Legislature(1997 - 1998)

03/03/1998 10:08 AM O&G

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= 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                  
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                   
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            
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                     
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             
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                  
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                
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              
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              
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             
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                 
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               
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                    
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                 
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                 
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.                                                        
Number 0861                                                                    
CHAIRMAN HODGINS adjourned the House Special Committee on Oil and              
Gas meeting at 11:58 p.m.                                                      

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