Legislature(2007 - 2008)HOUSE FINANCE 519
10/21/2007 01:00 PM House OIL & GAS
| Audio | Topic |
|---|---|
| Start | |
| HB2001|| SB2001 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB2001 | TELECONFERENCED | |
ALASKA STATE LEGISLATURE
JOINT MEETING
HOUSE SPECIAL COMMITTEE ON OIL AND GAS
SENATE RESOURCES STANDING COMMITTEE
October 21, 2007
1:04 p.m.
MEMBERS PRESENT
HOUSE OIL AND GAS
Representative Kurt Olson, Chair
Representative Nancy Dahlstrom
Representative Mark Neuman
Representative Jay Ramras
Representative Ralph Samuels
Representative Mike Doogan
Representative Scott Kawasaki
SENATE RESOURCES
Senator Charlie Huggins, Chair
Senator Bert Stedman, Vice Chair
Senator Lyda Green
Senator Gary Stevens
Senator Lesil McGuire
Senator Bill Wielechowski
Senator Thomas Wagoner
MEMBERS ABSENT
HOUSE OIL AND GAS
All members present
SENATE RESOURCES
All members present
OTHER LEGISLATORS PRESENT
Representative John Coghill
Representative Mike Kelly
Representative Carl Gatto
Representative Andrea Doll
Representative Berta Gardner
Representative Bob Buch
Representative Harry Crawford
Representative Bryce Edgmon
Representative Anna Fairclough
Representative Les Gara
Representative David Guttenberg
Representative Lindsey Holmes
Representative Craig Johnson
Representative Wes Keller
Representative Beth Kerttula
Representative Bob Roses
Representative Paul Seaton
Representative Peggy Wilson
Senator Con Bunde
Senator Fred Dyson
Senator Johnny Ellis
Senator Kim Elton
Senator Joe Thomas
COMMITTEE CALENDAR
HOUSE BILL NO. 2001
"An Act relating to the production tax on oil and gas and to
conservation surcharges on oil; relating to the issuance of
advisory bulletins and the disclosure of certain information
relating to the production tax and the sharing between agencies
of certain information relating to the production tax and to oil
and gas or gas only leases; amending the State Personnel Act to
place in the exempt service certain state oil and gas auditors
and their immediate supervisors; establishing an oil and gas tax
credit fund and authorizing payment from that fund; providing
for retroactive application of certain statutory and regulatory
provisions relating to the production tax on oil and gas and
conservation surcharges on oil; making conforming amendments;
and providing for an effective date."
- HEARD AND HELD
SENATE BILL NO. 2001
"An Act relating to the production tax on oil and gas and to
conservation surcharges on oil; relating to the issuance of
advisory bulletins and the disclosure of certain information
relating to the production tax and the sharing between agencies
of certain information relating to the production tax and to oil
and gas or gas only leases; amending the State Personnel Act to
place in the exempt service certain state oil and gas auditors
and their immediate supervisors; establishing an oil and gas tax
credit fund and authorizing payment from that fund; providing
for retroactive application of certain statutory and regulatory
provisions relating to the production tax on oil and gas and
conservation surcharges on oil; making conforming amendments;
and providing for an effective date."
- HEARD AND HELD
PREVIOUS COMMITTEE ACTION
BILL: HB2001
SHORT TITLE: OIL & GAS TAX AMENDMENTS
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR
10/18/07 (H) READ THE FIRST TIME - REFERRALS
10/18/07 (H) O&G, RES, FIN
10/19/07 (H) O&G AT 1:30 PM HOUSE FINANCE 519
10/19/07 (H) Heard & Held
10/19/07 (H) MINUTE(O&G)
10/20/07 (H) O&G AT 12:00 AM HOUSE FINANCE 519
10/20/07 (H) Heard & Held
10/20/07 (H) MINUTE(O&G)
10/21/07 (H) O&G AT 1:00 PM HOUSE FINANCE 519
BILL: SB2001
SHORT TITLE: OIL & GAS TAX AMENDMENTS
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR
10/18/07 (S) READ THE FIRST TIME - REFERRALS
10/18/07 (S) RES, JUD, FIN
10/19/07 (S) RES AT 9:00 AM BUTROVICH 205
10/19/07 (S) Heard & Held
10/19/07 (S) MINUTE(RES)
10/20/07 (S) RES AT 8:00 AM BUTROVICH 205
10/20/07 (S) Heard & Held
10/20/07 (S) MINUTE(RES)
10/21/07 (S) RES AT 1:00 PM HOUSE FINANCE 519
WITNESS REGISTER
PAT GALVIN, Commissioner
Department of Revenue
Juneau, Alaska
POSITION STATEMENT: During hearing of HB 2001, answered
questions.
TOM IRWIN, Commissioner
Department of Natural Resources
Anchorage, Alaska
POSITION STATEMENT: Provided comments on HB 2001.
CHERYL NIENHUIS, Petroleum Economist
Department of Revenue
Juneau, Alaska
POSITION STATEMENT: During hearing of HB 2001, provided a
PowerPoint presentation titled "The Cost Story".
MICHAEL WILLIAMS, Chief Economist
Tax Division
Department of Revenue
Anchorage, Alaska
POSITION STATEMENT: During the hearing of HB 2001, discussed
the difficulty of forecasting cost.
ANTHONY FINIZZA, Ph. D., Consultant
to the Department of Revenue
(No address provided)
POSITION STATEMENT: Reviewed the PowerPoint presentation titled
"The Palin-Parnell Administration presents ACES" and answered
questions.
RICH RUGGIERO
Gaffney, Cline & Associates
Houston, Texas
POSITION STATEMENT: During hearing of HB 2001, answered
questions.
KEVIN BANKS, Acting Director
Division of Oil & Gas
Department of Natural Resources
Anchorage, Alaska
POSITION STATEMENT: During hearing of HB 2001, answered
questions.
ACTION NARRATIVE
CHAIR KURT OLSON called the joint meeting of the House Special
Committee on Oil and Gas and the Senate Resources Standing
Committee to order at 1:04:47 PM. Representatives Olson,
Dahlstrom, Neuman, Ramras, Samuels, Doogan, and Kawasaki and
Senators Huggins, Stedman, Green, Stevens, McGuire,
Wielechowski, and Wagoner were present at the call to order.
Also in attendance were Representatives Buch, Edgmon,
Fairclough, Gara, Guttenberg, Holmes, Johnson, Keller, Kerttula,
Roses, Seaton, and Wilson and Senators Bunde, Dyson, Ellis,
Elton, and Thomas.
HB2001-OIL & GAS TAX AMENDMENTS
SB2001-OIL & GAS TAX AMENDMENTS
1:06:02 PM
CHAIR OLSON announced that the only order of business would be
HOUSE BILL NO. 2001, "An Act relating to the production tax on
oil and gas and to conservation surcharges on oil; relating to
the issuance of advisory bulletins and the disclosure of certain
information relating to the production tax and the sharing
between agencies of certain information relating to the
production tax and to oil and gas or gas only leases; amending
the State Personnel Act to place in the exempt service certain
state oil and gas auditors and their immediate supervisors;
establishing an oil and gas tax credit fund and authorizing
payment from that fund; providing for retroactive application of
certain statutory and regulatory provisions relating to the
production tax on oil and gas and conservation surcharges on
oil; making conforming amendments; and providing for an
effective date." and SENATE BILL NO. 2001, "An Act relating to
the production tax on oil and gas and to conservation surcharges
on oil; relating to the issuance of advisory bulletins and the
disclosure of certain information relating to the production tax
and the sharing between agencies of certain information relating
to the production tax and to oil and gas or gas only leases;
amending the State Personnel Act to place in the exempt service
certain state oil and gas auditors and their immediate
supervisors; establishing an oil and gas tax credit fund and
authorizing payment from that fund; providing for retroactive
application of certain statutory and regulatory provisions
relating to the production tax on oil and gas and conservation
surcharges on oil; making conforming amendments; and providing
for an effective date."
1:06:45 PM
PAT GALVIN, Commissioner, Department of Revenue, informed the
committees that the focus will be on the impact the tax program
has on the investment climate. Also, the analysis done by the
Department of Revenue (DOR) and Department of Natural Resources
(DNR) on that issue will be shared. He then reviewed an outline
of what the administration would present today.
1:08:48 PM
TOM IRWIN, Commissioner, Department of Natural Resources,
reminded the committees that in May the governor directed the
commissioner of DOR to undertake a review of the petroleum
production profits tax (PPT) in a manner that ensures a
transparent process, that the state is getting a an appropriate
share, and that the state provides a healthy investment climate.
He opined that DNR certainly agreed with those principles. He
then informed the committees that DNR was asked to participate
and it has participated in this evaluation process from the
beginning. Commissioner Irwin opined that Alaska's Clear and
Equitable Share (ACES) [HB 2001] provides a good balance between
encouraging investment and providing a fair share to the state.
COMMISSIONER IRWIN then recalled discussions of PPT in which he
and the deputy commissioner were very vocal in support of a
gross tax alternative. He said although he maintains his like
of a simple concept, one couldn't be identified. He opined that
the lack of communications between departments lead to the
strong gross versus net positions. However, now both sides are
more knowledgeable and closer to making an informed decision.
Commissioner Irwin said, "We support what the Department of
Revenue is presenting today and this information led us to
recognize the limitations of just a pure gross system."
1:13:21 PM
CHAIR HUGGINS requested a copy of the May directive cited.
COMMISSIONER IRWIN recalled that it was a verbal request rather
than a written request.
1:13:58 PM
SENATOR WIELECHOWSKI recalled that Commissioner Irwin has been
an advocate for the gross. He further recalled that there have
been press reports relating that during the ACES process there
was division with regard to going forward with gross versus net.
Were those press reports true, he asked.
COMMISSIONER IRWIN stressed that he spent untold hours in
meetings with the governor, DNR, and DOR as well as technical
staff within the department and from outside of it. He
mentioned the goal with this administration has consistently
been what's best for the state. During review of the gross, the
matter of developing correct incentives had to be addressed.
The first thought was to use a fixed number, but the variety of
wells and situations is complex, particularly with heavy oils.
The thought then was to have the companies put forth what the
incentives should be by the cost, which resulted in data that
pointed "virtually back to net." Commissioner Irwin opined that
ACES, with its gross protected floor and net approach with
significant incentives, is sort of a marrying of the two. He
emphasized that no one was ever precluded from providing input.
1:17:37 PM
SENATOR STEVENS inquired as to why the governor has transitioned
from a gross tax to a net tax.
COMMISSIONER GALVIN related that the intention is to lay out the
full discussion and what was discovered that led to the
development of ACES.
1:18:56 PM
CHAIR HUGGINS opined that it's important that whatever happened
in the meetings resulting in ACES comes out in this public
process.
COMMISSIONER IRWIN said that's why these hearings are so
important. "Again, everybody in this room is for Alaska; we
want to choose what's right for Alaska." He highlighted that
ACES includes both gross and net as there are merits to both.
He opined that today's meeting should relate the process
utilized to get to the ACES proposal.
1:21:28 PM
CHERYL NIENHUIS, Petroleum Economist, Department of Revenue ,
said she would begin with how production tax revenues are
forecast. Referring to slide 2, she explained that under the
PPT there are three unknowns of which some are more known than
others, such as with production. The department actually has a
petroleum engineer who does the production forecast and has been
for a number of years. Production, which is utilized in the
production tax calculation, is updated every six months. Still,
it's somewhat of an unknown, particularly so lately as there
have been some production disruptions. The next unknown is
price. For price forecasting, almost all of the state's
economists come together for a day and discuss oil markets,
various drivers of demand and supply, and worldwide prices. At
the end day, [each economist] specifies what he/she believes to
be the best price forecast, which is included in the short- and
long-term forecast. The price is another of the variables that
is considered in the production tax calculation. Under the PPT
there is a third unknown, which is the cost of production. Cost
can be viewed simply as cost or as investment. Cost has two
basic elements: the operating expenditures (opex) and capital
expenditures (capex). Ms. Nienhuis explained that operating
costs are generally those costs that go into producing oil or
gas. The operating costs can be fixed or variable. Capital
costs are those costs that are generally incurred for expenses
that lead to some sort of asset or development that either
furthers production or somehow is beyond the operating cost.
Both the capex and the opex are important to the calculation of
the tax.
1:24:57 PM
MS. NIENHUIS then turned to slide 3 titled "2006 PPT Costs."
She explained that during the PPT debates the cost assumption
sources used were basically historical data from 2002 to 2004,
such as federal partnership tax returns, some departmental
information on capital spending in Alaska on the North Slope,
some confidential information received through the negotiation
process for the gasline, and NPSL lease-cost information, some
of which was a little older. There were also published reports
from different firms, such as CERA [Cambridge Energy Research
Associates] and Wood Mackenzie as well as financial information
from companies. A lot of publicly available information was
also available. Additionally, the department had consultations
with industry staff and [during] the gasline negotiations some
confidential information was received. She emphasized that
throughout the process industry was involved as there were
formal and informal discussions with them about the cost
structure. Ms. Nienhuis reminded the committees that the
department's cost estimates were reviewed by the legislature's
consultants, and therefore were aware of the department's cost
forecast.
1:27:08 PM
MS. NIENHUIS, referring to slide 4 titled "PPT Forecast
Timeline", informed the committees that the first cost forecast
was put together in the fall of 2005 when [the state] was in
negotiations with the industry on the gasline and there was a
push to change the oil tax. At that time, a number of the
department's economists obtained as much information as they
could and put together a cost forecast, which became part of the
fiscal note for House Bill 3001 [in 2006]. She said,
"Basically, what it amounted to is somewhere in the neighborhood
of $7 a barrel." However, she noted that it wasn't all a
variable cost as there were different mechanisms included that
weren't totally variable. In August 2006, the fiscal note for
House Bill 3001 was put out for the current PPT tax system. She
pointed out that throughout the PPT's debate, the department
made a point of not changing its cost estimates because it was
important to not bias one different tax plan or proposal over
another. Furthermore, there wasn't the time to re-evaluate the
costs. Ms. Nienhuis opined that the department felt it had the
costs right and there was lots of support for that. In November
2006 a revenue forecast was put together. At that time, the
department re-evaluated the costs as it realized that capital
costs had increased. In fact, the price of steel and labor had
rose significantly, and therefore the department adjusted its
forecast to increase capital costs.
1:29:23 PM
SENATOR WAGONER inquired as to what information is available to
substantiate that the price of labor has increased considerably.
MS. NIENHUIS said she is speaking from two sources of
information, which include industry discussions. The other
source is the knowledge that certain job classifications have
had higher labor cost increases than others. For example, there
is a shortage of engineers, which has caused the salaries for
some of those engineers to increase as well as for some of the
actual mechanics and workers in the field.
SENATOR WAGONER opined that it should be easy to document those
increases. He expressed interest in seeing a list of those
increases and the total effect of those. The largest number of
those working in the petroleum industry are those working in
operations and maintenance, which probably haven't experienced
much of an increase in their wages.
COMMISSIONER GALVIN clarified that Ms. Nienhuis mentions that
primarily to note what occurred between the time the original
fiscal note assumptions were made and prior to the receipt of
the reports from the taxpayers that resulted in the current
level of expectation. He further clarified, "I think it's a
fair question to ask industry ... since they're the ones that
talk about these things. We're just reporting back to you what
we're hearing from them. We don't have those particular
sources." He said that [ACES] wasn't built on a particular
source, nor did a particular source change a number.
1:32:12 PM
SENATOR STEDMAN highlighted that there can be a situation in
which there are hourly and salary increases when there's $70-$80
a barrel oil with $7 costs. He emphasized that there's an
important delineation between more employment in the basin
versus actual salary increases.
COMMISSIONER GALVIN said that's precisely the type of
information the ACES information provision should acquire.
There is no knowledge as to whether the costs are increasing
because the price of a particular item is increasing or whether
more items are being purchased.
SENATOR STEDMAN opined that the goal, creating incentives for
oil and gas development in Alaska and obtaining the state's fair
share of revenue during high price periods, of ACES seem similar
to that of PPT. He then asked if PPT is delivering the
beginnings of a wave of expansion in the oil basin.
COMMISSIONER GALVIN related that DOR's view and industry experts
have said that the timeframe thus far isn't an indication of a
change in behavior as a result of PPT having passed. Although
the industry has related that this year it will be ramping up
costs, the industry doesn't directly cite the change in the
credit system for PPT but rather discusses the need for more
system integrity. The question would be appropriate to ask the
industry.
SENATOR STEDMAN said that if the industry is changing its
behavior and [PPT] is doing what is desired, then he asked if
it's it too early to act.
COMMISSIONER GALVIN said the question is whether or not a change
in the oil tax proposed by ACES will modify that same incentive.
The basic incentives included in PPT and intended to drive that
decision remain within ACES. The information being provided
today is regarding whether the change recommended will dampen
PPT, to which the administration's response is no. He opined
that ACES should result in the same amount of incentive to
increase that behavior because the credits and other incentive
vehicles remain within the system.
1:36:02 PM
SENATOR WIELECHOWSKI turned to the forecasting errors of 2006,
which he characterized as fundamental errors. He asked if ACES
is addressing those errors in order to prevent them from
recurring.
MS. NIENHUIS said she believes so. The department has much more
information now than it had at the time. Furthermore, ACES
requires better reporting, both in the current month and the tax
return at the end of the year. Moreover, companies are required
to provide forward-looking information with regard to what they
expect for costs in the next year.
1:37:25 PM
REPRESENTATIVE SAMUELS suggested setting aside the tax rate
question and assume that the department has enough auditors, and
asked if the audit would be able to relate whether the price of
a widget has increased or whether more widgets are being
purchased. He noted his agreement with Senator Wagoner that
labor costs couldn't have risen that much in three years.
However, the cost increase could be due to hiring more people.
COMMISSIONER GALVIN related his belief that the department
should be able to get a lot closer to that issue because the
information from the audit would allow a determination as to
whether there was an increase in man hours or other factors. As
a result of both the requirement for information and the audit's
ability to confirm that, more information would be available
[regarding the cost of labor].
1:38:53 PM
CHAIR HUGGINS inquired as to what if Commissioner Galvin is
wrong. He then expressed concern with what isn't known. He
opined that he didn't want to enter a fourth year dealing with
this issue.
COMMISSIONER GALVIN highlighted that the professionals within
the agency are dealing with the numbers. He then highlighted
that a year ago [departmental professionals] were asked to make
an assumption about the current costs. Although they didn't
have adequate information from the companies, they made the best
assumptions possible. A few months later the numbers from the
companies were available and [the department professionals] were
off by 50 percent. The numbers being used from that point
forward are based upon those reports. Therefore, the deviation
will be a matter of changes in the environment and the economics
of the field. Today, decisions are being based on the best
information available now because that reported information is
available.
CHAIR HUGGINS noted his appreciation and emphasized his desire
to get this correct. He then recalled that Dr. Van Meurs has
said that the cost data being relied upon isn't reliable and
suggested that it needs to be audited because it's overstated.
Furthermore, Dr. Van Meurs has said that Alaska's gasline isn't
economically feasible at this time. The aforementioned is of
concern, he stressed.
COMMISSIONER GALVIN noted his agreement with wanting to get it
correct also. He expressed the need to realize that Dr. Van
Meurs has been gone from the state for a year, and furthermore
he has expertise in certain areas but not others, such as in
accounting and cost forecasting. However, staff within the
agency have been working on the issue daily for the last year in
order to understand what was the difference. Commissioner
Galvin said, "There's a significant difference in confidence
that I would have that I would have in comparing what my agency
staff have brought to the table today, in terms of what they
used a year ago compared to what information they have today, as
opposed to Dr. Van Meurs coming in a year later ... saying ...
this is what I think might have happened."
1:44:00 PM
CHAIR OLSON recalled that in Ms. Nienhuis' presentation she
indicated that the decision was made with respect to the fiscal
note for House Bill 3001 to use the $7 a barrel cost and
continue using it although the department was aware of the
change. He inquired as to who specifically made that decision.
MS. NIENHUIS clarified that she wouldn't say that the
[department] was aware of any change or didn't contemplate any
change until the fall forecast. She further clarified that the
[department] had no reason to suspect its numbers were wrong.
1:44:51 PM
REPRESENTATIVE DOOGAN asked if the difference between the
projection and the situation the department is in now is the
difference between a guess and a claim. He related his
understanding that the knowledge that is available now is only
that information that has been claimed, since there haven't been
audits.
COMMISSIONER GALVIN said that the discussion today and the
projections are based upon the reported costs. The
aforementioned is something the department is willing to rely
upon as it reflects what the industry says are the costs.
However, a year ago, [the projections] were an educated guess
that proved to be an inaccurate reflection of what the reported
costs would be.
REPRESENTATIVE DOOGAN related his understanding from previous
testimony that there's essentially no penalty for the industry
if it over reports its claim.
COMMISSIONER GALVIN said that there are penalties associated
with interest that is accrued for the unreported or unpaid
interest.
REPRESENTATIVE DOOGAN opined that the state won't "hit them in
the bank account" if the company has over reported by say, 20
percent
COMMISSIONER GALVIN replied no, not under the current PPT.
REPRESENTATIVE DOOGAN asked if this problem is an inherent
problem with a net tax because in order to determine whether the
state is getting what it thought, a process that is likely to
include an audit is required and perhaps even lead to a lawsuit.
COMMISSIONER GALVIN explained that with a system that requires
companies to report costs, there are a series of clarifications.
The first clarification occurs when the company has to report
its costs the first time. Under the current PPT, the
aforementioned occurs at the end of the year, while under ACES
it would occur monthly. There is also clarification provided
from the auditing process and if there are conflicts with regard
to the lawsuit. Commissioner Galvin opined that anytime there
are deductions based upon cost, this issue will arise.
1:48:16 PM
SENATOR MCGUIRE echoed the earlier sentiments to get this right.
She asked if [ACES includes] independent experts who know what
the costs should be and the best field practices. She expressed
the need to be able to justify and understand any change and why
the costs are what they are.
COMMISSIONER GALVIN said the he views [the administration's]
responsibility as providing the committees with the best
information available today, in context of where things will go
from here. He said that he's merely pointing out the experience
the economists had in putting together the numbers that went
into the fiscal note from a year ago and operating with the best
information available at the time, although that proved to be
wholly different than what was experienced just a short time
later. Looking forward, the reported costs are now known.
Still, he reminded the committees that as more is learned, it's
refined. With regard to whether the decision on the tax rate
should be deferred, he pointed out that there is a cost
associated with that. He then related that there is a level of
confidence that exists in today's numbers that didn't exist a
year ago. Commissioner Galvin said that if this is addressed
again it will likely be because the costs have deviated due to
two things. If the changes have occurred because the world has
changed, then he opined that it isn't necessarily valid to come
back because it's a net-based tax and the costs are taken as
they come. However, if the change occurs because of inaccurate
reportings, it would be an entirely different situation, which
he didn't anticipate.
SENATOR MCGUIRE returned to Representative Doogan's comment that
this is a claim, and there's no basis in reality for assessing
that claim. Therefore, part of the equation is missing.
Although she said she didn't disagree that through [ACES] there
is a better method of obtaining information from the producers,
it still relies on what the industry says. Therefore, she
inquired as to what is embedded in the process, in terms of
experts and personnel that have an objective ability to analyze
[the claims].
COMMISSIONER GALVIN answered that one can try to rely upon these
experts, such as Dr. Van Meurs, Mr. Johnston, Wood Mackenzie,
etcetera. Those were the types of experts who led to the
assumptions made a year ago. The question becomes: "Who's
going to tell you those numbers?" The end result is that
currently the numbers are coming from the source in a documented
statement that had to be certified and described versus merely
public statements, which provides a wholly different level of
confidence.
1:55:17 PM
CHAIR HUGGINS said that he would give Commissioner Galvin and
his staff a list of categories of tax projections and how valid
they were or weren't for discussion. He indicated that the list
relates the expectations and reality for various taxes in the
long-term.
COMMISSIONER GALVIN said [the department] would be happy to
review that. He opined that's it's important to recognize that
DOR is responsible for looking to the future and evaluating what
will happen and determine a single number that will result in
the state's revenue. The aforementioned means that [the
department] must recognize what it can identify and accurately
predict and those components for which it can only take a best
guess. Within the area of cigarette taxes although the sales
are unknown, the department can calculate a trend and have a
certain level of confidence in that number. On the oil tax side
there are three different variables: production, price, and
costs. He explained that if the costs are wrong, the
expectations at a particular price or production will be wrong.
If the aforementioned is something that we can improve and
achieve a higher level of confidence on, then the overall
estimating can be better and more precise. Furthermore, then
the acceptance of the price and productivity variability are
just that. Commissioner Galvin said, "Here, we're saying we can
give you a number that has a greater degree of confidence than a
year ago."
1:59:21 PM
SENATOR STEDMAN inquired as to what level of confidence there
will be. He further inquired as to what percentage plus or
minus, [the projections] will be.
COMMISSIONER GALVIN said that Ms. Nienhuis will discuss that
during her presentation.
2:00:01 PM
MICHAEL WILLIAMS, Chief Economist, Tax Division, Department of
Revenue, pointed out that the U.S. Department of Energy's files
for cost of all the production areas in the U.S. doesn't
included Alaska. At the time [the division] was preparing the
fiscal note [for House Bill 3001], it was realized that DOE
didn't have the information on Alaska and that there weren't
large changes. Only anecdotal information was available.
Publications such as "Middle East Economic Survey" and
"Petroleum Intelligence Weekly" would, every two to three
months, have an article reporting an increase in capital costs.
For example, a 50 percent increase in capital costs in Badami
was reported. Although the [division] wasn't clear about what
was going on, consultations with the oil companies left them
feeling pretty good. He recalled Representative Doogan's
earlier question regarding whether it would be easier to have a
gross tax with credits. However, credits are capital
expenditures and thus in order to forecast credits, which are
directly deductible from tax liability, one must know what the
costs are. The aforementioned would be the case even in a gross
system with credits. He then recalled Senator McGuire's
questions regarding consultants and pointed out that review of
some of the cost data provided by the consultants shows that
they were off just as much as the state, possibly more. He
related that Cambridge Energy Research Associates has a capital
cost forum in which organizations can pay $50,000 a year to sit
in on the forum, which tracks projects in 28 countries around
the world to understand what's going on with capital cost.
After inquiring about joining that, he was told that one must be
an oil company and thus the state wasn't allowed to join.
However, they offered to sell their consulting services. Mr.
Williams concluded by saying that determining cost is
challenging and difficult as the companies keep the information
very well guarded.
2:03:16 PM
COMMISSIONER GALVIN, in response to Representative Ramras, said
that in the next few days the department will provide a slide
relating what particular fields will look like if the investment
doesn't come forth.
2:04:29 PM
REPRESENTATIVE NEUMAN inquired as to whether anyone can specify
whether the reinvestment in Alaska is more valuable in terms of
returning it to government or jobs.
MR. WILLIAMS answered that there are national and regional
studies illustrating the impact of investments. A company out
of Minnesota has an input output model. The [department] has
attempted to do an input output model with the state. In fact,
at one point the department negotiated with a company to develop
a model. However, it was discovered that Alaska is very
different from other states. So different, in fact, that major
economic consulting companies don't have a model in which it can
see the input and output effects of investment in the oil
industry in Alaska. The department struggled with that for a
year and a half and received no response. Therefore, he said he
is reluctant to say [the department] can do it.
COMMISSIONER GALVIN said that there are economists who will be
able to relate the affects of the oil industry within the rest
of the economy as there are a number of statewide economic
studies. However, one of the points he understood
Representative Neuman to be making draws upon the false
assumption that $1 less tax income equals $1 less investment in
Alaska's oil industry. The aforementioned is a truly false
assumption, he opined. Commissioner Galvin specified that
through ACES, the administration is suggesting that the same
level of investment and more money can be brought in because the
money being brought in is money that would otherwise go to the
company outside of Alaska. He clarified that he didn't want to
leave the committees with the impression that it's making a
choice between taking more money as part of the state's share
and that money otherwise going into the field.
2:08:48 PM
REPRESENTATIVE NEUMAN said that he realizes that it's not dollar
for dollar. He surmised that perhaps he should talk with
Department of Labor & Workforce Development staff. He then
inquired as to how closely does the government work together.
Representative Neuman emphasized that his concern is in regard
to the impact on jobs. He expressed his desire for the dollar
to stay in Alaska.
COMMISSIONER GALVIN said that will be discussed throughout the
day.
2:09:43 PM
CHAIR HUGGINS recalled use of the term "lumping" and inquired as
to its meaning.
MR. WILLIAMS explained that a company may spend $2 million
before the first barrel of oil is produced. The large capital
investment up-front is to what the term refers.
CHAIR HUGGINS further recalled that a consultant cautioned
against drawing conclusions with one-year reviews.
2:11:14 PM
SENATOR GREEN commented that she would hate to take anyone to
task for errors with fiscal notes because they are rarely right
as they are nothing more than a best guess estimate.
2:12:41 PM
MS. NIENHUIS returned to slide 4, and highlighted that February
2007 was when the first PPT returns were received, and they were
quite close to the forecast. The true-up returns were received
from the oil companies in April 2007, and the department's
estimates were a bit off. Also in April 2007 was DOR's spring
revenue forecast, which was the last official forecast. The
department is now working on the fall forecast. For this
particular exercise, the price forecast has been updated and the
petroleum engineer has provided new production numbers for
fiscal year (FY) 2008, which is some 40,000 barrels below what
was predicted in the spring of 2007.
2:14:07 PM
MS. NIENHUIS continued with slide 5 titled "How our Assumptions
Changed". The largest change since the adoption of the PPT is
the level of information available. In fact, the department has
adjusted its models based on actual PPT tax return filings.
Furthermore, costs are now expressed in nominal dollars with an
inflation component. She noted that although nominal dollars
may look as if they're increasing, it might not be the case in
real dollars. She then informed the committees that the
department has reviewed production profiles, which illustrate
that production is increasing through 2012. The aforementioned
was an important component of the cost estimates that has now
been added into the model.
2:15:16 PM
REPRESENTATIVE RAMRAS expressed frustration that the governor
isn't present. He then recalled his belief that this special
session is bad policy and ACES is a bad plan. He then recalled
attending a town hall meeting during which the governor was very
adept at articulating how her luggage was lost, but not adept at
articulating the ACES policy. "I just don't get what we're
doing here," he said. He questioned this broad overarching
assumption that the existing policy can be tweaked without
impacting the outcome. Representative Ramras stressed that a
sweeping assumption can't be made based on one year's worth of
data. He opined that there must have been a conversation
between the commissioner and the governor in which there was a
catalyst that led to this [special session]. Representative
Ramras said that he would rather have the governor present to
articulate economic policy as this matter is the lifeblood of
Alaska.
2:20:37 PM
COMMISSIONER GALVIN stated that the governor has been very clear
about why the legislature is in session today and the reasons
why the issue must be addressed now. Commissioner Galvin
specified that the issue of cost is only one part of why the
legislature is in session. He characterized it as an issue of
public confidence. The governor requested that the department
review the situation and make a recommendation based on the
information available now. The new information resulted in the
need to change the assumptions used a year ago. Additionally,
DOR and DNR [are present] to provide the committees with this
newly available detailed information that is necessary to make
the decision today. "We believe that it makes a compelling case
that we can make a change and still have that proper balance,"
he opined. The governor has been very much involved in every
step of this. However, the governor is charged with running the
state and it's not her responsibility to be before the
committees. The aforementioned is the responsibility of the
commissioners [and department staff].
2:23:05 PM
SENATOR STEDMAN pointed out that there has been a road show
around the state discussing the $800 million gap between what
would be expected under the PPT versus ACES. With an effective
date of January 1, the gap is reduced to $400 million. Senator
Stedman opined that there's no reason why this couldn't be done
during the next regular session and have a retroactive effective
date.
COMMISSIONER GALVIN clarified that when ACES was presented
throughout the state, there wasn't a slide in the presentation
discussing the gap because that's not the target. The
information with regard to the difference was revealed in the
analysis of the PPT. He specified that he wasn't given the
directive nor was ACES designed to recover that money. However,
it's correct that on September 3rd when information was provided
about ACES, the slides did show an $800 million gap between the
existing PPT and ACES. He noted that ACES was projected to
bring in $600 million more than the existing PPT. Subsequent to
that there was a decision not to make ACES retroactive to the
entire fiscal year, and therefore the numbers presented today
show the difference for FY '08 aren't for a full fiscal year.
Commissioner Galvin opined that the desire was to design the
best system for the long term.
2:26:39 PM
SENATOR STEDMAN inquired as to when the legislature can expect
to view the algorithm that will be used.
COMMISSIONER GALVIN said that the department is working with the
consultants "to replicate as best they can" because the
[algorithm] includes confidential information that can't be
released.
2:27:38 PM
REPRESENTATIVE SAMUELS indicated that the production in the last
three months [has been lower] than the initial projection. He
inquired as to how much of the loss is the result of higher
costs over fewer barrels. He said that the administration can
get this answer later.
2:30:35 PM
MS. NIENHUIS, continuing her presentation, referred to slide 6
titled "Capital Spending as Reported in PPT Tax Returns, March
2007 and 2007 Forecast." She reminded the committees that the
PPT includes a provision called the transition investment
expenditures, which is the TIE credit. In order for the
taxpayer to receive credits for the TIE credits, the taxpayer
must file a form with the department stating the expenditures
during the five-year period of April 1, 2001 through March 31,
2006. The information on slide 6 illustrates that in calendar
year 2002 there was about $1.3 billion in capital spending,
which remains fairly flat through 2005. In 2006 it increased
about $400 million over the previous year. The capital spending
specified for 2007 is a forecast. Ms. Nienhuis opined that it's
too early to say whether the PPT had anything to do with the
additional capital spending. She then moved on to slide 7
titled "Cost Forecasts", which compares what was projected in
the fiscal note for House Bill 3001 versus the spring 2007
forecast. Based on the tax returns, the total costs increased,
as is reflected in the spring 2007 forecast, to about $4
billion. Therefore, there was almost a doubling, she said.
2:33:37 PM
REPRESENTATIVE SAMUELS turned to the capital costs in the fiscal
note. He asked whether the fiscal note for House Bill 3001
included Pioneer's project at Oooguruk where it spent $500-$600
million.
MS. NIENHUIS explained that there was a certain amount per
barrel for developmental capital, which was for capital projects
coming on line in the next couple of years. Therefore, it was
incorporated in that analysis, although not specifically at any
particular field.
REPRESENTATIVE SAMUELS asked if there were any other large
dollar expenditures across the North Slope other than that by
Pioneer.
MS. NIENHUIS said she wasn't sure how much she could disclose in
regard to specific projects. Furthermore, [the department]
doesn't have a level of detail as it has cost by unit.
2:35:34 PM
SENATOR WIELECHOWSKI asked if any of the costs specified are
retroactive costs, attributable to the claw back provision of
PPT.
MS. NIENHUIS replied no. Any transition or claw back costs
would've been declared prior to this as these are current year,
fiscal year 2008, costs.
COMMISSIONER GALVIN explained that slide 7 relates what amount
of capital costs were reported that qualified for a certain
amount of TIE credit. In this instance, when a company applies
for credits, it received an extra bump in value.
SENATOR WIELECHOWSKI surmised then that none of the numbers on
slide 6 are increased because of the claw back provision.
COMMISSIONER GALVIN related his agreement.
2:37:14 PM
REPRESENTATIVE DOOGAN asked if slide 6 reflects everyone who
could have claimed TIE credits. He asked if the numbers
specified are the total for capital expenditures on the North
Slope or might there be more capital expenditures which weren't
filed.
COMMISSIONER GALVIN responded that potentially the only category
would be those taxpayers that had capital expenditures during
that period, but didn't last year and thus didn't have any
reason to claim a TIE credit referenced back. He said that not
many in that category come to mind.
REPRESENTATIVE DOOGAN recalled that yesterday the committee was
told that the total cost per barrel is $22, although slide 7
uses a forecast of $14.56 in total cost per barrel.
MS. NIENHUIS clarified that the $22 includes the transportation
costs to transport the oil from the North Slope to the market,
which is a downstream cost. The costs [presented on slide 7]
are upstream costs as they're above the point of production.
2:39:08 PM
COMMISSIONER GALVIN, in response to Chair Huggins, explained
that review of the economic drivers that drive investment and
the revenue that can be generated by changing the numbers
identified that the state's share could be increased while
protecting the investment climate. The [numbers on slide 7] are
merely the numbers that were input into the model in order to
ensure that there was accurate information. In further response
to Chair Huggins, Commissioner Galvin specified that the
modeling is based upon the $14.56 total cost per barrel.
2:40:21 PM
CHAIR HUGGINS, referring to a slide from the previous day's
meeting, highlighted that a single year [view] can be deceptive
and that large costs are often incurred at discrete timeframes,
lumpiness. The slide goes on to say that a single year can't
depict the economic picture.
COMMISSIONER GALVIN clarified that these are the numbers being
forecast based on the information that is available. He further
clarified that last year's numbers, conversations with the
industry, and understanding the trends were used to project
forward because one can't simply say that last year will be
replicated each year going forward. He opined that the
department's numbers are more accurate today than they were a
year ago because of the large data dump in the middle of the
year when the companies provided their returns. That
information was used to project going forward.
2:41:32 PM
SENATOR WIELECHOWSKI opined that these numbers and charts seem
to coincide with PPT. He asked if PPT is causing this increase
in investment.
COMMISSIONER GALVIN reminded the committees that the PPT was
passed in August 2006 and the amount of time it takes a company
to go from an investment decision to actually expending the cost
is a significant lag time. Therefore, it's extremely unlikely
that there were significant expenditures resulting from the
passage of the PPT.
2:42:24 PM
COMMISSIONER GALVIN, in response to Senator Stedman, referred
the committees to slide 4. He explained that when the true-up
payment was received in April 2007 a lot of information pointed
to the significant deviation from the fiscal note. A
modification was made in the fall, the true-up was received and
the department realized it was still off. Therefore,
conversations with the industry ensued in order to determine
what was occurring. Commissioner Galvin said, "It was based
upon the information that came in with the annual return."
SENATOR STEDMAN inquired as to how quarterly data is handled.
MS. NIENHUIS said that this will be addressed later in her
presentation. However, she informed the committees that the
department does receive information at least quarterly and the
models are adjusted as new information becomes available. The
information mainly comes from credit applications.
2:45:02 PM
REPRESENTATIVE RAMRAS posed a scenario in which ACES passes and
it's wrong. In such a scenario, he inquired as to how quickly
the department will return to the legislature to implement a
major policy change.
COMMISSIONER GALVIN emphasized, "There's a significant
difference between the reason why we're here today and simply
the fact that these numbers are wrong. That was a contributing
factor." Commissioner Galvin said he didn't expect that entire
series of events to occur again and result in revisiting the
matter due to an error in a forecasting number.
REPRESENTATIVE RAMRAS surmised then that if the numbers are
incorrect, there won't be a review of the policy unless there's
another cataclysmic situation in the legislature.
COMMISSIONER GALVIN said that he could assure the committees
that the numbers will be incorrect because they are forecasts.
The question is whether the department should use the numbers
and data it has to make the decision necessary at this time. He
opined that it's inaccurate to say that the department is
present today because the numbers are inaccurate; it's not a
true reflection of why the administration is before the
legislature. Furthermore, it's not an indication of whether the
matter will be revisited. "The administration is not of the
mindset that we need to revisit this once we have resolved the
issue at this time," he stated.
2:47:15 PM
SENATOR GREEN suggested that people on the street have been
given the idea that the $800 million delta is the reason the
legislature is in session.
COMMISSIONER GALVIN acknowledged that the dollar figure is easy
to grab on to.
2:47:58 PM
SENATOR MCGUIRE asked whether the department is privy to the
U.S. Securities and Exchange Commission (SEC) filings. She also
asked if there is any provision for information sharing with
federal agencies, such as the Internal Revenue Service (IRS),
that have more resources available to them.
COMMISSIONER GALVIN answered that he doesn't believe there's a
method for the department to obtain confidential information
from the SEC or the IRS.
MS. NIENHUIS interjected that the department does receive
federal partnership return information, which is somewhat
useful. However, she noted that it's a little bit farther from
the PPT calculation as it describes projects or something that
isn't entirely unit operation. The primary focus, she said,
will be on the required reporting from the taxpayers under ACES.
2:49:11 PM
SENATOR MCGUIRE recalled that the fiscal note for House Bill
3001, production, and the spring forecast have a slight
deviation. However, the difference in operating and capital
costs is double. From that one could assume that PPT stimulated
investment or has altered the behavior of oil companies and how
they report. She inquired as to the response of the
aforementioned from the administration.
COMMISSIONER GALVIN said that the opex is less likely to be
impacted by decisions to invest more in Alaska. When looking at
stimulating investment, it's initially expected to be reflected
in an increased level of capital expenditures that would, over
time, add to the operating expenditures as new equipment and
responsibilities are added. He related that the [department]
was most troubled by the increase in opex and the fact that
there was such a gap between what was assumed and what was
reported. In regard to a change in reporting behavior, he
related his belief that there's a question as to whether or not
the level to which there was some over reporting or whether
there was a lack of information of the true operating
expenditures, which won't be revealed for some time.
2:51:49 PM
REPRESENTATIVE SAMUELS asked whether [the department] has access
to billings sent between companies.
COMMISSIONER GALVIN noted that the department's accountants are
more familiar with the reporting being received. However, he
did inform the committees that [the department] does receive
joint interest billings, a part of which includes reports of
billings between partners. Therefore, [the department] does see
what partners charge each other.
2:53:09 PM
REPRESENTATIVE SAMUELS asked if the larger problem for DOR is
when there's a sole operator, such as the Milne Point Unit, for
which there are no billings between companies.
COMMISSIONER GALVIN explained that under HB 2001 [ACES], the
desire is to obtain more flexibility with joint interest billing
and the information it will use. The expectation is that there
will be more readily available information by an operator that
has to report to partners as opposed to one that merely has to
generate internal reports.
2:55:09 PM
MS. NIENHUIS turned the committees' attention to slide 8 titled
"Current Revenue Forecasts". She explained that she has laid
out actual estimated production tax payments that were received
for the first three months of the fiscal year. There is also
information regarding the production levels and the price. From
the aforementioned information, the department can calculate
what the tax payments should be. Rather than doing each
separately, she has lumped them together and took an average of
production and price. She then utilized those averages on the
right-hand side of slide 8 to do DOR's forecast for the three-
month tax calculation.
2:57:51 PM
SENATOR WAGONER inquired as to where the wellhead value is
measured.
COMMISSIONER GALVIN answered that the wellhead value is measured
after treatment, basically at the top of the pipe.
2:58:14 PM
MS. NIENHUIS continued reviewing the DOR calculation utilized to
arrive at DOR's forecast. She pointed out that DOR's forecast
is fairly close to the actual payments.
3:00:10 PM
SENATOR WIELECHOWSKI asked if there is an estimate of the oil
companies' profits during the same timeframe.
MS. NIENHUIS replied no.
COMMISSIONER GALVIN offered to request that information from the
section that would have it.
The committees took an at-ease from 3:00:58 PM to 3:29:10 PM.
3:29:50 PM
MS. NIENHUIS moved on to slide 9, titled "Tools for Forecasting
Costs". One of the tools for forecasting cost includes cost
reporting. Currently, cost reporting and the annual filing
isn't consistent across taxpayers. Therefore, the goal is to
make it a bit more consistent in order to obtain the data
necessary in a more timely fashion. Under ACES forecasted
information will be required. The aforementioned would enhance
the department's ability to forecast revenues, she said.
Another tool for forecasting costs is monitoring data submitted
to DOR, such as the information received by way of credit
applications. The hope, she opined, is that the data will be
better. Another tool is the ability to monitor data submitted
to other agencies, such as plans of development. The last tool
is monitoring publicly available information, which is already
occurring. The department keeps abreast of developments
worldwide, she noted.
MS. NIENHUIS continued on to slide 10 titled "Three Cost
Forecasts". The fiscal note and various publications relate the
department's best guess forecast, which she referred to as the
mid forecast. She said that this time around there is the
belief in the need to put out some cost sensitivities in
relation to various what-if scenarios. Therefore, the model
includes mid, low, and high cost scenarios. The low cost
scenario has different assumptions regarding unplanned
maintenance costs and spending behavior, and therefore it's not
necessarily a built-in margin. The low cost scenario is plus or
minus 5-6 percent of what is being spent in the current high
cost scenarios. The department can run sensitivities to cost.
In fact, the model currently includes some of that cost
sensitivity. The models also include cost adjustments based on
price as the department believes that the cost adjustments over
the last few years are related to high oil prices. She then
turned to slide 11 titled "Impact of Low, Mid, and High
Forecasts on Tax Revenues", which illustrates a cumulative
forecast production of tax revenues over three years with a $60
per barrel price. The production tax revenue forecast for three
years for the low, mid, and high price scenarios are around $6.5
billion, $5.5 billion, and $4.5 billion, respectively. Moving
on to slide 12 titled "Forecast Adjustments", Ms. Nienhuis
reminded the committees that forecasting is a dynamic process.
In fact, the department updates its price and production
forecast every six months. With cost forecasts, the department
expects to do something similar, perhaps even more frequently.
The department receives information at least quarterly, and
sometimes more often. If a change or trend in costs or a large
expenditure on behalf of a taxpayer is seen, the department
plans to build it into the forecast and become part of the
assumptions going forward. Ms. Nienhuis suggested that the
department will get better at forecasting.
3:36:20 PM
SENATOR STEDMAN inquired as to when the fall forecast could be
expected.
COMMISSIONER GALVIN said that the model will be available over
the course of the next week. The official forecast will be
complete during the first week of November. The department is
trying to provide those [forecasts] relevant to the oil side
sooner.
3:37:28 PM
MS. NIENHUIS directed attention to slide 13 titled "Forecasting
Improved Through ACES". This legislation requires more complete
cost reporting, both monthly and annually; requires forward-
looking information; provides clearer rules for defining leases;
and improves the audit function. She opined that all of the
aforementioned will improve the department's ability to
forecast. She moved on to slide 14 titled "Costs Policy
Implications" and related that costs of production shouldn't be
ignored in tax policy because understanding industry costs
provides knowledge with regard to how dollars are spent on the
North Slope. Also cost charging through credits puts the state
in "partnership" with the industry from which everyone
ultimately benefits, she opined.
3:39:54 PM
REPRESENTATIVE DOOGAN said that typically entities in a
partnership share the costs, risks, and rewards. However,
[under ACES] the state is giving tax credits to the companies
and the state isn't receiving an equity position.
COMMISSIONER GALVIN confirmed that the state isn't receiving an
equity position. However, upcoming slides will illustrate that
the state receives a benefit. In further response to
Representative Doogan, Commissioner Galvin said he is prepared
to defend the use of the term "partnership" in the sense that
there is a mutual benefit and a mutual risk.
3:40:35 PM
COMMISSIONER GALVIN turned the committees' attention to a
PowerPoint titled "The Palin-Parnell Administration presents
ACES".
3:42:06 PM
ANTHONY FINIZZA, Ph. D., Consultant, to the Department of
Revenue, reviewed his background, including 25 years as the
chief economist at ARCO. He said that he currently works as a
consultant in the energy area and is a university teacher on
energy, economics, forecasting, and industrial organization.
Dr. Finizza began by stating that some of today's discussion
reminds him of his forecasting class in which he takes at least
a week to discuss the bias that is brought to forecasting. The
strongest bias of everyone is hindsight bias, which he cautioned
against. He then informed the committees that he became
involved with [the ACES process] in August and was charged with
pulling together the work between the department and the outside
consultants and make any recommendations or communications
deemed necessary. He related that he participated in a number
of economic team meetings comprised of staff from DOR, DNR, and
outsiders during which he didn't see any bias toward choosing
the net versus gross philosophy. All on the team contributed to
the analysis and developed ideas that contributed to the net
system and others to the gross system. In fact, during the
first week he was called upon to develop a scheme to help a
heavy oil field in a gross system that might be impacted by high
costs.
3:45:51 PM
DR. FINIZZA said that he would begin by reviewing the framework
and methodology for analysis to develop an improved tax system.
Referring to slide 4 titled "Producer Economic Metrics", he
highlighted that net present value (NPV), the value of future
cash flows as well as the capital investment made on a project,
is the main producer economic metric. The NPV is a way to think
about whether a project adds value to a firm. Slide 5
illustrates a balancing act to ensure that a tax system in
place, from the producers' point of view, allows for projects to
be attractive to the producers and the state. He explained that
producer economics will be evaluated on whether the project adds
present value if undertaken. From the state's point of view,
the critical question is in regard to how much the government
take is. With regard to legacy fields, fields that are in
production, the important metric is marginal government take.
The marginal government take is how much, at a given price, an
additional dollar brings to the state. For new fields, the
metric for examining government take is a discounted government
take over the life of a field.
3:49:28 PM
DR. FINIZZA, referring to slide 6, explained that an NPV of zero
means that the company has captured its return on investment and
thus anything beyond zero is profit. He then turned attention
to slide 7 titled "Stylized Project Cash Flow" and highlighted
that typically there's a very heavy up-front capital investment
prior to any positive revenue from the investment. The flow is
returned to the investor in the future. He noted that there's
an uncertainty about the cash flow and the time-value of money,
and therefore the cash flow [of the up-front capital investment]
has to be balanced with the return on investment. Slide 8 "Cash
Flows for New Fields" has graphs illustrating an explicit
production profile that draws from characteristics of the
particular field. He reviewed the three graphs for the annual
production, capital and operating costs, and annual net cash
flow.
3:53:49 PM
SENATOR WAGONER asked if there is a general rule of thumb that
companies use with regard to amortization of investment.
DR. FINIZZA noted that appreciation schedules are followed for
both federal and state income tax purposes. In further response
to Senator Wagoner, Dr. Finizza said that the break even point
varies, although he suggested that in some high risk projects it
occurs a few years after production.
COMMISSIONER GALVIN interjected that representatives from
Gaffney Cline can speak to that during their presentation.
3:55:22 PM
DR. FINIZZA, continuing with slide 9 "Producer View of Future
Oil Prices", highlighted the need to determine whether the
fiscal regime will encourage investment, not impair investment.
The first item for review is in regard to the set of prices at
which one should perform the analysis. He pointed out that the
forecasting of oil prices is very difficult and the industry has
been burned by being optimistic with regard to high oil prices.
He said, "The consequences of error are not symmetrical." The
producer does have a view toward the future with a price path,
which he suggested is around $50 a barrel of oil. These are
long-term investments, he noted. In terms of investment
analysis, he suggested mimicking how the producers view
evaluating projects. One way is to ensure that the project can
pass the stress test case, such that if there was a downside
price fall the project would still return enough to cover the
investment. He related that today's stress price would be $40 a
barrel. Referring to slide 10, he reviewed the common
assumptions used in analyses.
3:58:49 PM
REPRESENTATIVE RAMRAS requested review of the source of funds
for these types of projects.
DR. FINIZZA said that for the purpose of economic evaluation of
the goodness of the project, the analysis is independent of how
it's financed. Therefore, the question is whether the project
stands on its own. He said that oil companies will make a later
decision with regard to how to finance a project, much of which
will be through retained earnings.
3:59:57 PM
DR. FINIZZA, referring to slide 10, explained that there are
assumptions in order to maintain uniformity: 3 percent
inflation; a producer discount rate at 10 and 15 percent with
today's results shown at 10 percent; and state discount rate of
5 percent and 8 percent with today's results shown at 5 percent.
He then reviewed slide 11 titled "Tax Plan Evaluation Process",
which reviews the tax plan evaluation process. The process was
geared toward finding good net tax and good gross tax plans. He
explained that the process begins by considering tax plans
falling within the $1,400-$2,200 million revenue range and
viewed in terms of new field economics and mature field
economics. The question for new fields is whether new field
economics are preserved such that a positive net present value
is achieved at the $40 stress test price. The question for
mature fields is whether the tax plan also preserves investment
in mature fields such that positive NPV is achieved.
4:03:16 PM
SENATOR WIELECHOWSKI requested an explanation of the meaning of
reinvestment in legacy fields.
DR. FINIZZA answered that it's investment to prevent natural
decline and keep decline at a lower a rate. Dr. Finizza said
that he would address the specifics later.
4:04:25 PM
DR. FINIZZA moved on to slide 13 titled "Seven New-Fields
Analysis", which utilizes data from known fields to create the
hypothetical fields. Slide 14 reviewed the characteristics of
the seven fields one would typically expect in development in
Alaska. The seven fields are as follows: medium heavy oil
satellite in existing mature unit, offshore small reserves,
satellite in existing unit, remote field, new unit with very
heavy oil, offshore medium reserves, and new unity with large
reserves. The fields range in reserves from 40-300 million
barrels with various combinations of ownership. Slide 15
provides more detail with regard to the characteristics of the
fields.
4:06:25 PM
REPRESENTATIVE RAMRAS asked if this exercise/model was designed
to help the legislature understand or was it developed in a
series of meetings with DOR and DNR to develop a theory to
implement ACES.
DR. FINIZZA said that the seven fields model was developed with
the notion of analyzing new fields.
COMMISSIONER GALVIN specified, "This was put together in order
to provide us with a tool to decide where to go with a
recommendation on the tax structure." The committees are being
provided with a representation of that model and the mountain of
data behind it.
REPRESENTATIVE RAMRAS asked then if the legislators should
presume that this model was used to develop the economic theory
behind ACES.
COMMISSIONER GALVIN clarified that this was the model used for
the policymakers and the governor to understand the implications
of various choices and upon which they could make a reasonable
decision on what to move forward with the knowledge of its
impact.
4:08:32 PM
SENATOR STEDMAN requested that Dr. Finizza provide a timeframe
with regard to when he was engaged with the administration and
the evolution of the process. The aforementioned relates to
what went on at the administrative level during the change from
a gross to a net.
DR. FINIZZA related that when he started in the beginning of
August, the process had already been under way and the seven
fields model had already been developed. He said he didn't know
when the model started.
COMMISSIONER GALVIN interjected that the model comes from DNR
and is one that it has had for many years in various parts. He
informed the committees that back in May, June, and July the
model was combined with a discussion with DOR in terms of
revenue of generation such that the actual field impact of
various structures was reviewed. When Dr. Finizza entered the
scene, most of the analysis had already been performed and Dr.
Finizza participated in analyzing the different outcomes and
choosing amongst the impacts and refining it. In further
response to Senator Stedman, Commissioner Galvin clarified that
there are two major models involved: the seven fields model
from DNR, and a revenue estimation model from DOR. The decision
making within the model and the results occurred within the
conversations between the departments and the governor's office.
SENATOR STEDMAN inquired as to the tweaks Dr. Finizza made to
the model.
4:12:59 PM
DR. FINIZZA returned to slide 11, and stated that each of the
three boxes is a model. For example, the left box represents a
revenue model. The first step is to start with a set of tax
assumptions to satisfy some revenue range being sought. The
results, which are characteristics of the tax plan, are the same
features used in the second model, the new fields model
developed by DNR, in the second box. The third model is the
mature fields model, which is simpler. He noted that he
contributed to the third model as it wasn't finished at the time
he became involved.
4:14:59 PM
SENATOR WIELECHOWSKI directed attention to slide 15, and related
his understanding that for Field A the capex is $11 a barrel and
the opex is $7 a barrel with an additional $7 a barrel for the
tariff, which amounts to $25 a barrel to bring the oil to
market. Therefore, at $40 a barrel money will be made on Field
A, he surmised.
DR. FINIZZA pointed out that with Field A the capital is put up-
front and the profit comes much later. In fact, the time value
of money has the potential to destroy the value of that project
because of the heavy up-front capital piece.
SENATOR WIELECHOWSKI said that Field D seems to be the most
expensive of the fields listed on slide 15. However, all the
fields listed are profitable at $40 a barrel.
DR. FINIZZA reiterated that all the fields have high up-front
capital costs prior to oil flowing. Profit comes many years
later, probably well after the peak and thus it could be perhaps
seven to eight years before profits arrive. Dr. Finizza said
that the snapshot would seem to relate that the fields are
profitable from day one, but that would only be the case if the
capital side of the equation is eliminated. Dr. Finizza said
that although he didn't develop the seven fields model, he did
[review] it to ensure that it accomplished what he thought it
should.
4:17:44 PM
REPRESENTATIVE SAMUELS, referring to slide 11, asked if in the
tax plan one would also consider the potential of increased
royalties with increased production. From the economics, he
asked if the extra royalty or a steep decline curve when
investments are made is incorporated or is it kept at 6 percent
or 8 percent in this model.
DR. FINIZZA explained that all the analysis is performed at the
same price and production profile. Dr. Finizza requested
clarification of the question.
REPRESENTATIVE SAMUELS asked whether a different production
profile is used if an investment isn't made. As costs decrease
because spending isn't occurring, does the production drop from
6 to 6.5 percent, he asked.
DR. FINIZZA explained that [the process] was examined for the
existing fields. He noted that the revenue target is short term
and compared to the new fields, which doesn't impact the revenue
range looked at over the next few years.
COMMISSIONER GALVIN said that the box illustrates the cycle of
the analysis, not how one reaches the decision as to what is the
optimal choice. He explained that one must review a range of
revenue-generating taxes simply to bracket the sample size. The
objective, he opined, is to ensure that no projects are lost and
to only select those tax systems to move into the next level of
evaluation that wouldn't result in a decline in production. "It
wasn't so much that we had to build in an assumption of a
decline curve because we chose a revenue stream that was too
high to allow for those projects to go forward because once ...
it resulted in a loss project, it was no longer considered," he
explained. He noted that the mature fields are a different
model in which they were reviewed in relation to the impact to
existing fields and what that would do to the mature fields.
The mature field model was determined to be less sensitive than
the new field model. Therefore, the new field model became the
driver and the mature field model became the confirmation that
it was okay.
4:22:27 PM
REPRESENTATIVE NEUMAN, referring to slide 15, related his belief
that most investments in new fields are reinvestment earnings.
He requested [clarification] of how the net present value and
the ratings apply in the different fields.
4:24:01 PM
DR. FINIZZA indicated that it may become clearer with the
results. He then turned the committees' attention to the graph
referring to "Annual Net Cash Flow" on slide 8. He explained:
The one on the right, the "Annual Net Cash Flow",
that's production times revenue minus costs and other
expenditures that you make in that year, taxes,
etcetera, coming out. And you're trying to say if I
were standing at a point in time, at the beginning of
this chart, and I make an investment of $1 billion ...
and if I have a discount rate of 10 percent rate ...,
I would expect to be able to earn that kind ... of
money each and every year. The fact that I have a
negative outflow at the beginning poses a big burden,
it really requires me to do very well in the future to
compensate that because that dollar in five years is
lost its time-value plus the opportunity to make that
investment.
4:25:39 PM
REPRESENTATIVE NEUMAN surmised then that the $1 billion
investment has to equate on top of the $32 per barrel actual
cost of production.
COMMISSIONER GALVIN suggested that once one gets to the point of
producing, the operating expenditures are being experienced as
a single field. The profit in that particular year will be a
reflection of the operating expense plus the transportation cost
which will be subtracted from the price. In a scenario in which
a $1 billion up-front investment is made and the discount rate
is 10 percent, then a company would need to make $100 million a
year to break even. If a company receives its $100 million each
year, then the [project] would be considered to have a NPV of
zero. He explained that a company would take the price minus
operating and transportation expenses, and determine whether
it's above or below $100 million year. Anything about $100
million a year will result in a positive NPV whereas anything
below would be negative and "slide that out" for all the
expected positive cash flows.
4:27:48 PM
COMMISSIONER GALVIN, in response to Representative Doogan,
clarified that if a field/project that would otherwise be
positive and receive investment was placed in a category of not
obtaining investment to proceed, that field/project wasn't
considered. He reminded the committees that the goal was to
protect the investment climate. In further response to
Representative Doogan, Commissioner Galvin confirmed that these
seven fields were the only ones used and the one at the bottom
will become clear momentarily.
4:29:12 PM
SENATOR STEDMAN, referring to the graph on the right of slide 8,
suggested that 25 years ago there would have been a much lower
stress price than $40. He surmised that the particular field
would be skewed if a project was decided upon and $40 a barrel
of oil increased to $80 or $90 a barrel of oil. He then
suggested that it would be rational to assume that a 25-year-old
field in Alaska that's still producing is a valuable cash
generating asset at $60-$80 a barrel oil.
DR. FINIZZA replied yes, adding that many such fields will
require capital to continue to produce.
4:30:36 PM
DR. FINIZZA moved on to slide 16, which reviews some of the 25-
plus tax scenarios considered. In the analysis it became
apparent that given the up-front capital, a gross tax system was
enhanced and needed with a credit "to make it even come close."
Still, the gross tax system wasn't found to be overwhelmingly
favorable. He then highlighted that one of the gross plans
utilized a tax table with a five-year tax holiday, progressivity
as the price increased, and a high tax rate for mature fields.
He continued with slide 17 that provides a description of a new
field model. The aforementioned is a cash flow model that
mirrors the production process and tax system.
4:34:36 PM
DR. FINIZZA turned attention to slides 18-19, and specified that
the left portion of the spreadsheet contains the assumptions of
the tax plan and is segregated into net taxes on the top and
gross taxes on the bottom. The right side of the spreadsheet is
the NPV at $40 a barrel for each of the seven fields. Although
the model traces the NPV at all prices, the critical point is
where the stress price is. After reviewing the plan, the
question would be whether the plan preserves economics. Dr.
Finizza then walked the committees through ACES, as is, versus
the PPT and highlighted that ACES has a higher value. He then
moved on to the gross tax system and highlighted that there's no
gross tax scheme in the first four rows that preserved economics
such that it would be positive in a net system. He acknowledged
the entry for the progressive tax table in the amount of $40
million, and explained that in trying to implement the
aforementioned tax table the difficulty in treating the field
lives differently was discovered. He then highlighted that
Field E, which has one of the highest costs, doesn't fair well
under either a net or gross system. The negatives throughout
the gross production tax scenarios suggest that they wouldn't
work over a wide range of real fields that Alaska could expect
in its future.
4:40:14 PM
SENATOR WIELECHOWSKI related his understanding that under ACES
all the fields are fairly comparable, save Field A. He inquired
as to why such a large disparity exists with the various net
production tax scenarios for Field A. He further inquired as to
whether there are a lot fields on the North Slope that are
comparable to Field A.
COMMISSIONER GALVIN reminded the committees that Field A is
within a legacy field and is a heavy oil project, which means
that it has the strained economics of the heavy oil and will
potentially be impacted by the gross tax floor. The crossover
point with the gross tax floor is around $40, $41. Therefore,
when one assumes $40 across the line, it will impact the
economics of that particular field.
SENATOR WIELECHOWSKI suggested that there would be the desire to
treat heavy oil fields differently, since there's a lot of heavy
oil on the North Slope.
COMMISSIONER GALVIN said that various options were reviewed and
it was determined that a net-based system is the most effective
means to target the heavy oil. The methods of manipulation
available for a gross-based system aren't precise. Furthermore,
such methods won't necessarily reflect the actual economics of a
particular project because a proxy for a cost will be chosen and
it's likely to miss the mark and won't be as effective as simply
allowing the deduction of the costs of the marginally challenged
field.
4:42:39 PM
SENATOR WIELECHOWSKI opined that if the goal is to maximize
benefits to Alaskans and to maximize investment, then a tiered
system could be tailored such that maximum benefit is received
from legacy fields while treating the viscous oil, heavy oil,
and legacy oil fields differently and having some form of a net
profits tax on the exploration fields. The aforementioned would
seem to achieve the best of all possible worlds, he said.
COMMISSIONER GALVIN said he would agree, but emphasized that
thus far no one within Alaska has identified an integrated
system in which there is a method to segregate and tax
separately one type of oil for another. He noted that [DOR]
spent a great deal of time working with DNR, which would be the
entity upon which segregation of the oil would fall. The result
of the conversation was the recognition that it wasn't going to
be a practical outcome because of the inherent incentive to
identify all new projects as new oil and the lack of a
technically verifiable method to specify whether it's really new
or not.
SENATOR WIELECHOWSKI surmised that's the point at which the
auditors enter. If the aforementioned is done elsewhere in the
world, he said he has faith it can be accomplished in Alaska.
COMMISSIONER GALVIN said that once the oil comes out of the
ground, the auditors would be the least knowledgeable about
whether it came out of what's considered a new pool versus an
existing pool. The conversations resulted in the realization
that the state doesn't have the necessary tool, and therefore
other options had to be reviewed.
4:46:32 PM
REPRESENTATIVE SAMUELS pointed out that the effective tax rate
increases once the floor is reached, although that's the time
when investment is needed the most, in a scenario in which there
are falling oil prices and profits. The aforementioned seems
backwards, he opined.
DR. FINIZZA highlighted that it's important to review a project
in terms of prices. He related his belief that a floor would be
valuable to protect the state against falling prices.
REPRESENTATIVE SAMUELS, with regard to attracting ongoing
investment in Prudhoe Bay and Kuparuk, surmised that ongoing
investment is necessary to keep the decline curve up.
DR. FINIZZA noted his agreement, and added that one, as a
producer of those types of fields, should expect a very cyclical
pattern of revenue over time. He clarified that he's portraying
that there wouldn't be a serious impact on investment to say
that the project will make sense at $60 a barrel on average with
deviations to $40 and $80 from time to time.
4:49:42 PM
REPRESENTATIVE DOOGAN recalled testimony that most of the oil
revenue from the production tax comes from the legacy fields.
However, only one legacy field project was modeled and it was
the most difficult one at that. He inquired as to why there
seems to be disproportionate modeling with only one legacy field
when that's from where most of the oil revenue comes.
COMMISSIONER GALVIN explained that a new heavy oil project out
of a legacy field is considered a new venture, a new level of
investment, and a new target. Therefore, it's treated as a new
field so the investment question is analogous to similar
questions directed outside the legacy fields. At the legacy
mature field level of analysis there's a certain amount of
investment necessary to maintain production at certain level of
decline. The gap between not investing and investing can be
treated as if a separate project in the existing field and
infrastructure, he explained. For example, Field A was placed
in the analysis of a new field as opposed to being placed in the
overall reinvestment in the existing fields. In further
response to Representative Doogan, Commissioner Galvin said that
another model reviewed existing fields.
4:52:47 PM
REPRESENTATIVE DOOGAN related his understanding that in all
cases Field E is under water at a $40 stress price. He asked if
that's because it has a relatively high capital cost and heavy
oil will be slow to produce.
COMMISSIONER GALVIN replied yes.
REPRESENTATIVE DOOGAN surmised then that adopting a medium rate
gross production tax on the new project in the legacy fields
would make money.
DR. FINIZZA specified that it's at 30 and compared to ACES it's
less than [30] and considerably less than under the PPT.
REPRESENTATIVE DOOGAN further surmised then that although it's
less profitable, it's still profitable.
COMMISSIONER GALVIN interjected that it's important to recognize
[that's the case] under this model and the information
available.
REPRESENTATIVE DOOGAN pointed out that for Field A the
administration's proposal only results in a 10 whereas a medium
rate gross tax is a 30.
COMMISSIONER GALVIN explained that's because of the effect of
the floor that kicks in at $40. Therefore, moving to $42 or
$43, suddenly it's at 120 whereas at the medium rate gross, the
30 doesn't change much when moving from $41-$43.
4:55:07 PM
COMMISSIONER GALVIN, in further response to Representative
Doogan, said that in order to provide the numbers on the chart a
snapshot is taken. The $40 price was recognized as an adequate
stress price, although different companies will have different
numbers. He explained: "We could show you it at $45 and the
difference would be that the ACES with the floor and without the
floor would have no change at any of the fields. But that
wouldn't be ... a fair representation of the potential impact of
the floor on an economic decision. But if we showed you that
$45, the change in the impact of that medium rate gross would be
fairly small." He suggested that companies will view the
aforementioned situations differently and view more of a
likelihood of a less economic situation at the gross situation
rather than the floor situation.
DR. FINIZZA clarified that the notion was to move away from
picking an entry in the table. Therefore, the approach was to
view a tax scenario across all fields.
4:57:07 PM
REPRESENTATIVE DOOGAN opined that either these are good numbers
or not. He further opined that an oil company with Field A
would like the medium rate gross production tax better than ACES
because "it's using the stress price that you're telling me they
use and making the decision the way you're telling me they make
it, that's a better deal for them."
COMMISSIONER GALVIN explained that he's trying to provide
information that represents the distinctions in the programs in
a way that doesn't hide any facts while not overwhelming the
committees with information at each price. He further explained
that the exercise was extremely dynamic and he's trying to
condense a couple of months of work for the two hour
presentation today. He indicated that this isn't a pure
representation of the economic decision being made and offered
to provide a broader view of the sensitivities between the
different choices.
4:59:47 PM
SENATOR STEDMAN recalled the difficulties surrounding the floor
and the progressivity under the PPT. He said that the
progressivity was partially utilized to have more on the upside
at $60, $70, and $80 a barrel oil. After much debate, the floor
mechanisms were deliberately left out because there was more
economic interest for the state to take a higher percentage at
$60-$80 a barrel oil. He said that he will personally push for
the concept of the state taking a larger percentage at higher
oil prices.
COMMISSIONER GALVIN characterized that as a legitimate policy
call. The information being provided is the information that
lead the administration to its policy calls, he noted.
5:03:04 PM
SENATOR STEDMAN recalled that the state was better off when it
took a couple of years of a larger percentage with higher oil
prices than having the floor. The important caveat is that the
state takes the revenue during the high revenue times and roll
it forward, which is occurring. The aforementioned is, in
effect, preparing the state for the collapse of oil prices.
5:03:45 PM
CHAIR HUGGINS related that he received a call asking whether the
state is in high level negotiations over the gasline to which he
responded that he didn't know. He then recalled that during the
hearing of AGIA, there was insistence from some in the
legislature that as soon as requests were received, the
legislature would see those and there wouldn't be any surprises.
Therefore, he inquired as to whether the state is in high level
negotiations over the gasline.
COMMISSIONER GALVIN replied no, and added that [AGIA] created a
public, competitive process that will provide the next step in
discussions in the form of proposals that are received.
5:06:01 PM
CHAIR HUGGINS said that he was told that on KTUU one of the
administration's special assistants said, "We are in high level
negotiations on the gas pipeline."
COMMISSIONER GALVIN responded:
That was a turn of phrase to represent that when the
producers come out publicly and make a statement with
regard to what they feel about the nature or the
likelihood of the pipeline going forward, that it is a
representation that there's a great deal of
negotiation going on. Very publicly these
negotiations are going on where there's an attempt to
influence the market, influence the interest in
participating in our competitive process. And that we
shouldn't take everything at face value, that we
should recognize that there is a negotiation going on
out in the public, over the future of this gas
pipeline. And that was the point of that
representation.
CHAIR HUGGINS suggested that perhaps that needs to be clarified
throughout the state.
5:07:24 PM
COMMISSIONER IRWIN noted his agreement with Commissioner Galvin.
He explained that to ensure there are no behind-the-scenes
negotiations, as soon as the request for applications (RFA) was
put out an independent blind portal website was established.
This website allows companies to ask technical questions without
the administration knowing from whom the question comes. The
aforementioned illustrates that the administration has gone to
great lengths to ensure that this is a fair and open process.
5:09:20 PM
CHAIR HUGGINS suggested that to the extent reasonable the
conversations the administration is having be shared with the
legislature. He expressed interest in the legislature being up
to speed when contracts are received. He then expressed concern
with regard to Dr. Van Meurs comment on the economic viability
of a gasline.
COMMISSIONER IRWIN commented that consultants say many things.
He then related that he has heard from multiple sources in the
Lower 48 with regard to the extreme demand for Alaska's gas.
5:11:01 PM
CHAIR HUGGINS emphasized the need to listen to Dr. Van Meurs and
suggested that it bears analysis as to why he came to the
aforementioned conclusion. Chair Huggins further emphasized,
"This is about the revenue for ... 50 years out." He then asked
if the administration holds the belief that the first gas will
arrive in 2013.
COMMISSIONER GALVIN responded that in two months more will be
known. On behalf of the administration, Commissioner Galvin
said that he and Commissioner Irwin would know if there are any
high level negotiations related to the gasline. Commissioner
Galvin specified that no high level negotiations with regard to
the gasline are occurring. Furthermore, Dr. Van Meurs'
statements regarding the viability of the project were premised
on his assumptions that the cost estimates used seven years ago
were an accurate reflection of the cost to get from the North
Slope to the market - those costs having doubled - and on the
question of whether the market could bear the price necessary to
account for the doubling of those costs; those assumptions will
be proven one way or another in a few months. Commissioner
Galvin pointed out the need to have the process play out,
receive the applications, and receive the information regarding
the current cost estimates.
5:13:09 PM
CHAIR HUGGINS recalled that during the earlier mentioned KTUU
broadcast, it was said that the first gas will arrive in 2013.
COMMISSIONER GALVIN said that he wouldn't back that up because
he doesn't know upon what it's based.
COMMISSIONER IRWIN said that the premise with AGIA is to obtain
bidders and then recommend a winning applicant.
5:14:37 PM
SENATOR GREEN commented that it's troublesome that the
administration has staff making such statements.
5:15:07 PM
SENATOR WIELECHOWSKI, returning to slide 15, inquired as to the
most common types of fields that the state needs to incentivize
on the North Slope. A plan to incentive whatever is the most
common type of field should be crafted, he opined.
COMMISSIONER GALVIN answered that there are a variety of
potential developments that are foreseen. The administration
isn't in a position of identifying which field is most likely
since the industry is still evaluating those as well. The
administration, he related, felt it inappropriate to substitute
its judgment and prioritize among the seven fields. Therefore,
the seven fields provides a spectrum.
SENATOR WIELECHOWSKI surmised that heavy oil legacy fields, such
as Field A, are the type that should be incentivized.
COMMISSIONER GALVIN said that Field A is a representation of a
near-term heavy oil project. There are probably other fields
that would be further down the line, in terms of more stressed
and perhaps being pursued after the state has had a longer
experience with higher prices. Currently, Field A is the
state's best representation of a heavy oil field.
5:17:24 PM
SENATOR WIELECHOWSKI said it would be most helpful to know what
type of field the state is trying to incentivize on the North
Slope.
COMMISSIONER GALVIN offered to have a separate briefing from
DNR. He then pointed out that one challenge in an open public
forum is to balance what can and can't be revealed with regard
to various aspects of these fields.
SENATOR WIELECHOWSKI suggested that perhaps there should be a
closed session because this is a critical issue. He opined that
the legislature can't be expected to make this decision in a
vacuum.
COMMISSIONER GALVIN acknowledged that the legislature will have
to decide how much of the information it will need and the steps
necessary to provide the information. He reminded the
committees that the Department of Law has said that once the
legislature is in session, there is more of an opportunity to
have executive sessions, private briefings, confidentiality
agreements, and so forth. Therefore, it's up to the legislature
to make a determination as to whether it wants to engage more in
the details.
5:19:11 PM
SENATOR STEDMAN commented that he is looking for more oil
patches to be developed. He then recalled that earlier
Commissioner Galvin had said that any high level negotiations
were through the press or the news media.
COMMISSIONER GALVIN clarified that he was characterizing the
intent of the statement to which Chair Huggins referred. There
was a statement made in response to a public statement that
characterized the nature of the project or the likelihood of
additional participants. That statement was to make sure that
Alaskans recognize that the state is involved in a high level
negotiation as it relates to the state's natural resource. The
aforementioned wasn't intended to mean that there were private
negotiations between the administration and a project proponent.
The aforementioned was a way that [the administration's staff]
described the public discussion occurring with regard to the
gasline project.
The committees took an at-ease from 5:20:59 PM to 6:19:55 PM.
6:20:02 PM
DR. FINIZZA said that slide 19 relates the implications for the
state revenues from the various [net profit tax] scenarios.
6:21:13 PM
COMMISSIONER GALVIN recalled from a previous hearing that
Representative Doogan had requested an indication of the return
on the investment the state is making. This is a reflection of
the net present value to the state of the cash flows that would
arrive through the tax system alone and demonstrates the value
of the projects going forward. Therefore, in a sense it's a
reflection of the investment in the form of the credits and so
forth and how much the state will receive because the project
moved ahead.
6:21:49 PM
DR. FINIZZA moved on to slide 20, which refers to the government
take and the position of Alaska in relation to the other tax and
royalty regimes. He highlighted that the median government
take, discounted at 10 percent for ACES, over the six potential
new fields with a positive present value is 70 percent.
6:22:32 PM
SENATOR WIELECHOWSKI drew attention to the median government
take of 68 percent under the PPT, which varies quite a bit from
the average tax rate projected by Econ One last year at which a
tax rate at $60 under various proposals resulted in about 61
percent government take. He related his understanding that
under ACES the state boosts its tax rate significantly.
However, ACES raises less money than what PPT would raise.
Therefore, he inquired as to how ACES has a higher tax rate than
PPT.
DR. FINIZZA explained that [the information on slide 20] uses
today's cost structure and each field has the same cost
structure. The Econ One information from last year used a
different concept and was done over existing production, and
thus there was no information regarding new fields. Also the
Econ One information was looking at undiscounted government
take.
SENATOR WIELECHOWSKI surmised then that the way in which the
calculation is occurring is changing under ACES. He said that
he has a much harder time understanding that there's a much
higher tax rate under ACES because the state is receiving less
money under ACES than under PPT.
6:25:22 PM
COMMISSIONER GALVIN clarified that there are different ways of
calculating government tax. The 61 percent is based on one
method of measurement as current cash flows are reviewed across
the entire North Slope in current amounts. However, [slide 20]
is looking at future projects and reviewing them from cradle to
grave over the net present value of the cash flows. He then
highlighted the need to recognize that the government take is
inherently a calculation on the net. When costs increase by 50-
100 percent, that alone has a significant impact on the
government take calculation when reviewing Alaska specific
economics. Commissioner Galvin said that an apples-to-apples
comparison would be more analogous to the slide addressing the
current cash flow and the difference between the two is
primarily the cost. Therefore, when compared across the same
method of calculation, the deviation is the cost story.
SENATOR WIELECHOWSKI inquired as to why a different calculation
would be used this year as compared to last year.
DR. FINIZZA echoed that [slide 20] is reviewing the fields where
the full cycle, cradle to grave, can be measured. Those were
calculated in fields under production for a long time, and
therefore one wasn't able to make the calculation like that [in
slide 20]. This [calculation] isn't appropriate for new fields
and [the Econ One analysis] didn't include new fields.
SENATOR WIELECHOWSKI related his belief that one would want a
lower tax rate on new fields.
COMMISSIONER GALVIN said that it's a matter of comparison. He
clarified:
We're not saying that the numbers that were used last
year were the appropriate target or not. We used the
same calculation method and under ACES, it's 65
percent that we're going to get to. This time around,
because we have the field models, we can also ...
model government take based upon the project's life
cycle, which is, frankly, the one that you find most
of the time in the government comparisons between
different regions. And so, we were able to do that
for these ... six fields that were economic. ...
we're not substituting one for the other because we're
providing them both. But we're saying this is an
additional tool for making that evaluation.
6:28:46 PM
REPRESENTATIVE DOOGAN requested why, for the government take,
the calculation uses a 5 percent NPV and a $60 price.
COMMISSIONER GALVIN, with regard to the discount rate and the
state's perspective, clarified that the time value of money is
different to the state than to private industry. Therefore,
it's appropriate for the state to review the cash flow stream
with that different discount factor. From the industry's
perspective, the industry views it as a higher risk factor
because it wants to obtain a higher return on its money. When
one reviews the industry's investment decision, the industry
will test it at the stress test, $40, rather than the expected
price. However, it would be misleading for the state to say
that it will check what revenues will be available at a $40
price when the state expects it to be much higher and thus the
state uses what's closer to the expected long-term price, $60.
REPRESENTATIVE DOOGAN surmised then that $60 is closer to what
the state is forecasting oil prices will be over the long term.
COMMISSIONER GALVIN stated his agreement.
6:30:32 PM
DR. FINIZZA moved on to slide 21, which places the six projects
in the array of all the projects in the analysis that Petroleum
Finance Company (PFC) did for tax and royalty regimes. As the
graph illustrates, Alaska's government take falls in the third
quartile.
6:31:00 PM
SENATOR WIELECHOWSKI asked if it's true that the discount rate
is a huge factor. He further asked if it's fair to say that the
tax rate can be adjusted, and companies can bear it when there
are high capital credits up-front.
COMMISSIONER GALVIN said yes.
DR. FINIZZA nodded yes.
6:31:45 PM
REPRESENTATIVE RAMRAS inquired as to how to address the fact
that this is a significant tax policy change within 14 months.
DR. FINIZZA commented that various factors beyond government
take, including prospectivity and fiscal stability, are
considered in determining where someone might invest and in that
sense, it's a factor. However, it isn't a factor in this
analysis [before the committees today].
6:33:22 PM
REPRESENTATIVE RAMRAS commented that he has been troubled with
regard to the deviation to the KTUU news story and said that he
thinks highly of the staff who was quoted by KTUU.
6:34:13 PM
DR. FINIZZA continued with slide 22, which concludes the new
fields portion of the analysis. After all the scenarios that
were run, it was determined that the new fields would likely not
be developed under a gross tax system, as a broad tax policy.
For these heavy capital intensive fields, capital credits are
essential to preserve investment efficiency and keep that
climate positive. Dr. Finizza pointed out that ACES tends to
level the playing field for small producers [and new entrants]
because of the ability to monetize losses at the tax rate.
6:35:03 PM
REPRESENTATIVE DOOGAN related his understanding that references
to a "gross tax system" refer to a tax system with no credits or
deductions of any kind.
DR. FINIZZA mentioned that things that did have a tax credit for
investment were included in the gross tax system. However, it
wasn't a cost-based system in which operating costs could be
deducted.
REPRESENTATIVE DOOGAN surmised then that a gross system is a
system in which the companies wouldn't be able to deduct
operating costs.
COMMISSIONER GALVIN indicated agreement. He then highlighted
that missing from this slide and the charts is that comparisons
of the various gross tax systems was performed using an apples-
to-apples comparison. In other words, the goal was to compare
the net tax with a gross tax that would result in a similar
amount of revenue. The various rates and investment impacts are
all on gross tax-based systems that are expected to result in a
similar amount of revenue to the state. Therefore, on slide 22
when it says that new fields would likely not be developed under
a gross tax system, it's a gross tax system that would bring in
a similar amount of revenue as would ACES, for example.
6:37:11 PM
SENATOR STEDMAN referred to the monetization of credits. He
asked if there has been an analysis on the purchasing power loss
that the credits will produce. He expressed interest in
obtaining background as to why the state should take an interest
(indisc.).
COMMISSIONER GALVIN explained that the information on slide 22
that specifies, "Can monetize losses at same rate as large
producers" refers to net operating losses an explorer would
experience when that explorer doesn't have any production.
Under PPT, that's carried forward the following year at the 20
percent rate. An existing producer would be able to deduct that
at the 22.5 percent rate. Under ACES the explorer can carry it
forward at the tax rate, and therefore it's an equivalence with
a year delay. The aforementioned is illustrated in some of the
increase in value between going from the PPT to ACES on some of
the projects. With regard to receiving 100 cents on the dollar
for credits, Commissioner Galvin explained that the state
doesn't receive reports regarding the amount for which credits
were sold. The reports received prior to the August 3rd report
was that the companies were having difficulty finding a market,
but since that time there have been reports that companies have
sold a number of credits close to full value. In the end, the
administration believes there's a policy justification for the
state providing full value rather than requiring it to be sold
at a discount. In terms of quantifying the discount, that will
have to come from the companies.
SENATOR STEDMAN opined that with issues such as this there seems
to be a lack of backup. He further opined that if there were
issues in a particular market, the numerics of the trade would
be available to illustrate that there's a problem and there
would be calculations on the opportunity loss of carrying these
[credits] forward. He said he wasn't sure that the state should
be all that concerned. In fact one of the questions that needs
to be asked is whether the 20 percent credit is too much.
COMMISSIONER GALVIN reminded the committees that it's a private
market with private deals, and thus the parties determine how
much information they will make available to the state. Aside
from that, it's ripe for a policy discussion with regard to
whether it's appropriate for the state to provide full value or
not. There is also the question as to whether explorers should
be provided with the same level of credits as others are
provided.
SENATOR STEDMAN recalled that some of these issues were fully
debated under PPT while others weren't.
6:42:12 PM
DR. FINIZZA directed the committees' attention to the analysis
of mature fields, which he said isn't as detailed as the seven
fields analysis as there isn't much knowledge of the project
specifics. Still, some assumptions can be made that result in
the conclusion that a gross tax doesn't bode well for mature
fields. As specified on slide 24, the assumption is that
reinvestment in legacy fields requires substantial capital in
order to keep the decline from occurring very quickly. He
pointed out that one mode to consider is placing a mature field
in a harvest mode in which the field is allowed to decline
naturally. The assumption was 15 percent decline per year.
Another mode, reinvestment, is one in which capital is invested
to stem the decline such that it's at 3 percent per year. If
each mode is thought of as a separate project, one can perform
the analysis in the same sort of net present value manner and
compare the economics of investing versus investing less. A
picture of that, slide 25, illustrates a reinvestment mode
decline that's a slow slope and the harvest mode with a sharp
decline of 15 percent.
6:44:23 PM
SENATOR WIELECHOWSKI inquired as to the mode under PPT.
DR. FINIZZA said that currently [the state] is close to the
reinvestment mode, which he opined would probably be the case
for any net system.
6:44:46 PM
REPRESENTATIVE RAMRAS inquired as to how a more aggressive tax
would impact the harvest mode. He related that one could
conclude that the more is harvested in taxes, the more the
reinvestment mode could be hampered.
DR. FINIZZA answered that in general, that's true. However, at
a given net tax rate, even if the tax rate is higher than under
the PPT, one would still be better off investing than adopting a
harvest mode. He explained that the aforementioned is the case
because the net present value is still higher to invest. He
acknowledged that although it may be lower in a lower tax world,
it would be better than the alternative.
REPRESENTATIVE RAMRAS surmised that the alternative is to leave
the oil in the ground.
DR. FINIZZA replied yes, adding that one could leave a lot of it
in the ground.
COMMISSIONER GALVIN pointed out that the oil itself, the
production of the oil, and the profits that will be generated
are the motivators to obtain the investment. The tax system
won't make the decision. Regardless of whether it's PPT or ACES
if the value of the oil remains and making the investment
remains, the investment will be made.
6:46:28 PM
REPRESENTATIVE RAMRAS noted his agreement, save for those
marginal projects that are lost, the dampened investment
climate, and the view that Alaska becomes a basket of
instability. To shift tax policy again and dampen the broader
climate introduces another variable, that of instability, that
hasn't been articulated in any of today's slides. He opined
that tax policy impacts behavior. He then inquired as to Dr.
Finizza's sense of the variable that tax policy impacts
behavior.
COMMISSIONER GALVIN reminded the committees that yesterday there
was discussion with regard to stability, which is clearly an
issue as it relates to the attractiveness of investment in
Alaska. Today the discussion is centering around the economic
side in which stability can't be quantified.
REPRESENTATIVE RAMRAS interjected that stability will be
discussed every day because it's a big deal.
COMMISSIONER GALVIN clarified that these are economic models and
the issue of stability isn't included in each slide. He
emphasized that the issue of stability isn't being ignored.
6:49:36 PM
CHAIR OLSON expressed concern with the work product being
produced in this short time. He highlighted that when this
issue was addressed the last time it took eight months.
6:49:54 PM
REPRESENTATIVE DOOGAN inquired as to from where the 3 percent
and 15 percent came.
DR. FINIZZA specified that those percentage came from
information he collected with regard to the production forecast
that was made for the state. He noted that there were a range
of potential volumes that seem to fit the harvest mode.
REPRESENTATIVE DOOGAN surmised then that Dr. Finizza determined
that if there was no reinvestment, there would be a 15 percent
decline in production. He inquired as to the assumptions that
resulted in the 3 percent annual decline.
DR. FINIZZA, referring to slide 26, explained expenditures of
$15 a barrel for the reinvestment mode over the 20-year horizon.
In the harvest mode, those things to keep the field going would
result in about $5 barrel. The critical variable is the
difference between the two. The assumptions were applied to
various sampling of tax cases. Over the 20-year horizon, the
NPV of those strategies with those tax policies was calculated.
In the first column, the sustain production mode, ACES had a NPV
a little over $8 billion. In the harvest mode there would still
be a positive NPV of about $6.9 billion. Therefore, a producer
with these options would improve its NPV by investing to sustain
a low decline mode. If there was a switch to any gross case,
the opposite conclusion happens in each such that the sustained
production load had a NPV lower than just allowing for strict
harvesting. The volume of oil recovery in both cases is fairly
substantial as well, 1 billion barrels less.
6:53:31 PM
REPRESENTATIVE DOOGAN surmised then that the lower the taxes,
the more barrels of oil will come out of the ground. He asked
if the aforementioned is why the NPV under the PPT is higher
than the NPV under ACES.
DR. FINIZZA explained that the PPT has a higher NPV because the
tax rate is lower. The NPV under PPT of doing nothing or to
allow a rapid decline by investing less is higher than the ACES
case. The difference between the two still relates that under
the PPT, the NPV is improved with investment as would be the
case with ACES and even a higher tax rate.
REPRESENTATIVE DOOGAN asked whether the 3 percent of sustained
production is a prediction of what will happen if the changes
the governor recommends are passed. In other words, will the
decline rate be cut in half with the passage of HB 2001.
DR. FINIZZA said that he made no assumptions about any change in
the decline rate as a result of any of the tax policies. In
further response to Representative Doogan, he confirmed that he
picked 3 percent and then ran the calculation.
6:55:35 PM
SENATOR STEDMAN inquired as to the amount of extra capital
necessary to maintain 750,000 barrels of oil per day or increase
to 1 million barrels on the Trans-Alaska Pipeline System.
DR. FINIZZA said he couldn't answer that question.
COMMISSIONER GALVIN related his understanding that no matter how
much investment is made in the legacy fields, the [producers]
won't be able to level it out. With regard to the question as
to whether the decline can be slowed by investing more money,
Commissioner Galvin said yes. However, the question regarding
how much the decline can be slowed remains. This slide simply
illustrates that the amount [an explorer] needs to invest to
stave off the production decline is a decision that will be made
from now over the next 20 years. He opined that [the
administration] wants to ensure that the tax code doesn't
provide a disincentive for that investment. Based on these
assumptions, under ACES or PPT the choice will be to make the
investment because more money will be made from the oil than if
the investment wasn't made. However, under a gross tax scenario
on the legacy fields, the investment decision is driven toward
not investing and letting the field decline. The aforementioned
isn't in the state's interest. Commissioner Galvin pointed out
that the aforementioned led to the decision in terms of the
impact of gross tax versus a net tax and where the rate could
move.
SENATOR STEDMAN recalled discussions during the PPT when it was
said that an extra $1 billion reinvestment a year in the field
is necessary on an ongoing basis to slow decline. He expressed
interest in having some targets as the oil basin is monitored.
6:59:52 PM
REPRESENTATIVE SAMUELS asked if the 15 percent decline refers to
normal reservoirs around the world or only to Prudhoe Bay and
Kuparuk.
DR. FINIZZA said that's probably a better question for a
geologist rather than an economist. He said that he has
received numbers from geologists relating to Prudhoe Bay. He
then recalled a similar decline rate in BP discussions.
REPRESENTATIVE SAMUELS inquired as to whether one could consider
that all reservoirs act similar in that they produce 10-15
percent a year and then start to decline. He asked if one can
determine the amount of investment it would take to stop the
decline, or are all the fields different.
DR. FINIZZA said that he hasn't studied that. Although there
aren't too many fields around of this size to make the
comparison, it would be worth doing.
SENATOR WIELECHOWSKI opined that another column or chart
specifying Alaska's NPV is necessary if a billion more barrels
is received under the PPT.
COMMISSIONER GALVIN specified that the same amount of barrels is
received. In further response to Senator Stedman's earlier
question, Commissioner Galvin explained that the needed opex and
capex investment of $15 per barrel is similar to what is being
experienced across the North Slope with $14.56 per barrel, which
equates to almost a $2 billion capital expenditure per year.
"We're probably in the ballpark, if not even pushing it a little
bit higher than the billion dollars of reinvestment required in
order to hit this same number. So, I think ... it's a
comparable number than what you were talking about a year ago,"
he said.
7:03:29 PM
SENATOR STEDMAN asked if there's a chance that the state might
be on track with PPT.
COMMISSIONER GALVIN opined that hopefully the state is moving
toward that reinvestment mode and getting [explorers] to
maximize their opportunity to produce oil. Furthermore, perhaps
the net structure and up-front credits will drive the state to
that. The question become if the aforementioned will be driven
away if the state moves to ACES, which is what this analysis is
intended to illustrate.
7:04:25 PM
DR. FINIZZA said that another gage, to determine whether the
state is driving investment away is to review what the producers
are actually keeping out of each additional dollar, which is
illustrated on slide 27. The graph on slide 28 plots all of the
ongoing projects in the PFC database. The graph highlights
where the Alaska legacy marginal take is relative to mature
fields. He related that the [fields] with the higher marginal
government take are in Norway and the ones that are lower are in
Norway or Australia.
7:05:40 PM
SENATOR STEDMAN, referring to slide 27, surmised that it's
speaking to the vast majority of the basin, Kuparuk and Prudhoe
Bay. Under the PPT the government take is 61 percent of the
[$1.00] whereas last year Econ One estimated that the government
take at $60 a barrel of oil is 60.4 percent, which he suggested
could be a rounding error.
DR. FINIZZA said that's fortuitous since the run performed last
year was under a different cost structure and production
profile. The information being provided today uses the latest
production forecast as well as the higher costs. Dr. Finizza
said that it was felt important to use this metric as opposed to
what was used by Econ One last year. Furthermore, it provides a
way of comparing mature fields in other parts of the world.
SENATOR STEDMAN requested written delineation of the two.
7:08:30 PM
DR. FINIZZA concluded with slide 30, which uses ACES at $60 and
peels back some of the features of ACES in order to relate how
much each, when relaxed, would change total revenues for the
next three years. He noted that there won't be a very dramatic
fiscal change in 2008 because half of that year is already
included. Therefore, he suggested that it may be best to review
the impact on fiscal year 2009 to gauge the importance of some
of these pieces. For example, under fiscal year 2009 ACES is
estimated to have tax revenues in the amount of almost $2
billion. If the tax rate is moved to the PPT rate and
everything else under ACES remained the same, $229 million less
would be produced in fiscal year 2009. If ACES remained the
same save changing the progressivity to the PPT progressivity,
it would result in approximately $150 million less in 2009. He
reviewed the results of various changes to ACES.
7:11:21 PM
DR. FINIZZA, in response to Representative Samuels, said that
the assumption for [fiscal years] 2008-2010 is that it's
declining. The projects all assume the mid cost numbers related
by Ms. Nienhuis.
REPRESENTATIVE SAMUELS then requested the production forecast
for this particular model.
7:12:29 PM
SENATOR STEDMAN, returning to the government take of PPT as
reported on slide 27 and projected under Econ One's slide from
last year, reiterated his earlier statement that the two, in
terms of the percentage of government take, seem to be on top of
one another.
DR. FINIZZA restated that the two were calculated using
different methodologies. Therefore, if the current assumptions
were utilized with the Econ One presentation of last year,
different numbers would result because of the use of different
concepts. If the same concepts were used, the result would be
fairly close. "So, I would not think they would quibble with
our percentages here," he said.
7:14:22 PM
REPRESENTATIVE DOOGAN directed attention to slide 18 and related
his understanding how a company would rank the various scenarios
relative to Field A. He asked if there is any way for the state
to determine if a company would be satisfied and make the
investment with ACES and no floor, although it wouldn't produce
as much as under other scenarios.
DR. FINIZZA stated that a company should be willing to undertake
a project that has positive NPV at its stress price. In further
response to Representative Doogan, Dr. Finizza said that
basically anything not in parenthesis is an investment that a
company may make when viewed on that one metric.
REPRESENTATIVE DOOGAN surmised that the reason the information
in slide 18 is being discussed at length is because the state
can't do anything about the world market price of oil or
anything to make more oil on the North Slope. The state can
only tinker with the taxes.
DR. FINIZZA responded that the state can tinker with the taxes,
which includes providing capital credit investments and things
of that nature.
REPRESENTATIVE DOOGAN related his understanding that one must
keep in mind that if the price decreases or increases, then, in
terms of investment decisions, this "goes right out the window."
DR. FINIZZA replied yes, if the new stress price is $50 or $60.
7:17:30 PM
CHAIR HUGGINS characterized this as a rather sterile look. He
then opined that there are many risks beyond NPV and the tax
structure.
7:19:15 PM
SENATOR WIELECHOWSKI highlighted that the experts he has heard
have said this can be done and more money can be made without
discouraging investment. If the state were to adopt ACES, how
would a business person view the situation, he asked.
DR. FINIZZA opined that the financial view would suggest that
the investments are doable and considered on the worldwide view
to be projects that would be undertaken.
7:21:02 PM
RICH RUGGIERO, Gaffney, Cline & Associates, said that the
decision "depends upon where you were when." He then recalled
working with an oil company on a major project in another part
of world. The opportunity for NPV growth was tremendous, but
the company wasn't willing to make the decision because the
company had a number of other larger opportunities and had, as
do many oil companies, limited ability in terms of people
resources. There are a number of different factors that are
considered in these decisions, but they probably don't remain
the same over time. With regard to whether the tax system will
be better or worse than the previous tax system, Mr. Ruggiero
related that investment decisions were being made much like the
oil companies are doing today, that is around a wide range of
tax systems or fiscal policies. He suggested that businesses
will choose a situation in which they can achieve higher
production within a realm of manageable risks, although it may
be at lower cost return.
7:24:06 PM
REPRESENTATIVE RAMRAS inquired as to the impact of changing the
tax policy with such frequency.
DR. FINIZZA noted that he has reviewed two recent reports on
fiscal stability, the PFC report and the Wood Mackenzie report.
He related his belief that the PFC report is correct in that the
fiscal stability in Alaska is much closer to a neutral position
rather than an extreme change. Dr. Finizza said that personally
he didn't believe one should view Alaska as an unstable
environment. Furthermore, he opined that he didn't believe
producers would leave because of this proposed tax change.
7:26:28 PM
SENATOR STEDMAN asked if anything, short of nationalization,
could be done to completely drive out the producers from a basin
that's 20-30 years old and on the magnitude of Kuparuk.
DR. FINIZZA said that he has no opinion on that, adding that
every change has the potential to be followed by other changes.
However, he didn't believe it's at that situation.
SENATOR STEDMAN related his understanding that the risk is not
the industry leaving the oil basin, but rather not reinvesting
to help slow the decline.
DR. FINIZZA replied yes.
7:27:57 PM
REPRESENTATIVE SAMUELS asked if Dr. Finizza does modeling for
Alaska for the economy as a whole. He asked if the models
review how the spending circulates around the economy. For
example, if the state raises the tax to 40, the investment dries
up and declines to 15 percent. He inquired as to whether any
models review the impact of the aforementioned scenario on the
private sector.
DR. FINIZZA replied that although such hasn't been done, it's
possible. In the example cited, there would be an issue and
modeling should be performed.
REPRESENTATIVE SAMUELS acknowledged that his example was
extreme, but highlighted that Alaska's economy is small and
susceptible to a [slight deviation] from oil and federal
government funds.
DR. FINIZZA said that there are economic consultants who have
done regional impact models with input/output analysis, and
there's likely one for Alaska.
7:30:04 PM
COMMISSIONER GALVIN turned the discussion to what ACES provides
as value for explorers. As discussed earlier, ACES primarily
provides cash for credits earned by explorers and is exercised
through a tax credit fund that would fund the credit payments
from the state. Another value is the ability to carry-forward
value of investment at the full tax rate. He requested that Mr.
Ruggiero comment on isolating Alaska as a place for new entrants
in comparison to the rest of the world.
7:32:14 PM
MR. RUGGIERO began by addressing the attractiveness of Alaska or
any regime relative to any other regime. As Dr. Finizza
mentioned, [companies] look at the NPV or internal rate of
return (IRR) that can be made as well as whether there are
barriers to entry for new entrants as opposed to an incumbent.
He then recalled an earlier question regarding the expectation
on the time to recover an initial investment. In much of the
development of oil fields it's not uncommon for it to take 3-6
years to receive the return on the capital expenditure. For
gas, the return on investment can be 5-9 years as gas generally
has a lot of infrastructure. The question becomes where [a
particular project] stands in relation to other countries or
other regimes. Under the production sharing contract (PSC), the
recovery of costs is commonly known as "cost oil" and the
attractiveness of regimes is based on how quickly one can
recover the costs through cost oil. He related that some
regimes place no annual cap on the ability to recover and thus
every dollar received, as soon as production occurs, goes to the
oil company's account to repay it for the capital it spent to
develop the project as well as for current operating costs.
However, in other regimes there may be a cap with regard to the
amount of revenue each year that can be used against the cost
oil account, with the remainder going to profit oil and split
with the government. Therefore, the result is that countries
will tweak various aspects to make their system look better than
others, such as with the uplift and the share of first tranche
petroleum, royalty. In tax and royalty regimes, the recovery is
basically the corporate code for depreciation, which also
varies.
7:37:23 PM
MR. RUGGIERO highlighted another key impact with regard to
attractiveness. He related that a situation in Trinidad and
Tobago when then-Amoco was able to advance [development]
relative to its competitors in the country. At that time Amoco
was "Ring Fenced" in the country and thus all the exploration to
find more gas and any associated costs could be deducted against
current income because the company had other active operations
in the area. Basically, Amoco was able to write off as soon as
there was an expenditure and thus reap the tax benefit. Others
who were competing to place gas in the train were part of single
field, single-blocked ring fenced PSCs. Therefore, anything
those companies spent on exploration had to wait until the field
was developed, put on production, and had revenue against which
it could be deducted, which may mean 7-11 years of expenditures
before it could be written off. Therefore, the type of factor
as well as the timing is a factor.
MR. RUGGIERO turned to the question of how important the timing
is to the decision-making of an oil company. He posed a
scenario in which in year zero an entity invests 20 and for the
next 10 years that entity has an income of 10, for a total of
100. The entity splits that income such that the oil company,
contractor, receives 32 and the state receives 68. He noted
that the aforementioned scenario is a 10 percent IRR, which
means that the NPV 10 is at zero, the break even point. On a 5
percent discounting, the state's NPV is 52. At this point, the
entity only has to tweak it a bit, such as by allowing more cost
recovery early on, and suddenly with the state still receiving a
total of 68 over 10 years and the oil companies still getting 32
units of cash flow, it becomes a 14 percent IRR and the NPV
becomes positive. He noted that the state's NPV would decrease
with the lower discounting, but not as much as the oil
companies' NPV increased. At this point, one can become
generous and give credits or 100 percent of cash flow in the
early years can go toward recovery of the 20 investment.
Therefore, a little up-front incentive creates a 19 percent IRR
while the state's NPV 5 didn't drop much. In the extreme, if
the oil company was to receive all 32 of its units up-front and
the state receives its 68 units on the backside, a very good
project in terms of IRR and NPV has been created for the oil
company. Mr. Ruggiero said that the way in which a company is
allowed to recover its investments has a significant impact in
the economics and, from his experience, on decisions regarding
where to invest.
7:42:01 PM
MR. RUGGIERO then turned to the question of the relative
attractiveness of the credit system on a worldwide basis. From
his perspective, [Alaska's] credit system compares favorably on
an international basis. Furthermore, it's done in such a way
that the state and the federal government actually become the
majority investor in exploration that takes place. Moreover,
the credit system quite significantly levels the playing field
between a new entrant and an existing player. In Alaska, the
ability to obtain the credits and the ability to take a loss
forward and turn into another credit means that a company can
obtain a return of the majority of the investment rather
quickly. After taking into account what can be deducted against
state income and federal income and what can be taken as
credits, the net contractor share of a new investment, depending
upon the rules related to previous units and existing wells, is
$.21 to $.36 on the dollar. The combination of the state
through the credits and the federal government through income
tax deduction of the expenditure result in the two together
paying 64-79 percent of the investment. The aforementioned is
very favorable on a world scale, he emphasized, as very few
countries allow the write off of credits or deductions so
quickly.
7:44:53 PM
SENATOR WIELECHOWSKI asked if the system can be structured with
the credits up-front in order to sustain government at it's
current [budget] plus 3-4 percent inflation and make it to 2020.
COMMISSIONER GALVIN explained that the purpose of the analysis
thus far has been to identify the investment opportunity that
exists in Alaska and to ensure that the tax system provides as
good an opportunity to participate in those investments as
possible, with the market driving the rest. He further
explained that the credit program is being utilized to entice
new entrants and attract new investment. The is goal to strike
a balance that provides maximum opportunity to attract
investment.
7:47:24 PM
REPRESENTATIVE SAMUELS related his impression that many of the
true exploratory credits aren't taken advantage of. He then
asked if some of the credit systems Alaska offers is in the
margins.
7:48:37 PM
KEVIN BANKS, Acting Director, Division of Oil & Gas, Department
of Natural Resources, informed the committees that the division
is receiving paperwork from DOR to validate the data
requirements and the targets for which credits are being
applied. Therefore, he said he knows that credits are coming
and thus are being used. However, he said that he didn't know
how much money the state has paid out for the credits that have
come in to this point.
7:49:29 PM
REPRESENTATIVE SAMUELS inquired as to the percentage of credits
used in Prudhoe Bay, Kuparuk, and Alpine as opposed to the
credits used in the outlying areas in the NPR-A and the
foothills.
COMMISSIONER GALVIN highlighted that it's important to recognize
that the 20 percent credit is equivalent to the basic PPT
credit. Therefore, the analysis specifying [that the state
pays] 64-79 percent represents the value of an in-field credit;
the amount of credit being provided to the existing entities
drilling within the existing areas.
REPRESENTATIVE SAMUELS inquired as to whether anyone is doing
wildcat exploration.
MR. BANKS replied yes.
7:50:57 PM
CHAIR HUGGINS recalled that the conversation of amending the PPT
began because the costs were much higher than thought. However,
now the discussion is how attractive and beneficial this will be
to both the state and the industry. He related his assumption
that some of the more generous aspects of PPT are being
withdrawn, such as the claw back. He then requested an
explanation of the reasoning behind the expansion from 12 to 24
months for the cost expenditure recovery.
COMMISSIONER GALVIN said that for new entrants and explorers,
[ACES] would be what it [has to deal with] whereas a company
that is in the process of entering will experience a lower value
in the move from the existing PPT to ACES. Commissioner Galvin
said that with regard to the new entrants, the focus is on net
positives while for existing players it would be viewed as a net
negative. Those in between will be dependent upon the
individual company.
7:54:54 PM
CHAIR HUGGINS posed a scenario in which a company drills two
holes, which are dry and thus the company leaves within 18
months. In such a scenario would the company lose anything, as
far as cost recovery for the investment, by departing from the
state, under ACES.
COMMISSIONER GALVIN answered that the aforementioned company
would receive more money back from the state under ACES than
under the existing PPT.
7:56:16 PM
SENATOR STEDMAN pointed out that there isn't any data on the
markets of these credits, and therefore it's difficult to place
a dollar value on it.
COMMISSIONER GALVIN said, "Let's assume $.96 and the question
becomes if it's $.96, is it worthwhile to the state to require
an explorer to earn a $1 credit and get $.96 for it and existing
taxpayer to get $.04 and the state to be out a $1 as opposed to
the state giving the explorer the full $1."
SENATOR STEDMAN said he understands the state will be out $1
either way. Senator Stedman characterized the 20 percent credit
as huge and one that will light the gas basin on fire and cause
the need to return in a few years to ratchet it back. He
inquired as to where in the global oil basins are there 20-40
percent credits. "Isn't this 20 percent credit an aggressive
credit and an aggressive economic stimulus for that oil basin,"
he asked.
COMMISSIONER GALVIN replied yes. However, with regard to the
nature of the transferability of the credit the question is
whether the state is offering equal value whether its an
incumbent or a new explorer. By having that barrier to
obtaining full value to the explorer, the incumbent receives
full value plus the opportunity for a windfall.
SENATOR STEDMAN emphasized that the state should be able to see
what kind of market is actually there. Some historic trading
activity should be available prior to modifying this policy, he
opined.
COMMISSIONER GALVIN remarked, "Well, I guess the question would
be if the answer was $.98 or $.68 is there going to be a
different answer."
SENATOR STEDMAN related his belief that the less liquid the
credit, the wider the discount because at some point there will
be competition between the harvesters to dilute their taxes. He
recalled earlier indications that once HB 2001 was introduced,
the market became more liquid. Is that the case within this
market, he asked.
COMMISSIONER GALVIN said that the identification of a lack of a
market was merely a recognition that the situation was worse
than expected. Even if [the credits] are being sold in a liquid
market, they will be sold at a discount. The aforementioned
results in a policy question for the state regarding whether
it's an appropriate inequality between new entrants and
incumbents.
SENATOR STEDMAN interjected that the aforementioned was settled
under PPT and can be settled again.
8:00:30 PM
REPRESENTATIVE DOOGAN turned to the earned credits of 20
percent, up to 40 percent of qualifying expenses and asked if
that's under PPT or ACES.
COMMISSIONER GALVIN said that it's under both. He mentioned
that would be addressed in the next presentation.
REPRESENTATIVE DOOGAN related his understanding that the farther
out one is drilling, the larger the credit. Therefore, an
independent explorer far from the oil fields of the North Slope
can get up to 79 percent of its costs paid for by the state and
federal government. He inquired as to what part of that 79
percent is from the federal government.
COMMISSIONER GALVIN estimated that about 15 percent of that 79
percent is from the federal government.
REPRESENTATIVE DOOGAN surmised then that the state is paying
$.64 on the dollar for the riskiest investment that can be made
in the oil and gas industry in the state, under these credits.
COMMISSIONER GALVIN noted his agreement.
8:02:26 PM
REPRESENTATIVE SAMUELS recalled that when PPT passed, the
largest loser was ConocoPhillips Alaska, Inc. because its large
field, Kuparuk, had a zero tax while the second largest loser
was the federal government, followed by BP and ExxonMobil. With
regard to buying the credits, he recalled that there was the
desire to ensure to cap the amount the state could buy until
2011 because of the concern with regard to cash flow to the
state. He asked if taking the cap off is of concern under ACES.
COMMISSIONER GALVIN explained that under ACES there is a vehicle
to provide the funding. He said that the issue is cash
management, in terms of whether the state has the money with the
authorization to make the payments. The administration has
recognized that it's a management issue in terms of the
appropriation process and thus has been addressed by the
establishment of that credit fund. Currently, there is a mini
version of the same issue because the administration has to
anticipate from one year to the next, without that fund, what
authorization will be requested looking a year-and-a-half in
advance to obtain the authorization to pay off the credits.
Having the fund in place provides a buffer in order to have a
minimal affect.
The committees took an at-ease from 8:06:21 PM to 8:07:03 PM.
8:07:04 PM
MR. BANKS directed attention to his PowerPoint presentation
titled "Alternative Tax Credits for Oil and Gas Exploration ACES
Amendments to AS 43.55.025". He noted that he will be
discussing credits that were established prior to PPT. He said
that he sometimes thinks of these credits as exploration
incentive credits (EICs) while others refer to them as the 20:40
credits because of the fact that on some wells one can receive
as much as a 40 percent credit, which is determined by how far
away the site is from existing units. In the amendment [to AS
43.55.025] a time dimension would be added to the number of
wells for which a credit could be received from 50 days to 540
days. The aforementioned provides an explorer the opportunity
to work a similar prospect over two drilling seasons on the
North Slope. There is also a definition for targeting
distinctly separate targets, which means that in addition to
being 3 miles from an existing well the same horizon shouldn't
be penetrated. In spite of the fact that these are some of the
riskiest investments on the North Slope, the state should be
able to be sure that new opportunities are being targeted. The
40 percent credit is allowed on wells drilled more than 25 miles
from an existing unit in the North Slope and more than 10 miles
from an existing unit in the Cook Inlet. He then reminded the
committees that under the existing law there is a 40 percent
credit for seismic surveys and ACES adds a new credit for old
seismic data, data collected prior to 2003. This new credit
provides the state the opportunity to purchase old data. He
noted that the commissioner of DNR has to make a determination
that the data is of appropriate quality, is for a location in
which the state is interested, and is in a readily usable
format.
8:10:54 PM
REPRESENTATIVE SAMUELS asked if Point Thomson is considered an
existing unit.
MR. BANKS answered that Point Thomson is considered an existing
unit as it is under PPT.
8:11:18 PM
REPRESENTATIVE DOOGAN asked if the reference to within 25 miles
refers only to onshore units.
MR. BANKS said that it would only be within state waters and
onshore.
8:11:34 PM
MR. BANKS, in response to Representative Samuels, related his
understanding that the federal government doesn't have similar
credit provisions for offshore units. He reminded the
committees that in the Gulf of Mexico the minerals management
offers a royalty holiday on the first several million barrels of
oil produced. There is no pre-production exploration offered.
The state can offer royalty relief, which offers a similar
effect, but it's only the success leg that the relief is
offered. Therefore, when it's factored into an explorer's
economics, they are discounting the value of that credit or
lower royalty on a basis of the percentage of its success. The
royalty discount doesn't have as much "horse power" as a credit
awarded up-front.
8:13:19 PM
SENATOR WIELECHOWSKI asked if the 5 percent credit for old
seismic surveys is mandatory.
MR. BANKS said he interpreted to be left to the discretion of
the applicant to sell the old seismic surveys. In further
response to Senator Wielechowski, Mr. Banks stated that the
commissioner of DNR wouldn't purchase bad seismic data.
8:14:11 PM
CHAIR HUGGINS asked if HB 2001 comprehensively covers the entire
state.
MR. BANKS replied yes, noting that there are provisions that
apply outside of the North Slope and into the Cook Inlet.
8:15:09 PM
MR. BANKS returned to his presentation. He informed the
committees that ACES requires preapproval of exploration well
plans or seismic survey plans, and therefore there is a judgment
up-front so that an applicant doesn't have to worry about being
turned down after drilling due to a misinterpretation of the
statute or regulations. Furthermore, it protects the state from
being obliged to pay a credit on a prospect that wasn't
appropriately drilled. Mr. Banks, referring to slide 4
"Information Requirements", noted that many of the changes to
[AS 43.55.025] have to do with what the state receives in turn
for its investment in exploration. To date, the aforementioned
has been relatively limited. The state, he opined, should
strive to acquire the information and provide it to others, if
the state so desires. More information would, in general,
enhance the value of the state's prospects and be of interest to
potential explorers. Therefore, rules will be established so
that the state obtains core information, acquires test fluids,
and obtains seismic data. Normally, DNR receives seismic and
well information on all wells drilled in the state. However,
the well information is made public after two years.
8:20:38 PM
REPRESENTATIVE SAMUELS posed a scenario in which DNR acts as a
commercial agent and sells royalty-in-kind (RIK) oil in the
marketplace. In such a situation, the department having access
to tax information may be construed as an advantage in the
marketplace over those who are now the commercial competitors.
MR. BANKS pointed out that there are differences in the missions
of DOR and DNR that impact the cultures. When DNR was given the
ability to audit its own royalties, it changed DNR's culture.
He explained that if DNR acquires any taxpayer information in
the pursuit of an audit in a royalty case, DNR faces the same
criminal penalties as DOR if that information is revealed. He
then turned to the issue of whether the state receives an
advantage when selling RIK gas or oil because of access to
taxpayer information. Now that DNR audits its own royalties and
because of the provisions of several of the royalty settlement
agreements, DNR does receive contract information about oil and
gas sales from the lessees. He pointed out that the information
is received after it has already happened in the marketplace.
He further pointed out that DNR enters this commercial space
very rarely. In fact, the last time DNR engaged in RIK activity
was when DNR sold oil to Flint Hills for a 10-year contract in
2004. Mr. Banks opined that it's not an issue because the
department so seldom participates in that marketplace and the
information DNR has is of relatively limited valuable. He added
that since 1984 [DNR] has only sold oil to in-state refineries.
Furthermore, the last time DNR sold oil to an entity that would
export it to the Lower 48 was done in a bidding process, which
resulted in fairly transparent pricing. Mr. Banks noted that
when DNR sells in-state, it takes into account the economic
benefits beyond royalty revenues.
8:25:13 PM
REPRESENTATIVE RAMRAS recalled a conversation with Jeff Cook,
Flint Hills, who related that Flint Hills is nervous that if
there continues to be a decline in oil production, the state
will have difficulty selling an adequate amount of oil to Flint
Hills and Alyeska Pipeline Service Company may opt to batch oil
through TAPS every 2-3 days. He highlighted the risk to the
economy as there are 450 direct jobs in the Fairbanks North Star
Borough and the proximity of a refinery to Eielson Airforce
Base. He requested comment about the issues surrounding Flint
Hills and the result of declining production of TAPS.
MR. BANKS specified that currently, the contract obliges the
state to deliver between 56,000 and 77,000 barrels a day. If
the state fails to meet that, Flint Hills takes the risk. When
the pipeline went down last August, it was a fairly significant
risk for Flint Hills and DNR scrambled to obtain more oil from
other units in order to supply the refinery. The producers
cooperated by excusing some of the notice requirements. It's
possible that in the future, before the expiration of this
contract in 2014, the state may not be able to meet the
aforementioned requirements.
REPRESENTATIVE RAMRAS related that Flint Hills is concerned that
there could be a situation placing them at risk in about 3-4
years. With regard to the different regions in the state that
are vulnerable, Representative Ramras emphasized the impact to
Fairbanks in terms of jobs and adding a risk factor to Eielson
Air Force Base. He then expressed the need for stability.
8:30:18 PM
MR. BANKS returned to his presentation and directed attention to
slide 5 titled "Timing Requirements". Currently, it's possible
to receive a credit for a well that's suspended or in some sort
of operational shutdown. [Under ACES], the credit will be
limited to ensure that the wells are completed or abandoned.
Currently, wells are kept confidential for 24 months and after
30-day notice the information can be made public. The
aforementioned may be extended by permission from the DNR
commissioner if there is land near the well that remains
unleased. He noted that it applies to the state as well as
private and federal land within the state. Under ACES, if one
applies for a credit that potential extended confidentiality
isn't received. Similarly, seismic surveys aren't governed by
any limits to confidentiality. He explained that the state only
acquires seismic surveys if they were shot over state land.
However, under ACES all seismic information, no matter from
where, would be given to DNR and the confidentiality would be
offered for 10 years. Under the [AS 43.55.025] credits the
applicant was required to give information to the state within
30 days, which is changed to six months under ACES. When the
data is remitted the state offers the credit certificate.
8:33:17 PM
MR. BANKS referred to a map titled "North Slope Oil and Gas
Activity 2006-2007". He directed attention to the cluster of
reddish wells in the center of the map, which represent wells
permitted by Chevron in its White Hills prospect. He said that
Chevron probably won't drill all of those wells and would be
lucky to drill half of them in the time during which their
permits apply. Focusing on activities in the last year, he
highlighted Cronus, Noatak, and wells drilled by Fedex (ph) and
PetroCanada not on the map that are deep in the NPR-A. He then
turned attention to the Colville River area where ConocoPhillips
has drilled exploration wells within that unit. He continued to
review the various wells and the stages in which they are at the
moment. With regard to an earlier question, Mr. Banks said that
there has been a fair amount of drilling and exploration
activity.
8:39:07 PM
REPRESENTATIVE NEUMAN highlighted that Chevron's White Hills
wells are away from developed infrastructure. He asked if the
PPT credits could account for the increase in activity away from
known infrastructure.
MR. BANKS said that he doesn't know because he said he didn't
know how long ago those wells were planned.
8:40:41 PM
REPRESENTATIVE NEUMAN expressed the hope to see more [of such
development away from existing infrastructure] in the future as
it will spread the infrastructure and make it more feasible for
more wells to be drilled.
MR. BANKS pointed out that in the lower left area the shaded
areas illustrate gas accumulations that Anadarko intends to
drill. Therefore, in addition to credits, gas is becoming a
more likely possibility for development on the North Slope, he
opined.
8:42:06 PM
SENATOR WAGONER inquired as to the percentage of liquids in the
Anadarko leases as they were drilled in the past.
MR. BANKS said that if that information is available and not
under confidentiality restrictions, he will provide it to the
committees.
8:42:43 PM
CHAIR HUGGINS, referring to the distribution of exploration and
potential production, said that it looks like there will be
quite the spider web of infrastructure for delivery to market.
MR. BANKS said that the White Hills prospect is one in which
folks have known about for some time and it hasn't been proved
up.
CHAIR HUGGINS opined that it will take money and people to
develop these wells located far from the infrastructure. He
inquired as to the timeframe of permitting and construction,
assuming that there is success in 90 percent of what was
described on the map.
MR. BANKS said that probably the fastest development in recent
years is the Oooguruk project, followed closely by the Colville
River Alpine prospect. Those came online in a matter of seven
years or less. Those two represent an unusual situation because
they were located relatively outside of existing infrastructure.
For prospects like those of White Hills, it will obviously take
longer.
CHAIR HUGGINS clarified that his point is that it will take
time, money, as well as permitting. He then commented that the
number of jobs involved for Alaskans is dramatic.
8:45:50 PM
SENATOR STEVENS asked if it's true that as one moves west to
east there's less gas and more oil.
MR. BANKS said that he wouldn't make that generality. However,
north to south one finds more of the gas prone options because
the geology of the foothills represent something similar to the
American Rockies where much gas is found.
The committees took a brief at-ease.
8:47:20 PM
CHAIR OLSON announced that the sectional analysis will be heard
in separate committees.
[HB 2001 was held over.]
ADJOURNMENT
There being no further business before the committee, the House
Special Committee on Oil and Gas meeting was adjourned at
8:48:18 PM.
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