Legislature(2021 - 2022)BARNES 124
03/05/2021 01:00 PM House RESOURCES
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| Audio | Topic |
|---|---|
| Start | |
| HB81 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| *+ | HB 81 | TELECONFERENCED | |
| + | TELECONFERENCED |
ALASKA STATE LEGISLATURE
HOUSE RESOURCES STANDING COMMITTEE
March 5, 2021
1:03 p.m.
MEMBERS PRESENT
Representative Josiah Patkotak, Chair
Representative Grier Hopkins, Vice Chair
Representative Calvin Schrage
Representative Sara Hannan
Representative George Rauscher
Representative Mike Cronk
Representative Ronald Gillham
Representative Tom McKay
MEMBERS ABSENT
Representative Zack Fields
COMMITTEE CALENDAR
HOUSE BILL NO. 81
"An Act authorizing the commissioner of natural resources to
modify a net profit share lease."
- HEARD & HELD
PREVIOUS COMMITTEE ACTION
BILL: HB 81
SHORT TITLE: OIL/GAS LEASE:DNR MODIFY NET PROFIT SHARE
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR
02/18/21 (H) READ THE FIRST TIME - REFERRALS
02/18/21 (H) RES, FIN
03/05/21 (H) RES AT 1:00 PM BARNES 124
WITNESS REGISTER
JHONNY MEZA, Commercial Section Manager
Division of Oil and Gas
Department of Natural Resources
Anchorage, Alaska
POSITION STATEMENT: Gave a PowerPoint presentation on HB 81.
ACTION NARRATIVE
1:03:16 PM
CHAIR JOSIAH PATKOTAK called the House Resources Standing
Committee meeting to order at 01:03 p.m. Representatives McKay,
Rauscher, Hopkins, Hannan, Gillham, Schrage, and Patkotak, were
present at the call to order. Representative Cronk arrived by
teleconference as the meeting was in progress.
HB 81-OIL/GAS LEASE:DNR MODIFY NET PROFIT SHARE
1:04:50 PM
CHAIR PATKOTAK announced that the only order of business would
be HOUSE BILL NO. 81, "An Act authorizing the commissioner of
natural resources to modify a net profit share lease."
1:05:47 PM
JHONNY MEZA, Commercial Section Manager, Division of Oil and
Gas, Department of Natural Resources, described HB 81 as
legislation that would "modify certain aspects of the existing
statutes for royalty modifications." He began a PowerPoint
presentation on HB 81 [hard copy included in the committee
packet] and turned attention to slide 2, titled "OUTLINE", which
read as follows [original punctuation provided]:
I. Overview of Net Profit Share Leases
II. Why DNR would modify the royalty rate?
III. Why DNR would modify the net profit share rate?
IV. Overview of the modification process
V. Appendix
MR. MEZA showed slide 3, titled "I. OVERVIEW OF NET PROFIT SHARE
LEASES" and paraphrased slide 4, titled "ROYALTY AND NET PROFIT
SHARE," which read as follows [original punctuation provided]:
1. What is royalty?
club In its role as owner of the hydrocarbons in the
subsurface, and in exchange for allowing a lessee the
right to explore and develop said resource, the state
reserves for itself a percentage of the gross value of
that resource when produced by the company.
club This percentage (the royalty rate) is established in
the oil and gas lease contract.
club All oil and gas leases offered by the state have a
royalty provision.
2. What is a net profit share?
club For a small group of leases, the state, also acting
as resource owner, reserves for itself, in addition to
royalty, a percentage of the profits from the lease.
club A lease with royalty and net profit share is called
a "Net Profit Share Lease."
club The "sharing of net profits" occurs once the
exploration and development costs allocated to this
lease are recovered through the revenues (net of
operating costs) from this lease.
MR. MEZA further explained that the company pays the state a
share of the profits, with percentages ranging from 30 to 79
percent. He said that while all oil and gas leases contain a
royalty provision, only 26 leases contain a net profit share
provision, referred to as net profit share leases (NPSLs).
1:09:40 PM
REPRESENTATIVE HANNAN referred to the 26 NPSLs and asked how
many total leases exist.
MR. MEZA answered that the NPSLs represent a tiny minority of
all oil and gas leases.
1:10:24 PM
MR. MEZA presented slide 5, which includes a table comparing
royalty, production tax, net profit share, and profit to the
lessee at various times throughout the life of the lease. He
explained that the state, acting in its role as resource owner,
establishes the royalty and net profit share rates in the
contracts. Acting in its role as sovereign, the state also
determines the production tax according to state law. While the
commissioner of the Department of Natural Resources (DNR) is
currently authorized under AS 38.05.180(j) to modify the royalty
rate, there is no such statute pertaining to the net profit
share rate; HB 81 is proposing that net profit share rate be
included in the royalty modification statute. Mr. Meza noted
that net profit share rate has been modified for one lease by
legislative action and stressed that production tax would remain
unaffected . He went on to explain that royalty is assessed on
the gross value of production from a lease, which is key in
differentiating it from the net profit share rate, which is
assessed on the profits net of any associated costs; however,
royalty payments begin immediately at the start of commercial
production, while net profit share payments begin when the lease
reaches the "payout" stage, which is when two conditions are
met: resources are produced, and some of the costs associated
with exploration and development have been recovered. Mr. Meza
concluded the explanation of this slide by explaining that a
rate of net profit sharing is assessed for each NPSL; in
contrast, the profit received by the lessee is likely assessed
at the project level and may result from a collection of leases.
1:15:04 PM
REPRESENTATIVE HANNAN noted the reference to the DNR
commissioner's statutory authority to modify royalties and asked
how often modification occurs. She also referred to the one net
profit share modification passed by the legislature and asked
about the circumstances.
MR. MEZA responded that of the 1,598 current leases, 461 are
producing, and there have been eight requests for royalty
modification by the lessees. He also said that the specific
legislative action to modify a net profit share would be
discussed in a later slide.
1:17:19 PM
REPRESENTATIVE HOPKINS asked whether the royalty rates are
public information.
MR. MEZA replied that they are.
REPRESENTATIVE HOPKINS followed up to ask whether it is also
made public when NPSLs reach the payoff stage.
MR. MEZA answered that, because the state receives payments, the
information is made public.
1:18:03 PM
MR MEZA presented slide 6, titled "NET PROFIT SHARE LEASES",
which illustrates an example of an NPSL. By statute, he said,
the DNR commissioner has the authority to issue oil and gas
leases via a competitive bidding process; different types of
leases may be offered, those with a royalty component being most
common. Leases that have both a royalty component and a
provision for net profit sharing are the NPSLs; the example
illustrated on this slide has a royalty provision of 20 percent
and a net profit sharing rate of 93.2 percent. The winner of
this lease was the bidder who offered the highest share of net
profit.
1:20:10 PM
MR. MEZA presented slide 7, a graphical illustration comparing a
lease with only a royalty component, and an NPSL with both
royalty and net profit share components. Both leases have
identical costs for capital expenditures, operating
expenditures, transportation costs, and royalty; in contrast,
the NPSL lease shows the net profit share to the State of Alaska
in its role as resource owner and lower production tax to the
State in its role as sovereign. As a result, the NPSL lease
shows less profit retained by the lessee.
1:22:42 PM
REPRESENTATIVE RAUSCHER referred to an earlier remark by Mr.
Meza and asked if it was correct that eight companies have
requested this legislation.
MR MEZA clarified that DNR has received eight applications for
royalty modifications since the statute was enacted in 1995.
REPRESENTATIVE RAUSCHER asked why a company would want to do
that.
MR. MEZA replied that this question would be answered later in
the presentation.
1:23:44 PM
REPRESENTATIVE MCKAY stated that he believes the idea is to
"help marginal leases" get back into production by writing off
development costs against the royalty.
MR. MEZA said that Representative McKay is correct, and that the
objective of DNR is to "prevent resources from remaining
stranded."
CHAIR PATKOTAK referred to Representative Rauscher's earlier
assertion that eight companies requested this legislation and
clarified that the companies requested changes to their lease
terms; they don't necessarily support this legislation.
MR. MEZA further clarified that the eight applications were for
royalty modifications.
1:25:07 PM
MR. MEZA presented slide 8, titled "MAP OF NET PROFIT SHARE
LEASES", which showed a map of the North Slope with the existing
oil and gas units and distinguishing the 26 NPSLs. He explained
that an oil and gas unit contains a set of leases, either NPSLs
or leases with only a royalty component. He said that it is
worth noting that there also exist leases, issued in the 1970s
and 1980s, which are not a part of any unit and have net profit
shares rates ranging from 30 to 79 percent.
1:27:39 PM
REPRESENTATIVE HANNAN asked for further explanation of the map
and referred specifically to the numbered leases on the Duck
Island Unit. She asked whether the two NPSLs in the unit
comprised the entirety of the leases and or if a portion of the
tract was not an NPSL.
MR. MEZA answered that the map was showing only the NPSLs with
the remaining area, shown in yellow, containing royalty-only
leases.
REPRESENTATIVE HANNAN followed up to ask whether it's the same
company that owns both the royalty-only leases and the NPSLs.
MR. MEZA replied that while different ownership of the leases is
possible, it's most commonly the same owner.
1:28:56 PM
MR. MEZA finished his explanation of the map with the note that
some of the NPSLs have already paid a total of $1.17 billion;
others have not yet shared profits because they are not yet
producing or have not yet reached the payout stage.
MR. MEZA continued to slide 9, "26 ACTIVE NET PROFIT SHARE
LEASES ON THE NORTH SLOPE," which showed for each lease the net
profit share rate, royalty rate, whether the lease has reached
the payout stage, and the cumulative net profit sharing to the
state. He noted that most of the NPSLs were issued in the 1970s
and 1980s, while three were established more recently due to
"lease segregation," which means the original lease was
partitioned into two leases. He said HB 81 proposes authorizing
the DNR commissioner to modify both the royalty rate and the net
profit share rate if DNR finds that doing so is in the best
interest of the state. The modification of the net profit share
rate would comprise a temporary reduction of the rate with a
gradual increase under certain conditions, to be illustrated
later in the presentation.
1:31:30 PM
REPRESENTATIVE HOPKINS asked whether there is a definition for
"in the best interest of the state."
MR. MEZA answered that the state is mandated by statute to
maximize the value of the resources; by considering royalty or
net profit share modifications, the goal is to encourage
additional production of leases which would otherwise remain
stranded.
REPRESENTATIVE HOPKINS asked whether the goal is more production
versus a higher monetary value per barrel.
MR. MEZA responded that without modification to the rates there
would be no production, and more production means more revenue.
REPRESENTATIVE HOPKINS referred to slide 9 and noted that 14 of
the 26 leases have not yet reach payout stage. He asked whether
all 26 leases would be eligible for modification or only those
that have reached the payout stage.
MR. MEZA answered that HB 81 doesn't specify a particular case
for modification but noted that Representative Hopkins' question
makes sense. He said that the bill is intended to be
comprehensive, and that it would immediately impact those leases
currently in the payout stage and would have future impacts on
leases not yet in that stage.
1:34:15 PM
REPRESENTATIVE HANNAN referred specifically to the Point Thomson
Unit as having the oldest lease and asked Mr. Meza to explain
why that lease hasn't paid the net profit share.
MR. MEZA answered that the Point Thomson unit began production
in 2016 and is in a group of leases that do not include any
NPSLs. He said that when a company considers applying for
royalty or net profit share modification, a convincing and clear
plan must be provided to DNR showing that a modification would
improve the lease's economic viability for future production.
He said DNR analyzes and reviews all applications.
REPRESENTATIVE HANNAN asked, "Did you say that there are some
leases in Point Thomson that are in production, but they are
royalty agreements?"
MR. MEZA replied that the leases which are producing only
contain the royalty component.
1:37:54 PM
REPRESENTATIVE MCKAY explained that Exxon was building out the
infrastructure in the Point Thomson area, which is why there was
no production for so many years after the first issuance of the
lease.
MR. MEZA told the committee that Representative McKay was
correct.
1:38:41 PM
REPRESENTATIVE SCHRAGE asked whether it's correct to say that
the proposed bill would allow the adjustment of NPSLs for fields
that are in production as well as those that have not reached
the payout stage.
MR. MEZA answered that is correct, and explained that HB 81
would allow the lessee to apply for modification of royalty
and/or net profit share regardless of whether the lease is
producing or not, because the statute "contemplates clearly
defined scenarios under which an applicant needs to support its
application." He said that the bill is constrained to apply
only to specific scenarios under which modification might be
considered.
REPRESENTATIVE SCHRAGE asked whether it would be a correct
assumption that "we would be targeting those fields that have
not reached that payout stage such that by modifying that profit
sharing agreement, economically, they would be motivated or
incentivized to have output and begin production."
MR. MEZA replied that Representative Schrage's statement is a
possibility and that it could encourage incremental production,
with associated incremental revenues, from both producing and
non-producing leases.
1:40:35 PM
CHAIR PATKOTAK surmised that HB 81 would be establishing
parameters within which the state may operate when considering
modifications to lease terms.
MR. MEZA replied, "That is correct."
1:41:26 PM
MR. MEZA presented slide 10, "MODIFICATION OF NORTHSTAR UNIT
NPSLS THROUGH LEGISLATIVE ACTION IN 1996," showing four leases
in the Northstar Unit originally offered in 1980 with a fixed
royalty rate of 20 percent; companies bid on the leases, which
were awarded to those who offered to pay the highest net profit
share rate. The lessee, British Petroleum (BP), evaluated
future development of the lease and informed DNR of the expected
viability of the project, given the costs. In 1996 DNR and BP
negotiated net profit share and royalty rate modification terms
and proposed changes to the legislature, which passed a bill to
modify both rates. The legislature found that unless the net
profit share rates were modified the unit would be unlikely to
produce until 2002, if at all. The purpose of modifying the
rates, Mr. Meza explained, was to encourage production in a case
where none would otherwise occur, which would result in no
revenue to the state.
1:43:25 PM
CHAIR PATKOTAK asked whether it is currently incumbent on the
legislature to change both royalty and net profit share rates.
MR. MEZA explained that the DNR commissioner is currently
authorized by statute to modify royalty rates, if DNR finds that
the modification is in the best interest of the state. In
contrast, net profit share rate modifications must be done by
legislative action. He said HB 81 proposes giving the DNR
commissioner the authority to modify the net profit share rate
under the statute that allows modification of the royalty rate.
In response to Chair Patkotak, he relayed that in 1995 the
legislature enacted the statute the allowed the DNR commissioner
to modify royalty rates because the net profit share rates were
not eligible for modification under statute. The net profit
share rates on the BP leases were modified through legislative
action in 1996.
1:46:03 PM
REPRESENTATIVE MCKAY stated his belief that ConocoPhillips
Alaska, Inc. originally owned the Northstar Unit leases and sold
them to BP, which then approached the state for net profit share
modification. He said that if the field or pool is "shut in,"
then production may never occur or may otherwise become
uneconomic.
MR MEZA replied, "That is precisely correct."
1:47:41 PM
REPRESENTATIVE HANNAN asked whether the Northstar leases have
produced as expected since the modification was made. She also
asked whether these are the leases that recently transferred
from BP to Hilcorp Alaska, LLC.
MR. MEZA replied that production began in 2002 and has been
approximately 178 million barrels of oil.
1:49:12 PM
MR. MEZA introduced the next section of the presentation with
slide 11, "WHY DNR WOULD MODIFY THE ROYALTY RATE" and proceeded
immediately to slide 12, "STRANDED RESOURCES MEANS ZERO
PRODUCTION AND ZERO REVENUES TO THE STATE," which illustrates a
2005 case in which DNR granted a modification. He explained
that the Oooguruk unit has four NPSLs and several royalty-only
leases; in its application, the developer, Pioneer, said that
without lower royalty rates the project would "fail to meet
minimal economic targets," thereby leaving the project stranded
and providing no revenue to the state. He said DNR did its own
analysis and agreed with that assessment and allowed a temporary
reduction in royalty rates to 5 percent. Production began in
2008 and cumulative revenues to the state have been $145 million
in royalties and $12 million in net profit sharing.
1:51:08 PM
MR. MEZA continued to slide 13, "WHY WOULD DNR ALLOW THE
MODIFICATION OF THE ROYALTY RATE?", which demonstrates revenues
and expenditures over time for two hypothetical leases with and
without royalty modifications. The two cases have identical
development costs, operating costs, and revenues; the production
tax, royalty rates, and net profit sharing are considered in the
economic evaluation for the project. From the perspective of
the lessee, Mr. Meza explained, the project without royalty
modification is not profitable, so "the investment is not
sanctioned, resources are stranded, and the projected revenues
to the state are not realized and they become zero." Maximizing
the value of resources is in the best interest of the state, so
reducing the royalty rate in turn leads to a profitable enough
project. In this way, resources are produced, and the state
realizes revenue. Since the leases in this hypothetical also
have net profit sharing components, Mr. Meza said, "it is
possible that the same goal could have been achieved by
modifying the net profit share rather than the royalty rate,"
which would be possible under HB 81.
1:54:13 PM
REPRESENTATIVE HOPKINS asked at what point during the life of
the lease there would be a change in the net profit share rate,
should HB 81 pass.
MR. MEZA answered that the only change in this example is the
royalty rate. He said that in describing this hypothetical the
question was posed, "Could DNR have obtained a similar result of
incentivizing the investment by, instead of modifying the
royalty, we modified the net profit sharing?".
REPRESENTATIVE HOPKINS asked whether there would be a
demonstration showing a point in the project when a developer
would understand that the field is unprofitable, leading it to
apply for a net profit sharing modification.
MR. MEZA replied that slides 24 and 25 would show that
possibility.
1:56:05 PM
MR. MEZA continued to slide 14, titled "HISTORY OF DNR ROYALTY
MODIFICATION APPLICATIONS." This slide is a chart showing the
outcome of each application for royalty modifications since
1995. Of eight applications, three were approved; two were
denied; and three were withdrawn by the applicant. The new
terms of the three approved leases contained a provision
establishing the specific modification of the rate. In the case
of the Oooguruk (Kuparuk and Nuiqsut) field, the royalty rate
was reduced to 5 percent at the beginning of production and
gradually increased back to its original level when the lease
reached the payout stage. For the Oooguruk (Nuna Torok) field,
the modification of royalty was granted but the company didn't
make the necessary capital investment; therefore, the
modification was rescinded.
1:58:03 PM
CHAIR PATKOTAK stated his understanding that when rate
modifications are made there's a clause that specifies capital
investments are required.
MR. MEZA answered that the decision issued by the DNR includes
"multiple covenants and conditions" in order to keep the
modification.
1:58:51 PM
REPRESENTATIVE HOPKINS asked whether the sliding scale
mechanisms are unique to each field or developer, and he asked
whether HB 81 would allow the DNR commissioner to continue
having that latitude.
MR. MEZA answered that HB 81 would maintain the commissioner's
existing flexibility in deciding the mechanism for modification
and would not only maintain it, but would expand it to modifying
the net profit share rates in NPSLs if, through DNR's best
interest finding, including public comment and presentation,
it's found that modification is in the best interest of the
state.
REPRESENTATIVE HOPKINS noted that it wouldn't be necessary for
the rate to go back up.
MR. MEZA replied that it's possible to have a case in which the
net profit share rate doesn't need to return to original levels,
depending on the project in question. He said that with
reference to the NPSLs, there are also other mechanisms
available.
REPRESENTATIVE HOPKINS said that getting the fields productive
is a good goal.
2:02:32 PM
CHAIR PATKOTAK asked for a brief overview of what the parameters
are in determining eligibility for an NPSL modification.
MR. MEZA replied that a partial answer to his question is in the
presentation and that he would provide further explanation.
CHAIR PATKOTAK noted that it would be helpful in phrasing the
bill and to show that there are checks and balances.
2:03:55 PM
MR. MEZA explained that when DNR proposes a modification, it's
mandated that the department publish a best interest finding,
which is subject to a public comment period, and to "offer a
presentation" to the legislative budget and audit committee,
which will be described later in the meeting.
MR. MESA introduced the third section of his PowerPoint
presentation, "III. WHY DNR WOULD MODIFY THE NET PROFIT SHARE
RATE?" and paraphrased slide 16, titled "1. INCREASE PRODUCTION
FROM OTHERWISE STRANDED RESOURCES," which read as follows
[original punctuation provided]:
A. Under certain circumstances, even with royalty
modification, it is possible for continuing or for
incremental production from pools which contain NPSLs
to be stranded.
? If resources are stranded ? Project does not
happen ? No royalty or net profit sharing to the State
? Modification of the net profit share may make
such production economic.
B. Modification of royalty and/or net profit share for
pools which would otherwise be stranded could extend
the life of such field and other existing fields.
? This would result in additional royalties, net
profit share, taxes, etc. that the State would not
otherwise receive.
2:06:12 PM
MR. MESA paraphrased slide 17, "2. FLEXIBILITY FOR ROYALTY
MODIFICATIONS," which read as follows [original punctuation
provided]:
Currently, DNR can modify royalty but not the net
profit share.
A. NPSL Modifications would give DNR flexibility
to elect targeted reductions and could be a useful
tool in environments of high oil price volatility.
? Under certain circumstances, it may be in
the best interest of the State to modify net profit
share instead of royalty.
? Royalties are paid sooner than net profit
shares and are more predicable over the life of an
investment.
? Alternatively, smaller reductions in both
royalty rate and net profit share may allow for a more
advantageous "blended" incentive structure.
B. NPSL Modifications would enable DNR to
increase net profit shares in scenarios where DNR can
structure potential payback of foregone revenues in
the event of higher prices or production levels.
2:07:52 PM
REPRESENTATIVE SCHRAGE asked whether he's correct in his
understanding that in an economic environment with low oil
prices a royalty reduction would allow a production to begin,
but the state would lose money should oil prices increase;
allowing adjustment to the net profit share rate would mean that
in this case, the state receives increased revenue later.
MR. MEZA responded that Representative Schrage's summary is one
possible scenario showing the "valuable flexibility" that HB 81
would allow the DNR commissioner.
2:09:04 PM
MR. MEZA presented slide 18, "WHY WOULD DNR ALLOW THE
MODIFICATION OF THE NET PROFIT SHARE RATE? A HYPOTHETICAL
EXAMPLE," which shows two graphs representing a case in which
production is defined by a set of leases with both royalty and
net profit sharing, and another case in which it's defined only
by net profit sharing, with profitability shown from the
perspective of the lessee. An evaluation of the investment is
determined in "year zero" (a point at which no expenditures or
revenues have existed), including a combination of variables
including production, price, and cost, to determine whether
investment should occur; if projections show a negative return,
investment will not take place. Mr. Meza directed the
committee's attention to the graph, titled "20% of production
allocated to the NPSLs" where a light blue line represents
profits with no modification to the rates, showing negative
value for the project. By modifying only the royalty rate,
shown by a dotted orange line, the value becomes positive. By
modifying only the net profit share rate, as shown by the dashed
blue line, the project likewise becomes more valuable than with
no modifications. Mr. Meza then directed the committee's
attention to the other graph titled "100% of production
allocated to the NPSLs," which shows modification of either rate
by itself is not enough to make the project economically
feasible, thereby changing the company's investment decision;
only combined modification of royalty and net profit share rates
make the project economic. When granting a modification, Mr.
Meza explained, the objective is not to guarantee a profit to
the company, but to incentivize the company to sanction capital
investment to develop and produce the resources. Included on
the slide was the following note [original punctuation
provided]:
The State may find that, to make a project economic,
it is in its best interest to?
A. Modify only the net profit share rate rather
than the royalty rate without giving up too much of
its potential revenues
B. Modify both if the modification of either is
not enough to affect the investment decision of the
lessee
2:12:36 PM
MR. MEZA paraphrased slide 19, " 3. STREAMLINE PROCESS FOR NPSL
MODIFICATIONS," which read as follows [original punctuation
provided]:
A. Current process to modify NPSLs is for DNR to
negotiate a modification package and submit proposal
for legislative action. ? In 1996, four NPSLs in the
Northstar Unit were modified to a sliding-scale
royalty.
? The Legislature ratified the modification in HB
548 (Chapter 139 SLA 96).
? The Alaska Supreme Court upheld the
modification in Baxley v. State, 958 P.2d 422 (Alaska
1998).
B. Providing for NPSL Modification in statute would
streamline NPSL modification process, while allowing
for the Legislature to set conditions and limits on
NPSL Modifications.
C. As with Royalty Modification, NPSL Modification
decisions are reported to the Legislature, which may
require hearings or take additional legislative
action.
2:13:52 PM
REPRESENTATIVE HANNAN asked whether other administrations have
proposed similar legislation since 1996 when the four NPSLs in
the Northstar Unit were modified.
MR. MEZA said that he does not know of any previous legislation.
2:14:21 PM
REPRESENTATIVE SCHRAGE said that modification of the rates seems
to have merit and noted that "we've proven that these agreements
can be changed through the legislative process" and asked about
the advantage to giving DNR the flexibility in making the
decisions, rather than continuing using the legislative process.
MR. MEZA replied that the current statute for modification
establishes the process that DNR must follow for complicated and
detailed financial and technical information; while legislative
review is a possibility, HB 81 proposes giving the DNR
commissioner the authority to carry out that process, publish
the findings for public comment, and present to the legislature.
He also noted that in many cases the applications contain
sensitive and confidential information meant solely for review
by DNR.
2:16:31 PM
REPRESENTATIVE HOPKINS referred to the "royalty modification
checkbox" currently required under statute and asked whether the
checkboxes would be in statute under HB 81 or in regulations by
DNR.
MR. MEZA replied that HB 81 does not propose changing any
existing processes, in fact, it proposes using the same process
for reviewing net profit sharing modifications as it does for
royalty modifications.
REPRESENTATIVE HOPKINS surmised that net profit sharing
modifications would be in statute, not in regulations.
MR. MEZA said, "That is correct."
2:17:55 PM
MR. MEZA presented the fourth and final section of the
presentation with slide 20, "IV. OVERVIEW OF THE MODIFICATION
PROCESS," and proceeded immediately to paraphrase slide 21, "
WHAT HB 81 ACCOMPLISHES," which read as follows [original
punctuation provided]:
1. Expand the royalty modification process to include
NPSLs:
A. Commissioner would have the authority to
modify net profit share rates in the same manner as
royalty rates under AS 38.05.180(j).
? Objective is to encourage production of
otherwise stranded resources.
2. Other changes:
A. Creates an additional qualifying scenario for
modification of either royalty or NPSLs
? For producing pools, where incremental
production requires incremental capital expenditures,
which, in the absence of modification, would be
uneconomic.
B. Clarifies that test production during
exploration does not disqualify a field or pool from
royalty or NPSL modification based on new production.
? This codifies DNR's existing
interpretation and is offered to resolve a potential
ambiguity. It does not constitute a change in current
policy.
MR. MEZA paraphrased slide 22, "WHAT TYPE OF MODIFICATION IS
WARRANTED?", which read as follows [original punctuation
provided]:
A. Royalty Modification is capped at certain minimum
royalty rates.
? Five percent for .180(j)(1)(A) or three percent
for .180(j)(1)(B)(C).
B. The proposed NPSL modification also establishes a
minimum net profit share of ten percent.
C. The modification may be based on a sliding scale
mechanism.
? It could vary with the price of oil, volume of
production, per-barrel costs, etc.
D. Modifications of royalty or net profit share can be
either lower or higher than the original percentages.
(AS 38.180(j)(3))
? In certain circumstances, this would allow DNR
to recapture foregone royalties or net profit revenue
if oil prices rise, or even to participate in "upside"
price movements if DNR provides "downside" relief.
2:20:52 PM
CHAIR PATKOTAK asked whether there's a way for the state, rather
than the developer, to request a modification.
MR. MEZA answered that the current statute for royalty
modification, and now proposed for net profit sharing
modification, specifies application by the lessee due to
requiring the inclusion of technical and financial information.
2:22:19 PM
REPRESENTATIVE RAUSCHER surmised that, without an application,
DNR cannot initiate the modification process.
MR. MEZA replied, "That is correct."
2:23:10 PM
MR. MEZA presented slide 23, "ELIGIBLE SCENARIOS FOR
MODIFICATION." The first three scenarios currently exist under
the current statute for royalty modification; HB 81 would allow
net profit share modifications in these scenarios as well. Mr.
Meza explained the scenarios on the slide, described as follows
[original punctuation provided]:
A. New Production: If the development of a new field
or pool would not be economic without modification, so
long as the field or pool is sufficiently delineated.
AS 38.05.180(j)(1)(A)
B. Extend Production: To prolong the economic life of
a field or pool when rising per-barrel costs (due to
declining production or otherwise) would make
continuing production no longer economic without
modification. AS 38.05.180(j)(1)(B)
C. Restore Production: To reestablish production of
shut-in oil or gas that would otherwise not be
economically feasible without modification. AS
38.05.180(j)(1)(C)
MR. MEZA explained that HB 81 proposes adding a fourth scenario
of eligibility for modification, which would apply to both
royalty and net profit share modifications; illustrated on the
slide as "scenario D," which read as follows [original
punctuation provided]:
D. Incremental Production: If incremental production
from producing pools requiring incremental capital
expenditures is uneconomic in the absence of
modification.
Examples: Expansion of existing pools, additional
drilling pads, enhanced oil recovery projects, etc.
MR. MEZA gave additional examples, including expanding a
currently-producing pool by drilling new wells outside the
boundaries of the known reservoir and a project targeting
incremental production by building additional drilling pads and
using an extended-reach drilling rig. He explained that DNR is
attempting to unlock additional resources which, without
modification of the rates, may be stranded; extending the lives
of existing pools means reaching existing resources, and
receiving the associated revenues, without creating a larger
infrastructure footprint.
2:27:07 PM
REPRESENTATIVE GILLHAM asked whether the DNR commissioner would
have the sole authority to approve an application for
modification.
MR. MEZA replied that the existing statutes for royalty
modification allows the commissioner sole authority and include
a significant period of review of technical and financial
information. He noted that HB 81 would not change that process.
2:28:21 PM
REPRESENTATIVE HOPKINS asked about the original impetus for HB
81, given that it's been 25 years since the legislative decision
for net profit share modification.
MR. MEZA summed up his previous explanation.
REPRESENTATIVE HOPKINS said that he understands that production
has been declining since approximately 1988, but he wants to
know from where the idea for the bill came.
MR. MEZA said that he would look into it.
2:31:04 PM
REPRESENTATIVE HANNAN asked whether there is a companion bill in
the Senate.
MR. MEZA replied that he is not aware of a companion bill
addressing net profit share rates, although he proffered SB 61
is a similar bill with the same goal.
REPRESENTATIVE HANNAN asked whether SB 61 had been presented to
the Senate Resources Standing Committee.
MR. MEZA answered that it had.
2:32:02 PM
CHAIR PATKOTAK offered his assumption that at this time there
are no pending applications for modification.
MR. MEZA told the committee that Chair Patkotak is correct.
2:32:20 PM
MR. MEZA resumed his presentation with slide 24, "ELIGIBLE
SCENARIOS FOR MODIFICATION," which shows two graphs representing
scenarios A and B from slide 23. The graph labeled "New
Production" illustrates scenario A, and the graph labeled
"Extend Production" illustrates scenario B; for this example,
scenario B has been producing for 16 years and projections show
that future production would translate into an operating loss,
with the economic life of the field nearing its end.
Modification via a reduction of royalty or net profit share
rates could ensure that production continues, thereby continuing
the associated revenues to the state.
MR. MEZA used this graph to answer Representative Hopkins'
earlier question by explaining that there were several years
with net profit share payments; however, the field would require
modification to the lease terms in order to ensure future
production.
2:35:00 PM
REPRESENTATIVE HOPKINS referred to slide 10, where Mr. Meza
asserted that the developer who bid the highest net profit
sharing rate would be awarded the lease and described a
hypothetical situation. He asked whether it's possible for a
bidder, committed to a net profit sharing rate of 99.999
percent, can decide during development that the rate is
untenable and modify it to a rate lower than what the other
bidders proposed.
MR. MEZA explained that there are several stages in development
including exploration of wells; appraisals, which provide
information on volume of the resource; and determination of how
the facilities would need to be designed to produce the
resource. This means actual production of the resource could
begin 10 to 20 years after the lease is awarded. The rate in
the initial bid may be economically unfeasible by the time the
field is fully developed.
REPRESENTATIVE HOPKINS surmised that it would take a decade or
more for a developer to realize that its bid is not profitable.
MR. MEZA replied, "That is correct."
2:38:26 PM
REPRESENTATIVE MCKAY offered his experience of being involved in
a project in which the developer intended to frack, but due to
the geology of the area the plan was impossible to execute so
changes were made.
2:39:16 PM
CHAIR PATKOTAK asked Mr. Meza whether there are periodic goals
within the life of the lease that need to be met in order to
make the lease eligible for modification.
MR. MEZA explained that with the issuance of a lease, the lessee
has a period during which there are no requirements for
exploration or development; in a few cases DNR will propose
commitments, but most frequently activities occur in a manner
deemed appropriate by the lessee. At a certain point, however,
the lessee must demonstrate exploitable resources.
2:41:39 PM
MR. MEZA continued to slide 25, "ELIGIBLE SCENARIOS FOR
MODIFICATION," which is a continuation from slide 24 and shows
two graphs representing scenarios C and D from slide 23. The
graph depicting scenario C shows the lease in year 21, and
production has stopped; without modification there is no
incentive for the lessee to continue producing, so there will be
no more resource extraction and no more revenues to the state.
The graph depicting scenario D, which is proposed under HB 81,
shows the lease is in year 15 and the lessee is considering
capital investment in the field, such as drilling outside the
boundaries of the known reservoir. The investment is not
expected to be profitable; however, and the rate modifications
would be necessary to incentivize the developer to make the
necessary investment, thereby providing revenue to the state.
2:43:19 PM
MR. MEZA presented slide 26, "DECISION-MAKING PROCESS," which
read as follows [original punctuation provided]:
A. HB81 does not propose to change the modification
process.
B. A producer applying for a royalty modification must
provide a clear and convincing showing that they meet
the statutory requirements.
? A higher standard of proof than required for
most other DNR applications.
? Applicants required to provide abundant
evidence to justify any request for relief.
C. DNR may require (for .180(j)(1)(A)) or request (for
.180(j)(1)(B)(C)) that producers pay up to $150,000
per application for consulting work to support DNR's
evaluation of the application.
D. Publication of Best Interest Finding and offer
presentation to Legislature (AS 38.05.180(j)(9)-(10))
E. If granted, modifications are not transferrable
without the authorization of the Commissioner. (AS
38.05.180(j)(5))
2:45:19 PM
REPRESENTATIVE MCKAY asked for an estimate for how much
production would increase as a result of HB 81.
MR. MEZA responded by explaining that economic viability of the
fields is the focus, with estimates of future production to be
included with the application for modification.
2:46:50 PM
REPRESENTATIVE GILLHAM asked whether there must be a minimum
production level before modifications can be put into place. He
referred to the Kuparuk River Unit on slide 9 and asked whether
that lease would have to produce 50,000 barrels a day in order
to get a modification, or whether the modification would be in
affect with the first barrel of oil.
MR. MEZA replied that HB 81 doesn't propose requiring a certain
level of production but that the information would be important
when evaluating the application for modification. In the
Oooguruk unit modification, which had been approved by the
legislature, the reduced royalty rate was in effect with the
first barrel because the pool hadn't been producing previously
and had a "defined expiration mechanism" that would gradually
return royalty rates to the original level.
2:48:54 PM
CHAIR PATKOTAK referenced slide 26 and noted that HB 81 isn't
proposing changing the process for royalty rate adjustments, and
he asked Mr. Meza to clarify whether HB 81 requires the DNR
commissioner to follow the same process for net profit share
rate modifications as it does for royalty modifications.
MR. MESA confirmed that is correct. He said HB 81 would
establish that DNR follow the same process as is applied for
royalty modifications.
CHAIR PATKOTAK noted that the focus thus far has been on the
North Slope and asked whether HB 81 would affect oil production
in the rest of the state.
MR. MESA responded that there are no NPSLs anywhere other than
the North Slope.
CHAIR PATKOTAK asked whether HB 81 would apply to all oil and
gas production instead of being specific to a region.
MR. MESA replied, "Yes, correct."
2:50:39 PM
REPRESENTATIVE SCHRAGE stated his assumption that there are
other factors that go into a company's production decision
besides the royalty and net profit share rates.
MR. MESA replied that there are other variables such as price,
the cost structure of the project, and the fiscal system in
general. He said that this presentation is showing only the
cases of royalty and net profit share modifications because
those are areas "within the purview of the DNR commissioner."
REPRESENTATIVE SCHRAGE asked whether there is a scenario in
which rate modification could coincide with changing economic
conditions and result in the state receiving less revenue than
it would have under the original lease agreement.
MR. MESA answered that DNR considers both current and expected
future price levels over the life of the project, and weighs
both highly optimistic and highly pessimistic cases, and
everything in between, in modification adjustments.
2:53:04 PM
CHAIR PATKOTAK said that in future meetings the committee would
be looking at the process by which an NPSL is modified and what
criteria the lessee must meet.
2:53:55 PM
REPRESENTATIVE HOPKINS said that he would be looking for an
answer to the question of the origination of HB 81.
2:54:01 PM
REPRESENTATIVE HANNAN noted that she would like to know "how
long the idea has been brewing" and why it hasn't been addressed
before now, especially in the face of declining production.
[HB 81 was held over.]
2:55:59 PM
ADJOURNMENT
There being no further business before the committee, the House
Resources Standing Committee meeting was adjourned at 2:56 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| HB 81 Presentation to HRES 3.5.2021.pdf |
HRES 3/5/2021 1:00:00 PM HRES 3/10/2021 1:00:00 PM HRES 3/19/2021 1:00:00 PM |
HB 81 |
| HB 81 Sectional Analysis Version A 2.23.2021.pdf |
HRES 3/5/2021 1:00:00 PM HRES 3/10/2021 1:00:00 PM HRES 3/17/2021 1:00:00 PM HRES 3/19/2021 1:00:00 PM |
HB 81 |
| HB 81 Sponsor Statement 1.28.21.pdf |
HRES 3/5/2021 1:00:00 PM HRES 3/10/2021 1:00:00 PM HRES 3/17/2021 1:00:00 PM HRES 3/19/2021 1:00:00 PM |
HB 81 |
| HB 81 Support DNR NPSL One Pager 3.5.2021.pdf |
HRES 3/5/2021 1:00:00 PM HRES 3/10/2021 1:00:00 PM HRES 3/17/2021 1:00:00 PM HRES 3/19/2021 1:00:00 PM |
HB 81 |