Legislature(2005 - 2006)CAPITOL 124
04/07/2005 05:00 PM House OIL & GAS
| Audio | Topic |
|---|---|
| Start | |
| HB234 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 234 | TELECONFERENCED | |
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.
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