Legislature(1997 - 1998)
03/03/1998 10:08 AM 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 3, 1998 10:08 a.m. MEMBERS PRESENT Representative Mark Hodgins, Chairman Representative Scott Ogan Representative Norman Rokeberg Representative Joe Ryan Representative Con Bunde Representative Tom Brice Representative J. Allen Kemplen MEMBERS ABSENT All members present OTHER HOUSE MEMBERS PRESENT Representative Kubina COMMITTEE CALENDAR HOUSE BILL NO. 393 "An Act relating to contracts with the state establishing payments in lieu of other taxes by a qualified sponsor or qualified sponsor group for projects to develop stranded gas resources in the state; providing for the inclusion in such contracts of terms making certain adjustments regarding royalty value and the timing and notice of the state's right to take royalty in kind or in value from such projects; relating to the effect of such contracts on municipal taxation; and providing for an effective date." - HEARD AND HELD (* First public hearing) PREVIOUS ACTION BILL: HB 393 SHORT TITLE: DEVELOP STRANDED GAS RESOURCES SPONSOR(S): RULES BY REQUEST OF THE GOVERNOR Jrn-Date Jrn-Page Action 02/11/98 2280 (H) READ THE FIRST TIME - REFERRAL(S) 02/11/98 2281 (H) OIL & GAS, FINANCE 02/11/98 2281 (H) 2 FISCAL NOTES (DNR, REV) 02/11/98 2281 (H) GOVERNOR'S TRANSMITTAL LETTER 02/19/98 (H) O&G AT 11:00 AM CAPITOL 124 02/19/98 (H) MINUTE(O&G) 02/24/98 (H) O&G AT 10:00 AM CAPITOL 124 02/24/98 (H) MINUTE(O&G) 02/26/98 (H) O&G AT 10:00 AM CAPITOL 124 02/26/98 (H) MINUTE (O&G) 03/03/98 (H) O&G AT 10:00 AM CAPITOL 124 WITNESS REGISTER ROGER MARKS, Petroleum Economist Department of Revenue 550 West 7th Avenue, Suite 570 Anchorage Alaska 99501 Telephone: (907) 276-1363 POSITION STATEMENT: Testified on HB 393. DR. PEDRO VAN MEURS Independent Consultant Van Meurs & Associates 115 Sierra Morena Court, S.W. Calgary, Alberta Canada T3H 2X8 Telephone: (403) 246-7088 POSITION STATEMENT: Testified on HB 393. ACTION NARRATIVE TAPE 98-16, SIDE A Number 0001 CHAIRMAN MARK HODGINS called the House Special Committee on Oil and Gas meeting to order at 10:08 p.m. Members present at the call to order were Representatives Hodgins and Ryan. Representatives Kemplen, Bunde, Brice, Rokeberg and Ogan arrived at 10:09, 10:10, 10:12, 10:18 and 10:23 a.m., respectively. HB 393 - DEVELOP STRANDED GAS RESOURCES Number 0112 CHAIRMAN HODGINS announced the committee would hear HB 393, "An Act relating to contracts with the state establishing payments in lieu of other taxes by a qualified sponsor or qualified sponsor group for projects to develop stranded gas resources in the state; providing for the inclusion in such contracts of terms making certain adjustments regarding royalty value and the timing and notice of the state's right to take royalty in kind or in value from such projects; relating to the effect of such contracts on municipal taxation; and providing for an effective date." He called on Roger Marks to testify. Number 0156 ROGER MARKS, Petroleum Economist, Department of Revenue, stated that he would give an introduction to Dr. Pedro van Meurs and how the history of the oil and gas taxes in this state applies to Prudhoe Bay gas. The current tax system that is in place is not appropriate for this resource. He referred to a tax time-line and gave a brief history of the economics of Alaska's hydrocarbon resources. Number 0300 MR. MARKS stated that in 1968 the Prudhoe Bay discovery was announced and in 1973 the TAPS construction was authorized. In 1974, because of the Arab oil embargo, Cook Inlet oil prices increased from $3.50 a barrel to $12 a barrel. In 1977, Prudhoe Bay oil began flowing and in 1979 the Iranian revolution increased oil prices to $40 a barrel. He stated that the tax structure reflected the economics of the resources. Number 0380 MR. MARKS stated that there are three main taxes; property, production and corporate income tax. He stated that the production tax was enacted in 1955 in anticipation of a possible Cook Inlet discovery and was 1 percent of value for both oil and gas. The tax was then brought up to 2 percent in 1967, for both oil and gas due to a bad flood in Fairbanks. This tax was then increased to 3 percent due to the favorable economics of the McArthur River Granite Point, Beluga River Trading Bay and Middle Ground Shoal fields. He pointed out that in 1970 there was a feeling that the taxes should reflect more the economics of the resource, the higher the well productivity of a field the higher the tax rate would be. He stated that for oil, a stair-step rate was put in place; the first 300 barrels a day was taxed at 3 percent, the next 700 barrels at 5 percent, the next 1,500 barrels at 6 percent and anything over 2,500 barrels a day was taxed at 8 percent. He stated that the gas tax remained at 4 percent. The tax was passed on to consumers and there wasn't an interest in increasing the utility rates for consumers at that time. Number 0529 MR. MARKS stated that in 1972 the oil production tax was modified to include a cents-per-barrel floor. In that way it adds protection against low prices, the state would still get a minimum amount for the resource. In 1973 there was a provision put in to enact a royalty credit against the severance tax when the cents per barrel floor was invoked, in order to offset that credit and to keep the tax rates the same as they were before, the oil tax rates were increased. The stair-step rates were increased slightly to keep the effective rate the same. Number 0583 MR. MARKS stated that in 1977, when Prudhoe Bay started up, there was a concern that we had two vastly different oil provinces, the North Slope which was very prolific and proceeded to be very profitable after the Arab oil embargo, coupled with Cook Inlet, which had older fields and less profitable fields. The idea was to have a common tax structure that would apply to both provinces. What the legislature did, was increase the nominal severance tax rate up to 12.25 percent, but that was subject to the economic limit factor, (ELF). This took the stair-step curve and made it into a smooth curve by giving 300 barrels, per well, per day, tax free for each field, and then every barrel over the 300 paid the 12.25 percent. The intent was to increase the tax rates on the profitable Prudhoe Bay field and at the same time decrease taxes on Cook Inlet, or at the most have the Cook Inlet taxes stay the same. Number 0672 MR. MARKS stated that the gas prices were tied to the oil prices which was up in Cook Inlet. Three-fourths of the gas was either being exported in the form of liquefied natural gas, (LNG), or used as rental gas to move over to Swanson River to reinject that reservoir, the consumers were only consuming about one-forth of it. The reason was to increases the tax rate on gas by increasing the nominal rate to 10 percent and subjecting that to an economic limit factor of "3,000 MCF" per day, tax free. He stated that the ELF is a decimal between zero and one, it's multiplied by the nominal rate to give a lower effective rate. For instance, if the ELF was .5, the effective tax rate would be .5 times the 10 percent or 5 percent. Number 0739 MR. MARKS stated that in 1981, the tax rate was increased to 15 percent. The corporate tax rate was reduced in 1981 which was offset to attempt to make those changes revenue neutral. The severance tax rate was increased to 15 percent after the first five years of production. And the application of the ELF was modified at the same time; if the ELF was greater than .7 for the first 10 years of a field, it got bumped up to one. In 1989 the ELF was modified to include the average well productivity of the field and field size. This was done to offset some unintended consequences of the 1981 corporate income tax and production tax changes. Number 0823 MR. MARKS stated that the state, "20 mills" property tax was enacted in 1973. Prior to 1973, municipalities could tax property in their jurisdictions at a rate of up to "30 mills". Only pipelines were subject to the property tax per the 1955 production tax statutes. Production facilities could not be subject to a property tax. He pointed out that there was a concern that if communities could tax only the pipeline at "30 mills", it would be a unfair tax burden on the pipeline compared to what the rest of the community was being taxed. The way the "20 mills" property tax was enacted in 1973, communities could tax both production facilities and the pipeline at the mill rate that all other property in the community was being taxed at. He explained that the state would tax "20 mills", but what was paid to the communities would be a credit against the state tax. For instance, if Valdez had a "16 mills" rate, the first "16 mills" would go to Valdez and the state would get the other "4 mills". This was also an opportunity for the state to get some money for property in the unorganized borough. Number 0930 MR. MARKS stated that prior to 1978 the state's corporate income tax was what is called apportionment. Apportionment is an attempt to apportion world wide income to the state in order to tax that income. Alaska, at that time, apportioned income based on property, payroll and sales. The average of these three is the apportionment factor and that factor times the worldwide income is the deemed state income, which is subject to whatever the state's income tax rate was. He pointed out that it created a couple of problems for Alaska in 1978. The first problem was that with a particularly profitable enterprise where the income per unit of an apportionment, that you are getting, is high, since apportionment is an artificial way to establish income, a lot of the income from the profitable Prudhoe Bay field was sort of leaking out of the state for tax purposes. Number 1003 MR. MARKS stated that the other problem apportionment created was that not a lot of oil was being sold in the state, it was being sold outside the state. The sales factor was very low, therefore the state was losing out by using those three factors. He explained that it was felt that the Prudhoe Bay field and Alaska operations were geographically segregatable from a lot of world wide activity, separate accounting income tax was enacted in 1978. This just looked at the activity, itself, for oil and gas and for its operations, by company and for the state. Those would then be segregated and taxed at the same nominal rate, 9.4 percent. He explained that because only the oil and gas industry was segregated for the tax or subject to that tax, the other industries in the state were still on apportionment and litigation ensued. He stated that by 1981 the state was running a high contingent liability if it lost the litigation and so the state changed its corporate income tax structure to modified apportionment. Before there was property, payroll and sales, the payroll factor was replaced by what we call the extraction factor. Therefore, even though the state was not seeing much in sales because a lot of oil was being extracted in the state, the apportionment factor was increased. Currently this is the corporate income tax that the state is on. Number 1141 MR. MARKS stated that the tax that is in place now, has always been explicitly tied to the economics of the resource. The tax that Prudhoe Bay gas is currently subject to, has evolved based on either the economics of Prudhoe Bay oil, or the economics of Cook Inlet gas, two vastly different resources. One of the differences between Prudhoe Bay oil and Prudhoe Bay gas is the cost. He explained that in world energy markets, BTUs are what is being sold. He stated that the TAPS oil pipeline was built to carry two million barrels a day down the pipeline. It is envisioned that the gas pipeline will carry about two billion cubic feet a day. He pointed out that 1,000 cubic feet of gas has about one-sixth the BTUs of a barrel of oil. This equates to 3 million MCF versus two million barrels of oil. He stated that oil has about six times the BTUs being carried down and the cost of the pipeline is roughly the same amount, therefore, Prudhoe Bay gas has a big problem on the cost side compared to Prudhoe Bay oil. Number 1205 MR. MARKS stated that the fundamental differences between oil and gas is how they are marketed. A barrel of oil in a tanker could be sold at the world market price that day. Gas is different. He explained that everyone in the world uses gas and if they had access to gas by a pipeline they would use that gas rather than using gas that comes in the form of LNG, because LNG costs more. Therefore, LNG can only be sold in markets where there is not pipeline access. There is a much more limited market for LNG than oil or pipeline gas and because of the high cost of making an LNG project, no one will sell liquefied natural gas unless they have long-term contracts. Number 1272 MR. MARKS stated that the difference between North Slope gas and Cook Inlet gas is that an 800-mile pipeline is not needed to get the Cook Inlet gas into a marketable form. It is needed for North Slope gas. He stated that the bottom line is that because of the differences in these resources and because the current tax system is tied either to Prudhoe Bay oil or Cook Inlet gas, we see the current tax system as being inappropriate for this resource. He stated that if the tax system is not changed the probability of the project happening will be reduced even more. Number 1349 CHAIRMAN HODGINS asked if was basically correct that we could tailor taxes according to the commodity and decide what is the best trade-off between getting this product on the market and what the people from the state of Alaska will receive in revenues. Number 1369 MR. MARKS replied that there is a tradition in this state of tailoring the tax system to reflect the economics of the resources. Number 1381 CHAIRMAN HODGINS asked if Dr. van Meurs, did any economic analysis on some of the other technologies, such as gas-to-liquids and the types of regulatory changes we would have made in that. Number 1407 MR. MARKS replied that Dr. van Meur's contract did not look at the gas-to-liquids technology. He stated that his own perception is that every gas-to-liquids project around the world is loosing money before taxes, therefore we do not see it as a tax issue. Number 1435 CHAIRMAN HODGINS asked that in regards to the gas-to-liquids, unless there is a technology break through there is nothing we can do tax-wise to make our North Slope gas viable at this time. Number 1446 MR. MARKS stated that one would have to look at the most appropriate tax for that resource at that time. In the future, as the economics evolve, it would then be appropriate to do that. Number 1468 REPRESENTATIVE JOE RYAN referred to the stair-step tax and the larger production from each well was getting the larger tax. He asked if that was to encourage the producers to not deplete the field too quickly or was it just a straight up tax. Number 1490 MR. MARKS replied that was to do both. With a stair-step tax, the more prolific well productivity, there is a more economic field and a higher tax rate and vice versa. He stated that with the stair- step rate there was a floor of 3 percent, the first 300 barrels paid 3 percent. One of the deficiencies of that was pointed out, which led to the enactment of the ELF, was when a point is reached late in the field life where more than 300 barrels is needed to cover the operating costs. He explained that if only 100 barrels were needed to cover the operating costs and 3 percent was being paid on the first 300, a premature shut-down of the well would occur. He stated that what ELF did was to make it so well productivity got down to zero the tax rate would be at zero, therefore the burden of the tax would not cause a premature shut- down of the field. Number 1555 REPRESENTATIVE RYAN referred to a supreme court ruling regarding Barkley's [ph] bank and the state of California over apportion taxing that influenced a lot of tax relief laws. He asked if his understanding was correct that ELF could be characterized as the tax allowing the producers to take the capital money to produce the well. Number 1626 MR. MARKS replied that the intent of ELF is that depending on the size of the field and the well productivity decline, the tax rate will go down. He stated that the 300 barrels is very arbitrary because it does not reflect the actual costs, or what the price of oil is. He explained that the intent of the legislation in 1977, was that one needed the revenue from 300 barrels a day to cover the operating costs. Therefore, the first 300 barrels a day would be tax free. If the 1,000 barrels a day are produced then the first 300 would be tax free, and tax would then be paid on the remaining 700 barrels, the ELF would be .7. He reiterated that intent of ELF is so that the burden of the tax itself, would not cause a field to shut down. Number 1693 REPRESENTATIVE NORMAN ROKEBERG referred to the modified apportionment income tax in 1981 and asked what component, payroll or sales replaced extraction. Number 1707 MR. MARKS responded that ordinally it was payroll, property and sales and the modified apportionment replaced payroll with extraction. REPRESENTATIVE ROKEBERG asked why wasn't sales replaced. Number 1723 MR. MARKS replied that he did not know. He stated that the sales did include the TAPS' tariff and in that way the income of the pipeline company was being captured to the sales factor but a lot of production activity was not being captured. Number 1747 REPRESENTATIVE ROKEBERG asked if it would be possible to apply the formula used for ELF, to the royalty to create a sliding scale. Number 1770 MR. MARKS responded that in theory one could. He stated that there might be some institutional challenges given how the lease form is constructed. Number 1782 REPRESENTATIVE ROKEBERG asked if it is just a rumor that there are some arithmetic problems under ELF calculations. Number 1789 MR. MARKS replied that arithmetically it is working fine, however it is certainly not the perfect tax. Number 1802 REPRESENTATIVE ROKEBERG asked if there is any distinction made between oil and gas petroleum corporations and other corporations as far as corporate tax. MR. MARKS replied the non-petroleum corporations have payroll in their extraction factor. The modified apportionment is modified because it uses extraction instead of payroll and it only applies to oil and gas petroleum corporations. Number 1837 CHAIRMAN HODGINS said, "I know that some of the oil and gas industry holdings are classified as property and some of them are classified as real and could you just give us a real quick little primer on the possibility of which is which. Oil lines versus platforms versus refineries versus LNG plants?" MR. MARKS replied that he could not at the moment but would get it to the committee. Number 1878 CHAIRMAN HODGINS stated that it needs to be understood that there are differences between real and property tax based on how we are going to levy them. He stated that in regards to the oil pipeline, a precedent was set by giving tax holidays and asked if anything was learned from this that could be applied to the gas line. MR. MARKS asked what tax holidays he was referring to. Number 1913 CHAIRMAN HODGINS stated that he thought some sort of tax relief was offered for the oil pipeline, but maybe he is mistaken. Number 1919 MR. MARKS replied that the oil pipeline was taxed quite regressively and front-end loaded. Number 1950 REPRESENTATIVE CON BUNDE stated that the bill discusses an equity position from municipalities and asked what the perspective is on that factor. Number 1974 MR. MARKS responded that Representative Bunde should talk to "them" about that as "they" have not gone into detail about what "they" mean by that. He stated that replacing a front-end loaded regressive property tax would just be an equity gift that doesn't get very far in helping the project. Number 2000 REPRESENTATIVE BUNDE asked if he knew of other areas in the U.S. where the municipalities have an equity position in a project that involves statewide resources. MR. MARKS replied that he could not think of any. CHAIRMAN HODGINS asked Mr. Marks to present Dr. van Meurs. Number 2022 MR. MARKS stated that Dr. van Meurs, for about 25 years, has been helping other countries around the world establish their fiscal terms and negotiates tax terms with producers. He stated that he has consulted for about 80 countries and publishes a compendium of oil and gas fiscal terms around the world which is the standard desk reference for anyone who is looking at what comparative fiscal terms are. Number 2071 DR. PEDRO VAN MEURS, Independent Consultant, Petroleum Fiscal Systems, stated that it is great to be here with a very innovative and proactive document, with respect to the development of LNG for Alaska. He stated that he thought the document is very innovative in a sense it is a very concrete response to the competitive nature of this business. He stated that the fiscal terms for LNG are negotiated and tailored to the specific nature of the project. He pointed out that the existing fiscal terms in Alaska were really not appropriate for this type of project but with the bill, Alaska establishes the power to tailor LNG terms to the specific nature of the project in order to compete with other countries in the world. The bill is a innovative approach to authorizing the government to negotiate a contract with a wide range of conditions and criteria, but with no specific fiscal features established in the law. He stated that it is an interesting document that would place Alaska in the best possible position to try to develop a competitive project. Number 2160 DR. VAN MEURS stated that the important criteria for a new fiscal structure would be to make the fiscal terms progressive and back- end loaded which are included as criteria in this bill. He stated that they are very important criteria because they are the types of criteria that will create a fiscal structure that would be competitive for the situation in Alaska. Number 2180 DR. VAN MEURS referred to the competitiveness of Alaska to other projects, particularly in Ras Laffan and Qatar and stated that the bill would permit the state to negotiate to overcome the 2 percent differential and become competitive. He explained that back-end loaded means that it is not only an effort on the state to allow investors to recover their investment early in the project, it involves shifting the risk. He stated that the important aspect of a project of this nature, is the dissolution and nature of the risk. He stated that by back-end loading and by making the project progressive, the state and the promoters of the project share the risks, and consequently the fiscal structure contemplates a shifting of the risk, to a degree from the project promoters to the state. All of this is very significant in bringing this project about because we are not only competing on the profitability, we are competing on price risk and cost overrun risk. Number 2254 DR. VAN MEURS stated the bill is a proactive way of placing Alaska in the international competition in the Pacific area. He stated that the time-line is very important. The negotiations for a contract of this nature will be complex and it will take some time to arrive at a detailed contract to be considered. In order for this project to start off production in the year 2007, steps have to be taken now to permit the process to take place; to negotiate the contract, to develop the market, to make the market contacts and put a package together that will be satisfactory. The construction of the project will take five years. Number 2304 DR. VAN MEURS stated that the bill comes at a very important time in the Asian market. He explained that Alaska has had trouble competing with Malaysia and Indonesia, who actually provided significant subsidies and low cost financing to the development of LNG projects at a very high state involvement, sometimes in the investments. He pointed out that the interesting development is that both Malaysia and Indonesia are in much tougher financial shape, and we may actually see a structural change whereby Malaysia and Indonesia are forced by International Monetary Fund, (IMF) to be required to compete on our terms. Consequently projects now have to compared to be more on the inherent economics of the project. He stated it is important to place Alaska in the international arena because the Alaska project, is a project that is 100 percent financed privately. He referred to the Australian project, which is also 100 percent financed by private capital and is the front runner. He stated that it is important to let the world know that Alaska has a project, contrary to other projects in the world, does not require state capital or concessionary financing by the state in order to be competitive and will compete on the basis of a fiscal package that is to be negotiated depending on the circumstances. Number 2434 DR. VAN MEURS stated that over the last few months there has been a strong interest expressed by the project developers, as they are actively participating in the development of this bill. He stated that this project would bring significant benefits to the state during construction and would establish an infrastructure for the state that may help the state for decades in the future. TAPE 98-16, SIDE B Number 0019 MR. VAN MEURS stated that the infrastructure is in place that opens up the possibility for a whole new gas exploration industry and a whole new set of possible incremental investment that could be beneficial for the state for many decades to come. He stated that he would be glad to answer any questions the committee may have. Number 0033 CHAIRMAN HODGINS stated that he thought that the "hurdle rate" has now been lowered because of the economic impact of Asia and asked how long would that have to last or positively affect our project on the world market. Number 0043 DR. VAN MEURS responded that he did not see that the "hurdle rate" was lowered very much. He stated that due to the crisis in Iraq, the financial crisis in Southeast Asia and the political difficulties in Indonesia; Alaska and North America are a very safe place to invest. He stated that probably the "hurdle rate" in Alaska could be somewhat less than in other countries because of the perception of a lower country risk. Number 0117 CHAIRMAN HODGINS asked if he would be more optimistic about the project at this point. Number 0120 DR. VAN MEURS responded that he would be more optimistic because the investors now realize that the two main competitors of Alaska; Malaysia and Indonesia, actually have more problems attached to it than was perceived only four months ago. It doesn't seem that the current measures Indonesia is taking, are putting the country on a path of great stability. However, Korea seems to be taking steps that might bring the country back into shape. He stated that he is quite optimistic that the country will emerge strong and have a market for Alaskan gas. REPRESENTATIVE RYAN referred to Malaysia's finance minister, Mr. Abraham who talked about the initial public offerings (IPO) that were being privatized and that certain families made tremendous fortunes on the IPOs. He referred to Indonesia and the strong army presence that it has in the country, making it not a good place to invest. He stated that in Alaska it has always been very easy for investors to a business here quite profitably, especially compared to the other jurisdictions with their problems. He stated that he is happy that a couple of producers have shown an interest. Number 0283 REPRESENTATIVE ROKEBERG asked if he could expand on the reasoning behind back-end loading of risks. Number 0318 DR. VAN MEURS stated that the main fiscal instrument that can be used to reduce project risk is the fiscal style that is suggested in the bill. Price risk is attached to this project. He explained that a huge investment that is needed requires a relatively strong price, so there is a risk. He stated that there is also a cost overrun risk because there is so much capital involved in the development of this project. These risks are even higher than with competing projects because the other projects are smaller and the portion of capital in its total is less. He stated that the cost of projects can be implemented somewhat quicker in other parts of the world, so that the price risk is also of a different structure. He stated that in order to make the Alaska project competitive we have to address the cost overrun risk and the price risk. He stated that we need to build a fiscal structure that minimizes those risks as much as possible. He stated that the idea of a progressive system presented in the bill, is that if the costs turn out to be high, and the price turns out to be low, then the tax burden would be modest. He stated that if the price turns out to be high and the costs turn out to be low then the benefit to the state should be very significant. Consequently, the fiscal terms have become a function of the cost and the prices. He stated that it is a way of risk sharing that does not exist in the current fiscal set-up. He pointed out that by moving from the current system to this system, the state by implication is sharing the price risk and the cost overrun risk. Number 0454 REPRESENTATIVE ROKEBERG asked how the state of Alaska can get into this contract in such a way that the returns will be based on the price sensitivity. He asked if we should bargain a preset, determined profit and/or margin over the project costs. He stated that he assumed that given what it takes to build a LNG project, usually the price is set on a long-term basis as far as delivery is concerned. He stated that there would be a margin of profitability for the sponsors and also a share of that for the state for whatever taxes we end up doing. He asked how we would focus on that. Number 0522 DR. VAN MEURS responded that the project promoters will negotiate a price, but the price will be linked to crude oil or other agency indicators. He stated that the price is not a guaranteed fixed price. He stated that the price is linked to crude oil and will go up and down with crude oil in the same way or depending on the formula negotiated in the contract. That is what creates the price risk. He stated that the promoter will not go into the project unless they feel that they have a sufficient margin and that the profitability on average, looks acceptable. There is the price risk that if crude oil prices slip significantly that LNG prices will slip with it and that is a significant price risk. He stated that in regards to the fiscal terms, in order to make this project less risky, would be to say that if the price drops we will be a little bit easier on our take and if the price increases we will be a little bit tougher on our take, which can be done through a wide variety of formulas. He stated that it could be a simple formula based on price and cost. He stated that it could be a percentage of the margin. This bill leaves the various models open and it depends on the specific sponsor group, as to what specifically will be negotiated and what seems to be the most appropriate formula. He pointed out that all of the formulas will have that characteristic, that the system is generally progressive and generally back-end loaded. Number 0637 CHAIRMAN HODGINS asked it the balance of trade helps with countries such as Asia, that are trying to get more products into the U.S. so they would be more inclined to purchase more things from us, such as LNG. Number 0668 DR. VAN MEURS replied that he did not believe that the balance of trade will have a direct impact on this project, however, nor would the countries like it very much if it were an offset project, it's very difficult to negotiate. However, the President of the United States has indicated to China, Korea and Taiwan, that the United States likes the balance of payment addressed. And the U.S. would welcome measures that Asian countries would take to bring the balance of payments differential. This project is a golden opportunity to do this. Number 0712 REPRESENTATIVE ROKEBERG asked if Dr. van Meurs looked at what other types of industries could be spawned from the installation of the gas pipeline in using gas as feed stocks. DR. VAN MEURS stated that he did not, his contract related to the fiscal and economic aspects of the project. Number 0078 REPRESENTATIVE ROKEBERG asked if he had visited Southeast Asia or Jakarta. Number 0794 DR. VAN MEURS replied that he had been to Kuwait during the almost impending new Gulf war but not to Jakarta. Number 0859 REPRESENTATIVE ROKEBERG referred to Dr. van Meurs testimony regarding price sensitivity. He asked if there could be a BTU driven formula; things besides price to bargain on. Number 0912 DR. VAN MEURS replied that it would be an issue of the project sponsors to negotiate a price. Traditionally in LNG contracts there has been floor prices. However, recently, particularly Korea has objected to signing contracts with floor prices. Consequently, the factor that the world oil price seems to be on a declining trend for at least a few months, or even a few years in addition to the governments unwillingness to accept floor prices, affects this project negatively. REPRESENTATIVE ROKEBERG asked if demand was a factor in Korea. Number 1004 DR. VAN MEURS responded that demand was not. He stated that in regards to the short term, Korea has canceled all of their spot contracts, a drop of about 2 million tons. Their long-term projects are still valid. The projection now is that Korea will grow 6 percent this year. He stated that there is hope for a positive economic growth and if it materializes it is hopeful that the long-term trend will come back. He agreed that in the short term there is a negative impact on demand. Number 1064 REPRESENTATIVE BUNDE stated that he would like to hear Dr. van Meurs reaction to the municipalities in Alaska taking an equity position in private industry and how it relates to the investment climate. Number 1088 DR. VAN MEURS replied that the bill leaves wide open what kind of financial compensation the municipalities can receive in lieu of the removal of the property tax, there is no obligation to go into an equity position. He explained that his view is that this equity position, in whatever form in this project, is a risk investment and the communities making the equity investment would have to consider their options very carefully. The bill does not oblige them to make equity investments, it simply gives them the option, and if some of the communities feel that it is advantageous to them, then the bill does not preclude it. Number 1183 REPRESENTATIVE BUNDE stated that the municipalities really do not have any risks because if they go bankrupt, they come looking to the state for help. Number 1197 REPRESENTATIVE GENE KUBINA stated that British Petroleum came in with the proposal to change the North Star project and asked if he was suggesting that profit be taxed. Number 1228 DR. VAN MEURS stated that he was not an expert on the North Star situation but understood that it was based on bids that were based on profit. This situation is not off a bid. He stated that he believed that a progressive fiscal system has to take into account the profitability of the project. The project sponsors would like to see a fair return on their investment and the state has to be sensitive to that desire in order to bring the project forward. Whether the precise formula will be based on profitability or some broader criteria, remains to be seen. Number 1284 REPRESENTATIVE KUBINA stated that we are looking at price relative to the cost of everything. He stated that the state's take would increase because once it is over the 14 million metric tons mark, the profits would increase. Number 1320 DR. VAN MEURS replied that is correct. It is important to understand that this is a project-by-project concept in order to compete with a similar concept in other countries. The project could be defined as a 14 million ton deal, with whatever fiscal incentive given only applying to that 14 million tons. He stated that if there is an incremental investment that involves further transports throughout the line so that the average costs of transportation, or the incremental costs of transportation, are considerably less, or if there are different kinds of gas resources becoming available, that is a whole new project and the fiscal terms of that project will be negotiated with the best interest of the state, as outlined, based on the characteristic of the incremental project. He stated that he agreed that there is great scope that the incremental projects will see a much better take for the state than the initial project that has to establish the basic infrastructure. Number 1384 REPRESENTATIVE KUBINA stated that he felt because we were in a rush to get the oil pipeline going, we maybe lost out on some of the benefits there. With this gas line, when converting from a gas to a liquid there's a huge amount of waste heat that could provide a vast amount of electricity shipped back to the Railbelt to benefit a lot of people. He asked if he has heard anybody talk about any of these issues and if it would play a part in these contracts. Number 1442 DR. VAN MEURS responded that the bill leaves open a wide variety of possibilities to enter into a contract. The bill has stringent criteria and if the commissioner doesn't believe the project is effective to the state then there will not be a contract, it is up to the sponsors to demonstrate that a project is beneficial. He stated that there is a wide scope for add-ons to this project of which the communities along the line, could greatly benefit. Number 1535 REPRESENTATIVE ALAN KEMPLEN stated that there are a lot of dynamic forces at play in regards to the LNG contracts and trying to lock down certainty in a very uncertain world. He asked if because of the uncertainty in the market place, if LNG contracts have ever been renegotiated or altered because of economics of political circumstances. Number 1638 DR. VAN MEURS replied no. He agreed that we are facing high risk and a variable market which is why the fiscal system has to be flexible so it can respond to whatever comes out of the market. The LNG contract have been reasonably stable, however it is definitely the case that a number of countries have taken steps to adjust terms over time. He stated that Australia, Indonesia, Malaysia and Qatar have adjusted their terms in some way but it was mutual. He stated that in general, the world terms have been reasonably stable and since other nations have more flexible systems than Alaska there was not a great need to adjust terms. He stated that the inflexibility of the current fiscal system would need frequent adjustment if you wanted to optimize the take for the state and for Alaskans. The fiscal structure will have to enhance the possibility of having a stable agreement over the time-period. That is the reason it is contemplated that there will be the fiscal stability in production sharing agreement and other agreements around the world. He pointed out that it is understood that if the two parties, voluntarily, are prepared to renegotiate something, they can. The intention is to negotiate a contract that is stable, but inherently flexible so that it responds to the widest set of circumstances. Number 1833 REPRESENTATIVE KEMPLEN referred to the economic rent in the bill and asked if an equity investor would have a higher probability of capturing the economic rent. He asked how quasi-public corporations, separate from the state, participate in the projects and how would the markets interpret that. Number 1931 DR. VAN MEURS responded that the great advantage for Alaska right now is that Qatar, Malaysia, Abu Dhabi, and the large number of LNG exporting countries, in the past, captured economic rent by co- investing. In other words, they made a very favorable deal, allowing the investor to pay only a small fraction of the economic rent and then co-invest it. The style of capturing economic rent in the above mentioned counties, was to participate strongly through a state company, up to as much as 60 to 70 percent. He pointed out that the current situation indicates that those nations have over extended themselves and it is unlikely that this will happen to the same degree in the future, which is an advantage for Alaska. He stated that the bill does not define any particular sponsor group. Whether the state of Alaska should use the participation route as a way to capture economic rent, it could only be done with the permanent fund which would not be in line with the current objectives of that fund. He stated that the bill does not prohibit a sponsor group with a quasi-public entity along with them. Number 2128 REPRESENTATIVE KEMPLEN asked if it was correct that those Middle East countries did capture their fair share of economic rent, it was just that they overextended themselves. Number 2149 DR. VAN MEURS replied that it only works if you are lucky. Qatar is a good example of the problem. They participated 60 percent in the Ras Laffan project and with the decline in the crude prices and a slower Korean market, the rate of return may not be great, consequently they may not capture any attractive share of an economic rent. He stated that it depends on how the deal is structured as to what the outcome will be. Number 2228 REPRESENTATIVE RYAN asked if the gas contracts are subject to variations in the spot market. Number 2251 DR. VAN MEURS replied no, the long-term LNG deals are tied to the crude prices, and the Alaskan project can not come about unless there is a long-term contract with respect to the supply because otherwise the investment cannot be justified. Separately, from that, a spot market has developed for smaller volumes. He explained that in most of the plans that he builds has some surplus capacity, so there is the possibility for occasional spot cargos. It is probable that the spot market will gradually expand, but it would not be possible to develop an Alaska project on the basis of the spot market. Number 2368 REPRESENTATIVE RYAN asked how the Australian LNG project is progressing. Number 2382 DR. VAN MEURS replied that the interesting development over the last few months is that the Australian project is entirely privately financed, so it does not depend on state considerations. He stated that the Australians now have a project that stands on its own on the basis of reasonable economic criteria and looks good compared to Indonesia, Malaysia and Qatar. Australians are suddenly quite optimistic that their project will have an edge, in the same manner that an Alaska project would have an edge. TAPE 98-17, SIDE A Number 0020 REPRESENTATIVE ROKEBERG asked if he thought Qatar was lucky or unlucky now. DR. VAN MEURS replied unlucky now. REPRESENTATIVE ROKEBERG asked if most of the co-investment schemes, particularly in the Third World usually assume that the co- investing country actually provides a capital investment to the project and shares it with their other private partners. He asked how those schemes usually come together. Number 0090 DR. VAN MEURS responded that the countries contributed their own share, but it was typically along with some other arrangements and each case is different in this respect. Number 0213 REPRESENTATIVE ROKEBERG asked if it is possible for the state of Alaska to back load their tax deferrals in the form of equity of downstream basis or timing. Number 0266 DR. VAN MEURS replied that some countries have replaced equity participation for royalties, but usually not for corporate income tax. The concept does exist, but whether it is beneficial for the host nation is open to question, because what you are doing is buying a share of the economic rent through your co-investment, that otherwise you could have obtained largely for free by properly negotiating a fiscal system. Number 0342 REPRESENTATIVE ROKEBERG asked that wouldn't it have the advantage of freeing up the capital requirement in the front-end for the sponsor investor groups by deferring those capital needs until later. Number 0398 DR. VAN MEURS replied yes. He stated that there is the issue of does the project need capital. There would not be a shortage of capital for the project, if the project could be designed in terms of risk and profitability in an attractive manner. He stated that he does not think Alaska has a situation where we need more capital. He stated that state participation could take a large number of forms. The actual options are very limited and it is questionable whether it will help as much as defining a sensible fiscal system and a risk profile that is acceptable. Number 0504 REPRESENTATIVE ROKEBERG stated that bribery, it seems, could take up to 20 percent of the deals in these Third World countries. He asked if we could bargain for the state to participate to have a small percentage degree in the equity by having deferred their taxes, and picking up equity after a point in time. Number 0552 DR. VAN MEURS replied that the advantage in Alaska is that there is no corruption, like that and investors look positively on that factor. Number 0613 REPRESENTATIVE ROKEBERG said, "We need to look at as a committee is we could defer that in lieu of taxes till, at that point, where you pick up an equity interest." Number 0666 REPRESENTATIVE KEMPLEN stated that for local municipalities one could see a deferral of property taxes for an equity interest in the project, and that they create a quasi-public corporation to manage that equity interest. Number 0727 CHAIRMAN HODGINS stated that the committee was out of time and he would hold HB 393 over. ADJOURNMENT Number 0861 CHAIRMAN HODGINS adjourned the House Special Committee on Oil and Gas meeting at 11:58 p.m.