Legislature(2007 - 2008)BARNES 124
03/23/2007 01:00 PM House RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| HB128 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
| = | HB 128 | ||
ALASKA STATE LEGISLATURE
HOUSE RESOURCES STANDING COMMITTEE
March 23, 2007
1:07 p.m.
MEMBERS PRESENT
Representative Carl Gatto, Co-Chair
Representative Craig Johnson, Co-Chair
Representative Vic Kohring
Representative Paul Seaton
Representative Peggy Wilson
Representative Bryce Edgmon
Representative David Guttenberg
Representative Scott Kawasaki
MEMBERS ABSENT
Representative Bob Roses
COMMITTEE CALENDAR
HOUSE BILL NO. 128
"An Act relating to allowable lease expenditures for the purpose
of determining the production tax value of oil and gas for the
purposes of the oil and gas production tax; and providing for an
effective date."
- HEARD AND HELD
PREVIOUS COMMITTEE ACTION
BILL: HB 128
SHORT TITLE: OIL & GAS PRODUCTION TAX: EXPENDITURES
SPONSOR(s): REPRESENTATIVE(s) OLSON
02/12/07 (H) READ THE FIRST TIME - REFERRALS
02/12/07 (H) O&G, RES, FIN
02/22/07 (H) O&G AT 3:00 PM CAPITOL 124
02/22/07 (H) Heard & Held
02/22/07 (H) MINUTE(O&G)
03/01/07 (H) O&G AT 3:00 PM CAPITOL 124
03/01/07 (H) Moved CSHB 128(O&G) Out of Committee
03/01/07 (H) MINUTE(O&G)
03/05/07 (H) O&G RPT CS(O&G) 3DP 1NR
03/05/07 (H) DP: DOOGAN, RAMRAS, OLSON
03/05/07 (H) NR: SAMUELS
03/19/07 (H) RES AT 1:00 PM BARNES 124
03/19/07 (H) Heard & Held
03/19/07 (H) MINUTE(RES)
03/21/07 (H) RES AT 1:00 PM BARNES 124
03/21/07 (H) Heard & Held
03/21/07 (H) MINUTE(RES)
03/23/07 (H) RES AT 1:00 PM BARNES 124
WITNESS REGISTER
KONRAD JACKSON, Staff
to Representative Kurt Olson
Alaska State Legislature
Juneau, Alaska
POSITION STATEMENT: Presented Amendment 1 on behalf of
Representative Olson, prime sponsor of HB 128.
DON BULLOCK, Attorney
Legislative Legal and Research Services
Legislative Affairs Agency (LAA)
Alaska State Legislature
Juneau, Alaska
POSITION STATEMENT: During the hearing on HB 128, answered
questions.
JOHN IVERSEN, Director
Anchorage Office
Tax Division
Department of Revenue
Anchorage, Alaska
POSITION STATEMENT: During hearing of HB 128, answered
questions.
JUDITH BRADY, Executive Director
Alaska Oil and Gas Association (AOGA)
Anchorage, Alaska
POSITION STATEMENT: Testified in opposition to HB 128.
MICHAEL HURLEY, Director
State Government Relations
ConocoPhillips Alaska, Inc.
Anchorage, Alaska
POSITION STATEMENT: Testified that HB 128 is duplicative since
the 30 cents per barrel is already in place.
GARY ROGERS, Production Audit Manager
Tax Division
Department of Revenue
Anchorage, Alaska
POSITION STATEMENT: During hearing of HB 128, answered
questions.
KEVIN BANKS, Acting Director
Division of Oil & Gas
Department of Natural Resources
Anchorage, Alaska
POSITION STATEMENT: During hearing of HB 128, answered
questions.
JOHN NORMAN, Commissioner/Chair
Alaska Oil and Gas Conservation Commission
Department of Administration
Anchorage, Alaska
POSITION STATEMENT: During hearing of HB 128, provided comments
and answered questions.
JASON BRUNE, Executive Director
Resource Development Council (RDC)
Anchorage, Alaska
POSITION STATEMENT: Testified in opposition to HB 128.
ACTION NARRATIVE
CO-CHAIR CARL GATTO called the House Resources Standing
Committee meeting to order at 1:07:38 PM. Representatives
Gatto, Johnson, Guttenberg, Edgmon, Kawasaki, Kohring, Wilson,
and Seaton were present at the call to order.
HB 128-OIL & GAS PRODUCTION TAX: EXPENDITURES
1:08:01 PM
CO-CHAIR GATTO announced that the only order of business would
be HOUSE BILL NO. 128, "An Act relating to allowable lease
expenditures for the purpose of determining the production tax
value of oil and gas for the purposes of the oil and gas
production tax; and providing for an effective date." [Before
the committee is CSHB 128(O&G).]
1:08:30 PM
REPRESENTATIVE SEATON moved that the committee adopt Amendment
1, labeled LS-0561\K.1, Bullock, 10/17/07, which read as
follows:
Page 3, lines 22 - 23:
Delete "the standard practices of the industry"
Insert "good oil field practice"
REPRESENTATIVE WILSON and CO-CHAIR JOHNSON objected.
1:09:05 PM
KONRAD JACKSON, Staff to Representative Kurt Olson, Alaska State
Legislature, presented Amendment 1 on behalf of Representative
Olson, prime sponsor of HB 128.
1:10:02 PM
DON BULLOCK, Attorney, Legislative Legal and Research Services,
Legislative Affairs Agency (LAA), Alaska State Legislature, told
the committee that Amendment 1 was suggested by Mr. Iversen, Tax
Division, Department of Revenue (DOR), and Robert E. Mintz, a
contract attorney formally with the Department of Law. He said
both men think using "good oil field practice" in place of
"standard practices of the industry" will provide a better base
from which to operate. Mr. Bullock stated that normally, taxes
and royalty issues don't get to the cost of production; the
change in the petroleum production profits tax (PPT) has
generated that change. He concluded, "This goes back to
expectations, and ... what's expected in return for the
deduction, and how can the Department of Revenue determine
whether a deduction's appropriate with the policies that you
folks set."
1:11:48 PM
MR. BULLOCK, in response to Representative Seaton, said the
term, "good oil field practice" is mentioned in the manual of
oil and gas terms, as well as being used in certain cases. In
further response, he explained that in addition to legal terms
found in statute, there are also legal terms that courts have
defined as necessary to define the law. He offered his belief
that ["good oil field practice"] is a common law term that could
have been developed in a contract.
1:12:52 PM
REPRESENTATIVE SEATON said "good oil field practice" sounds like
a term that could be used in several places and have several
different meanings. He asked if there needs to be a certain
citation.
MR. BULLOCK said the aforementioned manual of oil and gas terms
is a generally recognized resource. He continued:
When I was researching this bill at the request of the
sponsor, I spent quite a bit of time trying to find a
universal standard, and there just isn't. And that's
why it's important that the committee consider what
kind of standard you want to apply. And this is the
approach that the Department of Revenue feels that
they can find the most information about, that they
can say, "This is what we expect, and if you did what
we expected, you get the deduction." So, if it was
something less than what would be expected under this
standard, then the deduction would be denied or
adjusted.
1:13:56 PM
REPRESENTATIVE SEATON directed attention to the words, "taking
into consideration", which appear on page 3, line 22, preceding
the words proposed in Amendment 1. He asked, "Does that mean
that they are required to follow the standards of good field
practice that you just mentioned they would find as a standard?"
MR. BULLOCK responded:
It means that they have to look at the standard when
they're ... making their decision as to ... what's
expected, they would take that into consideration and
give it appropriate weight. They may find other
standards that are also applicable. They may look at,
perhaps, a standard operating agreement form to see
what normally would be expected.
... This is ... trying to establish ... expectations:
what kind of care is expected; what kind of avoidance
of unnecessary costs could be anticipated. Like I
say, this is a new area, and they felt that they
needed some discretion and some area within which they
can operate to be reasonable, because no doubt this
type of expense will be appealed if the deduction's
just allowed. Obviously they want to make a good case
ahead of time.
1:15:25 PM
CO-CHAIR GATTO commented that what is considered good
maintenance in Saudi Arabia may be different than in another
part of the world. He indicated that the term, "good" must
apply in the Arctic.
MR. BULLOCK said it's not just a location issue; another
consideration is what is in the oil itself. Some oil will be
more corrosive, he said. He offered further details. He said
the department needs the discretion because there is no "silver
bullet standard."
CO-CHAIR GATTO related that good oil field practices are also
determined by oil flow.
MR. BULLOCK said there are risks that can be identified that are
within the scope of regulation of the government. The industry,
he said, is actually the best source for what constitutes good
oil field practices.
1:20:34 PM
MR. BULLOCK, in response to Co-Chair Johnson, said the
aforementioned manual of oil and gas terms can be found in the
legislative law library.
1:20:59 PM
REPRESENTATIVE WILSON asked if there is any reason that the
committee could not take "that definition" and put it in the HB
128.
MR. BULLOCK said he thinks that would be possible, however
whatever standard the legislature picks should reflect not only
policy, but also what the legislature is "speaking to."
1:21:48 PM
CO-CHAIR GATTO commented on other variables.
1:22:29 PM
MR. BULLOCK, in response to Representative Wilson, indicated
that he would try to incorporate the definition in the manual
into the bill, as Representative Wilson had suggested.
1:22:56 PM
CO-CHAIR JOHNSON asked if there is any inconsistency in the
makeup of the oils on the different North Slope fields.
MR. BULLOCK suggested that the oil companies could better answer
that question; however, he surmised that there would be some
differences.
1:24:04 PM
CO-CHAIR JOHNSON asked if it would be necessary to have a
different standard for each field.
MR. BULLOCK responded, "It's not so much how big the bill's
going to be, but how much the Department of Revenue has to do to
decide how broad the standard can be applied. But the factors
for applying the standard may be same." He offered examples.
1:25:20 PM
CO-CHAIR JOHNSON asked how the flow into a pipeline would be
monitored if it is coming from several different areas. He
offered an example in which too much money is paid on
maintenance that is unnecessary because the standard was set to
the lowest denominator. He asked, "So, are we going to be in a
situation where we're getting tax credits for doing stuff we
don't need to do, because we've set a standard that's for the
worst-case scenario?"
MR. BULLOCK said if the presumption was overly strict for one
field, it could be changed.
1:26:31 PM
CO-CHAIR JOHNSON explained that he does not want the presumption
to be defined in court, but would rather have legislation
crafted that is not incident driven but withstands the test of
time.
1:27:26 PM
MR. BULLOCK responded that although there may have been a
particular incident that brought the proposed legislation to
mind, the bill has not been written to apply only in 2007. A
good oil field practice would be looked at each time a tax
return would be audited for the deductions; therefore, as
technology improves, the good oil field practice would also
"rise to a higher level."
1:28:04 PM
REPRESENTATIVE GUTTENBERG related he is under the impression
that [Amendment 1] addresses Co-Chair Johnson's concern. He
explained as follows:
Standard on one field or one situation or one type of
oil wouldn't be the right standard on another. So, if
you ... go to this definition of ... good oil field
practices, somebody could come in and say exactly
that: "That used to be the standard, but ... this is
a good practice." And, while there ... might be
challenge by the department, they could say, "No, this
is the oil; this is the content we have; this is the
flow rate. That might have been the standard in
another situation, but this is the good standard
here." And they could justify that and come back with
the argument.
... It goes both ways for both parties. They could
come in and say, "The standard is not necessarily the
best in every situation." ... Instead of being so
rigid, simply say, "standard."
1:29:48 PM
CO-CHAIR GATTO suggested that the highest standard could be
consistently applied, although it may be difficult to attain.
REPRESENTATIVE GUTTENBERG responded, "Sometimes the highest
standard causes things to break prematurely."
1:30:04 PM
REPRESENTATIVE SEATON said he is uncertain that requiring "good
oil field practices" to be taken into consideration will result
in those practices being used. Problems in the past have
resulted from some unexpected factor. He said, "If it was
something that could have been anticipated, it's already covered
under gross negligence." He continued:
So, I don't even know why we have gross negligence in
the bill if we adopt this, because gross negligence is
always going to be improperly maintained; it's going
to be at least this standard if it ever arises to
gross negligence.
REPRESENTATIVE SEATON asked Mr. Bullock to address his concern.
1:32:46 PM
MR. BULLOCK clarified that he had not meant to say that every
time a tax return is filed a new determination would be made as
to what good oil field practice is. He said that determination
would be field specific and applied over several years. He
continued:
The state is giving up a dollar deduction for a dollar
of cost in maintaining the field, and that works out
to about 22.5 cents for every dollar that's spent.
And if it's a qualified capital expenditure, that's
another 20 percent out of that dollar. So, the real
question is: What does the state expect? Does it
expect for oil field practice to be the standard? So,
are we willing to share the cost of poor maintenance
or improper maintenance? Or are we going to say ...,
"This is our money. We don't want you to spend money
unnecessarily, so we're going to ask that you comply
with good oil field practice, with how the industry
defines it ...." And if it is and there's still a
problem, ... we've set the standard as good oil field
practice, even if it doesn't get us as much protection
as we want from our revenue stream. So, what this is,
is it's trying to use the industry's own standard to
be reasonable and apply the state's expectations to
these expenses, to say, "These are the ones we're
going to share the cost in, and something less we
choose not to share the cost."
1:35:02 PM
[Co-Chair Gatto passed the gavel to Co-Chair Johnson.]
REPRESENTATIVE WILSON asked:
Since this happened up on the North Slope, has the
department itself changed any of [its] regulations? I
mean, are they looking at things a little differently
than they did before? And if they are, maybe this is
covered just in regulation ....
1:35:34 PM
MR. BULLOCK deferred to Mr. Iversen.
1:36:07 PM
JOHN IVERSEN, Director, Anchorage Office, Tax Division,
Department of Revenue, in response to Representative Wilson's
questions, said the department envisions two rounds of
regulations, the first of which is waiting only for final
review. Any substantive changes that are made to those
regulations would need to be approved by the commissioner and
lieutenant governor. He said, "That [first] round of
[regulations] has not addressed the issue of lease expenditures
in the context that we're talking about in this section, so,
that would be the part of the second regulations ...." The
second round of regulations will be considered through spring
and summer [of 2007]. Regarding whether "the legislature needs
to put this into a statute as opposed to what's in the law
already," he explained:
When we draft regulations, we're limited as to what we
can say ... by what's in the statute - ... the
regulations implement the statute. Any regulations
that would be ... outside of the bounds of what's in
the statute would be subject to legal challenge. If
... we were to write a regulation that expressly
incorporates the language that's in this bill, as to
improper maintenance, that would be subject to a legal
challenge. That doesn't mean it would necessarily get
shot down, but it would be more subject to legal
challenge than if ... we were actually going off this
express ... language in the statute. Stated another
way: A regulation that we would draft like this does
not find explicit basis in the statute. That doesn't
mean we can't necessarily get there, it's just that if
the legislature wants to make sure and clarify that
these sorts of costs are going to be excluded, then
the bullet-proof way to do it would be through a
statute.
1:39:39 PM
[Co-Chair Johnson returned the gavel to Co-Chair Gatto.]
1:40:35 PM
CO-CHAIR JOHNSON removed his objection to Amendment 1.
1:40:38 PM
CO-CHAIR GATTO asked if there was any further objection to
Amendment 1. [The objection by Representative Wilson was
treated as withdrawn.] There being no other objection,
Amendment 1 was adopted.
1:40:52 PM
JUDITH BRADY, Executive Director, Alaska Oil and Gas Association
(AOGA), testified in opposition to HB 128. She said AOGA
believes that the state is already protected and the proposed
legislation would not survive a legal challenge. In response to
Co-Chair Gatto, she said AOGA members have not had a chance to
study the bill with the newly adopted Amendment 1, but she said
with that amendment, the bill is certainly "moving in the right
direction."
1:42:22 PM
CO-CHAIR GATTO noted that Ms. Brady would be allowed additional
testimony at an upcoming meeting in order to respond to the
bill, as amended.
1:42:41 PM
MS. BRADY remarked that all the issues that have been discussed
during the last two hearings on the bill are issues that have
been discussed during the prior year. She said there is
precedent for people to change their opinions about legislation
after being presented with another viewpoint.
MS. BRADY related that AOGA is concerned about adding a broad
category of costs that cannot be deducted and will result in a
constant adversarial relationship between the industry and the
state, litigation, and a raised level of uncertainty about how
to operate in Alaska. She said the proposed legislation is
moving from an "incident-related concern about costs" to "a
place where you're going to ... end up requiring an audit of
every single capital expense."
1:45:42 PM
MS. BRADY stated, "The concern of the sponsors now is exactly
the concern of the legislators last year - and for very good
reason." She continued:
The PPT ... did two things: Number one, it raised
taxes when prices are higher; and two, because there's
this need for new investment in the state, they
decided that the state would share some of the risk of
the expense, and they would allow the deduction of
lease expenditures, ... and they're immediately
expensed before you come to the production tax value.
And in addition, ... capital costs are eligible for 20
percent. And the purpose was to encourage
reinvestment in Alaska. It did raise taxes, but it
also raised very high concerns. There was hearing
after hearing ... talking just about exactly what
you're talking about: "Well, shoot, how are we going
to know what's a real expense and what's not an
expense? We could be expensed right down to the point
where we don't have any ... tax money coming in; we
could be expensed down to zero. ... How are we going
to be able to audit this?" All of the things you're
raising now were raised over and over ... again at
that time, and ... they came up with more and more ...
answers.
1:47:21 PM
MS. BRADY drew attention to "the lease expenditures part of the
bill." She continued:
They start out with saying that for purposes of this
bill [PPT?], lease expenditures are the ordinary and
necessary cost upstream of the point of production
that are direct cost exploring for, developing, or
producing gas deposits. So, that was the first ...
requirement: Direct and ordinary.
Then further back in that section they say, "And if
the cost is disputed by working owner interests, the
state ... doesn't have to pay that cost either. They
were talking about the fact that working owner
interests have very highly developed audit
capabilities; they audit each other all the time to
see about costs. And if you don't think that's true,
there's about 4,000 categories of costs for Prudhoe
Bay alone that are constantly audited by ... the four
or five working partners.
MS. BRADY, in response to Co-Chair Gatto, characterized the
4,000 number as "pretty accurate." She said the interest
owners' value is dependent upon reasonable costs. She said
there are almost eight pages of discussion under lease
expenditures that attempt to close the gap on decisions made as
to what can and cannot be deducted.
1:49:30 PM
MS. BRADY recalled that just before the House passed the PPT
bill, on August 6, 2006, BP discovered a leak at Flow Station 2
in the oil transit line. The company notified the authorities,
implemented procedures to stop the leak, and began the process
of suspending production from the entire field. The House was
informed about the leak just before voting on the PPT bill and
that legislation passed the House 29:10. She continued:
But as more information came out, the level of concern
regarding the effect of this bill heightened.
Legislators did not want the State of Alaska to end up
paying for the result of this bill, under the PPT, if
the standard had been ignored - exactly the kind of
thing you're concerned about today. And, as a result,
the Senate ... super committee ... went over the whole
lease expenditure piece again. ... They added and re-
added and talked about lease expenditures would not
include costs arising from fraud, willful misconduct,
or gross negligence. And there was a lot of
discussion at the time about whether to go to
negligence and gross negligence, and it was decided -
on much of the same information that Commissioner John
Norman, the AOGCC, talked about the other day - to go
with gross negligence. It was further decided that
costs incurred for containment, control, cleanup or
removal in connection with any unpermitted release of
oil or hazardous ... substance would not be included
as lease expenditure. So, ... bills related to an
incident cannot be ... deducted.
1:51:27 PM
MS. BRADY, continuing her review of the history of the PPT
legislation, noted that there had been two amendments containing
"the same language that you are looking at today." There were
questions regarding the definition of "properly maintained" and
"diminished capacity," whether an auditor should make the
decisions, what would constitute a red flag for the auditor,
whether there has to be an incident like an oil spill, and
whether every expenditure must be audited - whether or not there
has been a spill. She continued:
In response to this, Pedro van Meurs, who was the
consultant, did two presentations to the Senate, ...
talking about a way to do it. And on August 8, he had
a white paper ... disallowing deemed capital costs,
and he said, "Should companies receive tax deduction
and tax credit, together with 40 percent of the value"
- that was under the 20/20 - "for replacing a pipeline
that was defective and not properly maintained?" And
he said, "Well" - and it brings up a larger policy
area, the gray area between betterment and repair,
replacement. And so, what he suggested is you do not
want to do a case by case audit; you do not want to be
auditing every single expenditure. You don't have the
time; you don't have the personnel; it will cost you
more than -- it's not done. And the other thing is
it's not done anywhere. So, he suggested that you
disallow 30 cents per barrel for every barrel
produced, regardless if there's any question, and that
will take care of and adds about $45 million to $100
million a year in taxes, and that will take care of
any kind of general maintenance that otherwise you'd
have to do on an audit of every expenditure for. And
that was what the Senate agreed to do. Instead of
doing an audit on every single expenditure, they would
take the 30 cents a barrel regardless ... if a company
had an issue or not ... to keep the state whole.
1:53:59 PM
CO-CHAIR GATTO asked if the 30 cents to which Ms. Brady referred
is related to maintenance or capital improvement.
MS. BRADY said breakdown is expected and the 30 cents would
cover that; it would cover any miscellaneous maintenance or
capital costs.
1:56:01 PM
CO-CHAIR GATTO offered his understanding that the 30 cents would
cover capital expenses, not maintenance costs.
MS. BRADY responded that the Department of Revenue's source book
for Fall 2006 states: "In order to protect the state from
crediting companies for unmet maintenance obligation, the
legislature specifically disallowed capital expenditures up to
30 cents per barrel under the PPT."
1:57:30 PM
CO-CHAIR GATTO surmised then that if there is no capital
expenditure, "then you don't get this 30 cents for maintenance."
MS. BRADY replied, "You pay the 30 cents regardless."
CO-CHAIR GATTO said he would seek further explanation from an
upcoming testifier.
1:58:16 PM
MS. BRADY recalled Mr. Norman, Commissioner, AOGCC, pointing out
that the PPT protects the state from intentional negligence,
willful negligence, gross negligence, and strict liability. The
strict liability is encompassed in the language "any
unpermitted release." Therefore, it doesn't matter the reason,
it can't be deducted. Commissioner Norman went on to say that,
therefore only simple negligence is left, which is when he made
the point that simple negligence is when things happen. "If you
were going to go into that level, you were talking about trying
to bullet proof or zero tolerance for almost any capital
expense," she said. If that's the case, she opined that the
legislation no longer functions as a vehicle for sharing the
risk. Therefore, the sponsors of the legislation and other
legislators may want to review the protections that are already
in place and be clear regarding whether the state is protected
enough. She said that some of the conversation ends up about
determining what's heavy oil or light oil and the state, in
effect, becomes oil field operators. The aforementioned results
in the costs, for the purposes of this legislation, being more
than is secured from the taxes.
2:01:04 PM
MS. BRADY said that if the determination is that the state is
protected enough, then the exercise of going through all this
reasoning, yet again, has been helpful. However, if it's
determined that the state isn't protected, then she suggested
concentrating on standards that have legal meaning and limiting
the application. Currently, there is no beginning for an audit
as it isn't incident driven and [an audit] can be [caused by]
any expenditure that catches the auditor's eye. Furthermore,
there's no end due to the cascading. Ms. Brady expressed hope
that the [committee] will decide that the state is as covered as
it can be and that it cannot be bullet-proof. Moreover, the
things that would be expected to be covered have been. If there
is a change, then it must be done in such a manner that doesn't
place the state and the oil industry in a permanent adversarial
position. She expressed further hope that some of the answers
will come from the Petroleum System Integrity Office.
2:03:23 PM
MS. BRADY, in response to Co-Chair Gatto, clarified that
currently it's not incident driven and there is no action to
start the audit so everything will have to be audited. She
surmised that everything will have to be audited for improper
maintenance because there's no "flag" to start the audit.
2:04:48 PM
CO-CHAIR GATTO surmised, "So, you're saying, 'Let the oil flow.
When there's an incident that occurs, we'll know it.'"
MS. BRADY replied yes, adding that the state is already
protected when an incident occurs. The language accomplishing
such is already in place.
2:05:54 PM
MICHAEL HURLEY, Director, State Government Relations,
ConocoPhillips Alaska, Inc., regarding the 30 cents, directed
attention to a memo from Dr. Pedro van Meurs dated August 8. At
the time the PPT was being developed, there was discussion about
the incident at Prudhoe Bay. As a body, the legislature has the
ability and obligation to determine what items can be deducted
and what items cannot be deducted. The issue then became a
question as to whether the state wants to address the matter on
an incident-by-incident basis or develop some sort of proxy. He
questioned, "Do you want to just develop some kind of a standard
deduction to the deductions for maintenance that we know you're
going to screw up?" The aforementioned was debated. The
ultimate choice was to take 30 cents a barrel and disallow the
deduction. The aforementioned was what Dr. van Meurs explained
and recommended in the August 8 memo. In fact, in the last
paragraph of the last page of the memo, Dr. van Meurs said, "I
believe that this would provide a good answer to possible public
criticism that under PPT, we would provide 50 percent of the
replacement costs of pipelines as a result of the Prudhoe Bay
shutdown." Mr. Hurley related that ConocoPhillips believes HB
128 is duplicative because the policy call, 30 cents a barrel,
has been made. Although the legislature may want to revisit
that policy and may determine to approach on an incident-by-
incident basis, Mr. Hurley stated that it's inappropriate to do
both.
2:09:57 PM
MR. HURLEY, in response to Co-Chair Gatto, explained that a
company will have "a bucket of costs" that a company will be
allowed to deduct against its revenue. From that bucket of
costs, 30 cents a barrel has to be taken out and can't be
deducted. Therefore, that 30 cents is an amount that a company
can't deduct.
2:10:51 PM
REPRESENTATIVE WILSON posed a scenario in which [production] is
down to 750,000 barrels a day, which at 30 percent amounts to
about $81 million a year. In such a scenario, she said she
understood that a company can deduct the $81 million but nothing
else.
MR. HURLEY replied no, adding that Dr. van Meurs' analysis used
numbers that were in the $40-$50 million range. He explained
that the maintenance costs to run the fields is in the hundreds
of millions of dollars. For instance, if it was $345 million,
that would be deducted against all of the company's revenue for
maintenance. However, because of that [30 cents] provision, the
company can only deduct $305 million. Therefore, instead of a
company being able to deduct all of its costs, it can deduct
fewer of its costs. In response to Co-Chair Gatto, Mr. Hurley
confirmed that the 30 cents is the first thing that happens.
CO-CHAIR GATTO surmised then that if an incident occurs, [the
funds] for it are already covered due to the 30 cents.
MR. HURLEY interjected that the [cost of an incident] would
already be covered by that 30 cents. Additionally, if the
incident is something that's not allowed in terms of good oil
field practice within the unit and the other owners won't pay
for it, then the state doesn't have to pay for it either.
2:13:42 PM
CO-CHAIR GATTO asked if such cooperation occurs with three oil
companies.
MR. HURLEY confirmed that there are lots of times when oil
companies don't cooperate.
2:14:02 PM
CO-CHAIR JOHNSON posed a scenario in which Mr. Hurley is the
chairman of the board of ConocoPhillips. He then asked if Mr.
Hurley, as chairman, would contest the expenditure on this
particular incident.
MR. HURLEY informed the committee that ConocoPhillips has had
discussions with the operator at Prudhoe Bay regarding its plans
to fix and replace transit lines. [The operator] has made
proposals to the other owners to fund some of those activities.
He noted that those are currently under review and aren't yet
approved.
2:14:59 PM
CO-CHAIR JOHNSON said that he understands the transit lines, and
highlighted that "we're dealing with an incident here."
MR. HURLEY stated that at some point, the producers will
complete their review of the incident and a decision will be
made. However, at this point, only one authorization for
expenditure (AFE) has been submitted to the other owners from
the operators. He opined that it will be a long process to
perform all the things discussed. All the discussions with the
other owners about the technical feasibility, the cost, and the
schedule haven't been completed. Furthermore, the analysis of
the issues by the other owners hasn't been completed.
2:16:24 PM
CO-CHAIR JOHNSON questioned whether the cart has been placed
before the horse, since there aren't regulations yet. He
related, "We are talking about a process ... as opposed to ...
looking down the road. I'm ... a little uncomfortable looking
that far."
2:16:51 PM
REPRESENTATIVE SEATON recalled the notion that good oil field
practices would be applied at each tax return if not at every
audit. He asked if that's something ConocoPhillips would
contest through litigation as selective enforcement. The
provision in HB 128 isn't incident driven and applies to an
expenditure that may have resulted from improper maintenance.
He inquired as to Mr. Hurley's perspective as to what he would
expect as far as the tax auditing.
MR. HURLEY confirmed that to be one of the issues that concerns
ConocoPhillips about how this particular disallowance structure
is established because it is incident driven. He explained that
the "first cut at it" would be when the company files its
monthly production tax return and an auditor reviews it. The
auditor will make some decision regarding good oil field
practices, although that auditor may not have much expertise in
that area. The auditor will then go to either DNR or the AOGCC
in an attempt to get them to agree that things shouldn't have
been done as they were. The aforementioned is of concern
because an auditor who is reviewing something from a tax
perspective is being asked whether [an incident] represents good
oil field practice.
2:19:58 PM
REPRESENTATIVE SEATON questioned whether this is incident driven
or investment driven. He opined that it's really investment
driven because it's a tax audit. If there's a large
expenditure, then review of that expenditure will occur to
determine whether improper maintenance was the cause of that
expenditure.
MR. HURLEY answered, "That's probably correct." He surmised
that an auditor whose job it is to maximize return to the state
would look for things that were improper maintenance. "It will
be driven by their review of tax audits, rather than necessarily
by any incident that actually occurred or didn't occur," he
remarked.
2:21:06 PM
MR. IVERSEN noted that he has had discussions with the audit
supervisor for the Oil & Gas Revenue Section, which will be the
section to implement this. There are a number of different ways
that these costs will turn up. For instance, it could be front-
page news as is the case with the current incident. Another way
that the costs show up is through an application for a credit
for the expenditure to replace or repair whatever is broken.
Yet another way the costs show up is in an audit that uncovers
an uncharacteristically large cost figure or simply an
uncharacteristic cost figure. When the auditor asks questions,
if the auditor turns up something that seems to fall under
improper maintenance, the auditor would confer with DNR and
AOGCC, as appropriate.
2:23:31 PM
CO-CHAIR JOHNSON asked if Mr. Iversen envisions auditing every
return.
MR. IVERSEN deferred to Mr. Rogers.
2:23:58 PM
The committee took an at-ease from 2:23 p.m. to 2:24 p.m.
2:24:55 PM
GARY ROGERS, Production Audit Manager, Tax Division, Department
of Revenue, specified that if there was knowledge as to from
where the costs were coming, the returns of those partners
involved would be audited. Therefore, all returns would be
audited. In response to Co-Chair Gatto, Mr. Rogers confirmed
that his job is to audit every return, although he noted that
sometimes the audits may be full-blown field audits while other
times it may merely be a desk audit. The auditor uses his/her
professional judgment and materiality comes into play, he
related.
2:25:37 PM
CO-CHAIR GATTO remarked that it reminds him of sampling, which
the Internal Revenue Service (IRS) does to determine who to
audit. He related his understanding that there are certain red
flags that [trigger an audit].
MR. ROGERS informed the committee that the division is in the
process of developing the audit program for this new tax. In
the past, if there have been 14-15 taxpayers, the division has
been able to review every taxpayer's return. Now with the
complexity and volume of information as well as the increase in
the number of expenditures and deductions, the division may not
have the luxury of auditing every taxpayer's return. Therefore,
the division may have to choose which taxpayers are audited and
which aren't.
CO-CHAIR GATTO questioned whether one option might be to hire
more people.
MR. ROGERS noted his agreement that hiring more people is an
option.
2:26:45 PM
MR. ROGERS, in response to Co-Chair Johnson, explained that for
a field audit, the auditors go to the taxpayer's offices and
review documentation in their offices. However, for a desk
audit the auditor may review the return filed and decide whether
more information is necessary. A standard audit procedure, he
related, is to actually go in the field and observe the
facilities, the assets, the equipment and determine whether
those exist and are in place. Mr. Rogers noted that he has done
the aforementioned before, although it's not done very often.
2:28:04 PM
CO-CHAIR JOHNSON asked if any of the auditors receive special
training that allows the auditor to determine what is and is not
good oil field practice.
MR. ROGERS clarified that the auditors aren't engineers of any
type, and thus the auditors would consult with engineers when
they felt there was issue needing an opinion from the engineers.
He informed the committee that the auditors do study oil and gas
industry accounting practices, oil and gas industry joint
venture auditing practices, and oil and gas industry financial
reporting practices. In further response to Co-Chair Johnson,
Mr. Rogers informed the committee that currently the division
has an engineer on contract that assists with property tax. The
division also uses the engineers at DNR and AOGCC. Mr. Rogers
mentioned that he would anticipate needing outside expert
contractors to perform the audits.
2:30:57 PM
CO-CHAIR GATTO directed attention to the term "gross negligence"
and related that Blacks Law Dictionary defines it as: "willful,
wanton, or reckless misconduct or such utter lack of all care as
will be evidence thereof". "Does that mean if something
happened, that really is the definition of gross negligence," he
asked. He clarified, "If, indeed, we have some evidence, does
it immediately default to gross negligence even if it isn't
willful, wanton, or reckless or utterly lack of care or does it
simply say ... if something happened, that's gross negligence?"
2:32:03 PM
KEVIN BANKS, Acting Director, Division of Oil & Gas, Department
of Natural Resources, said that would be beyond his expertise.
Mr. Banks related his belief that the language "evidence
thereof" seems to indicate the need to determine that if the
accident was caused by someone performing with utter disregard.
Therefore, one would [seek information] regarding what someone
did or didn't do in a particular situation. Negligence and the
lack of good oil field practices is broader in scope and doesn't
require that someone has done something with the willful intent
to cause an incident.
2:33:41 PM
CO-CHAIR GATTO commented that "willful" is such a high bar.
2:34:27 PM
REPRESENTATIVE WILSON related her understanding that by the end
of this month, the first tax return will be available and thus
there will be real figures.
MR. IVERSEN confirmed that returns will be received at the end
of this month, and thus more will be known with regard to the
gross numbers. What's actually being claimed won't be known
until there's an analysis of the returns, receipt of
applications of credits, and goes through the audit cycle. The
aforementioned will take some time. In fact, there's a three-
year audit cycle and there's time for amended returns. He then
pointed out that although the gross numbers in terms of gross
receipts that were paid in total can be released, any
information about the taxpayer can't be released because under
statute it's confidential.
2:36:42 PM
CO-CHAIR JOHNSON asked if that confidentiality could be waived.
MR. IVERSEN replied yes, adding that the confidentiality belongs
to the taxpayer who can waive it.
2:37:09 PM
JOHN NORMAN, Commissioner/Chair, Alaska Oil and Gas Conservation
Commission, Department of Administration, pointed out that AS
31.05.010(15) references good oil field engineering practice in
the definition of waste. That concept of failure to apply good
oil field practice has been utilized and thus isn't a new
practice. Furthermore, that concept exists throughout the
regulations and generally would tie back into the American
Petroleum Institute (API) standards as well as other
professional standards.
2:39:14 PM
REPRESENTATIVE SEATON recalled testimony that [a red flag] could
be raised due to an article in the newspaper or an application
for a credit for expenditures to replace or repair something
large or from an oddity in an audit. He asked if Mr. Norman
views the legal language that specifies that good oil field
practice will be taken into consideration means those are the
standards that will be used or are they reviewed but not
necessarily followed as a strict guideline.
MR. NORMAN answered that the black letter standards would be
applied to the extent that they exist. He noted that in prior
correspondence he has noted that in many instances such
standards don't exist. He expressed the hope that in applying
those standards, a measure of common sense would be applied such
that the totality of the circumstances would be considered.
2:41:18 PM
REPRESENTATIVE SEATON inquired as to how Mr. Norman would make
the determination that there was improper maintenance.
MR. NORMAN acknowledged that a newspaper article would identify
an incident. However, he mentioned that normally there would be
a time lag between the filing of a taxpayer's return, the
claiming of a lease expenditure, and working through the
different filters. Timing would be of concern because there is
a need in oil field diagnostic to move quickly when looking for
root causes. The earlier AOGCC is involved, the more accurate
the assessment would be, he opined. He noted that currently
there are reporting requirements that come in daily, but
matching it to a tax deduction would be somewhat awkward. He
emphasized that AOGCC would do its best to work out protocol
with DOR, but he expressed the need to have some retention of
evidence in order to have the ability to review the situation
and determine whether there's been good oil field practices.
2:44:22 PM
REPRESENTATIVE SEATON remarked that Mr. Norman had answered his
question in relation to an incident. However, he expressed
interest in how the AOGCC would address the application for a
credit for expenditures to replace or repair. He related his
understanding that the aforementioned would occur after the
expenditure is made and then the application for the credit
comes in with the tax payment. The aforementioned would then be
after the repair or replacement occurred. Representative Seaton
asked if Mr. Norman is saying that a new procedure would have to
be established such that the replaced or repaired items would
have to stay in place in order to allow AOGCC to determine
whether it was replaced or repaired due to improper maintenance.
MR. NORMAN explained that generally speaking instances in which
there would be gross negligence, willful misconduct, or careless
disregard often self-identify. Those will be the most obvious
and AOGCC would probably have received advance notice on those.
If a contact came in from DOR, AOGCC would relate that it has an
incident file and an investigative file. The more difficult
situations will be equipment that breaks down, which could occur
in the ordinary course of business. Those are more difficult
because those aren't situations on which the AOGCC would have
incident files. He said that the response of AOGCC is more
incident- or event-oriented. Therefore, Mr. Norman opined that
the legislation, with regard to gross negligence moves into a
new area. This is a level of conduct that AOGCC previously
hasn't monitored, which is ordinary maintenance. If some of
AOGCC's specific regulations had been violated, AOGCC would've
been aware as AOGCC inspectors are constantly checking things.
However, there are other areas of maintenance that could become
problematic because a question may not be presented to AOGCC
until well after the event and thus it may be difficult.
2:49:33 PM
CO-CHAIR GATTO pointed out that the question of gross
negligence, willful misconduct, and fraud is already included in
the PPT. This bill really only addresses the concept of
improper maintenance not gross negligence. Therefore, the only
word we're dealing with is "improper". He asked if everything
is being driven by identifying what "improper" is.
MR. NORMAN replied yes. He said that the term "improper" can be
identified, although there are subtle distinctions. He
explained that generally there's an analysis in the concept of
simple negligence. If between paragraph (6) and (19) the
intention is even a broader standard than negligence, then it
seems to move toward strict liability and therefore almost
necessitates the guarantee of a perfect operation.
2:51:45 PM
JASON BRUNE, Executive Director, Resource Development Council
(RDC), informed the committee that RDC is a statewide business
association with a very diverse membership, including oil and
gas, mining, timber, fishery, and tourism companies as well as
regional Native corporations, local communities, and labor
[organizations]. Mr. Brune then related RDC's opposition to HB
128, which he characterized as bad legislation. He further
characterized HB 128 as bad public policy that's potentially
precedent setting for other industries in the state. He
emphasized that with the passage of the PPT, the state
effectively tripled the production taxes on the oil industry in
Alaska, which he said would likely result in over $1 billion in
additional revenue to the state this fiscal year. In exchange
for these additional taxes, producers are now allowed to deduct
operating expenses in calculating these taxes. Additionally,
the producers are allowed to take a 20 percent credit for
capital investments as an incentive for improving the North
Slope infrastructure. However, these deductions may not include
costs arising from fraud, willful misconduct, or gross
negligence. He related the definition he found for gross
negligence, as follows: "a careless disregard for the
consequences of an action or lack of action". He stressed that
the definition refers to "lack of action."
MR. BRUNE opined that HB 128 proposes to disallow costs "related
to the repair and replacement of property or equipment that was
not maintained or was improperly maintained." He related his
understanding that the aforementioned is already covered under
the current gross negligent requirement. If this language is
adopted, he questioned how the term "improper maintenance" would
be defined as it's not defined in HB 128. In fact, the
aforementioned was echoed in a February 16, 2007, letter from
Mr. Norman, AOGCC, in which he says, "Our main concern with this
bill is the absence of a precise definition of improper
maintenance. The bill proposes relying on standard practices of
the industry to gauge whether there has been improper
maintenance, but often there are not established industry
standards to rely upon." The aforementioned brings up the
question regarding what it would take for the state to declare
improper maintenance. Mr. Brune questioned whether it would
take a spill. He posed a situation in which two sets of pipe
have the same maintenance history, but one develops a leak while
the other does not. Would replacement of one pipe be allowable
as an expense and the other not, he asked. He then questioned
whether HB 128 will cause the producers to overcorrect and
replace pipe more frequently than necessary in order to ensure
they qualify for the deduction. By doing so, it would net back
less for Alaska as these expenses would then be permissible.
Mr. Brune related that RDC's members believe that HB 128 will
exponentially increase disputes between the state and the
producers. He stressed that passage of HB 128 will lead to
endless litigation. In conclusion, Mr. Brune reiterated RDC's
opposition to HB 128 and belief that the gross negligence
standard is in place to satisfy the intent of the legislation.
He encouraged the committee to give the PPT a chance to work
before changing it.
2:56:59 PM
REPRESENTATIVE WILSON announced that because there are so many
unanswered questions, she is withdrawing her co-sponsorship of
the bill.
[HB 128 was held over.]
2:57:52 PM
ADJOURNMENT
There being no further business before the committee, the House
Resources Standing Committee meeting was adjourned at 2:57 p.m.
| Document Name | Date/Time | Subjects |
|---|