Legislature(2007 - 2008)HOUSE FINANCE 519
11/02/2007 09:00 AM House RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| HB2001 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB2001 | TELECONFERENCED | |
ALASKA STATE LEGISLATURE
HOUSE RESOURCES STANDING COMMITTEE
November 2, 2007
9:10 a.m.
MEMBERS PRESENT
Representative Carl Gatto, Co-Chair
Representative Craig Johnson, Co-Chair
Representative Anna Fairclough
Representative Bob Roses
Representative Paul Seaton
Representative Peggy Wilson
Representative Bryce Edgmon
Representative David Guttenberg
MEMBERS ABSENT
Representative Scott Kawasaki
OTHER LEGISLATORS PRESENT
Representative Mike Chenault
Representative Les Gara
Representative Kyle Johansen
Representative Mike Kelly
COMMITTEE CALENDAR
HOUSE BILL NO. 2001
"An Act relating to the production tax on oil and gas and to
conservation surcharges on oil; relating to the issuance of
advisory bulletins and the disclosure of certain information
relating to the production tax and the sharing between agencies
of certain information relating to the production tax and to oil
and gas or gas only leases; amending the State Personnel Act to
place in the exempt service certain state oil and gas auditors
and their immediate supervisors; establishing an oil and gas tax
credit fund and authorizing payment from that fund; providing
for retroactive application of certain statutory and regulatory
provisions relating to the production tax on oil and gas and
conservation surcharges on oil; making conforming amendments;
and providing for an effective date."
- HEARD AND HELD
PREVIOUS COMMITTEE ACTION
BILL: HB2001
SHORT TITLE: OIL & GAS TAX AMENDMENTS
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR
10/18/07 (H) READ THE FIRST TIME - REFERRALS
10/18/07 (H) O&G, RES, FIN
10/19/07 (H) O&G AT 1:30 PM HOUSE FINANCE 519
10/19/07 (H) Heard & Held
10/19/07 (H) MINUTE(O&G)
10/20/07 (H) O&G AT 12:00 AM HOUSE FINANCE 519
10/20/07 (H) Heard & Held
10/20/07 (H) MINUTE(O&G)
10/21/07 (H) O&G AT 1:00 PM HOUSE FINANCE 519
10/21/07 (H) Heard & Held
10/21/07 (H) MINUTE(O&G)
10/22/07 (H) O&G AT 9:00 AM HOUSE FINANCE 519
10/22/07 (H) Heard & Held
10/22/07 (H) MINUTE(O&G)
10/23/07 (H) O&G AT 9:00 AM HOUSE FINANCE 519
10/23/07 (H) Heard & Held
10/23/07 (H) MINUTE(O&G)
10/24/07 (H) O&G AT 9:00 AM HOUSE FINANCE 519
10/24/07 (H) Heard & Held
10/24/07 (H) MINUTE(O&G)
10/25/07 (H) O&G AT 10:00 AM HOUSE FINANCE 519
10/25/07 (H) Heard & Held
10/25/07 (H) MINUTE(O&G)
10/26/07 (H) O&G AT 10:00 AM HOUSE FINANCE 519
10/26/07 (H) Heard & Held
10/26/07 (H) MINUTE(O&G)
10/27/07 (H) O&G AT 2:00 PM HOUSE FINANCE 519
10/27/07 (H) Heard & Held
10/27/07 (H) MINUTE(O&G)
10/28/07 (H) O&G AT 2:00 PM HOUSE FINANCE 519
10/28/07 (H) Moved CSHB2001(O&G) Out of Committee
10/28/07 (H) MINUTE(O&G)
10/29/07 (H) O&G RPT CS(O&G) NT 4DP 1NR 2AM
10/29/07 (H) DP: SAMUELS, NEUMAN, RAMRAS, OLSON
10/29/07 (H) NR: DOOGAN
10/29/07 (H) AM: KAWASAKI, DAHLSTROM
10/29/07 (H) RES AT 1:00 PM HOUSE FINANCE 519
10/29/07 (H) Heard & Held
10/29/07 (H) MINUTE(RES)
10/30/07 (H) RES AT 9:00 AM HOUSE FINANCE 519
10/30/07 (H) Heard & Held
10/30/07 (H) MINUTE(RES)
10/30/07 (H) RES AT 6:30 PM HOUSE FINANCE 519
10/30/07 (H) Heard & Held
10/30/07 (H) MINUTE(RES)
10/31/07 (H) RES AT 9:00 AM HOUSE FINANCE 519
10/31/07 (H) Heard & Held
10/31/07 (H) MINUTE(RES)
11/01/07 (H) RES AT 9:00 AM HOUSE FINANCE 519
11/01/07 (H) Heard & Held
11/01/07 (H) MINUTE(RES)
11/02/07 (H) RES AT 9:00 AM HOUSE FINANCE 519
WITNESS REGISTER
DAN DICKINSON, Consultant
Legislative Budget and Audit Committee
Alaska State Legislature
Juneau, Alaska
POSITION STATEMENT: Provided a presentation on HB 2001.
STEVE PORTER, Consultant
Legislative Budget and Audit Committee
Alaska State Legislature
Juneau, Alaska
POSITION STATEMENT: Provided a presentation on HB 2001.
PAT GALVIN, Commissioner
Department of Revenue
Juneau, Alaska
POSITION STATEMENT: Provided a presentation on HB 2001.
JONATHON IVERSEN, Director
Anchorage Office
Tax Division
Department of Revenue
Anchorage, Alaska
POSITION STATEMENT: During hearing on HB 2001, answered
questions.
MARCIA DAVIS, Deputy Commissioner
Department of Revenue
Juneau, Alaska
POSITION STATEMENT: Provided a presentation on HB 2001.
JERRY BURNETT, Director
Division of Administrative Services
Department of Revenue
POSITION STATEMENT: During hearing of HB 2001, answered
questions.
NANETTE THOMPSON, Unit/Tech Support
Division of Oil & Gas
Department of Natural Resources
Anchorage, Alaska
POSITION STATEMENT: During hearing of HB 2001, answered
questions.
BOB GEORGE
Gaffney Kline and Associates
Houston, Texas
POSITION STATEMENT: Provided a presentation on HB 2001.
RICH RUGGIERO
Gaffney Kline and Associates
Houston, Texas
POSITION STATEMENT: Provided a presentation on HB 2001.
ACTION NARRATIVE
CO-CHAIR CARL GATTO called the House Resources Standing
Committee meeting to order at 9:10:43 AM. Representatives
Roses, Wilson, Fairclough, Seaton and Gatto were present at the
call to order. Representatives Johnson, Edgmon, and Guttenberg
arrived as the meeting was in progress. Other legislators
present were Representatives Johansen, Chenault, Kelly, and
Gara.
HB2001-OIL & GAS TAX AMENDMENTS
9:11:38 AM
Co-CHAIR GATTO announced that the only order of business would
be HOUSE BILL NO. 2001, "An Act relating to the production tax
on oil and gas and to conservation surcharges on oil; relating
to the issuance of advisory bulletins and the disclosure of
certain information relating to the production tax and the
sharing between agencies of certain information relating to the
production tax and to oil and gas or gas only leases; amending
the State Personnel Act to place in the exempt service certain
state oil and gas auditors and their immediate supervisors;
establishing an oil and gas tax credit fund and authorizing
payment from that fund; providing for retroactive application of
certain statutory and regulatory provisions relating to the
production tax on oil and gas and conservation surcharges on
oil; making conforming amendments; and providing for an
effective date." [Before the committee was CSHB 2001(O&G).]
9:11:53 AM
CO-CHAIR GATTO informed members that Mr. Dickinson and Mr.
Porter would present to the committee, after which the committee
would break until 1:00 p.m. The committee would then hear from
Commissioner Galvin and take a break at 3:00 p.m. so that
Representative Wilson can attend another hearing. He said after
the presentations, he would like to schedule a committee
discussion on ACES or have a discussion then. A round table
discussion with the administration and stakeholders would be
held the following day.
9:12:15 AM
MR. DAN E. DICKINSON, Consultant, Legislative Budget and Audit
Committee (LBA), Alaska State Legislature, said he would give a
10-minute explanation to flesh out a request to present some
material he already presented but with actual numbers, rather
than round numbers. He told members:
... When I sent my slides in [to committee staff],
they said the numbers are wrong and two of your slides
are mislabeled because instead of saying November 11,
they say October 30th. That was intentional because
that was the original slide but the version you got
they were efficient and updated. So, all of yours
will say November 2nd on them if you're looking at the
pieces of paper but, on the slide, this was the
original slide that was presented and, as you may
recall, I used some very round numbers, $7 and $20.
This slide was actually put together from home to call
in with a presentation to make some illustrations
here.
9:16:16 AM
The request that I received was to put in actual
numbers. And so, let me go to the next slide and
that's exactly what I've done here is put in actual
numbers....
CO-CHAIR GATTO interrupted to welcome Co-Chair Johnson.
MR. DICKINSON continued.
Maybe repeating the points that I made earlier, what
this is comparing is the [petroleum production profits
tax] PPT, [Alaska's Clear and Equitable Share] ACES
and the House Oil and Gas Committee substitute.
Flipping back and forth, the barrels that I was using
before were 244 million barrels for the year. In fact,
the actual that was used in the current Department of
Revenue's forecasting and that was used in the
material that was presented to you by Econ One -
that's 230.5 million barrels. Co-Chair Johnson asked
that I pull out the oil price that day. I went to the
Department of Revenue website and that was $89.09 so
that's a breathtaking number for those of us that have
been looking at prices for awhile.
CO-CHAIR GATTO asked about this morning's price.
MR. DICKINSON thought the price was in the $90s.
CO-CHAIR GATTO asked if the highest it reached was $97.
MR. DICKINSON said two numbers are available: inter-day trading
as opposed to the close out.
REPRESENTATIVE EDGMON asked if the lifting upstream costs of
$18.57 were higher than what DOR actually quoted.
MR. DICKINSON said the next slide would address that point and
that some controversy surrounded that number.
9:18:55 AM
MR. DICKINSON continued:
I framed this just kind of as - some folks may have
been following - Representative Doogan made the exact
same point you did. He said, gosh, I thought costs
would be closer to 20 - he said the costs were closer
- were 15, how come you used 20? What's going on
there? What I've got here are 3 comparisons and the
ones on the left are numbers we can all look at. On
the right is what was used by Econ One and you can see
the numbers are very, very close. I don't want anyone
to be misled. By doing it very simplistically, there
are some pennies that are going to be different. I
want to illustrate the point.
The Department of Revenue, currently estimating for FY
2008, $4.2 billion in upstream [indisc.]. When it
comes time to turn that into a dollar per barrel
number, and I remember Secretary McNamara had a phrase
he used - never express things on a per unit basis and
when somebody expresses things to you on a per unit
basis, be suspicious of why they are doing it. So,
this may be an illustration of that.
But you need to divide through by the barrels. So,
how many barrels were their daily volume - 722,000
barrels a day, 365 days in a year? So, you come up
with 2.6, 3.5 million in barrels a year.
Now this is where it gets, perhaps, tricky. If you
look at the taxable barrels, you're going to divide
through by - take that number and multiply by .875. In
other words, roundly speaking, it's not quite that
number but, just for illustration, there's a 12.5
percent royalty. Those barrels aren't taxed so you
simply divide through by taxable barrels and what you
find is that you've got $18.57 as the consequence of
that division.
According to the statute, that's the number that you
use. You take the total cost, you divide through by
the taxable barrels. Now I think what's confusing is
if you ask someone what are your costs per barrel.
What does it cost to operate the field. They'll say
here are our costs. Here are the barrels. divide
that one through the other and you come out with a
number that's 12.5 percent lower or $16.25. And so, I
think the problem is - and it was probably exacerbated
by my trying to illustrate one barrel, is when you ask
the question what are your costs per barrel, you'll
get something that's closer to $16.25. If you're
trying to mechanically reproduce what's going in the
statute, you will come up with a number that's 18.57,
or roughly $2 higher. If you take the two numbers
that are used in the Econ One data, you'll come up
with $18.50 and I'm not sure what the - there's lots
of small things in the model that I'm not replicating
- it's very simplistic.
9:19:37 AM
REPRESENTATIVE EDGMON said he recalled a number of $14.56 and
asked if that was from DOR. He also asked if Mr. Dickinson's
calculations are different from DOR's or contain more up-to-date
data.
9:20:18 AM
MR. DICKINSON explained that every number he has used comes from
the Department of Revenue. He noted the numbers he was using
were for FY 2008 and said he would have to see what numbers
[DOR] was using. He said a lot of the data is based on a 10-
year average - he would have to look at that number. He
confirmed that his numbers come from the Department of Revenue.
9:20:33 AM
REPRESENTATIVE WILSON recalled DOR was using 2006 figures.
MR. DICKINSON said his understanding, looking at the graphs, is
if 2006 numbers were used, his numbers are higher.
9:20:55 AM
REPRESENTATIVE EDGMON asked where the numbers would differ in
that chart.
MR. DICKINSON asked if he wanted to know the implications.
CO-CHAIR GATTO clarified that Representative Edgmon was asking
if 2006 was $14 and 2007 is $16, what changed to change the lift
cost.
9:21:02 AM
MR. DICKINSON said all three things. The number of barrels have
declined so, to the degree the costs are fixed, a smaller number
of barrels divided through will raise costs per barrel. The
second factor is that actual costs have increased. Oil field
costs are inflated at $90 per barrel as compared to $60 per
barrel in 2006. The mathematical implication of those go in the
same direction.
9:21:53 AM
REPRESENTATIVE GUTTENBERG asked if the transportation costs were
included.
MR. DICKINSON responded transportation costs are not included.
He said the transportation costs of $6.73 used on the previous
slide were from DOR, although it was not in DOR's published
forecast, which had costs at $7.22.
9:22:34 AM
CO-CHAIR GATTO asked whether ocean transportation cost changes
vary according to supply and demand of tanker space, fuel
prices, or distance to a refinery.
MR. DICKINSON said all three of those factors affect costs. Fuel
cost has a huge impact because that affects every tanker. The
issue of tight demand affects only the tankers at the margin.
Most of the fleet is on hold. Each one is owned by a subsidiary
of an oil company. If two tankers are laid up, that [oil] might
come in at a high price but it will only drive the average up a
small amount. He believes the Puget Sound, Los Angeles, and San
Francisco markets have been fairly steady recently. If one round
trip takes longer than another, the cost will be higher.
9:24:11 AM
REPRESENTATIVE SEATON said he believes the state takes all of
its value in royalty. He asked if there is any royalty
implication in this figure.
MR. DICKINSON replied:
This is going to be the total royalty costs of the
non-royalty barrels divided through by the non-royalty
barrels, or the total cost divided through by all the
barrels. In either way, you'd come up with the same
number. Because the royalty costs are deductible for
calculating the royalty, and the entire royalty is
subtracted from what the PPT is applied to, I don't
think there's any controversy about that. In other
words, if you ask somebody what does it cost to ship a
barrel? You'd say $6.73. What does it cost to ship a
taxable barrel - $6.73.
9:25:23 AM
CO-CHAIR GATTO asked what it costs to ship a royalty barrel.
MR. DICKINSON replied $6.73.
9:25:36 AM
REPRESENTATIVE GUTTENBERG asked whether the charge for diesel
fuel differs for the tankers owned by an oil company and the
independent tankers, assuming the tankers run on diesel fuel. He
questioned whether that is part of the problem with vertical
integration.
MR. DICKINSON said he believes clauses in both the royalty
contracts and the tax would look at that if they were paying
anything other than fair market value. Typically, the rule is
they charge the same price other companies would charge. He
noted that is a specific audit issue, and the effect, if any, is
fairly small because of publicly reported numbers.
9:26:40 AM
REPRESENTATIVE GUTTENBERG stated:
If I may - just an observation and I meant to bring it
up the other day - when we're talking about the
topping plant, the difference between what they pay
their contractors or for their BP pick-up or a Conoco
pick- up on the Slope versus the difference between
what they charge for others - but I think this is part
of the problem that we're seeing in some of the tariff
situations. What's the real cost? And the public is
very cynical about this. It's the oil industry
complaining about the price of oil and their prices
are rising. They're scratching their head saying,
huh? It doesn't make any sense to them at all. We
know lifting prices haven't changed. Operating costs
haven't gone up considerably and they're complaining
about what they're selling it at the pump [for] and
they're getting the money back. We should be a little
cynical about that also.
9:27:30 AM
MR. DICKINSON continued with his presentation.
Using the $6.73 and the $18.57 upstream lifting cost
figure, we derive a production tax value of $63.79.
Multiply that times the taxable barrels and the base
for the tax base is $14.70 billion in both the PPT
case and the ACES case. The progressivity - I think
we walked through that before - you knock off $40 from
the $63.79 to get to your starting place so that's
$23.79. You multiply each dollar in that. It's an
additional quarter of a percent so there's 5.95
percent additional progressivity. That gets applied
against the base for a total of additional dollars -
in this example of $874 million.
The original progressivity tax in the original
presentation was 732 so it's been an increase and the
increase has occurred. You had smaller barrels but
you had higher starting prices and smaller deductions.
So you kind of had three things moving and the net
effect of them is, the ones that were increasing it,
increased it more than the ones that the decline in
barrels, which was a decrease in this example. The
House Oil and Gas is going to be a slightly different
calculation because their progressivity is based on
the gross and, so, when you do this calculation your
base is the same volumes but it's times a wellhead
number, which doesn't have the lifting costs taken
out. So, it's the gross value at the point of
production as opposed to the production tax value, to
use the technical terms in the statute. You then
subtract a larger figure from that, $50, and so the
price index is $32.36. The per dollar variation is
between 2.5 and .2 percent, .225 so the progressivity
factor, 7.28, that's multiplied times the base for a
new progressivity number. Again, you'll see this one
went up less than the others and that's because you're
not taking - in my simplistic example when I was using
$20 to generate this, you've made a change but that
change did not affect the House Oil and Gas Committee
substitute.
9:30:24 AM
MR. DICKINSON continued:
[Slide 5] So, the next question on this - so what,
what does that mean? I presented this diagram. This
is the original and basically there's two things you
could see from this. One was the fact that they are
very close. As prices go up, the total tax before ...
taking the credits, very close but when you're
comparing the House Oil and Gas Committee CS what
you'll see is - it is below ACES and then there comes
a point at about $77 where it surpasses ACES and then
at higher prices it is higher. Someone pointed out to
me that this diagram was sort of hard to read or
wasn't information filled. When I plotted out the new
version using the daily price and the DOR cost of
volume assumptions, you get a very similar drawing.
House Oil and Gas is below the Governor's proposal.
The crossover point moves up a little bit. It's in
the - a later slide will tell you exactly what it is
but it's right here in this range. And from that
point on up, the House Oil and Gas version would
produce more revenues before credits than the ACES
plan.
9:31:56 AM
REPRESENTATIVE GUTTENBERG asked why, if everything changes with
credits, the diagram doesn't contain a line that shows what
happens with credits.
MR. DICKINSON explained he was trying to isolate one piece and
illustrate it. If both bills had the same amount of credits, the
lines would [go] lower but they wouldn't change in their
relationship to one another. The House Special Committee on Oil
and Gas restored TIE credits, to his understanding. Therefore,
if the House Special Committee on Oil and Gas credits were
plotted, they would be different than the credits under ACES.
So, all of the effects were put together and reflected in DOR's
fiscal note. He reiterated he was trying to isolate those
pieces.
REPRESENTATIVE GUTTENBERG said the committee is trying to figure
out what the government take is so it would be good to know what
that real slope looked like.
MR. DICKINSON replied:
... we're so far from government take because we don't
have federal taxes, we don't have state income taxes,
we don't have royalties, we don't have property taxes.
This is not - I apologize if anyone thought this was a
government take figure.
9:33:13 AM
REPRESENTATIVE GUTTENBERG asked the graph would slide down or
slide out if the credits were put in.
MR. DICKINSON said it would slide down with the credits; the
slope would change with the royalties; the income tax would
change the slope in the other direction; and the property tax
would change the slope and slide down.
9:33:53 AM
MR. DICKINSON, in response to Representative Guttenberg, said
many of those were produced for another committee at various
points. He said when they were provided, people questioned how
PPT fit in and there is only a minor difference. He noted some
analyses break it down, some synthesize the information. He
repeated his presentation breaks it down.
9:34:38 AM
REPRESENTATIVE GUTTENBERG said understanding what one is looking
at and how it was built is very important. The economists are
working on pure theory, which is great to hear, but sometimes
members need real numbers or information that is policy driven.
MR. DICKINSON said he appreciates that but the problem is, "If
you look at $62 and say I want to get that up to $63, you then
have to open the hood and figure out which parameter you're
going to change."
9:35:24 AM
REPRESENTATIVE SEATON referred to the bottom of the previous
slide that speaks to the progressivity rate and base, and asked
if the line that refers to tax only applies to progressivity or
whether that shows the difference between 22.5 and 25.
MR. DICKINSON said those pieces only apply to progressivity.
9:35:52 AM
MR. DICKINSON then moved to Slide 6 and told members:
... What I originally did is ... I had a slide that
had these lines on it - it had 6 different lines and
each one looked just about the same and it was ACES
versus the House Oil and Gas Committee substitute,
once with the $27 cost, once with the $15, and once
with the $22 in between. You had 6 lines and ... it
didn't communicate very much. What I tried to do was
extract three points from that [Slide 7], which is on
the same graph where House Oil and Gas and the ACES
bill, where would they overlap?
In other words, if you come down here to the left of
where any of these points are, you would find that the
ACES raises more revenue [indisc.] credits - I want to
make sure that's clear here. Just using a simple
example - just using this portion of it, ACES will
raise more revenue than House Oil and Gas and the
reason is ACES is a 25 tax percent rate before any
progressivity and the House Oil and Gas is at 22.5 so
they will be below. Then the progressivity occurs and
at some point the House Oil and Gas Committee
substitute goes above ACES and the question is where
is that point. If the costs in the illustration I
gave to you - you use $27, that point is right here at
about - it's ... $79 and the total tax coming in is
about 3.8 [indisc.] credits.
As you take out costs, the crossover point moves to
the right and, so, if I use the actual costs of the
Department of Revenue, that would move the crossover
point up to something about $10 higher, $87 dollars
when both systems would produce about $4.4 billion in
revenue. If you go all the way out to $22, in other
words a $15 cost, the round figure, the crossover
point is extremely high. It's above $110 ANS. Maybe
someday we'll be able to say that and it will sound
natural - a couple of weeks from now but right now
that sounds [like] a very, very high number. So, as
the costs change, when you are comparing the ACES plan
and the House Oil and Gas Committee substitute, where
... one raises ... more revenue than the other is very
dependent on the costs that go into that.
Again, I'll repeat something that you've probably
heard ad nauseum. You can make a gross that looks like
a net if you define exactly what the costs are but
then when the costs change, you no longer have an
exact match here. Your gross is no longer reflecting
your net. So anytime you take a gross piece and you
fix a point where a different system allows that to be
variable as it effects the outcome, you will change
the relative of those two costs - the relative
revenues or the relative costs over point.
So, I hope this slide has clarified, as opposed to
obscured.
9:39:43 AM
REPRESENTATIVE GUTTENBERG asked what happens when the credits
are added.
MR. DICKINSON said he believes the crossover points would not
change on the X axis but they would all drop on the Y axis.
9:40:16 AM
REPRESENTATIVE GUTTENBERG asked to what level.
MR. DICKINSON explained if one is talking about the TIE credits,
the difference between that being fully allowed and not being
allowed should be about 10 percent of the capital number, which
is a $200 million difference. In further response to
Representative Guttenberg, Mr. Dickinson specified the angle
will stay the same; it will just move down.
9:41:10 AM
REPRESENTATIVE FAIRCLOUGH opined that what members are trying to
get on the record is that the government take would be less when
credits are applied than what is on the graph before members.
She added a taxing policy is not just based on revenue; it's
also based on investment and actually monetizing resources. She
stated:
The Representative has appropriately pointed out with
credits not before us, it is over-inflating what
Alaskans would see as the benefit of any of the three
tax analyses that we're looking at. All three have
variables that include advantages to encourage
different kinds of exploration. One bill encourages
more small companies to come in and invest. The
original [economic limit factor] ELF encouraged the
big three, per say, to have a better benefit to
disallow the smaller investors to come in. So it's
all - I think I'm going back to BP and Ms.
Fitzpatrick's ... pace and time of the investments
that companies come forward with - pace and scale with
what we do.
So, I think the Representative appropriately points
out that we're looking at a picture that is modified
in the sense that there are other things that
negatively affect the cash flow in being able to
monetize our resource.
9:42:31 AM
CO-CHAIR GATTO said the committee came looking for the science
of numbers but is being asked to apply art to mentally calculate
the credit variations across the board. The committee has been
presented with a chart but must overlay parts of the chart. He
felt it is asking a lot of members to include all of the
testimony it has heard and then be shown a chart that
demonstrates before credits.
MR. DICKINSON acknowledged that is a fair point and everything
can be presented every time, however that might obscure what the
committee is looking at in detail.
9:43:41 AM
REPRESENTATIVE SEATON asked if members are essentially looking
at the base tax differential in the House Special Committee on
Oil and Gas version and ACES and the progressivity.
MR. DICKINSON said that is correct.
REPRESENTATIVE SEATON asked, "And so if we were just looking at
the progressivity without the change in base, then we're looking
at this graph?"
MR. DICKINSON said that is correct. He added,
The bottom lines here are straight. If you plotted
the straight lines that flow from there out here, the
difference between them, that straight line and the
reason it no longer stays straight, is the
progressivity piece. But what people were interested
in this conversation for producing this graph was this
notion that when you're not in progressivity, when
you're in the range to where investments may be
affected, ACES takes more than the House Oil and Gas.
They were concerned about that. But what they wanted
to show was when prices go up, they felt it was
appropriate to have a more assertive or a
progressivity which took a higher share. So, it's try
to combine those two pieces and those two pieces in
isolation.
9:45:16 AM
REPRESENTATIVE FAIRCLOUGH referred to a previous comment made by
Representative Roses about time and some of the particular
things the committee is looking at today. She opined that the
cross sections the committee is looking at to monetize Alaska's
money are obscure because of the historically high price of oil.
Alaskans could be shown a model right now that shows a state
take of billions in progressivity if oil prices were at $200 per
barrel. That would show Alaskans the state was really "sticking
it to" producers and would serve to provide a scenario that
looks very good for government take. However, the reality is,
in the time continuum of 50 years of investment of oil and
organizations involved in this industry, the state must look at
an average price closer to the $30 range. She expressed concern
that the legislature is considering building something in
progressivity while looking at the $100 per barrel price and
losing sight of the average. She said the House Special
Committee on Oil and Gas has made an attempt to tell Alaskans it
is trying to balance at a low price per barrel but take more at
the high end. She expressed concern that legislators believe
that whatever tax policy it puts out is based on a realistic
price of oil. She pointed out the price of the American dollar
is on the decline, which is contributing to the inflated barrel
price, as is instability in world regions with oil. She
cautioned that many variables exist so it is dangerous to focus
on progressivity as the one answer.
9:48:41 AM
MR. DICKINSON noted his agreement with Representative
Fairclough's observation and said he anticipates a price
correction. He added he recognizes the reason the proxy for
costs built into the ELF system broke down was because no one
graphed outside of their imagination. He suggested that the
state should not count on extremes, but should be prepared for
them.
9:49:39 AM
CO-CHAIR GATTO asked if he would be able to avoid an asymptotic
line if the amount was brought out to $1,000.
MR. DICKINSON said they will continue to separate, but they will
cap out at some point. He believes the cap in both is at 50
percent so the production tax would be taking 50 percent, but
the split is not 50/50 because of royalty and everything on top.
At that point, the total government take would be in the 80s.
9:50:14 AM
REPRESENTATIVE SEATON clarified that he believes the bills cap
progressivity at 25 percent so it is the equal share concept
through PPT that the legislature approved earlier. That was
based on 25 percent in the base price and 25 percent in the
progressivity. That was the basis for the equal share through
half in progressivity and half in the base price. The PPT was
adopted at 22.5 and progressivity is capped at X + Y = 50
percent but it is capped at 25 percent in all bills. It is
dependent on the base price: if that is 22.5, the cap will be at
47.5. The idea behind the 25 percent was that at high oil prices
the state wanted to have an equal share so it was a question of
where that would be reached.
REPRESENTATIVE WILSON asked to hear from Mr. Porter.
9:51:35 AM
STEVE PORTER, Consultant to the Legislative Budget and Audit
Committee, Alaska State Legislature, recalled one of the
questions was how credits affect the line. He said credits are
the simplest model. He explained:
It really is $1 out of one pocket into another so it
truly does just drop the line. For every dollar of
credit, it drops a dollar down so that line is exactly
parallel. For every dollar of credit it would drop
down a dollar. So the credits are simple. They just
move the line up and down, do not change the slope of
any of the lines. They are all in rough ratio to each
other because you calculate the slope then you
subtract the credits. It's just straightforward. The
things that change the slope of the line ... the
starting point doesn't change the slope of the line
but it tells you how you are going to start.
Definitely the progressivity factor that the .225 or
the .25 - that's going to change the slope of the
line. How you affect the [operating expenditure] opex
and [capital expenditure] capex - how much you bring
into that and the level that you - whether it's gross
or net, that's going to change the methodology and the
slope of the line. It's similar to the difference
between multiplication and addition and subtraction.
Multiplication is going to change the slope, addition
and subtraction is just going to drop the thing up and
down. So it's actually roughly, as you look at each
one of the variables, we can talk conceptually about
how they affect the relationship. That's something
we're available to do.
9:53:16 AM
REPRESENTATIVE ROSES remarked that yesterday's testimony from
Pioneer was eye-opening. He told members:
They talked about the fact that they had to go in and
renegotiate the lease with the state and not only were
they paying all of this but they were also paying 30
percent on the net. The progressivity we have is never
going to get to 30 percent on the net. So there isn't
a single company out there that had existing leases
prior to this that's ever going to get as high as what
the negotiated rate was for Pioneer. On top of that,
we're giving them this additional boost so I'm trying
to get my hands around how the fact that we hold some
of those particular situations harmless and I don't
know whether the cap takes care of that or not but it
doesn't appear that it does. So I guess we're - I was
struggling with this and thought these little dynamic
changes of 2 percent here and .0002 here and .003 here
and then I look at 30 percent and say we're not even
in the ballpark. We're grappling over peanuts when
the peanut farm is over here. So it sort of pales in
comparison so when people say it's going to change the
dynamic by raising this 2/10ths of a percent, and we
saw somebody else get theirs raised by .3, not ...
2/100ths of a [percent], it just blows my mind. It
just seems to me like we're arguing over some of the
wrong points.
9:55:33 AM
REPRESENTATIVE SEATON said the 30 percent net cost share
contract kicks in after [Pioneer] has recovered all costs,
operating and capital. They also got royalty relief so that
upfront their royalty is 12.5 instead of 5. That's a trade-off
on net present value versus future. He was surprised to hear of
30 percent net profit sharing in addition to PPT, until he
understood royalty reduction was given and the 30 percent net
profit sharing was a trade-off for the upfront royalty relief
that doesn't kick in until costs are recovered.
REPRESENTATIVE SEATON pointed out that another difference does
not show up on the graph because the [numbers] are static in
time. Oil and gas will remain at that curve as will the curve
for ACES, if one assumes increases in costs or inflation will
move further to the right. One of the points discussed about
time is that the trigger point being on the net accounts for all
of the differences. That is not the slope of the line change
or whether the tax is on wellhead versus net after costs. He
continued:
That is not the determining factor of having this tax
last for a long time and acquire the positions of
having built into it the idea that it won't have to
come back and be fixed because if you trigger it on
the net, which ACES does, then those are taken in as
whether you have inflation or whether you have
increased costs in some fields. And so I just want to
make sure that I'm understanding that right so if we
look at those graphs and make some presumptions of 5
years from now with some inflation and everything
else, those lines are going to move apart. But that
wouldn't be the case if we keyed the gross
progressivity on the net profit margin, the same as in
ACES. Is that correct?
9:58:47 AM
MR. DICKINSON said yes, if one trigger is gross and one is net
as costs change, the two will move further apart. He noted, in
this graph, as costs increase, even with declining volumes and
no inflation, the cost per barrel will be higher. The line will
move to the left, not to the right.
REPRESENTATIVE SEATON clarified that ACES would move to the
right and the gross trigger would keep it where it is.
MR. DICKINSON said that is correct. He added there are a number
of net profit share leases on the North Slope. Pioneer is
unique in that most of its oil is in the one lease. He pointed
out:
The only other observation I'll make is also it then
becomes deductible for PPT so the net effect, once
payouts reach and those payments are there, then the
PPT will drop some. But, you're right, it's a much
larger figure.
10:00:13 AM
REPRESENTATIVE FAIRCLOUGH stated, in regard to the comments
specific to Pioneer, she met with Commissioner Galvin and some
geologists to discuss those numbers. She learned that Oooguruk
has been waiting to be developed for at least 40 years. Pioneer
took a risk in stepping forward to produce it and was able to do
that now because of the transition in basin holders that has
allowed smaller explorers to come in. That facility agreement
has allowed Pioneer to access a line at a much reduced cost
rather than building new structures. She said the dynamics of
who is investing in Alaska is changing as the statute matures so
hopefully its tax policy will reflect that.
CO-CHAIR GATTO said hopefully the next Oooguruk will be able to
take advantage of the infrastructure.
10:01:53 AM
REPRESENTATIVE WILSON said because of the dynamics occurring
right now, legislators must be careful. North Slope activity is
increasing so the legislature must be careful to do nothing to
stop that.
10:03:03 AM
MR. DICKINSON replied the PPT does more than that. Instead of
impeding investment, it makes it more attractive. He continued
with his presentation., as follows:
... My last slide [Slide 7], everyone was hoping for,
which is a little bit of algebra. Basically, some
people think visually, some people in tables and some
people think in equations. So I'm basically just
trying to differentiate between the gross
progressivity and the net progressivity. ...Let me
start at the bottom with the net progressivity, which
is the current law and how that works.
You basically have a rate. You start with R, which is
the rates and it's a per barrel amount. It typically,
in current law, it's .25. You multiply that times two
other things. The first thing is to my mind how you
get the total progressivity rate and so you multiply
that times the gross value at the point of production,
minus all those upstream costs. You divide that
through by taxable barrels so that this expression
gives you a per barrel amount.
And then you say, okay, we're going to - not only will
you get to recover your costs but before progressivity
kicks in, you get to recover another $40. This tells
you how much the per barrel cash flow is from each
barrel less $40. Let's say that came out to be $10.
You then would take your rate, which is a quarter of a
percent per barrel, and you'd come out you'd say okay,
that's 2.5 percent. And then you'd take that 2.5
percent progressivity and you'd multiply that times
the same thing that you calculate your total taxes
against, which is your gross value less your upstream
costs.
So that's how that currently works and that's how that
works under ACES, and the only difference being that
this 40 becomes 30, and the R - I guess I wasn't
consistent in how I treated that - the R, instead of
being .25 is .20. But the mechanics of it are the
same. The equation looks the same.
The progressivity tax on gross is simpler. That
doesn't mean it's right but it is simpler. I think,
as everyone realizes, is all it means is you go and
strike out - wherever you see an N here - a
subtraction of costs, you strike that out and,
probably partially to compensate for that, then this,
the number that you subtract was up to 50.
So what it is, you take your per barrel rate, you say
what's my gross value at the point of production,
divide through by my barrels, find out what that is
and knock out $50. That gives me my index of the same
thing. If it was a quarter of a percent, and that's
$10, you have 2.5 percent, and then you take 2.5
percent times the gross. So you're typically going to
have a higher figure here and because costs are always
going to bring that down. Whether this is high or not
depends on whether the difference between 50 and 40 is
larger than the difference between the costs and no
costs.
I hope that's - now there's a third way of thinking
about that. As Representative Roses has - full
equation and then for Representative Guttenberg's, you
would then take this whole thing and add on the
regular tax and then subtract the credits and the
equation is a lot longer.
10:07:34 AM
REPRESENTATIVE SEATON pointed to two different functions in both
of the equations. One is what you're taxing on at the end, G or
G-N. The other is the trigger point, which is the middle
sections and nothing prevents changing the trigger point from
the lower equation into the upper equation and taxing on the
wellhead instead of the net.
MR. DICKINSON said that is absolutely right. He pointed to the
graph and said, "To put it in classic tax terms, this is your
base and this is your rate, and there's no reason that you have
to have the same figure in both."
10:08:16 AM
CO-CHAIR GATTO said the cross point is the intriguing number.
MR. DICKINSON told members the cross point will change,
dependent on N.
10:08:42 AM
REPRESENTATIVE ROSES said the committee heard that due to
progressivity on the gross, at a certain price and a certain
cost, there would be no taxes on the base, therefore the cost
would wash out and the progressivity would kick in. He asked
for clarification.
MR. DICKINSON explained the progressivity does not affect the
base calculation, nor can the progressivity go negative. If the
per barrel amount is $40, and $50 is subtracted from that, that
doesn't equate to a negative $10 refund.
10:09:39 AM
REPRESENTATIVE ROSES said he thought that speaker's point was
that if $40 is the trigger point, but costs wash out to zero, no
taxes would be paid on the base. However, with the gross, a
progressivity tax would be paid but that isn't possible because
the [progressivity tax] would only trigger in above that amount.
MR. DICKINSON opined that the opposite is true. He said the $40
figure has nothing to do with the base. The state gets 22.5
percent of the net - that will never change. He said he shares
Representative Roses' confusion about how that might work.
10:10:43 AM
CO-CHAIR GATTO said if the gross kicks in at $50 and the cost is
$60, the company is not making any money. However the
progressivity costs have still kicked in because it's a gross
amount.
MR. PORTER explained that would occur in a high price
environment for oil, where progressivity would kick in, and a
company is spending so much capital that the net was spread to
zero. He said he believes that is the only environment where
that scenario could be possible.
MR. DICKINSON presented a hypothetical case of a company with
existing production that makes a huge investment in a new field.
Their net could be zero over all of their barrels because that
new investment wipes out the tax on the original. However,
those original barrels could still be taxed under gross
progressivity. He said that might be likely if one of the
current small players decided to make a huge investment.
10:13:00 AM
REPRESENTATIVE SEATON asked if gross progressivity was based on
the trigger point of the net, that could never happen because
the progressivity would not kick in without a profit margin of
30 or 40.
MR. DICKINSON responded that is correct. If any number goes to
zero in the multiplication, the entire equation goes to zero.
MR. PORTER told members he and Mr. Dickinson are available to
answer questions.
10:13:56 AM
REPRESENTATIVE ROSES asked:
After the bill came out of [the House] Oil and Gas
[Committee], there was an article in the paper and there
was some concern about the fact that because of the cost -
and that's why you were here to show the actual costs as
opposed to the $20...
MR. DICKINSON interrupted to clarify Representative Roses was
referring to the actual estimated costs.
REPRESENTATIVE ROSES continued.
...exactly, well, the number based on what we think is the
current cost. And there was an article that talked about
the fact that under the House Oil and Gas provision that
the state would get no additional revenue for 5 years based
on the progressivity and the rate that they were in there.
Did you follow that and understand what that meant?
10:14:39 AM
MR. DICKINSON explained that the fiscal note uses a forecast.
Typically those prices start at $70 and go down. In that case,
the higher progressivity doesn't kick in, so the CSHB 2001(O&G)
raises less revenue than ACES.
REPRESENTATIVE ROSES responded, "Under that prediction of a
decline of prices."
MR. DICKINSON verified that is correct. He then explained that
the second fiscal note forecast uses a nominal and real [number]
and assumes a start point of $80 and prices rise due to
inflation. In that case, five years out the [barrel price] hits
the $90 range where the cross over occurs and that is the only
time CSHB 2001(O&G) would raise more revenue than ACES. He said
if today's price is used and one assumes that increases, the
CSHB 2001(O&G) would raise more revenue today.
REPRESENTATIVE ROSES said the only way that would happen is if
the stars were aligned properly.
MR. DICKINSON jested only one star would be needed to align with
exactly what DOR said would happen.
MR. PORTER said if one asks about the impact of CSHB 2001(O&G),
that version raises more money at higher prices and less at
lower prices. The crossover point is roughly in the $80 range,
depending on a number of variables.
10:17:32 AM
REPRESENTATIVE WILSON said almost any scenario can be shown
dependent upon what numbers are used. Legislators must base
decisions on whether the prices are high or low and ensure the
state is covered in either case. She expressed concern that if
prices are low, developers will leave, which happened once
before in Alaska. She opined that she does not want to repeat
history.
MR. PORTER agreed that is very important and said it is also
important to understand the relative significance of changing
the numbers. He said he would compare a gross tax, which the
state does not currently have, to a net tax, which is in both
ACES and PPT and the relationship between the tax and
progressivity. Each one of those elements substantially effects
the economics of a project regarding taxes. If a company spent
$1 billion to get to the point of first production and 10 years,
that is a huge front-end expense before it receives its first
dollar. A gross tax would take a portion, maybe 20 percent, of
that first dollar, which delays the amount of time that company
can recover its costs. On a net basis, the company's cash flow
is taxed, which helps the company recapture its money. The
advantage of progressivity is that it gives the company $30
(ACES) or $40 (PPT) in cash flow before the state starts taking
its portion of the windfall. If the state is trying not to
impact the overall impact of a project, the progressivity on the
top end will not affect the overall economics of the project as
much as raising and lowering the base tax. He is a strong
proponent of keeping the base tax stable and as low as is
reasonable and in sharing in the income at the top end.
10:21:53 AM
REPRESENTATIVE SEATON noted that ACES has a fairly significant
gross floor, 10 percent. That would be taken into
consideration by a board when deciding whether to sanction a
project. The committee has seen $32 used as the stress point in
models but now that has been kicked up to as high as $75. He
asked if setting the progressivity amount above that analysis
point would prevent it from impacting a decision about
sanctioning a project.
MR. PORTER replied:
... Especially if you're on - your trigger points on
the net because you are giving them cash flow before
you even start the progressivity. The problem with
the gross floor on a percent basis is you really are
taxing that first dollar that they're trying to
capture. I look at two things. If, in fact, West Sak
is at 40, which I think the administration testified
to, in that low environment that becomes very, very
difficult. So a floor impacts your most marginal
projects more than it does the very prolific projects,
you might say. So that's the ones that you don't want
to hit. To be very direct, that's a bad idea.
10:24:13 AM
REPRESENTATIVE SEATON said in looking at the give and take
balance, the floor has been eliminated in CSHB 2001)O&G), which
is a large percentage at low oil prices, yet the progressivity
has been modeled to equal ACES so that it is not aggressive. He
pointed out it is hard to tell the difference between the PPT
and ACES line. He asked if Mr. Porter's understanding is the
same.
MR. PORTER said Representative Seaton's analysis is correct, but
needs to be qualified. He pointed out that although the lines
are pretty close, the difference is significant in those out
years as the difference amounts to hundreds of millions of
dollars. He said the key is, when legislators look at
progressivity, they need to figure out how much cash flow per
barrel it wants to let the company recoup before it starts
taking its windfall. Legislators will either determine the
slope of the line depending on how quickly it wants to capture
incremental value or decide to share the cash flow for every
dollar in revenue. If legislators decided to set the number at
$120, at that point it would max out the state's share at 50/50.
Legislators can do two things: choose the start point and choose
the upper point where it wants to start sharing 50/50, and the
slope will create itself. He emphasized he is speaking to net so
that $120 would represent the price per barrel less any costs.
10:27:31 AM
REPRESENTATIVE FAIRCLOUGH suggested the committee begin a round
table discussion on the hot point issues so that the public can
understand the different pieces going into the decision
legislators are trying to make. She suggested beginning the
discussion with net versus gross and continuing with the
recognition of costs, the Governor's proposal, et cetera.
10:29:54 AM
CO-CHAIR GATTO said all of those issues could be resolved
quickly if members knew what the price of oil was going to be.
He said if one takes the historical average of a postage stamp,
that would amount to about 20 cents, since the price has
increased from 1 to 41 cents. However, no one can mail a
letter for 20 cents. He thought, in trying to pick an
historical average for oil prices short of a world wide
recession, the average is unlikely to recur. He wished someone
could establish a fixed price for oil from which to make
decisions, but that can't happen. He noted the legislature is
dealing with knobs and pulleys so that every time one issue is
changed, everything else changes. Experts cannot predict the
price of oil.
CO-CHAIR GATTO remarked that Representative Fairclough's idea of
a round table discussion is superb because most public support
appears to counter simplistic advertising. He opined that the
committee should discuss the fact that the issue is barrels, not
taxes, because changing the tax could result in fewer barrels.
CO-CHAIR JOHNSON said he agrees with the round table suggestion
but asked that all committee members be present.
CO-CHAIR GATTO noted that three of the absent members are
Democrats. Those members are in a meeting. He said he is so
pleased that partisanship has not entered into this issue. He
suggested taking a recess to wait for those members to return.
REPRESENTATIVE WILSON suggested taking a 10-minute break and
informing the absent members of the plan.
REPRESENTATIVE ROSES suggested having the round table discussion
after members submitted amendments, since there is a deadline
for doing so.
CO-CHAIR GATTO reminded members that amendments were due at noon
the following day. He said the committee could take a recess
after the amendments are submitted so that members could review
them.
10:36:59 AM
REPRESENTATIVE FAIRCLOUGH related her desire to have full
participation and is willing to wait for the absent members to
return. She clarified her desire is that people articulate the
different positions on each issue, not advocate for any
position. She said all legislators come to the table with a
different filter due to their different backgrounds. Her
intention, she relayed, is to ensure all members have understood
the testimony in the same way and to inform the public, not to
participate in partisan politics. She further said she wants
her constituents to know that all committee members believe this
point in time to be very important for Alaska and they are
trying to balance all of the issues put before them.
CO-CHAIR GATTO said he would also like the public to understand
that the differences between the types of oil are as varied as
the difference between soft and alcoholic drinks. The formula
must adjust to the different types of oil because the expenses
are very different.
10:41:01 AM
The committee took an at-ease from 10:41 a.m. to 10:57 a.m.
10:57:17 AM
CO-CHAIR GATTO called the meeting back to order. He announced
the agenda for the remainder of the day would consist of a
recess from noon to 1:00, at which time members would hear from
the commissioner of the Department of Revenue and others. At
3:00 p.m. the committee will either recess or adjourn, depending
on the amount of material covered.
CO-CHAIR GATTO invited members to begin an internal discussion
for the benefit of the public, as well as members. He said
members will meet at a second round table with the producers and
the administration on Saturday. He asked Representative Roses
to discuss ground rules.
10:58:37 AM
REPRESENTATIVE ROSES said his understanding is that this
opportunity is not to be used as a press conference or to
discuss members' opinions, but to get areas of concern on the
table so that further clarification can be requested. That way
future round table participants will be prepared for the line of
questioning.
10:59:58 AM
CO-CHAIR GATTO explained that when Prudhoe Bay was young, the
first barrels of oil had the consistency of a bottle of Coca
Cola. As time went on, the lightest and thinnest oil had been
pumped and the consistency of the oil turned to that of syrup.
The new oil, not yet available, will have a substantially
thicker consistency. That oil will probably be developed in a
decade because the technology does not yet exist to make
development economically feasible. However, because that target
is known, organization resources are focused in that direction.
11:01:34 AM
REPRESENTATIVE SEATON said he would lay out the issues in CSHB
2001(O&G) that he would like the experts to further clarify. The
first is the exploration incentive credit (EIC) because he has
not heard enough information on all standpoints.
11:02:33 AM
REPRESENTATIVE FAIRCLOUGH said she would like the producers and
the administration to discuss progressivity, specifically about
appropriating funds into the Constitutional Budget Reserve
(CBR), the permanent fund, or a separate account, at the round
table scheduled on Saturday at 9:00 a.m.
11:03:58 AM
CO-CHAIR GATTO opined that it is time the legislature repaid the
funds it borrowed from the CBR, and thus he expressed interest
in that being part of the discussion.
11:04:21 AM
REPRESENTATIVE GUTTENBERG said he thinks members already know
what industry representatives are going to say at the round
table, for example they want a partnership but it does not need
to be balanced. He said he would like to get a definition of
windfall profits, and discuss terms of behavior. The
consultants have told legislators they do not have enough
information from the course of the last 30 years to predict [oil
companies'] behavior. He believes part of that behavior is
influenced to a great degree by happenings elsewhere. He
specified that he would like to hear from the administration
about the evolution of the ACES bill, especially its change from
the gross, and how it expects behavior to change. He also wants
to know how the bill evolved from going to the gross to ACES.
11:06:56 AM
CO-CHAIR GATTO said he would also like to hear about the
evolution of ACES and its change from the governor's initial
campaign promise.
11:07:19 AM
REPRESENTATIVE SEATON requested discussion about [AS
43.55].165(e)(6) and the BP situation. He would also like all
of the participants to discuss expanding [AS 43.55].165(e)(6) to
include criminal negligence, the fact that those costs would be
non-deductible, and on the impacts of eliminating the section
about unscheduled shutdowns and how audits would be handled.
11:08:56 AM
CO-CHAIR GATTO asked if Representative Seaton thinks it is
necessary to discuss fines and penalties that have already
occurred.
REPRESENTATIVE SEATON related his understanding that all bills
have a retroactivity portion that deals with that issue so he
doesn't think that would be built into new legislation. He then
expressed interest in discussing how that issue can be handled
in the most expeditious way for all parties.
11:09:51 AM
CO-CHAIR GATTO said legislators spent a lot of time trying to
figure out best oil field practices. He asked about the 30
cents a barrel issue.
11:10:33 AM
MR. DICKINSON recalled that Representative Seaton characterized
[AS 43.55].165(e)(6) as the BP issue. He pointed out if a cost
is disallowed in Prudhoe Bay, half of that interest belongs to
BP, almost one-quarter belongs to ConocoPhillips, almost one-
quarter belongs to ExxonMobil and the remaining interests belong
to small operators. One of the issues legislators wrestled with
was working interest owners, specifically how an operator's
criminal negligence would affect the tax return of the working
owner. He said negligence issues need to be thought through.
11:11:35 AM
REPRESENTATIVE FAIRCLOUGH said she would like the administration
to speak to the issue of confidentiality. The committee has
talked about a wide variety of people who would have access to a
wide variety of information in both DOR and DNR. She questioned
whether the administration would be willing to trim down the
exposure because the producers have spoken to how
confidentiality impacts their competitive edge on return on
investment. She supports the Governor's attempts at
transparency while providing confidentiality but wants to know
how she plans to do that.
REPRESENTATIVE WILSON said that is her concern also. She added
the data in ACES is wide open. She would like to know whether
that can be narrowed down.
11:13:35 AM
REPRESENTATIVE SEATON said he wants to make sure the producers
and the administration are aware that members have requested
specific information, such as amendment language from possibly
ConocoPhillips to tighten up the confidentiality issue.
MR. DICKINSON provided three observations on confidentiality.
The first is that DOR would share forecast information with DNR
but the time period for the forecast information is not
specified. Currently, most oil revenue is taken in cash
payments but, 20 years ago, most of it was taken in-kind. He
pointed out that DNR was acting as an agent, selling oil and
held several competitive sales. Although DNR has not done that
recently, it retains that right. He noted if a company's
potential competitors for sales in Alaska must submit all
forward-looking information, legislators might consider whether
DNR's marketing folks will be looking at that as they think
about RAV.
MR. DICKINSON turned to his second concern: that on the
forward-looking information, in a worse case scenario, auditors
may find a document necessary to forecast or with the potential
to forecast and say that should have been produced. However,
DOR could wait to notify the company until the end of the time
period, six years, and send the company a bill for $2 million,
which equals a fine of $1,000 per day times six years. He said
if the intent is to fine a company when it does not produce a
document requested by the department, the $1,000 per day fine
should suffice [and the company should be notified immediately].
He opined that concern should be addressed.
MR. DICKINSON said his third concern addresses a technical
issue. The current tax statute says the department can publish
information as long as it's combined so that a particular
taxpayer's business cannot be identified. The ACES bill will
eliminate that protection and instead requires that three
taxpayers' information be combined so that BP's tax information
could be combined with the two smallest taxpayers' information
and be published. He said the same approach is used for the
salmon pricing report so that if there are fewer than three
taxpayers in a category, the information is not published. If,
at some point, three can be combined statewide or one taxpayer
represents more than 80 percent or two taxpayers represent more
than 90 percent, the data will not be published. Second, the
salmon pricing report remains under the general tax rule that
requires the particulars of a taxpayer's data be disguised. He
related his belief that rule should remain, but noted his
agreement with the overall goal of clarifying what can be
published.
11:21:16 AM
CO-CHAIR GATTO asked if that falls under the confidentiality
provision.
MR. DICKINSON answered it falls under the publication and
sharing of taxpayer data between departments provision. He said
Representative Wilson's concern about the forward-looking
information pertains to being more specific. It currently says,
"anything necessary for a forecast." A taxpayer could consider
information useful but not necessary to forecast. He suggested
telling taxpayers to tell DOR for the next eight years what the
following categories will be: capital and operating costs;
exploration costs; and projected volumes. Where a unit exists,
the state should be privy to any information passing between
members of the unit, such as when projects get approved.
CO-CHAIR GATTO asked if Mr. Dickinson will be participating in
the round table discussion.
MR. DICKINSON said he will not.
11:23:04 AM
REPRESENTATIVE FAIRCLOUGH asked if the House Special Committee
on Oil and Gas extended the auditing period to six years. She
noted that producers and the public have said allowing a
bureaucracy additional time will only increase the longevity to
produce a document. She pointed out that Representative Roses
has requested that the administration provide facts at previous
meetings on how often audits have been pushed out past the three
year timeframe. She added federal tax returns can be audited up
to seven years after being filed. She has not seen a response
and she would like an answer before looking at CSHB 2001(O&G).
11:24:36 AM
REPRESENTATIVE ROSES recalled he also asked how many times a
situation has been pushed into jeopardy status.
MR. DICKINSON said no statute of limitations applies to
situations like fraud.
11:25:23 AM
CO-CHAIR GATTO said the base rate could be a topic.
11:25:32 AM
REPRESENTATIVE ROSES said he is sure the administration will try
to justify why the legislature should adopt 25 percent and a 10
percent floor but he does not have any questions about it.
11:25:56 AM
REPRESENTATIVE EDGMON said he does not expect the parties to be
surprised by any questions at this point since the deliberations
have been going on for 16 days. He thought Representative Roses
characterized the situation most candidly when he said the
legislature is in session because the price of oil is at $96 per
barrel, so the discussion is about money on both sides. He said
the committee heard testimony yesterday about finding a sweet
spot but he believes, as policy makers, legislators are looking
at a fairly balanced viewpoint, that being the yield curve where
it starts at the bottom end and goes to the top end so that both
sides share in the risk and the reward. He pointed out the
producers have talked almost exclusively about the risk side.
11:27:54 AM
REPRESENTATIVE SEATON pointed out that members heard a lot about
underestimation of costs and possible underpayment of tax based
on costs claimed that may not be appropriate. He was not sure
whether the reporting requirements in the bill will cover all of
that. He requested more information on what the penalties for
underpayment need to be to get as close as possible to the
estimated tax payments for the net present value.
11:29:27 AM
REPRESENTATIVE WILSON expressed interest in hearing more about
the topping plant. She recalled asking how many barrels are
involved right now and whether expanding its use to all
operators on the Slope will significantly increase the number of
barrels and impact the royalties the state receives.
CO-CHAIR GATTO said he would like to know whether the topping
plant saves the producers or the state money.
11:30:46 AM
REPRESENTATIVE FAIRCLOUGH said she does not want to advocate for
a large credit for a particular company. However, she related
her belief that the EPA and environmental standards to reduce
sulfur in diesel specific to the topping plant issue can be
compared to land use issues. If one wants something to be done,
one changes a behavior; in this case, at the state level on
taxation, at a local level on land use policy. Sometimes
unintended consequences occur. She continued:
So, I think that the federal government in the EPA ruling
that mandates a reduction in sulfur and diesel, their
intent is to take carbon monoxides and toxic chemicals out
of the air. And so, I'd like to have a conversation of the
dollars and cents, as Representative Wilson and you have
both spoken to, but then I have to take a step back and say
what was EPA's intent. If we're going to put 50 trucks,
and I'm not certain if that is round trip or not because
that means it could be up to 100 trips per day, on a road
that the State of Alaska will have to maintain, so there
will be costs allocated to that maintenance that aren't
picked up by those trucks because the diesel that's hauling
the trucks will contribute to the federal tax on fuel but
what they are hauling will not. My point is there are air
quality issues and other issues that will impact a decision
of building something on the North Slope that goes beyond
the finances and that is that EPA is trying to extract
toxic poisons out of our air, which is a global issue.
Again, it's weighing that balance.
I'm certainly not advocating for the credit but I am
advocating for the consideration of there is more to the
issue than dollars and cents when it reaches the general
public and the benefit of the general public. The bottom
line is that the intent from EPA is to get the toxins out
of the air and then we're going to, because of economics,
choose to put hundreds of trucks on a daily basis. I
wonder what the dialog will be and how much carbon we stick
back in the air in putting the lower diesel fuel into
service. I'm sure that you understand what I mean. I just
know that there's a trade-off there.
11:33:24 AM
CO-CHAIR GATTO acknowledged both a social and economic cost.
REPRESENTATIVE FAIRCLOUGH said [oil development] creates an
environmental cost, a health cost, and a global warming cost.
11:33:44 AM
REPRESENTATIVE SEATON asked if members received a three-page
memo on the number of trucks and maintenance costs. He said he
would distribute it if they did not.
11:34:04 AM
REPRESENTATIVE WILSON said she would like to know whether
companies can deduct payments to the state from federal taxes
and whether they could still take those deductions at the
federal level if the state does not give them. She asked:
If we said we weren't going to use that as a deduction, do
they still get to deduct it at the federal level? I would
like to know that because that would make a difference in
what I did too. If they're going to get it deducted at the
federal level, then why would we give them a deduction for
it?
MR. DICKINSON explained many expenses on the North Slope are
deductible for the purposes of PPT, state income tax, and
federal income tax. He pointed out a deduction does not
provide 100 percent recovery of costs. He felt it is entirely
appropriate, given three different taxes, to allow companies to
deduct something from each. Generally, the deductibility on the
federal tax will be very separate from the way the state treats
it. The state income tax uses the same standard so it would
probably be deductible state income tax whether or not it was
deductible from the state production tax, unless the legislature
specifically prohibited it.
11:36:23 AM
REPRESENTATIVE ROSES said he thought Representative Wilson's
concern was not so much about the deductibility of expenses but
whether or not the company was receiving a federal credit or a
special write-off on federal taxes. Her concern was not about
the state issuing credits on top of those credits, he suggested.
MR. DICKINSON agreed and said credits would add up more quickly
but even a federal credit is not typically 100 percent.
11:36:55 AM
CO-CHAIR GATTO announced that the committee would recess until
1:00 p.m.
1:22:28 PM
CO-CHAIR GATTO reconvened the meeting and asked Mr.
Gavin to give his presentation.
1:22:38 PM
PAT GALVIN, Commissioner, Department of Revenue, gave the
following testimony:
Thank you, Mr. Chair. Today I wanted to just pick up
some loose ends and cover some things that we haven't
had a chance to cover in the previous testimony. Some
of this is in response to issues of concern that have
been raised to us or questions that people have asked
us to pursue.
And I've broken this down organizationally into four
different topics. I've got the first one - an
explanation of credits. There was a lot of discussion
about the way that the credit system works between new
companies coming in, current companies who are
currently producing, and then when we start talking
about the exploration incentive credit program, all
the numbers start to blur and so what I've tried to do
is capture as neatly as I can, in just a few slides,
some of the distinguishing characteristics of the
credits as it relates to new entrants, existing
explorers or existing producers and the EICs. And so
that's one section.
The next section I wanted to do is just run through
from the administration's vantage point, the House Oil
and Gas CS and give you our comments in terms of
things that we would like to see changed in the CS
when you consider moving something out of this
committee. I'm going to walk through those and, in
the process of that, identify maybe some other
directions on the issues that were being addressed in
that CS.
The next area is talking about transportation
deductions. This is something that hasn't come up in
this committee yet and it was an issue that's come up
through a number of legislators who have asked about
how the tax system deals with the transportation
deductions associated with pipelines that have tariffs
with maybe distinctions between what are the actual
costs versus what are the applied tariff costs and how
that relates to the tax system. So, I've got a
description of that and hopefully I'll have some
expertise on the phone to help me with that.
And then finally, there's been a lot of discussion
about progressivity, about ways of calculating it,
about net versus doing it on a gross basis. The House
Oil and Gas CS is on strictly a gross basis and
there's been talk about doing some sort of a mixture.
And so I wanted to bring the Gaffney Kline guys back
and give you an opportunity to just ask them about
these different options and I've had them respond to
some of the ideas that I've heard from different
members and to give you an idea of their perspective
on the different options that have been discussed.
1:25:36 PM
REPRESENTATIVE FAIRCLOUGH said a copy of the slide in front of
members is not on their table.
COMMISSIONER GALVIN said the slide he is showing is just a
navigational slide; copies of the remainder of his slides are in
members' packets.
1:26:15 PM
CO-CHAIR GATTO asked if someone would be showing up with a
packet of information for members.
COMMISSIONER GALVIN said it was distributed to members and is
entitled, "The Credit Story."
CO-CHAIR GATTO informed members that Ms. Thompson, Division of
Oil and Gas, will be on-line and available to answer questions.
1:26:30 PM
COMMISSIONER GALVIN said Ms. Thompson is the expert on the
transportation deductions. He then continued his presentation:
[Slide 2] So turning to the credits, I hope this is
helpful. I put this together this morning after
thinking about the way that this is rolled out over
the course of the days that you've been working on
this and realizing that it kind of comes disjointed
and sometimes it's difficult to understand how they
all fit together. And to this is an attempt to kind
of bring that together in one place to hopefully
better understand how these parts work.
CO-CHAIR GATTO informed members they should have a copy of a
letter that was to accompany a chart on the structure that was
previously received.
1:27:25 PM
COMMISSIONER GALVIN continued:
So what I'm going to go through are two different
scenarios where you have a development project that is
being undertaken by a new entrant, somebody who has no
current production, no current tax liability and then
look at a similar project if it were undertaken by
what I am referring to as an incumbent, somebody who
currently has production and is currently paying
production tax and has the opportunity to transfer
credits directly. And then, separately, we'll talk
about the exploration incentive credit program and how
that treats different activities.
1:28:10 PM
So, in the first example, a new company comes in, and
a prime example of this would be Pioneer. They come
in with a new project and let's just, for the sake of
explanation, think about their project costing $200
million in development costs. Under both PPT and
ACES, they get a 20 percent credit that's going to be
taken off at the bottom of any tax liability. Both of
them get the same ... under PPT and ACES it's still
the same and so it's worth $40 million to them in the
end with a $200 million project. In addition to that
credit, as they're experiencing those costs, they're
deducting it from zero revenue and so they're
experiencing a loss in the amount of $200 million. And
then they apply their tax rate to - that they are
allowed to apply against that loss - and that results
in a net operating loss. Under both PPT and ACES,
they are allowed to carry that forward one year and it
turns into a credit the following year. It turns into
a transferable credit that is the same as if they had
earned it the following year.
1:29:36 PM
CO-CHAIR GATTO asked if a company starts out with a cost of $200
million and gets a 20 percent investment credit worth $40
million, the company's loss would equal $160 million.
COMMISSIONER GALVIN said that is correct; although he has the
numbers in reverse order. A company would first deduct the $200
million from revenue, which results in a $200 million loss.
Taxes are calculated on that. A 20 percent rate can be applied
under PPT, and then the credit would be calculated.
Commissioner Galvin said the main point of Slide 2 is that under
the PPT, the tax rate a new entrant is allowed to apply to an
operating loss is set at 20 percent.
1:31:00 PM
COMMISSIONER GALVIN continued with his presentation.
And you'll see on the next slide [Slide 3], if they
were an existing producer the tax rate would be 22.5
percent. What we're doing with ACES is we're going to
have the same rate apply for either one of them - and
you'll see that as we go through. So now we've got the
incumbent situation - same project, $200 million,
company gets a 20 percent net credit at the end for
$40 million. But, in this instance, the company has
production. They have a tax liability and so that
$200 million is just added to their capital costs for
the year and it just reduces their tax base that their
tax rate is then applied against. It reduces their
taxes to the tune of $45 million, 22.5 percent. Under
ACES the tax rate is higher so it amounts to a $50
million value. The other additional thing to note is
when you are with an incumbent, they are going to also
likely have the eligibility for the TIE credit ... 10
percent in addition so they get another $20 million.
ACES doesn't allow that.
1:32:09 PM
So, comparing them side-by-side, ACES - new entrants,
incumbents - for a $200 million project, the new
entrant is looking at a total credit under PPT of $80
million and under ACES it would be $90 million, the
primary difference being that they get to write their
net operating loss off against their actual tax rate
as opposed to the 20 percent, sort of the artificially
lowered number under PPT. With the incumbent, they're
looking at ... what I missed in this is the TIE credit
so you can add 20 on to these. Under the PPT one it
would be $105 million, including the TIE credit. The
primary distinction I wanted to make was to show that
under PPT, the new entrant for the same project gets
an $80 million credit, while the incumbent gets the
$85 million credit plus the TIE credit. Under ACES
we're going to bring them both and let them both have
a $90 million credit so we're trying to create equal
value between the incumbents and the new entrants.
1:33:52 PM
REPRESENTATIVE SEATON asked if those calculations are based on
the assumption that progressivity has not been reached.
COMMISSIONER GALVIN said that is correct.
REPRESENTATIVE SEATON related his understanding that if
progressivity was reached, the amount of deductions allowed for
new entrants and incumbents would definitely differ.
COMMISSIONER GALVIN said yes, but one has to remember that
progressivity is going to be based on the taxpayer's blended
margin, so it would not necessarily be what the progressivity
would calculate for this project. Each taxpayer and each
incumbent will have a different progressivity number.
1:34:55 PM
REPRESENTATIVE SEATON asked if, for instance, the progressivity
in either ACES or PPT was calculated on net and amounted to 10
percent, the incumbent would be able to subtract another 10
percent while the new entrant would not be affected because that
entrant would be in the net operating loss category.
COMMISSIONER GALVIN said that is correct.
1:35:33 PM
COMMISSIONER GALVIN continued with his presentation, as follows:
And then the last slide I wanted to go over [Slide 5]
because it is very confusing, is the exploration
incentive credits program. I focused here on the
credit for exploration wells. Just as a side note,
the credits that are allowed under the EIC program are
in exchange for the 20 percent credit that they would
normally get under the ACES or PPT. So, when we talk
about 30 percent or 40 percent credit under the EIC,
it's substituting for the 20 percent credit that you
get otherwise under ACES or PPT.
1:36:43 PM
So in this particular instance, we've got an
exploration well program that costs $100 million. And
there's two tests that are going to decide how much of
a credit they are going to get. The first one, under
A, is if they are three miles from an existing well. I
have existing well in quotation marks because it's
important that there's a change in the definition of
existing well between PPT and ACES that says an
existing well is one that has been drilled within the
last 25 years but does not include a well that's been
drilled within the last year and a half. And so what
that allows is for companies to come in with a
drilling program under ACES and drill a series of
wells in one area and get full credit for all of the
wells of that program. Under PPT, they are only
allowed the wells they drill in a single year. After
that, those wells are considered existing wells when
they come back the following year and so they don't
get any credit for that delineation well and the rest
of the wells they need in order to establish whether
or not to pursue the project.
So within these two tests, you look at the well and
the first question is: Does it meet the first test,
three miles from an existing well? The answer is yes
and they qualify for at least the first part of the
credit. Under PPT that credit is 20 percent, which is
the same amount that they would get if they weren't
applying the EIC program, just under the existing tax
law. And so there is no reason to believe or to
expect they are going to avail themselves of this
program when they already have the underlying program
that gives them the exact same value. And so, the
recommendation under ACES is to move that percent up
to 30 percent to provide some attractive value to it.
The folks from DNR explained the value to the state of
having them use the EIC program because it makes
information that is generated by that program
available to the state and ultimately to the public
that otherwise wouldn't be and that there's a value
there and that's why we're providing the increase in
value of the credit if they decide to use that program
- it's an exchange. We're buying the information
exchange for a higher credit.
1:39:24 PM
If they meet both tests, three miles from a well and
25 miles from a unit, then they are going to qualify
for a 40 percent credit - so again, 40 percent in
exchange for the 20 percent that they otherwise would
get under the tax code.
1:39:43 PM
REPRESENTATIVE ROSES asked if the commissioner is saying that
information is so valuable we are willing to spend $10 million
of every $100 million to get it.
COMMISSIONER GALVIN said DNR is saying yes, that is the value
they place on getting that information.
1:40:05 PM
REPRESENTATIVE SEATON asked if there is also a difference in the
value of credits taken under EIC as opposed to PPT. His
understanding is the PPT credits cover more costs and are
broader so that a company would receive less value under the EIC
for the three mile distance because of the base.
COMMISSIONER GALVIN said that is correct. He explained the
definition of what is an allowable or qualified expense under
the EIC program is more narrowly drawn toward the well or the
seismic program. The tax provision has a broader definition of
capital expenditure.
1:41:09 PM
REPRESENTATIVE SEATON questioned whether that narrower
definition reduces the value of the credit, whether that has
particular value to the state and whether there is any reason to
retain that distinction in the base amount against which a
credit is applied.
COMMISSIONER GALVIN said he believes the distinction should be
retained because of the value exchange that has been identified.
That will give 30 percent of the costs of a particular type that
go directly toward the acquisition of that information. Also,
that will establish what DNR is willing to pay in order to get
that information. He continued:
When we talk about the 20 percent rate they would fall
back to otherwise, we take a broader view of basically
any capital expenditure they make in association with
production or exploration. Since we are not tying it
to the acquisition of the information, the actual
either drilling or seismic project, we can have a
broader view and a lower rate. I think if you end up
taking the - what is referred to as the 023 definition
of what qualifies for your credit - and just
referenced that and used that as your 025 amount, we'd
end up paying a lot more because we'd have a broader
pool of costs that now we're paying at the 30 or 40
percent rate. That's not the exchange that we had
originally set up. I think the distinction still
makes sense.
1:43:26 PM
REPRESENTATIVE SEATON asked that DNR staff attend tomorrow's
meeting to help determine whether that percentage has been
adjusted. He noted that keeping dual sets of books, one on EIC
and one on PPT, becomes problematic for everyone. He is
wondering if a trade-off could be made so that the program is
more efficient.
1:44:10 PM
REPRESENTATIVE ROSES asked Commissioner Galvin:
A few moments ago I asked you the question was it
worth $10 million out of every 100 for you to get the
information and the answer was yes. Now I'm going to
ask the question the other way. If there was a choice
between the EIC and the other credits, you said the
reason we bumped it up to 30 was to make this an
enticement so we could get the information. Is the
exclusion of those additional deductions going to be
worth the $10 million that you are putting up to the
oil companies or are they going to want to try to
stick to the original, given an option?
COMMISSIONER GALVIN said that is not an evaluation that can be
made in the abstract right now. Different companies will be in
different situations, particularly with an incumbent. An
incumbent may be looking for a potentially qualifying drilling
program. They may have other values for drilling infrastructure
in the area as a starting point for another project down the
road. Their capital expenditures associated with that drilling
program may not be directly related to the information from that
location. The company may be looking into moving the
infrastructure out to that spot as an interest in something else
further down the road. Under the 023 program with 20 percent
across the board, those equivalents are made. Under the 025
credit program, the state wants to know the costs associated
with the acquisition of information that it will get. That will
limit it to the cost associated with that drilling program.
1:46:06 PM
COMMISSIONER GALVIN continued his presentation, as follows:
So the next area is a reflection of the previous
discussion, in terms of those net losses that under
the PPT, the incumbent is going to get the 2.5, the
new entrant will get 20 percent. Under ACES it makes
them the same. And so, at the very bottom you see the
difference in values between an incumbent and a new
entrant. Under PPT, the incumbent is getting more
value than the new entrant on either of the
categories. Under ACES it makes them equal and also
between PPT and ACES we're providing more value for
this whole exploration program across the board than
under PPT. So we're trying to get all the numbers in
one place to try to show where the move is going from
PPT to ACES.
1:47:14 PM
REPRESENTATIVE SEATON asked if the difference between PPT and
ACES is that deductible costs are allowed to be deducted at a
higher tax rate.
COMMISSIONER GALVIN specified that the primary difference
between the incumbents and the new entrants is the tax rate
issue.
CO-CHAIR GATTO asked if the state should raise the taxes higher
in order to give the new entrant an opportunity.
COMMISSIONER GALVIN replied, "If they're only worried about
credits, yes. But I think they're also worried about how much
they are going to pay us on the backside."
1:48:13 PM
COMMISSIONER GALVIN referred to the topics page and told members
he wanted to walk through the [provisions] in CSHB 2001(O&G)
that DOR would like changed. He told members he would reference
sections from the original ACES bill, HB 2001, and compare that
to CSHB 2001(O&G) when discussing sections he would like to see
reinstated.
1:48:51 PM
COMMISSIONER GALVIN explained:
The first one goes to Section 1 of the original bill
and that's a section that deals with legislative
intent language. This legislative intent language is
intended to reference that the legislature intends the
change in the statute of limitations language to
incorporate the regulatory interpretation of a
particular potential event. That potential event is
where a taxpayer files a tax return and somewhere down
the road there is a decision by some sort of a
regulatory body that affects the credits or the
valuation that they put into that tax return and
retroactively brings it back and says it is different
for the tax year that you had filed at some previous
point.
1:50:18 PM
Under the existing regulations they are required to
then alert the department and file an amended tax
return to say hey, our rates changed, our valuation
changed by this ruling. The statute of limitations on
that amended tax return starts then because they've
just filed a new tax return. This legislative intent
is merely to say when we change the statute of
limitations from three to six years, it also captures
that instance where they have filed an amended return
due to a regulatory decision. That's the
interpretation that exists within our regulations and
it's just merely to capture that when you change the
statute of limitations, you're incorporating basically
that interpretation.
1:51:07 PM
CO-CHAIR GATTO asked if, when an amended return is filed, the
six-year clock is zeroed out for the entire return or the
amended portion only.
COMMISSIONER GALVIN replied only for the amended return.
1:51:31 PM
CO-CHAIR GATTO said that might be the right approach but he
wanted to clarify that the zeroing out of the six-year clock
would apply to those amended portions only.
COMMISSIONER GALVIN said he would have someone check on that.
1:51:54 PM
CO-CHAIR GATTO asked if, under IRS rules, when a company files a
1040X, an amended return, the statute of limitations also zeroes
out for the amended part.
COMMISSIONER GALVIN said that is correct otherwise everyone
would wait to file until the statute of limitations was about to
expire.
1:52:39 PM
CO-CHAIR GATTO said he understood the section that required the
change but wanted to make sure the filers were not being
penalized.
COMMISSIONER GALVIN told members that section was removed in
response to a concern raised by AOGA as it read this provision
as encapsulating an interpretation of how interest would be
calculated retroactively but was referencing the wrong
regulation. When PPT regulations were adopted several months
ago, an existing regulation that dealt with this aspect was
repealed and replaced with new PPT related language. The AOGA
position was based on the previous regulation.
1:53:30 PM
CO-CHAIR GATTO asked if this section was in the ACES bill but
deleted in CSHB 2001(O&G).
COMMISSIONER GALVIN replied affirmatively.
1:53:34 PM
CO-CHAIR GATTO inquired as to where that section is located in
CSHB 2001(O&G).
COMMISSIONER GALVIN said the original bill had this legislative
intent in Section 1, but Section 1 was not included in the
committee substitute so it disappeared. He expressed the need
for that intent to be put back in the bill.
1:54:11 PM
REPRESENTATIVE ROSES referred to responses to committee members'
questions in a letter from DOR dated 10/30/07. An answer to a
question he asked is on page 2, which was about extending the
statute of limitations to six years and about frequency. He
noted the response says desk audits are done for the four to
five small taxpayers so they are not affected. However, for the
six or seven taxpayers that undergo full blown audits,
extensions occurred about 85 percent of the time. He asked
Commissioner Gavin,
...Out of the 85 percent of the times that you've done
it, has it taken it out to the full six years or does
an extension mean one day, five days, a week, a month?
I guess the question that I'm asking is you're asking
for six years but is four enough, is five enough? The
point is, we want to give you what you need but you
also do not want to create a situation by where if you
got the time they might take it. We want efficiency
as much as we can get it.
COMMISSIONER GALVIN clarified that it is the administration's
intent, and remains a big part of what it is requesting in terms
of audits, et cetera, to complete the audits as expeditiously as
possible.
1:56:21 PM
REPRESENTATIVE FAIRCLOUGH asked how the history was compiled to
come up with 85 percent. She noted that, so far, DOR has only
been able to audit ELF on a gross tax basis and questioned how
DOR determined six years for a net tax.
COMMISSIONER GALVIN admitted DOR does not have experience with a
net tax so it is extrapolating from its experience with the
current tax system. Under that system, audits are conducted for
transportation costs and other aspects of the tax calculation.
From the experience of the group and the audit supervisors, they
recommended an increase from three to six years to avoid having
an extension be the normal course of business. In terms of
whether empirical evidence was used to make that determination,
DOR has not had enough experience to collect empirical evidence.
1:57:57 PM
REPRESENTATIVE FAIRCLOUGH asked:
... In the experience that we have - that is having
the department estimate a need for an additional three
years, is there any way you could articulate for us
what the specific triggers were that caused the
extension because three years on a gross - I mean do
you not have the appropriate personnel? I guess
that's what comes to mind first because I did hear
from the other side of the coin, per say, that feel
like a liability hanging out there for an additional
three years is not advantageous to good business
practices. They have to carry larger liabilities on
their books for potential loss of revenue in future
years. So I'm trying to balance your request - and
understanding [that] bureaucracy and government don't
move as fast as the private sector in some instances.
COMMISSIONER GALVIN asked a staff member to join him to provide
a more detailed description of discussions with the auditors and
their experience and, particularly, whether the extension was
requested because of "bureaucratic crawl" or because companies
need more time.
1:59:58 PM
JONATHON IVERSEN, Director, Anchorage Office, Tax Division,
Department of Revenue, introduced himself.
REPRESENTATIVE FAIRCLOUGH asked whether the answer is "yes" or
"no."
MR. IVERSON said it is yes.
2:00:21 PM
CO-CHAIR GATTO said it seems to have taken a fairly long time to
reach the end of the auditing cycle under the gross tax
situation. That would mean that under a net tax situation, [the
process] will be stretched out beyond the statute of
limitations. He asked Representative Fairclough to rephrase her
question.
2:00:51 PM
REPRESENTATIVE FAIRCLOUGH noted DOR has recommended an increase
in the statute of limitations on the auditing function from
three to six years. She recalled that Representative Roses
asked how often the problem was a matter of fact. To which the
response was there has been an 85 percent history showing non-
compliance and having to extend past the three-year deadline.
She clarified that her question is if DOR only has experience
under ELF, and extensions were required 85 percent of the time,
what is causing the delay in completing the audits, and how did
DOR ascertain that three years would help when, with a gross tax
system, the three-year limit needs to be extended.
MR. IVERSON referred to DOR's 10/30/07 letter and read, "For the
largest taxpayers, where we conduct full audits, we need
extensions for 85 percent of those taxpayers." He explained in
general, 15 to 20 taxpayers pay oil and gas production taxes
annually. The state has a handful of large taxpayers. Of those
taxpayers, 85 percent extend past the three year deadline,
therefore 3 or 4 taxpayers need waivers. Those waivers would be
for six months to one year.
2:03:06 PM
MR. IVERSEN continued:
... The first question, if I'm interpreting it right,
is what is driving the need for an extra three years;
a couple of things. The first is that we are going to
be relying on, to the extent that it's going to be
helpful - and we plan on using these in audits - joint
interest billings and joint interest audits as an
input into our audit function. These would be the
audits that are conducted by working interest owners
in a unit on the operator - in other words, to
determine if they've been billed appropriately under
the operating agreement. Those audits take time in
the first instance anywhere from a year to a few years
- two or three years ostensibly. From there there's
going to be issues that are exceptions that are going
to have to be worked out between the parties. What we
would like to do in order to benefit from those is
have that time on the front end to be able to actually
use those joint interest audits and joint interest
billings and be able to see how those are resolved as
a means to feed into our audit process. If a joint
interest audit is completed after two years, and then
there's exceptions still lingering, we would only have
the benefit of that joint interest audit on the very
tail end of our audit cycle if we're on a three-year
statute of limitations, which puts us in a very
compressed timeline.
In addition, we are dealing with, as Chairman Gatto
pointed out, we are dealing with a net tax world now
so we are looking at an increased bucket of costs. So
that additionally adds into why we need the additional
time.
2:04:42 PM
REPRESENTATIVE FAIRCLOUGH asked if DOR looked at joint interest
agreements under the audits it did under ELF and whether that
entailed auditing four or five companies and required, on
average, a six-month extension.
MR. IVERSEN said the primary driver for the extensions under the
ELF audits is the fact that several exchanges of requests are
necessary to get the information to do the audit. Sometimes it
is in the taxpayer's interest to make sure it gets the
information to DOR to substantiate its tax return so that DOR
does not have to estimate the amounts.
2:06:27 PM
REPRESENTATIVE FAIRCLOUGH referred to a response in DOR's
10/30/07 letter that says one corporation refuses to comply with
the extensions based on its corporate philosophy. She noted:
What I want to make sure of is that's not how we're
reacting to the six years to penalize all producers or
all people filing tax returns because one individual
taxpayer is refusing to extend like you would like.
MR. IVERSEN said that is certainly not the case. The DOR is not
basing its request on the acts of a single taxpayer. The
purpose of DOR's request is to get the information it needs out
of the joint interest audits and have adequate time to address
the upstream costs that are not addressed in the ELF audits.
2:07:22 PM
CO-CHAIR GATTO stated a properly filed tax return has no need
for an extension. He said he doubts whether the legislature
could pass any legislation to address the timeline for the one
entity that is causing so much grief. He added a six-year
timeline would not be a penalty for those taxpayers who have
properly filed their returns.
MR. IVERSEN nodded affirmatively.
2:08:24 PM
REPRESENTATIVE WILSON admitted that she is amazed that a company
can get away with [non-compliance] by saying it has a different
corporate policy.
COMMISSIONER GALVIN clarified the issue is that when a company
says that, the state is put in the position of facing the
statute of limitations so it has to file a claim against that
company based on the information it has at that time. That
creates a less than optimal situation for either party because
the claim is based on a worst case assumption.
2:09:21 PM
REPRESENTATIVE WILSON surmised then that a lawsuit occurs.
COMMISSIONER GAVIN said the audit supervisor first works with
the company. If the point comes when the state has to make a
claim, the next step is the administrative appeal process. If
no resolution occurs, the next step would be to take the case to
court.
REPRESENTATIVE WILSON asked if that happens in every case.
COMMISSIONER GALVIN said it happens every time a company refuses
to give an extension.
REPRESENTATIVE WILSON asked if it is always the same company
that refuses to give an extension.
COMMISSIONER GALVIN replied:
Only when that company - when their tax return isn't
completed by the time you get to the statute of
limitations. So it's not every time that they file a
return that we end up backed up to the statute of
limitations, but every time that we do get backed up
to the statute of limitations, we have this
experience.
2:10:43 PM
REPRESENTATIVE WILSON said she is appalled by that situation.
She then said DOR has asked for more auditors, not because it
would help get the audits done sooner, but because it doesn't
have the information.
COMMISSIONER GALVIN said an extension might be requested for a
variety or reasons. It could be that DOR has a difference in
opinion about whether a particular cost should be credited. That
dispute would require additional discussion to resolve the
dispute, the deadline kicks in and the case moves into the
formal appeal process. It's not necessarily that DOR doesn't
have the information, sometimes more time is needed for
negotiation and agreement.
2:12:06 PM
REPRESENTATIVE SEATON related his understanding that
Commissioner Gavin is saying the net tax will have more costs to
review. However, if the audits required of the partners in
joint interest agreements become the starting point for the
state audits, the joint interest agreements must first be
completed, which could take two years. In addition, the filing
date for federal purposes is in October, almost a year later.
COMMISSIONER GALVIN said that is correct.
2:13:11 PM
REPRESENTATIVE FAIRCLOUGH asked:
... If the taxpayer who refuses to file the extension
has submitted at the same time that the one - that
another large taxpayer submits to say yes, it's all
right for the extension, whose tax return gets
finished first?
COMMISSIONER GALVIN said at the risk of generalizing too much,
it is more likely the taxpayer who offers the extension will
finish first because the process will continue in an informal
way. The one who doesn't grant the extension ends up in a more
formal process with additional procedural requirements. That
creates barriers to resolving the issue.
2:15:00 PM
REPRESENTATIVE FAIRCLOUGH commented that if big business is
choosing to be confrontational, a time or money advantage must
be involved or it would change its business practice.
COMMISSIONER GALVIN replied:
... You asked me whether they are resolved in a more
timely manner. ... I don't know whether they would
end up calculating that they ended up with a better
outcome by going through the formal process. It may
have taken longer but they may feel like they got a
better outcome because they formalized it and didn't
compromise in an informal way.
2:16:00 PM
REPRESENTATIVE WILSON noted it costs the state more to go
through the extra steps and asked if anything can be changed to
prevent that scenario from occurring.
COMMISSIONER GALVIN said either you have a deadline or you
don't; when you have a deadline both parties are forced to deal
with that deadline. It would be a mischaracterization to say
they are in the wrong when they refuse to give an extension.
Any company has the right to force the process to the next step.
He expressed concern that unintended consequences would result
if this issue was addressed as if a company that refuses to
grant an extension is always in the wrong.
2:17:47 PM
REPRESENTATIVE WILSON asked if the time period is extended from
3 years to 6 years, a company's approval of an extension will be
unnecessary.
COMMISSIONER GAVIN said the state will not be faced with the
need to get an extension at the third year.
REPRESENTATIVE WILSON asked if the state will face the same
problem later down the line.
COMMISSIONER GALVIN said he didn't know, but added that DOR
expects to have its audits done within that timeframe.
2:18:41 PM
CO-CHAIR GATTO asked if a national association of auditors sets
standards that might apply to this type of situation or provide
parameters from which to work. He said he thought those
standards might include a standard fine when the deadlines are
exceeded.
MR. IVERSEN informed members that standards that govern both
accounting principles and petroleum accounting do exist. He
related that to his knowledge, those standards do not include a
specific timeframe. Regarding penalties, DOR can only authorize
them by Alaska statute.
2:20:28 PM
REPRESENTATIVE ROSES noted the committee has a deadline for
submitting amendments and his are based on CSHB 2001(O&G). He
told members the legal drafters believe the amendments should
apply to the original ACES bill. He asked which bill the
committee will be working from.
2:21:00 PM
CO-CHAIR GATTO said he will address that question as soon as the
meeting is over.
REPRESENTATIVE GUTTENBERG said he asked Co-Chair Gatto the same
question during the break and was told the amendments should be
drafted to the CSHB 2001(O&G) version. He opined that the
drafters should be informed of which version.
The committee took an at-ease from 2:21 p.m. to 2:41 p.m.
2:41:22 PM
CO-CHAIR GATTO reconvened the meeting and told members the
committee will be working from the CSHB 2001(O&G) version.
2:41:58 PM
COMMISSIONER GALVIN continued with his presentation, as follows:
So turning to the economic terms, the base rate within
the CS is 22.5. The administration feels strongly
that it should be 25 percent as a base rate. On a tax
floor, the original bill included a 10 percent tax on
the gross for the Legacy fields. We still believe it
is the state's interest to have that protection on the
downside when you have low prices. We recognize that
if the legislature chooses not to have that floor in
exchange for higher progressivity, that's a choice of
the legislature but, if so, it should be traded out
for that upside and it should be greater than what is
proposed in the original bill.
2:42:56 PM
CO-CHAIR GATTO noted the two sections are not married so each
would have to be dealt with separately.
COMMISSIONER GALVIN responded:
Right, but we recognize that it is a bit of a choice
in terms of if you protect yourself from the risk
associated with low prices, to a certain extent, you
can be expected to ask less on the upside. But if
you're dropping that risk, you're going to accept the
risk of the low prices and take that on, then you're
trading that off for more on the high side and we
would also expect that it would be the intent to save
that money to cover those times when we might have
lower prices.
2:43:48 PM
CO-CHAIR JOHNSON asked if the state gets more revenue at the
high end through progressivity under CSHB 2001(O&G) using the
current system.
COMMISSIONER GALVIN said all the consultants agreed that CSHB
2001(O&G) brings in less than ACES will until 2012. At an $80
price, the CS would exceed ACES after 2012 based on the
combination of the whole package included in the CS, including
progressivity and the credits.
2:44:59 PM
CO-CHAIR JOHNSON asked if Commissioner Galvin had information
about the difference between the progressivity on the gross and
the net.
COMMISSIONER GALVIN said from the administration's perspective,
when looking at the impact of progressivity on the variety of
fields and the variety of players, it recognizes the value of
having the progressivity triggered off of the margin. Gaffney
Kline made an extremely compelling argument about the value of
achieving two primary objectives: to bring in revenue and to
positively impact the investment drive to attract the more
challenged fields. That is done by having it set on the margin.
The rate is a balance between the low and high end. The CS is
fairly close to the original ACES with just a little bit more on
the upper reaches. If the committee is going to be looking at a
proposal where the administration's proposal is rejected to
protect the state on the floor side, it would highly recommend
taking more on the upper end. If the committee presents a
proposal where it rejects the administration's proposal to
protect the state on the floor side, it recommends the CS take
more on the upper end.
2:46:39 PM
CO-CHAIR JOHNSON asked if the same would apply to the 22.5
versus the 25, so that recouping it on the progressivity side
would accomplish the same goal.
COMMISSIONER GALVIN related that the administration's belief is
when the price comes down to a level where progressivity is not
kicking in, the rate should be 25. That's the appropriate rate
given the investment opportunities according to the models.
2:47:16 PM
REPRESENTATIVE ROSES asked if escalators were built into
marginal rates, the administration would retain that view. He
said progressivity is now fixed at one rate based on the margin.
He questioned whether the administration would feel the same way
about 25 if the margin was a certain amount at $30 or $40 or
$80.
COMMISSIONER GALVIN said it would because that is the
appropriate place for the system to land when it gets down to
where new projects start when they are dealing with smaller
margins without progressivity yet.
2:48:17 PM
REPRESENTATIVE ROSES recalled that three of the four experts the
committee has heard from about that issue and one of the reasons
the House Special Committee on Oil and Gas did what it did was:
The philosophy was if you're working off of the net or
working off of a margin, you get to share a greater
amount of the profits on the higher end and you take
less of the profits on the lower end and you're
willing to take a little bit more risk when you're
taking risk.
Representative Roses expressed concern that if it gets down to
that lower end, the legislature will be back for more
discussions anyway.
COMMISSIONER GALVIN said the principle is one that is commonly
accepted. When talking about what the rate should be, Pedro Van
Meurs said 25 percent is the right number. The administration's
consultants said 25 percent is the right number. The previous
administration said 25 percent was the number. The
administration, he related, believes the collective analysis
proves 25 percent is the number. He questioned:
Again, is that the steady state where projects are
burgeoning until they get to where their profit margin
reaches a point where they should be paying more? We
feel strongly that 25 percent is the right number to
start with.
2:50:09 PM
REPRESENTATIVE GUTTENBERG said legislators are dealing with a
world with many corporate models for structure. It looks to him
like the different versions being presented use a "one size fits
all" concept with differences in how the credits would apply.
He asked if it would be simpler to draw a line to separate the
Legacy fields from the new fields that are farther away because
even though the operating expenses might be higher on the legacy
fields, their volumes are exponentially higher.
COMMISSIONER GALVIN specified that the starting point would be
that distinction. He explained that a variety of new fields and
some of the long-term existing fields outside of the legacy
fields and they have economic structures and challenges that are
more diverse than the legacy fields. He said:
However, as we move forward in time and we look at the
evolution of those legacy fields, what we see is the
legacy fields themselves become a microcosm of the
rest of the North Slope in that they are going to be
moving into smaller fields...decisions on smaller
developments that have those same challenges that we
see outside of the Legacy fields.
And so when you end up taking the analysis to that
level and you say okay, let's just isolate the Legacy
fields and say what system should we have just within
these, you end up making a similar line and - call it
a line in the sand ... and you say okay, well,
geographically we can describe the Legacy fields.
But when you get inside those fields and you're trying
to distinguish those new developments that you're
trying to encourage and help along with a tax system
that doesn't overly burden them while still hitting
the fields at the rate that we want to hit the
existing production, then you no longer have the ease
of just drawing a line on a map and saying this unit
is going to be under one and this is going to be under
a different one because those fields now are
distinguished no longer by ... horizontal separation.
Now you've got vertical and you've got just the
essence of the product, of the resource. When we
looked at ways of distinguishing that in-field
development, what we found was there were just
physical limitations of being able to distinguish one
type of development from the existing production and
treat one differently than the other and we just hit a
wall there in terms of what we -
So, just backing up, we could come up with one system
for the Legacy fields and a separate one for
everything else that may be more dynamic and this one
is more static. But in doing so, you're back to the
same choice. Are we going to sacrifice, in some
sense, the flexibility of the system within that and
potentially jeopardize that new investment? It's a
choice that's a very difficult one to make when you
actually see the economic results resulting in a lack
of investment.
2:54:39 PM
REPRESENTATIVE GUTTENBERG said credits are already delineated by
mileage from an existing well. He pointed out:
There is a phenomenal economic advantage to be in-
field drilling between directional drilling and ...
multiple holes in the same place - multilateral - and
then laterals off the laterals and laterals off those
that you could still use the same model, whether the
pads are there and the few places where there's more
than 3 miles, 6 miles between - because that's what
you're talking about. If you're more than 6 miles
between drill pads, there might be that little gap
between the two of them - it's 3 miles. It just seems
like the infrastructure is there in place, the
knowledge is there in place in some ways now that they
are now drilling on the same pad and they have been
able to get to different structures down below.
COMMISSIONER GALVIN said that is exactly right. Companies are
drilling off of the same pads to access different resources, so
distinguishing characteristics, like distance from
infrastructure, cannot be used. Once the resource comes into
the system, it integrates with the existing production.
REPRESENTATIVE GUTTENBERG said that was his point also.
COMMISSIONER GALVIN said the bottom line is that the companies
that are exploring and developing within the existing field have
an economic advantage because they have the infrastructure
there. The question is how to recognize that in the tax system,
which is to do it off the margin and recognize that it will be
more profitable for them rather than for a company that needs to
put infrastructure in place.
2:57:22 PM
COMMISSIONER GALVIN returned to his presentation, as follows:
Now turning on the economic side to something that was
added - this is a new area that was not part of the
original bill that was a desire to provide a tax
treatment for gas that's produced in a part of the
state outside of Cook Inlet that's going to be used
within the state and to ensure that they get the same
type of a tax treatment that is available for gas
produced within Cook Inlet. In the [House] Oil and
Gas version, and it was particularly focused on - I
think Nenana was the primary - there's the Nenana
Basin - we've got an exploration license in that area,
that that was the target and the language was used by
expanding what is, within the Department, referred to
as "Middle Earth," the part between Cook Inlet and ...
you've got the North Slope, you've got Cook Inlet, and
you've got Middle Earth - that's everything else. ...
And what we recognize is that this isn't complete and
it's not complete for a variety of reasons. We've got
a project that's being proposed and I know that people
are talking to a number of you where they are looking
at taking gas from the North Slope and liquefying it
and trucking it down to Fairbanks to deal with the
market there. That gas is being produced on the North
Slope and so it doesn't qualify for this. Similarly,
if Cominco wanted to pursue - they have gas
possibilities at the Red Dog Mine, and they wanted to
produce that gas and use it for their purposes at the
mine site, they're above the cut-off line currently
for the North Slope and so they would face the higher
rates.
2:59:29 PM
CO-CHAIR GATTO asked if any distinction is made between shallow
gas versus conventional gas.
COMMISSIONER GALVIN said that trying to make a distinction by
depth becomes problematic because, for example, in Cook Inlet
the gas is both fairly shallow and fairly deep. On the North
Slope the gas is probably deep in one situation and shallow in
another. That distinction would not help in this regard. Many
legislators are concerned about addressing disparate treatment
for Cook Inlet versus other places. He related that DOR
believes the way to address that is to say if gas is produced
for in-state use, it gets the Cook Inlet tax treatment. That
would apply statewide, he noted.
3:01:19 PM
CO-CHAIR JOHNSON noted that staff has compiled a list of all of
the questions that have been asked in Legislative Budget and
Audit Committee, the House Special Committee on Oil and Gas and
the House Resources Standing Committee. He said he would like
to verify which ones have been answered to date. He then said
he has some questions about the broad definition of "gas
produced for in-state use" and that he would like DNR to come up
with a definition of "below 64" that would not include the North
Slope.
3:02:35 PM
REPRESENTATIVE FAIRCLOUGH asked if the administration has
prepared an amendment to address the in-state use issue.
COMMISSIONER GALVIN said he will provide that shortly for
members' consideration.
3:03:18 PM
REPRESENTATIVE SEATON said he would like to know whether the
administration has worked on distinguishing between commercial
and residential use versus industrial use.
3:03:34 PM
CO-CHAIR GATTO announced that the committee would recess until
5:05 p.m.
CO-CHAIR GATTO reconvened the meeting at 5:25 p.m.
5:25:02 PM
MARCIA DAVIS, Deputy Commissioner, Department of Revenue, told
members she was filling in for Commissioner Galvin because he is
attending another committee meeting. She told members:
As I understand it, we're in the process of describing
what is bullet point number 2, which are the
adjustments from the administration's view we would
like to see addressed in a CS that would come from
this body. We are down to - I think you had closed out
what I'll call the economic terms and I'd like to
raise as the next point of concern of the
administration the carry-forward loss rate. I believe
that was discussed briefly in the House Oil and Gas
[Committee] and Representative Samuels made a closing
note that they had intended to capture this and had
run out of time.
And so, what we would counsel this body to do is,
regardless of the base tax rate you arrive at, whether
it remains at 22.5 or is our recommended 25 percent,
we'll make sure that it matches in the carry-forward
loss rate.
The other issue regards the DOR procedures for issuing
credit certificates and, again, because we've switched
out of doing it over two years, we don't need the
provisions that talk about splitting certificates into
two certificates. But there is a piece in the section
in the Governor's bill that we want to not lose and
that is the extension of time for the administration
to issue certificates. Right now it's at 60 days
instead of - we've asked for 120 days and the reason
we have is because we are getting those submissions
and they have a lot of information. We need to make
some initial determinations and qualifications and we
are getting pressed because we don't really have any
[indisc.] to say gee, you got your information late to
us or whatever. There's no authority for us to go
beyond 60 days so our auditors and our administrative
staff would like 120 days to process those. And we'd
like that timeline to run from the date that that
taxpayer is in good standing. Again, because we're
requiring them to file annual reports, if for any
reason they had failed to file their annual reports or
resisted filing them, for the state to then issue tax
certificates at the same time while they're not
providing what they are supposed to provide for us.
We want those linked.
5:27:21 PM
CO-CHAIR JOHNSON asked Ms. Davis if the administration's
adjustments will be presented to the committee in the form of
amendments.
MS. DAVIS said they will.
5:27:39 PM
MS. DAVIS continued discussing the administration's desired
changes, as follows:
The next item is the administration does believe that
an oil and gas tax credit fund would be an
administratively better way to approach providing the
funds necessary to provide refunds of the exploration
credits and the capital credits. While currently we
are having to submit to the appropriations and keep
coming back and trying to, it's a very disruptive
process for the legislature and also for the
individuals we are trying to provide an incentive to,
which is to assure them that when we hit our deadline
and we give them their certificate and it's
appropriate for them to get that cash refund, that we
don't say sorry, no can do, we're still in an
appropriations cycle and there's no funds.
5:28:26 PM
REPRESENTATIVE GUTTENBERG asked, recognizing that the
administration does not want to wait for a legislative
appropriation, whether there would be reporting requirements to
keep the legislature informed of what happened.
MS. DAVIS said it is her understanding that DOR has to report
and account for the flow. The funds are not dedicated so DOR
needs to keep the legislature informed of the inflow and
outflow.
5:29:00 PM
CO-CHAIR GATTO asked if the administration is seeking a separate
account with a name on it.
MS. DAVIS deferred to a staff member to answer that question.
5:29:17 PM
JERRY BURNETT, Director, Administrative Services Division,
Department of Revenue, said the answer is yes, it would be a
separate-named fund. In the original bill, an annual
appropriation would be made to the fund as a percentage of
production tax revenues. Payments would be made directly from
the fund.
5:30:02 PM
MS. DAVIS continued:
The next item is TIE credits and the administration is
concerned about the TIE credit language that is in the
current House bill committee substitute from Oil and
Gas. We also don't necessarily like what we did in
ACES, which was to completely eliminate them. As
we've been learning and seeing what the legislative
body has been discussing, we actually like the change
that the Senate had in their version. The reason is,
we heard from the small producers since we drafted
ACES, and their concern about being cut off from the
ability to use TIE credits for their '06 and '07
expenditures that puts them on an even footing with
the incumbents that had production and could use them
in those years. So we like the revised language that
the Senate has on that that changes ACES so we would
be proposing to put that language in place of what's
there now in the House committee substitute.
5:30:59 PM
MS. DAVIS explained that exploration incentive credits (EIC)
existed prior to PPT so they were not changed when PPT was
enacted. The administration has proposed some enhancements to
the EIC program. She deferred to Ms. Thompson to describe the
key enhancements.
5:31:41 PM
NANETTE THOMPSON, Unit/Tech Support, Division of Oil & Gas,
Department of Natural Resources, told members the bill as
originally proposed would expand the program and make it
available to more wells. Also, the enhancements were designed
to better define the data that the state would receive and to
make sure it is received.
MS. DAVIS said one other key change the administration wants is
to increase the base credit from 20 to 30 percent and that is
better than what is available under the capital credit program.
5:32:32 PM
CO-CHAIR GATTO asked if the changes were "costed" out.
MS. DAVIS said they were by determining the incremental
difference in costs if the change had been in place last year.
5:32:56 PM
CO-CHAIR GATTO asked if DOR could make that determination in the
Gaffney Kline model.
MS. DAVIS said she did not know whether the exploration credit
was broken out in detail, but she said the staff that worked on
that will arrive shortly and be able to answer that question.
5:33:13 PM
MS. THOMPSON said the other reason to increase the base credit
from 20 to 30 percent is that the administration realized there
might not be enough value because of the additional requirements
involved in applying for an EIC.
MS. DAVIS continued:
The next area is the penalties for failure to report.
The House picked up the reporting requirements and
left out the two penalty sections and we would like to
see those restored so that there is some enforcement
on the reporting requirements.
5:34:01 PM
CO-CHAIR GATTO asked if the failure to report carries a penalty
with interest.
MS. DAVIS said it does.
REPRESENTATIVE FAIRCLOUGH said she believes an amendment is
being drafted to address that issue.
5:34:24 PM
MS. DAVIS continued:
Another key area of difference between the House
committee substitute and the original ACES structure
was lease expenditures are described and what our
language sought to accomplish was have regulations
define what ... allowable lease expenditures [are] as
opposed to leaving the burden upon the agency to start
to look at the universe of costs that are being
claimed and start to pick out the ones that they are
disallowing because before it was self-implementing.
What the House bill has is currently that same
language, which says lease expenditures are anything
that are reasonable, direct - you know, et cetera that
meet these broad adjectives and then it comes in and
it's up to us to then pick them back out through
regulation. What we're suggesting be done and what
was in ACES is essentially say they need to be
reasonable, direct, et cetera, and be embodied in the
department's regulations. That certainly places the
monkey on our back to get the regulations out by the
first of the year and provide the guidance to industry
as to what those lease expenditures are going to be.
5:35:33 PM
CO-CHAIR JOHNSON asked if committee members will have an
opportunity to get a list of the anticipated amendments to check
that there is no duplicity for the legal drafters.
MS. DAVIS said that effort will be made.
5:36:07 PM
MS. DAVIS continued:
One other aspect of the changes, the role of company
operating agreements - whereas the House CS did, in
fact, remove .165(c) and (d), which ... created this
whole collateral process for the department to have to
assess and decide whether they were going to accept
them - kind of rubber stamp them. In the ACES bill,
knowing that that was going away, we still wanted to
hardwire a mandatory review by the agency in
consideration of operating agreements, industry
practices so that language got left out. So we think
that might have been inadvertent on the [House] Oil
and Gas Committee substitute but we will be proposing
that that language come in to ensure that those items
are taken into consideration by the department.
Finally, in definitions, in the CS they dropped out
the definition of "unit" probably because the legacy
language went away but, in fact, if the EIC credit
language does come in we'll need a unit description
because DOR's view of units is statewide, whereas
DNR's definition would only pertain to state lands.
With respect to the final one, it's actually going to
get toward this transportation deduction issue and
again, I may resort to Nan Thompson on the phone for
the intricacies regarding the FERC language. But
what we're recommending is a change to Section 150.
This was not in our ACES bill and what we feel needs
to go into Section .150 (a) and (b) of DOR's net tax
structure. In order to derive a net tax value, you
need to deduct transportation costs and the way the
statute is currently written in .150, it reads more
like the royalty language in the sense that it hard
wires the tariff and it presumes the tariff is the
right charge to be deducted. The reason it was done
in royalty was through contract and settlement
agreements.
DOR is not similarly constrained. It is our job to
assess what is a reasonable cost for transportation
and, therefore, we're looking at .150 (a) and (b) to
restore that balance so that what we deduct from the
revenue to derive the taxing value is a reasonable
charge for transportation. So some change is going to
have to be made to the bill to get there.
5:38:38 PM
MS. DAVIS said those are the broad changes the administration
would like to see made. The bill would also need statutory
conforming language, depending on which language is included or
removed. She said the administration's goal is to present
appropriate amendments that will be grouped and that can be read
as a cohesive whole. She said she would contact DOR's
progressivity experts to come discuss that topic.
5:40:19 PM
REPRESENTATIVE SEATON asked if the amendment about assessing
transportation charges will look at the Regulatory Commission of
Alaska's (RCA's) settlement regarding reasonable fees.
MS. DAVIS said no. The administration is looking at the
existing statutory language in .150, which requires that a
finding of three criteria be met. Before the state can deviate
from a FERC established charge, it would have to prove that the
parties are affiliated, that the transport contract is not an
arm's length transaction or not representative of market value,
and that the transportation method is not reasonable in view of
alternative methods. She explained that elsewhere in DOR's tax
code, when it tries to establish the appropriate value of, for
example, diesel on the Slope, it looks at whether the
transaction is an arm's length transaction. If not, it reverts
to a different average price from the closest locale. That is
the only criteria so DOR is looking to reestablish its ability
to consider whether the charge is reasonable. Currently, the
statutory hurdle is very high because DOR has to meet all three
criteria.
5:42:21 PM
REPRESENTATIVE GUTTENBERG stated, in this instance, the state is
unable to change FERC's tariff rate to what RCA has determined
to be reasonable. He asked if the state could use a rate
established by a regulatory agency on the calculated
transportation costs.
MS. DAVIS said DOR could look at the regulatory agency's finding
as evidence of reasonableness.
REPRESENTATIVE GUTTENBERG noted the amendment has already been
written.
5:43:12 PM
CO-CHAIR GATTO asked, if the TAPS line has established a rate
that is well outside of what anyone expected, how that is paid.
He questioned whether it is paid first and then challenged.
MS. DAVIS explained that a shipper would be required to pay the
approved rate and then follow the procedures in place, in that
case FERC's procedures and for intrastate transport the RCA's
procedures. The rate payer would file an appeal and allege that
the rate was not authorized by statute. From the state's
perspective, when shipping royalty oil, it would be in the shoes
of a shipper. If the state is acting as the sovereign, it
incurs the tariff costs when deducted for tax purposes.
5:44:43 PM
REPRESENTATIVE SEATON asked what the administration is proposing
regarding TIE credits.
MS. DAVIS said the proposal is to include all five years of
prior investments from the '01 to '06 time period, so it is a
single number accumulated during that time period as any
particular producer's TIE credits.
5:45:28 PM
CO-CHAIR GATTO asked if that covers a six-year time span.
MS. DAVIS said it is considered to be five years. With that
bucket of credits, the producers will be allowed to look at
their expenditures in '06 and '07 and, to the extent they can
carry 20 percent of that bucket of five-year costs forward as a
TIE credit for each year, they can do so provided the 20 percent
number is not in excess of 10 percent of their total capital
credits. The incumbents can realize the benefit of that because
they had production in '06 and '07 and DOR will allow those
credits. A group of explorers that invested and spent money
during that five year time period have a bucket of [credits].
She furthered:
What we're proposing be done is that the amount that
they could have carried forward in '06 and '07, based
on how much money they've expended in those two years,
because they have to spend money to have some benefit
there, we're going to allow them to carry forward for
that time period that captures the value, and it's
benchmarked against how much they spent in '06 and
'07.
So that will be locked in time. It's as though that
ability to use TIE credits gets vested by virtue of
the investments they made in '06 and '07.
5:47:16 PM
MR. BURNETT noted in the PPT bill, companies were required to
spend twice the amount they could claim in credits. When these
companies spent in '06 and '07, they relied on being able to
take advantage of this provision. He said it's a fairness
issue since the companies with tax liabilities were able to take
those credits against their tax liabilities.
REPRESENTATIVE SEATON surmised that would mean the proposed
amendment still has a January 2008 "drop dead" date so that
those credits that couldn't be used in '06 or '07 fade away,
except for those companies that didn't have production to write
the credits off against.
5:48:25 PM
MS. DAVIS explained:
It fades away for everybody. After January of '08, except
for what got vested in either got used or didn't get used
because they couldn't. No one else can reach back into
that bucket and dig out 20 percent and carry it forward
into '08, '09, and '10, so no one will be carrying TIE
credits beyond '08.
5:48:50 PM
REPRESENTATIVE SEATON asked if TIE credits stop in '08, except
that those companies without production can carry them forward
for the investment equal to 10 percent in '06 and '07 and the
effect would be minimal.
MS. DAVIS replied yes. In order of magnitude, DOR's ability to
forecast the value of the TIE credits hinges in part on
producers voluntarily telling DOR about them before they file to
collect. Based on DOR's knowledge, the value of the credits
that could still be used in the future by non-producers is $60
million. Based on what DOR knows about the large producers,
another $700 million could be used in '08.
CO-CHAIR GATTO noted that is a substantial change.
5:50:26 PM
REPRESENTATIVE FAIRCLOUGH asked Co-Chair Gatto to take committee
members' amendments prior to [the administration's] amendments.
She opined that the administration should have found a sponsor
for its amendments.
5:51:11 PM
CO-CHAIR GATTO said he intends to group the amendments according
to subject.
5:51:28 PM
REPRESENTATIVE FAIRCLOUGH asked that each committee member be
given the opportunity to submit an amendment so that one member
does not use all of the allotted time.
5:51:53 PM
BOB GEORGE, Gaffney Kline and Associates, told members:
Much as we have warned against the issue of taking
snapshots on anything, I would just like to add before
we go on here is what we have is a work in progress
coming up. We've been looking beyond where we were
two or three days ago when we did a presentation on
the nature of the ACES' PPT structure and how
different alternatives, particularly on the
progressivity, impacted things.
We've taken that one step further and looked at one
additional idea that's come forward on the way the
progressivity may be handled. We are also in the
process of looking at further alternatives on that but
have not quite got there yet so I beg your indulgence
while we progress that at the moment. But, we'd like
to share with you at this point what we have got and
what things are looking like from there.
CO-CHAIR GATTO asked if they intend to produce more or whether
they are working against a deadline.
5:53:59 PM
MR. GEORGE said it was their intention to do their best to serve
everybody's needs in a rapidly changing landscape. He continued:
What I'd like to do is I'm going to [indisc.] three or
four slides from last time as a link on from where we
were and then I have just a couple more slides dealing
with this additional progressivity component and then
Rich has got some dealing with another issue in
relation to it.
The slides I put up last time looked at a portfolio of
investments and compared the outcomes on it under PPT
as it currently exists. The progressivity portion of
that on which I will focus in here increased the tax
rate on the profitability as expressed in net cash
flow per barrel by 1/4 of 1 percent for every dollar
that that net cash flow per barrel exceeds $40. I
have called it an amendment here - I guess the correct
term is the wording in the House Oil and Gas CS -
maintain the basic PPT rate of 22.5 percent based on
the net cash flow per barrel, but added an additional
tax of .225 for every dollar that the gross value at
the point of production exceeded $50. That rate was
applied to the gross value at the point of production.
5:55:59 PM
I again would just add in here what I have used as
some illustrative examples. They are not intended to
portray any forecast of revenues or the fact that the
DOR's strong recommendations for a 25 percent base
rate. I used 22.5 percent in mine, merely because
that was the existing PPT rate. I showed this slide
before, where under the existing PPT system, if we had
a portfolio of investments and each incremental
investment was economically a little more challenged
than the previous one, and my definition of
economically more challenged was that it had a smaller
margin than the previous one, the progressive nature
of PPT and under the net system meant the more
challenged investments actually got some assistance
from the PPT structure and therefore concluded that
within a single system, such as PPT, you could co-
exist opportunities of different profitability and the
system would accommodate and adjust to that.
I showed also this slide, where with the House Oil and
Gas CS progressivity proposal, that assistance given
to the lower margin properties was significantly taken
away. I have added one more slide that was in fact
shown in front of the Senate Judiciary the following
day but had not been prepared when we presented in
front of you, and also showed that if that margin -
and as you move from the existing reservoirs to
investments X, Y, and Z, if that margin was caused
entirely by an increase in the production costs at the
field, as opposed to some part of the margin being
caused by a squeeze in the price as well as increased
production, then you could actually get a regressive
structure getting out of it, such that the more
marginal fields were actually being taxed at a higher
rate ... than the more profitable fields. It's just
the mathematics of the way it works out. So the
conclusion there was there was a difficulty with the
structure that is a pure gross progressive margin on
top. That was the one additional slide looking at
that.
MR. GEORGE continued:
We've then gone on and looked at a further idea that has
been out there and what I have termed in here, the net
gross progressivity, whereby the rate of tax is calculated
on the net cash flow per barrel, but it is applied to the
gross value at the point of production. For the purposes
of this example, I maintained a progressivity slope that
produces about the same amount of petroleum tax revenue
after capital investment after the House Oil and Gas one.
So the net, again to be clear, the net gross progressivity
structure has a rate that is based on the net margin but is
applied to the gross and, in this case, I took away the net
in excess of the point at which the base rate kicks in in
order to maintain a reasonable slope in there. If you took
the whole of the net margin, you'd have to have a much
lower slope than is actually possible in there.
6:00:14 PM
So what I've put up here now is, again, that same base
slide that I've shown before based on PPT. And then
when you apply the sort of net gross progressivity, it
provides, in that snapshot, a very similar result in
there. Again, it maintains the progressive feature,
not quite as much as on a pure net system, but largely
the same based on the fact that the rate itself is
being set off profitability. Even though it's
actually been applied to a higher tax base, that is
the gross value at the point of production itself.
I looked at these as well in a couple of additional
ways here and I looked at the effective tax rate, and
by effective tax rate, I mean the additional
progressive tax being taken, divided by the
profitability and I've got three colored bars on there
that are variously annotated as NN, NG, and GG - NN
for a pure net system - a tax calculated on the net
margin applied to the net margin. The NG, which is
this new addition in there, is a rate calculated on
the net margin but applied to the gross value at the
point of production, and the GG, which is the pure
gross system we looked at previously. The effective
tax rate, particularly on the gross-gross one, can be
seen to raise much, much more quickly on there,
because everything has been applied off the gross.
I have isolated, in this particular example, just the
effect on the most marginally challenged field in
there so I sort of subtracted out that on the basis of
just looking, if I can go back up on here, on to field
Z on there, I just looked at the effect that was
taking place on field Z alone if you develop that
incrementally to everything else in there.
On the pure gross system, the rate rises much more
rapidly and challenges the properties, the more
marginal properties, much more rapidly than if you
base it on the net. Basically, these are two slides
with the same basic information but where, on the
gross system, some of the margin squeeze is caused by
lower value per barrel at the point of sale, so it
actually does lower the total gross value at the point
of production as well.
6:03:22 PM
The conclusions, such as we might draw at this point
in time from them, I think the first one is to caution
that any of this needs to be tested on a much broader
portfolio of properties and example fields as we were
just really looking at the structure in this case, but
with that caution. The gross progressivity structure,
which is based on oil price and the gross value at the
point of production, does hit the lower profitability
fields harder to the point where you can actually get
a regressive feature coming in on it there, although
again, we note in that proposal there, the main
portion of the tax that will be collected, which is
actually from the base rate, is actually based on
profitability.
The gross progressivity, where the rate is based on
the net cash flow per barrel, that's the sort of so-
called net gross one, does damp that issue reasonably
significantly it would appear. It still has some
increase on - it has a rising impact on the real
profit because it's based on gross at the point of
production but does produce results that are much
closer to the net system in there.
I think that was basically all I had to add at this
point on it and, as I say, right now we're also
looking at this further, at additional ways of looking
at the slopes on the net gross system.
6:05:11 PM
CO-CHAIR JOHNSON asked if Mr. George and Mr. Ruggiero would be
attending the round table discussion.
MR. GEORGE said either he or Mr. Ruggiero would attend.
6:05:45 PM
RICH RUGGIERO, Gaffney Kline and Associates, provided the
following testimony:
Thank you, Mr. Chairman and Representatives. As we
were giving our previous presentations - particularly
Representative Seaton asked many questions and raised
concerns that we really take a look at and understand
that if you end up with a progressive system based on
net margin, what would be the contribution that the
state would be making to investments at certain points
along, if you will, the graph or the plot of the
production tax rate that you might put in place.
So one of the things that I was asked to do this
morning is to use the words "find an exit ramp" for
when the speed starts getting up there and you're
getting up high on that progressivity slope, is there
an exit ramp that might be sensible for the state to
take and for you all to take as you deliberate on this
bill as to where you would want the off ramp, if you
would, with respect to topping out the state's
contribution in any investment scenario.
What I wanted to do, because I found this quite
enlightening myself, is if you actually start playing
with some of the nuances of the system that you have,
you start to find that there are a few kinks and
corners or elbows as we've talked about them, that
have some interesting things happen at those
inflection points. And so we wanted to go through and
talk about what those look like, give an idea of how
they come about, why they come about, and therefore
you'll have this as background as you deliberate and
then further questions tomorrow at the round table.
A couple of things I wanted to do in here is talk
about a progressive system, and especially in a
progressive system what happens when the net margin
changes by a dollar. Remember we're talking about
margin and not price so this is when the net profit
before tax changes by a dollar a barrel. What is the
impact if an operator should choose to make an
investment before he finishes out that tax year.
What we have depicted here is a hypothetical system.
This would be initially based on the net-net and then
Representative Seaton, about an hour ago, asked if we
could take a look at the net gross so I'll have that
on the last slide. I was able to get that plotted up
for him.
But anyway, we're talking about a basic structure
where you'll start out with some base rate, so from
zero margin you'll have a base rate up to a kick off
point and, for this example, using $30 net margin per
barrel is the kick-off point. The slope, in this case
using a .4 slope for the entire range, and then you
cap off at some maximum. We chose to do that at 50
percent for this illustration.
What you also have then is a contribution when
figuring out the production taxes to be paid as you do
have an investment credit that sits in there right now
at 20 percent. When we start talking about the tax
deduction that would be available to a company if they
should invest and write it off in the year in which
they spend the money, they would not only get a tax
break on the production tax, but they would also be
receiving the investment credit.
So a way of looking at this is that the tax credit is
on top of the marginal tax rate that they would be
receiving or the tax break they would be receiving for
the investment. I've got some examples to run through
this for us.
6:09:52 PM
REPRESENTATIVE ROSES referred to the previous slide that
contained a 25 percent base with a $30 margin kick-off at .4
and asked how those numbers were arrived at.
MR. RUGGIERO said he had a range of .1, .2, .3, .4. He used
those numbers because it tops out at about $100 per barrel,
which is in today's range.
6:10:24 PM
MR. RUGGIERO continued:
To kind of show - I'll take you through a simplistic
example. But, as it says up here, let's just assume
there's a company that on a net basis, that is after
their operating expenses have been covered, they have
$1,000 available as pre-tax cash flow. If we go ahead
and say - they can be anywhere along that slope - if I
go back up, having a position of $1,000, they could be
anywhere from just barely making a margin because they
have lots of barrels. For example, I could be making
a $1 margin on 1,000 barrels or I could be all the way
at the other end making a $1,000 margin on one barrel.
That situation could put you anywhere on the curve.
What I do say up here is that if the margin is such
that the per barrel margin is under $30, the
production tax savings then associated with making a
$100 investment, so at that point making a $100
investment, they would have an associated tax savings
of 25 percent. That's because they're on the
baseline. If we then go all the way above the top
end, where it caps out, so if there's a margin that's
significantly greater than $92.50 per barrel, then the
production tax savings for making that $100 investment
would end up being 50 percent or $50.
But here is where it gets interesting. If I'm
somewhere between $31 per barrel and $92.50, when I
make that investment and we run through the math, the
production tax savings could be anywhere from 25
percent, or $25, to over 100 percent, basically the
state writing a check for the investment and I'll show
you how that happens.
6:12:21 PM
MR. RUGGIERO continued:
What I want to do is take a look at four cases at each
one of these points and I'll explain them in order as
A, which is where I'm on the base rate, so that's a
margin below 30. We'll then go to case B, where I'm
much above the $92.50 point where it caps out. Then
I'll choose two different points, C and D, on the
slope to show you that the change of each of those
points is not identical, and I will talk through that.
If we first go to a taxpayer who is sitting at Point
A, basically to do the math on the net-net system,
you'd take the $1,000 revenue, you'd go up on the
graph at the margin, and we're going to assume here
that we've got 40 barrels so the margin is $25 per
barrel, the tax would just work out to be that $1,000
times the 25 percent rate, which would be a $250 tax.
But let's say now, right here near the end of the
year, looking at things I think this is a good time to
invest $100 up there. What that does is it takes my
net cash flow before taxes down to $900, because I've
invested that $100. Because I had 40 barrels, my
margin is now down to plus or minus around $22 a
barrel. And you can see my tax rate though, at that
margin, is still 25 percent so my tax is 225 and, if I
come down to the bottom, what I've actually saved in
taxes overall is $25 over my $100 investment so the
marginal tax savings investing at that point is $25 or
25 percent.
6:14:07 PM
MR. RUGGIERO continued:
If I go all the way, as you remember, to Point B,
which is up there at about $120 per barrel, I actually
ran this case at $125 and then you can see that the
investment of the $100 brings me down to $110 a
barrel. It's similar math but because the tax rate at
both points - both the cash flow before I invested and
the cash flow after I invested - is $50, it's no
surprise that the marginal rate turns itself out to be
$50 as well. So if I'm already capped out, at that
point the state's contribution to a $100 investment
would be $50.
6:14:39 PM
But now let's move to Point C, which is on the low end
of the slope. This is where the math gets a bit more
interesting so if I confuse anyone, please stop and
ask me questions. I'm going to take that $1,000 and
I'm going to put me initially at a $50 margin. That
means I have 20 barrels, I'm making $50 a barrel, I've
got $1,000. If I go up that curve at the base rate of
25 percent plus the progressivity, it said my tax at
that point would be 33 percent. So multiply it out.
If I don't invest, my tax bill will be $330. However,
now I decide to invest and actually it takes my cash
flow back down to $900 and I still have those 20
barrels. My net margin comes down to $45 and now if I
work that through the base plus progressivity
calculation, I'll find out that my tax rate is 31
percent and my overall tax bill is now $279. So if
then go down and look at my tax savings for having
made that investment, I take the $330, I subtract the
$279, which is $51 divided by the $100, and I found at
that point, even though the overall production tax
rates were between 31 and 33, marginal savings
available to a company for making that $100 investment
would be a 51 percent contribution by the state.
6:16:11 PM
Now let's move up the slope, which is not far from
where we're at today. If I start at $85 per barrel -
again starting with 25 percent base tax at a kick-off
point of $30 per barrel - I've got $55 above the
index. I put my slope on, I find that my tax rate is
47 percent or I'd have a tax bill prior to investment
of $470. Again, subtracting the $100 because I make
it as investment, I'd go and find out that my net
margin per barrel is now 72. That makes my tax rate
43.6 percent, or my total taxes would be $392. When I
then subtract the $392 after investment from the $470
before investment, you find that my tax savings is 78
percent and that overall, then my marginal rate,
because it's a $100 investment, is 78 percent. In
this case the state's contribution would be 78 percent
of the investment.
So here we have situations, and I know that they're
made up numbers, but I can put someone in that $1,000
cash flow before tax position anywhere on the curve
and, depending where on the curve, there would be a
different contribution by the state towards any
investment that they made.
6:17:43 PM
If we actually - instead of just looking at distinct
points - but let's take it as a curve, what I've
plotted up here is the bottom line - is the arrow that
points to no investment. That's basically the tax rate
that would be paid on the $1,000. If I invest,
depending on where I am on the net margin curve or the
X axis, you then have to follow the top line and that
is the marginal tax rate that would apply at each
point along that system. So, you can see that right
before we hit the max rate, the way the mathematics
works, ... is you actually get to an 82-83 percent
marginal rate on a $100 investment at that point.
What I then did - that line if you remember was a $100
out of $1,000. That was 10 percent of pre-tax cash
flow being reinvested in the business. So what I did
is I actually ran this at a 1 percent reinvestment
rate, a 5 percent reinvestment rate, a 10 percent
reinvestment rate, and a 10 percent reinvestment rate.
What you see is the reinvestment rate gets higher. We
still have the same general effect but as the
reinvestment rate gets higher, the curve tends to
flatten out and extend in time. The reason that it
extends is that the more that you reinvest, then the
more your net margin comes down after the investment
and that actually brings you back down below that 92.5
point where you max out on the total tax.
6:19:40 PM
REPRESENTATIVE SEATON asked if 20 percent is reinvested, the
rate would be longer but lower.
MR. RUGGIERO said that is correct. The marginal rate for
investing at 20 percent is a little less than it would have been
if you'd only invested 10 percent at that point. The impact
continues on for much longer because of the size of the
investment.
6:20:15 PM
REPRESENTATIVE SEATON asked if the marginal rate is on the
investment dollars or on the entire $1,000.
MR. RUGGIERO said two impacts are taking place. When the
investment is made, it reduces the taxable base. In this case,
the taxable base was reduced from $1,000 to $900. At the same
time, a double impact occurs because not only did the tax base
decrease from $1,000 to $900, the tax rate applicable to that
amount decreased from 47 to 43. That creates a compounding
effect. It comes in two parts: part because the capital
spending can be deducted in the year in which it is spent and
part because it takes you down the tax curve.
6:21:21 PM
MR. RUGGIERO continued with his presentation, as follows:
If you then put the 20 percent tax credit and make
that available, and you plot that above these curves,
and I did this just above the 10 percent curve that
we've been working with, you'll see that when we get
near the $80 to $90 net margin range, the contribution
overall from the state could get as high as 104
percent.
6:21:56 PM
REPRESENTATIVE SEATON asked if federal income tax is included.
MR. RUGGIERO said it is excluded. This [graph] only shows the
production tax and the tax credits for investments. He said
[the federal tax] would increase the overall government take or
the government share of any investment made by one of the oil
companies.
6:22:29 PM
REPRESENTATIVE SEATON asked if Mr. Ruggiero was referring to the
government contribution to the cost when he spoke of government
share.
MR. RUGGIERO said adding the federal and state income tax
impacts into this, the number would get larger.
6:22:55 PM
REPRESENTATIVE WILSON asked if Mr. Ruggiero is saying the
legislature needs to be very careful about the progressivity
number because the state's risk could be higher than intended.
MR. RUGGIERO replied:
Representative Wilson, the questions were being asked
so we went and started marching our way along the
curve and saying were there any anomalies that we can
see and yes, there was an anomaly and so what we're
doing is just bringing it to your attention so that
you can choose how to use that in your deliberations.
REPRESENTATIVE WILSON questioned whether the answer is yes.
6:23:43 PM
MR. RUGGIERO said he has a few more slides to show but no matter
what progressive type of system is used, that issue must be
dealt with. He continued with his presentation. He explained:
Again, we kind of put up a question. Is there some
sort of cap mechanism that you may want to put -
location on here again is just for use of
illustration, but you may want to say that the state's
share or the state's contribution toward an investment
at any point need not exceed a certain level.
6:24:29 PM
CO-CHAIR JOHNSON referred to Mr. Ruggiero's answer to
Representative Wilson's question and asked if he was saying that
regardless of the progressivity system used, an anomaly will
occur.
MR. RUGGIERO said a double contribution will always occur if
progressivity is based on the net margin where both the tax base
and tax rate are changed. It will have a compounding effect,
which is the anomaly, he remarked.
6:25:02 PM
CO-CHAIR JOHNSON recalled that in Mr. Ruggiero's previous
presentation, he heard of two changes the administration would
like to see made to ACES, perhaps a third. The legislature has
30 days, with 14 days left, and Mr. Ruggiero is presenting
changes to his original plan. He suspected the legislature will
have to return again to address this issue. He said he sees red
flags everywhere and questioned whether ACES was not well
thought out.
MS. DAVIS explained that because ACES is built on the backbone
of PPT, the administration is trying to build in refinements and
understandings that take place with time and study. During the
last go-around, this body worked very hard to understand PPT and
establish a progressivity structure. What ACES proposes at
this time is a tweaking of the numbers of the progressivity
structure. The current form of ACES merely contains a change in
the trigger price and the change in the slope, so no structural
changes were made to progressivity. Ms. Davis explained that
what has come about through the continuing study is the effort
to educate members on the linkages with capital credits and on
how changes affect investment. She said DOR was asked to
identify anything it has seen in its course of study. What
staff has been discussing today is the aspect of what exists
with PPT so, if nothing is done, those things remain. She said
if this body does not want to discuss aspects of the current law
or the content of the amendments that is its choice.
6:27:52 PM
CO-CHAIR JOHNSON said he believes the PPT needs to be given time
to work. In two weeks, the committee has been presented with
three changes. The existing information [about its impact]
conflicts and consultants present dueling information. He is not
comfortable with it.
6:29:18 PM
CO-CHAIR GATTO opined that 85 percent of the state's revenue is
based on oil. Every year the state will discover something
about the oil industry that it did not anticipate. As a result,
the state is at a disadvantage. If the state discovers
something it did not anticipate that is an advantage, he is
willing to face that too if it was not in the plan. He admitted
that he does not think the legislature's actions in the next 15
days will be the end of the story. He likened the situation to
studying for a law exam. He is hopeful, with PPT or ACES, the
legislature finally reaches a point where the changes that need
to be made are like fine tuning an engine. He believes at this
point the legislature is working on a 1972 small block Chevy
with bad valves.
6:31:21 PM
REPRESENTATIVE ROSES commented:
Earlier I asked you to go back to a slide and I asked
you why you picked 25 percent and .4 and I didn't know
whether that was something that you had generated for
the Senate or if it was something that you generated
on behalf of the administration to coincide with the
compass piece saying if you're going to drop the 10
percent floor, then you've got to be more aggressive
on the progressivity. That's why I asked if this was
just a simple snapshot, a perfect example, or this
actually was fitting what had been requested, either
through the administration as part of their new
proposal or whether it was something you created for
the Senate in their Judiciary Committee as part of
their process.
So that's why I asked the question and I think it goes
along with what Representative Johnson was suggesting
that this was the administration's proposed new change
to ACES and that's why I asked. I don't know that it
was. That's why I asked the question. I didn't want
to make that assumption.
6:32:17 PM
MS. DAVIS told the committee that the administration does not
have a formalized cap proposal. It has not talked about
language. It knows the issue exists and simply wanted to bring
it to the legislature's attention when developing tax policy.
She believes legislators are owed the service of getting this
information. She repeated the administration does not have an
amendment to address this issue.
6:32:56 PM
REPRESENTATIVE ROSES said he was not referring to the cap
proposal. He was addressing the 25 percent and .4 scenario.
MS. DAVIS replied, "We don't have it. There have been a huge
number of pieces floating through with everybody having
different options. I didn't know what the number was until it
showed up here."
REPRESENTATIVE ROSES thanked her for the information.
6:33:40 PM
MR. RUGGIERO told members he chose the number to show that it
can be over 100 percent. Within the realm of prices over the
next few months, the state could be operating near that peak
where it could be contributing over 100 percent of anything
spent by a number of the companies.
6:34:07 PM
REPRESENTATIVE WILSON assumed he did not know that ahead of time
so showed the committee how various numbers would change the
outcome.
MR. RUGGIERO said the model is not a snapshot but a model of a
cash flow program from the Prudhoe Bay drilling program. By
modifying the numbers in the cash flow model, the inputs were
changed. The model was not created to illustrate marginal
impacts seen with this type of a fiscal structure. He
explained:
But it was then going back and playing with the fiscal
structure - and in, actually, this came about because
in running that, we'd step through 1/10th of a
progressivity, 1/10th of progressivity and every now
and then we'd see things jump big, instead of a small
jump. That's the type of thing - the engineer - you
go hmmm, something happened, I've got to figure that
out.
That's when we started - and then the questions that
came from Representative Seaton about the
participation that we then started looking into and
saying there is a compounding effect just looking at
the state tax that is apparent. And then we haven't
even started to model what that means from adding the
federal and the corporate income tax into it.
6:35:49 PM
REPRESENTATIVE WILSON expressed concern that the state could be
jeopardized because it is taking on much more risk than it wants
to. She believes a cap is necessary.
MR. RUGGIERO said the legislature needs to assess whether that
is a risk and decide whether it wants to use state money to back
the oil companies' investments. He believes one point
overlooked in the discussion is that if the state is ever
contributing a marginal 80 percent that will be on 10 percent of
the taxable cash flow. The advantage is if the state
contributes 82 percent to that investment to encourage it, the
other 90 percent of their cash flow is attracting a high tax
rate as well. If the price increases to where a company makes an
additional $100 but no more barrels are produced, the marginal
tax paid on that increase is also 82 percent.
REPRESENTATIVE WILSON commented that the amounts are tremendous.
6:37:45 PM
REPRESENTATIVE SEATON told members:
I think everybody needs to realize that in PPT we were
putting together a tax plan and we were asked to tie
that up for 35 years and we said wait a minute, we're
designing a new tax plan and somebody wants us to tie
this up for 35 years. We don't know what all the
consequences of this tax plan are going to be and so
we said no. This is one of the reasons because what
we did in PPT is we said we're going to contribute -
we did a net-net. We didn't out of this committee.
This committee said that progressivity should be on
the gross, which means this effect does not come in
because progressivity does not kick in additional
state participation into the cost.
When it went through the process, it got turned into a
net progressivity. Nowhere was this ever discussed
that turning that progressivity into the net doubled
the state's risk of participation and capital into the
program. The problem is that our participation into
the program through deductions and credits is meant to
say we want to get projects sanctioned. So we went to
these levels where they're going to influence
decisions to go forward with the projects but the
progressivity feature comes at high prices where
you're beyond that analysis beyond those decisions to
sanction.
So if we do the progressivity on the net, we are now
learning we are contributing a massive amount of
capital, which will have absolutely zero effect on
project sanctioning because it's outside of the realm
where those analyses are made. So I specifically
requested the analysis of state risk and Pedro Van
Meurs brought this up to us in a little 30 second
comment he made when we were first here. He said ...
exactly the first day - was asking about progressivity
and he said your risk to the state having net
progressivity is high and if you have net
progressivity and you have it keyed to the net - in
other words to the profit margin, you doubly risk
yourself.
So I don't think any of us really concentrated on what
that meant and so I understand Representative Wilson's
concern because, you know, how long has it been since
we did PPT and I never caught it. I never realized
that - but we were never looking at - we knew we went
up and capped at 25 percent to try to harvest an equal
share, about 25, 25 percent in the base rate and then
another 25 percent in the upper rate, which is a 50
percent split. But we never got around to thinking at
a 50 percent tax rate, that means before credits,
we're contributing 50 percent of the costs and then
you add 20 percent credits on top of that and then you
can add the corporate income tax contribution
deductible against that on top of that and all of a
sudden we are up into a range where those are things
we didn't consider.
6:41:36 PM
So I'm very happy that we're here today looking at the
tax, PPT, or ACES. This is not a function of ACES.
This is a function of PPT and what we came forward in
that and looking at it and seeing that - do we want to
take that additional risk and get no gain because
we're not going to get any projects sanctioned when
we're talking about making contributions when the
price of oil is $100 per barrel.
There's lots of money on the table. We've got to
remember if it's $100 a barrel and we're getting $5
billion out of the production tax, that means they're
getting another $5 billion so it is not as if more
cash taken out of the progressivity and putting on
costs is going to gain us anything. I'm very
comfortable that we're here talking about these issues
that weren't addressed when we went through PPT and I
hope that we look for solving those problems as we go
forward. Sorry for taking so long.
6:42:27 PM
CO-CHAIR JOHNSON said he thought Mr. Romero said [the state] is
encouraging production, increasing investment and generating no
more money in the big picture. He thought Mr. Ruggiero also
said even though we may be risking in this marginal area, once
we get into that price structure we're generating a lot of
money. This can be translated onto many fronts: employment,
housing, taxes, and other benefits to the state. He further
stated:
I think your answer to her [Representative Wilson] was
the most telling thing I've heard. One snapshot, yea
we get gamed a little bit, they invest a lot of money
or more money. We get jobs for that - all the things
that go along with that. On the other end of that,
when we're at those prices, the treasury doesn't do so
bad either.
6:44:26 PM
MR. RUGGIERO said he hoped no one believes he was saying the oil
companies are "gaming" the system. He said it can be viewed as
a problem or an opportunity. One thing this tax system could
encourage is if a company is near the top end, it might decide
to invest $120 million into a heavy oil test well because it can
do so with the state's contribution. Part of the state's
contribution would be to R&D work, which is actual in-the-field
testing. That would lower the technology risk and raise the
possibility of investment in the higher cost, low market value
heavy oil development. He noted the amount could be as high as
35 billion barrels.
6:45:30 PM
CO-CHAIR JOHNSON asked how that would be a problem.
MR. RUGGIERO repeated it is not a problem; some may see it as an
opportunity. He said in a previous presentation, he discussed
five goals. Goal number 2 is that a highly progressive system
will actually encourage investment in the Legacy units. He
continued:
And it's this impact, because of where they find
themselves on this curve, they should be interested in
investing in that point in time because of the
contribution that the state's making. If you design a
system like this, in a way, as a state you're saying
you have faith in their ability and their capability
and the rest actually spend that money wisely and
bring more barrels in for the state.
6:46:29 PM
MS. DAVIS explained part of the purpose of bringing this forward
is to recognize the positive aspects and realize this as an
embedded opportunity. She said it requires a conscious decision
so that the full magnitude of the incentive that's being created
for industry is understood. She pointed out the House Special
Committee on Oil and Gas was very concerned about quantifying
impacts to investment and whether it would be enhanced. DOR's
ability to answer those questions requires a precise
understanding of each element of the PPT structure, as modified
here does. With that understanding, committee members can test
their own personal resolve and decisions about what level of
state support should be involved.
6:47:42 PM
REPRESENTATIVE FAIRCLOUGH asked if the DOR forecast reflects the
$90-plus per barrel cost of oil.
MS. DAVIS said DOR just completed a Delphi protocol, where an
economist and industry experts are brought in. They developed a
near and long term forecast, which should be released within
days. She said she was not at liberty to say what the numbers
are but they reflect the current market conditions. So, DOR
does reflect near terms to some extent but it does not assume
that price will remain.
6:49:15 PM
REPRESENTATIVE FAIRCLOUGH said she believes if one looks at the
history of revenue projection, the state has been overestimating
the price per barrel and production that goes through on a
continuous basis.
Several members clarified that DOR was underestimating the
price.
REPRESENTATIVE FAIRCLOUGH said she truly believes Alaskans need
to get their fair share for their resource through a taxation
mechanism that encourages exploration and development. She
wants the pipeline to be used maximally. She asked for Mr.
Ruggiero's opinion on the future outlook on crude oil.
6:51:38 PM
MR. RUGGIERO replied:
What I would say is what we're presenting today, and
even what we presented a couple of days ago to this
committee, is not to be predictors of where the price
is. We're firm believers that ... as Mr. George said,
we'd be on his private island right now if we could
predict prices that well.
What we've been trying to bring forward is 1) views,
perspectives and a little bit mixed in recommendations
based on the fact that the three-legged stool of
production price and cost is always going to be
tilting one way or another from where you thought it
was going to be. Because of that, what you want to do
is think about, as you put your fiscal structure
together, what is the structure, what are the
mechanisms - if you would, where are the bail-out
points or where are the pressure relief valves in that
system, such that you don't have to worry about
whether or not DOR gets it exactly right because the
system that you will put in place will help Alaska
overall to react properly to however those three
things change. ... I think all we're trying to show
here is not to say that you should pick something to
happen at 92. You may pick it to happen at 62, you
may pick it to happen at 162. That's your choice.
This effect that we show on the slide will help happen
regardless of where you pick your kick-off points;
your capping points are the rest. It's just something
you're going to have to deal with unless you go to a
straight increased royalty - straight gross tax, which
I highly recommend against. But if you pick a system
that meets the goals of the state, gets equitable or
fair share at high prices, but at the same time
encouraging investment where you want the investment,
then these are the type of issues you are going to
have to deal with.
6:53:33 PM
REPRESENTATIVE FAIRCLOUGH commented that no matter whether the
price of oil is $10 or $100 per barrel, it is important to have
a model that is good for Alaskans, the state, employment and
businesses. She said she didn't want to get caught in a
"rabbit hole" by failing to recognize that extremes may occur on
either end. She again asked Mr. Ruggiero for his future
forecast on the price of oil.
MR. RUGGIERO spoke about an ongoing piece of work from a
California university which charts the predictions of renowned
experts in the oil and gas business. The most accurate
predictor, with twice the accuracy of any other predictor, was
the five-year forward strip on the NYMEX.
6:55:17 PM
REPRESENTATIVE GUTTENBERG said one of the experts tracked in the
report is named Yergen (ph) and he was wrong more often than
right. He said the graph raises concern about the state's
involvement, but the expectation was that production would
increase as the result of an increase in development. That's
the goal. He pointed out that in some years the liability may
be high but eventually the production curve will rise. He asked
if that is the balance Mr. Ruggiero is referring to.
MR. RUGGIERO said that is exactly correct. If the state chooses
to believe the oil companies are doing a good job, backs them
and provides this incentive that should lead to significant
production.
6:56:58 PM
REPRESENTATIVE ROSES said the discussion has been about a cap on
the credits at a certain level. He asked:
Don't we also have a cap on the progressivity at this
point and what would happen worrying about the effect
on the progressivity of investment if there were no
cap on the take? Because in the bills we have right
now, we have progressivity built in but when it gets
to 25 percent it stops. It doesn't go beyond that.
But if the price continues to go, there's less take
even though the price is higher. Does it have an
effect on whether or not this cap changes if you
didn't stop the cap on the progressivity?
MR. RUGGIERO said the shape of the curves on the graph occur
because of the cap. That curve occurs at the 50 percent
overall, or 25 percent progressivity added to a 25 percent base.
If that was allowed to continue, the curve that is very steep
and high would continue to track way above the progressivity
curve if it continued to go up as well. He has heard people say
when the progressivity caps out, the state does not make any
more money. He explained it actually means that every
incremental dollar is shared 50/50 with the oil company.
Therefore, as the price increases to where it goes off the right
hand side of the plot, the progressivity has capped out but the
state's share continues to grow with each dollar of additional
margin that's realized.
6:58:41 PM
REPRESENTATIVE WILSON asked Ms. Davis if she asked that other
anomalies be looked for by the model makers.
MS. DAVIS said the process has been iterative. Mr. Ruggiero and
Mr. George have been working with DOR economists to try to
identify these effects. She said the only other concern that
has been raised is whether or not anything needs to be done as
the result of this effect. She added:
Frankly, it is properly the remit of the legislature
to look at this and decide what level of investment we
want to provide as a state - co-investment, so to
speak, as a state, encouraging this kind of future
investment.
As we've modeled, all of our models have taken into
account in any given - we've stated what our
assumptions are so this effect is embedded in part and
parcel of everything we've presented. We just haven't
gone in and extracted it as an independent slide.
Frankly, these gentlemen have been working very hard
and fast and furiously in the last day and one half to
help us understand how to portray it. So, hopefully,
after this point, if there's a structure that this
group decides on, we would be able to back into,
again, just letting folks know what this effect is so
they have a comfort level that they like where that
is.
7:00:40 PM
REPRESENTATIVE WILSON said she was thinking about the state's
overall goals and one is to increase production.
7:00:53 PM
CO-CHAIR GATTO said he considers tonight's meeting an investment
in tomorrow, when the committee considers amendments that deal
with progressivity.
7:01:22 PM
REPRESENTATIVE EDGMON questioned whether a similar model is in
use in other places around the world or whether Alaska is moving
into uncharted waters.
MR. RUGGIERO said other regimes have progressive systems that
address this type of issue. The structure of those systems is a
little bit different. That is why it is not always easy to see
where these types of events will occur.
7:02:36 PM
REPRESENTATIVE EDGMON questioned whether this situation has
variables that differ from other tax regimes, but it is not
entirely unique regarding a cap with a progressivity feature.
MR. RUGGIERO said the last two [models] that he was involved in
dealt with rate of return. Because of some of the features seen
here, S curves were created. The S curve along the X axis would
be the actual rate of return already realized with the tax rate
up the Y axis. Part of the reason for the rate of change and the
rest was to address some of the issues with respect to the delta
movement up or down on the curve and the state's participation
in that.
7:03:33 PM
CO-CHAIR GATTO noted several other states have mature fields. He
asked if the legislators in those states were wrestling with
these questions five years ago and resolved the issues to their
satisfaction.
MR. RUGGIERO said he did not know.
MR. GEORGE thought the systems in those states are based on a
royalty and severance tax, which would be a gross system.
7:04:23 PM
MR. RUGGIERO told members:
If I can, Mr. Chairman, continue? We've actually
addressed a lot that's on this slide but I just wanted
to put it up and I think this goes right to your
point, Representative Roses. You can choose when you
eventually do set up, whatever it is, the structure
that you are going to vote on as a House. But, as you
change base rate, as you change kick off points, as
you change slopes, as you change caps, any change in
any of those, including the investment credit rate,
will lead to a different answer on the previous slide.
Each time you change one of those variables, the plots
are going to change ever so slightly. That's why I
said, we did this to be illustrative, and what you can
know is that as you choose something, this is just an
issue you need to affirmatively address as to how you
want it to be handled once you get there.
The other thing is - before you adjourned, I guess
that was about 3:30, Representative Seaton said, geez,
I have an idea, can you run this for me? So, this is
a slide I just threw into the presentation. It is
the previous slide with two additions. It's the lower
two lines. The one that's listed as net gross, which
is the solid blue, it is actually the lowest-most line
that is sloping from left to right. And then we have
a 30 percent credit above that. I was kind of
listening with my ear to the discussion that was going
on here and I think Marcia threw the task over the
shoulder - you know, should you do a 30 percent credit
or not and said those Gaffney Kline guys would be
here.
So, I went ahead and put it up there just to see what
it would do. Even off the recommendation of
Representative Seaton that we look at, for the base
tax, whatever that is, it's a base rate times the net
margin that's made. But then to look at a
progressivity factor, which is based on the net margin
per barrel, but applied to the gross value realized.
And so, what we did is we ran through the same
examples at $1 increments all the way from the bottom
to the top, that same sort of $1,000 question of
revenue before cash flow and do I invest or do I not
invest that $100. And what you'll see is because of
the nature of it being based on gross, you get a
slightly different kick off point and the slope of it
is much more shallow as far as the state's
participation. This has to do with basing it on the
gross value overall before costs.
What you have in there - it eventually will cap out at
75 percent but it gets far into the future when it
does that because of the much slower growth of it.
But as you put any investment credit on top of it, be
it 20, be it 30 - I just did this as an extreme, based
on the discussion I'm going in here, and I put 30
percent and you can see that because the base
progressivity on a marginal basis continues to grow,
when you put the cap on it the overall would continue
to grow. At roughly $135 margin, you can see that the
marginal rate just based on the progressivity based on
the gross, is at roughly 63, 64 percent and that would
put the overall with the 30 percent investment credit,
a contribution in the 92 to 93 percent range. So
that at least gives an early indication of the
difference between, call it the net-net system, as Bob
showed earlier, and then the net-gross system, which
is the progressivity calculation based on the net
margin but applied to the gross value at the point of
production.
7:08:26 PM
MR. RUGGIERO continued:
This is the last slide. One of the things we were
asked is if you were to do something with a cap, stir
up the gray cells in the back of the brain and say
what would you come up with? I guess from personal
experience, the idea of something like an AMT came to
mind. If you should choose to cap, for whatever
reason, the contribution of the state, and I guess I
need to be clear this is not Gaffney Kline's
recommendation that you do so, but, as we said, we
presented an issue, one of the ways you can choose to
deal with it is to cap it off. And so what we've got
up here is basically is you can calculate your tax the
normal way. You have your wellhead value, you
subtract your costs, you then subtract your
investments. You get a net margin or a net cash flow
per barrel. You find the tax rate, you calculate the
tax due.
The other way you could do it, for example, based on
where I had my suggested line, is you can calculate
the tax payable without any deduction of the capital -
or the qualifying capital expenditures but, for those
qualifying capital expenditures, apply a fixed rate or
a fixed credit rate, if you will, overall, then
compare with that credit applied against the tax
without the investment deduction against the total tax
to be paid with the investment deduction and you could
have it pay the greater or, like an AMT.
There probably are some other mechanisms that could be
looked at, that could be used, if that's something you
wish to do. This is a mechanism that can be easily
carried out with the data that would be available at
the time of return.
7:10:31 PM
REPRESENTATIVE GUTTENBERG noted the production side of the
equation is not on the board. Industry representatives told
members they do not chase investments without production on the
other end. He questioned whether the state should take on risk
if the industry has not sanctioned a particular project.
7:12:27 PM
REPRESENTATIVE SEATON said the discussion is about stimulating
the oil industry's behavior to invest in projects that are
economically viable. Whenever the state gets into a situation
where it pays 100 percent, it risks stimulating investments that
make no sense. He thought the goal behind PPT was to put in a
base rate that is deductible and give tax credits, so that the
state would be investing 45 or 50 percent of the capital costs.
If the state is in a situation where it is putting up all of the
money for investment via tax credits and tax deductions, it
could be participating in projects that are occurring for tax
purposes only. He opined that the legislature needs to develop
mechanisms that stimulate investment in economical projects. He
fully agrees with state participation but does not believe the
state should be a 100 percent owner. He noted when federal
corporate income tax is considered, an oil company might get
$1.25 or more back from the state and federal government for
each dollar spent on a project.
7:15:38 PM
REPRESENTATIVE FAIRCLOUGH said she looks forward to seeing an
amendment that will address the issue Representative Seaton
raised. She agreed that "if there is not skin in the game, you
can lose value for those who are contributing," but she also
agreed with Representative Johnson that jobs, especially in
rural Alaska, are very important. She stated that she has
repeatedly heard Alaska has a maturing basin on the North Slope
and that the state is in a transition period in which it wants
to encourage smaller explorers to start producing barrels of
oil. She asserted:
And so, we will need to carefully balance the look at
those costs because as, at least from one economist's
perspective, the conversation has been that in this
transition we will see more exploration after the
puddles, per say, the smaller fields that are under
... 500,000 barrels per puddle - it's a pretty big
puddle for anyone to step in - and that the major
players will move to explorations that may be more
risky but looking for the elephant projects. Hopefully
that will still be in Alaska but - the bottom line
though that I remember from everything we've heard
over the last 16 days is it's about the rocks, as far
as the risk and investment goes when producers and
explorers are out there looking for fines.
So, I think that I look forward to seeing
Representative Seaton what you have, because I think
you make a valid point and I will be looking at how we
balance that so that we make sure that the new
explorers that don't have production that we do sort
of want to participate in that incentive with how do
we make that differentiation between those costs
versus the big players and keeping the playing, as the
administration has so admirably put forward, to make
sure it's flat and fair for all who want to enter the
market. Thank you Mr. Chairman.
7:18:06 PM
CO-CHAIR JOHNSON asked Mr. George and Mr. Ruggiero if they have
both worked for oil companies and presented projects to a board
or acted as advisors.
[No response was audible.]
CO-CHAIR JOHNSON asked what a board of directors would say if
they presented a project that cost $100 million with little
chance of hitting oil, but provided a tax deduction.
MR. GEORGE said the board of directors would look at the after-
tax impact when making an investment decision.
CO-CHAIR JOHNSON asked if the after-tax impact would be
production of oil.
MR. GEORGE said if the board is looking at an exploration play,
it will balance off the reward if successful on an after tax
basis. The board would also look at the cost if not successful
on an after tax basis.
7:19:59 PM
CO-CHAIR JOHNSON asked if the board would want to go ahead with
a project that might not produce oil under this scenario. He
elaborated:
You've got a chance where we're going to go out and
invest $100 million. We may not hit a barrel of oil -
no bookable reserves, none of the things that our
stock shareholders are going to look at, but we're
going to get a tax deduction that may or may not
because we do live in an environment where things can
change around here in this state, that we may or may
not hit oil. Can you tell me what that board of
directors would tell you?
MR. GEORGE said that question cannot be answered without looking
at numbers. The answer depends on the size of the prize
relative to the size of the investment and the risk involved.
He thought Chevron showed a slide during its presentation that
showed the calculation. Chevron would look at the after-tax
effect.
CO-CHAIR JOHNSON asked, "So, there's a board of directors out
there for an oil company that are going to take a risk that they
may not find oil or a very low risk they may find oil, based
upon getting a tax credit?"
MR. GEORGE replied the decision will move with the net benefit
after tax and the net cost after tax.
CO-CHAIR JOHNSON asked Mr. Ruggiero if he agreed.
7:20:29 PM
MR. RUGGIERO said that depends on where you were when, because
different circumstances come into play. He said when the PPT
credits were opened up in the UK, people were actually buying
small pieces of a field so that they could purchase the PPT
liability, which would be cover for the exploration they would
do. He said boards of directors do make decisions based on tax
credits to lower the risk of risky exploration.
7:21:20 PM
CO-CHAIR JOHNSON said he thought they were in the job of finding
oil. He said he couldn't think of any other business that would
do that.
MR. RUGGIERO opined that a board of directors would spend money
just to receive a tax credit. They are not in the business to
spend money just because it is government money. He explained
that oil companies have to keep track of internal metrics. He
believes an oil company's most valuable asset right now is its
employees. He furthered:
Just because there's a tax credit, the number of
people it will take just to drill - let's call it a
wildcat exploration well in this state, especially on
the northern part of the state - would take away
valuable assets from other operations. I do not see
any of the board of directors, just because you're
giving a little tax credit, going out there and
spending your money just because of that tax credit.
No. They would have to take a look at it with respect
to the rest of their portfolio. They'd have to look
at it - are they getting value for the people
involved? They'd have to look at it as - and they'd
still want a chance at success before they would do
that.
CO-CHAIR JOHNSON thanked Mr. Ruggiero.
7:22:54 PM
CO-CHAIR GATTO said he suspects that is a matter of how to
calculate the risk and how to estimate the reward and then
evaluate which projects are the best. A lot of guesswork is
involved so a decision would depend on the ratio. He said the
calculation is what is so hard and that is why good employees
are so valuable.
7:24:13 PM
REPRESENTATIVE EDGMON inquired about the next day's agenda.
7:24:57 PM
CO-CHAIR GATTO announced the next meeting would begin at 9:00
a.m. and a group discussion would take place.
[HB 2001 was held over.]
ADJOURNMENT
There being no further business before the committee, the House
Resources Standing Committee meeting was adjourned at 7:25 p.m.
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