industry in terms of how we can talk through some of our differences. He said he was convinced they could work through those differences. COMMISSIONER SHIVELY mentioned he would like to comment on the confidentiality issue. He said they put this into the legislation because they believe the industry needs to make the choice as to whether the information they provide the state is confidential. In discussing this issue with the industry both privately and publicly, he has told them it is in their best interest to make public as much information as possible. This is because the more public the decision is, the better off we will all be. This is part of being a partner with the state. Number 611 REPRESENTATIVE DAVID FINKELSTEIN asked about the issue of appeals. He stated as he understood the argument, a company which enters an arrangement has accepted the arrangement whether they get a benefit on top of that or not. He said there is another side to this argument. If someone from the public believes the commissioner makes a decision which is not beneficial to the state, there needs to be some sort of procedure available to look at the decision. He mentioned this may be best solved by some sort of internal review. Number 623 COMMISSIONER SHIVELY stated the decisions are currently being made that way. He said he has this discretion, under current law, for fields which are abandoned or are about to be shut-in. In terms of a review process, the courts tend to give a lot of discretion to the decisions. He stated the legislature can provide for that. Commissioner Shively said they are asking for more contention and more delay. Number 632 CHAIRMAN ROKEBERG said he wanted to make a statement, and asked Mr. Coughlin to correct him if he is wrong. He stated that as he understands this, there is no appeal by the applicant, and there is nothing in this statute to prohibit a third party from suing. Number 637 MR. COUGHLIN said to make that point clear you might want to insert the words "by the applicant" into the legislation. Number 638 CHAIRMAN ROKEBERG then said his own personal preference would be to insulate the process from an outside litigant. Number 639 MR. COUGHLIN explained the court will honor the legislative statement of finality which, in essence, is in the bill. TAPE 95-8, SIDE B Number 000 REPRESENTATIVE FINKELSTEIN said if this is interpreted as it was just mentioned, then he does not have a problem with it. He did state that if someone is going to make the case, the public interest isn't being represented in a major decision like this, they can go to court and say the provisions of the constitution regarding fair return have to be followed. He then stated he doesn't see how they will protect public interest. When the courts review this, they should also be able to review the particular provisions of this which happen to implement the fair return with the language requiring a determination of making something uneconomical, economical. He stated this is what the legislature has asked you to do, and the courts will be looking at the constitutional challenge to determine if the decision which the commissioner has made on whether an uneconomical project has become economical, and does it fit under the constitutional requirements to get a return on our resources. Number 040 REPRESENTATIVE TOM BRICE said there needs to be some type of system, whether we want to keep the language the way it is or delineate it a little more, that insures finality in a timely manner for both the industry and the state. Otherwise, I can see these types of challenges continuing like the issue of back taxes where nobody is helped by having it thrown back into the legislature to become a divisive fight. He then mentioned this may be appropriate to leave this with the commissioner so we can side step the entire problem. Number 060 CHAIRMAN ROKEBERG asked if there was any existing regulations, under the Administrative Procedures Act, allowing the applicant to appeal for reconsideration. Number 071 MR. COUGHLIN said under DNR's regulations, there is the right to ask the commissioner for reconsideration. Number 072 CHAIRMAN ROKEBERG said there is at least a way they can get back in the door if they can correct a problem. He then asked if it was possible to reject an application and then give the company a hint as to the best way to come back. Number 077 COMMISSIONER SHIVELY said most of these are probably going to be negotiated because the companies are going to concentrate on what they see as the current economic situation. He said he has to make a determination whether a reduction in royalty is justified. Assuming he gets to that step, he said his concern and the concern of future commissioners is going to be on the other end of the scale. He said he doesn't think there will be just a straight application up or down, it is going to be a negotiated process as to what happens with the royalty reduction on downside economics and what happens when it goes back up. Commissioner Shively said he would hope that during the process there would be the ability to be able to come to some agreement on those. However, if they couldn't agree, and he refused the reduction, they could come back and look at this in a different way we will entertain your request. Number 118 REPRESENTATIVE WILLIAMS referred to the sectional analysis for the bill, and asked how they will know what a companies costs are going to be. Number 121 COMMISSIONER SHIVELY responded to the question by stating they will know the costs on a field which is already producing because the company will provide the costs to the commissioner. In the case of a new field, the company will make projections as to what their costs will be. Number 122 REPRESENTATIVE WILLIAMS said he was referring to the fields which were already there. He then stated he was familiar with the costs of a logging operation, and asked if this was a similar type of situation. Number 140 COMMISSIONER SHIVELY said it clearly is when they near the end of the life of an oil field because you will be able to go in and look at their records from previous years, and make projections as to the future costs of operation. With a new field, this is a little different because there will be more assumptions made. However, they will still have to share their economic assumptions about the field, and we will review them. For example, let's say a company came to me and said the cost of operating a certain field is $100 million dollars per year, and we look at the field a couple of years later and the cost is only $50 million dollars, this means the economic assumptions we based the royalty reduction on were wrong. He then stated they would go back to the company and re-open the process. Commissioner Shively then referred to logging and stated there are changes in technology and price, which change costs. He said there could be one area which was logged ten years ago, which had different costs than a company logging it today. The same thing happens with oil fields. Number 163 REPRESENTATIVE OGAN asked what would happen in the event an oil company goes into the field and there turns out to be a greater production level than was anticipated. Will this automatically roll up, or is it the commissioners discretion to roll up? He also asked if the company has requested this information to be confidential, and how does the public know the prices are being rolled back up? Number 175 COMMISSIONER SHIVELY said the commissioner will not have full discretion to make changes. Surely in terms of price, the public is very aware of what happens to oil prices. Lets say we make the assumption that a field is going to be developed at $16 per barrel, and four years from now it is $22 per barrel. There are two possibilities in this circumstance, one, in the agreement is a "step-up" where the royalty increases after the price of oil increases. Another thing is to provide for a re-opener, and re-negotiation, and if we can't come to an agreement, the royalty returns to its original level. He noted the other two parts of the economics of an oil field are the volume and costs which they keep track of both. Number 192 REPRESENTATIVE OGAN said lets say the oil company says the field they are producing is a marginal field and they request a reduction. After this they continue to play shell games regarding volume and keep production low. He then said he wanted to know about any safeguards which will prevent a company from doing this. Number 208 COMMISSIONER SHIVELY said it is easy to determine this on the North Slope because all the oil goes through the pipeline. He then stated the companies are required to report the volumes. If the companies don't want to take out the oil at the fastest possible rate, he wasn't sure if there was anything they could do about it. He stated if you look at the economics, when they come in to request a reduction, we will look at what they estimate to be the total recoverable volume in the field. If we get down the road eleven years and the company has produced the amount of oil they estimated and is still going strong, this becomes a reason to change the royalty. Number 226 MR. VAN DYKE stated the past disputes with royalties and the AOGCC have not revolved around how much oil is coming from one horizon versus another horizon, or from one lease versus another lease. The disputes are value disputes and not volume disputes. There are very few disputes, with the lessee, over volumes and where those volumes come from. He then mentioned if a company wants to produce a well at 100 barrels per day, or 150 barrels per day, this is their choice. Number 238 COMMISSIONER SHIVELY then mentioned the Oil and Gas Division is staffed with people who understand this process. They know how to look at the data, and if we thought it was important, we would have it independently looked at. Number 242 REPRESENTATIVE OGAN asked if the amount of royalty changed depending on how much they produce per day. For example, they have the ability to produce 150 barrels, per day, and they only produce 100 barrels, per day. Number 250 COMMISSIONER SHIVELY said they are not looking so much at volumes, per day, as they are looking at recoverable volumes in the field. It would be very strange for an oil company, once they have made the capital investment, to not want to try to maximize the amount of oil they can recover. As he understands it, one of the jobs of the AOGCC is to make sure they don't maximize it to such an extent that they do damage to the field. We will base our decision on how much oil they say is there. If it turns out they underestimate the amount, which often happens, you can have a delineated field where as the company does further drilling they find more oil than they estimated. Representative Ogan then said you hope that happens. Commissioner Shively stated that is right. Number 263 REPRESENTATIVE MIKE NAVARRE asked if it kicks back up retroactively to oil which has already been produced. Historically, we have seen significant underestimates, and part of that is due to increased investment. He asked how do you go back. Number 269 COMMISSIONER SHIVELY stated he does not anticipate you would go back. What he does anticipate, under certain circumstances, the royalty could end up being higher at that end of the scale than it was in the original lease. If we can take it down from one set of economics below what is in the current lease, we can take it up if those economics are substantially better. Number 277 REPRESENTATIVE NAVARRE stated he would agree, except then you are increasing the amount on a significantly reduced volume because the high end of production would come on the front end. He then asked how the numbers came about on page 3, line 18, 70 percent, 50 percent production, which is equivalent to the amount that goes into the general fund. The permanent fund is held harmless so-to-speak, but the general fund is impacted potentially 100 percent. He said his question is since the legislature is not going to have this information except on your finding, but with the Department of Revenue with respect to production taxes and the application of the economic limit factor (ELF) which could reduce the production taxes down to zero. Number 293 COMMISSIONER SHIVELY stated as part of his best interest findings, he has to look at what the financial impact of the state will be, what jobs are at issue, along with other things. He stated his guess was if you have a field which will qualify for a royalty reduction, it qualifies under ELF. Therefore, you could end up in a situation where there was no contribution to the general fund. We discussed earlier whether it was necessary to have this language in the bill, and it is not. If the legislature wanted to change the language to state any royalty which was left was appropriately split either 25-75 percent, or 50-50 between the general fund and the permanent fund, that is possible. Number 305 CHAIRMAN ROKEBERG said we have talked about the sunset clause, and said he wanted to get the answer Commissioner Shively had told him the other day. Number 313 COMMISSIONER SHIVELY when we look at what we were doing, which was making a part of the existing law operate better, the existing law had no sunset. As we go down with the Oil and Gas Policy Council and look at other ways to make the industry competitive internationally, it may turn out this can be replaced with something else in which case it would be repealed, but otherwise we think it is just a better re-write of current law. Number 320 CHAIRMAN ROKEBERG asked if Commissioner Shively if he or staff would be available next Tuesday. COMMISSIONER SHIVELY stated he would be in Fairbanks until Monday night, and said he would be happy to make himself available. Chairman Rokeberg thanked Commissioner Shively. Number 339 CHAIRMAN ROKEBERG stated there were a few areas which he felt needed to be discussed further. These are issues which will revolve around making decisions in terms of the best interest finding. He said he would like to know the concerns of the Commissioner to see if the committee can be helpful in any way. He said he is certain the committee will have language as it relates to the volume of a particular field. He then directed the members to page 3, line 24 which states, "if any relevant factor such, as the price of oil and gas, changes." He stated he had problems with the term "any relevant factor" because it was too ambiguous. He then said he was concerned about costs. Chairman Rokeberg stated that costs can be defined where an existing field, in one set of circumstances, versus a new prospect and this is significant given depreciation schedules and attitudes about evaluations of money in time are significantly different between an old field and a new field. He then mentioned there were some questions, from committee members, about the reasonable rate of return, which is certainly a major concern. Chairman Rokeberg then mentioned he would like to discuss some of these areas on Tuesday. He also asked if the department could present any suggestions they would like to enter into the legislation. He stated they may even enter a definition of reasonable rate of return. Number 390 COMMISSIONER SHIVELY stated the whole concept of reasonable rate of return, the reason we took it out, is we feel it was not something you can really determine. For example, a reasonable rate of return for Representative Ogan may be unreasonable to himself. He stated the different industries not only view it differently, but one company may view it differently than another company, and in terms of marginal fields, by definition we will have a lower rate of return on the marginal field than you would on a greater field. Oil companies have made those decisions to proceed when the economics looked very close. Sometimes this has helped them and they turn out better than planned, and sometimes they don't. COMMISSIONER SHIVELY then stated this is a very difficult concept to get at. The whole idea of what they get out of this deal is something he looks at in terms of whether or not the reduction is justified. He then said they are willing to discuss this. Number 410 CHAIRMAN ROKEBERG said this certainly would come into play when every decision would be made by the commissioner. COMMISSIONER SHIVELY responded by stating, "Amount of money they will make under what conditions?" CHAIRMAN ROKEBERG mentioned some of his concern about the prior criteria used by the state is rather disturbing. This is why the legislature should perhaps help make some policy in this regard. Number 420 REPRESENTATIVE FINKELSTEIN stated his goal was not to get an exact number figure, or definition of reasonable return. He said his goal was to make sure we look at the bigger picture. Companies are differently situated, and what may be enough incentive for one company, may not be enough for another because some have bigger shares of the pie. He then said his goal is to make sure the broadest set of factors get considered. Number 426 COMMISSIONER SHIVELY stated this is where the real difficulty lies, their economic interests versus our economic interests. When you are making this, you have to try and define a very difficult line. You know that sometimes the views of the state and the oil company will be very different. When we start, they are going to give their best case for the lowest possible royalty. Number 436 CHAIRMAN ROKEBERG said one of his concerns is if you were to have somebody in your chair, in the future, who might have a more hostile attitude towards the industry, these variables are all going to change. He said he thinks that has been demonstrated in the past, and that is a concern he has. Number 442 COMMISSIONER SHIVELY said the problem is no matter what you put in, in that regard, if a future commissioner who's less reasonable than he is were to say he found against a reduction because he felt something wasn't a reasonable rate of return, then that is the end of the deal. So putting this into the bill doesn't force the equation unless you want to have another appeal process above the commissioner. Number 450 REPRESENTATIVE FINKELSTEIN stated he wanted to pursue the issue of appealability. He stated he understood the arguments being presented, but he also said anyone in the Administration would love to have their decisions not subject to appeal. What makes this different is some of these things are easy to factually determine. On the other side of this, the costs are not easy to determine. We are spending tens of millions of dollars arguing with the companies over allowable costs. If this was an easy question, we wouldn't have these tariff disputes. He said he is not yet convinced there is anything inherent in this particular decision making which would argue we should treat this differently. Number 465 CHAIRMAN ROKEBERG asked if there were any more questions for Commissioner Shively. Number 470 REPRESENTATIVE WILLIAMS stated he needs to think about the economic life being prolonged with increasing costs in the later stages of production. He said he wants to understand this area better. COMMISSIONER SHIVELY offered to have one of his staff members come to speak with him. Number 476 CHAIRMAN ROKEBERG said he had some concerns about the differentials between existing older fields and newer fields. For example, even stipulating some kind of return criteria which would be different. He said a lower return for an older field is obviously more suitable. Number 481 COMMISSIONER SHIVELY said under the old language, if for instance, in the year 2022, if ARCO and BP were to come to them and say it is time to shut this field down, however, if you give us a reduction we could keep it going for two years. If we took in the rate of return for the total field, which is what the current language states, the answer would be no, however, we might keep the field open to provide jobs or even a small revenue stream. Number 494 REPRESENTATIVE WILLIAMS stated he agreed with the Commissioner Shivley's statement. He said he had a problem with watching the bells and whistles go off. You are going to be making these decisions, what can company "A" do to get to where they would like to be. He then asked how is the state watching the early stages of a field in relation to how the later stages are being watched. Representative Williams said there are ways, you can say company "A" should have been using this type of pumping technique. Number 505 COMMISSIONER SHIVELY stated as he understands it, the rate of production is the responsibility of the Alaska Oil and Gas Conservation Commission and not the commissioner. He then stated the AOGCC does, in fact, make those decisions as an independent within the Department of Administration. Number 511 CHAIRMAN ROKEBERG then told Commissioner Shively about some of the questions the committee plans to ask on Tuesday. He asked the Commissioner if he had any comments. Number 513 COMMISSIONER SHIVELY said he thinks if the legislature wants a review process, the AOGCC would be his last choice because they are interested in the field development, itself, and not the economics of the field. So, if you were at an existing body within state government, which was outside having other commissioners look at it, the royalty board would be a more appropriate institution to use. Number 517 CHAIRMAN ROKEBERG asked if the Royalty Board was used to observing confidential information. COMMISSIONER SHIVELY said not generally. CHAIRMAN ROKEBERG asked if they serve at the will of the Governor, or if they have to be dismissed for cause. COMMISSIONER SHIVELY stated he thought the Royalty Board did not serve at the will of the Governor. CHAIRMAN ROKEBERG asked Commissioner Shively why he did not like the AOGCC. Commissioner Shively stated because the AOGCC does not generally deal with a royalty issue. CHAIRMAN ROKEBERG thanked the Commissioner and his staff. ADJOURNMENT Number 525 CHAIRMAN ROKEBERG declared the committee adjourned at 2:41 p.m.