Legislature(2005 - 2006)CAPITOL 124
02/27/2006 12:30 PM House RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| HB488 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 488 | TELECONFERENCED | |
ALASKA STATE LEGISLATURE
HOUSE RESOURCES STANDING COMMITTEE
February 27, 2006
12:48 p.m.
MEMBERS PRESENT
Representative Jay Ramras, Co-Chair
Representative Ralph Samuels, Co-Chair
Representative Carl Gatto
Representative Gabrielle LeDoux
Representative Kurt Olson
Representative Paul Seaton
Representative Harry Crawford
Representative Mary Kapsner
MEMBERS ABSENT
Representative Jim Elkins
COMMITTEE CALENDAR
HOUSE BILL NO. 488
"An Act repealing the oil production tax and gas production tax
and providing for a production tax on the net value of oil and
gas; relating to the relationship of the production tax to other
taxes; relating to the dates tax payments and surcharges are due
under AS 43.55; relating to interest on overpayments under AS
43.55; relating to the treatment of oil and gas production tax
in a producer's settlement with the royalty owner; relating to
flared gas, and to oil and gas used in the operation of a lease
or property, under AS 43.55; relating to the prevailing value of
oil or gas under AS 43.55; providing for tax credits against the
tax due under AS 43.55 for certain expenditures, losses, and
surcharges; relating to statements or other information required
to be filed with or furnished to the Department of Revenue, and
relating to the penalty for failure to file certain reports,
under AS 43.55; relating to the powers of the Department of
Revenue, and to the disclosure of certain information required
to be furnished to the Department of Revenue, under AS 43.55;
relating to criminal penalties for violating conditions
governing access to and use of confidential information relating
to the oil and gas production tax; relating to the deposit of
money collected by the Department of Revenue under AS 43.55;
relating to the calculation of the gross value at the point of
production of oil or gas; relating to the determination of the
net value of taxable oil and gas for purposes of a production
tax on the net value of oil and gas; relating to the definitions
of 'gas,' 'oil,' and certain other terms for purposes of AS
43.55; making conforming amendments; and providing for an
effective date."
- HEARD AND HELD
PREVIOUS COMMITTEE ACTION
BILL: HB 488
SHORT TITLE: OIL AND GAS PRODUCTION TAX
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR
02/21/06 (H) READ THE FIRST TIME - REFERRALS
02/21/06 (H) RES, FIN
02/22/06 (H) RES AT 12:30 AM HOUSE FINANCE 519
02/22/06 (H) Heard & Held
02/22/06 (H) MINUTE(RES)
02/23/06 (H) RES AT 12:30 AM HOUSE FINANCE 519
02/23/06 (H) Heard & Held
02/23/06 (H) MINUTE(RES)
02/24/06 (H) RES AT 12:30 AM HOUSE FINANCE 519
02/24/06 (H) Heard & Held
02/24/06 (H) MINUTE(RES)
02/25/06 (H) RES AT 10:00 AM SENATE FINANCE 532
02/25/06 (H) Joint with Senate Resources
02/27/06 (H) RES AT 12:30 AM CAPITOL 124
WITNESS REGISTER
BRIAN WENZEL, Vice President
for Finance and Administration
ConocoPhillips Alaska, Inc. (Conoco)
Anchorage, Alaska
MS. MARIANNE S. KAH
Chief Economist
ConocoPhillips Alaska, Inc.
Planning, Strategy and Corporate Affairs
Anchorage, Alaska
MR. DARREN JONES, Vice President
for Commercial Assets
ConocoPhillips Alaska, Inc.
Anchorage, Alaska
ACTION NARRATIVE
CO-CHAIR RALPH CO-CHAIR SAMUELS called the House Resources
Standing Committee meeting to order at 12:48PM. Representatives
Ramras, Samuels, Seaton, Olson, Crawford and Seaton were present
at the call to order. Representatives Kapsner and LeDoux
arrived as the meeting was in progress. Representatives
Berkowitz, Kerttula, Gardner, and Guttenberg were also present.
HB 488-OIL AND GAS PRODUCTION TAX
CO-CHAIR SAMUELS announced that the only order of business would
be HOUSE BILL NO. 488, "An Act repealing the oil production tax
and gas production tax and providing for a production tax on the
net value of oil and gas; relating to the relationship of the
production tax to other taxes; relating to the dates tax
payments and surcharges are due under AS 43.55; relating to
interest on overpayments under AS 43.55; relating to the
treatment of oil and gas production tax in a producer's
settlement with the royalty owner; relating to flared gas, and
to oil and gas used in the operation of a lease or property,
under AS 43.55; relating to the prevailing value of oil or gas
under AS 43.55; providing for tax credits against the tax due
under AS 43.55 for certain expenditures, losses, and surcharges;
relating to statements or other information required to be filed
with or furnished to the Department of Revenue, and relating to
the penalty for failure to file certain reports, under AS 43.55;
relating to the powers of the Department of Revenue, and to the
disclosure of certain information required to be furnished to
the Department of Revenue, under AS 43.55; relating to criminal
penalties for violating conditions governing access to and use
of confidential information relating to the oil and gas
production tax; relating to the deposit of money collected by
the Department of Revenue under AS 43.55; relating to the
calculation of the gross value at the point of production of oil
or gas; relating to the determination of the net value of
taxable oil and gas for purposes of a production tax on the net
value of oil and gas; relating to the definitions of 'gas,'
'oil,' and certain other terms for purposes of AS 43.55; making
conforming amendments; and providing for an effective date."
12:48:44 PM
BRIAN WENZEL, Vice President for Finance and Administration,
ConocoPhillips Alaska, Inc. (Conoco), said Conoco is the leading
oil producer in Alaska and has invested over $5.8 billion in
capital in the last 10 years and $6.8 billion in expense and it
pays $1.6 billion to the state every year. He spoke of Conoco's
employees who see themselves as playing a role in building
Alaska's future. He said the company generates direct and
indirect employment. He said there needs to be mutual respect
between the state and the company so they are better off than if
they pursued their short-term interests.
MR. WENZEL said the governor's bill is balanced in favor of the
state with an aggressive level of state take. He spoke of other
taxes to the state as well as surcharges and fees paid during
the permitting process. That is, of course, on top of federal
corporate taxes, he noted. He spoke of layer upon layer of
payments to the government; investment will be impacted and job
growth will be affected. He said he sees that the state cannot
adopt tax policy that only seeks to maximize the robustness of
the participants in the economy. The government provides
essential services to the citizens, and must turn to taxing
powers to pay for them, he added. He said Conoco reluctantly
supports the passage of the bill when the government is enjoying
a budget surplus. The tax rate is too high to guarantee
increased investment over the long term, he stated. It punishes
companies that have made investments in Alaska and have created
jobs, royalties and property taxes. He said he would oppose
this bill except it allows parties to come together under the
Stranded Gas Act to move the gas pipeline to the next phase.
Advancing the gas pipeline is a key priority for Conoco.
12:55:06 PM
MR. WENZEL said since 1989 Conoco has been involved with 14
satellite [oil fields], which are marginal developments that the
state is targeting with HB 488. They were able to be developed
in the favorable treatment under the ELF system. It made an
additional 1.9 billion barrels from the North Slope, he said,
which is equivalent to a Kuparuk-size field. He said the
company has drilled 40 other appraisal wells in the last five
years.
MR. WENZEL spoke of a graph shown to the committee. He said the
ELF increased barrels in the pipeline and the state was able to
collect taxes on those developments, and the Alaska economy was
able to grow. "There is no such thing as a perfect tax system."
He said the governor's tax is a wise policy, but HB 488 will
cost the industry $1 billion at today's prices. "This
unprecedented increase will more than double the existing
severance tax payments," he said. He showed a graph under the
proposed profits-based Petroleum Production Tax (PPT) system.
He said the future of oil production is dependent on existing
fields. He said HB 488 adversely impacts production from
existing fields, and the transition plan is necessary. The new
PPT will impact Alaska's global competitiveness. The purpose of
the Stranded Gas Act was to encourage the development of the gas
pipeline by establishing fiscal terms for certainty. Oil and
gas exist together, which means the fiscal certainty under the
Stranded Gas Act could be inadequate if it only applied to gas,
he opined. The administration was unwilling to consider fiscal
certainty on oil under the terms of current statute, but it was
willing to propose this legislation that could become part of a
fair and durable fiscal regime for both oil and gas. The
administration made it clear that the new tax had to stand on
its own in the absence of a pipeline deal. He said Conoco would
not support the bill if it didn't think that it would result in
an agreement to move forward on the gasline.
1:01:06 PM
MR. WENZEL said the administration's proposed tax is balanced to
facilitate future investment, including a gas pipeline. The
producers will pay substantially more in taxes than under the
current regime, he noted. He showed a slide of oil production.
The heavy oil resource will play a more significant role in the
North Slope, but technology limitations will restrict heavy oil.
"It could be many years before the resource reaches its
potential."
1:03:03 PM
CO-CHAIR SAMUELS asked the view of Conoco regarding incentives
for heavy oil. He mentioned the royalty reduction program, and
predicted an allocation nightmare for the state and the
industry, including litigation. He said that instead of a
separate tax system for different geographical locations, "would
it be beneficial to instead address the problem through the
royalty reduction...If you think you need more money to develop
the heavy oil, and the costs are high, the profit is less, and
there's just not going to be enough even potential profit to
move forward with heavy oil...instead of having the nightmare
scenario of cost allocation arguments, is to instead move
forward with a royalty reduction argument, where you still can
push more money into your column." He asked the benefit of
having two tax structures.
1:04:30 PM
MR. WENZEL said Conoco is willing to work with either mechanism,
but he assumes it would be more palatable for the state to look
at a differentially lower tax rate or higher tax credit for
heavy oil production. He said he understands the challenges of
allocation expenses. "In terms of doing it with royalty
reduction, we have not had a lot of success getting royalty
reductions in the past, but if that is the preferred path
forward from the state, I think we can easily work with that."
MR. DARREN JONES, Vice President for Commercial Assets,
ConocoPhillips Alaska, Inc., said the issue with royalty
reduction is that it can't be depended on because it is
negotiated, unless the law is changed. In the new system, if
it's not paying royalty, then it will be subject to the PPT,
"and if we're already getting credits for PPT investments, and
all that means is the new oil would get taxed at 20 percent."
He said the company would have to think more about the
ramifications of royalty reduction.
REPRESENTATIVE SEATON said if all costs are subtracted before
taxing, what is the problem of developing higher-cost heavy oil.
The PPT would act the same, he noted, and all the higher costs
would be subtracted.
MR. WENZEL said he agrees that all the costs would be captured
under the PPT, but because of the technology leaps that are
necessary to extract heavy oil, it requires more motivation than
simply the current tax system.
MR. JONES said light oil fields tend to have pretty high initial
rates with decline over time, and "the heavy oil fields, like
West Sak that we are developing now, we're drilling more wells
to build it up more slowly over time, so there is sort of a rate
of return impact issue of the heavy oil. It takes longer to get
the production up." He noted that the wellhead value of heavy
oil is significantly less.
MS. MARIANNE KAH, Chief Economist, ConocoPhillips Alaska, Inc.,
said in a high price environment, "you would think that heavy
oil becomes more economic, but what we've seen happen, because
we produce a lot of heavy oil in Venezuela and Canada, is that
the differential of heavy oil to WTI [West Texas Intermediate]
widens. So, I remember at the end of last year we actually had
to write off all of our [indecipherable] reserves, even at the
high price environment because there was like a $17 a barrel
discount to WTI, making it appear to be uneconomic. When, of
course, it came right back on our books the year later when we
started producing it. So there's a problem, even in a high oil
price environment because of the discounting. And that occurs
because there isn't enough upgrading refinery capacity to
process that crude, even after you get it out of the ground.
And it take years for that market to get back in balance. So
every time the oil price goes up, you see the discount of heavy
sour crude to WTI widens. Today it is about $16 a barrel." She
added that it will be a much bigger discount in Alaska. That
has to be taken into account, she said.
1:08:50 PM
REPRESENTATIVE SEATON asked if a widening difference at high
prices is because more heavy oil is produced without enough
facilities.
MS. KAH said that is one thing, the other is that Saudi Arabia
is replacing crude that is lost on the market and their crude
that is shut in tends to be heavy sour crude. She said there is
also strong demand, so the light product has a higher value and
heavy oil goes down in price. It is cyclical, she said. The
world's crude is going to get more heavy and more sour, and
sulfur regulations are getting more stringent. "So over time, I
would expect to see a gradual widening-not from where we are
today, after it gets back to normal-I'd expect to see a gradual
widening over time just because there's going to be more of this
in the global crude slate."
1:09:58 PM
REPRESENTATIVE BERKOWITZ noted that Mr. Wenzel said that past
investments have led to an additional $5 billion of revenue to
the state, and he asked how much of that came from Conoco and
what profits did the company show for its Alaska investments.
MR. WENZEL said he doesn't think he has profits for that period,
but Conoco's profits were $2.5 billion in 2005.
REPRESENTATIVE BERKOWITZ asked if that was in Alaska.
MR. WENZEL said yes.
REPRESENTATIVE BERKOWITZ asked about the timeframe where Alaska
received an additional $5 billion.
MR. WENZEL said he believes that has been in the past 10 years
that Conoco has spent $5.8 billion in capital and $6.8 billion
in expenses.
REPRESENTATIVE BERKOWITZ asked how much of that came from Conoco
investments.
MR. WENZEL said it is all from Conoco.
1:11:15 PM
REPRESENTATIVE GATTO addressed the heavy oil that Mr. Wenzel
showed on a graph and asked if it refers to heavy oil reserves
or oil that "you can get to." He noted that there is heavy oil
at Prudhoe Bay that is impossible to access.
MR. WENZEL said the blue bar is the heavy oil that is possible
to develop with today's technology.
1:12:09 PM
REPRESENTATIVE BERKOWITZ asked for the [profits for the last ten
years].
MR. WENZEL said there are over 20 billion barrels of oil in
place. There is potential that can't be extracted today. The
technology will require huge expenses and therefore heavy oil
should be given a differential consideration in the form of a
lower tax rate or additional credits. The bill has been
designed to attract new players, and Conoco encourages new
investments, which can be beneficial. He said Conoco has
already made partners of several of them. The terms of
attracting new investors come with a cost. The governor's tax
increase mainly targets large, legacy investments including
Prudhoe Bay and Kuparuk, and will result in perhaps "the highest
severance tax burden...anywhere in the United States. This is
an unprecedented fiscal increase," he said. He told the
committee Conoco has stayed in Alaska during difficult times,
including times of low oil prices. Such an increase could
undermine investor confidence, he opined.
MR. WENZEL showed a slide of the effective tax rate of the core
versus satellite fields. Core assets represent 65 percent of
the North Slope production and they will experience a much
higher effective tax rate.
REPRESENTATIVE SEATON asked how much of the difference is
because of the $73 million allowance.
MR. WENZEL said the $73 million is included in the graph lines,
but it's a relatively small impact.
REPRESENTATIVE SEATON said, "So the difference between
satellites with the new PPT, versus core assets...the $73
million has very little relationship to the differential between
those two lines?"
MR. WENZEL said that is correct and it is mainly driven by the
higher level of investment relative to production and revenue on
those new satellites. "You've got essentially all of the
capital to develop those resources and the tax credits come in
related to that, bringing down the effective tax rate. Whereas
on the core fields and known resources, much of that capital has
already been expended and there's no resulting impact."
1:16:12 PM
CO-CHAIR SAMUELS said the $73 million is a competitive
disadvantage over companies that pay no taxes. He asked if
Conoco would like to keep the provision in the bill.
MR. WENZEL said it was put in place to bring small players into
the state and assist small companies. It has a larger impact on
those players; as such it is much more appropriate to speak with
the independents on that issue, he said. Conoco pays $1.6
billion in tax or royalty to the state. He said Conoco has a
desire for equal treatment.
MS. KAH said without equal treatment, partners have misaligned
interests, which is a problem with developing fields.
1:18:43 PM
REPRESENTATIVE SEATON asked if the $73 million allowance is
equal treatment or not.
MR. WENZEL encouraged the legislature to consider another
alternative that is applied equally.
1:19:19 PM
REPRESENTATIVE GATTO asked the return on Conoco's investments.
MR. WENZEL said he doesn't have the public return on investments
and can't disclose the return on particular projects.
REPRESENTATIVE GATTO asked for the two most recent annual
filings.
1:20:06 PM
MR. WENZEL said the huge rate increase in the bill is supported
reluctantly by Conoco. The state is enjoying a budget surplus.
The PPT rate would be 13 percent instead of 20 percent in order
for Conoco to pay the same taxes. Some suggest that the rate
should be 25 percent, but that would take money away from the
private sector and is not in the long term best interest of the
state. New fields are small and costs are high, he stated.
Conoco spends a lot of resources assessing the upside potential
and the downside risk. "When we invest we fully understand that
there is a chance that we may not get a return on investment,
but also acknowledge that results could exceed expectations."
He said Conoco bears the greatest risks and should be
appropriately rewarded. He said tax credits reduce the risks,
but high tax rates significantly reduces the upside potential.
If credits are too high, the state will take too much downside
risk, and if taxes are too high, investors look for better
opportunities elsewhere. He said, "Moving upwards from 20
percent will seriously disrupt this risk-and-reward balance."
1:22:59 PM
CO-CHAIR RAMRAS spoke of the public testimony a few days
earlier, and he said he was struck by the debate being focused
on the tax rate and tax credit rate. Representative Kelly has
asked why the increments are in fives. His concern is the
severance rate for ELF. He noted a presentation called "Current
Production Tax and Why it is a Problem," by Dan Dickenson. He
said the current production tax is at 15 percent, and applying
the ELF brings it down to about 7 percent. Going up to $60 a
barrel, the effective tax rate is about 14 percent. "We are
increasing the taxes on the industry enormously, because right
now the effective tax rate is...6 percent." He said a member of
the public assumed that a 20 percent tax was offset by the 20
percent credit, so people are thinking that there will be no
taxes. "We are taking the actual tax up for the benefit of the
State of Alaska from its current rate of 6 to 14." He said he
wants to make it clear that the rate is going up. He stated
that the rebate of the credit is the issue of progressivity
because as the price of oil goes up, the effective tax rate goes
up.
1:27:39 PM
CO-CHAIR SAMUELS said the effective tax rate is now closer to 4
percent after counting all the incentive programs.
MR. WENZEL said it is important to be very careful when speaking
about the effective tax rate and be sure to understand what the
denominator is. He said he is showing the effective tax rate
relative to revenue. The ELF was a revenue-based system, and it
was a 15 percent tax multiplied by an ELF factor that brought
the tax down to around 7 percent. He said the new system is
based on profits instead of revenue, so it is important to be
careful in comparing the two.
CO-CHAIR RAMRAS expressed that tax credits are not widely
understood by the public.
1:29:43 PM
MS. KAH said the tax credit would be subtracted from costs, but
the tax applied to the profit can't be compared to the current
tax system.
MR. WENZEL said the 20 percent base tax rate in the PPT is
applied against profits, and the 20 percent tax credit is
applied against capital and exploration expenditures, which is
probably a smaller number than profits at today's prices. For
example, in 2005 Conoco had a profit of $2.5 billion and capital
expenditures were about $700 million. The credits come from a
smaller number and do not reduce all of the tax that is
calculated.
1:31:28 PM
CO-CHAIR RAMRAS said it is good to work with real numbers. So
20 percent tax on $2.5 million is $500 million, and if it is a
$700 million expense, the 20 percent credit will be $140 million
to subtract from those taxes. He stated that the effective tax
would be $360 million, which is 13 or 14 percent. The committee
will debate the combination of tax and credit, and he said he
will suggest higher exploration credits because "exploration
will drive the state more than development." He said credits
are poorly understood. Under the new system he worked out the
difference in taxes, and said, "We're going from $160 million to
$360 million when we go into the next year. That's the nature
of what we're talking about by making this shift in real life
terms. Which is why this is a considerable paradigm shift for
the producers to concede." He said he really wants people to
understand that it is "not 20 in and 20 out."
1:34:41 PM
REPRESENTATIVE BERKOWITZ said the PPT is deductible against
corporate income tax. He said there is another fund, the 470
fund or oil spill prevention fund, that's not included as part
of the tax bill. He asked how much of an impact that would be
on the numbers that Mr. Wenzel is showing.
1:35:24 PM
MR. WENZEL said the PPT will be deductible for corporate income
tax purposes, and the numbers displayed don't include those
effects. The deduction at the federal level will decrease
Conoco's tax burden but it won't account for all the increase of
the PPT.
REPRESENTATIVE BERKOWITZ asked how significant it will be.
MR. WENZEL said the effective tax rate line on the graph would
shift down.
REPRESENTATIVE BERKOWITZ said the 470 fund will be removed as a
tax burden. He asked how much of an impact that would have and
if the PPT makes other changes to Conoco's benefit.
1:36:44 PM
MR. WENZEL said he will have to get back to him.
MR. WENZEL spoke of the transitional provision in the bill,
where expenses in the past five years may be deducted from the
taxes owed in the future, and Conoco supports that provision.
He said it is an essential piece of the bill.
1:37:52 PM
REPRESENTATIVE BERKOWITZ asked if the impact of the transitional
plan will lower Conoco's effective tax rate.
MR. WENZEL said his chart includes the transitional plan.
REPRESENTATIVE SEATON said he was interpreting the "core" as
already having the capital expenditures, versus satellites, so
there would not be a 20 percent capital [deduction] in core
areas. "Is that the difference between these two?"
MR. WENZEL said historical capital is already expended, but
maintenance capital is definitely included as part of the
effective tax rate.
1:39:07 PM
REPRESENTATIVE SEATON asked about the difference between the two
dotted lines, the new fields and the satellite fields, "if
that's not mainly explained by the capital tax credit, what is
mainly explaining the difference in those two lines from the
solid effective tax rate?"
MR. WENZEL said, "It is explained by tax credits, just not
exactly the tax credits on maintenance capital. The investments
in the satellites and the new fields are much larger. You have
large investments early on to put all the holes in the ground,
put the facilities in place, and then ramp up with production.
The yellow dotted line here at the top only includes a smaller
level of maintenance capital, not the original capital to
actually put the facility in [and] the wells on line." He spoke
of a chart showing the capital profile of a particular project.
"The lower effective tax rate on new and satellite fields would
represent all this capital plus the revenue that comes off of
it, whereas the orange line up on the top would instead only
include a smaller level of maintenance capital. It wouldn't
include all the early capital to put the fields in place."
1:40:54 PM
REPRESENTATIVE CRAWFORD noted that depreciating capital expenses
is accelerated and most of the benefit is gotten up front.
MR. WENZEL said not to confuse depreciation deductions for state
corporate income tax with a production tax. "These are two
totally different taxes." For state corporate income taxes,
yes, "you'd appreciate assets to recognize the value of those
assets over time, and try to line that depreciation up with your
revenues. On production taxes, under the ELF-based system, it's
a tax simply based on revenue. The new system...is based on
profits." He said the capital is recognized when it is spent
instead of depreciating it over time.
REPRESENTATIVE CRAWFORD said he was referring to the claw back
provision.
MR. WENZEL said, "The rationale for looking back, under a
production tax, to those prior investments is that those
investments were put in place at a time prior to this new PPT,
did not receive any credits, and yet the profits off of those
investments will be heavily taxed as we go forward...So we have
an unfair treatment of these recent capital expenditures, which
are very much contributing to our revenues the day this tax goes
into place. If we don't look back and capture some of those
very recent capital expenditures for the last five years, we end
up with a higher tax rate under this new PPT than is really
appropriate relative to our true profits and cash expenses, if
you will."
1:43:44 PM
REPRESENTATIVE GUTTENBERG said that most people think of capital
investment as pipes, pumps and similar things. He asked if
finance charges are built into those costs.
MR. WENZEL said, "No, we are not including any capitalized
interest or things of that nature in those capital costs. I
think that will be driven by the definition of those terms in
the bill."
CO-CHAIR SAMUELS asked what is spent every year to keep
production going, and how its behavior would have changed if
Conoco had known about the PPT. Of all the money spent in the
last five years, how much of that was meant to increase
production and how much was spent to keep production going? He
said there were expenses that Conoco would have had to spend
even if it was taxed at 100 percent. He questioned how the
legislature should judge, as policy makers, what Conoco would
have spent anyway. "How much of it was to bump up production
and how much of it was the way of the world?"
1:45:55 PM
MS. KAH asked if he was talking about administrative costs.
CO-CHAIR SAMUELS said he is talking about the money that will be
considered for the transitional provision.
MS. KAH said it is hard to separate "because the natural decline
rate, production would be in steep decline if you didn't spend
what you're probably thinking of as maintenance capital. But
that counts. It's keeping the decline rate from dropping."
CO-CHAIR SAMUELS said, "And what would you have spent no matter
what the tax rate was?" He said it was somewhat of a rhetorical
question, but he is struggling with it.
REPRESENTATIVE GATTO said it may be a good idea to go back five
years, but to go back the same amount for each of those years
does not seem reasonable. "Wouldn't you suggest that we should
ladder all the way back?"
1:47:39 PM
MR. WENZEL said, "There's actually another argument here that we
should go through...It's related to the expectations we had when
we decided to make those investments...No, we would not
recommend a laddered approach going back over time. Rather...we
invested in the past based on expectation of future profits.
That's how we make our decisions about whether to invest or not.
It's based on maintaining production. It's based on new
production. Those expectations were based on an ELF system."
He said suddenly that expectation was very wrong. "Now our
effective tax rate on the production tax side has doubled."
1:48:53 PM
CO-CHAIR RAMRAS said Conoco's expectation of the value of oil
was wrong too: $62 a barrel instead of $30 a barrel. He said
Conoco made an investments thinking oil would be at $30 per
barrel, and "you have been the beneficiary of a terrific
economic cycle." He said Conoco was lucky and "it doesn't wash
with me. You're going to have a damn hard time getting all of
this claw back/transition provision by me. I'm not buying it."
1:50:03 PM
MS. KAH said, "When we look at projects we price risk them. We
take both the upside and the downside into account when we look
at projects." She said Conoco makes investment decisions for 10
to 20 years. "We are not thinking of a five year investment."
She said people think $60 is a very high price, but people don't
realize that Conoco's costs are high. She spoke of the
increases in steel price. She said, "The service industry has
just not kept pace with us." She said that needs to be taken
into account. "We definitely did not consider a change in the
basic tax structure when we made that investment decision."
1:50:58 PM
CO-CHAIR RAMRAS asked how much is the depreciation life of the
$700 million. He further asked, "How much of it is 5-year
goods, how much of it is 15-year goods, and how much of it is
39.5-year goods? When you say it's 20-year replacement, how
much of that $700 million is 5-year goods? I don't want to sit
here and listen to a bunch of baloney." He said much of the
testimony is impressive, but when he feels he is not being told
the truth, "I'm going to call you on it. Because I am not going
to sit here with producers and just rubberstamp disingenuous
testimony. A great deal of that $700 million is maintenance
material that's going to be replaced on a 5 to 7-year lifecycle
and not based on a 20-year investment horizon. I am not going
to accept that."
MR. WENZEL said there is a mix of capital expenditure, but he
doesn't have it broken out. He added that depreciation lives
are set for income tax purposes based on deductions. He said
when Conoco makes an investment it looks at prices and takes the
risks of upsides and downsides. The fact that prices are high
is not getting lucky but is an offset when estimates were off in
the other direction. He said Conoco stockholders expect stock
to increase in value when oil prices go up. He said Conoco
recognizes that there are upsides. There are many other years
when Conoco sees a downside. "It does look like, and it is
true, we are being very profitable at the moment because of oil
prices being high." He said costs are up also, but not as much
as the price of oil. When looking at all of Conoco's
investments, it is imperative that Conoco passes the oil price
risk to stockholders. It is inappropriate for Alaska to come in
and actually take away part of this upside that the investor
should get. He said Conoco did not expect a change in taxes.
He said the company expects something much more stable. "As we
change taxes this dramatically in the State of Alaska, we are
actually affecting investor confidence in the state."
1:54:51 PM
REPRESENTATIVE OLSON asked what price Conoco is budgeting for
next year.
MR. WENZEL said Conoco doesn't disclose that.
REPRESENTATIVE OLSON said Alaska is predicting oil to be $45 to
$50 per barrel, and one of your competitors is in the same
range. "Apparently they didn't have a problem with it."
1:55:29 PM
REPRESENTATIVE SEATON said the State of Alaska is taking a
considerable downside risk under the PPT, and it takes away the
oil companies' risk on the downside by taxing profits. At $20
per barrel the state will only be getting a three percent tax
instead of six. He said the PPT gives the state the downside
risk while taking more profit on the upside.
1:56:10 PM
MR. WENZEL said it is a profits-based tax, so the burden of the
tax comes down as profits decline. When the tax is imposed,
Conoco will build it into its expectations.
REPRESENTATIVE SEATON asked about Conoco's investment strategy
when ELF was aggregated. He asked if Conoco stopped putting in
capital investments when that happened.
MR. WENZEL said Conoco continued to invest with new
expectations. He added that the change was inappropriate
because it was a change in the tax law on a particular day when
investments had been made under other expectations. He said
Conoco paid its taxes on that basis, but it affected future
projects. He said Conoco has requested clarification from the
state that their Alpine field would not be aggregated so the
economics would allow the project to go forward. Conoco proved
to the state that the project was not economic under the ELF
system in an aggregation. The Department of Revenue said it
understood, so it gave them a letter saying the field would not
be aggregated with Alpine. So the project proceeded and added
production to the State of Alaska and royalties and taxes.
1:58:37 PM
MR. JONES said, "At Prudhoe we were planning to move ahead with
part of the development of the Orion heavy oil resources that
overlies Prudhoe Bay reservoirs, and we had a plan...but because
of the change in the ELF aggregation that the governor put
forward, we delayed that work."
REPRESENTATIVE SEATON said heavy oil was excluded from
aggregation.
MR. JONES said it wasn't excluded and the project was delayed
because the incremental impact of the ELF on that field is in
the range of 20 percent.
1:59:35 PM
REPRESENTATIVE BERKOWITZ said Conoco keeps indicating that the
state has benefited from everything that Conoco has done, "but
I'd also like to remind you...that Conoco has also reaped some
pretty handsome profits over the last couple of years." Not
everything done by the state is just for the state's benefit.
He asked if Conoco has recouped the transitional expenses, and
if not, "What is your internal schedule for recouping those
expenses? What do you consider to be price risk?"
2:00:25 PM
MR. WENZEL said he sees this as a partnership and both the
industry and the state benefits from a healthy oil industry
today. The transitional expenditures have not been recouped.
"They were part of our expectation." They have probably been
recouped for corporate income tax and largely depreciated. But
he said this is a different tax. The ELF doesn't provide any
credits; it was a revenue-based tax.
REPRESENTATIVE BERKOWITZ noted that Conoco has already expensed
them for corporate income tax purposes, and with the PPT it can
expense them against profits retroactively.
MR. WENZEL said that is correct and it is a different tax. "We
have taken the benefit of those to reduce our state corporate
income tax according to the tax code." He said that it appears
there will be a new tax that is a proxy for profits so it is
appropriate to deduct them on this side.
REPRESENTATIVE BERKOWITZ noted that one expense will get
deducted twice.
MR. WENZEL said yes because it is two different taxes.
REPRESENTATIVE BERKOWITZ said Mr. Wenzel mentioned a price risk,
and he asked him to explain it.
2:02:21 PM
MS. KAH said oil prices are "mean reverting", but she doesn't
know what the mean will be, and part of the price risk is "we
don't know what the average sustainable price is going to be,
but we also don't know where we're going to be in the price
cycle when we bring our projects on." She said she uses a
decision and risk analysis. The company puts price risk into
project economics weighted by probabilities of future prices.
It is a sophisticated process. She stated the concern that the
government loves to take on the upside but not help on the
downside.
REPRESENTATIVE BERKOWITZ assumed a price risk analysis was done
and he asked where Ms. Kah thinks things are headed.
MS. KAH said it is only done at the project level, not for the
Alaska business unit.
REPRESENTATIVE GATTO said Conoco answers to its stockholders.
He said the risk/reward ratio changes over time. Prices may go
up or down, and he said to be responsible to stockholders,
unexpected changes should have been already calculated. This
tax change was already priced into Conoco's overall
calculations. He said he would be surprised if it wasn't. "It
can't be a complete surprise to you that sooner or later
something would have had to change, and you've already had the
good changes, the enormous bump in prices." The increase in the
tax rate would have been anticipated, he surmised.
2:07:14 PM
MS. KAH said Conoco takes political risks into account and views
Alaska very favorably. Some countries are viewed as risky in
terms of changing their tax rates, "but we don't expect it of
the State of Alaska." She said that makes it more likely that
Conoco will invest in Alaska rather than other places.
2:07:47 PM
REPRESENTATIVE GUTTENBERG said the ELF has been in place for a
number of years and was expected to change. He said everyone
knew there was a gasline on the horizon, adding to expectations
of a change of policy or attitude. He noted that Conoco builds
political risk into its equations. The state constitution
requires maximizing the benefit of resource development to
Alaskans. He said roads are going out and schools are being
closed [indecipherable] and Alaska "brings you back to the
table, just as you bring us back to the table to reevaluate the
policy. And I think this is just the point that that's been out
there in the future and now we're there. And that's been built
into the equation."
2:09:42 PM
MR. WENZEL said he disagrees. He said Conoco staff who are
running projects every day would not have had a doubling of the
tax rate built into their expectations. He said it undoubtedly
must be done in other countries with political risk, but in
Alaska his analysts are not told to expect a change in taxes.
"We are willing to support this bill with its tax increase based
on the overall balance of where we're going in the future, our
desire to move forward on large investments--gas pipeline and
other." He said the company is reluctantly supporting HB 488
but it never expected a tax increase in Alaska.
2:11:11 PM
REPRESENTATIVE CRAWFORD noted that Ms. Kah said Conoco has not
projected its future in Alaska except on a project basis. He
asked them to take the projects and give the committee a
projection over the next several years. He asked where Conoco
thinks the equilibrium price for oil is, so the legislature can
get an idea of the best tax policy.
MR. WENZEL said he would do that and he continued to read his
testimony. He said a field was discovered in 1992 prior to the
discovery of the Alpine field, and it was not possible to
develop it by itself. With the expansion of the Alpine
facilities in 2004, it is now possible. He said the project
began in 2003 and was faced with ELF aggregation. In 2005 the
administration allowed it to be stand-alone and thus pay little
severance tax, so Conoco went ahead with it. It will be an 18-
well roadless satellite with 17,000 barrels per day. He said
capital costs are $300 million. Oil and gas prices have
increased, so labor and material costs have increased. He said
costs will be $30 million higher than anticipated.
REPRESENTATIVE KERTTULA asked what the production tax on that
field would have been.
MR. WENZEL said he doesn't have that figure, but he can get it.
He said the costs were expended before the PPT. The project was
decided based on the premise of paying little or no severance
tax. It will be now be subject to a 20 percent tax rate, "and
without the transition plan, the increased fiscal terms will
result in a reduction of over $100 million in gross value and a
six percent reduction in our average return at the $40 West
Coast price."
CO-CHAIR RAMRAS asked what the West Coast price is today.
MR. WENZEL said it is about $60.
2:15:53 PM
MR. WENZEL continued reading his testimony. He spoke of two
other satellites that will have similar losses of value. There
are several other projects undertaken in the past few years that
will have full value eroded as a result of the new tax. He said
a transition plan is essential.
CO-CHAIR RAMRAS noted opening remarks that said Conoco would
reluctantly accept this 20/20 plan. He asked Conoco to work on
a finer transitional plan. "This transition plan will not
survive in its present form." He said Conoco should look at a
variable to reduce the credits, "because to get 100 percent of
the last five years, I think, is an unrealistic expectation."
2:17:05 PM
MS. KAH said her job is to describe to the committee how Alaska
is viewed versus other locations. She read from written
testimony. She said Alaska has higher capital and operating
costs than in other places.
CO-CHAIR SAMUELS asked how much of the price is the Trans-Alaska
Pipeline System tariff.
MS. KAH answered about $3.50 per barrel.
REPRESENTATIVE BERKOWITZ said the tariff is scheduled to be
reassessed, and he wondered if it will come down.
CO-CHAIR SAMUELS said the realistic question is what the
industry is assuming will happen in 2009 when the Trans-Alaska
Pipeline System settlement methodology [TSM} comes to play
again.
MR. JONES said he is supposed to talk about tariffs, but his
company will have to renegotiate the TSM. He said the other
factor is how much oil is in the pipeline, because with less oil
the tariff could be higher.
2:21:03 PM
MS. KAH said her slide does not include the fact that Alaska
crude does have a lower value because it is not at the Gulf
Coast, "where we set WTI." She said it adds another couple of
dollars to get it to the WTI basis. She said her only point is
that costs need to be taken into account when setting the tax
rate. Countries with the lowest cost are able to have the
highest tax.
CO-CHAIR SAMUELS asked if Conoco looks at the percentage of the
Trans-Alaska Pipeline System that it is paying to itself through
Alyeska when looking at the economics of a project.
MR. JONES said it is looked at both ways.
2:22:47 PM
MS. KAH said places with high cost and low tax are favorable
places to operate. High cost and high tax places are not
getting sufficient investment, she stated. There is a
relationship, as costs go up, tax rates go down. Alaska, under
ELF, is in high cost, low tax, but under the PPT, Alaska's
position will rise to the high cost, high tax quadrant, and she
warned Alaska to consider that.
2:25:11 PM
CO-CHAIR SAMUELS said that in Norway taxes are high and credits
are high, and they do have a lot of exploration. He asked if
Conoco invests in Norway, how much, and why, if Norway is in the
quadrant of high tax and high cost.
MS. KAH said Conoco invests in Norway because their field is so
large it is attractive to maintain investments. She said Norway
is not getting enough investment.
2:26:17 PM
REPRESENTATIVE BERKOWITZ said he has been hearing that cost and
tax are critical components for investment, but he is not
hearing about the effects of the market, which is a much bigger
determinate of investment than "these relatively incremental
amounts of cost or tax." If Conoco predicts high oil prices,
that should be a bigger determinate of investments than tweaking
a tax rate.
MS. KAH said Conoco price risks all its projects, but it doesn't
know how to take all the political risks and tax rate changes
into account. "What amazes me is that Norway has not seen more
activity despite the fact that we have been in a high price
environment the last three years." She said they will have to
lower tax rates to get that.
REPRESENTATIVE BERKOWITZ said Alaska has concern with stability,
and it can't forecast whether mergers are going to occur. "I
would argue that there would be no Conoco profits in Alaska
whatsoever had the State of Alaska not interceded to protect you
so you could continue to make profits here." He said that needs
to be considered.
2:28:26 PM
MS. KAH said she looks at her chart from the bottom line of net
importing countries, which generally want to maximize their
production and minimize imports. She said Norway is a net
exporter, so it is not as desperate for production. Her next
slide is about "prospectivity." Areas with higher prospectivity
can assess higher taxes she said. The Alaska North Slope has
limited prospectivity compared to countries like Kazakhstan, she
noted, and tax rates need to reflect that. The Alaska
consultant compared competitiveness of Alaska's tax rate, but he
addressed something that is not important to companies. "If you
want to understand how an investor would look at it, you should
look at the net present value." She said the consultant
provides both.
CO-CHAIR SAMUELS asked about the net present value.
MS. KAH said, "The net present value is king even though we do
look at all available indicators."
2:30:38 PM
REPRESENTATIVE OLSON asked if political or tax stability is more
important.
MS. KAH said both are factored into the equation, but political
risk is not as quantifiable, but the company would require
higher returns to be willing to be in a higher risk country.
She noted that Pedro van Meurs tried to compare Russia,
Azerbaijan and Angola to Alaska, and it is not a meaningful
comparison because of the field size. The risk of a 700 million
field in Russia is not comparable to a 50 million barrel field
in Alaska. So tax rate needs to be a lot lower in Alaska before
Conoco would be equally interested.
REPRESENTATIVE GARDNER asked about Russia.
MS. KAH said she does not have data, but Conoco is looking at
investing in arctic Russia.
2:33:08 PM
REPRESENTATIVE BERKOWITZ said Ms. Kah made the comparison of the
700 million barrel field in Russia and the 50 million barrel
field in Alaska, and he asked if Conoco can get investors for
Russia, "shouldn't we be able to get someone to come in here and
invest for our 50 million barrel fields?"
MS. KAH said she will be talking about the independents later.
She said she has a sense that the new tax law is designed for
new players, and she will address that later, but the state
needs the major producers.
REPRESENTATIVE BERKOWITZ said the majors have been fine
partners, but the state is reaching a maturity in the North
Slope; the state needs to make sure Alaska's fields get
developed. "We don't have the option of going to another
place."
2:34:34 PM
MS. KAH said her point is that the tax rate needs to be
commensurate with prospectivity, field size and costs.
CO-CHAIR SAMUELS said Ms. Kah said Conoco doesn't quantify
political risks, but in Azerbaijan or Nigeria it has to be far
more risky than what the legislature comes up with, which will
be reasonable. "We are not going to nationalize you and we are
not going to blow up the pipeline and we're not going to execute
your workers."
MS. KAH said there is risk in those places, but there have been
very few nationalizations. She said they have seen incremental
tax changes, and Venezuela has given them substantial payback;
it has been an attractive place to invest in spite of political
risk. Alaska has been attractive because of low political risk,
she noted.
2:36:52 PM
MS. KAH said the state's consultant said Norway is comparable to
Alaska, but Norway has a lower cost structure and better
prospectivity. It has unique circumstances of a large field, so
Conoco will continue to invest there. Norway has significantly
higher taxes than Alaska, and it is not a helpful comparison.
Crude production has declined in Norway since 2001.
REPRESENTATIVE GATTO asked if all production in Norway is in the
North Sea.
MS. KAH said it is in the North Sea.
REPRESENTATIVE GATTO said the risk in the North Sea must be high
expenses.
2:38:22 PM
MS. KAH said that on the United Kingdom side, the costs have
gone up, but it was one of the lowest cost regions before that
because they did a lot of work on getting joint facilities
between the competitors. The UK has been low cost and Norway
has been more expensive.
2:38:49 PM
MS. KAH said investors need stable fiscal terms, that is why
Alaska has been an attractive place to invest. "I am truly
becoming concerned that global tax takes are reaching a point
where private companies...are finding it challenging to invest
and meet our shareholders' return requirements." She said that
is the reason industry reinvesting rates are not keeping up with
oil price increases. "I believe one of the major reasons is
that we are finding it increasingly difficult to invest [in a
way] that meets our shareholder requirements."
MS. KAH said investment may be declining because there is an
expectation that prices will cycle down, and because there is a
lag time in developing new projects to invest in. She said the
oil industry is afraid countries will change tax rates, and "we
did not have that fear five years ago." She is concerned that
private oil companies will not be able to invest in conventional
oil and be forced to invest in alternative energy supplies, with
more favorable tax terms. She said she has never seen in the
last 20 years oil companies being pushed out of the conventional
oil business.
2:40:51 PM
REPRESENTATIVE SEATON asked if slide number 22 represents Alaska
only.
MS. KAH said it was worldwide total spending. This is a global
trend, she noted. She said major oil companies are concerned
that there is a bias in favor of new investors, smaller
investors instead of the "legacy" investors. She said there is
a common misperception that small petroleum companies have lower
return requirements than the majors, but she doesn't think that
is true. Independents have higher costs of capital and they are
less diversified and have higher risk, and therefore they need
higher returns.
2:41:57 PM
REPRESENTATIVE BERKOWITZ asked what Conoco's targeted rate of
return is.
MS. KAH said she can't tell because it is competitively
sensitive. She stated that oil companies are not happy in this
economic environment. "We are worried about the future."
REPRESENTATIVE BERKOWITZ asked if she could tell him what the
expected rates of return would be for Alaska independents. "You
made the statement that they need higher rates of return, and I
need to be able to quantify that."
MS. KAH told the committee to look at other investments the
independents might be considering. They will look at the Gulf
of Mexico and the United Kingdom as alternative investments,
"and I might say that all of those tax rates are in that lower
left hand quadrant of the chart we looked at earlier." She said
their alternative investments have a much better cost position
than Alaska. She said she would think independents would want a
higher return than they are getting from their existing lower 48
production to invest in Alaska.
2:43:25 PM
REPRESENTATIVE BERKOWITZ said that is just an assumption. He
said the legislature is trying to set concrete numbers for tax
rates, and it is very difficult to be told it is proprietary
information. "You're asking us to make a concession to you
without you telling us what it is that you are trying to
achieve, and that to me is problematic."
MS. KAH said she feels uncomfortable talking about what the
independents want. There does seem to be a bias for newcomers.
She said, "Well what about us, the legacy investors who have
been investing here year after year?"
REPRESENTATIVE BERKOWITZ said, "We are not forgetting you; you
have been making handsome profits for a good long period of
time, and we hope you continue to make handsome profits for a
good long period of time. But when you're making internal
investment decisions that force you to choose between an Alaskan
investment and a Russian investment, we want you to go ahead and
make whatever investment you want to make, but we also want to
make sure that the Alaskan investment comes to fruition somehow.
Because we don't have a choice. Our money comes from Alaskan
oil; it doesn't come from Russian oil."
2:44:50 PM
REPRESENTATIVE SEATON said other than the $73 million, won't
Conoco be getting exactly the same capital credits and allowance
for operating costs as the smaller companies?
MS. KAH said the committee told her that Conoco was going to
have problems with the transition program, and that is how
Conoco would be treated unfairly.
REPRESENTATIVE SEATON said in trying to stimulate new
investment, Conoco's investments are treated the same.
MR. WENZEL said that is correct, for new investment the bill is
equal for small and large producers. He said Conoco's issue is
around the fact that it already has a lot of investment, which
does not receive some of the benefits from the new program.
2:46:37 PM
REPRESENTATIVE KERTTULA said Conoco gets a deduction both under
the current system and the new one on the corporate income.
Conoco doesn't get the credit, but it didn't get it under ELF
either, so "I don't see the change there."
MR. WENZEL said that is correct, there wasn't a tax credit under
the ELF system, but the system was based on revenue and it
wasn't appropriate to have a tax credit there.
REPRESENTATIVE KERTTULA said, "It didn't exist then, it doesn't
exist now, and you did get the corporate income tax. So I know
we're putting a new tax onto the revenue but the other things
have not changed."
MR. WENZEL said there is a dramatic change in the tax rate.
REPRESENTATIVE KERTTULA said she doesn't see the change in terms
of the deduction.
2:48:02 PM
CO-CHAIR SAMUELS referred to a statement that independents'
money might go to the UK, where taxes have gone up 50 to 60
percent in the last couple of years.
MS. KAH said the UK has no royalties, but the UK is still in the
lower left hand quadrant. She said they went from 30 to 50
percent tax, and now it is viewed as a risky place to invest.
She guaranteed that the UK will now get less investment.
CO-CHAIR SAMUELS asked if other countries are changing taxes
because profits are so massive. "If they all switch that way,
the competition for capital will be on an even playing field."
2:49:33 PM
MS. KAH said she is very worried about the future of the oil
industry because "I feel like the entire oil industry is being
pushed out of conventional oil investment." She said some of
that investment is continuing, but it's national oil companies
from consuming countries who are still willing to make
investments with lower returns than a private company. "My
worry is the future of the industry is pushing the oil industry
out of oil and into unconventional oil and LNG...and other
things.
MS. KAH said she wishes "you would like us to stay in this
country." She spoke of the environmental sensitivity of the
North Slope and said Conoco has a good track record with strong
standards put in place. If Alaska replaces Conoco with lots of
small companies, there may be environmental problems. She is
particularly worried if Conoco is partnering with "these
people". Conoco wants to continue to have a significant role in
Alaska and has the skills and experience for all projects under
arctic conditions. Conoco has, in particular, experience and
technology for heavy oil, and it is the second largest refiner
in the United States, so it can allow the refineries to take
more heavy crude. Conoco has access to markets that allows it
to maximize the value of the resource. Conoco has strong risk
management skills with a diversified portfolio. Conoco has a
long-term investment horizon, which means that it invests year
in and year out regardless of market conditions.
CO-CHAIR RAMRAS asked Ms. Kah to talk about exploration credits.
He said he is fascinated that development and exploration costs
are approached with the same credit. "What kind of change do
you think would be enjoyed by the State of Alaska if we lessened
your concern on the exploration side and participated more in
the risk side with oil companies and increased significantly the
exploration credit?"
2:54:01 PM
MR. WENZEL said Conoco would view that very favorably. He said
Conoco continues to explore in Alaska and is using current
exploration credits.
REPRESENTATIVE CRAWFORD said that the governor's advisor said
everything in this "so-called" oil tax relates to gas too, in a
ratio of 6,000 cubic feet of gas to one barrel of oil. He said
he asked him how this ranks Alaska in the world, and was told
not to worry because the gas tax part will be changed within two
or three weeks, "but we may never get to that part--this may be
the only stage that we deal with." He asked what Conoco says as
to where Alaska will be in the range of gas tax if this is the
gas tax that we are faced with.
2:56:02 PM
MR. WENZEL said with respect to Alaska's gas tax, "I think we
will definitely tell you...without that fiscal stability and
those provisions of that stranded gas fiscal contract that will
come out, there is not sufficient incentive to develop that gas
and bring it to market today, under the current system or under
this PPT."
MS. KAH said the investment contemplated for the pipeline is $20
billion and has a ten-year lead time, and is much more risk than
Conoco is comfortable with. "It would need better treatment
than even an LNG project that's $5 billion because it's just too
big a risk for a company even our size to contemplate without
making sure we had good enough fiscal terms and stability of
fiscal terms."
2:57:21 PM
REPRESENTATIVE CRAWFORD asked if Conoco would be adverse to
someone else using the $18 billion worth of loan guarantees and
building a pipeline that Conoco could put its gas through.
MS. KAH said she has not been involved in the issue.
MR. WENZEL said, "We don't view that as the most economic
answer. We believe our project is viable and doable. Sure, we
will look at any possible way of monetizing that resource,
bringing it to market for the full benefit of both Alaska and
ConocoPhillips. If there are other alternatives better than the
one that we've come up with, we're happy to consider those."
2:58:07 PM
MR. JONES said controlling the risks is one of the big
challenges.
CO-CHAIR SAMUELS asked how the PPT looked for Conoco in Cook
Inlet.
2:58:39 PM
MR. JONES said there is a difference between oil on the North
Slope and gas in Cook Inlet. He said people may ask why there
hasn't been more exploration for gas in Cook Inlet. "And as you
probably know, it has been a stranded gas market, where there
has been a lot more gas resource than market that needs the gas.
So just changing the credit system to try and get people to just
produce more gas, other than very small amounts...you won't get
people going out looking for half a TCF or TCF-sized fields
because once you find it, it's now stranded again." He said he
hasn't thought through the ramifications of the PPT, and it is a
big change that may have unintended consequences. "What kind of
happens is that profits from the existing assets get used to
incentivize new development, so what may happen is that profits
from Cook Inlet get used to incentivize new developments on the
North Slope, since it's...around all of Alaska. So I think
that's a challenge that you may want to consider."
3:00:02 PM
CO-CHAIR SAMUELS said he has worked hard to not have this be a
forum on any proposal that may or may not ever be brought
forward by the producers on a gas pipeline. He noted that this
is complicated enough without that overlay. "You guys have been
very careful not to say that if the oil tax regime does x, y, or
z, that it has a direct impact on any potential gas pipeline.
Now, I am still not convinced I understand how they're
politically attached. I understand how they're attached
obviously in geography, but economically-speaking, I am thinking
the gas deal has to stand alone on the gas deal, and the oil
deal has to stand alone on the oil deal. And I fully understand
why you want fiscal stability so that we don't bait you in and
half way down the project, and we go: 'Well, just kidding, we
want more money out of our hydrocarbons in general.' So I
understand the fiscal stability you're looking for, but what I
don't have a grasp on yet, or I guess I disagree with, is how
the economics are so completely tied together that you can't
divorce the discussions and do what is best for oil and oil
development and oil exploration, and then hopefully, sometime
soon, do what is best for gas, gas development, and build a gas
pipeline." He asked Conoco to say how the two are so
economically interlinked.
3:02:00 PM
MR. WENZEL said he cannot give more comfort in terms of an
economic linkage. He said it is very much about fiscal
stability and knowing that taxation on the gas side will not
result in instability on the oil side. "They are definitely
linked that way." He said there is no doubt that allowing the
gas project to move ahead will further enhance oil production;
it will extend the life of the pipeline. He stated that for
Conoco the key part of where it stands on HB 488 "is the fact
that we want that gas pipeline to go ahead. We see this bill
and the balance it provides as sort of a maximum we can accept
as a balance and move forward and stay aligned with the other
sponsors of that project." He said it is a difficult balance,
but Conoco sees HB 488 as the most expedient way to go forward.
3:03:11 PM
REPRESENTATIVE BERKOWITZ said Conoco jumped first and signed an
agreement on gas prior to any understanding or discussion of
oil. He asked why Conoco was willing to go ahead at that point
and now, all of a sudden, linkage is important.
MR. WENZEL said Conoco did step out and reached a point where
the terms of the gas project were sufficient to move ahead. He
said that even then Conoco recognized that if the project was
going to be moved forward on a reasonable and expedited basis,
"the other two sponsors needed to come to that same recognition,
and I think they've come there now in the last couple weeks."
He said they are continuing to work with the administration to
find the right balance that "gets everyone on the same page."
He said he can only reiterate that fiscal certainty on gas and
oil are now critical to all three sponsors for moving the
project forward.
REPRESENTATIVE BERKOWITZ said there was introduced legislation
on oil taxes, "and even then you were still willing to go on
gas. I'm just trying to understand why."
MR. WENZEL said from Conoco's perspective, it reached that point
where the terms on the gas deal were sufficient to move ahead,
and Conoco announced that.
REPRESENTATIVE SEATON stated that he wants to set aside the
pipeline and consider this bill as involving oil and gas. He
said, "So we have a whole different relationship here with a
whole different set of tax credits, a whole different tax rate
and tax system." He said he asked the administration for charts
showing the effect on gas under this PPT. He said he doesn't
think the data show that there has been a conjoining of gas and
oil on a BTU basis. He thinks they have been quite disparate.
He wants to understand if Conoco thinks gas needs to be in this
PPT, and whether it complicates or simplifies the structure.
"We were considering this PPT as an oil tax bill, and now it's
an oil and gas tax bill." He asked if it is beneficial for this
oil tax to also apply to gas.
3:07:53 PM
MR. WENZEL said in moving to a PPT, it would be important to
combine the taxation of oil and gas together in order to
simplify the process. He said that trying to separate all
expenses and revenue between gas and oil might be very
difficult, because they are often produced out of the same area.
Gas is a smaller piece of Conoco's business, and Conoco has been
more focused on the taxation of its future gas business under
the stranded gas fiscal contract.
REPRESENTATIVE SEATON said he is also concerned that the state
hasn't looked at the tax ramifications of this proposal on gas
and gas production, and whether gas becomes more favorable or
less for Conoco's business.
MR. JONES said Conoco has not run economics on all of its
projects for the new bill, but initial estimates are that the
PPT will double the severance tax in Cook Inlet. These tax
increases will be passed on to the consumers in South Central
Alaska. He said some independents may say that the PPT will
increase investments, but you need a market to sell the gas.
3:10:55 PM
REPRESENTATIVE OLSON said assuming there is fiscal certainty on
gas and oil in the next few months, what impact will that have
on the 2009 export license renewals?
MR. JONES said Conoco's current LNG export license ends in 2009,
and "we're looking to...extending it assuming we have the gas,
assuming South Central demands are met and that it's the right
thing to do." He said the PPT will make it less profitable, and
that may impact it.
REPRESENTATIVE SEATON said he represents that area and is very
concerned that nobody has done an economic analysis on that, and
it may be good to just throw [a gas tax] in, but if it means
that the export license doesn't make any sense with world
markets on LNG, "that's a huge deal to us on the Kenai
peninsula." He said he would sure like Conoco to run some
numbers on the other effects of the PPT, and not just look at
the North Slope.
3:12:30 PM
REPRESENTATIVE KERTTULA asked if Conoco has thought about
crediting its gas costs against its oil profits and how it plays
into HB 488.
MR. WENZEL said gas costs, including capital and expense, go
into the formula and affect the overall taxation.
3:13:08 PM
MS. KAH said large producers are desirable because they have
large investment spending capacity. She said the tax proposal
is the upward boundary of what is fair.
3:13:53 PM
MR. WENZEL said Conoco has suggestions for changes in the bill,
including how eligible deductions and credits are identified and
how the value at the point of production should be done. He
noted that the proposed tax will more than double Conoco's
effective tax rate. In isolation it is not reasonable or
appropriate, particularly because the state has a budget
surplus, but to facilitate future investment the company
reluctantly supports HB 488.
3:15:14 PM
REPRESENTATIVE BERKOWITZ noted that Mr. Wenzel doesn't want a
tax increase when the state has a surplus, but when the state
has a deficit, the industry opposes a tax increase.
MR. WENZEL said if the state was running a deficit, investors
would be more understanding, but if the state has a surplus, it
is important to consider the message the state sends when the
money is not needed.
REPRESENTATIVE BERKOWITZ said a progressive structure has been
discussed for a long time, with oil companies suggesting it.
"We have been locked into a regressive structure, which hurts
industry at low prices and didn't help the state at high prices,
and that's why you're seeing the change today...It's really
about getting a more equitable share."
MR. WENZEL said he doesn't dispute moving to a PPT; it could
work very well. But his point is the state is increasing the
tax burden.
3:17:32 PM
REPRESENTATIVE BERKOWITZ asked if Mr. Wenzel would favor a tax
that is more progressive.
MR. WENZEL said he would be happy to consider some step levels
depending on the price. "We are very much focused on the base
tax rate and the ability to look at that base tax rate and
figure out what our upside is in the future. So for us, this
balance works, but to the extent that the legislature, this
committee, had a proposal along the lines of a stepped series of
tax rate, that could work also. Again, it would be key to look
at the base rate that's appropriate at more commonly expected
prices as opposed to setting it at today's prices."
REPRESENTATIVE BERKOWITZ asked if he would share those commonly
expected prices with the committee.
MR. WENZEL said there are a number of forecasts. But he will
not divulge Conoco's forecast. He said Ms. Kah is concerned
about where oil prices are headed.
MS. KAH said she reads the external forecasts of prices not
staying at the current level. She said it is uncertain how fast
prices will drop. Inventory is extremely high, so there is a
potential for a collapse. She said there is concern about
supply disruptions, so historically, at the current level of
inventory, the price of oil today should be $35, but it is not,
it is $60 per barrel because of insecurity. She said the
question is whether the price will decline slowly or bounce.
She said most forecasts are between $30 to $50 per barrel, but
oil companies are more conservative.
3:20:48 PM
REPRESENTATIVE GATTO noted that the tax is doubling under HB
488, but Conoco stated there will be a 200 percent increase,
which is a tripling.
MR. WENZEL said Conoco was inappropriate in saying 200 percent.
CO-CHAIR SAMUELS asked why the state should give a tax credit
for abandonment expenses. He asked how many abandonments there
have been during the claw back provision.
MR. WENZEL said he doesn't have those numbers. Those expenses
are simply related to abandoning individual wells. His view is
that those are appropriate expenses that should be incorporated
in any profits-based tax. It is a cost of doing business.
Those expenses do not receive a capital tax credit because they
are operating expenses. There won't be many profits to take the
credits against for abandonment of large fields like Prudhoe
Bay. They have to be taken against production tax, and can't be
moved. He said the company could turn them into a tax credit by
virtue of having a loss, but they could only be used against
other production tax.
3:23:43 PM
REPRESENTATIVE GATTO asked if there is a "removal and
rehabilitation" for when the last barrel of oil flows through
the pipe. "Don't we already put that as upfront expenses?"
3:24:11 PM
MR. JONES said the TAPS settlement methodology includes a factor
for dismantling and restoration of the pipeline, and that is the
only context for that allowance.
3:24:34 PM
REPRESENTATIVE BERKOWITZ said the removal and rehabilitation has
the industry setting aside money to accommodate that. It should
have been expensed in already.
3:24:53 PM
MR. WENZEL said, "We need to remember we're talking about a
profits-based tax on production. The fact that those costs are
usable either in tariff methodology or elsewhere, doesn't change
the fact that if you are going to do a tax for production based
on profit, you need to bring in expenses."
3:25:15 PM
REPRESENTATIVE BERKOWITZ said you need to remember that there is
a deal that has already been struck that shouldn't be part of
another bite of the apple. He said the removal and
rehabilitation is a done deal, and if it's not, he would surely
like to know. There should be billions of dollars there at this
point. "I'd like to have that money if we are going to
renegotiate it."
3:25:43 PM
MR. JONES said the TAPS investors/owners have received
reimbursement for that expense as part of the TAPS tariff. That
money is what is set aside, there is no similar account for the
North Slope oil fields.
3:26:10 PM
REPRESENTATIVE KERTTULA said that will work under the TAPS
settlement; that isn't something that's covered by this bill.
3:26:25 PM
REPRESENTATIVE OLSON said he thought that 30 years ago there
were open-ended bonds posted to handle that.
MR. WENZEL said he would get back on that.
MR. JONES said it is likely there were bonds, but there is not a
similar TAPS mechanism for the North Slope oil fields.
3:27:35 PM
REPRESENTATIVE CRAWFORD asked if Conoco would be expensing for
that all along.
MR. JONES said in Conoco's financial books, clean-up is taken
into account.
3:28:16 PM
CO-CHAIR SAMUELS said that having the gas tax in the bill
doesn't bother him much because gas from the slope will be
locked into a contract. He said his concern is with the tax
credits for Point Thompson where there is very little
exploration risk, so why should the state have a tax credit?
The state doesn't need incentives, and this issue at Point
Thompson is where his red flags go up when he sees gas included
in this bill. He said Cook Inlet will be a separate issue.
3:29:47 PM
MR. WENZEL said Conoco's view on tax credits for Point Thompson
is not different from its view on all other tax credits. "We
believe the tax credit should apply uniformly across all
investments in a basin, at the very least. We would not
recommend creating some differential treatment for a very
specific asset in this bill." He said it would set a precedent.
REPRESENTATIVE SEATON said the $73 million allowance was to give
stability and to not over-tax production of less than 5,000
barrels. He said he is concerned that that number was arrived
at for oil prices of $43 per barrel, so the state is giving a
pass for $23 a barrel oil for a field producing 20,000 barrels a
day. He asked if it is reasonable that that size of a field
would pay no tax.
3:31:40 PM
MR. WENZEL said that base allowance is worth $15 million to
Conoco, so it is appropriate to discuss it with others where it
represents a larger cut.
REPRESENTATIVE SEATON noted that the monthly tax bill will have
a 10 percent holiday, and no interest owed on that money. He
asked if Conoco pays interest on the underpayment for federal
taxes and why not have that same system.
3:33:27 PM
MR. WENZEL said there is no interest as long as the taxpayer
meets that 90 percent threshold, and he doesn't know about
federal taxes.
REPRESENTATIVE SEATON said if it is normal, will Conoco do it
for the state?
MR. WENZEL said Conoco will pay interest if that is what the
legislature wants.
3:34:31 PM
CO-CHAIR SAMUELS said that Dan Dickenson testified that the
point of production was going to change, and he asked what the
advantages or disadvantages of changing it is to Conoco.
MR. WENZEL said he is not up to speed on the point of
production. He said the North Slope is a large heavy oil
resource that is significantly disadvantaged in technology,
quality and cost. He said it will be key to incentivize heavy
oil to increase production. The transition plan is essential to
ensure equitable treatment. Many investments were marginal and
only justified under the ELF system. The tax rate pushes Alaska
into a high tax bracket, so the state must be comfortable with
the risk that such a high rate gives the state. He concluded
that many variables need to be considered in a tax regime.
[HB 488 was held over]
3:37:21 PM
ADJOURNMENT
There being no further business before the committee, the House
Resources Standing Committee meeting was adjourned at 3:38 PM.
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