Legislature(2005 - 2006)CAPITOL 124
03/01/2006 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
March 1, 2006
12:38 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
OTHER LEGISLATORS PRESENT
Representative Ethan Berkowitz
Representative Eric Croft
Representative Les Gara
Representative Berta Gardner
Representative David Guttenberg
Representative Beth Kerttula
Representative Vic Kohring (via teleconference)
Representative Mark Neuman
Representative Norman Rokeberg
Representative Woodie Salmon
Representative Peggy Wilson
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
02/27/06 (H) Heard & Held
02/27/06 (H) MINUTE(RES)
02/28/06 (H) RES AT 12:30 AM CAPITOL 124
02/28/06 (H) Heard & Held
02/28/06 (H) MINUTE(RES)
03/01/06 (H) RES AT 12:30 AM CAPITOL 124
WITNESS REGISTER
JOHN ZAGER, General Manager - Alaska
Chevron Corporation
Anchorage, Alaska
POSITION STATEMENT: Expressed concerns with regard to HB 488.
KEVIN TABLER, Manager
Lands and Governmental Affairs
Chevron Corporation
Anchorage, Alaska
POSITION STATEMENT: Answered questions about HB 488.
MARK HANLEY, Manager
Public Affairs for Alaska
Anadarko Petroleum Corporation
Anchorage, Alaska
POSITION STATEMENT: During hearing of HB 488, related Anadarko
Petroleum Corporation's views.
PAT FOLEY, Manager
Land, Commercial
Regulatory Affairs
Pioneer Natural Resources
Anchorage, Alaska
POSITION STATEMENT: Testified in support of HB 488, but
requested that the tax credits be refundable.
JIM WEEKS, Alaska Operations Manager
Ultra Star Exploration LLC
Anchorage, Alaska
POSITION STATEMENT: Testified in support of HB 488.
ACTION NARRATIVE
CO-CHAIR RALPH SAMUELS called the House Resources Standing
Committee meeting to order at 12:38:58 PM. Representatives
Ramras, Samuels, Gatto, Olson, Seaton, Crawford, and Kapsner
were present at the call to order. Representative LeDoux
arrived as the meeting was in progress. Representatives
Berkowitz, Croft, Gara, Gardner, Guttenberg, Kerttula, Kohring
(via teleconference), Neuman, Rokeberg, Salmon, and Wilson were
also in attendance.
HB 488-OIL AND GAS PRODUCTION TAX
12:39:09 PM
CO-CHAIR SAMUELS announced that the committee would continue its
discussion of 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."
12:41:35 PM
JOHN ZAGER, General Manager - Alaska, Chevron Corporation
("Chevron"), said his the company has had a relatively short
time in which to review the proposed profit-based petroleum
production tax (PPT), and therefore some of the conclusions are
preliminary. He then familiarized the committee with Chevron's
asset base, which was formed when Chevron acquired Union Oil
Company of California (Unocal) in August of this year. Both
companies, he noted, have been active in Alaska for several
years. In fact, both companies were active in the early
discoveries at Cook Inlet. Currently, Chevron is the fourth
largest producer in the state, although it's far below the
state's third largest producer in terms of total production.
Chevron is large enough that it would be treated similar to the
producers with regard to the PPT, but the company isn't small
enough to reap the benefits aimed at the smaller producers. Mr.
Zager informed the committee that Chevron has 382 full-time
employees or contractors, of which 272 are located on the Kenai
Peninsula and the remainder in Anchorage. With the
aforementioned staff and a more than $45 million payroll, he
opined that it's obvious that it would have a large impact on
the economies of the earlier mentioned areas. The company also
contributes to the economy by serving customers such as Tesoro,
ENSTAR Natural Gas Company, Chugach Electric, Agrium, and
Aurora.
12:44:54 PM
MR. ZAGER highlighted that Chevron is unique in that it's the
only producer in the state with a relative balance of production
between the Cook Inlet and the North Slope with production in
the amount of 60 percent and 40 percent, respectively. Either
stream of production alone is large enough to trigger the PPT.
Because of this, Mr. Zager opined that Chevron's Cook Inlet
assets are uniquely positioned to suffer from the PPT, in terms
of its low margin of business and difficulty to support an
additional tax. He then reviewed Chevron's assets on the North
Slope, as illustrated on slide 3, which are as follows: Alpine
- 1 percent; Greater Prudhoe Bay - 1 percent; Greater Kuparuk -
5 percent; Endicott - 11 percent; and Point Thomson - 25
percent. Additionally, Chevron is one of the owners of the
currently leased land within the Arctic National Wildlife Refuge
(ANWR). Chevron also has exploration acreage on the North Slope
as well as a fairly extensive lease interest in the foothills.
He acknowledged that Chevron did participate in a lease sale in
Anchorage in which it spent approximately $7 million acquiring
42 leases, for a total of some 480 square miles of new leases in
the area from Kuparuk down south.
12:47:00 PM
MR. ZAGER, in response to Representative Gatto, explained that
the reference to "ORRI" stands for overriding royalty interest
and means that the company doesn't pay any of the cost but
receives 1 percent of the production. He likened this to the
royalty the state has on certain leases.
REPRESENTATIVE BERKOWITZ surmised that if Chevron just spent $7
million to acquire 42 leases, it wouldn't seem to be concerned
with the implementation of a new tax regime.
MR. ZAGER reminded the committee that originally the lease sale
was scheduled for October and Chevron had decided to participate
in the lease. However, the lease sale was delayed until today,
which led the company to discuss whether it should change its
plans due to the possibility of a new tax regime. The company
decided that due to the many unknowns at this time, it's hard to
evaluate the company's economic position based on what might be
the final form of HB 488. Since the state has always seemed to
establish reasonable tax regimes, Chevron decided that it was in
the best interest to proceed with the lease sale.
12:48:34 PM
MR. ZAGER then turned the committee's attention to slide 4,
which relates Chevron's more complicated Cook Inlet position.
He reiterated that Chevron, which is the dominant operator in
the Cook Inlet, operates 10 of the 15 platforms in the area. He
noted that eight of its platforms in the Cook Inlet are
producing while two platforms have been shut in. He then
reviewed Chevron's onshore and offshore assets in Cook Inlet.
Mr. Zager highlighted that Chevron is 100 percent owner and
operator of the Swanson River field, which is the location of
the Kenai gas storage facility where the gas is stored in the
summer months until needed in the winter. The gas storage
facility has proven to be very instrumental in meeting the peak
needs of the Cook Inlet area in the winter months. He then
mentioned that Chevron is constructing a new storage facility at
Pretty Creek field. He then highlighted new exploration at the
Ninilchik Unit, which is operated by Marathon and in which
Chevron has a 40 percent working interest, and the Happy Valley
field, which is a 100 percent Chevron asset. Chevron's total
production in the Cook Inlet is about 25,000 barrels per day of
net oil and about 16,000 barrels per day of net production on
the North Slope.
12:51:46 PM
MR. ZAGER, in response to Co-Chair Samuels, reiterated that of
the 10 platforms, eight are currently producing and two are shut
in and not producing. He then shared a photograph of the
Trading Bay Unit [on slide 5] and reminded the committee that
the North Slope isn't the only location with difficult operating
conditions in the state. The Cook Inlet also has its challenges
with its high tides and ice floes. Mr. Zager acknowledged the
notion of bringing in new producers to the state, and requested
that the committee consider the implications/risks of a much
smaller and perhaps thinly capitalized company behind these
assets. He highlighted that these operations require a lot of
maintenance and integrity because no one wants an environmental
incident.
MR. ZAGER moved on to the graphs on slide 6, which is a
logarithmic scale that plots time/years against production
rates. He informed the committee that in the 1970s Alaska was
just at 200,000 barrels per day of production as compared to
today when there is about 13,000 barrels per day of production.
Although the aforementioned illustrates that production is a
small fraction of what it used to be, operating costs have not
decreased at all, which is illustrated with the water cut line
that specifies that today a little over 90 percent of the fluid
being moved is water. The aforementioned adds to the expense of
the Cook Inlet.
12:55:14 PM
MR. ZAGER turned the committee's attention to similar graphs on
slide 7, although they only refer to the Trading Bay Unit. The
graph illustrates that the peak production was about 120,000
barrels a day, which has decreased to about 7,000 barrels per
day. The water cut is up to about 95 percent of the production.
Mr. Zager informed the committee that Cook Inlet is a very high-
cost area in that its direct lift costs are $20-$25 per barrel,
and therefore including the transportation and indirect costs,
it amounts to more than $30 per barrel to operate in the inlet.
Therefore, the breakeven on a cash flow basis is a bit more than
$30 a barrel.
CO-CHAIR RAMRAS asked if those figures include depreciation.
MR. ZAGER replied no. He noted that this entire discussion is
focused on profit as defined by the PPT, which he referred to as
free cash flow. However, in business, earnings are very
important and it means that another depreciation line would be
added. For the Cook Inlet [holdings], that amounts to about
$10-$12 a barrel of additional noncash expense that is reported
for earnings purposes. He pointed out that large corporations
are especially graded on their earnings per barrel, the priced
earnings ratio. Therefore, a company generating barrels in
production but not earnings is an issue that would need to be
addressed in the portfolio of that company.
12:57:34 PM
REPRESENTATIVE GARA reminded everyone that until a few years
ago, oil was at $18 and $20 per barrel. Therefore, he
questioned whether Chevron was losing money on its Cook Inlet
operations at that time.
MR. ZAGER answered that in certain parts of the Cook Inlet,
Chevron was losing money, as evidenced by the closing of two
platforms. The other platforms were basically breakeven or in a
slightly positive position, but given the uncertainty in oil
prices and that things could get better, the company decided to
continue to operate those. He noted that once the decision is
made to cease production, it's irrevocable and "you really can't
go back and decide to start those platforms up again." At this
point, the decision to continue was the right decision because
at current prices Chevron is obviously making some profits.
However, when one reviews the amount of operations, resources,
capital, and expense that go into it, one must question at what
point is that amount of profit irrelevant to the operations. He
explained that although the PPT will not take Chevron's profits
negative, it will reduce them to the point at which the company
may decide to say, "enough is enough." Furthermore, the PPT
will tend to drive Chevron's earnings per barrel into the
negative range. The aforementioned would all be considered in
deciding the future of the operations.
KEVIN TABLER, Manager, Lands and Governmental Affairs, Chevron
Corporation, interjected that one must also remember that
production is continuing to decline.
REPRESENTATIVE GATTO inquired as to the cost to shut in a
platform.
MR. ZAGER explained that to shut in a platform means to cease
production on the platform permanently, which is an expensive
proposition. There is an initial cost to the platform during
the initial closure because the platforms are cleaned
thoroughly. The cost to cease production and clean the platform
is several million dollars per platform. However, if the
platform is abandoned, it could amount to a million dollars per
well. He noted that ultimately the platform would have to be
removed, which would be an expensive process. In further
response to Representative Gatto, Mr. Zager explained that once
the platform is shut in, it moves into the lighthouse phase and
it will continue to have power in order to maintain the lights
and avoid the platform becoming a navigational hazard. The
aforementioned alone costs hundreds of thousands of dollars per
year per platform. He noted that the company also periodically
checks the shut in platforms to ensure that there aren't
problems.
1:01:14 PM
MR. ZAGER related that if production continues to decline at the
rate that it will without additional capital spending, the life
of [Chevron's] platforms will be fairly limited. Moreover,
there are significant operational risks to merely maintain these
platforms in Cook Inlet. Although the risk of having a large
incident in Cook Inlet is very low, it could have a very high
impact if there was an incident. He reminded the committee that
two platforms are shut in. He then explained that the platforms
are codependent and share overhead and the onshore facility is
located in Nikiski. When one platform becomes economic, the
remaining overhead and fixed costs must be shared amongst the
remaining platforms, which makes it more difficult for the
remaining platforms to be viable. "So, once one starts to go,
there's going to be a cascading effect," he related. Therefore,
the Cook Inlet is very challenging and can't afford an
additional production tax.
MR. ZAGER then updated the committee with regard to what has
happened since Chevron acquired Unocal, which occurred on August
10, 2005. At the time, there was speculation that Chevron would
divest the Alaska assets, especially the Cook Inlet assets. The
thought was that a company of Chevron's size wouldn't see much
financial benefit in retaining those assets. From October to
January, Mr. Zager said that he and his staff spent time with
Chevron's management to familiarize them with Unocal's
operations and opportunities in Cook Inlet. Through that
process, it was determined that there are incremental investment
opportunities in the Cook Inlet, although they amount to the
lowest part of Chevron's portfolio in terms of reinvestment
opportunities. There was another list of projects that didn't
make the list, and thus at the end about 35-50 projects made the
list while a similar amount didn't. In February, Chevron
decided to retain all of [Unocal's] Cook Inlet assets, with the
intent to begin a multi-year investment program. He related
that on a gross basis, spending with Unocal's partners, the
company envisions spending about $200 million over a four-year
period. He noted that the aforementioned spending is only in
the oil portion of the business.
1:04:49 PM
MR. ZAGER informed the committee that Chevron will retain the
current office locations and all its employees. In fact, the
company anticipates that six months from now it will have a
larger in-state staff than currently. He noted that over 99
percent of the employees are in-state residents and the company
anticipates that six months from now there will be an even
larger in-state staff base. However, there's a bit of a problem
in that the company performed its analysis several months ago
with the current severance tax paid to Cook Inlet, which is
essentially zero for these assets. When modeled under the
proposed PPT, it was determined that the proposed PPT affected
the economics of the company's projects. He explained that the
economics for the best projects in the portfolio became less
attractive. He attributed that effect to the fact that the
projects were generating lots of profits and would have to pay
the additional PPT. However, the projects on the bubble
benefited under the proposed PPT because the projects weren't
generating quite as much income on which to pay taxes while
benefiting from the capital credit part of the investment.
However, the benefit doesn't makeup for the increased tax on
some of the other investments.
REPRESENTATIVE BERKOWITZ inquired as to which projects were
positively affected and which were adversely affected.
MR. ZAGER posed a hypothetical example in which a project had a
30 percent internal rate of return (IRR) and after running
through this proposed model, the additional taxes and the
capital credit would cause the IRR of the project to drop to 25
percent. However, under the proposed PPT, a project with a 12
percent return that wouldn't normally meet the cut would see an
increase in IRR to about 15-18 percent. When all those are
added together under the 20/20 PPT, the entire package is
degraded somewhat.
1:08:03 PM
REPRESENTATIVE BERKOWITZ characterized [HB 488] as a one size
fits all approach. Therefore, he inquired as to how Mr. Zager
would tailor it, if allowed.
MR. ZAGER opined that there are two components that would
benefit, such as the upfront 20 percent that takes MPV [market
place value] away from the project in the out years. For
incremental investments, the ratio is going to be very
important, he said.
REPRESENTATIVE BERKOWITZ asked if Mr. Zager felt that there
might be a better taxing regime than the proposed PPT.
MR. ZAGER surmised that the economic limit factor (ELF) is off
of the table. He informed the committee that Chevron hasn't
analyzed other possible taxing scenarios. He highlighted that
the current taxing regime is one under which Chevron can live
with.
REPRESENTATIVE GARA inquired as to the IRR that Mr. Zager felt
would be necessary on an oil and gas project in order to proceed
with it.
MR. ZAGER answered that he couldn't provide those numbers
because they are held close.
1:10:38 PM
REPRESENTATIVE GARA surmised then, based on Mr. Zager's earlier
testimony, that a 12-13 percent IRR peaks Chevron's interest.
MR. ZAGER commented that Representative Gara may be reading too
much into the earlier hypothetical investment. Mr. Zager
continued by reminding the committee that under the proposed
PPT, the portfolio overall was slightly degraded. Therefore, by
lowering the tax rate or increasing the tax credit or some
combination of the two would improve the situation. The other
issue with regard to the PPT is related to the alignment of
partners. Although the current partners in the Cook Inlet can
already find ways in which to be misaligned, this proposal will
create a direct financial misalignment because the partners will
be in different tax positions depending upon whether the credit
is received and the amount of capital invested elsewhere in the
state.
1:12:34 PM
MR. ZAGER moved on to the production profile for the Cook Inlet,
the Cook Inlet offshore production as presented in the graph on
slide 11. The graph relates the effects of the four-year
capital investment program. He explained that the green area
represents the base production with no additional capital
investment. The graph shows a decrease from 2,000 barrels a day
to about 4,000 barrels a day. "Even at current oil prices, I'm
pretty sure that that would be under water on a cash flow
basis," he opined. The modeling demonstrates that with four
years of capital spending, production could be maintained at a
flat level for four years. The hope is that during those four
years of capital programs, Chevron could identify other
programs. Furthermore, more tax credits could help place some
of the projects just below the threshold of investment quality
over that threshold. Therefore, with capital investment, he
predicted that Chevron should be able to maintain current
production for that four years.
1:14:39 PM
MR. ZAGER then turned attention to slide 12 regarding the
reasons to spur Cook Inlet investment. Since the gas is running
out there needs to be a plan to meet the energy needs of
Southcentral Alaska. On the oil side, oil redevelopment will
maintain and add new jobs and will extend field life. Another
reason to spur Cook Inlet investment is new exploration.
Currently, there is a lack of real significant exploration and
there seem to be a limited number of players looking for gas.
1:16:45 PM
MR. ZAGER concluded by relating that HB 488 is a huge increase
in taxes. "When we model it, it looks like a minimum of a two
times tax severance tax increase. And depending on some of
these other levers ... as changing the tax rate, taking away the
transitional capital, it could be up to a four times increase in
severance tax," he opined.
REPRESENTATIVE BERKOWITZ inquired as to Chevron's effective tax
rate under the current system versus under the PPT. He also
requested that the answer distinguish between Cook Inlet and the
North Slope assets.
MR. ZAGER said that he may be able to only answer parts of the
question because Chevron and Unocal's financial systems have not
been integrated yet. On a statewide basis, the Unocal portion
was about 1 percent. He recalled that on the Chevron side, it
was much higher, perhaps more than 10 percent.
REPRESENTATIVE BERKOWITZ asked if Mr. Zager felt that 1 percent
for the Kuparuk [River Unit] is fair.
MR. ZAGER said that he didn't want to speculate regarding what
is fair. However, he acknowledged that it's a big oil field
that generates significant profits under the current system.
1:18:53 PM
CO-CHAIR RAMRAS inquired as to what Chevron gives back to the
communities of Alaska each year.
MR. ZAGER said that he didn't have a specific figure. He
related that Unocal has been very active relative to its size.
He noted Unocal's involvement with the United Way. He opined
that Unocal is doing its fair share, if not more. He estimated
that for this year there is about a $300,000 budget as well as
other funds that come from the "corporate." In further response
to Co-Chair Ramras, Mr. Zager estimated that [Chevron's]
profits, as defined under HB 488, are in the amount of
approximately $300 million in 2005.
REPRESENTATIVE KOHRING asked if Mr. Zager believes the
restructuring is a good concept, although the tax level in HB
488 is too high. He inquired as to Mr. Zager's recommendation
as to how to modify HB 488.
1:20:56 PM
MR. ZAGER said that would be answered momentarily. In summary,
Mr. Zager agreed that HB 488 proposes a large tax increase. He
reiterated that the better projects in a company's portfolio
will be degraded and the poorer projects will be enhanced.
Therefore, the legislation is increasing incentives to invest in
marginal projects or projects with a high risk. The
aforementioned will impact each company differently on a
portfolio basis. He expressed the need to review how those
projects compete worldwide and domestically.
REPRESENTATIVE GATTO inquired as to how much of the
approximately $300 million Chevron made in the state would HB
488 deduct.
MR. ZAGER estimated that a 10 percent deduction would not be
unreasonable, although it could be less than or more than that.
1:24:11 PM
MR. ZAGER, in response to questions, related that production is
about 40,000 barrels a day. The bill, as presented by the
governor, is something that [Chevron] can support. However, he
expressed concern that there are four major levers, which he
anticipated would be changed/modified to move into the state's
direction. If all those levers move simultaneously, it will be
a very different position than currently. Chevron, he opined,
believes those to all be material levers. For the larger
producers, the standard deduction is small to the company's
total business. For those companies that don't produce oil or
haven't invested in the state, the transition capital is an
irrelevant number. Mr. Zager opined that Chevron, for its size,
has been producing and investing heavily or more heavily than
anyone in the state.
CO-CHAIR SAMUELS inquired as to the credits Chevron expected
from the transitional money in HB 488, as it stands now.
MR. ZAGER answered that Chevron has spent in the range of $400
million over the last five years.
CO-CHAIR RAMRAS inquired as to how much [Chevron] has spent over
the last two years.
MR. ZAGER estimated that [Chevron] spent in the range of $150
million.
1:27:07 PM
MR. ZAGER said that [Chevron] has a few ideas. He explained
that Chevron is the only company in the state with a relative
balance of production between the Cook Inlet and the North
Slope. He explained that Chevron views the standard $73 million
deduction will be eaten up on Chevron's North Slope production
and thus leave the Cook Inlet production to bear the brunt of
the petroleum tax. However, Chevron's joint venture partners
and competitors in Cook Inlet are under the umbrella of the $73
million exemption. He opined that the state would want to
encourage investment wherever possible in the state. Therefore,
Mr. Zager proposed that whatever standard deduction applies, it
could be narrowly applied to the Cook Inlet offshore oil or as
broadly as south of the Brooks Range in order to encourage those
who haven't had production in the North Slope to explore and
develop elsewhere in the state and to be on equal footing as
those present.
CO-CHAIR RAMRAS said that he didn't disagree with regard to
drawing a line south of the Brooks Range in order to address
Cook Inlet. However, he questioned how he could explain to
those in his community to allow [Chevron] $146 million before
the state takes a single dollar in severance tax.
MR. ZAGER clarified that it would only be 20 percent of $146
million. He opined that it's in the economic best interest of
the state to keep the production on line in Cook Inlet. He
reminded the committee that it receives the severance tax as
well as the royalties, the property tax, and the economic
benefit of the jobs and the jobs associated with them.
CO-CHAIR RAMRAS asked if it's in the best economic interest of
Chevron.
MR. ZAGER replied yes.
CO-CHAIR RAMRAS asked if it's in the best interest of the
Fairbanks Northstar Borough School District.
MR. ZAGER answered, "To the extent they're part of the state of
Alaska, I think it's in the best interest of the state to
encourage as much production everywhere in the state as
possible, and encourage investment everywhere in the state as
possible because that benefits the entire state and ... I assume
they receive money from the state to support the school
district."
1:31:23 PM
REPRESENTATIVE GARA inquired as to Mr. Zager's view of a
proposal in which the tax rate is reduced below $20 a barrel and
the same equivalent for gas while raising the tax rate above $30
a barrel in order to protect the company on the low end and
provide the state with a larger share on the high end.
MR. ZAGER responded that the idea of a tiered system is going to
add a lot of complexity with regard to tracking. In fact, he
suspected that it would create the need for additional staff to
monitor it. Therefore, he viewed keeping it simple as a
definite advantage. Although he said he wouldn't rule it out,
he suggested the need to achieve a single rate for which
everyone could agree.
MR. ZAGER clarified his first proposal, which would take the
standard deduction and apply it not only to the North Slope but
to another area where there is a distinct and separate operation
such that everyone is on the same playing field. The second
proposal is around the rates such that the front-end rate is
lowered or the capital credit is increased to encourage
investment, or a combination of the two. He highlighted the
importance of taking down the front-end rate because it will
come out of the base operation. He noted that additional
credits on the back side will certainly help on incremental
projects.
1:34:50 PM
REPRESENTATIVE ROKEBERG related his belief that if HB 488 worked
for Chevron, it could work across the state. He inquired as to
the affect the PPT has on the Cook Inlet gas. He related his
assumption that under HB 488, Chevron would pay PPT on the gas
only portion of the company's portfolio.
MR. ZAGER noted his agreement, and explained that when Chevron
reviewed the basis for the company's recommendations with regard
to the Cook Inlet oil, which is a low margin business, it
couldn't make the same arguments for the Cook Inlet gas.
Therefore, it led to the earlier suggestion to provide relief to
the Cook Inlet oil segment.
REPRESENTATIVE ROKEBERG related his pleasure in hearing that the
leases brought $7 million [in bids].
MR. TABLER commented that the decision to bid on that was a leap
of faith for which only time will tell whether it was a good
decision or not.
REPRESENTATIVE ROKEBERG recalled testimony that the Chevron
board had approved or there had been a suggestion to make
substantial investments. He inquired as to the type of
investments being reviewed to boost the company's production.
MR. ZAGER reminded the committee that Chevron had 35-50
individual projects that were wells off of existing platforms.
REPRESENTATIVE ROKEBERG related his understanding that one of
Mr. Zager's recommendations is to raise the tax credit for CO2
reinjection.
MR. ZAGER continued, and related his recommendation that there
be an additional 5 percent incentive for certain types of
projects that are challenged, such as the heavy oil development.
He noted that recently there has been discussion with regard to
using CO2 in the Cook Inlet for tertiary projects. He
emphasized that it's a very expensive proposition to take an old
field and turn it into a CO2 project, although there could be
millions of barrels of additional resource. He then expressed
the need to have absolute clarity with regard to the terms and
definitions.
CO-CHAIR SAMUELS related that there have been discussions with
the three major producers regarding having a plan for royalty
reduction rather than having the conflicts that arise with the
cost allocations for a certain type of oil.
1:40:09 PM
MR. ZAGER acknowledged Co-Chair Samuels concerns and related
that in a large area, an oil field could have several different
qualities of oil and lead to conflicts. Therefore, he suggested
that perhaps an area could be designated as a heavy oil area
beforehand. He then commented that other mechanisms should be
considered, in terms of how to approach the heavy oil or the CO2
projects.
REPRESENTATIVE ROKEBERG asked if the measurements of the center
coil of gravity could determine what is heavy oil and what
isn't.
MR. ZAGER replied yes, but expressed concern that in an area
with a thick "pay" interval there could be different gravities
of oil in the same well or field. In further response to
Representative Rokeberg, Mr. Zager related his understanding
that those in Alaska use the terms viscous and heavy oil
interchangeably, although technically they aren't. He specified
that he is referring to viscous oil development in which the
reservoir temperature is relatively low and it's difficult to
flow the oil.
REPRESENTATIVE ROKEBERG related that he has reviewed carving out
the Cook Inlet sedimentary basin for different treatment in
order to enhance the investment. He announced that he would be
willing to suggest that the state default to the ELF for oil in
the Cook Inlet. However, he inquired as to how one would
account for gas production in Cook Inlet. He pondered whether
the PPT would be left in place for that. He then inquired as to
what would happen if a larger field was discovered.
MR. ZAGER said that he didn't have a silver bullet for that, and
noted that some of Chevron's fields produce both oil and gas.
Therefore, he suggested that perhaps it will have to move to a
field-by-field basis designation.
REPRESENTATIVE ROKEBERG interjected that the legislature has
done that in the past.
1:42:48 PM
REPRESENTATIVE GATTO turned attention to slide 2, which
specifies the number of employees and the company's payroll.
From that he extrapolated that the average payroll for each
employee is $125,000 per year. He asked if that's a typical
industry standard.
MR. ZAGER opined that Chevron offers a competitive pay with its
peers. However, he noted that the figure presented may include
benefits and thus may not be the actual take-home pay.
REPRESENTATIVE GATTO recalled the testimony that Chevron's
production is 40,000 barrels per day, which amounts to 14
million barrels per year. The reported $300 million in profits
would come out to $20 per barrel, which is of concern because
$20 per barrel at these high prices would mean that a $20 drop
in price would place Chevron at the "break over point." He
asked if that's reasonable.
MR. ZAGER clarified that the [$300 million] in profit was
defined by the net profits tax, which means that the capital
would need to be added in. Doing so would increase the price
per barrel by $5 or so. The point, he said, is that Chevron is
significantly more challenged than those operating exclusively
on the North Slope.
1:45:18 PM
CO-CHAIR SAMUELS asked if Mr. Zager believes that the state
should offer incentives for the removal of a platform that has
sellable tax credits for that particular function.
MR. ZAGER highlighted that the state has benefited greatly from
the platforms or the facilities on the North Slope in that the
state has built an envious financial position. Therefore, he
indicated that when it comes time to cleanup, the state should
[pay] its fair share.
CO-CHAIR SAMUELS inquired as to whether Mr. Zager believes that
all of the royalty owners in the state should be treated the
same.
MR. ZAGER said he couldn't answer that question.
REPRESENTATIVE GARDNER reminded everyone that over the course of
this week, all of the major producers have come before the
committee with concerns, but ultimately in support of HB 488 as
written. However, Chevron supports the legislation with
stipulations. She inquired as to Chevron's position were HB 488
to pass as written.
MR. ZAGER informed the committee that since Chevron first heard
about the proposed PPT tax, it raised concerns with regard to
the Cook Inlet. The company has constantly been ensured that
the Cook Inlet will be taken care of. However, the proposal
doesn't seem to do so, from Chevron's perspective. Therefore,
Mr. Zager said that he would be very disappointed if the
legislation doesn't include something to help the Cook Inlet,
and thus the company put forward two ideas for consideration.
In further response to Representative Gardner, if the
legislation doesn't provide additional consideration for the
Cook Inlet, he said that he would have great difficulty
supporting HB 488.
1:48:07 PM
CO-CHAIR SAMUELS asked if Mr. Zager believes that the $73
million would make a difference if the company is only in Cook
Inlet. He noted that it has been argued that the $73 million
has addressed Cook Inlet, but Chevron, with its involvement in
both Cook Inlet and the North Slope, has a unique situation.
MR. ZAGER specified that if Chevron didn't have any North Slope
assets, its Cook Inlet severance taxes would double under the
proposed scenario. Mr. Zager said:
I guess if I own a Cook Inlet company, I would then
certainly take some comfort in the $73 million
deduction as being fair, relative to the other
producers. I still think we would have - and it's in
the best interest of Chevron, but it's also in the
best interest of the state ... to encourage everyone
to expand investment opportunities in the Cook Inlet.
So, I would still be a proponent of considering ...
adjusting either the tax or the credit rate for the
Cook Inlet.
REPRESENTATIVE SEATON said that he has been concerned with the
inclusion of gas in the oil because the two are taxed at
different rates and receive different credits. He asked if Mr.
Zager was saying that HB 488 would have the same impact on gas
and oil and thus he sees no difference in the two.
MR. ZAGER replied yes, and explained that since it's a net
profits tax when one makes a profit on gas, a profit is also
being made on oil. However, he said that he does draw a
distinction in Chevron's portfolio with regard to its Cook Inlet
assets and the cost basis between its oil and gas operations.
Mr. Zager related that from Chevron's perspective, the most
critical aspect is the oil operations. If the [legislation]
were expanded to include the gas operations, he said he wouldn't
object.
REPRESENTATIVE SEATON surmised then that Mr. Zager didn't view
the difference in the oil tax rate and the gas tax rate on the
production tax as significant.
MR. ZAGER said that [Chevron] actually didn't do that analysis
and merely reviewed Chevron's current severance tax without
breaking it down between oil and gas. Then, it was reviewed on
a combined basis afterwards.
1:51:49 PM
MR. ZAGER reminded the committee that Chevron has been in Alaska
for a long time and, as indicated by the results of the sale
today, Chevron hopes to operate in Alaska for a long time.
However, that will depend, to some degree, on the measures taken
on the new petroleum tax. Mr. Zager opined that the state would
benefit if it could establish a formula to attract additional
capital.
1:53:58 PM
The committee took an at-ease from 1:54 p.m. to 2:03 p.m.
2:04:03 PM
MARK HANLEY, Manager, Public Affairs for Alaska, Anadarko
Petroleum Corporation ("Anadarko"), began by informing the
committee that Anadarko is a large independent, which means that
it explores for and produces oil and gas. Generally, Anadarko
doesn't have refineries or gas stations. He further informed
the committee that Anadarko is a $23 billion market cap company
with a little over 3,000 employees. Mr. Hanley related that
Anadarko is one of the larger independents.
2:06:00 PM
MR. HANLEY highlighted that Anadarko is operating in Alaska
exclusively on the North Slope, as illustrated by the pink and
yellow areas on the slide entitled "Anadarko's Alaska Acreage
Position." He noted that Anadarko partners with ConocoPhillips
Alaska, Inc. and Pioneer for which ConocoPhillips Alaska, Inc.
is the operator. However, Anadarko also has interests in which
it's the operator in the amount of 2.2 million net acres, which
results in ConocoPhillips Alaska, Inc. and Anadarko operating
about the same net acreage. However, that will shortly decrease
because Anadarko brought in a new partner, BG, that is a large
worldwide gas player. Anadarko, he opined, has multiple
opportunities and has developed a regional model in order to
model various areas. For the purposes of this PPT discussion,
Mr. Hanley characterized Anadarko as a bit of a hybrid. He
noted that although Anadarko doesn't have interests in Cook
Inlet, it does have production there.
2:08:20 PM
MR. HANLEY related that Anadarko views the North Slope as a
world class petroleum basin in which much oil has been found and
much remains to be found. Anadarko, he further related, tends
to focus on legacy or anchor field opportunities that would
support stand-alone facilities. Furthermore, Anadarko views
Alaska as a favorable political environment. In response to Co-
Chair Samuels, Mr. Hanley clarified that Alaska is a favorable
political environment because it's a western democracy in which
the risks aren't the same as in other areas. Moreover, the
State of Alaska views development positively. Also, Anadarko
views the abundant new entrants as partnering opportunities.
CO-CHAIR RAMRAS asked Mr. Hanley if [Anadarko] views the State
of Alaska as a partner or merely a taxing agent.
MR. HANLEY answered that generally, [Anadarko] views the state
as a partner, and mentioned that the company has been able to
work collaboratively with the state.
CO-CHAIR RAMRAS related his fascination with the exploration
credits and the opportunity to bring down the cost for explorers
and be in partnership financially.
MR. HANLEY said he would address that at the appropriate time
during his testimony.
2:11:39 PM
MR. HANLEY continued and added that Anadarko also views the new
entrants as a positive in order to explore the basin. "The fact
that there's new players with different ideas from us is a
positive for us," he stated. However, [the challenge] is that
it's a maturing basin with high costs, a lack of infrastructure
in some respects, limited access at times to facilities and
pipelines, extremely long lead-time exploration, and short
operating windows. Therefore, there is a cost and the proposed
credits help to recover some of those costs faster thereby
reducing the cost of the development.
2:14:14 PM
REPRESENTATIVE GARDNER pointed out that although Anadarko views
new entrants and partnering as opportunities, it is competition,
which is a challenge.
MR. HANLEY clarified that the reference in the presentation to
competition is the lack thereof. However, he noted that one of
the reasons Anadarko looks for anchor fields is because it
doesn't necessarily want to access existing facilities and have
to deal with the satellite issues. It's a factor that Anadarko
considers, he said.
CO-CHAIR SAMUELS turned attention to the challenge, as specified
by Anadarko, of limited access to facilities and pipelines.
With regard to the TAPS [Trans-Alaska Pipeline System]
settlement methodology (TSM) reopening in 2009 or 2011, he asked
if Anadarko has a methodology to [predict] the result of it. He
asked whether Anadarko factors in the aforementioned reopening
or has to utilize the economics of the current tariff when
running the economics.
MR. HANLEY said that currently Anadarko is using the numbers as
they are. He expressed hope that the state won't have to deal
with TSM because Anadarko is before the Federal Energy
Regulatory Commission (FERC) challenging those rates. He opined
that well before 2009, there should be a decision. A judge will
determine who is in the right in this case, and Anadarko is
fairly confident that interstate rates will also decrease.
Therefore, the state may be able to reopen TSM because the FERC
may have set a just and reasonable rate.
CO-CHAIR SAMUELS mentioned that the TSM will play into the $73
million and the tax credits.
2:16:57 PM
MR. HANLEY continued with the challenge relating to the lack of
a gas market. He specified that Anadarko is very supportive of
getting a gas line built in Alaska because it will improve both
oil and gas economics. In regard to Anadarko's view of the PPT,
Mr. Hanley opined that the administration did a good job
balancing the issues and the priorities. He related that from
Anadarko's perspective, the higher prices it might pay from its
Alpine production are offset by what the company generally views
as improved economics for exploration and development as well as
protection on the downside. Therefore, overall Anadarko views
[this proposal] as a positive balance because it improves the
company's exploration economics and for that reason Anadarko
supports it.
REPRESENTATIVE GARA related, "It seems to me that, as I've heard
from your company in the past and others, the prospects of major
gas finds, assuming there is a gas pipeline and ... an open
season that lets you get gas into the pipeline, ... are so great
that nobody was talking about the need for these additional
credits before." Therefore, he inquired as to what Mr. Hanley
could say to convince him that the companies really need the
proposed credits in HB 488.
MR. HANLEY related that Anadarko believes there's tremendous gas
potential, although it's not a sure thing. He then highlighted
that there is a difference between finding a lot of gas and
whether that gas is commercial. Compared to the economics of
the existing gas, "ours is less economic," he opined. Anadarko
has exploration risk, development risk, et cetera. He informed
the committee that there would have to be very large field sizes
that flow fairly well because Anadarko, in this high price
market, can't afford to drill many wells to obtain the gas.
Anadarko, he opined, believes there's potential, and the
credits, particularly the exploration incentive credits, have
helped.
2:21:42 PM
MR. HANLEY pointed out that Anadarko has had the concept for a
couple of weeks and the legislation for a week. Therefore, he
said he would like to reserve the right for Anadarko to change
its mind because the company isn't sure how HB 488 affects gas
economics. Under the old system, the maximum tax on gas was 10
percent and there was a different ELF. He explained that
generally Anadarko, on both its oil and gas prospects, will pay
a high ELF because Anadarko is looking for fields such as Alpine
and large fields on gas. Moreover, Anadarko's modeling is
generally based on high severance taxes.
MR. HANLEY then turned the committee's attention to the slide
entitled, "New Small Oil Development," which specifies that it
would have an ultimate recovery of 47 million barrels. He then
turned to the graph on the slide entitled, "Small Oil
Development - Rate of Return." He specified that the red line
is the value of the $73 million. If one views the [small oil
development], one can see the improvement in the rate of return
in comparison to the current case. He then highlighted that the
green line is the same model, without the $73 million. The
aforementioned, he said, is Anadarko because it would use the
$73 million against Alpine. "It gives you an idea of the
relative value between an existing player on this particular oil
development and a new player who has the ability to use that $73
million as part of their economics." Therefore, there's a
fairly good delta there. He pointed out that the graph [with
the maroon line] assumes an existing producer at the 25/20 PPT.
The green line illustrates that Anadarko would have an
improvement in its economics. If the tax is raised to 25
percent, it actually reduces the economics below the current
system. He pointed out that Dr. Van Meurs' 11.6 chart for a 50
million barrel field for which Dr. Van Meurs predicts that at a
25/20 PPT without the $73 million still improves the economics.
Therefore, the differing model results needs to be addressed.
If the goal is to have more wells drilled on the North Slope,
and not enough are being drilled under the current system, one
would think the [state] would need to improve its economics.
However, raising the tax to 25 percent brings "it down to the
same level," then that goal hasn't been achieved.
2:26:32 PM
CO-CHAIR RAMRAS requested that Mr. Hanley explain the graph on
the slide entitled, "Small Oil Development - Rate of Return."
He pointed out that the graph doesn't specify what happens if
the price of oil reaches $60 a barrel. He also requested that
Mr. Hanley explain where Anadarko is with the production tax,
under the ELF.
CO-CHAIR SAMUELS also requested that Mr. Hanley define what
Anadarko considers to be small oil development in terms of the
number of barrels per day.
MR. HANLEY reminded the committee that the small oil field is a
47 million barrel recoverable field with a maximum of 15,000
barrels of oil per day. Again, these are all variables and thus
the maximum doesn't mean it's the average. Furthermore, how
fast the field comes on line and how quickly the company can
produce it make a difference in the economics. He informed the
committee that Anadarko did try to utilize some of [the
elements] used by Dr. Van Meurs. Although Anadarko didn't
totally succeed in that respect, Mr. Hanley related that the
trends presented by Dr. Van Meurs are correct. For instance,
Dr. Van Meurs used the West Texas intermediate (WTI) oil price
while Anadarko used a wellhead price, which Mr. Hanley said Dr.
Van Meurs had to establish in order to determine the impacts.
Therefore, he opined that everyone should be placing the
wellhead oil prices at the bottom of the graphs in order to
compare apples to apples without the need for a conversion
figure.
2:29:34 PM
MR. HANLEY then addressed effective rates, and informed the
committee that currently at Alpine Anadarko is paying just under
13 percent. Last year Anadarko was paying in the "low tens,"
which he explained is because under the current system the first
five years of production a company has the ELF multiplied by
12.5 percent and after that it's multiplied by 15 percent. He
characterized the current ELF that Anadarko pays as high and
suggested that the ELF for Prudhoe Bay may be the only field
with a higher ELF. He explained that under the PPT as it exists
today, if were it applied in 2005, Anadarko would actually pay
$13 million less than under the old system. Part of the reason
that Anadarko would pay less under the proposal in HB 488 is
that it had a lot of capital investments, which offsets those.
In further response to Co-Chair Ramras, Mr. Hanley specified
that over the last five years, Anadarko has invested in the $90
million range. He offered to determine how much the company has
invested in the last two years.
2:31:53 PM
REPRESENTATIVE GARA, referring to the lines on the graph that
represent the existing ELF tax and the 25/20 PPT, noted that the
two are very close. However, according to Wood MacKenzie the
rate of return in Alaska, under existing law, is higher than
most places at $25, $35, and $40 per barrel. Therefore, he
questioned whether, under existing law, too much money is
leaving the state and thus he further questioned why something
better than 25/20 shouldn't be adopted if it also leaves
Anadarko with a high rate of return.
MR. HANLEY said that he couldn't comment on the Wood MacKenzie
study. However, he related that most of the small oil field
developments are very challenging and thus not many are drilled.
He said he didn't believe the contention that a lot of money is
left on the table that the state could tax more under the
current system and still have investment.
REPRESENTATIVE NEUMAN highlighted that Anadarko's graphs seem to
stop at the $45 to $50 per barrel range. However, the reality
in recent times has been that oil prices are $60 per barrel.
Therefore, he inquired as to what the graph would look like at
$60 per barrel oil.
MR. HANLEY offered to provide a graph with $60 per barrel oil.
However, he pointed out that the graph he provided is based on a
wellhead to about $43 per barrel of oil. He noted that Dr. Van
Meurs' graphs went to a $40 WTI, which equates to about a $32
wellhead price.
2:35:19 PM
MR. HANLEY continued his testimony by highlighting that the rate
of return is just one measure. He then referred to [the graph
on the slide entitled "Small Oil Development - Net Present
Value"], which includes a 12 percent discount rate on the after
tax net present value. Generally, the discount rate changes the
crossover points, but not necessarily in a relative manner. In
regard to what Anadarko uses for a hurdle rate, Mr. Hanley said
that it isn't something that the company discloses. However,
the numbers can be run at various hurdle rates and he opined
that the legislature's consultants could do so and present a
tight range of the numbers that companies will use. In concept,
the graph relates that at the high end, the state gets more
while at the low end, the [state] takes some of the risk [and
takes less]. Compared to the current system, at the high prices
there is less net present value.
MR. HANLEY, in providing clarification, pointed out that the
graph discounts the value of the money in the future at some
rate. The [after tax net present value] is another way that
companies look at measuring their return. He offered to get the
committee a better explanation.
2:39:18 PM
CO-CHAIR RAMRAS surmised that the graph entitled "Small Oil
Development - Net Present Value" isn't about the state's take
but questioned what it is actually addressing.
MR. HANLEY explained that this graph is discussing the same case
as before, just on a discounted basis. "If you value the cost
of money into the future and the relative value of that as you
go forward, not just on a rate of return basis," he further
explained.
CO-CHAIR RAMRAS related his understanding that Anadarko is
supposed to be speaking as the representative of small
producers, and therefore "what's good for Anadarko is good for
the whole PPT theory." He related his further understanding
that Anadarko, under the PPT system, would pay $13 million less.
Therefore, PPT incentivizes small producers to explore more. He
asked if the graph entitled, "Small Oil Development - Net
Present Value" is showing four different scenarios a small
explorer who wants to enter the Alaska market, as Anadarko
believes, may face if the net present value is utilized. He
then inquired as to the difference between the green line, which
refers to an existing producer for which the exemption is
applied elsewhere, and the red line, which refers to a new
entrant for which the exemption is applied to the evaluation.
MR. HANLEY explained, "It's a relative impact on us looked at
from a different way." He [turned attention to the graph
entitled "Small Oil Development - Rate of Return"] which
illustrates that "they all were either better or about the same
as the current system ... [for] a small field, I guess you would
say."
CO-CHAIR RAMRAS related his understanding that the discussion is
in regard to the profitably for [the company] that is drilling.
MR. HANLEY stated his agreement and mentioned that it could be a
small producer or a large producer. He specified that the
difference between the green line and the red line is the $73
million in the green line is applied elsewhere with an existing
producer that won't have that exemption to help the [particular
field's] economics. However, [as illustrated by] the red line,
a new entrant would be able to apply the $73 million in its
economics with regard to how the particular field is valued.
CO-CHAIR RAMRAS posed a situation in which Chevron says that it
used the $73 million in the Cook Inlet, but the $73 million
wouldn't be available to use in another field unless the company
is allowed to apply it twice.
MR. HANLEY indicated his agreement and said that Chevron, in the
aforementioned case, would be the green line. Therefore, the
company would say it couldn't use the $73 million to evaluate
whether a prospect is of value. He said that Anadarko would
probably view it that way on this particular prospect because
Anadarko has used the $73 million elsewhere. However, another
company without production would use it and the $73 million
would be of value to them.
2:43:42 PM
CO-CHAIR RAMRAS surmised then that the red line appears to be
more desirable because it's a higher rate of return, which is
why it refers to a new entrant.
MR. HANLEY replied yes.
CO-CHAIR SAMUELS posed a situation in which TOTAL E&P USA, INC.
(TOTAL) wants to partner with BP. However, once they run the
economics on the same project, they would have different
results. The major producers pointed this out and thus the
argument can either be that it's philosophically unfair or that
there will be more problems with joint ventures. With the $73
million, there is also the argument that the state will get what
it asks for and thus there will be many [players], all with the
$73 million exemption and the ELF revisited.
MR. HANLEY remarked that [the $73 million] is also an
enticement. He recalled testimony relating that Norway is
actually giving people a check for $78 for every $1 [spent] to
every new entrant. Generally, the companies coming to Alaska,
after their first exploration, become an existing player.
CO-CHAIR SAMUELS, in regard to the 12 percent discount rate,
asked whether that's what Anadarko uses.
MR. HANLEY reiterated that Anadarko doesn't inform others of the
discount rate it uses, although [consultants] could inform the
committee how discount rates are used.
CO-CHAIR RAMRAS asked whether the lines would shift down if the
discount rate is 10 percent.
MR. HANLEY said that if the discount rate is decreased, the
lines will shift up. Therefore, the higher the discount on the
dollars, the less the value overall.
CO-CHAIR RAMRAS related his understanding that under the net
present value one looks at the return six years from now, such
that the dollar is discounted back. Therefore, at 12 percent
per year, that dollar would be worth $.28 in today's dollars.
MR. HANLEY said he agreed with Co-Chair Ramras' understanding.
However, he suggested that others could better explain this. He
pointed out that under "this model, the higher the price, more
of the people ... are underneath as far as the return based on
this method of evaluating it, compared to the current system."
Therefore, at higher prices, the state receives more and "you
see under this system some of those better prospects they had
get taken down at the high prices."
2:48:42 PM
REPRESENTATIVE CROFT returned to the chart entitled, "Small Oil
Development - Rate of Return," which illustrates that all of the
lines have the same curve. Although there is a difference
between the lines in terms of the rate of return, it doesn't
seem to fluctuate by oil price. However, the curves produced by
the net present value discount causes radically different curves
and thus there are different results for different oil prices.
Representative Croft inquired as to what curve is desirable if
the goal to have a small oil development with a good net present
value. He assumed that one would want a good net present value
at a range of prices and a relatively flat curve in order to
ensure that there is a good return at $20 and $40.
MR. HANLEY pointed out that if the tax rate is reduced, then the
economics will be approved, even under the net present value.
If the credits are increased, the same can be accomplished.
Combinations of what one does under the system will have
different impacts and the question is regarding what is [the
state's] goal. If the desire to have all the scenarios produce
a better net present value than the system, then at all prices
the state would take less money. He reminded the committee that
Anadarko believes that while the company may pay more on its
production in the future, it will be balanced by the fact that
the state is taking more at high oil prices and it's a balance
under some measures. If the goal is to obtain more money at
high oil prices, balancing that off against the economic
indicators that allow the companies to take more at the low end
while there is an improvement in the economics [counter]
balances paying more, he said.
2:52:08 PM
REPRESENTATIVE SEATON surmised that these graphs are presenting
[the take] from Anadarko's view. He related his understanding
that at $25 there is a crossover breakeven point. He asked if
the sensitivity calculation is merely a different set of
numbers.
MR. HANLEY clarified, "This is this proposal, the PPT, based on
those numbers."
REPRESENTATIVE SEATON further surmised then that with the PPT at
20/20, the red line, no matter the price, the company has a
higher after tax present value than under the current system.
Under the 20/20 proposal with higher oil prices, the state is
supposed to receive more. He asked if the aforementioned is a
function of change in money from the federal government to the
state government. He inquired as to how the company makes out
better in every scenario while the state does so as well.
MR. HANLEY attributed [the difference in the green and red
lines] to the $73 million deduction. As [the prices increase],
it gets closer to the existing system, he pointed out.
Therefore, eventually "all of those" will crossover and at a
certain high price even the red line will fall under the
existing system, he opined.
REPRESENTATIVE SEATON posed a situation at $50 Alaska North
Slope (ANS) price and surmised that the graph illustrates that
the company has higher profits, although that doesn't
necessarily mean that the state is receiving less money than
under the current ELF. He asked if the graph illustrates that
in the development of a small oil development at $50, it's
absolute that the red line specifies that the oil company will
make more money in comparison to the state.
MR. HANLEY said he didn't know the answer because it would be a
cash flow analysis versus the net present value. Mr. Hanley
then moved on to the graph entitled, "Medium Oil Prospect -
Risked Rate of Return." The aforementioned presents a similar
type of approach based on a larger field. He explained that
it's a risk analysis and thus there is a certain chance of
success. He pointed out that the graph illustrates that for a
larger field, the PPT improves the after tax rate of return line
for all the cases. Furthermore, the difference between the red
and green lines isn't as significant as in the earlier graphs.
2:56:48 PM
CO-CHAIR RAMRAS inquired as to what it would take to support the
same line, increase credits, and reduce the $73 million. He
then inquired as to whether the $73 million could be in place
for a few years and then sunset it and place the company under
the 20/20 proposal. If the aforementioned is an option, then he
inquired as to the number of years that a credit would need to
be provided and still enjoy new entrants who are then phased
into the regular PPT plan that is applicable to the majors.
MR. HANLEY opined that in one view the $73 million credit is
equal across the board because everyone gets it. However,
companies without production don't receive the credit, although
it helps the exploration economics. He specified that 20
percent multiplied by $73 million is $15 million in value,
regardless of the size of the producer. Therefore, in that
respect it's a level playing field. In regard to the relative
value, he posed a situation in which a company has 20,000
barrels per day of production and, for the sake of argument, the
$73 million is equivalent to 5,000 barrels per day at $40.
Therefore, 25 percent of the aforementioned company's production
would be tax free whereas a company with 250,000 barrels per day
would receive 2 percent tax-free production. Mr. Hanley then
provided the following example:
If you want to get rid of the $73 million and use the
tax rate, I don't have a tax credit. If you want to
use the tax rate to keep them whole ... effectively
... for the 20,000 barrel a day person you get rid of
the $73 million you've got to lower the tax rate from
20 percent to 15. That keeps them whole. For the guy
with 250,000 barrels a day, if you lower it a half a
percent, it keeps them whole.
MR. HANLEY surmised that it was all part of a package to come to
an overall dollar amount in which the tax rate was figured in
with the $73 million. He related his belief that if the larger
companies receive a 1 percent rate reduction in the tax or could
prevent a 1 percent increase those companies would give up the
$73 million. However, if a company gives up the $73 million and
can't decrease 5 percent, there is an adverse impact on the
smaller players.
3:01:07 PM
MR. HANLEY related that there seems to be an assumption that
there's a level playing field already. He suggested that to the
extent there is a tilted playing field, [under HB 488] it's
still heavily tilted away from some of the smaller, newer
players and toward the larger players. Mr. Hanley pointed out
that this is a net back approach in which one would normally be
able to deduct expenses. He explained that if Anadarko puts oil
down the pipeline and it costs the company $4 to send it to
Valdez, that's what the company pays. However, an owner has a
return on that and will, under the proposed system, be allowed
to deduct a profit as an expense. He characterized the
aforementioned as an unlevel playing field. Therefore, Mr.
Hanley said he wouldn't argue that it unfairly tilts the playing
field against the large players, although it does have an
impact. He suggested that even without this there may be
different companies in the same fields paying different tax
rates under this proposed system. He reiterated that whether a
company is exploring or not impacts the value of the credits
under the proposed tax structure.
3:03:34 PM
CO-CHAIR RAMRAS surmised then that if the $73 million were
reduced while continuing to incentivize small entrants, the tax
rate could be lowered or the amount of credits could be raised.
However, he opined that lowering the tax rate and reducing the
tax credit would [be received] poorly in many of the districts.
MR. HANLEY, in response to Co-Chair Ramras, informed the
committee that Anadarko has over 3,000 employees [worldwide] and
market capital of over $23 billion. Mr. Hanley acknowledged
that Anadarko is a large company.
CO-CHAIR RAMRAS pointed out that Anadarko would be the largest
company in Alaska were it based in Alaska, although it's being
referred to as a small company.
MR. HANLEY mentioned that the view one takes of this proposal
depends upon whether the company has production and what it's
looking to find. Again, the difference, under HB 488, for a new
entrant versus an existing producer is less for a [medium oil
prospect as illustrated on the graph entitled, "Medium Oil
Prospect - Risked Rate of Return"]. Therefore, there is less of
an impact on the company's economics as it goes forward.
3:05:29 PM
CO-CHAIR SAMUELS recalled Mr. Hanley's testimony that if the $73
million is eliminated, Anadarko would want to have a lower tax
on a certain amount of barrels or revenue. Still, the company
would effectively end up at the same place in that the benefit
would still be given to the large companies.
MR. HANLEY said, "To the extent that you want to incent new
companies, this is a much bigger issue and much more valuable to
the companies." He suggested that many companies, particularly
those without production, would view the elimination of the $73
million with a 1 percent decrease in the tax rate to be a much
worse system.
3:07:17 PM
REPRESENTATIVE GARA surmised that on one hand Mr. Hanley's and
Dr. Van Meurs' presentations say that at a 25/20 PPT at $40 per
barrel, the state would take more money than it does currently.
On the other hand, Mr. Hanley's graph shows that under the 25/20
PPT the company's rate of return is higher at $40 per barrel
than it is currently. Therefore, he inquired as to how the
company and the state can be making more money at the same time.
MR. HANLEY offered to provide the committee with an explanation
[at a later time].
REPRESENTATIVE CRAWFORD related his understanding that the after
tax rate of return axis is the return to the company. The
existing ELF is lower in all cases on the graph, although the
committee has been told that this is a tax hike. However, the
companies receive a larger after tax rate of return regardless
of the proposals presented on the graph.
MR. HANLEY explained that the graph views the field as a new
prospect such that the company is allowed to use all of its
credits against the prospect. The tax increase, he further
explained, comes from the existing fields. He related that a
company would have past capital that's invested and thus if a
company were to do a new Prudhoe Bay, its economics would change
because the company has a higher tax rate. Furthermore, there
would also be the many credits against the capital. The
aforementioned is why there is reluctance from the existing
producers. He opined, "It's essentially hammering existing
production." In some respects, under the 20/20 proposal, the
state is paying for 40 percent of the cost of development, which
more than offsets the higher tax rate. Therefore, the dollars
are coming from the tax increase on existing production.
3:11:10 PM
REPRESENTATIVE CRAWFORD characterized this as a "scary
proposition" because if the state is very successful with this,
the state could receive a lot less in the future.
CO-CHAIR SAMUELS related his understanding from economists that
getting many new entrants with the lengthy necessary exploration
lead time will result in the $73 million losing its value over
time.
REPRESENTATIVE GARA opined that the early tax credit is
important in achieving a higher rate of return and more taxes
under the analysis. Therefore, he surmised that the early tax
credit is almost more important to a new developer than the tax
rate once a field becomes profitable. He then posed a situation
in which the 25/25 system that was raised to 30/25 such that the
company is protected on the downside and receives a larger tax
credit when the situation is riskier. Therefore, it would be
worth the extra tax the company pays when the situation becomes
profitable. He asked whether he can assume that by raising both
5 percent, a new developer would be better off than if neither
were raised.
MR. HANLEY related his understanding that if there is a 5
percent increase, there would be a decline in the economics
because the tax rate is more valuable than the credit
increasing. In regard to the crossover point, Mr. Hanley said
that it's based on many variables. He offered to model it.
REPRESENTATIVE GARA said that if the answer isn't clearly in the
affirmative, then such a model isn't necessary.
3:14:14 PM
MR. HANLEY opined that there would have to be significantly
larger incentives on the back end to make up for tax increases.
He stated that Anadarko absolutely prefers a lower tax rate
because it improves the company's economics. This is a policy
call for the legislature.
REPRESENTATIVE GATTO commented that it doesn't matter what the
tax rate is if the company is paying zero. However, under some
scenario it's possible to take the credits and pay a tax rate
that's higher and do better, although he wasn't sure that most
of the companies would fit such a scenario.
3:15:19 PM
MR. HANLEY related his understanding that it seems that there's
concern that people made decisions based on low oil prices.
However, the prices have been higher and [the companies] have
been able to pay back their capital such that one would question
why the lookback should be allowed. In response, he highlighted
the Alpine field in which a project, two satellites, was
sanctioned in December of 2004 during a high oil price
environment. The satellites are due to come online this year
and thus there hasn't been a decrease of dollars coming in to
offset those. Therefore, one could argue that they are taking
the high side from Anadarko. With regard to an earlier comment
that price is what drives many of the issues, he acknowledged
that the price is a variable and the tax needs to be fixed.
3:17:49 PM
MR. HANLEY clarified that some have said that the tax rate is
insignificant compared to the swings in the price of oil.
However, Mr. Hanley reiterated that the price is the variable
and everyone has to deal with that. Therefore, he said he
wouldn't encourage a 40 percent tax rate because if the price
increases to $60, one has to review the variable price, which if
it decreases, will have a larger impact. With regard to prices,
Mr. Hanley indicated that without being able to determine the
price of oil between 2014-2034 or have protections on the price
during those times, [Anadarko] would be conservative,
particularly in an environment in which production in Alaska
takes longer from startup to production. Therefore, he opined
that companies are probably more conservative with price
estimates in Alaska. Despite the fact that prices are up, from
a company's perspective, companies could argue that the state
has been receiving higher than it should for a while. Mr.
Hanley informed the committee that one of the reasons Anadarko
can support HB 488 is because there is some protection in some
cases and some downside protection. Depending upon the model,
the state is going to take less money than under the current
system. However, "if we think that 10 years from now when the
price goes down, they're going to change it back and take that
... that hasn't helped us." He noted that such wouldn't be
modeled.
3:21:30 PM
REPRESENTATIVE BERKOWITZ, in regard to modeling conservatively,
opined that it must mean that Anadarko has some estimates as to
what the company believes the price will be in the future.
MR. HANLEY agreed that is the case. He said that on internal
rates of return, hurdle rates, discount rates, and prices one
can put those on graphs in order to review the ranges. The
consultants can provide the committee with ideas as to what
companies might use.
3:22:45 PM
MR. HANLEY commented that independents are sensitive. In one
respect independents don't have as broad a portfolio, but
independents tend to want to "confirm and condemn." Therefore,
things that the legislature does will impact independents, and
perhaps to a larger extent than some larger companies.
REPRESENTATIVE BERKOWITZ recalled that one of the earlier
presenters suggested that independents need higher rates of
return than the majors. He asked if Mr. Hanley agreed.
MR. HANLEY opined that each company's different. He suggested
that the committee ask its consultants to determine the cost of
finding versus the cost of capital. He highlighted that those
who are looking for new oil and gas on the North Slope are the
independents and new entrants, which he attributed mainly to the
internal hurdle rate on the size of the field. For some of the
larger companies, the expected size of fields aren't in Alaska.
However, he further opined that it does take a mix that one
needs "to balance that off." He expressed the need to have the
investment in the existing fields in order to have the
infrastructure and the pipeline in order to move oil down it.
Still, some companies will not look for things that others will
and thus the committee should be aware of the mix of heavy oil
as well as small fields and frontier fields.
3:25:40 PM
MR. HANLEY then discussed the credits that aren't. He noted
that Anadarko would be able to utilize credits since it has
income, and therefore he said that he would speak in regard to
companies that don't have existing income against which they
could use these credits. To the extent that the aforementioned
is the case, the new companies have to discount the credits.
Therefore, it's not a level playing field if companies with
existing income can use the credits at 100 percent while the
newer companies cannot. In fact, the new companies would have
to sell the credits to the [existing companies] and thus the
[existing companies] will take 10 percent more and the newer
companies will receive 10 percent less. Furthermore, the state
incents the same amount of money. Mr. Hanley then suggested
that a refundable credit should be considered. If it's costing
the state the same, he questioned "why not just cut the check."
The aforementioned would level the playing field for the new
entrants. To the extent the committee views refundable credits
as a problem, he suggested expanding the taxes and payments
against which companies can utilize those. He further suggested
that it could be utilized against corporate income taxes and
bonus bids. In fact, there is a precedent for such, as
demonstrated by the broader incentive credits under the
Department of Natural Resources (DNR). Mr. Hanley emphasized
the need to keep the tax credit level for the players that don't
have production, which he opined is best accomplished with a
refundable credit.
3:29:02 PM
REPRESENTATIVE GARA expressed his discomfort with the $73
million. To that end, he inquired as to why a lower tax rate
during the first few years of production wouldn't be continued
versus the free $73 million credit in profits.
MR. HANLEY clarified that the $73 million is an allowance
deduction. Although the state can structure this any way it
wants, it will be difficult for the newer players to replace the
$73 million because of the relative value, as described earlier.
REPRESENTATIVE BERKOWITZ pointed out that although there has
been discussion with regard to incentives, there hasn't been any
real discussion in the way of punishment for the failure to
perform. He asked if Mr. Hanley has any thoughts on the
aforementioned. He suggested that perhaps a "use it or lose it"
provision could be utilized in terms of whether a lease is
developed or not.
MR. HANLEY said the aforementioned can be done because there is
already a process by which the state can increase or decrease
the length of term of a lease. However, he said that incentives
are a better way to encourage development.
3:32:47 PM
REPRESENTATIVE CRAWFORD recalled the charts the committee has
been given that relate the state's oil production if there isn't
a gas line by 2012 to 2015. He related his understanding that
the state's oil production is enhanced if it has a market for
its gas. He suggested that it would be best if a gas line is
built and producing during that timeframe.
MR. HANLEY commented that for Anadarko's purposes, the sooner
the gas line is built the better. He then continued with his
presentation in regard to the state needing to be careful in
regard to what it asks because what the legislature decides will
drive behavior. Anadarko would like to drill more wells and to
have more exploration economics as well as more shareholder
value, all of which he didn't believe to be mutually exclusive
from the state's goal. He then expressed the need to review how
much the economics decrease if the tax rate is increased. He
also expressed the need to review how much the minimum economic
field size for certain areas increase as the tax rate is
increased. All things being equal, Mr. Hanley opined that as
the tax rate is increased the economics decrease, which can be
offset by certain credits or incentives. Drawing to conclusion,
Mr. Hanley urged the committee to do what it wants and mesh that
with what [the companies] want. Furthermore, he expressed the
need for all the players to talk in order to come to a common
understanding of the legislation otherwise the policy call and
impacts can't be reached.
3:36:50 PM
MR. HANLEY then recommended using some type of a work session
during which a range of the various elements can be chosen in
order to model for the various players and scenarios. He
related his belief that currently there will be unintended
consequences because the models being presented vary because of
the differing assumptions. Although Mr. Hanley said that he
seems to understand the intent of HB 488, it doesn't seem to be
clear in the statute.
3:39:55 PM
REPRESENTATIVE GATTO related that it would be fair to assume
that the large oil companies would really enjoy a very complex
system because they have a lot of certified public accountants
(CPAs) and attorneys. Therefore, he questioned whether the
course to take should be to forget the incentives, specify the
tax, and specify the percentage the state will give the company
that looks for a well.
MR. HANLEY acknowledged that such a course could be taken and
the companies could model it. However, the problem is that one
size doesn't always fit all. Mr. Hanley echoed his earlier
comment that the proposal encompassed in HB 488 is a "decent
mix." Again, the question is in regard to what the state is
trying to incent. From Anadarko's perspective, while it may pay
more, the legislation as it's written actually seems to improve
the companies economics and improve the downside. Therefore, he
suggested that some of Anadarko's prospects are more likely to
be drilled than they were before the legislation.
3:43:11 PM
The committee took an at-ease from 3:43 p.m. to 3:48 p.m.
3:48:35 PM
PAT FOLEY, Manager, Land, Commercial, Regulatory Affairs,
Pioneer Natural Resources ("Pioneer"), paraphrased from the
following written testimony [original punctuation provided]:
Pioneer began its investment in Alaska in early 2003
with the drilling of 3 exploration wells in the
shallow waters of the Beaufort Sea. Pioneer
significantly expanded its Alaskan inventory at the
October 2003 Alaska State Lease Sale where it was the
largest participant and successful bidder on
approximately 150,000 acres. We opened an office in
Anchorage in early 2004 and now employ 26 persons in
Alaska. In 2004, Pioneer concluded exploration
agreements with ConocoPhillips and Anadarko across a
vast portion of NPR-A. In 2005, Pioneer acquired a 10
percent working interest and the option to acquire up
to an additional 40 percent working interest and
possibly succeed ConocoPhillips as the operator of the
Cosmopolitan Unit located in the Cook Inlet. Pioneer
has significantly invested in the state and has
assembled a substantial portfolio with an interest in
approximately 1.6 million acres of leasehold.
On February 6, 2006, Pioneer announced that it
approved and is commencing the development of Oooguruk
field on the North Slope of Alaska. Pioneer is the
operator of the field, which is in the shallow waters
of the Beaufort Sea approximately eight miles
northwest of the Kuparuk River Unit. Pioneer has
commenced operations to install an offshore gravel
drilling and production site and we expect to complete
gravel hauling activities by the end of winter.
Following construction of the gravel drilling and
production, a subsea flowline and facilities will be
installed during 2007 to carry produced three-phase
liquids to existing onshore processing facilities at
the Kuparuk River Unit.
CO-CHAIR SAMUELS turned attention to the transitional phase, and
inquired as to how much Oooguruk is going to cost Pioneer to
develop in the last five years and two years. He also inquired
as to whether Pioneer has any other major developments.
3:51:21 PM
MR. FOLEY answered that currently Pioneer is exclusively focused
on the Oooguruk project. However, he related that this summer
Pioneer is likely to make a decision regarding what it will do
to continue work on Cosmopolitan. He highlighted that Pioneer
is heavily involved in exploration and has drilled five wells to
date. This winter Pioneer has been involved in three
exploration wells. He said that on a long-term basis, Pioneer
would expect to have a capital program similar to the last
several years. In regard to Pioneer's investment in the state
to date, he estimated it to be roughly $100 million over the
last three years. He returned to his testimony and paraphrased
from the following written testimony [original punctuation
provided]:
Pioneer plans to drill approximately 40 horizontal
wells to develop 50 million to 90 million barrels of
estimated gross oil resources. Total gross capital to
be invested in drilling and facilities is expected to
range from $450 million to $525 million.
MR. FOLEY added that Pioneer has a 70 percent interest in
Oooguruk and is a partner with Eni on this project.
REPRESENTATIVE GATTO inquired as to whether there is any
connection between Evergreen Resources and Pioneer.
MR. FOLEY replied yes, explaining that Pioneer acquired
Evergreen Resources in 2005.
3:53:14 PM
MR. FOLEY returned to his testimony and paraphrased from the
following written testimony [original punctuation provided]:
The wells are expected to be brought on production as
drilling progresses, with peak rates of approximately
15,000 to 20,000 barrels of oil per day expected by
2010.
For independent companies like Pioneer, the challenges
to building a business in Alaska are formidable. The
remaining North Slope resources are nothing like the
billion barrel fields that opened the Slope. The new
wave of developers are working to commercialize: a)
smaller, lower quality oil reservoirs, b) viscous oil
resources, c) remote resources in NPRA, the foothills
and offshore and d) natural gas resources, which will
not have a market until the next decade. All of these
resources are challenging to commercialize, but it is
a challenge that must be met to insure new sources of
supply for the state.
The North Slope is one of the highest cost areas in
the world. Remote geography translates to some of the
highest capital, lease operating and product
transportation costs in the world. Additionally,
North Slope projects have comparatively long cycles
[sic] times. From buying a lease to selling oil takes
5 to 10 years depending upon drilling success and
distance to existing infrastructure.
MR. FOLEY interjected that Pioneer's Oooguruk development will
be at the shorter end. However, he reminded the committee that
Oooguruk was a resource that was discovered in the late 1970s
and early 1980s and remained undeveloped until now. He then
continued his testimony and paraphrased from the following
written testimony [original punctuation provided]:
The largest challenge independents face on the North
Slope is arguably uncertainty. To be successful, we
must properly assess and make provision for a number
of uncertainties related to exploration risk, future
oil and gas prices, fiscal policy, regulatory
processes and access to infrastructure.
3:55:59 PM
The long cycle times for Alaska projects require that
we make our investment decisions based upon a long
term price projection. Although current prices exceed
$50 per barrel, the 10 year average price for North
Slope crude is approximately $25 per barrel. For
Pioneer's Alaska Projects, the price of oil in 2006 is
irrelevant. The prevailing price in the next two
decades will determine future cash flow for new
projects.
MR. FOLEY, in response to Co-Chair Samuels' query, related that
Pioneer, in general, has an aggressive view toward price. He
then returned to his testimony and paraphrased from the
following written testimony [original punctuation provided]:
Accurate assessment of risk is critical to the success
of an exploration portfolio. Will the value of the
fields we ultimately discover offset the cost of dry
holes, land, seismic data and development costs? For
many of the remote exploration areas in Alaska, it is
difficult to project acceptable full cycle returns.
3:57:37 PM
In 2003, the state initiated exploration incentive
credits for certain qualifying exploration
expenditures. These incentives encouraged Pioneer to
invest significantly in infrastructure challenged
areas such as NPR-A.
CO-CHAIR SAMUELS noted that Pioneer has taken advantage of some
exploration tax credits already; and asked if those are also
available for development tax credits. He further asked if
Pioneer would benefit from the proposed provisions in the
transitional money.
MR. FOLEY clarified that Pioneer has yet to be issued a tax
certificate and the [exploration] credits were derived from work
that was performed last winter. Therefore, the company has not
yet monetized those credits. Mr. Foley said that a company like
Pioneer would benefit from the transitional capital.
REPRESENTATIVE SEATON inquired as to the rate of credit for
which Pioneer has applied and believes it qualifies.
MR. FOLEY specified that the wells Pioneer drilled last winter
should qualify for the 40 percent tax credit rate. He mentioned
that this winter Pioneer is drilling one exploration well that
the company believes will also qualify for exploration incentive
credits, which should be creditable at a rate of 20 percent.
4:00:08 PM
MR. FOLEY again returned to his testimony and paraphrased from
the following written testimony [original punctuation provided]:
When Pioneer was considering its first investments in
Alaska, state officials were promoting the resource
merits of Alaska basins. Alaska certainly contains
world class petroleum systems. Additionally, the
officials promoted the fiscal policy including the ELF
formula and exploration incentives. Under the ELF
formula, only very large new fields would pay
severance tax and qualifying exploration expenditures
in remote areas would receive exploration incentive
credits at either a 20 or 40% rate. With this fiscal
system in place, Pioneer invested heavily in the state
over the last several years. When we learned that a
new severance tax policy was under development, we
were quite concerned that any new system would be
detrimental to our future investments and a departure
from the fiscal system promoted to the independents by
the state.
We recognize that the existing severance tax policy,
as it applies to the large fields on the North Slope,
is likely not sustainable and we are pleased that the
proposed PPT taxes profits rather than revenues.
Given that the state collects royalties right off the
top, it makes sense that any additional government
take should be assessed after costs have been
recovered. This concept is important to the smaller,
lower productivity and remote resources which are
critical to future production growth. Although the
proposed production tax rate of 20% is quite large
when layered upon the other burdens of royalty, ad
valorem tax, state income tax and federal income tax,
the impact of the large tax rate is tempered by the
allowance of cost recovery, investment tax credits and
the proposed taxable income threshold.
CO-CHAIR SAMUELS turned the committee's attention to the tax
rate at Oooguruk, and related his understanding that Pioneer
received a royalty reduction on that particular field and after
cost recovery Pioneer will pay 30 percent in that particular
field. He then inquired as to what Pioneer would consider its
effective tax rate.
MR. FOLEY said that he doesn't know Pioneer's total effective
tax rate. When Pioneer made its investment decision on
Oooguruk, it was with an expectation that the severance tax
would be zero. He informed the committee that some of the
leases at Oooguruk were a one-sixth royalty flap and others were
a one-eighth royalty with a 30 percent net profit component.
The 30 percent net profit component is preserved and the royalty
reduction has taken all of the royalties down to 5 percent until
payout at which point they would increase linearly over a four-
year period to reach the rates today.
4:04:15 PM
MR. FOLEY continued with his testimony and paraphrased from the
following written testimony [original punctuation provided]:
Pioneer is pleased to see the provision included in
the proposed legislation regarding the deductibility
of transitional capital. The provision serves to
compensate those companies, including Pioneer, who
have made significant capital investments over the
past five years based upon the fiscal terms in place
at that time.
We have reviewed the testimony of the administration
and agree that the PPT, as proposed, will provide
incentives for new investment by all companies.
Economic metrics for new investments will improve
under the PPT versus existing tax law. This should
encourage the development of marginal fields and will
reduce the minimum economic size for exploration
prospects, thus prompting more exploration and
increasing the chances of finding commercial-sized
fields. In addition, it should encourage reinvestment
in existing fields. We believe the PPT as proposed
will entice more companies to Alaska and increase
competition. More companies and more ideas will lead
to smarter field development methods, smarter drilling
and production equipment, which will further reduce
the minimum economic size of exploration prospects and
grow the resource pie.
4:05:42 PM
The tradable tax credits are a particularly effective
incentive for the exploration and development of new
resources. Under the proposed PPT, the higher risk,
higher cost and log project cycle times associated
with new resource exploration and development are
partially offset by the ability to monetize these
credits shortly after investment. In an exploration
portfolio, the large majority of projects are not
successful resulting in a total loss from all lease
acquisition, seismic and drilling costs. The tradable
tax credits would lessen the negative financial
consequences of the inevitable dry holes explorers
will drill.
A significant concern to Pioneer is the potential for
a lack of liquidity for the tradable tax credits.
Pioneers' outlook is to continue with very large
capital expenditures in the state over the next
several years. With only a handful of very large
producers as potential buyers for the credits, and the
proposed limit that a company may utilize purchased
credits to offset no more than 20% of its tax, we are
concerned that the market for the credits may not be
competitive.
4:07:02 PM
CO-CHAIR SAMUELS surmised then that Pioneer's concern with
regard to the credits is that the three [major producers] will
buy enough of the credits and the value of each individual
credit will decrease. In that scenario, the [three major
producers] become the driving market force.
MR. FOLEY indicated that to be the case as well as the imperfect
nature of a market with so few buyers.
REPRESENTATIVE SEATON asked whether Pioneer views oil prices
below $40 per barrel as untradable without a significant
discount. He asked if the aforementioned has been considered in
relation to the credits.
4:07:53 PM
MR. FOLEY said Pioneer has not considered the consequences of
that.
REPRESENTATIVE SEATON said that he might be mixing things
because the tradables are down to 20 percent and the investment
clawback is at $40.
CO-CHAIR RAMRAS clarified that the transition provision has a
$40 threshold while there is no threshold for the use of the
credits.
4:08:31 PM
MR. FOLEY returned to his testimony and paraphrased from the
following written testimony [original punctuation provided]:
New investors could face selling credits at a discount
to taxpayers who would in turn cash them in to the
state at full value. We appreciate that a buyer of
tax credits should recover its transition costs, but
we are concerned that the required discount might be
substantially greater. We respectfully ask the
legislature to consider implementing refundable
credits with appropriate limitations to protect the
state's cash flow in the event of low oil prices. The
program could provide that credits be refunded at a
modest discount to face value. This would allow the
State, and not a third party producer, to benefit from
any discount that a seller would be willing to accept.
4:09:24 PM
CO-CHAIR RAMRAS inquired as to what a modest discount would be.
MR. FOLEY said it would be close to 100 percent; and the closer,
the better. He related that during his career he has been
involved in purchasing and selling several credits, which often
sell at a discount of only a few percentage points.
4:10:13 PM
MR. FOLEY continued with his testimony and paraphrased from the
following written testimony [original punctuation provided]:
We believe that the PPT as proposed improves Alaska's
competitive position with respect to other investment
opportunities around the world. Mr. Van Meurs'
testimony indicated that the proposed PPT would
improve Alaska's competitiveness versus a number of
mostly large, international investment opportunities
around the world. To attract companies of Pioneer's
size and smaller, we believe that Alaska must
effectively compete with U.S. lower 48 opportunities
as well. With higher prevailing natural gas prices in
the lower 48, gas resource plays (tight sands, shales
and coalbed methane) are attracting huge amounts of
capital due to the relatively low risk, low cost and
short project cycle time relative to exploration. The
size of some of these resources is quite large
resulting in increased competition in the U.S. for
independent's capital. If Alaska wants to improve its
competitive position and attract new investors, we
believe that the legislature should take great care in
making changes to the administration's proposal that
would make it less competitive.
4:11:36 PM
For new investors to Alaska, particularly smaller
companies, exempting the first $73 million of cash
flow from taxation is a valuable feature of the PPT.
The obstacles to new investors are high. Most new
investment opportunities in Alaska are either small,
infrastructure challenged, risky (exploration) or some
combination of these factors. New investors are also
handicapped by not owning the existing infrastructure
and they lack the economies of scale enjoyed by the
large operators. To be an effective operator in the
state requires a huge commitment in highly compensated
personnel to effectively navigate the regulatory and
operational challenges that are unique to Alaska.
Under existing law, it is unlikely that an explorer
would pay significant production tax unless a huge
field was discovered. A number of new companies were
recruited to Alaska by the state and made substantial
investments based on the existing tax law. Under the
proposed PPT, exempting the first $73 MM of cash flow
from taxation will help deliver an investment climate
more consistent with the system that initially
encouraged Pioneer to explore in Alaska and will help
offset the high "start-up" costs.
In general, we believe the proposed PPT is a balanced
program with appropriate incentives to encourage new
investment in the state. We encourage the legislature
to carefully evaluate the proposal and take care to
insure that it results in fiscal policy that makes
Alaska more competitive. We also respectfully request
your consideration to make the tax credits in this
bill refundable to allow the new investors the full
intended advantage of the tax credit program. Thank
you for this opportunity to express Pioneer Natural
Resource's views on HB 488.
4:13:41 PM
CO-CHAIR RAMRAS inquired as to Mr. Foley's view if the state
offers to [make the tax credits refundable], but will not refund
the credits for a specific amount of time. In such a situation,
the state would benefit from the time value of the money, while
[delaying the refund] acts as a backstop. Therefore, the
company could determine whether to redeem the credits for
production, sell them to a major producer at a discount, or wait
the specified amount of time and redeem them with the state for
98 percent face value. He asked if that would be an attractive
approach.
MR. FOLEY replied no, pointing out that if a company doesn't
realize the value of the credit for two or three years, the MPV
of that credit would be less. He opined that the [discounted]
credit could be sold into the market sooner and would be
discounted less than the program Co-Chair Ramras described.
CO-CHAIR RAMRAS noted that he didn't disagree.
MR. FOLEY said the fundamental concept is that money is being
left on the table. In other words, a seller might be willing to
sell its credits at a discount, and therefore it seems
appropriate for the state to take advantage of that discount.
4:15:57 PM
CO-CHAIR SAMUELS posed a situation in which the state offers to
provide the company a 100 percent [tax credit] if it continues
to reinvest those funds into capital in Alaska. If not, the
company could take its chances with selling it privately [to the
major producers].
MR. FOLEY said that anything better than what is expected from
the market is an improvement.
4:17:32 PM
REPRESENTATIVE SEATON opined that Pioneer is in an interesting
position due to its Cosmopolitan holding, which he presumed will
be a gas play. He asked if Mr. Foley has analyzed the PPT on
the sole gas operation that Pioneer has in Cosmopolitan versus
an oil play on the North Slope. He further asked if the
differing tax structures and credits mean that the relationship
and advantage or disadvantage is different for the two resources
or are the two considered the same.
MR. FOLEY related his understanding that the Cosmopolitan
development has both oil and gas potential. Pioneer has
considered Cosmopolitan in a hypothetical success portfolio and
doesn't differentiate the value of a gas molecule or oil
molecule other than to make them (indisc.) equivalents.
4:18:38 PM
REPRESENTATIVE SEATON said this is a concern for him in the Cook
Inlet where there are a number of gas plays that are strictly
gas. He expressed concern that there hasn't been any review of
any differential effect of the changes from the gas tax
structure, which differs from the oil tax structure, to the
unified tax structure. Therefore, he requested that Mr. Foley
review that and determine if there is a differential impact or
not.
REPRESENTATIVE GATTO highlighted that the smaller the player,
the more excited they are about going to the PPT.
REPRESENTATIVE SEATON noted the $73 million credit.
REPRESENTATIVE GATTO pointed out that when Pioneer acquired
Evergreen, Evergreen held leases know as Pioneer that he
recalled were coalbed methane leases. He then asked if Pioneer
is going to drill for anything else in that Pioneer unit.
4:20:12 PM
MR. FOLEY clarified that the Pioneer Unit held by Evergreen that
was acquired by Pioneer was named the Pioneer Unit because of
[the proximity to] Pioneer Peak. Mr. Foley informed the
committee that Pioneer has surrendered all of its leases in the
Matanuska-Susitna Valley. All of the leases held by Evergreen
were focused on coalbed methane, and that was a project that
Pioneer decided not to pursue. In further response to
Representative Gatto, Mr. Foley explained that Pioneer, the
parent corporation, acquired Evergreen for which the vast
majority of its assets were in Colorado.
4:21:07 PM
JIM WEEKS, Alaska Operations Manager, Ultra Star Exploration
LLC, paraphrased from the following written testimony:
Mr. Chairman, distinguished members of the House
Resources Committee. My name is Jim Weeks, and I am
here today representing UltraStar Exploration LLC, a
very small all Alaskan owned independent explorer,
with strategically located leases on the North Slope.
UltraStar is based in Anchorage, with offices at 3111
C Street, Suite 500. The Company was formed in 2002
by me, John Winther, and Dale Lindsey, for the primary
purpose of exploring and developing leases on the
North Slope. UltraStar is 100% owned by Alaskans. I
am Managing Member, and moved to Anchorage in 1984
with ARCO, and have had a presence here ever since.
Dale, whom most of you know, was born and raised and
still lives in Seward. John, whom most of you also
know, was born in Fairbanks and raised in Juneau. He
currently lives in Petersburg. Thanks for the
invitation to testify on this important legislation.
First of all, I'd like to commend the Governor and
members of the Administration for addressing this
issue, and your Committee for the timely and thorough
review it is being given. During the last several
days, I've listened to a lot of testimony on the
proposal. Some witnesses wanted the Committee to
delay decisions on this issue. There should be no
delay, nor should there be a rush. This is a very
important piece of legislation, and you need to get it
right, less it results in unexpected and/or un-desired
outcomes. You are doing it right, giving the bill a
thorough and fair hearing in a timely fashion.
I will now offer a few specific comments on the bill.
You've heard lots of testimony supporting the 20-20
tax and exploration/development incentive split, and
the arguments in favor of these provisions have been
articulated very thoroughly and clearly, and I
certainly cannot embellish on them, so I won't even
attempt to. I'll just add UltraStar's strong support
for the positions of the existing producers and
independents and explorers on these issues.
John Winther testified to the Joint House and Senate
Committee hearing last Saturday, echoing UltraStar's
support for the 20/20 provisions, and the $73 million
deduction allowance in the bill. Since then, we've
learned that the $73 million allowance, granted to all
companies in Alaska regardless of the size of their
cash flow streams, may be a difficult pill for you and
your colleagues to swallow. Thus, you may want to
eliminate it from the bill. I encourage you not to
jettison it entirely, but consider an alternative that
will provide incentives for exploration and
development of small fields.
It's generally agreed that the big Prudhoe Bay and
Kuparuk sized fields have been found. The big
structures have been drilled, and what remains are the
10-100 million barrel accumulations. These are modest
by North Slope standards, but can add up to
significant amounts of oil and related economic
activity. The stock market rewards reserve
replacement. The current producers are huge, publicly
traded companies that have become so large that their
reserve replacement needs cannot be met by chasing
small satellites on the North Slope. For instance,
ExxonMobil produces 20 million barrels in 10 days.
We'd do jumping jacks in downtown Juneau if we found
that much oil on our leases.
But smaller accumulations can be attractive to small
independents like us, provided the right incentives.
Rather than the $73 million allowance for all
companies, I suggest you consider establishing a
ceiling above which large companies would not get the
$73 million allowance, and below which smaller
companies would. There is a precedent for this in the
"Charter for Development", a 1999 agreement between
the State, BP and ConocoPhillips that made the
combination of ARCO and BP possible. There are many
provisions in the Charter, but none of them requires
BP and ConocoPhillips to give preferential treatment
to small producers, called "qualified producers". The
Charter defines qualified producers as those with
worldwide assets of less than $1 billion dollars, and
establishes 5000 barrels per day as a maximum amount
of crude oil that a qualified producer can produce to
receive the preferential treatment.
MR. WEEKS, in response to Co-Chair Samuels' question as to how
UltraStar would define large and small companies, opined that it
would do so by calibrating a company by size and a threshold
amount of oil per day.
4:26:44 PM
MR. WEEKS then continued with his testimony and paraphrased from
the following written testimony [original punctuation provided]:
I realize that the provisions of the Charter were
developed for a different purpose, but certainly it
distinguished between "little guys", and "big guys",
and established a maximum production level for which
the benefits apply. Whether $1 billion dollars or
5000 barrels per day are the appropriate ceilings for
the PPT is subject to more debate, but such a two-
tiered approach will accomplish what I believe you
want: to provide incentive for entry by small
newcomers without giving an un-deserved windfall to
the established players. Please don't throw the baby
out with the bath water by eliminating the $73 million
allowance altogether.
4:27:26 PM
My last issue is pretty specific, but could be
significant for small independents. It regards the
exclusion of "amounts paid for purposes of
indemnification." on line 15 of page 14 of the bill.
Small independents like UltraStar will need to
indemnify facility owners and operators who will
process our oil through their facilities. We will
need to purchase real, third party, arms length
insurance to satisfy these requirements. We will also
need insurance to meet the bonding and financial
responsibility requirements of the Department of
Natural Resources and Environmental Conservation, and
the Alaska Oil and Gas Conservation Commission.
Depending upon the circumstances, membership in an oil
spill clean up cooperative may also be required. All
these costs can broadly be characterized as costs for
the purposes of indemnification, and could arguably be
excluded when direct costs are calculated, as defined
at line 21 on page 13.
Nearly 15 percent of the cost of the Winstar
exploration well at Oliktok Point in 2003 was for
insurance premiums, so these indemnification costs can
be significant for the little guy, and should clearly
be deductible to determine direct costs. In his
letter transmitting this legislation to this
committee, the Governor said that a number of indirect
costs are listed in the bill, and are to be excluded
from the calculation of direct costs. Indemnification
is one of the indirect costs listed. Trust me, Mr.
Chairman, there was nothing indirect about the
$370,000 check I wrote for the insurance premium on
our last well. The money went directly from our bank
account into theirs. I urge you to clarify your
intent on this issue, and allow real, invoice
supported, arms length indemnification costs to be
included.
Thanks for the opportunity to testify at this
important proceeding.
REPRESENTATIVE KERTTULA thanked Mr. Weeks for reminding the
committee about the charter, which she said he is correct about.
MR. WEEKS related that UltraStar holds the view that the charter
enables his company to look for small satellite accumulations.
4:30:31 PM
REPRESENTATIVE SEATON recalled that the $73 million [credit] was
based on a 5,000 barrel field by $40 [wellhead]. Representative
Seaton related his understanding that Mr. Weeks is saying that
although the 5,000 might be an adequate distinguishing
production value, perhaps a more long-term projection of price
should be used to arrive at a lesser figure.
MR. WEEKS said it would not be related to price. He suggested
that the 5,000 barrel a day was in the charter and it may be a
coincidence that the same figure was used to calculate the $73
million. Mr. Weeks opined that there should be a threshold in
the maximum level that's excluded until new entrants can start a
business and build a production stream from which they can begin
to pay taxes.
REPRESENTATIVE BERKOWITZ asked Mr. Weeks if he believes the ELF
is broken.
MR. WEEKS replied yes. For example, the leasehold that
UltraStar now holds that abuts the western boundary of the Point
McIntyre participating area can be drilled from a deviated well
from Point McIntyre No. 1, which is in the Prudhoe Bay unit.
Currently, UltraStar is negotiating with BP, as the operator of
the unit, for access to the drill site and the production
facilities that would process any oil found. Before the
governor's reinterpretation of the ELF in 2004, Mr. Weeks said
that his economic model/assumption was that any pool under
UltraStar's lease would be a separate reservoir from an ELF
standpoint and carry little or no severance tax. However, after
the reinterpretation to include the satellites with the facility
pools, the aforementioned became unclear. Therefore, Mr. Weeks
changed his assumptions such that any pool held by UltraStar,
since it would be produced and processed by Prudhoe Bay
facilities, would attract the crude oil. Mr. Weeks said that
the proposal in HB 488 is a cleaner method.
4:34:00 PM
REPRESENTATIVE BERKOWITZ asked if Mr. Weeks knows of any
mechanism besides the ELF and PPT that would be better.
MR. WEEKS said he hadn't given such any thought, but would do so
and share any ideas on that.
[HB 488 was held over.]
4:36:12 PM
ADJOURNMENT
The committee recessed at 4:36 p.m. to March 2, 2006, at 12:00
p.m.
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