02/20/2003 04:29 PM House O&G
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ALASKA STATE LEGISLATURE
HOUSE SPECIAL COMMITTEE ON OIL AND GAS
February 20, 2003
4:29 p.m.
MEMBERS PRESENT
Representative Vic Kohring, Chair
Representative Hugh Fate
Representative Lesil McGuire
Representative Norman Rokeberg
MEMBERS ABSENT
Representative Mike Chenault, Vice Chair
Representative Harry Crawford
Representative Beth Kerttula
COMMITTEE CALENDAR
OVERVIEW BY ALASKA OIL & GAS ASSOCIATION (AOGA), PART 2
- HEARD [See 3:25 p.m. minutes for this date]
SPONSOR SUBSTITUTE FOR HOUSE BILL NO. 28
"An Act relating to adjustments to royalty reserved to the state
to encourage otherwise uneconomic production of oil and gas; and
providing for an effective date."
- HEARD AND HELD
PREVIOUS ACTION
BILL: HB 28
SHORT TITLE:OIL & GAS ROYALTY MODIFICATION
SPONSOR(S): REPRESENTATIVE(S)KOHRING, ROKEBERG
Jrn-Date Jrn-Page Action
01/21/03 0039 (H) PREFILE RELEASED (1/10/03)
01/21/03 0039 (H) READ THE FIRST TIME -
REFERRALS
01/21/03 0039 (H) O&G, RES, FIN
02/19/03 0246 (H) SPONSOR SUBSTITUTE INTRODUCED
02/19/03 0246 (H) READ THE FIRST TIME -
REFERRALS
02/19/03 0246 (H) O&G, RES, FIN
02/19/03 0246 (H) REFERRED TO OIL & GAS
02/20/03 (H) O&G AT 3:15 PM CAPITOL 124
WITNESS REGISTER
BONNIE ROBSON, Deputy Director
Division of Oil & Gas
Department of Natural Resources (DNR)
Anchorage, Alaska
POSITION STATEMENT: During hearing on SSHB 28, conveyed overall
support with three possible amendments: delete the language
extending this to portions of pools, use the original language
with regard to obtaining data necessary to evaluate the
application, and allow DNR to choose the independent contractor
to evaluate the application.
ACTION NARRATIVE
TAPE 03-8, SIDE A
Number 0001
CHAIR VIC KOHRING called the House Special Committee on Oil and
Gas meeting back to order at 4:29 p.m. Representatives Kohring,
Rokeberg, Fate, and McGuire were present at the call back to
order. [For the Overview by the Alaska Oil and Gas Association
(AOGA), Part 2, see the 3:25 p.m. minutes for this date.]
HB 28-OIL & GAS ROYALTY MODIFICATION
Number 0020
CHAIR KOHRING announced that the committee would hear SPONSOR
SUBSTITUTE FOR HOUSE BILL NO. 28, "An Act relating to
adjustments to royalty reserved to the state to encourage
otherwise uneconomic production of oil and gas; and providing
for an effective date."
CHAIR KOHRING, joint sponsor along with Representative Rokeberg
of SSHB 28, informed members of the intention to explain the
bill but not move it from committee that day. Describing the
bill as "royalty adjustment legislation," he said the intent is
to modify a 1995 law that reduced royalties on marginal fields
in order to spur development of uneconomical fields. There are
several fairly sizable changes.
CHAIR KOHRING explained that SSHB 28 would give discretion to
the commissioner of the Department of Natural Resources (DNR) to
make decisions with regard to royalty reductions on marginal
fields, in order to expedite the process; now, by contrast, [a
proposed modification] goes to the commissioner and then to the
governor for final consideration. The bill also clarifies and
simplifies procedures relating to royalty reduction; he offered
to provide details later.
CHAIR KOHRING indicated that under consideration is removal of a
sunset deadline of July 1, 2015, for companies that would be
able to approach the department to be granted [a modification].
[Subsection (j)(1)(A), beginning on page 1, line 1, removes that
deadline.]
CHAIR KOHRING also pointed out that whereas statute now refers
to marginal oil fields, [the bill's sponsors] also are looking
at having it apply to portions of oil fields [which is in
SSHB 28]. Chair Kohring expressed the desire to be a little
more specific with this legislation, and to have the industry
work with the bill's sponsors to identify specific portions
within the oil fields.
Number 0262
CHAIR KOHRING explained that the bill is intended to jumpstart
activity by allowing companies to come to DNR and present
findings that they have uneconomical fields, which won't be
developed without some royalty reduction. It doesn't change the
public hearing process, which had been a concern with previous
legislation. He called attention to DNR's fiscal note [which
says that adding the language "portion of field or pool" could
result in a negative fiscal impact to the state.] He also
likened this to the debate involving Agrium a couple of weeks
ago [on HB 57], since the desire is to give a break to an
industry with the intent of allowing it to grow and develop.
Number 0392
CHAIR KOHRING highlighted the big question for the committee:
where to draw the line on how much [the state treasury] is
giving up through royalty reduction in exchange for further
development of the industry that will help generate jobs and get
more dollars flowing in the economy. He concluded by saying
this looks at accomplishing the same goal as HB 69, the
"permitting streamlining bill" [sponsored by him]: to encourage
more drilling activity in the industry, although with SSHB 28 it
is for oil, not gas. He invited Bonnie Robson to comment.
Number 0462
BONNIE ROBSON, Deputy Director, Division of Oil & Gas,
Department of Natural Resources, noted that Mark Myers, director
of the division, wasn't available that day and thus she would
speak instead. Addressing why the ability to reduce royalties
is a valuable tool, she told members:
Quite simply put, royalty reduction can make economic
oil and gas production that would otherwise not be
economic. It can extend field life for a field in its
sunset years, and it can bring into production a field
that would otherwise be on hold pending better
economics or better technology.
I'd like to work with an example today of royalty
reduction and how it can bring these benefits. First
of all, I think we need to assume an oil price of
$16.00. And we choose that because companies often
run their economics and make their decisions on
whether to continue production from a field - or to
develop a new field - based on an assumed oil price,
rather than the actual or current or average annual
price of oil. And $16.00 ... is in the range they
frequently use.
But royalties are not paid to the state based on
$16.00, and so the royalty reduction is not on $16.00
per se, but it's on the netback value of the oil. And
if you work with a $16.00 oil price, you would
typically have for, say, Prudhoe Bay oil, on the order
of $6.00 in reductions: about a dollar for either the
cost of NGL [natural gas liquid] manufacturing or
field costs, where allowable; another $1.50 for marine
transportation; and about $3.50 for TAPS [Trans-Alaska
Pipeline System] tariff or pipeline transportation.
These deductions total $6.00, and so royalties are
paid not on the basis of $16.00, but $10.00. And
while royalties can be at 12-1/2 percent, 16-2/3
percent, or 20 percent, they most frequently are at
12-1/2 percent of the netback value, so that on a
$10.00 netback, royalties would be paid at $1.25 per
barrel.
Number 0668
MS. ROBSON continued:
And under the existing law, royalties can be reduced
from the 12-1/2 percent to 5 percent if an application
for royalty reduction is approved, meaning that the
royalty take or the state's take could be reduced from
the $1.25 in our hypothetical situation to $.50 per
barrel. This would improve a company's economics by
$.75 per barrel. And that $.75 per barrel matters:
it effectively raises the assumed price of the oil
from $16.00 to $16.75, and helps make the project more
economic when compared to the other alternatives
available to oil and gas companies.
While this difference that the state can make - on the
order of $.75 per barrel in our hypothetical - is
dwarfed by price volatility, companies nonetheless
make their investment decisions based on their assumed
price of oil, and not on actual prices of oil. So if
the goal of the state is to, in fact, change the
behavior of companies and to cause investment that
would not otherwise occur, and they're going to work
off an assumed price of $16.00 per barrel, the $.75
royalty reduction may induce investment or prolong
field life even where $30.00 oil prices do not.
Number 0804
MS. ROBSON, addressing SSHB 28 specifically, continued:
The changes proposed by the sponsors to HB 28 do a
number of things that ... have already been well
described by the chairman. It's made the statute
plain English; it simplifies language in a number of
instances, even where the substance is not changed.
But it does change the substance in a number of
regards. To a certain extent, it certainly reduces
the paperwork that goes with an application for
royalty reduction. It also reduces the paper flow,
and it eliminates the requirement of ... personal,
[nondelegable] involvement ... by the governor.
But we think that some may view the most important
aspect of the proposed change to the legislation [as]
what it does to the current subsection (j)(3)(C)(i)
[of AS 38.05.180]. And while there's some argument
about how that subsection would be interpreted,
basically it requires that the state, when it receives
an application for royalty reduction, evaluate that
application in light of projected future oil prices.
And while it allows for a royalty reduction at lower
oil prices, it requires an increase in the royalty
rate at higher oil prices - that is, it makes it
mandatory.
Number 0924
MS. ROBSON continued:
So if we go back to our assumed hypothetical that we
were talking about, if at ... an assumed price of
$16.00 a company makes a showing that a project is not
quite economic - and that, in fact, ... royalty relief
on the order of $.75 per barrel would make that
project economic - the state can drop the royalty rate
down to, say, 5 percent, and accord the $.75 of
relief. ... [Mandated] in return is that when oil
prices are higher - say, above $17.00 per barrel -
that the royalty rate not only would be at ... the
contract rate of ... 12-1/2 percent, but be higher
than that rate, so that the state, if future prices
are as projected at the time of analysis, actually
recovers more than would otherwise be the case, absent
the application for royalty modification.
To restate that, basically it says to somebody coming
in the door and looking for royalty relief that ... if
price projections are accurate, your royalty burden is
actually going to increase. And one of ... the
aspects of the proposed amendment is that while it
still allows for a sliding-scale royalty - that is,
lower royalty rates at low oil prices and higher
royalty rates at high oil prices - it does not mandate
that the state, in its assessment, conclude that it
will be better off per barrel in terms of the royalty
take.
And it also allows the commissioner to exercise ...
discretion in terms of what the state receives in
return for any reduction in royalty rates. It may
still want to take some of the upside, but it may
feel, ... instead or in addition, that some work
commitment, some obligation to drill additional wells
or add additional gas-handling capacity within a
limited period of time, [is] reasonable in exchange
for providing the low-price protection, the royalty
relief at the lower prices.
MS. ROBSON noted that the bill also removes the sunset date and
express language allowing the disclosure of confidential
information to the legislature.
Number 1109
MS. ROBSON pointed out that one aspect may be troubling to some
parties: extension of royalty relief - currently available on a
field or pool - to portions of fields or pools. Fields and
pools aren't the same. A pool is an individual reservoir like
the main reservoir at Prudhoe Bay - Sadlerochit - or one of many
other reservoirs there like the Lisburne, the Point McIntyre,
the Niakuk, the West Beach, and so forth. Each is its own pool;
typically, they aren't in "hydrocarbon communication" with each
other, are at different depths, and may have different oil
characteristics. In contrast, a field is a larger
conglomeration. For example, all the pools or reservoirs at the
Prudhoe Bay Unit may be considered a single field; the same
concept is true at the Kuparuk River Unit. Ms. Robson told
members:
We think that the current statute allows royalty
reduction for a field or pool. And if you consider a
pool a portion of a field, then the current statute
also allows royalty reduction for a portion of a
field. What it does not go on to do is allow royalty
reduction for a portion of ... a pool. And there are
some troubling aspects to allowing royalty reduction
for a portion of a pool.
MS. ROBSON suggested thinking of a pool as a sponge or mud
puddle, and then allocating water - from the sponge when it is
squeezed, or the mud puddle when it is drained - to portions of
the pool, either the perimeter or the center. She also
mentioned the cost of draining the puddle or sponge, and asked
members to imagine allocating the cost to either the perimeter
or the center. It creates many complications in processing an
application for royalty reduction, she pointed out, which
includes the allocation of costs and production.
Number 1306
MS. ROBSON continued, providing an example:
Right now at Prudhoe Bay there are over one hundred
leases in the unit, and every lease, save one, bears a
royalty rate of 12-1/2 percent. And so when it comes
to the administration of leases for royalty purposes,
at present we don't need to know whether oil comes
from the center of any individual reservoir ... or
whether it comes from the perimeter; the royalty rate
is, and remains, 12-1/2 percent, and any royalty
relief accorded for an entire pool or reservoir would
extend to that pool or reservoir.
If there is an extension of royalty relief to portions
of pools, then the division has to get in the business
of allocating hydrocarbon production to portions of
pools. It also has to get into the business of
allocating the cost of the production from those pools
to the various parts of the pool.
Number 1377
MS. ROBSON explained another complication: every pool or
reservoir in Alaska - currently, to her recollection, there are
some 55 or 56 participating areas or pools - would become
eligible for royalty relief at some stage; there always would be
the last barrel, or last thousand or hundred thousand barrels,
that one could claim as marginal. She suggested it would put
the division in the business of having to entertain royalty-
reduction applications for every single pool and reservoir in
Alaska at some point in time. She told members:
Since leases and royalties are governed by a
competitive bidding process, if we are, in fact, going
to extend benefits to every pool and every reservoir
in the state at some point in time, we may not want to
do it through the process of applications for royalty
reduction that must be adjudicated one by one, but by
some more wholesale change in the laws of Alaska.
That addition of portions of pools, then, is a matter
of some concern to the division.
Number 1452
MS. ROBSON addressed three other areas in the proposed
legislation that may be problematic or may just "be a matter of
excessive worrying." First, the current statute provides for an
independent contractor to be retained by the state for purposes
of evaluating any application for royalty reduction, and that
independent contractor is to be paid for by the application.
She explained:
We think the initial intent behind that particular
provision was not only to assure that the state had
the necessary expertise ... to evaluate an
application, but also to see that the applicant paid
the cost of processing the application. It's ...
unclear from the proposed amendment whether or not the
state or the applicant would be the one entitled to
pick the independent contractor under the proposed
changes to the legislation. There is some concern
that if the applicant is allowed to pick the
contractor, and anyone who is able to do the math can
be on the list of eligible contractors, that we put
the applicant in the position of being able to -
through the process of selecting the contractor -
essentially guarantee the results it is looking for on
the application.
We don't think that's the sponsor's intent. But,
certainly, the language allows that possible
interpretation, and there is some argument for staying
with ... the existing statutory language that does
allow the state to choose an independent contractor,
paid for by the applicant, for purposes of evaluating
the application for royalty reduction. Again, that
may be excessive worrying on the part of the division,
but it is a matter that you may want to discuss
further.
Number 1591
MS. ROBSON discussed a second area of possible concern, in terms
of implementation. The existing language allows the department
to collect information it deems necessary to make a
determination on an application for royalty reduction. However,
the proposed bill says only information "reasonably available to
the applicant" is to be considered by the department in
evaluating the application. She explained:
Unfortunately, it's possible that on any given
application there may be some information that the
department considers necessary but an applicant says
is not reasonably available to the applicant. So
there is an invitation to a dispute over what is and
is not reasonably available to the applicant.
Also, the department can be in a difficult situation
because if it does not have the information it feels
is necessary to process an application, ... it's
unclear whether the application should then be
granted, despite the department's inability to
conclude the application is in its best interest, or
whether the application gets denied because the
department cannot conclude whether the application is
in the state's best interest. And, unfortunately,
that could result in a denial of an otherwise
meritorious application, and we don't think that's the
intent of the sponsors. We think the existing
language in the statute may work. But, again, we may
be "worrying" this issue a little too much.
Number 1693
MS. ROBSON addressed the third possible concern. Offering the
belief that the bill has done a very good job of simplifying and
cleaning up the language, she noted that it has removed express
language that talks about the department's ability to "condition
royalty relief and to require that assignments of royalty relief
be approved by the department." She explained:
We think that, even with the language as it is, the
department would retain those rights. The department
has historically interpreted its right to either grant
or deny an application as the right to grant that
application with conditions, rather than deny it. And
we would assume that the department would continue to
have those rights even under the modified or amended
language. If that is not the intent of the
legislature, then ... you might want to ... clarify
that for us. But that was a question that we had, at
least with regard to the proposed language.
Number 1753
MS. ROBSON concluded by saying the division supports SSHB 28
with [three] possible amendments: 1) delete the reference to
portions of pools; 2) if thought necessary, provide "some return
to the original language on DNR's ability to obtain data
necessary to evaluate the application"; and 3) have DNR retain
its current ability to choose an independent contractor to
evaluate the application. She added that, on the whole, the
division believes this is a very good effort to clean up the
current statute and provide an incentive for the production of
fields not yet in production, as well as to prolong the life of
fields that otherwise would be at their natural end.
Number 1811
REPRESENTATIVE ROKEBERG thanked Ms. Robson and the Division of
Oil & Gas for working with the sponsors and offering
constructive comments and criticisms. Explaining the reasons
for introducing the legislation, he began by offering some
history. As chair of the House Special Committee on Oil and Gas
when he and Representative Kohring first were elected to the
19th legislature, he recalled that Governor Knowles had
introduced HB 207, considered "the keystone of his economic
policy" with regard to the petroleum industry. The committee
held more than 15 hours' worth of hearings to develop the bill.
When the bill reached the Senate Finance Committee, however, it
was changed in such a way that it became a stumbling block,
because it "accepted the concept of a concessionary modification
as an incentive on the one hand, but it statutorily required
that the state ultimately get a payback."
REPRESENTATIVE ROKEBERG agreed with Ms. Robson that the
"(j)(3)(C)" language on page 3 [of SSHB 28] took away the
commissioner's ability to create a royalty reduction on a
sliding-scale basis that takes into account the various elements
of production costs, oil prices, and so forth.
Number 1981
REPRESENTATIVE ROKEBERG pointed out that when he'd had that bill
in committee, he'd been careful to develop a bifurcated track:
one for existing fields and one for new fields. He explained:
The governor's bill at the time was really related to
newer fields, and I had a great concern about the
existing fields of the Cook Inlet area, in particular,
and then some of the older fields in the state that
may well deserve and have some incentive justified.
And particularly in the older fields, this type of
language doesn't work. ... One size doesn't fit all,
because I think you need to look at each particular,
different application [for] fields or pool as a
separate entity, and take those matrix of different
issues together to make ... that decision. So to
require that a field pay back something that it
doesn't make downstream, and put that in statute, I
thought was a mistake.
REPRESENTATIVE ROKEBERG noted that there had been only two
applications, to his recollection, neither of which led to
production. Therefore, the bill hasn't been used - to his
belief because it wasn't really workable. Thus he has always
wanted to fix it, he said, since it was the first major
legislation he'd worked on. Suggesting SSHB 28 fits with the
current administration's desire for increased income from
natural resources, he said it is designed to extend the life of
fields or potentially assist in the development of a field that
would not otherwise be developed. "And that was the context in
which we had discussed this bill earlier," he added.
Number 2103
REPRESENTATIVE ROKEBERG pointed out that this is loosely called
"180(j) of our oil and gas statutes." He said there have been
provisions for royalty incentives for many years; HB 207 of
eight years ago changed the statute, and the intent of SSHB 28
is to tweak it again to make sure it's workable, because it
hasn't worked or made the state one penny. He also noted that
there had been a previous application - from Conoco Oil Company,
relating to Milne Point - during the Hickel Administration that
Representative Rokeberg said he'd studied in great detail.
Saying he was "somewhat astonished by the ultimate findings," he
told members:
It gave credence to the idea that the commissioner of
natural resources, given the proper tools and given
the proper statutory authority, with proper
safeguards, should have the discretion to make that
decision, because, lo and behold, the Hickel
Administration, with a commissioner that came directly
out of the "oil patch," turned down Conoco, and that
gentleman ... is sitting in our audience today,
[former] Commissioner Harold Heinze. And I studied in
depth ... his work.
REPRESENTATIVE ROKEBERG indicated part of the endeavor with the
previous HB 207 was to give the commissioner additional
authority, on one hand, but to have safeguards in terms of the
commissioner's best interest findings. However, the number of
safeguards was overkill and added complexity, he suggested,
including the Senate's putting the governor into the loop,
because the commissioner of natural resources works for the
administration in power at the time. He voiced frustration that
there is a perfectly good concept that could be applicable to
some development in the state, but that it hasn't been workable
because of certain provisions.
REPRESENTATIVE ROKEBERG suggested that oil companies may be
reluctant to testify on [SSHB 28] because of fear of looking as
though they are seeking a handout. He therefore proposed that
this is not a handout but a helping hand, and the invitation is
for the companies to bring forward applications that are
meritorious. Each application will be judged on its merits, he
said.
Number 2317
REPRESENTATIVE ROKEBERG addressed the first point made by Ms.
Robson. Recalling that it was debated heavily in the House last
time, he explained that with regard to extending it to a portion
of a pool, his concern was about "step-outs" or certain areas
that look marginal and might be considered part of the pool
because of geology, for example. Saying it is an arguable
point, he asked committee members to look at it further. He
added, "I'll give [the Division of Oil & Gas] the benefit of the
doubt here if they can prove ... otherwise, and we can remove
that."
Number 2377
REPRESENTATIVE ROKEBERG addressed a second point by Ms. Robson,
regarding the independent contractor. He indicated this area of
the [previous] bill was developed in the House Special Committee
on Oil and Gas at the time, in order to have "some real
expertise available both to the commissioner and to the company
involved that mandated that an outside consultant be brought in,
somebody who could crunch numbers and had a reputation within
the industry to assist in the analysis and development of the
best interest finding." He offered that at issue are the
changes [in the previous legislation] in the Senate, which to
his belief [probably occurred] because the Division of Oil & Gas
had wanted them.
Number 2404
REPRESENTATIVE ROKEBERG explained that [SSHB 28] defaults to the
older concept of who picks the consultant. It is from a list of
qualified consultants provided by the commissioner, but
ultimately selected by the applicant. He added:
The very simple reason is, the applicant's paying for
it. ... I always took offense at the idea that an
applicant would have to pay for a consultant selected
by the commissioner. ... Ms. Robson brings up the
point that, well, it may appear or may swing the
guarantee of outcome to a particular contractor. But
I believe by having the commissioner develop the
shortlist of reputable consultants - and the
reputation of that consultant should speak for itself,
and there's relatively limited amounts of those people
that could undertake that ... in the whole nation, I
think, or worldwide - ... that should be adequate
comfort for the commissioner. And the fact is, a
rather large sum of money I would expect to ... have
to be paid by ... the petroleum company bringing forth
the application. And they're paying for it; they
ought to get the final say. ...
It's kind of a philosophical thing, where ... I kind
of take offense that the government's going to tell
you that ... you have to hire somebody and then pick
them for you, and then you've got to pay for it. ... I
think it's something that needs further debate, and
I'm certainly open to that particular debate.
Number 2514
REPRESENTATIVE ROKEBERG addressed a third area discussed by Ms.
Robson, relating to page 4, line 28 [of SSHB 28], "reasonably
available to the applicant". He recalled that that phrase
stemmed from testimony eight years ago. There were a number of
transfers of properties, particularly in the Cook Inlet area,
from one company to another; there also had been testimony by
Union Oil Company of California (Unocal) and by some of the
successors in interest to those transactions that geological
data didn't necessarily come with the purchase of some of those
platforms out in the inlet. The reason for the provision,
therefore, was to [avoid] an extra requirement of providing data
that someone didn't even have.
REPRESENTATIVE ROKEBERG said while he appreciates the division's
concern that this may be some sort of an "out," he believes the
commissioner would have sufficient latitude or authority, if
lacking adequate data, to deny the application. He mentioned a
desire for assurance if an applicant could make a good enough
case that the data was reasonably available if that applicant
didn't even have it. He characterized it as a "successor-in-
interest-type argument." He also indicated the addition of the
words may and only [on line 26] might alleviate problems. He
continued:
It seems to me that the consultancy and the other
information and data that would have to be part of the
application obviously would have to be sufficient
enough to convince the commissioner to grant the
relief. And if they didn't make their case, ... they
wouldn't get it. ... We shouldn't make it mandatory
that they get this data, because the commissioner
could overdemand and never make a determination. So
that's kind of the rationale behind that one.
Number 2643
REPRESENTATIVE ROKEBERG referred to Ms. Robson's mention of
possible concern about assignment [of royalty interest]; he
suggested the need to look at that and iron it out. Suggesting
that all the issues can be resolved, he again thanked the
Division of Oil & Gas for stepping forward in fundamental
support of the bill, and said he looked forward to working to
resolve the concerns.
Number 2671
CHAIR KOHRING, crediting Representative Rokeberg with the work
on the bill, said he was looking forward to fine-tuning it and
advancing it to the next stage. He thanked Ms. Robson for her
thorough analysis and constructive criticism, noting that the
view of the administration is generally positive toward the
legislation. [SSHB 28 was held over.]
ADJOURNMENT
There being no further business before the committee, the House
Special Committee on Oil and Gas meeting was adjourned at
5:11 p.m.
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