Legislature(2005 - 2006)CAPITOL 124

04/07/2005 05:00 PM OIL & GAS


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05:05:39 PM Start
05:05:54 PM HB234
06:20:14 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+= HB 234 OIL/GAS ROYALTY DUE DATE & INTEREST RATE TELECONFERENCED
Heard & Held
Bills Previously Heard/Scheduled
                    ALASKA STATE LEGISLATURE                                                                                  
             HOUSE SPECIAL COMMITTEE ON OIL AND GAS                                                                           
                         April 7, 2005                                                                                          
                           5:05 p.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Representative Vic Kohring, Chair                                                                                               
Representative Lesil McGuire                                                                                                    
Representative Ralph Samuels                                                                                                    
Representative Berta Gardner                                                                                                    
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
Representative Nancy Dahlstrom                                                                                                  
Representative Norman Rokeberg                                                                                                  
Representative Beth Kerttula                                                                                                    
                                                                                                                                
OTHER LEGISLATORS PRESENT                                                                                                     
                                                                                                                              
Representative Jay Ramras                                                                                                       
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
HOUSE BILL NO. 234                                                                                                              
"An Act relating to the due date for the payment of oil and gas                                                                 
royalty and net profit shares and amending the rate of interest                                                                 
payable on royalties or net profit shares."                                                                                     
                                                                                                                                
     - HEARD AND HELD                                                                                                           
                                                                                                                                
PREVIOUS COMMITTEE ACTION                                                                                                     
                                                                                                                                
BILL: HB 234                                                                                                                  
SHORT TITLE: OIL/GAS ROYALTY DUE DATE & INTEREST RATE                                                                           
SPONSOR(s): OIL & GAS                                                                                                           
                                                                                                                                
03/23/05       (H)       READ THE FIRST TIME - REFERRALS                                                                        
03/23/05       (H)       O&G, RES, FIN                                                                                          
03/31/05       (H)       O&G AT 5:00 PM CAPITOL 124                                                                             
03/31/05       (H)       Scheduled But Not Heard                                                                                
04/07/05       (H)       O&G AT 5:00 PM CAPITOL 124                                                                             
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
SEAN PARNELL, Deputy Director                                                                                                   
Division of Oil and Gas                                                                                                         
Department of Natural Resources (DNR)                                                                                           
Juneau, Alaska                                                                                                                  
POSITION STATEMENT:  Testified in opposition to HB 234 and                                                                      
answered questions regarding the bill.                                                                                          
                                                                                                                                
MARTIN SCHULTZ                                                                                                                  
Audit Section                                                                                                                   
Division of Oil and Gas                                                                                                         
Department of Natural Resources (DNR)                                                                                           
Anchorage, Alaska                                                                                                               
POSITION STATEMENT:  Answered questions regarding HB 234.                                                                       
                                                                                                                                
JIM STOUFFER, Accountant IV                                                                                                     
Division of Oil and Gas                                                                                                         
Department of Natural Resources (DNR)                                                                                           
Anchorage, Alaska                                                                                                               
POSITION STATEMENT:  Provided information during discussion of                                                                  
HB 234.                                                                                                                         
                                                                                                                                
MARK BOND, Legal Counsel                                                                                                        
UNOCAL Alaska                                                                                                                   
(No address provided)                                                                                                           
POSITION STATEMENT:  Testified in favor of HB 234.                                                                              
                                                                                                                                
DON PAGE, Manager of Accounting and Finance                                                                                     
UNOCAL Alaska                                                                                                                   
(No address provided)                                                                                                           
POSITION STATEMENT:  Testified in favor of HB 234.                                                                              
                                                                                                                                
MARILYN CROCKETT, Deputy Director                                                                                               
Alaska Oil and Gas Association (AOGA)                                                                                           
Anchorage, Alaska                                                                                                               
POSITION STATEMENT:  Testified in favor of HB 234.                                                                              
                                                                                                                                
MICHAEL HURLEY, Director                                                                                                        
State Government Relations                                                                                                      
ConocoPhillips Alaska, Inc.                                                                                                     
Anchorage, Alaska                                                                                                               
POSITION STATEMENT:  Testified in favor of HB 234.                                                                              
                                                                                                                                
MYRL THOMPSON                                                                                                                   
(No address provided)                                                                                                           
POSITION STATEMENT:   Testified in opposition to HB 234.                                                                        
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
                                                                                                                                
CHAIR VIC  KOHRING called the House  Special Committee on  Oil and                                                            
Gas  meeting to  order at  5:05:39 PM.   Representatives  McGuire,                                                            
Samuels, Kohring, and Gardner were present at the call to order.                                                                
                                                                                                                                
HB 234-OIL/GAS ROYALTY DUE DATE & INTEREST RATE                                                                               
                                                                                                                                
5:05:54 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING announced  that the only order of  business would be                                                              
HOUSE  BILL NO.  234, "An Act  relating  to the due  date for  the                                                              
payment  of  oil  and  gas  royalty  and  net  profit  shares  and                                                              
amending the rate  of interest payable on royalties  or net profit                                                              
shares."                                                                                                                        
                                                                                                                                
5:06:32 PM                                                                                                                    
                                                                                                                                
CHAIR  KOHRING presented  HB 234  on behalf of  the House  Special                                                              
Committee on Oil and Gas, sponsor of the bill.  He said:                                                                        
                                                                                                                                
     [The  bill]  would  basically,   if  passed,  lower  the                                                                   
     interest    rate   that's    charged   for   over    and                                                                   
     underpayments  when it  comes to royalties  for oil  and                                                                   
     gas.  ... When  [oil  and  gas] companies  submit  their                                                                   
     payments  on  royalties  to  the  State  of  Alaska,  if                                                                   
     there's  [an]  overpayment  on  that,  then  the  state,                                                                   
     after  they  conduct  their  audit,  they  refund  those                                                                   
     monies  back  to  the  oil   industry,  and  there's  an                                                                   
     interest  rate  ...  associated   with  any  outstanding                                                                   
     dollars  during the  course of  that audit  in the  time                                                                   
     that elapses  from when those  payments were  made until                                                                   
     when  the refund  occurs.   And then it  cuts the  other                                                                   
     way  too; as  far as  any underpayments  were, upon  the                                                                   
     conclusion  of  an  audit,   it's  determined  that  the                                                                   
     industry  has not paid  enough, then  they owe not  only                                                                   
     the  money but  an interest  rate back to  the State  of                                                                   
     Alaska.   Now it's that interest  rate that has  been an                                                                   
     issue  of  contention  among folks  which  spawned  this                                                                   
     legislation,  not that  everybody  agrees  it should  be                                                                   
     lowered.   But  my position  is that  the interest  rate                                                                   
     should reflect prevailing market rates.                                                                                    
                                                                                                                                
5:07:42 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING continued:                                                                                                        
                                                                                                                                
     The interest  rate has been  set in statute for  quite a                                                                   
     few years now.  ... It's the higher of two:  it's either                                                                   
     prime plus [5]  ... or 11 percent, whichever  is higher.                                                                   
     In recent  years, ...  they've had  the option of  going                                                                   
     with  the  11  percent  interest  rate,  which  in  this                                                                   
     market  is   a  pretty  high  rate  when   you  consider                                                                   
     interest rates  having been as  low as ... 1  percent or                                                                   
     so,  in some  cases.   So  I'm looking  at  this from  a                                                                   
     perspective  of  fairness  to  the  industry,  but  also                                                                   
     fairness  to  the  state  because   it  cuts  both  ways                                                                   
     because of the under and overpayment scenario.                                                                             
                                                                                                                                
5:08:18 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING continued:                                                                                                        
                                                                                                                                
     We're  also, in this  bill, looking  at speeding  up the                                                                   
     process  as far  as  calculating those  payment  amounts                                                                   
     too,  so that  we can expedite  that and  not leave  the                                                                   
     industry  or the  state  hanging for  a  long period  of                                                                   
     time  in terms of  receiving those  refunds from  either                                                                   
     under or overpayments.                                                                                                     
                                                                                                                                
5:08:48 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE GARDNER asked if HB 234 was filed as a committee                                                                 
bill.                                                                                                                           
                                                                                                                                
CHAIR KOHRING replied, Yes, I filed it as a committee bill."                                                                    
                                                                                                                                
REPRESENTATIVE GARDNER asked if the bill was requested by                                                                       
anybody or if it was just something that Chair Kohring felt was                                                                 
needed.                                                                                                                         
                                                                                                                                
CHAIR KOHRING answered that the bill was requested.  He said:                                                                   
                                                                                                                                
     The genesis  of this  bill was the  result of a  hearing                                                                   
     that occurred  down on Kenai Peninsula about  two months                                                                   
     ago,  maybe  six weeks  ago,  where  there was  a  joint                                                                   
     meeting  of the  House  and Senate  resources  committee                                                                   
     and  we were  part of  that as  oil and  gas. ...  There                                                                   
     were  a  lot  of  issues  that   were  looked  at.    We                                                                   
     entertained  testimony  from the  oil  and gas  industry                                                                   
     and other  folks just  to find out  what it is  that the                                                                   
     state  can do  to  help the  industry;  what issues  are                                                                   
     outstanding.   And from that came this issue,  from that                                                                   
     came  the issue  of possibly  buying a  jack-up rig  for                                                                   
     exploration  in Cook  Inlet.  ... That's  how this  bill                                                                   
     was originated.   It  was not just  a thought that  came                                                                   
     to mind....                                                                                                                
                                                                                                                                
5:09:59 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE GARDNER  pointed out that  the fiscal note  shows a                                                              
cost to  the state,  which indicates  that in  practice the  state                                                              
doesn't  often  end up  paying  interest  for overpayments.    She                                                              
asked if this conclusion was correct.                                                                                           
                                                                                                                                
CHAIR KOHRING deferred to the Department of Natural Resources.                                                                  
                                                                                                                                
5:11:04 PM                                                                                                                    
                                                                                                                                
SEAN  PARNELL,   Deputy  Director,   Division  of  Oil   and  Gas,                                                              
Department of Natural  Resources (DNR), replied  that overpayments                                                              
are rare.                                                                                                                       
                                                                                                                                
5:12:20 PM                                                                                                                    
                                                                                                                                
CHAIR  KOHRING remarked  that because  of  the committee  members'                                                              
busy schedules, he  had to make a judgment call  regarding whether                                                              
a bill is  a committee bill or  not.  He told the members  that he                                                              
will make  a concerted  effort in the  future to communicate  more                                                              
with members before a bill is filed on the committee's behalf.                                                                  
                                                                                                                                
5:13:18 PM                                                                                                                    
                                                                                                                                
MR. PARNELL  stated that DNR opposes  HB 234 for  several reasons.                                                              
He explained:                                                                                                                   
                                                                                                                                
     First, [HB 234]  incentivizes a company ...  to underpay                                                                   
     their  contractual  royalty  obligations to  the  state.                                                                   
     And  secondly,  HB  234 would  diminish  state  revenues                                                                   
     with  no  correlative  upside  for  the  people  or  the                                                                   
     state.   In  our  view, the  current  statutory rate  of                                                                   
     compounding interest  strikes an appropriate  balance in                                                                   
     favor  of  compensating  the  parties for  lost  use  of                                                                   
     money over  time. ...  [Under existing law],  royalties,                                                                   
     net  profit   share  lease   payments  that  get   paid,                                                                   
     interest  is charged  on underpayments  at a floor  rate                                                                   
     of  11  percent;  when the  federal  reserve  rate  goes                                                                   
     above  a certain  rate on  a floating  basis [and]  that                                                                   
     rate is greater  than 11 percent, then the  greater rate                                                                   
     is  charged.   In these  times  the going  rate for  ...                                                                   
     underpayments  of  royalty is  11  percent.   The  state                                                                   
     pays  an  equivalent  interest rate  in  the  infrequent                                                                   
     event that the  state owes a refund because  the company                                                                   
     overpaid  its royalty obligations.   Under current  law,                                                                   
     interest  compounds quarterly  and  interest is  payable                                                                   
     from the date the obligation becomes due....                                                                               
                                                                                                                                
5:14:44 PM                                                                                                                    
                                                                                                                                
MR.  PARNELL then  described the  state's  royalty audit  process.                                                              
He said:                                                                                                                        
                                                                                                                                
     Our  division  employs  six  revenue  auditors  who  are                                                                   
     responsible  for auditing  or  reviewing  the state  oil                                                                   
     and gas royalty  and their profit share  lease payments.                                                                   
     ...  State royalty  collections amounted  to about  $1.4                                                                   
     billion  in  fiscal year  (FY)  [2004].   Department  of                                                                   
     Resources revenue  auditors must understand oil  and gas                                                                   
     operations   to  perform   audits;   they  are   clearly                                                                   
     professionals.  ...  The  legislature  transferred  this                                                                   
     sole  audit responsibility  to DNR less  than two  years                                                                   
     ago.    Prior  to that,  this  audit  responsibility  or                                                                   
     function  rested with the  Department of Revenue;  [DNR]                                                                   
     provided a  backup audit function  to them at  the time.                                                                   
     When  the  legislature transferred  audit  authority  to                                                                   
     DNR  the backlog  of  audits was  about  on average  six                                                                   
     years.   In  the last  two  years that  has been  shaved                                                                   
     down  to an  average of  three  years, in  terms of  the                                                                   
     backlog, so we're gaining some improvement there.                                                                          
                                                                                                                                
5:16:01 PM                                                                                                                    
                                                                                                                                
MR.  PARNELL pointed  out that  the division  completed one  major                                                              
audit in  FY04 and  has completed 14  audits so far  in FY05.   He                                                              
explained  that  audits usually  include  two  or three  years  of                                                              
royalty payments,  so the division looks  at two years  at a time.                                                              
He noted,  "It does take  some time for  those payments  to settle                                                              
out."  Therefore  if a company makes an audit  payment in January,                                                              
and then refiles  within six to 12 months, it might  take the rest                                                              
of the  year [for  the division  to have  the correct  numbers for                                                              
the audit].  He said:                                                                                                           
                                                                                                                                
     Within the last  two years, the division  completed Cook                                                                   
     Inlet oil  and gas production  audits through  2002, and                                                                   
     on  the  North  Slope, most  production  is  subject  to                                                                   
     royalty settlement  agreements [RSA].   Audit challenges                                                                   
     primarily relate  to obtaining information  necessary to                                                                   
     perform an audit  from lessees. ... Lease  terms provide                                                                   
     that the  state is entitled  to the higher of  the price                                                                   
     the lessee  receives for its  oil or gas, or  the prices                                                                   
     received  by  other  lessees   in  the  area.    So  the                                                                   
     auditors  have to  obtain  information  from the  lessee                                                                   
     and  other  producers  in  the  area  to  calculate  the                                                                   
     royalty  value  because the  state  gets the  higher  of                                                                   
     whichever  barrel   gets  the  highest  value   in  that                                                                   
     unit....                                                                                                                   
                                                                                                                                
5:17:38 PM                                                                                                                    
                                                                                                                                
MR. PARNELL continued:                                                                                                          
                                                                                                                                
     Much  of   the  information  is  confidential   and  the                                                                   
     auditor  must  obtain  confidentiality  agreements  from                                                                   
     each producer.   Obtaining  this information can  take a                                                                   
     great  deal of  time.   And another  audit challenge  is                                                                   
     that each  company's accounting system is  different and                                                                   
     the  auditor must  learn each  system.   Lessees do  not                                                                   
     always  provided   required  information  in   a  timely                                                                   
     manner  or  promptly  respond  to  audit  claims.    And                                                                   
     likewise the  state cannot always respond as  quickly as                                                                   
     we or  a particular  company might  like, in large  part                                                                   
     due  to our  workload.   Despite  these challenges,  the                                                                   
     division  believes that the  audit process is  equitable                                                                   
     to  lessees  and  provides   a  thorough  review  of  an                                                                   
     important   source  of  state   revenue.    Our   record                                                                   
     demonstrates as  well that we are on track  to improving                                                                   
     the timeliness of our audits.                                                                                              
                                                                                                                                
5:18:23 PM                                                                                                                    
                                                                                                                                
MR. PARNELL turned attention to HB 234 and commented:                                                                           
                                                                                                                                
     [The bill]  wrongly provides an interest-free  period on                                                                   
     contractual debts  owed the state.   Under HB 234,  if a                                                                   
     company   failed  to   pay   the  state   royalties   in                                                                   
     accordance  with  its  lease,   the  company  would  pay                                                                   
     interest  at a much  lower rate  only after a  completed                                                                   
     audit resulted  in notice to the company,  and then only                                                                   
     if the company  failed to pay within 60  days.  Contrast                                                                   
     HB  234  with  current law  which  requires  payment  of                                                                   
     interest  on amounts owed  back to the  due date  of the                                                                   
     payment.  [House  Bill 234] results in the  state giving                                                                   
     companies  interest-free loans  of public  funds for  an                                                                   
     average   of  three  years,   depending  on  the   audit                                                                   
     backlog.    Next,  the  bill   imposes  an  asymmetrical                                                                   
     repayment  obligation on  the  state....   While HB  234                                                                   
     lets companies  off the hook for interest  over a number                                                                   
     of  years  when  they fail  to  meet  their  contractual                                                                   
     obligations,  the   bill  requires  the  state   to  pay                                                                   
     interest  to a  company  that overpaid  its  obligations                                                                   
     from the date  of the overpayment.  There's  no fairness                                                                   
     or reciprocity in that provision.                                                                                          
                                                                                                                                
5:19:45 PM                                                                                                                    
                                                                                                                                
                                                                                                                                
MR. PARNELL continued:                                                                                                          
                                                                                                                                
     The  bill eliminates  the interest  floor provision  and                                                                   
     significantly  lowers  the  rate of  interest  owed  the                                                                   
     state.   Unlike the current  law which provides  a floor                                                                   
     of 11 percent,  HB 234 sets a freely floating  rate with                                                                   
     no interest  rate floor for the  state.  If HB  234 were                                                                   
     in  effect  today,  companies   would  pay  interest  at                                                                   
     around  5.75 percent  annually rather  than 11  percent.                                                                   
     In  1991,   when  the  interest  rate   methodology  was                                                                   
     enacted,  legislative  committee   testimony  noted  the                                                                   
     then existing  Federal Reserve rate was 6  percent.  The                                                                   
     Twelfth  District Federal  Reserve rate  today is  about                                                                   
     3.75  percent.   Thus  this  bill attempts  to  redesign                                                                   
     interest  calculations based on  a Federal Reserve  rate                                                                   
     that is  only about 2  percentage points different  than                                                                   
     when the existing methodology was implemented.                                                                             
                                                                                                                                
5:20:28 PM                                                                                                                    
                                                                                                                                
MR. PARNELL continued:                                                                                                          
                                                                                                                                
     The  bill   removes  the  compounding  feature   of  the                                                                   
     interest   provision.    The   compounding  feature   is                                                                   
     important;  it means real  money to  the state, and  the                                                                   
     bill  eliminates this  feature.  [The  bill] would  take                                                                   
     us  back to  a  simple interest  regime.    In 1991  the                                                                   
     compounding feature  was added to the statutes.   Before                                                                   
     the  amendment  on  compounding   interest  was  adopted                                                                   
     industry    representatives    testified    about    the                                                                   
     appropriateness  of  using compounding  interest  before                                                                   
     [Senate    Finance    Committee].        One    industry                                                                   
     representative   stated,    "Today's   market   interest                                                                   
     charges are  typically computed at floating  rates which                                                                   
     are compounded."   Nothing  today is different  relative                                                                   
     to  interest  rates  typically   compounding  in  market                                                                   
     transactions,  and  the committee  ought  to retain  the                                                                   
     compounding nature of interest in existing law.                                                                            
                                                                                                                                
5:21:16 PM                                                                                                                    
                                                                                                                                
MR. PARNELL explained:                                                                                                          
                                                                                                                                
     The essential  purpose of  interest is compensation  for                                                                   
     the  lost use of  money over  time.   Interest is  not a                                                                   
     penalty.   Where  the money  is  contractually owed  and                                                                   
     where  the state loses  the opportunity  to invest  that                                                                   
     money  in its people  via appropriations  or at a  long-                                                                   
     term rate  of return  in the  Permanent Fund, the  state                                                                   
     should be  compensated at  a fair rate  for lost  use of                                                                   
     those  dollars   over  time.     Royalty  payments   and                                                                   
     interest  are  the  lessee's   contractual  obligations.                                                                   
     This is  not a situation  where the state bills  someone                                                                   
     for  services  rendered  and  charges  interest  forward                                                                   
     from  that date.   Such  an  outcome effectively  shifts                                                                   
     all  risks of  underpayment to  the state  to catch  the                                                                   
     shortfall, and  diminishes the state's rights  under the                                                                   
     leases.                                                                                                                    
                                                                                                                                
5:21:59 PM                                                                                                                    
                                                                                                                                
MR. PARNELL continued:                                                                                                          
                                                                                                                                
     The  companies have  the  ability to  minimize  interest                                                                   
     charges on royalty  underpayments.  The Division  of Oil                                                                   
     and Gas posts  sales information by company  and by unit                                                                   
     on  the  [Internet].    For example,  if  a  company  is                                                                   
     genuinely  concerned about  11 percent interest  charges                                                                   
     on  its  underpayments,  the  company could  go  on  the                                                                   
     [Internet]  in  March  2005,  find out  that  the  other                                                                   
     lessees  in its  unit sold  their oil in  January for  a                                                                   
     higher   dollar  value  per   barrel,  recalculate   its                                                                   
     payment  to the state,  and refile,  thus avoiding  most                                                                   
     interest charges two or three years down the road.                                                                         
                                                                                                                                
Mr.  Parnell commented  that he  asked division  personnel if  any                                                              
companies actually  check the  Internet site  for the  sale values                                                              
in  order to  refile,  and he  learned that  one  company in  Cook                                                              
Inlet has refiled  its reports based on other  lessees' data, thus                                                              
mitigating its interest exposure.                                                                                               
                                                                                                                                
5:22:53 PM                                                                                                                    
                                                                                                                                
MR. PARNELL remarked:                                                                                                           
                                                                                                                                
     In  simple   terms,  the   companies  have   information                                                                   
     available   to   them   to   minimize   their   interest                                                                   
     obligations,  but choose to  take the simple  accounting                                                                   
     route  of reporting  only their  own  sales values  with                                                                   
     little   follow-up.   ...   A  company's   practice   of                                                                   
     reporting  its  own  sales   value  without  appropriate                                                                   
     follow-up  to see  whether  the company  is meeting  its                                                                   
     higher  royalty  payment  obligations  under  the  lease                                                                   
     effectively  shifts the  burden  to the  state to  catch                                                                   
     underpayments.                                                                                                             
                                                                                                                                
5:23:28 PM                                                                                                                    
                                                                                                                                
MR. PARNELL continued:                                                                                                          
                                                                                                                                
     [House  Bill]  234 increases  the  likelihood  companies                                                                   
     will underpay  royalty obligations.  At 11  percent, the                                                                   
     statutory  royalty  interest   rate  is  less  then  the                                                                   
     return   on  capital   employed  that   most  of   these                                                                   
     companies  receive.  Albeit  indirectly, companies  that                                                                   
     underpay  royalties  could   be  said  to  be  borrowing                                                                   
     public funds  for a number of years and  investing those                                                                   
     funds elsewhere.   They are doing so at  returns greater                                                                   
     than  11  percent and,  at  least  for the  first  three                                                                   
     years,  approximately, under  HB 234,  they would do  so                                                                   
     interest-free.  ... In an HB  234 world, what  incentive                                                                   
     exists  for  companies  to  do what's  right  under  the                                                                   
     lease?   Why under those  circumstances would  a company                                                                   
     accountant  ever proactively  set about  meeting his  or                                                                   
     her  company's royalty  obligations by  following up  on                                                                   
     sales values listed at the division's web site.                                                                            
                                                                                                                                
5:24:59 PM                                                                                                                    
                                                                                                                                
MR. PARNELL continued:                                                                                                          
                                                                                                                                
     Next, HB 234  will result in lost revenue  to the state.                                                                   
     Lost interest  revenue to  the state  from this bill  is                                                                   
     estimated  in  relatively  normal  years to  be  in  the                                                                   
     range  of [$1 million  to $5  million].   We did have  a                                                                   
     spike  in  interest  revenue   in  FY01  that  took  our                                                                   
     interest  recovery figures  in  the last  three to  four                                                                   
     years  north of  $10 million.   However,  I did want  to                                                                   
     correct an  impression that  I mistakenly left  the last                                                                   
     time  I  talked  with  you   and  some  members  of  the                                                                   
     committee:  I said that  we were  talking about tens  of                                                                   
     millions of  dollars, and ultimately  we are  over time.                                                                   
     But  on  a  year-to-year  basis,   we're  talking  about                                                                   
     smaller dollars;  we're talking about [$1 million  to $5                                                                   
     million].   So  while  the amounts  may  seem small  set                                                                   
     against the  state budget in  the millions, I  know that                                                                   
     you'd  agree that millions  of dollars  of public  funds                                                                   
     are still worthy of our attention.                                                                                         
                                                                                                                                
5:25:51 PM                                                                                                                    
                                                                                                                                
MR. PARNELL commented:                                                                                                          
                                                                                                                                
     The  current interest  rate  methodology is  reasonable.                                                                   
     The  current  interest  rate of  11  percent  compounded                                                                   
     quarterly   and  the   underlying   methodology  of   AS                                                                   
     38.05.135  as reasonable  when viewed  from a number  of                                                                   
     perspectives.    First,  turning to  the  time-value  of                                                                   
     money and  the state's  lost use of  it over time:   the                                                                   
     Permanent Fund,  where part  of these payments  go, gets                                                                   
     shortchanged  because it  misses out  on the  time-value                                                                   
     of  these  payments.    It  has  a  published  long-term                                                                   
     investment  return  in  excess   of  10  percent.    The                                                                   
     current royalty  interest rate of 11 percent  is not out                                                                   
     of   line  by   that   measure.     Additionally,   what                                                                   
     percentage  rate accurately reflects  the value  of lost                                                                   
     use of  that money  on an ongoing  basis to the  public?                                                                   
     Those  interest  rates  become more  precious  to  state                                                                   
     residents  in times  of general  fund  shortfalls.   One                                                                   
     could  easily  conclude  the   existing  law  strikes  a                                                                   
     balance  between  the  value  of lost  use  across  good                                                                   
     times and bad.   Third, the Federal Reserve  rate ... is                                                                   
     only  about 2  percent  different than  it  was in  1991                                                                   
     when  the existing  methodology  passed.   Today  audits                                                                   
     are  being completed  much  more  timely than  in  those                                                                   
     early  years.   So  why should  we  revisit the  statute                                                                   
     now?                                                                                                                       
                                                                                                                                
MR. PARNELL continued:                                                                                                          
                                                                                                                                
     Next, these  companies enjoy  returns on their  capitals                                                                   
     substantially  in excess  of  the 11  percent we  charge                                                                   
     for  underpaying royalties.    There's nothing  punitive                                                                   
     nor  coercive  to a  company  that has  to  pay a  state                                                                   
     interest of  11 percent on underpaid royalties  when the                                                                   
     companies'  return  on  capital   employed  exceeds  the                                                                   
     interest paid.   Fifth, interest  paid by the  companies                                                                   
     is  deductible  in  the  companies'  state  and  federal                                                                   
     income  tax   returns.    Thus  the  companies   pay  an                                                                   
     effective  rate of interest  and the  state receives  an                                                                   
     effective  rate of  interest  less than  the 11  percent                                                                   
     floor  we  have  discussed  when  tax  deductibility  is                                                                   
     considered.                                                                                                                
                                                                                                                                
5:28:10 PM                                                                                                                    
                                                                                                                                
MR. PARNELL stated:                                                                                                             
                                                                                                                                
     Finally, the  statutory legal  rate of interest  is 10.5                                                                   
     percent  under  the  trade   practices  section  of  the                                                                   
     Alaska Statutes.   It's  hard to make  the case  that 11                                                                   
     percent is  out of line  for royalty underpayments  when                                                                   
     a legal  rate of  interest by  statute is 10.5  percent.                                                                   
     A company  might argue that  its cost of money  today is                                                                   
     lower than when  this legislation went into  effect, and                                                                   
     therefore you  should pass the  bill.  What  the company                                                                   
     is saying  is that it can  borrow money to  finance debt                                                                   
     elsewhere  at a lower  rate, so  the state should  lower                                                                   
     its  interest  rate.    However the  state  is  not  the                                                                   
     company's  bank for  royalty collection  purposes.   The                                                                   
     state should  not be perceived here as ...  just another                                                                   
     lender.    The state  is  the  lessor in  a  contractual                                                                   
     relationship  with  the companies.    The companies  are                                                                   
     transforming  the state's royalty  share of oil  and gas                                                                   
     to money; they're  pulling it from the ground  and doing                                                                   
     that and  we appreciate that.  ... The companies  simply                                                                   
     need to  be more proactive  about accounting  and paying                                                                   
     royalties under the leases.                                                                                                
                                                                                                                                
5:29:00 PM                                                                                                                    
                                                                                                                                
MR. PARNELL concluded:                                                                                                          
                                                                                                                                
     The  existing  statutory  rate   should  remain  intact.                                                                   
     What has  changed requiring  interest-free loans  to the                                                                   
     companies?   What new  jobs will be  created?   What new                                                                   
     wells will be  drilled?  What new opportunities  will be                                                                   
     available  for  Alaska  citizens  as a  result  of  this                                                                   
     legislation?   In  other words,  what  public policy  is                                                                   
     furthered?                                                                                                                 
                                                                                                                                
5:29:17 PM                                                                                                                    
                                                                                                                                
MR.  PARNELL,  in response  to  Representative  Samuels,  answered                                                              
that   currently  interest   is   due  from   the   date  of   the                                                              
underpayment.   The  same is true  for any  overpayments as  well.                                                              
If HB  234 were  to pass, he  explained, a  company would  have 60                                                              
days  after  notification  of  underpayment  before  any  interest                                                              
would  begin accruing,  but in  the  case of  an overpayment,  the                                                              
state would still owe interest from the date of overpayment.                                                                    
                                                                                                                                
5:31:31 PM                                                                                                                    
                                                                                                                                
MR. PARNELL commented:                                                                                                          
                                                                                                                                
     I  am  a person  who  has  been known  around  here  for                                                                   
     supporting  industry,  supporting  industry  development                                                                   
     as  you  all  are,  because  it is  one  of  the  strong                                                                   
     economic  engines  of  the  state.   However  there  are                                                                   
     moments in  time when they  simply ask too much,  and it                                                                   
     doesn't  appear   ...  that  that  is  in   the  state's                                                                   
     interest, to go down the path of HB 234.                                                                                   
                                                                                                                                
5:32:58 PM                                                                                                                    
                                                                                                                                
MR. PARNELL, in  response to Representative McGuire,  replied that                                                              
the majority of the companies underpay.  He explained:                                                                          
                                                                                                                                
     They're reporting  their sales and if they're  in a unit                                                                   
     with other  interest owners  ... one company's  going to                                                                   
     sell higher than  the rest, and so the majority  of them                                                                   
     are going  to underpay  if they don't  take the  time to                                                                   
     go back and  try to mitigate their interest  exposure by                                                                   
     looking at  the web site and  the ... sales  values that                                                                   
     the other companies have obtained.                                                                                         
                                                                                                                                
5:33:56 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE McGUIRE  stated that she appreciates  the sentiment                                                              
under  which  the  bill's  sponsor introduced  it,  but  she  also                                                              
thinks that Mr.  Parnell made compelling arguments  about the fact                                                              
that  it's the  state's money  that  could be  going into  capital                                                              
projects  or school  funding.  She  voiced concern  that the  bill                                                              
could  offer  further  disincentive  for  the  companies  to  make                                                              
timely royalty payments if the interest rate was lower.                                                                         
                                                                                                                                
5:35:15 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING  commented that the  legislature needs to  decide if                                                              
the current  rates are punitive or  not.  He remarked  that he was                                                              
under  the   impression  that   the  current  administration   was                                                              
actually considering  this same legislation, and he  asked why the                                                              
administration   would  consider  the   concept,  then   have  the                                                              
Division of Oil and Gas vehemently oppose the bill.                                                                             
                                                                                                                                
MR.  PARNELL explained  that every  administration will  circulate                                                              
draft  legislation   and  collect   comments  from   the  impacted                                                              
agencies.   He noted that there  is currently no  legislation from                                                              
the  administration on  this topic  because  the agencies  opposed                                                              
it.                                                                                                                             
                                                                                                                                
5:36:31 PM                                                                                                                    
                                                                                                                                
CHAIR  KOHRING expressed  dissatisfaction with  the direction  the                                                              
administration  is going.   He reiterated his  belief that  the 11                                                              
percent interest rates are punitive.                                                                                            
                                                                                                                                
MR.  PARNELL  acknowledged that  he  has  heard the  concern  that                                                              
audits take  too long, but  he pointed out  that in the  two years                                                              
that DNR  has had responsibility  for the  audits, the  time taken                                                              
for  audits  has decreased.    He  encouraged companies  to  bring                                                              
concerns  and complaints  to his  office.   He noted  that he  has                                                              
currently only heard such comments from one company.                                                                            
                                                                                                                                
5:38:55 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING asked:                                                                                                            
                                                                                                                                
     Do you  suppose that maybe  we ought to deemphasize  the                                                                   
     interest  rate  side  of  this  legislation,  and  maybe                                                                   
     emphasize  the  timing  aspect?   ...  Maybe  lower  the                                                                   
     interest  rate so  it  does reflect  market  conditions,                                                                   
     ... [and]  speed up  the whole  [audit] process so  that                                                                   
     the  industry  is  not  hanging out  there  for  a  long                                                                   
     period of time waiting to get their refund.                                                                                
                                                                                                                                
MR.  PARNELL  replied   that  this  would  be   appropriate.    He                                                              
reiterated  that  an audit  on  average  takes  three years.    He                                                              
pointed  out that  one way  to speed up  the process  would  be to                                                              
have  more  auditors,  which  would  require  more  money  in  the                                                              
budget.   He noted  that for efficiency  purposes, DNR  audits two                                                              
to three  years at  a time.   He commented,  "I don't  necessarily                                                              
think we should be auditing every year, every unit."                                                                            
                                                                                                                                
5:40:41 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  McGUIRE  asked   how  the  oil  and  gas  industry                                                              
doesn't  know  it's  underpaying  when  it  is  one  of  the  most                                                              
sophisticated  industries in  the world.   In  addition she  asked                                                              
what  other  information  tools  are at  the  industry's  disposal                                                              
besides the DNR web  site.  Lastly, she asked if  there is any law                                                              
that prohibits  a company from  taking corrective measures  at any                                                              
point prior to the audit to remedy an underpayment.                                                                             
                                                                                                                                
MR. PARNELL deferred to the audit section chief of the division.                                                                
                                                                                                                                
5:41:44 PM                                                                                                                    
                                                                                                                                
MARTIN  SCHULTZ,   Audit  Section,   Division  of  Oil   and  Gas,                                                              
Department of Natural Resources (DNR) replied:                                                                                  
                                                                                                                                
     Under our  leases there are  various forms of  so-called                                                                   
     higher of  provisions, and what  that means is  that the                                                                   
     state  is  entitled  to  a royalty  value  that  is  the                                                                   
     higher  of either  the proceeds  that  the company  gets                                                                   
     for  selling its  oil, for  example, or  what others  in                                                                   
     the  same field  are selling  their  oil for.   And  the                                                                   
     mechanism  that a company  can take  to figure out  what                                                                   
     the other  lessees are  getting for their  oil is  to go                                                                   
     to our  web site.   And we publish  each month  for both                                                                   
     the  North  Slope  and Cook  Inlet  what  companies  are                                                                   
     reporting   in  terms  of   volumes  and  what   they're                                                                   
     reporting  in terms  of royalty  values.   So  companies                                                                   
     can do  that; they do  have access to that  information.                                                                   
     ...  At  least  one  company   in  Cook  Inlet,  an  oil                                                                   
     producer, routinely  does check  to see what  others are                                                                   
     selling oil  for in its unit,  and then refiles  at that                                                                   
     higher royalty value,  if it is a higher number.   So in                                                                   
     other  words, companies  don't have  to wait until  they                                                                   
     get an audit  to figure out what these higher  of values                                                                   
     can be.                                                                                                                    
                                                                                                                                
5:43:13 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  McGUIRE  asked what  percentage  of companies  are                                                              
audited.                                                                                                                        
                                                                                                                                
MR. SCHULTZ responded:                                                                                                          
                                                                                                                                
     Most of the  production on the North Slope,  which is of                                                                   
     course  the vast majority  of production,  is under  so-                                                                   
     called  royalty settlement  agreements [RSAs] that  came                                                                   
     about ...  as a result of  the ANS [Alaska  North Slope]                                                                   
     royalty  litigation. ...  Basically  the royalty  values                                                                   
     and the deductions  to arrive at the royalty  values are                                                                   
     specified  in great detail  in these  [RSAs].  And  what                                                                   
     we  do in  the  audit section  is basically  review  the                                                                   
     company's  financial  information to  verify  compliance                                                                   
     with  those   [RSAs],  and  also  for  the   purpose  of                                                                   
     negotiating amendments  where it's appropriate  relating                                                                   
     to  the royalty  values on  a going forward  basis.   So                                                                   
     that's the majority  of the production.  With  regard to                                                                   
     production  that is  not under settlement,  our goal  is                                                                   
     to audit  virtually all  of the  production that  is not                                                                   
     under settlement                                                                                                           
                                                                                                                                
5:44:55 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING asked what rate the state pays when dealing with                                                                  
royalty settlement agreements.                                                                                                  
                                                                                                                                
MR. PARNELL replied that under almost all the settlement                                                                        
agreements the interest owed is Bank of America prime rate,                                                                     
compounded daily.  He said:                                                                                                     
                                                                                                                                
     I think  there's a huge  distinction there,  when you've                                                                   
     got  those  settlement agreements  [that]  were  entered                                                                   
     into  following  a  decade   or  more  of  dispute  over                                                                   
     valuation  issues.    So that  interest  rate  in  those                                                                   
     settlement  agreements   is  a  compromise   amount;  it                                                                   
     represents  compromise of those  claims.  We're  talking                                                                   
     today  about, in  most  cases, ...  undisputed  interest                                                                   
     charges.   We're not settling  any claims.  This  is the                                                                   
     rate  that is  being charged.    And additionally  those                                                                   
     ...  [RSAs] which  the earliest  ones,  BPs, ARCOs,  and                                                                   
     Exxons,  were entered  in 90-91, right  around the  same                                                                   
     time   as  the   statute,  the   most  recent   interest                                                                   
     amendments   to   one  of   those   royalty   settlement                                                                   
     agreements   specifies  the   statutory  rate  ...   the                                                                   
     current  rate  of  11  percent.   So  the  most  current                                                                   
     interest  rate   change  to  one  of   those  settlement                                                                   
     agreements reflects existing statute.                                                                                      
                                                                                                                                
5:46:41 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE SAMUELS asked how long the DNR web site has been                                                                 
up.                                                                                                                             
                                                                                                                                
JIM STOUFFER, Accountant IV, Division of Oil and Gas, Department                                                                
of Natural Resources (DNR), replied that the web site was                                                                       
started in about  1998 or 1999, and has been up  and running since                                                              
that time.                                                                                                                      
                                                                                                                                
                                                                                                                                
REPRESENTATIVE  SAMUELS asked if  anyone had  tested the  web site                                                              
for data accuracy.                                                                                                              
                                                                                                                                
MR. PARNELL  reminded the  committee that  the division  posts the                                                              
sales  values from  the companies  when they're  due; however  the                                                              
companies  can refile  and  change  those amounts,  and  therefore                                                              
"looking  at the  web  is  a way  to  minimize or  mitigate  their                                                              
interest exposure."   He noted that  the data won't  be completely                                                              
correct if there has been a refiling.  He continued:                                                                            
                                                                                                                                
     They'll  have the  ability  to see  that  Company X  ...                                                                   
     reportedly  sold their oil  for 40  cents more a  barrel                                                                   
     than I did  in this particular month.  But  if Company X                                                                   
     changes/recalculates/refiles   six  months  later,  then                                                                   
     that's not  going to  get picked up  in that web  check.                                                                   
     They  are simply  going  to be  able  to minimize  their                                                                   
     exposure in most cases.                                                                                                    
                                                                                                                                
5:48:51 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  SAMUELS said  that  he would  assume that  someone                                                              
within  the industry  watches these  numbers  as well.   He  asked                                                              
what percentage of the audits indicate an underpayment.                                                                         
                                                                                                                                
MR.  SCHULTZ  replied, "The  majority  of  audits do  indicate  an                                                              
underpayment, but not all audits."                                                                                              
                                                                                                                                
5:49:37 PM                                                                                                                    
                                                                                                                                
MARK BOND, Legal Counsel, UNOCAL Alaska, stated:                                                                                
                                                                                                                                
     UNOCAL has  been an  oil and gas  producer in the  State                                                                   
     of Alaska  for over 40 years,  and during that  time our                                                                   
     company   has   never   been   accused   of   fraudulent                                                                   
     underpayment  of  royalties.    There  seems  to  be  an                                                                   
     indication   that  the   companies  would   deliberately                                                                   
     underpay  royalties  to  take   some  sort  of  untoward                                                                   
     benefit,  and  I guess  it's  fair  to  say that  I,  on                                                                   
     behalf  of the  company, resent  that  insinuation.   We                                                                   
     attempt to  pay our royalties  on time and to  the value                                                                   
     that  as  best  we can  determine  them.    Our  problem                                                                   
     arises from  the oil and gas lease, which  provides that                                                                   
     royalties are  based on ... no less than  the highest of                                                                   
     several  alternatives, one  of which  is the  prevailing                                                                   
     price  received by  other producers  in  the field  that                                                                   
     the well for  oil or gas of like grade of  gravity.  And                                                                   
     because  of the  usual confidentiality  in  oil and  gas                                                                   
     sales agreements,  and antitrust concerns ...  it is not                                                                   
     possible for  producers to  know what the highest  price                                                                   
     paid in the field or area is.                                                                                              
                                                                                                                                
MR. BOND continued:                                                                                                             
                                                                                                                                
     [The  Department of  Natural  Resources  (DNR)] has  put                                                                   
     the web  site up and I  guess we could digress  into how                                                                   
     frequently  and how  often each  of the  areas has  been                                                                   
     posted  on the website,  but at  best, by the  admission                                                                   
     of  the DNR  folks,  it is  unreliable  in  terms of  an                                                                   
     indicator  of the prices  received.  Furthermore,  there                                                                   
     are  substantial  antitrust  concerns  that  all  of  us                                                                   
     producers  have  in posting  the  prices for  the  other                                                                   
     producers  in  the field.    We're very  concerned  that                                                                   
     federal  law   ...  would  prohibit  us   from  actually                                                                   
     looking  at and using  the data, which  can be  used not                                                                   
     only  for the payment  of royalties,  but obviously  for                                                                   
     correction  -   I  could  go  beat  up   your  marketing                                                                   
     department,  I guess,  and  say, "Well,  these guys  are                                                                   
     getting X; why are we only getting Y?"                                                                                     
                                                                                                                                
     One  of those  who's very  concerned about  that is  Tom                                                                   
     Williams,  who  is  formerly  of  the  state  and  well-                                                                   
     respected,  and who probably  understands royalties  and                                                                   
     taxes  in  the  State  of  Alaska  better  than  anyone,                                                                   
     certainly  better   than  I,  and  now  works   for  [BP                                                                   
     Exploration  (Alaska)  Inc.].   And  Tom  has  expressed                                                                   
     that  concern  repeatedly and  lately  in  conversations                                                                   
     that we've had.                                                                                                            
                                                                                                                                
5:52:41 PM                                                                                                                    
                                                                                                                                
MR. BOND continued:                                                                                                             
                                                                                                                                
     It  requires  us  to  assume  also  that  the  state  is                                                                   
     correct in its  interpretation of the particular  oil or                                                                   
     gas  sales  contract.    And   furthermore,  the  deputy                                                                   
     director  indicates  that  a company  could  correct  by                                                                   
     refiling, which  would require basically  double-filing,                                                                   
     so  substantial  additional   work  for  the  accounting                                                                   
     department of the company involved.                                                                                        
                                                                                                                                
     We generally find  out what the higher of value  is on a                                                                   
     reliable  basis at the  time of the  audit.  The  deputy                                                                   
     director indicated  that the audits were as  much as six                                                                   
     years  passed.   Now  typically  we agree  that  they're                                                                   
     about  three years  later,  and they  tend to  aggregate                                                                   
     two  or three  years, which  requires them  to wait  for                                                                   
     two  or three  or four  years, and  generally the  years                                                                   
     that  are aggregated  are years  three,  four, five,  or                                                                   
     four,  five,  six  down  the   road.    So  there  is  a                                                                   
     substantial lag in the audits.                                                                                             
                                                                                                                                
MR. BOND continued:                                                                                                             
                                                                                                                                
     And at  that time, then, the  producer is faced  with an                                                                   
     amount due  based on the higher  of; once they've  had a                                                                   
     chance typically  then to look  at the other  producers'                                                                   
     sales contracts  under a confidentiality  agreement that                                                                   
     then  requires its use  only for  royalty payments,  not                                                                   
     for  any  marketing  purposes.    Plus  interest  at  11                                                                   
     percent  compounded  quarterly.     We've  talked  about                                                                   
     various rates  of interest;  ... the compound  quarterly                                                                   
     is significant in the equation.                                                                                            
                                                                                                                                
5:54:02 PM                                                                                                                    
                                                                                                                                
MR. BOND continued:                                                                                                             
                                                                                                                                
     The process  ends up  broken in  two respects.   Because                                                                   
     of the  language of  the lease and  because of  the high                                                                   
     rate  of interest, there  is actually  an incentive  for                                                                   
     audits to be  conducted in an untimely manner.   There's                                                                   
     certainly no  concern on the  part of the state  that it                                                                   
     conduct  audits in a  timely manner  because ...  if any                                                                   
     of us  could get  11.5 percent  compounded quarterly  in                                                                   
     any investment, we would be very rich people.                                                                              
                                                                                                                                
     Which brings  me to the  second point....   The interest                                                                   
     rate is far  beyond the compensation for  the time-value                                                                   
     of  money.     Now   it's  apparent   to  me  from   the                                                                   
     department's  testimony that  it considers the  interest                                                                   
     rate  on delinquent  royalties to be  a separate  profit                                                                   
     center rather  than imposing  interest at a  market rate                                                                   
     to compensate for the time-value of the money lost.                                                                        
                                                                                                                                
     I  share   the  deputy  director's  concern   about  the                                                                   
     duality of  the payments.   I have this comment  though:                                                                   
     it's   so  rare  for   a  producer   to  have  made   an                                                                   
     overpayment   that   the    duality   basically   is   a                                                                   
     nonargument.   However,  it can easily  be corrected  by                                                                   
     amending  subsection (e)  of the  statute to  make it  a                                                                   
     dual system,  and UNOCAL  would not  be opposed to  that                                                                   
     kind of an amendment.                                                                                                      
                                                                                                                                
     The  bottom  line here  is  that  the producers  face  a                                                                   
     punitive  rate of interest  for underpayments that  they                                                                   
     made in good  faith due to unknowable variables,  and we                                                                   
     have to  wait for  DNR to undertake  its audits,  and at                                                                   
     that  point, then  we get  reliable  information on  the                                                                   
     various  sales contracts  that they're  applying to  us.                                                                   
     And  then we  find  out the  value  upon  which we  were                                                                   
     supposed to pay.                                                                                                           
                                                                                                                                
5:55:41 PM                                                                                                                    
                                                                                                                                
MR. BOND continued:                                                                                                             
                                                                                                                                
     Other  comparisons  can  be made.    In  a memo  that  I                                                                   
     prepared,  I  compared  it   to  the  rate  of  interest                                                                   
     established  for judgments  between two litigants  where                                                                   
     the   state  has  to   impose  an   interest  rate   for                                                                   
     prejudgment and  postjudgment interests in  AS 09.30.070                                                                   
     - that's  substantially less  than [what] we're  looking                                                                   
     at here.   The  minerals management  service [MMS]  rate                                                                   
     for  royalties that  are due  from federal  oil and  gas                                                                   
     leases is  significantly lower than the  state collects.                                                                   
     It's established  under statute  by 30 USC 17.21,  which                                                                   
     basically makes  reference to the internal  revenue code                                                                   
     for Section  6621, which establishes a rate  of interest                                                                   
     at  the  federal  short-term  rate,  which  is  for  all                                                                   
     intents  and purposes  equivalent to  the discount  rate                                                                   
     plus 3  percent; that's  the rate that  the MMS  does on                                                                   
     its royalty leases.                                                                                                        
                                                                                                                                
     We'd like  to be in  a position where  we could  pay our                                                                   
     royalties  on time  and in  the correct  amount.   Given                                                                   
     the   language  of   the  lease   and  the   unknowables                                                                   
     associated with  that language, it is  virtually assured                                                                   
     that in the  absence of a royalty settlement  agreement,                                                                   
     a  company  will  not  be  able  to  correctly  pay  its                                                                   
     royalties  on  a timely  basis.   That  puts  us in  the                                                                   
     unenviable  position  of  allowing  the  state  then  to                                                                   
     decide  when and  where to  audit, to  aggregate two  or                                                                   
     three  years,  generally four  or  five years  down  the                                                                   
     road,  and   then  impose  the  11.5  percent   rate  of                                                                   
     interest.                                                                                                                  
                                                                                                                                
5:57:07 PM                                                                                                                    
DON PAGE, Manager of Accounting and Finance, UNOCAL Alaska,                                                                     
stated:                                                                                                                         
                                                                                                                                
     The  one thing  I must  stress in  here is  that the  11                                                                   
     percent  is  compounded  quarterly,  and  what  we  have                                                                   
     found  in previous  audits  is [that]  you  can have  an                                                                   
     audit,  either  in  the Department  of  Revenue  or  the                                                                   
     Department  of Natural Resources,  for either  severance                                                                   
     taxes or  royalties where,  by the time we're  receiving                                                                   
     the  audit   and  attempting  to  negotiate   the  final                                                                   
     settlement of  the audit, is  the interest is  more than                                                                   
     the principal.   And once  again, I believe  anybody who                                                                   
     has a retirement  account, a stock account  out there or                                                                   
     whatever, any  type of investment  out there,  will love                                                                   
     to have that  type of rate of return, where  your dollar                                                                   
     is  basically  doubling in  five,  six, or  seven  years                                                                   
     down the road. ...                                                                                                         
                                                                                                                                
     The royalty  payer should  not have  to pay for  another                                                                   
     agency  to play catch-up.  ... UNOCAL  has operated  for                                                                   
     over  40 years up  in Alaska,  and at  no point have  me                                                                   
     ever   fraudulently  tried   to   underpay  either   the                                                                   
     severance  tax,  income  tax, or  royalty,  all  through                                                                   
     those years....                                                                                                            
                                                                                                                                
5:58:36 PM                                                                                                                    
                                                                                                                                
MR. PAGE continued:                                                                                                             
                                                                                                                                
     One of  the issues that was  brought up by  the chairman                                                                   
     was  the issue  over  having the  audits  being done  in                                                                   
     multiple  years  at  one time.  ...  The  Department  of                                                                   
     Revenue, when  they do a  severance tax audit,  ... they                                                                   
     audit  one year  at a  time,  and we're  usually one  in                                                                   
     lag.   So we  don't have  the interest  rate issue  with                                                                   
     the Department of Revenue....                                                                                              
                                                                                                                                
     Because  they're  auditing  the multiple  years  at  one                                                                   
     time and  the compounded 11  percent, we shouldn't  have                                                                   
     to  pay for that.  ... The  other thing  that should  be                                                                   
     stressed is  this is primarily  a Cook Inlet  issue, and                                                                   
     as  you know,  most of these  Cook Inlet  assets are  at                                                                   
     the end of  their life; they're very mature.  ... It's a                                                                   
     closed-in  market; we're  all selling  our crude oil  to                                                                   
     one  person, and  it's Tesoro,  and we  should not  know                                                                   
     the  prices of  any of  the other  producers out  there.                                                                   
     But   not   only   that,  because   these   assets   are                                                                   
     economically   challenged   as  it   is,   to  have   an                                                                   
     accounting   department  have   to  go   out  and   file                                                                   
     royalties one  month and then, on the top  of that, have                                                                   
     to go  check the  following month  and refile  royalties                                                                   
     again  and again  and  again;   to  try  to chase  those                                                                   
     numbers,  the only  thing we're  going to  do is add  on                                                                   
     additional   administration   burden  on   top  of   the                                                                   
     producers.                                                                                                                 
                                                                                                                                
6:00:53 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  SAMUELS   commented  that  he  would   expect  the                                                              
companies to keep an eye on each other's prices.                                                                                
                                                                                                                                
MR. PAGE  replied, "We take  very seriously our  obligations under                                                              
federal antitrust  law, and we assiduously avoid  any knowledge of                                                              
any other  producers' prices for that  reason. ... We do  not know                                                              
and we  do not  want to  know, frankly,  what other companies  are                                                              
getting in price. "                                                                                                             
                                                                                                                                
MR. BOND noted that  they do not have access  to the competitions'                                                              
contracts, and do not want to have such access.                                                                                 
                                                                                                                                
6:02:15 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING  commented that he  still thinks that 11  percent is                                                              
a punitive rate of interest.  He noted:                                                                                         
                                                                                                                                
     I  also have  concerns  about the  state's  relationship                                                                   
     with the  industry, too.  I  know some of  the testimony                                                                   
     here  has suggested  that frustration  by  folks in  the                                                                   
     industry  who  feel  like the  state  is  implying  that                                                                   
     maybe  you  guys  aren't  being   honest,  and  so  that                                                                   
     concerns me.   ... I'd have to go back to  Mr. Parnell's                                                                   
     testimony as  being very honest,  and I don't  think ...                                                                   
     his intent  was at all  to communicate  that to you.   I                                                                   
     just  worry that  perhaps  [that], given  the  testimony                                                                   
     we've  heard,  the road  that  we're going  down,  we're                                                                   
     developing  a  further negative  relationship  with  the                                                                   
     industry in this state.                                                                                                    
                                                                                                                                
6:03:54 PM                                                                                                                    
                                                                                                                                
MARILYN   CROCKETT,   Deputy   Director,   Alaska  Oil   and   Gas                                                              
Association (AOGA),  explained that  AOGA is a private,  nonprofit                                                              
trade  association with  18 member  companies  that represent  the                                                              
majority  of oil  and  gas exploration,  development,  production,                                                              
transportation,  refining,  and  marketing activities  in  Alaska.                                                              
She stated:                                                                                                                     
                                                                                                                                
     We support purpose  and intent of this  legislation, and                                                                   
     particularly  the  change   to  the  statutory  rate  of                                                                   
     interest  under AS  38.05.135(d)  that  are proposed  in                                                                   
     [paragraph  2] of  the bill.    Currently the  statutory                                                                   
     rate  is  five  percentage   points  above  the  Federal                                                                   
     Reserve  discount  rate, or  11  percent APR,  as  we've                                                                   
     heard   today,  whichever   is  higher.     And  it   is                                                                   
     compounded  quarterly.   This  legislation,  of  course,                                                                   
     would set  the rate at  two percentage points  above the                                                                   
     federal reserve  discount rate,  and it would  eliminate                                                                   
     that 11  percent floor, would  use simple interest,  and                                                                   
     would  eliminate  the  quarterly   compounding.    These                                                                   
     changes  would make  the law  much  more reasonable  and                                                                   
     fair.   Frankly, when prime  rates ... are  running well                                                                   
     below 6  percent, as  they are today  and have  been for                                                                   
     several years,  a statutory rate of 11 percent  goes far                                                                   
     beyond  the line  between proper  compensatory  interest                                                                   
     and   interest    that   constitutes   punishment    for                                                                   
     underpaying.   And as we  heard Deputy Director  Parnell                                                                   
     indicate  today  that the  interest  is intended  to  be                                                                   
     loss-use of money and not a penalty for underpayment.                                                                      
                                                                                                                                
6:05:50 PM                                                                                                                    
                                                                                                                                
MS. CROCKETT continued:                                                                                                         
                                                                                                                                
     [Alaska Oil  and Gas  Association (AOGA)] believes  that                                                                   
     abusive underpayments,  ... if  they are a problem,  and                                                                   
     we  wonder  if  they  are,  there  are  better  ways  of                                                                   
     dealing with  this than having punitive  interest rates.                                                                   
     But from our  experience, the great majority  of royalty                                                                   
     underpayments  are  not abusive.   Under  paragraph  16,                                                                   
     the  producer owes royalty  on the  highest of  [either]                                                                   
     the price that  it gets from its oil - the  posted price                                                                   
     for oil from  the same field, or the highest  price that                                                                   
     any other  producer can  get from  oil from that  field.                                                                   
     And for  competitive and  antitrust reasons,  individual                                                                   
     companies  cannot  find out  and  should not  find  out,                                                                   
     frankly,  what  other  producers are  paying  for  their                                                                   
     oil.   They only  find out about  those other prices  if                                                                   
     DNR makes  a claim as  a result of  an audit that  there                                                                   
     is  a  higher   price  that's  being  paid.     In  this                                                                   
     situation, it  would be inappropriate to  apply punitive                                                                   
     rate of interest for that sort of underpayment.                                                                            
                                                                                                                                
     In summary,  HB 234 would change the  statutory interest                                                                   
     back into a  compensatory mechanism instead  of being an                                                                   
     instrument  of punishment,  and we  welcome this  change                                                                   
     in philosophy about the purpose of statutory interest.                                                                     
                                                                                                                                
6:06:53 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE GARDNER  asked, "The whole concept  of whether it's                                                              
proper and  appropriate or  even legal for  companies to  know the                                                              
prices that  other companies  are getting: how  long has  this ...                                                              
[statute]  been  in effect,  and  has it  not  been  an issue  all                                                              
along?"                                                                                                                         
                                                                                                                                
MS. CROCKETT  remarked that she  wasn't sure she was  qualified to                                                              
answer that question.                                                                                                           
                                                                                                                                
6:07:39 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING asked  Mr. Parnell if he knew when  the statute that                                                              
allows  for  the current  11  percent  interest  rate was  put  in                                                              
place.                                                                                                                          
                                                                                                                                
MR. PARNELL replied, "In 1991."                                                                                                 
                                                                                                                                
6:07:53 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  GARDNER  asked,  "If it's  been  in place  for  13                                                              
years, and  the issue  of whether  it's appropriate for  companies                                                              
to know  other companies'  prices -  has that  not been  a problem                                                              
during the 13 years?"                                                                                                           
                                                                                                                                
MS. CROCKETT responded,  "Perhaps one of the  other testifiers can                                                              
tell you  that."  She  added, "I know  that the interest  rate has                                                              
been in place for  11 years but I'm not sure  how long the process                                                              
that you're speaking to has actually been on the books."                                                                        
                                                                                                                                
6:08:22 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  SAMUELS, "Could  the  companies set  up a  Chinese                                                              
wall  where  the  auditor,  the  person  who's  making  the  audit                                                              
payment, could  look at the web  site, make the  payment correctly                                                              
with a bit of isolation? ... It seems that the information's on                                                                 
there [and] it shouldn't be [difficult]."                                                                                       
                                                                                                                                
MS. CROCKETT responded:                                                                                                         
                                                                                                                                
     I  think   you've  heard   concern  from  the   previous                                                                   
     testifier   about   the   fact,    frankly,   that   the                                                                   
     information's on  the web site in the first  place.  The                                                                   
     oil and  gas industry in  particular and AOGA's  members                                                                   
     are  extremely sensitive  ... about  any potential  that                                                                   
     they  could  be accused  of  any antitrust  ...  issues.                                                                   
     One  only  has to  think  about  the scrutiny  that  the                                                                   
     industry  comes over for  gasoline prices, for  example,                                                                   
     to sort of  lay the framework and the groundwork  on ...                                                                   
     what lengths  [a company]  will go  to to avoid  knowing                                                                   
     information  that the  antitrust  laws  really say  that                                                                   
     they can't  know.  Or  putting themselves in  a position                                                                   
     of  being  accused  of  knowing  information  that  they                                                                   
     really should not have access to.                                                                                          
                                                                                                                                
6:09:40 PM                                                                                                                    
                                                                                                                                
MICHAEL HURLEY, Director of State Government Relations,                                                                         
ConocoPhillips Alaska, Inc., stated:                                                                                            
                                                                                                                                
     [ConocoPhillips  Alaska, Inc.]  supports  the change  in                                                                   
     the statutory  interest rate for over  and underpayments                                                                   
     of royalties  to something  much more reflective  of the                                                                   
     actual time-value  of money.   The current statute  with                                                                   
     its arbitrary  high fixed rate acts more like  a penalty                                                                   
     than  a  reimbursement  for  the  opportunity  costs  of                                                                   
     funds.      Let   me   first   point   out   that   from                                                                   
     ConocoPhillips'  perspective,  this hasn't  historically                                                                   
     been a  big issue  for us....   The royalty  settlements                                                                   
     cover most  of the North  Slope leases, so  the interest                                                                   
     rates  applicable   to  most   of  our  production   are                                                                   
     governed by  those RSAs, and  they are running  at prime                                                                   
     based on the  Bank of America out of San Francisco.   So                                                                   
     it hasn't been a big deal for us.                                                                                          
                                                                                                                                
     However, as  a matter of public policy, we  believe that                                                                   
     interests should  reflect the costs of funds  and not be                                                                   
     some kind of  weapon to be used to try and  force people                                                                   
     to  pay more  than  they think  they  owed  just out  of                                                                   
     fear.   Additionally,  the  current  system often  makes                                                                   
     resolution  of substantive  issues difficult because  of                                                                   
     the  magnitude  of the  dollars  that  end up  being  at                                                                   
     stake just because  of the interest.  As  you heard some                                                                   
     of  the other  testifiers  say,  interest adds  up  very                                                                   
     rapidly  at 11  percent compounded  quarterly.   If  you                                                                   
     just  do  the  arithmetic,  interest can  amount  to  50                                                                   
     percent  of the  value of  an underlying  issue in  just                                                                   
     four  years.    So even  as  good  as  the  department's                                                                   
     getting  at  cutting down  their  audit times,  you  can                                                                   
     quickly  end up  with  50 percent  of  the  value of  an                                                                   
     issue  being interest.   If  you carry that  out to  six                                                                   
     years, you  end up doubling  the cost of whatever  it is                                                                   
     that's at  issue, [because of the quarterly  compounding                                                                   
     and the high rate].                                                                                                        
                                                                                                                                
6:12:10 PM                                                                                                                    
                                                                                                                                
MR. HURLEY continued:                                                                                                           
                                                                                                                                
     We believe that  rather than acting as an  incentive for                                                                   
     producers to  pay their royalties  in a timely  fashion,                                                                   
     it's  actually become  a disincentive  for the state  to                                                                   
     work  out these  substantive  issues.   Recapturing  the                                                                   
     time-value  of money  is an  appropriate  thing for  the                                                                   
     state to  do, and that's fine.   But having a  rate that                                                                   
     appears to be  a more onerous penalty seems  out of step                                                                   
     with a culture of encouraging resource development.                                                                        
                                                                                                                                
     One thing  we would  want to  suggest to the  committee:                                                                   
     if you  consider this  to be  an appropriate policy,  if                                                                   
     you want to  change the interest rate, we  would suggest                                                                   
     that you consider  changing it on the tax  side as well.                                                                   
     Right  now the  royalty interest  and  the tax  interest                                                                   
     are  set the  same: they're  both using  the 11  percent                                                                   
     compounded  quarterly.  However  you decide as  a policy                                                                   
     matter  to change  those or  not, you  should keep  them                                                                   
     consistent.   And  if  you agree  that  making a  change                                                                   
     makes sense, you can look for those in AS 43.05.225.                                                                       
                                                                                                                                
6:13:32 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING asked, "Since ConocoPhillips does business pretty                                                                 
much throughout the world, other states, and so forth, how does                                                                 
Alaska's system here compare ... with other states?"                                                                            
                                                                                                                                
MR. HURLEY replied:                                                                                                             
                                                                                                                                
     A lot  of the different states  do different things  - I                                                                   
     haven't  gone and  researched  them extensively.   I  do                                                                   
     know  that  a couple  of  them are  higher.    I know  a                                                                   
     couple of  them are  lower.  You  heard the MMS  example                                                                   
     that was  given by  the UNOCAL folks  who testified.   I                                                                   
     know  that   the  IRSs  actual   rate  of  interest   is                                                                   
     somewhere around prime.                                                                                                    
                                                                                                                                
6:15:46 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE SAMUELS asked, "If there is an overpayment by the                                                                
industry, does the compounding take effect?  The 11 percent                                                                     
compounding quarterly?"                                                                                                         
                                                                                                                                
MR. PARNELL stated that he believes this is the case.                                                                           
                                                                                                                                
6:16:33 PM                                                                                                                    
                                                                                                                                
MYRL THOMPSON said that he is from the Matanuska-Susitna area                                                                   
and he stated:                                                                                                                  
                                                                                                                                
     This is  almost shameful  legislation, if you'll  pardon                                                                   
     me.   And  let  me explain  it  to you  this  way: as  a                                                                   
     citizen, if  I underpay my taxes, the government  can go                                                                   
     seven  years and  make  me pay  a fairly  high  interest                                                                   
     rate and penalties  on top of that.  And  that's just me                                                                   
     as an  individual, and  I'm not  rolling in billions  of                                                                   
     dollars  of   profit  myself.    And  I'm   not  against                                                                   
     development,  and I'm  not against  even incentives  for                                                                   
     the oil  industry, and  ... we've  given them plenty  of                                                                   
     those....                                                                                                                  
                                                                                                                                
     [Under  this bill  the  interest is]  the  same for  the                                                                   
     state  as it  is  for the  industry.   If  the  industry                                                                   
     wants  to escape having  to pay  this interest, ...  low                                                                   
     or  high, all  they  have to  do  is hit  their  numbers                                                                   
     right,  not undercut it.   And  the testimony has  shown                                                                   
     that  it's not  over,  it's under,  and  it's under  the                                                                   
     majority  of  the time.    And personally,  maybe  there                                                                   
     should be  a penalty on  it; I know  I pay a  penalty if                                                                   
     my taxes aren't paid and I'm audited.                                                                                      
                                                                                                                                
     So ...  let's just be fair  to the state.   The industry                                                                   
     is  not hurting;  they're making  billions and  billions                                                                   
     and  billions of dollars  of profit,  in fact,  billions                                                                   
     more  than the  state's getting  on the  very same  oil,                                                                   
     which   is   our  oil.      And   you  folks   are   our                                                                   
     representatives.   I mean, we have to rely on  you to do                                                                   
     the right thing  for us, and all I'm asking  is that you                                                                   
     be  fair to  us.   And  shorting  the state  because  of                                                                   
     their  inability to  hit their  numbers is  not fair  to                                                                   
     us.   And it's a simple  matter of just  [dropping] this                                                                   
     bill  and let  them do  the  right thing  and hit  their                                                                   
     numbers.    They're  not losing  money;  they're  making                                                                   
     billions, it's as simple as that.                                                                                          
                                                                                                                                
                                                                                                                                
6:19:07 PM                                                                                                                    
                                                                                                                                
CHAIR KOHRING, after ascertaining that there were no more                                                                       
witnesses, closed public testimony.  He stated that the bill                                                                    
would be held over.                                                                                                             
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
There being no further business before the committee, the House                                                                 
Special Committee on Oil and Gas meeting was adjourned at                                                                       
6:20:14 PM.                                                                                                                   
                                                                                                                                

Document Name Date/Time Subjects