03/18/2005 08:34 AM House W&M
| Audio | Topic |
|---|---|
| Start | |
| HB52 | |
| HB63 | |
| Adjourn |
+ teleconferenced
= bill was previously heard/scheduled
ALASKA STATE LEGISLATURE
HOUSE SPECIAL COMMITTEE ON WAYS AND MEANS
March 18, 2005
8:34 a.m.
MEMBERS PRESENT
Representative Bruce Weyhrauch, Chair
Representative Norman Rokeberg
Representative Paul Seaton
Representative Peggy Wilson
Representative Max Gruenberg
Representative Carl Moses
MEMBERS ABSENT
Representative Ralph Samuels
OTHER LEGISLATORS PRESENT
Representative Beth Kerttula
Representative Berta Gardner
Representative Les Gara
COMMITTEE CALENDAR
HOUSE BILL NO. 52
"An Act relating to adoption and revision of a comprehensive
long-range fiscal plan for the State of Alaska."
- MOVED CSHB 52(W&M) OUT OF COMMITTEE
HOUSE BILL NO. 63
"An Act relating to the oil and gas properties production
(severance) tax as it applies to oil; establishing a minimum
rate of tax for certain fields of five percent; providing for an
adjustment to increase the tax collected when oil prices exceed
$20 per barrel and to reduce the tax collected when oil prices
fall below $16 per barrel; and providing for relief from the tax
when the price per barrel is low or when the taxpayer
demonstrates that a reduction in the tax is necessary to
establish or reestablish production from an oil field or pool
that would not otherwise be economically feasible."
- HEARD AND HELD
PREVIOUS COMMITTEE ACTION
BILL: HB 52
SHORT TITLE: LONG-RANGE FISCAL PLAN
SPONSOR(S): REPRESENTATIVE(S) GRUENBERG
01/10/05 (H) PREFILE RELEASED 1/7/05
01/10/05 (H) READ THE FIRST TIME - REFERRALS
01/10/05 (H) W&M, FIN
02/18/05 (H) W&M AT 8:30 AM CAPITOL 106
02/18/05 (H) Heard & Held
02/18/05 (H) MINUTE(W&M)
02/25/05 (H) W&M AT 8:30 AM CAPITOL 106
02/25/05 (H) Scheduled But Not Heard
03/18/05 (H) W&M AT 8:30 AM CAPITOL 106
BILL: HB 63
SHORT TITLE: OIL SEVERANCE TAX
SPONSOR(S): REPRESENTATIVE(S) GARA
01/12/05 (H) READ THE FIRST TIME - REFERRALS
01/12/05 (H) W&M, O&G, RES, FIN
03/18/05 (H) W&M AT 8:30 AM CAPITOL 106
WITNESS REGISTER
PETER NAOROZ, Staff to Representative Gruenberg
Alaska State Legislature
Juneau, Alaska
POSITION STATEMENT: Offered information on HB 52.
REPRESENTATIVE LES GARA, Sponsor
Alaska State Legislature
Juneau, Alaska
POSITION STATEMENT: Spoke as the sponsor of HB 63.
JUDY BRADY, Executive Director
Alaska Oil and Gas Association
Anchorage, Alaska
POSITION STATEMENT: Offered information regarding HB 63.
TOM WILLIAMS, Chair
Alaska Oil and Gas Association
Anchorage, Alaska
POSITION STATEMENT: Testified in opposition to HB 63.
ACTION NARRATIVE
CHAIR BRUCE WEYHRAUCH called the House Special Committee on Ways
and Means meeting to order at 8:34 a.m. Representatives
Weyhrauch, Rokeberg, Seaton, Gruenberg, and Moses were present
at the call to order. Representative Wilson arrived as the
meeting was in progress. Also in attendance were
Representatives Kerttula, Gardner, and Gara.
HB 52-LONG-RANGE FISCAL PLAN
CHAIR WEYHRAUCH announced that the first order of business would
be HOUSE BILL NO. 52 "An Act relating to adoption and revision
of a comprehensive long-range fiscal plan for the State of
Alaska."
8:35:18 AM
REPRESENTATIVE GRUENBERG made a motion to adopt CSHB 52, Version
24-LS0235\F, Utermohle, 2/24/05, as a working document before
the committee. There being no objection, Version F was before
the committee.
8:35:25 AM
PETER NAOROZ, Staff to Representative Gruenberg, Alaska State
Legislature, offered the committee research from the Internet
and the Alaska Municipal League regarding other states' fiscal
plans. He related that the aforementioned fiscal plans include
the following characteristics: looking beyond the current budget
to address the "big picture"; setting goals and objectives,
including value statements accounting for income, expenses,
assets, and liabilities; focusing on the realities of the world,
market, demographics of communities, concerns of the population,
and sensitivity to future projections; and communicating "openly
clearly, and [providing] a context for people to be educated and
make an evaluation and judgment." He added that Oregon,
Virginia, British Columbia, and Alberta have fiscal plans that
include the aforementioned criteria.
8:38:48 AM
MR. NAOROZ, in response to Representative Seaton, replied that
British Columbia and Alberta have specific sections [in their
fiscal plans] dedicated to natural resources. He related his
belief that Alaska is more "blessed" in terms of natural
resources than any of the aforementioned locations.
REPRESENTATIVE SEATON noted that analyzing the aforementioned
fiscal plans will be helpful.
8:40:25 AM
REPRESENTATIVE GRUENBERG moved to report CSHB 52, Version 24-
LS0235\F, Utermohle, 2/24/05, out of committee with individual
recommendations and the accompanying fiscal notes.
8:40:34 AM
REPRESENTATIVE ROKEBERG objected. He relayed that the bill does
not "actualize" a long-range fiscal plan, which is where the
legislature needs to apply its efforts.
8:42:00 AM
REPRESENTATIVE GRUENBERG said, "I would respectfully disagree,"
because the bill will make the legislature more likely to adopt
a fiscal plan into law.
8:43:29 AM
A roll call vote was taken. Representatives Weyhrauch, Wilson,
Gruenberg, and Moses voted in favor of reporting CSHB 52,
Version 24-LS0235\F, Utermohle, 2/24/05, out of committee.
Representative Rokeberg voted against it. Therefore, CSHB
52(W&M) was reported out of the House Special Committee on Ways
and Means by a vote of 4-1.
HB 63-OIL SEVERANCE TAX
8:44:13 AM
CHAIR WEYHRAUCH announced that the final order of business would
be HOUSE BILL NO. 63 "An Act relating to the oil and gas
properties production (severance) tax as it applies to oil;
establishing a minimum rate of tax for certain fields of five
percent; providing for an adjustment to increase the tax
collected when oil prices exceed $20 per barrel and to reduce
the tax collected when oil prices fall below $16 per barrel; and
providing for relief from the tax when the price per barrel is
low or when the taxpayer demonstrates that a reduction in the
tax is necessary to establish or reestablish production from an
oil field or pool that would not otherwise be economically
feasible."
8:44:53 AM
REPRESENTATIVE LES GARA, Alaska State Legislature, speaking as
the sponsor, relayed his belief that oil tax reform is
important. He highlighted the Alaska Constitution, Article
VIII, Section 2, which states that the legislature's duty is to
provide for the maximum benefit of its people. In response to
Chair Weyhrauch, Representative Gara clarified that oil tax
exemptions concern the means in which Alaska receives its fair
share. The largest tax portion received from oil is the royalty
tax proceeded by the production tax. He added that the
corporate and property taxes that are distributed through
municipalities have not been very high. He explained that
although the production tax is a 15 percent tax, also referred
to as a severance tax, that applies to every field, HB 63 only
addresses North Slope fields. The production tax is determined
by the economic limit factor (ELF). The ELF is a number between
zero and one [and to calculate the production tax] multiply the
field's ELF by the 15 percent production tax.
8:47:14 AM
REPRESENTATIVE GARA said the field's ELF rate is determined by a
formula that relies partly on the size and well productivity of
the field. Therefore, the higher those factors, the higher the
ELF. The largest fields, 0.8 fields, located in Prudhoe Bay,
North Star, and Alpine pay a 13 percent production tax. In
fiscal year (FY) 06, most fields in the state will pay 0 or less
than 1 percent for [ELF], he said. He turned to a graph
entitled, "ELF Now Exempts Blockbuster Fields", and pointed out
that the right column details the production taxes Alaska fields
pay. He offered that many believe the ELF was [initially]
intended to give incentives and reduce the taxes of the
producers of marginal, declining, and small fields. He offered
evidence to the contrary highlighting the FY 06 production tax
for Kuparuk, the second largest field in the U.S., which will
pay less than 1 percent. Some of the largest fields in the
U.S., including Milne Point, Endicott, West Sak, Tarn, Niakuk,
and Meltwater will pay 0 percent in production taxes. He added
that HB 63 does not apply to heavy oil, such as West Sak,
because it's more expensive to produce. He related his belief
that the production tax "shrinks" every year. According to the
Department of Revenue's projections, in 1993 the average
production tax on North Slope oil was 13.5 percent, in 2004 it
fell to 7.5 percent, and in 2013 it will probably fall below 4
percent. Although the ELF will continue to fall, the Governor's
Aggregation Order will cause it to spike this year. He pointed
out that about 10 percent of North Slope oil was brought from 0-
1 percent production tax rates to the Prudhoe Bay rate. He
reiterated that the ELF and the production taxes are declining.
Even assuming stable oil prices or stable production, the state
will continue to receive less revenue from its oil.
8:50:03 AM
CHAIR WEYHRAUCH said:
In the context of [Representative Gara's] presentation
is ... as the ELF gets smaller every year is it ...
providing an incentive to developing these fields. If
there's an incentive issue here, is it fulfilling that
strategic objective to bring more fields or more oil
and gas online. And at the same time, while there's a
production tax that ELF applies to, are there other
taxes that are being limited in a similar manner. And
is it minimizing the oil companies' general tax burden
at all or not.
REPRESENTATIVE GARA opined that the ELF is far too generous to
the oil industry, [considering that] the largest fields in the
U.S. are paying a 0 percent production tax. However, he further
opined that the philosophy "shelf the ELF", which means every
field should pay the full 15 percent, goes too far. He
explained that a field paying 0 percent production taxes pays
the same rate when profit margins are thin and when prices
increase. "Despite the name, the ELF ignores the biggest single
economic determinant, and that's price," he said.
REPRESENTATIVE GARA opined the ELF "somewhat disregards" the
production from the satellite fields, which are smaller fields
located around large pools of oil, because the rationale is it's
too expensive for processing facilities to be on every field.
However, since 1989 most of Alaska's oil comes from fields that
don't have processing facilities on them. For instance Tarn,
the nation's 67th largest oil field, is a satellite field that
requires two drill sites and three ten-mile pipelines to
Kuparuk's processing facilities so there is a 0 production tax
at Tarn.
REPRESENTATIVE GARA relayed that currently 25 percent of North
Slope oil is either completely exempted or almost completely
exempted from the state's production tax. In 2006, 250,000
barrels a day will pay less than a 1 percent production tax.
The governor's order effects about 100,000 barrels a day, which
is about 10 percent of daily production, and does not include
the margin effect on Prudhoe Bay. He added that according to
the U.S. Energy Information Administration the price of oil will
be $30 per barrel for the long-term.
8:53:31 AM
CHAIR WEYHRAUCH asked whether the aforementioned order affected
10 percent [of the daily production].
REPRESENTATIVE GARA replied "roughly." In further response to
Chair Weyhrauch, Representative Gara said the information is
cited from the Department of Revenue.
8:53:41 AM
REPRESENTATIVE GARA informed the committee that according to the
Energy Information Administration, "we're in a world" of $30 per
barrel oil over the long term. He related that British
Petroleum (BP) says at $20 per barrel "they're in the world of
windfall profits." According to a BP press release, issued over
half a year ago, profits above $20 per barrel will be
distributed to its shareholders and executives; he opined that
this indicates oil at $20 per barrel is quite profitable.
REPRESENTATIVE GARA turned to the chart entitled, "Thin Profit
Margins?" which shows in FY 04 the oil companies North Slope
profits totaled $3.55 billion and the state's profit share was
$2.5 billion, and thus the oil companies exceeded the state's
revenue by $1 billion.
8:55:35 AM
REPRESENTATIVE GARA turned to the page entitled, "This Year's
Profits?". That document details 2005 North Slope oil prices,
which average $42 per barrel. Therefore, an estimated gross
revenue of $12 billion was produced, of which the oil company's
profits are an estimated $5 billion and exceed the state's share
by $1.8 billion. The aforementioned state's share is estimated
to be $3 billion for the total production taxes, royalties,
property taxes, and corporate taxes, he added. Representative
Gara pointed to the Department of Revenue chart entitled,
"Impact of ELF Changes on Oil Severance Tax with Price
Sensitivity", which details the potential outcomes of severance
taxes with and without HB 63 and the Governor's Aggregation
Order.
8:56:21 AM
CHAIR WEYHRAUCH clarified that none of the slides [in the
presentation] show the total tax burden to producers but only to
the state's take on taxes.
REPRESENTATIVE GARA replied that thus far none of the slides
show the tax burden to the producers, and therefore he said he
will present an excerpt from the Wood Mackenzie study detailing
Alaska's tax burden is lower than the rest of the world. In
further response to Chair Weyhrauch, Representative Gara
clarified that the aforementioned government take refers to the
cumulative tax burden.
8:56:39 AM
REPRESENTATIVE ROKEBERG asked if the producers' gross profits in
the aforementioned example meant the same reference as gross
revenue prior to any other deductions.
REPRESENTATIVE GARA replied: "[Yes], it's not gross profit, it's
total sales price, it's total revenue, and more than half of
that's not profit." In further response to Representative
Rokeberg, Representative Gara said the net profit figures are
from the Department of Revenue, which should explain its
methodologies for estimating the corporate tax cost. He
reiterated that the aforementioned chart shows that at $42 per
barrel, even with the Governor's Aggregation Order, the oil
companies are taking $5 billion in profits from the North Slope.
8:57:32 AM
REPRESENTATIVE GARA turned to the slide entitled, "Healthy
Profits" which details four Wall Street firms net profit margins
in relation to their total revenue, which range from 7-18
percent with an average net profit of 10 percent. In 2005, at
$42 per barrel the North Slope producers will have approximately
40 percent profit margins. In 2005, if oil were to drop to $22
per barrel, the producers would still take a "healthy" 25
percent profit margin. If oil were to "tank" down to $15 per
barrel, there would be a "modest" 6.7 percent profit margin, he
highlighted.
8:58:32 AM
REPRESENTATIVE ROKEBERG related his belief that the
profitability of any investment needs to be analyzed over the
length of that investment, particularly for capital resourcing.
He stated that comparing the quarterly or annualized profit
margins of non-related industries is not a fair comparison
because it offers limited values in terms of analyzing the true
return.
REPRESENTATIVE GARA relayed that he is trying to offer every
possible measure for the committee to assess whether or not
Alaska receives its fair share for oil. He said:
[Alaska] is giving out a whole lot more money than the
state gets, in terms of share. [Alaska] is giving out
a very fair profit margin: 25 percent if oil were to
tank to $22 per barrel, [and] 40 percent this year.
[Alaska] is exempting a quarter of [its] oil from the
state's production tax. Those are three measures.
There will be more, and whether or not you want to
compare the profitability of Alaska's oil companies to
other companies in the world, that's totally
[subjective]. Last quarter Exxon earned the largest
quarterly profit of any corporation in United States'
history because the price of oil has been so high: BP
last quarter [earned] $4.4 billion in profits,
ConocoPhillips [earned] $2.5 billion in profits; just
their last quarter's profits totaled about $15.2
billion and that's about $7 million an hour .... On
the low end Alaska overtaxes ... and according to the
Alaska Oil and Gas Association (AOGA), they say a high
end estimate of what it takes to be profitable in
Alaska is $12.82 oil .... At low prices Alaska
becomes very unprofitable.
9:00:54 AM
REPRESENTATIVE GARA, in response to Representative Gruenberg,
replied that there is an additional profit North Slope pipeline
owners receive for running the pipeline. He said:
I'm not the expert in whether or not the pipeline
tariff is fair ...; I don't believe it is, and frankly
the higher the pipeline tariff, the more profit goes
to the companies and the less comes back to the state
in terms of production taxes and royalties. It gets
deducted from the money that [Alaska] get[s], so if
there is an overcharge in the pipeline, [Alaska's]
losing revenue for it.
9:01:50 AM
REPRESENTATIVE GARA turned to the slide entitled, "Wood
Mackenzie" which details Alaska's profitability according to the
Wood Mackenzie study. The study details that at $35 per barrel,
from 53 oil-producing regions, Alaska is the 14th most
profitable place and at $16 per barrel it's the 15th most
profitable of 49 regions. According to the study the
government's take on Alaska's oil taxes is the 19th lowest out
of 55 regions. For instance, the Alaska average tax on $35 per
barrel is about 58 percent, while the global tax is about 73
percent. He reiterated that as the price of oil rises, Alaska's
relative share decreases because Alaska taxes "poorly" at high
prices and over taxes at low prices.
9:03:12 AM
REPRESENTATIVE ROKEBERG asked why the presentation didn't
include the Wood Mackenzie study page that details Alaska has
some of the highest production costs in the world.
REPRESENTATIVE GARA clarified that the aforementioned study says
Alaska's "raw costs" are higher than most places in the world.
However, the total costs including production, development,
exploration, and taxes for a company to do business in Alaska
are among the least expensive and the most profitable in the
world, because Alaska's tax is so low at high oil prices, he
said. He reiterated that Alaska's [raw] costs are very high,
but its low taxes are very competitive.
REPRESENTATIVE ROKEBERG related that he "does not agree" with
Representative Gara's understanding of the Wood Mackenzie study.
REPRESENTATIVE GARA replied, "That's fine, and I hope that
members of the legislature would maybe work on a study that we
could discuss in public. I don't think it helps us at all to
have a study that we can't talk about."
9:04:51 AM
REPRESENTATIVE GARA moved on to the slide entitled, "How the
bill works - 5% "Minimum Tax", which details the two principal
reforms of HB 63. The first reform "leaves the ELF as is" and
it establishes a minimum 5 percent production tax. The second
reform imposes that oil above $20 per barrel is in the "windfall
profits range" and the production tax should increase
accordingly and below $16 per barrel, when oil becomes less
profitable, the production tax shall be reduced including the
fields with a 5 percent production tax. The second reform
incorporates a price factor into the ELF and production taxes to
reflect the reality that oil is very profitable at high prices
and not at low prices, he added. He noted that if this
legislation were to take effect at $22 per barrel it could raise
$90 million; at last year's price it would raise another $400
million, and this year's price would raise another billion. He
highlighted that the oil companies upside reward would be
protected if prices were to fall to $10 per barrel because the
state would give back roughly $50 million to the oil companies.
9:06:39 AM
REPRESENTATIVE GRUENBERG asked if Alaska were to give money back
to the oil companies wouldn't it be during a period when Alaska
needed that money the most.
REPRESENTATIVE GARA clarified that at $10 per barrel this
legislation would produce $50 million less in production taxes
than not doing anything. He said, "If [the state] want[s] to
have a system that slightly overtaxes at low prices and largely
under taxes at high prices, we can leave things the same. But
... by over pricing at low prices, you're deterring production
... [and] development. You're telling companies that they have
to take the risk that if oil prices tank they're going to lose
money .... And I think we have to share some of the burden at
low prices."
9:07:48 AM
REPRESENTATIVE GARA pointed out that the state and corporate
shares equalized in range, for $10-$50 per barrel, prior to the
Governor's Aggregation Order. Since the aforementioned order,
shares were altered such that the state receives a slightly
larger share than the corporate share. Representative Gara
paraphrased Jay Hammond as follows, "That the intent of Alaska's
oil tax system should have been to give the state roughly an
equal share to industry" but Alaska isn't doing that now.
REPRESENTATIVE GARA reiterated that this legislation includes
tax relief if oil drops below $10 per barrel and a provision
exempting heavy oil because it is more expensive to produce. In
addition, the legislation includes a provision expanding upon
the Royalty Relief law [House Bill 28 of the Twenty-Third Alaska
State Legislature] that if a company can prove the state's taxes
are making a field "uneconomic," the state will reduce that
field's taxes. In response to Chair Weyhrauch, Representative
Gara said the provision would be an administrative mechanism.
He reiterated that House Bill 28 and this legislation both
address whether taxes are making fields economically feasible
and if not, additional relief shall be granted.
9:10:28 AM
REPRESENTATIVE GARA opined that the oil industry tends not to
respond to the legislation [favorably] and neglects to focus on
issues such as the tax relief provision providing incentives for
production and the fact that Alaska is more profitable than
other places in the world. The oil industry responds to tax
reforms by declaring "[the legislature] can't change taxes [on
us] because a deal is a deal." He highlighted that the
legislature passes about 400 bills per session and "A law is not
a deal, a law is [the legislature's] policy judgment as to what
is right and what is fair to Alaskans." He alluded that under
"the deal is a deal argument" all fields would be paying the
original 15 percent production tax and the ELF wouldn't exist,
hence the "deal is a deal argument ... is a red herring."
9:11:18 AM
REPRESENTATIVE GARA, in response to Chair Weyhrauch, said:
[The aforementioned argument is a red herring because]
it assumes that industry is allowed to come to the
government get the best deal it can .... If it can
get a bill that under taxes its oil, then you come up
with a deal is a deal argument and you cement that
into law forever ... government should work better
than that. Government shouldn't have the worst law
possible that is negotiated on the books ... by ...
powerful industry lobbyists. If industry succeeds in
getting ... [an] anti-public interest, pro industry
bill and then says you can never change it, ... then
there is really no reason for us to be here. In 1989,
the same arguments you'll hear today were made then
... in various contents by various companies since
the first time anybody ever suggested an income tax.
But in 1989, they said ..., according to the Senior VP
of ARCO, the changes would put a burden on the oil
industry that will make them remove to other states or
countries, the money that would otherwise be spent on
investments in Alaska.
REPRESENTATIVE GARA suggested that companies often oppose
reforms by claiming reforms will drive the company out of
business or force them to do business elsewhere. He related his
belief that corporations have a legal duty to maximize the
profits of its shareholders, and the legislature has a legal
duty to maximize the tax revenue corporations pay to the state.
He highlighted a newspaper article in which BP claimed it has
too much money to invest, and therefore it returns excess money
to shareholders and/or uses it to provide corporate bonuses.
However, returning revenue to shareholders [contradicts] the
idea that tax reduction provides incentives for returned
investment in the state, he noted.
9:13:45 AM
REPRESENTATIVE GARA concluded his presentation by reviewing
measures necessary for oil tax reform. He said:
[The state is] treating very huge fields ... as if
they were marginal fields ... [and] exempting fields
from production tax even when oil is $50 a barrel ....
At average and high oil prices, according to Wood
Mackenzie, Alaska is one of the more profitable places
in the world to invest .... [According to] the
Department of Revenue's own projections, [Alaska]
produces a very healthy profit margin of somewhere
upwards of 25 percent, 30 percent, 40 percent at $22 a
barrel and above. So, [Alaska] is producing a healthy
profit margin for companies even after they back out
their exploration costs. [Alaska] rank[s] very well
in the world [and it's] exempting oil from very large
fields from the production tax. And ... the other
option is to just do nothing. [The] other option is
to sort of grapple over the crumbs and say [there
isn't] enough money for our schools and we have to cut
back on senior services, and the like; and I disagree
with that. I think that we're making ourselves
poorer. Every single year we sit by, [the
legislature] is running the risk that [it's] sending a
huge amount of money out of the state that could
either be put into needed services or put into our
savings account. [If nothing is changed this year]
according to the Department of Revenue, let's say the
standard is [to] equalize the share that the state
receives and companies receive in terms of profit ...
[then Alaska is] sending out $1 billion. [Alaska]
didn't do anything last year [and] we sent out $500
million in excess tax exemptions .... It's incumbent
upon the legislature to do something about this
problem now, every year that [the legislature] waits
[it's] sending out a huge amount of money from the
state. And my biggest fear ... is that [the
legislature] will finally act on oil tax reform when
oil prices go down to some low level, so [Alaska has]
these couple years where oil is fantastically
expensive and we're missing out. We're missing out on
money we could put into our savings account, ... money
we can put into our schools. I have the biggest fear
that we're not going to get our act together on this
issue until oil is back at $30 a barrel or maybe until
it tanks.
REPRESENTATIVE GARA then turned attention to old Alaska budget
reports from the Alaska oil industry, which charged that
Alaska's tax system isn't progressive enough. The
aforementioned can be attributed to the fact that Alaska's tax
system over taxes at low prices and vastly over taxes at high
prices. Therefore, the oil industry and the state should come
up with a system that doesn't deter or scare away investment at
low prices. He offered that companies considering whether or
not to invest in Alaska factor into their analysis the effect of
oil at low prices. He highlighted that this legislation
protects oil companies on the upside because the production tax
will be capped above 25 percent. He reiterated that the
legislation will protect business on the downside, protect the
profit margin on the upside, and gives Alaska its fair share.
9:18:04 AM
REPRESENTATIVE GARA, in response to Representative Rokeberg,
relayed that the heavy oil provision "can certainly be tweaked"
and the heavy oil standard adopted in this legislation is the
federal definition of heavy oil.
9:19:39 AM
REPRESENTATIVE ROKEBERG related his belief that production below
250 barrels per day zeros out a well, and therefore the proposed
5 percent minimum floor would be incentive to shut down a well.
He added that the administrative action for royalty relief can
be a long process, which, in the mean time, can cause
complications for the corporations.
REPRESENTATIVE GARA replied that the 5 percent tax is a modest
tax and in a situation in which taxes are too high this
legislation provides a system allowing companies entitlement to
tax relief if they can prove it's needed.
9:22:59 AM
REPRESENTATIVE WILSON inquired as to the evidence necessary to
prove taxes are making a company economically unfeasible.
REPRESENTATIVE GARA replied that the legislation specifies that
oil companies are not entitled to tax relief unless they show
clear and convincing evidence it's needed to make a field
economically feasible. The aforementioned, he opined, is a fair
method.
9:24:47 AM
REPRESENTATIVE ROKEBERG opined that there has never been one act
of royalty relief under the current statute.
REPRESENTATIVE GARA related his belief that the aforementioned
is the case because Alaska is a profitable place to do business.
He highlighted the Wood Mackenzie study and the profit figures
from the Department of Revenue which detail that the fields
online are profitable under the current tax structure, and
therefore not entitled to royalty relief.
9:25:59 AM
CHAIR WEYHRAUCH commented that the dialogue on this issue will
be continued at another time, in order for other people to offer
testimony.
9:26:44 AM
REPRESENTATIVE GARA summarized the Department of Revenue's
analysis details, at each price level, the corporate profits and
the state's revenue.
9:27:39 AM
CHAIR WEYHRAUCH surmised that the context of this legislation
addresses that the state overtaxes at low prices and under taxes
at high prices. He asked for an explanation on the
administrative order as it relates to the ELF.
9:28:31 AM
JUDY BRADY, Executive Director, Alaska Oil and Gas Association
(AOGA), relayed that AOGA is a non-profit with 19 members that
are involved in exploration, production, transportation, and
refining of oil and gas products in the state.
9:30:58 AM
TOM WILLIAMS, Chair, Alaska Oil and Gas Association (AOGA),
presented the slide entitled, "Oil and Gas: Vital to Alaska",
which shows a pie chart detailing the FY 05 unrestricted revenue
of which 88 percent is petroleum and 12 percent is non-
petroleum. He said, "Oil is going to account for three-quarters
of the pie ... through 2014 ...," and what determines that
percentage is the price of the oil and how much is produced. He
highlighted that the amount of oil produced requires significant
new investments and Alaska will have to compete with
opportunities elsewhere. Currently, Alaska receives four major
sources of revenue from the oil industry: the royalty,
production, property, and corporate income tax. In FY 04 the
royalty based on ownership of the land generated $1 billion that
was placed in the general fund (GF) and $500 million was placed
in the permanent fund. In FY 04 the production tax generated
$652 million. The property tax is determined by the state's
assessed value of the production, exploration, and
transportation costs; he noted that oil companies receive a
credit for local taxes paid against the state taxes on the same
property, of which most goes to the municipalities. However, in
FY 04 $50 million went to the state. In FY 04 the oil and gas
corporate income tax generated $300 million and accounted for 88
percent of the total corporate income tax. In FY 04, the oil
companies paid $2.75 billion in taxes however, the state only
counts a $2 billion figure in the budget because the permanent
fund and the municipalities' portions are not spendable. He
suggested the amount of taxes paid accounts for a difference in
perspective between the two entities. He added that only the
$652 million portion of the production tax is effected by the
ELF. He said that even if the ELF makes the production tax zero
for a field, the field still pays full royalty and property
taxes, contributes fully to the owners' income taxes, increases
the netback value by lowering tariffs, and creates more Alaskan
jobs.
MR. WILLIAMS turned to the slide entitled, "Production Tax",
which details the formula for the production tax: production
tax equals the ELF multiplied by the base rate, which is then
applied to the gross resource value. The gross resource value
equals the netback multiplied by the taxable volume. He
explained that the netback in FY 04 had the "same spot price" of
$25.00 for all the West Coast destinations, save the netback
value at pump station one totals $20.34.
MR. WILLIAMS said Alaska's leverage regarding the price of oil
flows back to the wellhead value. The base rate during the
first five years of production is at 10 percent for gas and
12.25 percent for oil; after those five years the rate is 15
percent. The oil ELF is calculated depending on the field's
size and well productivity; hence, larger fields with more
productive wells have larger ELFs and higher tax rates, while
smaller fields and lower well productivity have smaller ELFs and
lower tax rates.
MR. WILLIAMS turned to the slide entitled, "Why Have an ELF",
which details that the original purpose of the ELF was for a
high rate production tax early in a typical field's life while
avoiding the adverse consequences as the field depletes. The
severance tax is based on the gross resource value of where it
is produced and none of the operating costs for extraction are
deductible, he added. He said, "As operating costs rise during
the life of the field, the profit margin shrinks [because] the
resource is non renewable .... Production tax contributes to
the total costs and tends to hasten the time when this break-
even point [called the ELF] is reached ...."
MR. WILLIAMS turned to the slide entitled, "The Adverse
Consequences of a High Rate", which shows columns representing
four stages of the producer's gradual profit margin reductions
as the consequence of high operational costs. The producers'
responses to the higher operational costs are the "Do nothing
stage" where the cost is relatively small so the producers don't
respond. The second stage is the "Drive for efficiency stage"
during which the costs are getting to be a significant fraction
so the producer starts cutting costs wherever possible. The
efficiency stage makes new investments harder to be competitive
because the field is not as robust as its earlier years. The
third stage is the "Harvest stage" during which capital
opportunities are no longer possible and no competition exists
to help the field maintain production. The fourth stage is the
"Running in the red stage", which can occur because of low oil
prices or the huge costs terminating the field, such as
dismantling and removing the facilities. He noted that it can
be less expensive to run an operation than dismantling it, which
is how running in the red happens.
MR. WILLIAMS, in response to Chair Weyhrauch, explained on the
aforementioned graph that the color green represents one-eighth
royalty share, red is the 15 percent severance tax, black is the
operation costs, white is the producer's margin, and the hash
marks represent the severance tax being "eaten-up" by the
encroaching production costs. He explained that companies
[bank] on receiving large profit margins early in a field's life
or else they incur [phenomenal] costs with no return.
9:42:50 AM
REPRESENTATIVE SEATON asked if stage one shows any of the costs
associated with production, infrastructure, and drilling.
MR. WILLIAMS replied no.
REPRESENTATIVE SEATON asked if the production costs are a large
portion.
MR. WILLIAMS replied that the columns represent production,
infrastructure, and drilling as a "sum cost".
9:43:40 AM
MR. WILLIAMS, in response to Representative Seaton, recalled
that in the past taxpayers could show that there was a higher
level of cost than what was originally assumed. In 1977, the
Department of Revenue proposed that producers need a certain
amount of oil production to breakeven and the passage of the ELF
legislation increased the assumption to 300 barrels a day per
well based on the Prudhoe Bay costs.
9:45:15 AM
REPRESENTATIVE SEATON asked, for comparison purposes, if there
were [projections] available on the differences between the
Department of Revenue's and ELF's assumptions.
MR. WILLIAMS replied no.
9:45:48 AM
MR. WILLIAMS presented the Department of Revenue's formula that
was not enacted, which is one minus the production at the
economic limit divided by the total production during that tax
period. The aforementioned is the total percentage of costs to
cover the production out of the ground. Subtract the
aforementioned formula from 100 percent, which equals the
percentage that's the operating margin available for the
producer. The wider the operating margin, the higher the tax
rate because the field is healthier. When the operating margin
gets "squeezed" it lowers the tax rate because there is less to
bare the costs. He turned to the slide entitled, "How ELF
Avoided the Adverse Consequences" with four color-coded columns.
The chart shows the difference between the ELF and the
Department of Revenue's aforementioned formula. He reiterated
that in 1977 the Department of Revenue used the aforementioned
formula for simplifying assumptions to ease the cost burden to
the administration.
9:48:16 AM
REPRESENTATIVE GRUENBERG highlighted that the bottom of the
columns present the data as though all the costs are the same.
However, he related his belief that there are at least two types
of costs: those the producer can control and those over which
they have relatively little control.
9:48:47 AM
MR. WILLIAMS said he wouldn't make a distinction between the
costs. He related that some costs are controlled such as
operating a field with fewer employees. However, eventually the
fields, like those in Cook Inlet that have been producing over
40 years, have the minimum required for safety and operations
and thus there is no control because one can't safely run the
platforms below that. He added that the slide simply
illustrates an evolution over time, the easy oil comes first and
as the field depletes, it gets harder and more expensive to
recover the resources.
REPRESENTATIVE GRUENBERG specified he was pointing out it's not
as simple as presented.
MR. WILLIAMS replied "Fair enough."
9:49:46 AM
REPRESENTATIVE SEATON commented that the slide shows that the
ELF reduces revenue to the state, and yet there are still
healthy profits. He inquired as to why, under the stage 2
proposed scenario, would taxes need to be reduced.
MR. WILLIAMS replied that in 1977 the tax rate for Prudhoe Bay
wells at 10,000 barrels per day, before the ELF, was 7.8
percent. The aforementioned represents a 10 percent rate, and
therefore under stage 2 it was still viewed as an increase over
the prior system. The ELF was in conjunction with the tax
increase and the base rate increased to the 12.25 percent
applicable to the first five years of production. He explained
that "we were going" to raise the tax rate for Prudhoe Bay and
the base rate for all fields, and use the ELF to adjust it
appropriately. The stage 2 scenario, in the case of Prudhoe
Bay, would have been a higher tax that that prior to the ELF.
9:51:17 AM
MR. WILLIAMS pointed out that the oil industry opposed the ELF
because Prudhoe Bay's tax rate was increased from 7.8 percent to
11.7 percent. The owners of Prudhoe Bay opposed the hike in
taxes while in contrast the Cook Inlet owners saw a reduction in
their tax rates, and thus were less likely to complain except
for the fact they had interests in Prudhoe Bay. He reiterated
that industry opposed the ELF.
9:52:10 AM
MR. WILLIAMS relayed that the original ELF formula was driven by
well productivity, which was changed in 1989 to add the field
size, total daily production, to the formula. The field size is
compared to a reference level of a 150,000 barrel per day field,
any field larger than the aforementioned causes the ELF exponent
to move toward one and smaller fields would move toward zero.
Thus, larger fields have larger ELFs and smaller fields have
smaller ELFs. The field size is the dominant factor in the
formula, he noted. He recalled the example he offered the
legislature in which the tax rate was based on 500 barrels per
day: Prudhoe Bay's 375,000 barrels daily tax rate was 11.9
percent and Lizburn's 40,500 barrels daily tax rate was less
than 0.2 percent, which illustrates the formula is extremely
sensitive to field size.
9:53:46 AM
REPRESENTATIVE SEATON asked if the previous [change to the
formula] was based on the production facilities having to
fulfill certain volumes in order to be profitable.
9:53:53 AM
MR. WILLIAMS said the justification for adding field size as a
parameter was primarily because large fields can realize
economies of scale that small fields can't. He noted that other
reasons for the changes to the ELF included obtaining more
revenue for the state, providing incentives for smaller fields,
and providing pro-development incentives for West Sak viscous
oil. Furthermore, Prudhoe Bay and Kuparuk could afford it. He
recalled one reason for the change was after the 1986 crash when
oil was priced at $10 per barrel, Prudhoe Bay was costing the
state over $140 million per year and the administration told the
legislature "we shouldn't be giving that money away." He
reiterated that the ELF would reduce rates for all fields except
Prudhoe Bay and Kuparuk. He opined that the definition of
"marginal field", as described in the 1989 ELF legislation, "was
a rhetorical term ... and wasn't used with its dictionary
definition ... if 100,000 barrel a day field that came in early
and under budget ... was a marginal field." He recalled that
the legislature was told the following: the ELF could go to
zero under the new formula, smaller fields would pay less [tax]
even with the same well productivity as larger fields, and the
state would gain $2.7 billion. Therefore, the 1989 ELF change
worked exactly as it intended, he opined.
9:57:20 AM
CHAIR WEYHRAUCH asked if the methodologies were really fair and
whether it's time to review [the ELF].
MR. WILLIAMS replied, "It's not a deal is a deal, that is a
mischaracterization because ... ELF was enacted over the
industry's objections, but ... the legislature sets the tax
policy ... [which was] changed in 1989. Industry has acted in
reliance on the new policy. [The legislature] can change it
again but [the industry] has invested lots of money."
MR. WILLIAMS turned to the graph entitled, "Historical Effects
on ANS Production from Different Kinds of Investment", which
shows the production gain resulting from new investments since
1989. The graph's black portion represents the natural decline
of the fields would have been, the yellow portion represents the
actual production from the North Slope fields, which become less
important over time due to the contributions of wildcat
exploration, heavy oil, and satellite production. The
projections for the future detailed on the graph entitled,
"Contributions of Different Kinds of Investments in Additional
Oil Production" shows a color-coded graph, detailing black
representing the natural decline, yellow representing the
investments for existing fields, and the remainder of the chart
details new investments in wildcat exploration, satellites and
heavy oil production, and developing new fields that have
already been discovered.
CHAIR WEYHRAUCH surmised that Representative Gara's point is
that the oil companies are making the investments, but the state
is not getting any return.
MR. WILLIAMS recalled 1981 when President Carter created a
windfall profit tax in which 70 percent of oil profits were
divided and appropriated such that the state received one-third,
the federal government received one-half, and the oil industry
received one-sixth. He recalled when the ELF passed the state
was concerned about protecting its one-third and basically told
the oil industry to work out its "disproportionate sharing"
between the federal government. He said, "It's interesting how
if you don't know your lessons in history ... how you can
misdescribe what they are."
MR. WILLIAMS then turned to a slide entitled, "Point No. 5",
which highlights that both historically and for the future more
investment is crucial and a given tax change promises to impact
different classes of oil investments differently. Therefore,
any change made must be examined for "unintended consequences"
because more production could be lost than gained by raising the
tax. He said, "Sometimes its better to grow the pie than to
take a wider slice out of it."
10:00:11 AM
MR. WILLIAMS related that the governor's ELF decision lumped
together six smaller fields, which made them all larger for ELF
purposes. Because of the field size component in the formula,
aggregating the fields increased the ELF and raised the tax
rates for all the fields to the same rate. He added that two of
the aggregated fields are West Sak viscous oil. He noted that
American Petroleum Institute (API) gravity is not the
appropriate measure to judge viscous oil but rather centipoise
is. Centipoise is the measure determining how viscous the oil
is, meaning how slowly it transports from the ground into the
wells. He informed the committee that high viscosity oil is a
function of its temperature and its characteristics. He said
viscous oil also produces lots of silt and currently over 1,300
cubic yards of silt have to be dug out of the separators
producing West Sak oil and be disposed of somewhere else, which
is a very expensive process.
10:01:23 AM
MR. WILLIAMS related that AOGA opposes this legislation because
it's a structural increase. The Department of Revenue's long-
term forecast is $25.50, which is a 27.5 percent structural tax
increase. This legislation raises the cap rate two-thirds from
15 percent to 25 percent. The proposed 5 percent minimum is a
heavy burden on satellite development. This legislation fails
to protect the West Sak viscous oil because it uses the wrong
measurement, he opined. He said the legislation is not very
balanced because at the assumed high price of oil the industry's
tax increases to $500 million or $1 billion, while the state
offers a tax relief of $50 million when prices are low. He
related his belief that if oil prices drop, it's not likely that
the state will give back $50 million to the industry. He opined
that if oil dropped $12-$15 per barrel, then two-thirds of the
revenue accounting for 80 percent of the GF budget will
disappear. He relayed that a structural increase of 27.5
percent makes Alaska's investments less competitive. Alaska has
$20-$30 billion worth of investments to develop over the next
decade; therefore, it's crucial for the state to remain at a
basically flat production level of 850,000-900,000 barrels per
day, which is going to take a huge amount of investment and
those investments have to compete against opportunities
elsewhere, he noted. He alluded to the fact that when the oil
industry profits, so does the state government.
10:04:15 AM
MS. BRADY added the oil industries fought the introduction of
the ELF because in 1989 it would raise an additional $2.5
billion over the next ten years from Kuparuk and Prudhoe Bay.
She relayed that a production plan was intended so that when 2.1
million barrels per day fell to less than 1 million, like it is
today, there wouldn't be fiscal issue. Therefore, the state
anticipated the drop in oil production and it taxed the huge
fields then, and now those fields produce half of that amount.
The satellite fields and heavy oil started production five years
ago under the ELF proposals and already the state is proposing
changing the rules again. She reiterated that the state
received the revenue it intended to get from Prudhoe Bay and the
development of the new satellite fields. She said, "We have in-
built price benefit to the state, that's why we don't have the
prices right now from high prices ... ELF is working as well as
you can expect a state tax system to work and many places in
Canada look at Alaska as the model for taxation. We're going to
make more money this year in oil revenues then we have since
1981, and at that time we were producing almost half million
barrels a day more than what we are producing now."
10:06:21 AM
REPRESENTATIVE ROKEBERG asked what impacts would an adoption of
this legislation have on the negotiations regarding the gas
pipeline.
MR. WILLIAMS replied AOGA can't comment on that because it's not
involved in the aforementioned negotiations.
10:07:10 AM
REPRESENTATIVE ROKEBERG asked if the legislation's proposed 5
percent minimum tax would not only have a heavy burden on
satellite development but would also effect any well mirroring
the ELF in terms of lower productivity. He further asked
whether it would tend to be a disincentive for an early "shut-
in" of a particular well notwithstanding the impacts on the
entire field.
MR. WILLIAMS specified that the ELF works on a field basis as
the average well productivity rather than on a well-by-well
basis.
10:07:57 AM
REPRESENTATIVE ROKEBERG requested that the Department of Revenue
execute an analysis on the effects of this legislation. He
related his belief that the legislation would change state
policy regarding the government's take on the low end. He
recalled testimony stating that the state could lose two-thirds
of its current revenue at the lower pricing scale. He then
asked about the relative costs of production in Alaska versus
other provinces.
MS. BRADY relayed that the state has procured Chuck Logsdon to
analyze the Wood Mackenzie study. The aforementioned study used
different fields and timelines than those in previous studies.
She surmised that the state will be interested in the different
price scenarios used to determine internal rates of return. She
related her belief that Representative Gara misspoke about the
aforementioned study's operation costs and benefits for
operating in Alaska. She said, "the look out the window test"
shows a high level of reserves and a low level of investors in
Alaska. In 2004, AOGA had 21 members and lost 2 large
companies, Total and EnCana. If Alaska were as profitable as
Representative Gara related, there would be 20 companies and
every independent company in the world looking at Alaska.
However, that isn't the reality, she added.
10:11:28 AM
REPRESENTATIVE ROKEBERG asked if public information could be
used to compare Alaska with the Gulf of Mexico. He opined that
both places are North American provinces with different
government takes and economic profiles. He related his belief
that although the capital costs may be similar because of the
high initial investments, the tax regimes may put Alaska at a
disadvantage.
10:12:10 AM
MS. BRADY replied, "[AOGA] can verify that ... [when the Gulf of
Mexico] makes finds [they make] big finds ..., the government
take is low; its about half of what Alaska's is and that makes a
huge difference." She recalled the graph where the white
represents the producer's profit margins, which have to be made
up fast to compensate for the previous investments. She opined
that the oil industry is similar to the movie industry because
both need to make back the capital costs quickly. This country
lets the companies take all the risk and then hopes to get the
payback in a short period of time, she said. In 1986 to 2003,
oil prices averaged $17.70 and at that price the state received
46 percent; the government, state and federal, received 64
percent. Therefore, during that time the companies didn't make
much and there weren't many new investments in the state. The
state may have made an error by changing the ELF in 1989 and
taking that "big of a chunk", she opined. Currently, the state
is going to count on more investment than has been present since
the early 1980's. The Department of Revenue says the state
needs more investment than it's ever had because such
investments would keep the loss of production to under 800,000
barrels per day, which is the least amount of production ever
lost. She said that the state lost 1 million barrels daily from
1989 to 1999, another 400,000 barrels daily between 1999 and
now. The state needs to maintain a minimum loss less than
200,000 barrels daily or find more oil in order to be
profitable, she explained.
10:14:51 AM
REPRESENTATIVE ROKEBERG asked if Ms. Brady is testifying that
the ELF has or hasn't worked for creating an investment
environment.
MS. BRADY replied that the ELF worked, but the rate may have
been too high in the beginning after which there was a long
period of low prices.
10:16:04 AM
REPRESENTATIVE ROKEBERG commented that since 1999 the
investments in the industry have stabilized production levels,
and thus policies are balanced because it has maintained the
flow of production.
10:16:27 AM
MR. WILLIAMS answered that there were continuous investments in
the larger fields like Kuparuk and Prudhoe Bay despite the
change in higher tax rates. Since 1989, the oil industry has
been able to stabilize production and level off with no decline
after 1999 because of investments in large fields, satellites,
heavy oil, and wildcat exploration. The aforementioned
investments will continue to increase in the future in order to
maintain a stabilized level.
10:17:55 AM
REPRESENTATIVE ROKEBERG asked if the heavy oil projections
should be updated to FY 05 because the current production is
below the projections.
MR. WILLIAMS answered that he doesn't know [if the current
production is below the projections]. However, he agreed that
the heavy oil projections need to be updated because of the
technology breakthrough last August that allows drilling lateral
wells.
10:18:35 AM
REPRESENTATIVE ROKEBERG asked if currently Alaska is about
50,000-75,000 barrels per month below its former production.
MS. BRADY answered, "I believe that is right."
REPRESENTATIVE ROKEBERG asked if the aforementioned decline was
due to production glitches last year.
MS. BRADY relayed that generally there was a loss in production.
She said she was unaware of the specific reasons.
REPRESENTATIVE ROKEBERG questioned whether it is a long-term
trend.
CHAIR WEYHRAUCH announced that, if necessary, this discussion
would continue during the summer.
[HB 63 was held over.]
ADJOURNMENT
10:19:16 AM
There being no further business before the committee, the House
Special Committee on Ways and Means meeting was adjourned at
10:19 a.m.
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