Legislature(2005 - 2006)SENATE FINANCE 532
03/04/2006 10:00 AM Senate FINANCE
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| Hb488 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
MINUTES
SENATE FINANCE COMMITTEE
SENATE RESOURCES COMMITTEE
March 4, 2006
10:03 a.m.
CALL TO ORDER
Co-Chair Lyda Green convened the meeting at approximately
10:02:11 AM.
PRESENT
Senate Finance Committee:
Senator Lyda Green, Co-Chair
Senator Gary Wilken, Co-Chair
Senator Fred Dyson
Senator Bert Stedman
Senator Lyman Hoffman
Senator Donny Olson
Senate Resources Committee:
Senator Tom Wagoner, Chair
Senator Fred Dyson
Senator Bert Stedman
Senator Ben Stevens
Senator Kim Elton
Also Attending: SENATOR GENE THERRIAULT; SENATOR GARY STEVENS;
SENATOR GRETCHEN GUESS; JIM EASON,
Attending via Teleconference: There were no teleconference
participants.
SUMMARY INFORMATION
ACTION NARRATIVE
AT EASE 10:29:03 AM.
SB 305-OIL AND GAS PRODUCTION TAX
HB 488-OIL AND GAS PRODUCTION TAX
The Joint Committee heard a presentation on the companion bills
by a consultant to the Legislative Budget and Audit Committee.
No action was taken on the legislation.
SENATE BILL NO. 305
"An Act repealing the oil production tax and gas production
tax and providing for a production tax on the net value of
oil and gas; relating to the relationship of the production
tax to other taxes; relating to the dates tax payments and
surcharges are due under AS 43.55; relating to interest on
overpayments under AS 43.55; relating to the treatment of
oil and gas production tax in a producer's settlement with
the royalty owner; relating to flared gas, and to oil and
gas used in the operation of a lease or property, under AS
43.55; relating to the prevailing value of oil or gas under
AS 43.55; providing for tax credits against the tax due
under AS 43.55 for certain expenditures, losses, and
surcharges; relating to statements or other information
required to be filed with or furnished to the Department of
Revenue, and relating to the penalty for failure to file
certain reports, under AS 43.55; relating to the powers of
the Department of Revenue, and to the disclosure of certain
information required to be furnished to the Department of
Revenue, under AS 43.55; relating to criminal penalties for
violating conditions governing access to and use of
confidential information relating to the oil and gas
production tax; relating to the deposit of money collected
by the Department of Revenue under AS 43.55; relating to
the calculation of the gross value at the point of
production of oil or gas; relating to the determination of
the net value of taxable oil and gas for purposes of a
production tax on the net value of oil and gas; relating to
the definitions of 'gas,' 'oil,' and certain other terms
for purposes of AS 43.55; making conforming amendments; and
providing for an effective date."
HOUSE BILL NO. 488
"An Act repealing the oil production tax and gas production
tax and providing for a production tax on the net value of
oil and gas; relating to the relationship of the production
tax to other taxes; relating to the dates tax payments and
surcharges are due under AS 43.55; relating to interest on
overpayments under AS 43.55; relating to the treatment of
oil and gas production tax in a producer's settlement with
the royalty owner; relating to flared gas, and to oil and
gas used in the operation of a lease or property, under AS
43.55; relating to the prevailing value of oil or gas under
AS 43.55; providing for tax credits against the tax due
under AS 43.55 for certain expenditures, losses, and
surcharges; relating to statements or other information
required to be filed with or furnished to the Department of
Revenue, and relating to the penalty for failure to file
certain reports, under AS 43.55; relating to the powers of
the Department of Revenue, and to the disclosure of certain
information required to be furnished to the Department of
Revenue, under AS 43.55; relating to criminal penalties for
violating conditions governing access to and use of
confidential information relating to the oil and gas
production tax; relating to the deposit of money collected
by the Department of Revenue under AS 43.55; relating to
the calculation of the gross value at the point of
production of oil or gas; relating to the determination of
the net value of taxable oil and gas for purposes of a
production tax on the net value of oil and gas; relating to
the definitions of 'gas,' 'oil,' and certain other terms
for purposes of AS 43.55; making conforming amendments; and
providing for an effective date."
Presentation by Legislative Consultant Jim Eason
On
Proposed Oil and Gas Production Tax
10:43:15 AM
JIM EASON, Legislative Consultant, detailed his background in
the petroleum industry and government. His testimony was
outlined in a handout titled, "Presentation by Jim Easton" [copy
on file].
Mr. Eason read a quote from Page 2 of the handout into the
record as follows.
Who Said It … and when?
Since discovery of oil in commercial quantities on the
Kenai Peninsula in 1957, two great interrelated
responsibilities face the Legislature. One will be that of
encouraging future exploration and greater production.
Greater cost factors such as those incurred in reaching and
developing inaccessible fields may affect Alaska's
competitive position in world markets. We will wish to
consider how far to go in creating a favorable investment
climate toward attracting new payrolls and realizing rental
and royalty income for the state.
Mr. Eason attributed this statement to former acting Governor of
Alaska Wade, on the occasion of Alaska's first State of the
State address of January 1959.
Page 3
The Challenge
· Your responsibility is not unique - but you are
relatively better situated because you have the
benefit of historical perspective.
· Among your considerations, there is only one certainty
- your numbers are wrong, but not necessarily bad
· Why are your numbers wrong?
o Geological uncertainty
o Production volume forecasts
o Price forecasts
o Failing to identify and quantify the range and
magnitude of credits and deductions
· Not much control of these uncertainties - best
judgment.
· Your choice of words, however, can reduce fiscal risk
and provide greater certainty.
Mr. Eason stated that the legislators are not in a unique
position in revisiting how to balance the states interests in
promoting and benefiting from exploration of oil and gas. This
history is almost 50 years. The questions have always been hard.
However, the legislators have the benefit of the past 50 years'
efforts that was not available to earlier state leaders.
Mr. Eason intended to discuss this history in his presentation,
as several members might not be familiar with the major concerns
of past efforts, particularly litigation that has shaped oil and
gas law in the state.
10:48:07 AM
Mr. Eason qualified he is not an attorney and does not intend to
interpret law. However, in his capacity as a State employee, he
attempted to "unravel some of the problems that had been
created".
Mr. Eason announced that this presentation would contain "no
numbers", but would instead focus on the language.
Mr. Eason stressed the one certainty of the proposals before the
legislature is that the figures were incorrect. This is not
necessarily a negative. However, some would advise on the best
way to interpret those figures and understanding that the
figures were incorrect would be important in considering this
advice.
Mr. Eason stated that geological uncertainty is one reason the
figures were incorrect. A unique combination of events must
occur before oil and gas could form, and more unique events must
occur for that oil and gas to migrate to a trap and be
discovered by someone possessing the ingenuity to extract it.
The vast majority of discoveries are not commercial.
Mr. Eason remarked that this situation would not change
significantly with incentives. Exploration would expand and more
discoveries would occur. But assuming quantification of this
would be a mistake. Each legislator has a different level of
reliability on the information provided.
10:51:04 AM
Mr. Eason listed another uncertainty as the production volume
forecast. Significant modeling has been presented to demonstrate
the Department of Natural Resources' and consultant's
predictions. But in reality, the spectrum of production
forecasting varies from: known reserves that have been producing
for some time, to forecasting undiscovered resources.
Forecasting known reserves could be relatively accurate, while
forecasting undiscovered resources is highly speculative.
Mr. Eason reminded that the legislature is aware of the
variations of price forecasts, as these are addressed each year.
Mr. Eason cautioned that the aforementioned uncertainties could
not be controlled. Additional sampling and undertaking "things
around the margins" could improve the reliability of engineering
and geological assessments, "but you can't put oil where it
isn't and you can't put gas where it isn't either".
Mr. Eason stated that focusing on the language of negotiations
and statutory changes could assist in controlling expectations
and economic assumptions.
Mr. Eason stressed the importance of reviewing and understanding
past situations. His concerns with proposed language are based
on the history of prior oil and gas relationships.
Mr. Eason emphasized his comments are not intended to imply that
any of the past relationships are bad or one-sided, but rather
are normal commercial relationships. A tension exists between
the State as leaser and tax authority, and the lessee that pays
the tax and royalty. This tension is inevitable.
Mr. Eason indicated that the language of any agreements could
lessen this tension.
10:54:40 AM
Mr. Eason spoke of the inevitable tensions that would develop
between statutory changes and the reaction those changes create.
Page 4
· Cook Inlet example - "wells" versus "completions"
· North Slope example - the disaggregation and
aggregation issue.
· ANS Litigation History - the past can be the key to
the future.
· The most costly words - the ANS royalty litigation.
· Where and how - "at the well" and in a multitude of
ways.
Mr. Eason began with the situation involving resource
development in the Cook Inlet. The economic limiting factor
(ELF) has been in effect for several years. The assessment that
ELF has not been sufficient for the State in recent years has
become apparent. An obvious reason relates to disaggregation and
aggregation effects. Previous problems also demonstrate how
language could be used to produce a different result for
affected parties.
Mr. Eason told of an incident involving producers operating in
Cook Inlet whereby a policy was adopted to change the way wells
were characterized resulting in a lower ELF. Agreement would be
likely among legislators about the definition of a well: "a hole
in the ground" that could access oil, gas, water, etc. However,
a practice developed to consider the number of completions
inside a well to determine the number of wells present. That
affects the calculation of ELF, and reduces the State's revenue.
Mr. Eason gave another example as the aggregation affect from
the recent changes in Prudhoe Bay taxation for oil development
activities. The matter of disaggregation that preceded this
received less attention. For a number of years, the Prudhoe Bay
development was treated as a "very large field", and then a
practice began in which segments of that field were named as
individual fields as they were newly delineated or extended. The
issue is a question of interpretation. The decision makers "on
both sides" involved were "differently positioned"; some
ascertained these were not new fields, others contended they
were. Forethought could have avoided this problem and early
discussion could have resolved the dispute sooner.
Mr. Eason next addressed large problems and the lessons they
could provide. The most famous was the ANS royalty litigation.
10:58:17 AM
Page 5
The Lessons
· Milestones in the ANS Litigation.
o ANS field cost allowance settlement (1980)
o TAPS Agreement - "just and reasonable rates"
(1985)
o Royalty Settlement Agreements (early 1990's)
· One common lesson learned - reasonable opportunity to
revisit fiscal provisions critical to long term
satisfaction
o ANS field cost allowance history and magnitude
o TAPS Settlement
o Royalty Settlement Agreements
Mr. Eason provided a history of the ANS litigation. In 1959 as
the State was considering a competitive leasing program the
language of the federal leases was reviewed and regulations and
a draft lease form were adopted based on the federal example.
Shortly after drafting the lease form, the assistance of a
consulting attorney from San Francisco was offered. This
attorney represented a famous law firm with offices located in
the Chevron Building. With the participation of this attorney,
some terms were changed, including terms pertaining to "value"
and how price would be established. This created a situation in
which the State could benefit relative to other leases, but it
also introduced a "series of questions", which became an issue
when production was beginning in 1977. The terms were costly and
were based on how and where the State's royalty would be valued.
Mr. Eason said the issue appeared simple but was not, and
resulted in litigation that lasted 17 years and cost "untold
millions of dollars."
Mr. Eason defined the debate as whether the "State's oil" would
be "valued at the well", as the language of the lease actually
said, or that the value would be determined when the oil reached
the "edge of the unit or field", as intended by the lease
drafters. Also at issue was determining the allowable and
reasonable transportation down the pipeline and on marine
vessels, as well as how to value the different trades,
exchanges, external sales and other transactions made before the
oil reached "distant markets".
11:01:40 AM
Mr. Eason informed that immediately upon production in 1977, it
became apparent that all the lessees operating on the North
Slope had different interpretations of the language. The amounts
they reported for their royalties reflected this. At the time,
this was "unfathomable" for State officials to understand.
Mr. Eason related that the process began to settle this matter
in the court. "Obviously, those few words grew into a host of
separate issues." Over a number of years, the State and the
defendants argued and attempted to resolve all the issues.
Mr. Eason told of several "milestones" achieved during this
process. An early decision ruled that the State did have some
obligation to participate in the payment of fuel costs and
processing costs of oil if the oil was taken "in kind". This
resulted from a provision inserted by the consulting attorney
that allowed payment in kind, but failed to indicate the State's
obligation for processing costs.
Mr. Eason continued that interest was expressed in the process
of refining during the time of the aforementioned court
decision. The judge's decision included a ruling that although
the State must pay an in kind processing fee, doing so could
violate the legislative direction and therefore the State must
calculate the loss. As a result, the producers negotiated a
settlement in 1980 called the ANS Fuel Cost Settlement. The
State agreed to pay 43 cents per barrel for processing fees.
Similar arrangements were made for gas production.
Mr. Eason pointed out that an "escalator" formula was adopted
that provided for adjustment of the producer price index. Over
time, that amount has increased to the current cost of almost
one dollar per barrel. The State must determine how to proceed
with future development of gas and oil.
Mr. Eason listed a second milestone of the litigation process as
a determination of the method of calculating a tariff for the
Trans-Alaska pipeline.
Mr. Eason surmised that most agree that the "State's decision
may have been deficient in some respects." Whether this is true
is subject to individual interpretation. The decision was made
at a time when expectation was that Prudhoe Bay contained a
certain amount of reserves, a certain amount of costs would be
involved and that additional production could occur. The record
of these calculations is limited. The decision resulted in a
tariff recently determined to be high, and that could not be
changed by the State for some time and which the State must
defend in the event of other challenges. This has been a major
impediment for third party lessees and other producers.
Intentions were good, but the provisions were inadequate.
Mr. Eason noted that near the end of the litigation process, the
State appointed a team of negotiators to attempt to resolve the
outstanding oil and gas issues before the final court date. This
resulted in a series of royalty settlement agreements reached
with Atlantic Richfield Corporation (ARCO), British Petroleum
(BP) and Exxon.
11:06:22 AM
Mr. Eason detailed that these agreements "substituted for the
disputed value and price language of the lease" and created a
new system in which the parties negotiated individual valuation
provisions for each contract. All three agreements were based on
a "basket of crude oils and an evaluation of the differential
movement of the averages of the daily spot prices for those
crude oils month-to-month, adjusted for transportation, marine
transportation, Trans-Alaska Pipeline System (TAPS) tariff,
quality bank and other costs to move them back to the North
Slope." These agreements also included a reopening provision, as
each party realized "it was highly unlikely" that all parties
would be satisfied in the long-term.
Mr. Eason pointed out that this was an entirely new system. The
State had limited experience, in some cases because of the
unique mixture of the baskets.
Mr. Eason asided that the North Slope lessees not involved in
the litigation were offered a one-time opportunity to select one
of the three settlements to apply to their calculation of
royalty. That process has continued. A number of reopeners have
occurred in all three of the major producer settlements. One
pending reopener is beginning a second arbitration. Arbitration
is provided in each settlement.
Mr. Eason relayed opinions "from both sides" judging the
settlements as good, as producing fair value for the parties,
and that the mechanisms adopted have worked and served well in
identifying and resolving problems. Most of the decisions and
compromises have been reached without formal arbitration.
Mr. Eason reiterated that the three settlements all included an
arbitration procedure.
Page 6
Examples of Concerns
· Point of Production
· Definition of Gas Processing Facilities
· Definition of Gas Treatment Facilities
· The unknown relationship of terms to a stranded gas
contract
· The unquantified but major deduction and/or credit
exposure - "abandonment"
· Pending Questions
Mr. Eason next addressed his concerns with the proposed
legislation, based on the prior litigation experience and the
understanding of the impact of the language.
11:10:59 AM
Mr. Eason noted that value would be measured at the point of
production. The point of production determines "where the
obligation to the State begins" because the State would not be
assessed a portion of the production costs for activities before
the point of production. Postproduction is different.
Mr. Eason spoke to the complexity of activities within the
processing facilities on the North Slope, which State officials
had not focused on. The design and layout of gas treatment or
processing plants is not standardized.
Mr. Eason cautioned against allowing producers to construct and
operate these facilities solely for the benefit of changing the
value.
Mr. Eason qualified that the legislature has been requested to
not consider the implications of a possible natural gas pipeline
proposal in context with this bill. However, the
interrelationships and linkages between the terms of that
contract could impact the interpretation and administration of
this bill. The definitions for gas treatment plants and gas
processing facilities are new. The State would be vulnerable
without a full understanding of how the parties intend to
administer this, as well as an understanding of how the
facilities would be designed and built. This question has been
posed in writing and to date an answer has not been provided.
Mr. Eason remarked that the processing and treatment facilities
serve several purposes, which affect oil and gas. An allocation
and attribution of cost is "sometimes just unique" to a
particular facility. Understanding the impacts of this would be
important. Because he did not have sufficient information, he
could not advise on the implications on the costs of deductions
and credits.
Mr. Eason identified another potential concern as the "breadth
of the language allowing deductions for essentially all
qualified expenses for exploration, production and development."
Existing definitions of oil and gas terms demonstrate multiple
ways to assess exploration, production and development. An exact
listing of the qualified expenses is essential.
11:14:32 AM
Mr. Eason informed that some independent processors share this
position.
Mr. Eason stated this issue relates to tension between
departmental regulations and legislative statute and would be
worthwhile to establish. The cost ramifications could be
significant.
Mr. Eason spoke of the likelihood that the State would be
responsible for abandonment costs under the provisions in this
bill. This was confirmed in a written response issued by the
Department of Revenue, in which the Department indicated it did
not have any estimate, nor had it modeled any estimates of those
costs for the purposes of pricing. The reason was cited that the
Department did not have empirical data necessary to calculate an
estimate. The amount is significant.
Mr. Eason understood the legislature was considering allowing
deductions and credits for exploration, production and
development expenses for every well drilled and for capital
facilities. Securing a "proxy for these kinds of numbers" is
possible. The "number is large enough" for him to recommend
doing this.
Mr. Eason asserted that the State has no obligation to
participate in the cost of abandonment of the facilities
currently in place. This cost is assumed and recognized by lease
purchasers. Federal and State tax provisions allow certain
deductions for abandonment expenses. This legislation would
allow deductions and potentially credits for those costs.
Mr. Eason indicated the absence of public information regarding
the 16 platforms located in the Cook Inlet. The US Geological
Survey conducted a study two or three years prior on the
platforms located along the coast of the state of California.
Some of the facilities are large and sophisticated with loading
facilities, which are unlike any that would operate in Alaska.
Without defining the monetary reference, he stated that the
smallest platforms operating near California "were at $10.3
million up to about $129 million". The majority, 12 of 23, were
somewhat less than $30 million "but still big numbers.
Mr. Eason emphasized other factors must be considered in the
decision to abandon, including transporting heavy lift vehicles
to Alaska. Efficiencies could be achieved by having a number of
abandonments done in the same season. However, the actual costs
are unknown and would be significant. He cautioned against
allowing a situation "on the revenue stream of a magnitude and
timing that would be unfortunate."
Mr. Eason noted indications of companies' understanding of their
responsibility for the cost of abandonment of facilities located
in Alaska where they have net profit share leases. The Division
of Oil and Gas records provide information about the actual
abandonment cost calculated against net profit.
Mr. Eason related that "Endicott" had a net profit share
allowance of $110 million in 1995 for abandonment of "those
facilities". The Division contends the amount is high and that
the amount reflected the cost of abandoning the island on which
the facility was located. Questions were raised about whether
the federal Environmental Protection Agency and other agencies
would "require that" or whether the "island would be simply
stripped of its armor and just be allowed to go back to nature."
Mr. Eason stated, "assuming the best case they were still
looking at about $60 to $80 million. In the case of Endicott,
11:20:04 AM
Mr. Eason continued that the Division has other evidence from
submitted applications for royalty productions. Although the
identities of the companies were confidential and the specific
allocations the companies estimate as "proper" could not be
revealed, the "numbers that they have represent seven to 20
percent of the total facility plus well costs for these
developments."
Mr. Eason referenced "North Star" as having "$75 million",
noting, "the public information on that was… around a billion
dollars for development." Therefore seven to 20 percent as
estimated by the Department of Natural Resources, should be
considered in terms of "the world" from "Swanson River, across
Cook Inlet, to the North Slope, because there are a lot of
facilities that are going to have to be abandoned." Uncertainty
exists of what the requirements would be, but "people's view"
could provide an estimate in a "collective sense" to ascertain
"what kind of exposure you've got there."
Mr. Eason indicated the attempts to identify and address "larger
potential issues". The joint resources committees have posed a
series of questions.
Mr. Eason qualified that some information was outstanding and
would hopefully be received to provide greater clarification.
Page 7
Recurring Historic Themes
· The use of the unit operating agreements
o Substantial weight (see Sec. 21, pg. 12)
· The adoption of royalty settlement methodologies (see
Sec. 20, pg. 10)
· Arbitration
Mr. Eason noted that these themes have arisen in the context of
settlement negotiations on behalf of the Department of Natural
Resources, and unit negotiations "to create a unit" or discuss
development plans, and in the context of royalty settlement
agreements, which he helped negotiate for the State.
Mr. Eason asserted that a "slight red flag" arose as he
considered this bill relating to the reference of the "unit
operating agreement" as one indicator of cost. He was not
concerned that the unit operating agreement would be reviewed,
as current authority provides for this and all factors
indicative to qualify deductions should be considered. However
substantial weight should not be given to the one factor through
legislative directive. He did not understand the implications.
Mr. Eason pointed out that the State has no authority to change
the working unit operating agreements between parties or require
renegotiation. He detailed the processes of these agreements and
the multiple changes that occur.
Mr. Eason recommended legislative preference be retained.
Mr. Eason expressed additional concern with language included in
Section 20 of the bill that references the royalty settlement
agreements negotiated by the Department of Natural Resources as
one indicator of value. Currently the Department of Revenue has
broad authority to assist its efforts in determining the value
of the royalty that would be reduced by transportation and other
expenses. Relative to the Department of Natural Resources, "it's
an extraordinary position" because the Department had to rely on
the terms of the contract, which were disputed. A settlement of
this dispute was necessary if the State were to "get anywhere".
The Department of Revenue is in a stronger position due to
significant precedent, court reference and its decisions are
"usually pretty strong and pretty well defended."
Mr. Eason stated that although the royalty agreements have
"worked well and performed well, they have not performed as well
financially over time." The Division of Oil and Gas and the
Department of Revenue provided data that indicated that the
first ten years of those settlement agreements, with the
exception of a two-year period, the tax severance value has been
higher. In the most recent period of 2001 through 2005, the
difference has been consistent and about 40 cents per barrel
more "on the severance tax side on average than the royalty
side". This could increase.
11:26:50 AM
Mr. Eason was also concerned that because the linkages between
this agreement and the potential gas agreement are unknown, the
settlement methodologies referenced by the Department of Natural
Resources also contain arbitration provisions. Whether this is
relevant to the Department of Revenue at this time is uncertain.
Arbitration, if it were used in a tax setting, would not provide
the same protection as the State currently has. The arbitration
provisions, although different for the three major settlements,
remove the dispute from the "normal administrative and judicial
arena where the Department of Revenue has some deference" and
transfer the disputes to a "relatively unpredictable arena" with
limited discovery. If the issue were highly technical, the case
would be difficult to "make" because of differences in timing
and record building relative to the status quo.
Page 8
Recommendations
· Take the time to confirm the lessees' AND the DOR's
intent where there is an ambiguity
· Expect linkages and try to understand how they may
affect or be affected by future events
· Take advantage of your "extra eyes".
Mr. Eason overviewed the recommendations and concluded his
presentation.
Senator Therriault attempted to understand and appreciate the
importance of the point of production. The location of the point
of production would affect the transportation costs, a portion
of which the State would be responsible for offsetting, or would
affect the up field expenses that would be deducted from net
income. Yet the State has no control over the structure of the
processing equipment. He requested more information on the point
of production. Two different systems exist: the royalty tax
system and the taxable income system. The location of the point
of production impacts the two systems.
11:31:41 AM
Mr. Eason replied that it was a "matter of law" with precedence
established through the Department of Natural Resources and in
court decisions. Senator Therriault described the issue
correctly with regard to the location of the point of production
determining value.
Mr. Eason suggested having an understanding of the current point
of production for tax purposes and to determine whether the
point would change for anticipated facilities for a North Slope
"gas sale".
Senator Therriault cited a question the consultant had submitted
to the Department of Law asking, "please provide and identify
the point of production at each unit in the State under existing
statutes, regulations, agreements - provide the same under the
definition as proposed." A response was forthcoming. He surmised
this request is to review the history and understand the
complexity of the different fields. He asked if the witness
suggested that this history could influence a determination as
to where the point of production should be for future projects
to alleviate some of the uncertainty.
Mr. Eason recommended the identification of whether or not the
change of definitions and factual circumstances combined with
the construction of new facilities would change the State's
obligation. It is a question of "relative effects". The changes
are proposed without a full discussion of the rationale and the
implications of potential linkages for an agreement "that
everyone knows is finished and is waiting to see." With the
exception of the negotiators, the producers' intentions for the
location of point of production are unknown.
11:37:02 AM
Senator Dyson asked the range of the volume reduction per barrel
that occurs between the wellhead and the edge of the field after
"taking out" the water, municipal gas and other "things".
Mr. Eason could not provide an answer at this time. Water
content is growing over time and other factors are occurring on
a continuum. He deferred to an engineer currently involved in
the measurement and processing.
Senator Dyson asked if the range is approximately ten to 30
percent.
Mr. Eason estimated "the low end".
Senator Therriault referenced Section 20 of the bill on page 11
and subparagraph (1) on lines 6 and 7 that provides "a royalty
value determined under a royalty settlement agreement between
the producer and the state, with adjustments if appropriate".
Different methodologies are used by the Department of Revenue,
the Department of Natural Resources, and the federal Department
of Interior. The proposed method would be the "lower of all
three" and he has been told the amount would be up to one dollar
per barrel, which he considered substantial. He asked for an
explanation of the variations over time.
Mr. Eason informed he has seen adjusted and unadjusted data on
the "royalty side". The lessees would have authority under the
agreement to adjust for certain errors and omissions, which is
"bookkeeping" to account for physical measurements. Preliminary
data indicated "some delivery timing issues on the tax side that
really left sort of an apples to oranges comparison." He
suggested that the database would include "some high numbers".
The 2000 through 2005 period included some relatively high
figures that were unadjusted. However, the finalized figures
were approximately 40 cents per barrel on average.
11:40:57 AM
Senator Hoffman recounted statements asserting, "ELF isn't
working". He asked the point the current system failed, whether
it was when the price of oil exceeded $40 or $50 or another
factor. He questioned the July 2006 effective date of this
legislation and instead proposed a retroactive implementation.
Mr. Eason indicated this was a broader policy issue, which he
deferred to the Murkowski Administration. This bill would change
to a tax based on profits from the current tax based on
production. The current system was adequate before the resource
development at Prudhoe Bay was aggregated.
Senator Hoffman remarked that the policy question must be
addressed; whether to make this legislation effective on July 1,
2006 or the date at which oil prices reached $50 per barrel.
Mr. Eason indicated that an analytical and mathematical
examination of the issue could be undertaken.
Senator Elton referenced the witness' statements that this
legislation must be "sorted through on facts" and that the
legislature does not have all those facts. He asked if this
related to the negotiations for a natural gas pipeline, which
have been confidential and that decisions regarding oil and gas
taxes should not be made without knowledge of the specifics of
the negotiations.
11:45:37 AM
Mr. Eason corrected this was not his intention. Rather efforts
to secure information would likely be successful. However, if
that information were not received, the State would have
additional "exposure". Changes to a tax structure would always
result in exposure due to unforeseen factors but as many issues
as possible should be resolved before changes were implemented.
The outcome in 20 to 30 years would be difficult to predict.
History has demonstrated this.
Senator Guess referenced the witness' assessment that the term
"just and reasonable costs" had been discussed in the past and
she noted the term "direct, ordinary and necessary costs" is
utilized in Section 21. She asked if the consultant was
"comfortable" with those terms given past agreements and
litigation or whether this would introduce new terminology.
Mr. Eason answered, "I'm never comfortable with those sorts of
words," as they "invite disputes." However, he was unable to
suggest better terminology. Each term has the potential for
dispute.
Mr. Eason had greater concern with the "breadth" of the eligible
cost of exploration, production and development because he could
not identify any expenses that would not qualify. He anticipated
that costs would be claimed that had not been considered,
including abandonment costs.
11:50:09 AM
Senator B. Stevens appreciated the witness' comments about
uncertainty in the numbers presented and factors beyond the
ability of forecasting. Senator B. Stevens addressed the
comments about change in valuation based on point of production
and the concerns expressed with industry constructing or
relocating facilities for the purpose of changing valuation. He
requested a specific example.
Mr. Eason clarified that the practice more often involves
"moving the facilities inside the facility" and defining the
point of production relative to treatment and processing.
Senator B. Stevens understood the concept of moving the
conceptual point of production. However, he interpreted the
witness' comment to indicate moving the facility or constructing
a facility to influence point of production.
Mr. Eason reported that all his experience with this matter has
involved facilities built with the subsequent argument of the
location of the point of production inside the facilities. The
allocations made between oil and gas inside the facilities and
normal handling costs could be structured to take advantage of
the system to some extent. Modifications and improvements could
be made to facilities that would produce a different result.
This is not nefarious and is "technically immaterial", but
provides an advantage. This is not wrong, but must be considered
before regulations were changed because of the tax implications.
The issue is that the State's responsibility for treatment and
other costs in the future is unknown. Facts must be established.
Past administrations did not have this information.
11:54:38 AM
Senator B. Stevens appreciated the concerns related to
uncertainty regarding the natural gas issue, but stressed that a
gas plant does not exist. If one were constructed, those items
would be presented to the legislature and addressed at that
point. He directed attention to the impacts this legislation
would have on oil production. He questioned why industry would
construct a facility within a facility solely to affect
valuation and not improve efficiency.
Mr. Eason clarified this was not the message he intended to
convey. His assumptions presumed the changes did not affect
operation.
Senator B. Stevens interjected to cite Mr. Eason's statements
that the producer "built a facility within a facility" to change
the point of production. He assumed this would require
construction of a new facility. This is a conceptual point of
determining point of production and what operations are included
in the costs. That would affect valuation. He understood the
intent of this bill is to establish a consistent point of
production for all facilities to simplify past discrepancies.
Mr. Eason was not prepared to agree before receiving all the
information.
Senator Dyson furthered the discussion. Some producers utilize
the term "alignment". The negotiations with Governor Murkowski
would put all facilities in alignment. When he and Senator B.
Stevens had worked on the North Slope, they witnessed producers
"squabble over accounting in every facility." The producers are
now proposing that the State would have the "same interest" and
information as the other owners. This would enable the parties
to challenge the allocation of costs of gas processing. He asked
if the State's interest in oil and gas royalty would be exactly
the same as the other owners to ensure that the partners were
equally attentive to this issue and that the State would not be
taken advantage of.
11:59:25 AM
Mr. Eason replied this was not his experience. Even when
aligned, natural tensions exist. This legislation should resolve
some tensions but disputes would be inevitable. He elaborated on
possible scenarios.
Senator Dyson assumed the producer would make every effort to
maximize their profits and income. All owners of oil and gas
must be vigilant. The witness was cautioning the legislature to
be careful in setting up the agreements to prevent disagreements
and vulnerability.
Mr. Eason affirmed.
Senator Wagoner reminded that the process of natural gas
agreements has not reached that stage. The State is only dealing
with oil matters at this point. The State could consider any
options in addressing natural gas production in the
negotiations.
Mr. Eason countered that the issue of natural gas is relevant.
Decisions relating to gas are included in this legislation and
would impact the outcome of negotiations.
Senator Wagoner was speaking more specifically to stranded gas.
Senator Stedman regressed to the ELF discussion and the timing
of the formula and aggregation of fields, which was perceived as
"game playing" to place the State at a disadvantage. However, he
surmised the failure of ELF as more of a function of price
causing the regressive mechanism to royalty and tax.
12:05:59 PM
Mr. Eason acknowledged that the ELF is a regressive system, but
more related to volume than price and the large number of wells
that must be operating to reach production. The formula has not
been adjusted properly.
Senator Stedman remarked this information is different than
information received in the past. He recognized that ELF is a
"volume and number of wells issue" that does not consider price.
Without accounting for price, he asked how this could respond to
"a doubling, and tripling, and quadrupling of price without a
failure of a regressive system."
Mr. Eason agreed it could not. As prices increase fields benefit
from the current ELF structure.
Senator Therriault expressed that the problem with ELF began
earlier, although the price acerbates the issue. The affect on
the State's treasury is a function of price and a problem that
could have been "livable" has now become significant. The
crossover point of the existing system and proposed system is
the concern because when prices are very low, the broken system
would provide more income to the State.
Mr. Eason affirmed.
Senator Therriault referred to the conclusion of the
presentation in which Mr. Eason recommended taking advantage of
"extra eyes". This relates to a concern that much of the
testimony to date from State agency personnel has not included
the Department of Natural Resources. In attempting to understand
this, he spoke to former employees of that Department. He asked
the witness to recount his experiences and provide insight. The
staff at the Department is "on the front line, day-to-day"
dealing with producers on issues of lease language, unitization
language, and the point where a pipe connects to the existing
system. Over time a natural build up of friction could occur,
which he did not necessarily oppose. He would expect this to
exist, but would also expect it would be managed within the
Department. He hoped to receive testimony from the Department of
Natural Resources on this legislation.
12:10:41 PM
Mr. Eason emphasized the importance of the Department of Natural
Resources involvement. Although this legislation is a tax issue,
the Department of Natural Resources staff has talent and
longevity and the legislature has invested heavily in recent
years to strengthen the Division of Oil and Gas. The State's
economic interests would benefit over time with this
Department's participation. The viewpoints are different, which
is no reflection of agency personalities. This staff has more
direct facilities-related and unit-related experience. The issue
is very complex and the Department of Natural Resources could
assist in analyzing it.
Senator Therriault surmised the legislature should take
advantage of the Department of Natural Resources experience,
while being aware of possible prejudices.
Mr. Eason agreed. All participants have prejudices, which must
be managed, although this was not a concern. He experienced a
high degree of professionalism with this agency's staff.
Senator Therriault spoke to movable costs and costs of
demobilization. Under the current system, the State has no
obligation to participate in these costs and a policy call would
determine whether this would change under a new system. If a
decision were made that the State should participate in the
costs, the degree of its obligation would be at issue. He
questioned whether the State should share the cost for a
facility that existed before this change was implemented and has
been "mothballed" its entire productive life. Other facilities
have operated for 30 years and would likely continue to operate
for another 30 years, and the determination should be made
whether the State would provide a pro-rated share of the
eventual abandonment costs.
Mr. Eason replied that the provisions must be carefully written.
Pro-rations are complex and could be calculated by engineers and
other experts based on the number of barrels the facility
produced or by another method. The legislature should make an
informed decision.
12:15:14 PM
Senator Wagoner proposed that the State continue to not
participate in abandonment costs. The producer's accounting
systems includes the eventual removal expenses. To change the
current system could "cloud the issue".
Mr. Eason replied that Senator Wagoner "probably outlined the
two ends of the discussion as it moves forward."
Senator G. Stevens asked the implications of the witness'
comments about lessons learned on the duration of a contract.
Mr. Eason told of examples of 30-year agreements that could not
be revisited, including the TAPS royalty fuel cost settlement,
which all parties agree could be improved if internal changes
could be made. He knew of no agreement that satisfied all
parties unless provisions for some renegotiation were allowed.
He spoke of his first job at a large gas field.
12:20:37 PM
Senator G. Stevens asked if the contracts between producers
allow for re-openers.
Mr. Eason replied that resolution provisions are defined at the
onset of the contract with "wordsmithing" attempted for the
benefit of each party.
Senator Stedman pointed out that industry has the ability to
deduct removal costs of platforms located in the Cook Inlet from
federal income taxes. The issue is whether the State should
allow a credit and essentially pay 20 percent of the removal
costs.
Mr. Eason identified two issues: the deduction to oil value and
the status quo.
Senator Stedman understood the 20 percent credit for capital
expenditures could be used to offset those expenses, or could be
sold.
Mr. Eason affirmed.
Senator Stedman surmised the State would indirectly pay 20
percent of the removal costs.
Mr. Eason corrected the amount could be potentially 40 percent.
Senator Stedman stressed the immediate issue is consideration of
changing the laws and methods of taxing the oil and gas
industry. A natural gas pipeline may never be constructed, as
the State has already been waiting 30 years. However, the
potential connections to future gas activities must be
considered as well, and are of some concern. It is therefore
difficult to "read more into this bill" than is specified. For
example, this legislation would not commit the State to a
timeframe in which alterations could not be made. If the bill
were enacted, corrections could be made in the future to
accommodate "other arrangements". He warned of the potential to
make an incorrect decision due to "something that's on the table
because it's not."
12:26:22 PM
Senator Wagoner gave Point Thompson as an example for the tax
credit argument. The leases at that site should have been in
development, if not producing, much earlier. Recently, the
leaseholder was informed it must drill at least one well or
submit a plan of intended activities. That directive has been
delayed six months. He asked if these facilities would then
become eligible for the credit under the provisions of this
legislation.
Mr. Eason responded that Senator Wagoner, "touched on a
prejudice" of his past experiences, which he detailed. The
legislature changed leasing laws in 1978 and developed a program
to attempt to increase development. Many efforts were
undertaken; not all were successful. A successful venture
involved establishing guidelines for lease offerings. Efforts
failed in attempts for encouraging development in the areas east
of Prudhoe Bay, including Point Thompson.
12:31:54 PM
Senator B. Stevens redirected the discussion to the issue of
point of production. He asked if the witness had reviewed the
sectional analysis of the bill prepared by Assistant Attorney
General Rob Mintz of the Department of Law.
Mr. Eason answered that he had listened to a presentation on the
analysis.
Senator B. Stevens pointed out the analysis of Section 31
explains the provision would redefine gross value at point of
production. The interpretation is that "the oil point of
production definition is essentially unchanged. If there's gas
processing, the point of production for extracted liquids is
downstream of processing." He asked if Mr. Eason agreed with
this statement.
Mr. Eason answered "I certainly believe that I can take Rob
Mintz' representation of it."
Senator B. Stevens continued to the analysis of the definition
of gas processing and gas treatment in Section 33: "Gas
processing has been redefined to gas processing is the physical
process that extracts liquid hydrocarbons upstream of a sales of
gas treatment." Gas treatment as "downstream of point of
production is the removing of hydrocarbons substance for
conditioning of gas sale." Mr. Mintz has demonstrated that the
movement of point of production on gas "has gone downstream for
processing and upstream for treatment."
Senator B. Stevens asked if Mr. Eason agreed with this
assessment.
Mr. Eason responded that although this is the language of the
sectional analysis the question is what the options are for the
facility's configurations and the possible impacts of the
options. This is his concern. The definition alone is unclear in
its application of how the facilities would be designed.
Senator B. Stevens disagreed. The definition of gas processing
is to extract the liquid hydrocarbons, natural gas liquid (NGL).
The definition of point of production on gas is "what is liquid
and what is gas." He did not understand the concern about the
point of production for the upstream that would convert the
NGLs. At that point it "enters the sales system" and would
become oil.
Mr. Eason replied that changing the point of production for what
is considered oil and what is considered gas would have major
impacts on value.
Senator B. Stevens asked what the impacts would be.
12:35:24 PM
Mr. Eason listed richness of the gas as one issue, the
configuration of the facilities as another, and how the gas was
marketed from the North Slope, would all be impacted. The stage
in which liquids "come out" of gas could be controlled in a
variety of ways in the design of facilities. The facilities are
complex and must be understood. He was concerned with the
attempt to adopt the relevant regulations into statute and the
relationship to the status quo of existing facilities versus a
facility designed for the future.
Senator B. Stevens qualified that the gas costs "aren't even on
the table." The State captures value from the oil form at likely
a higher value regardless of whether it is transformed into
liquid form. At current prices, the preference would be to
liquefy all of the gas.
Senator B. Stevens requested Mr. Eason submit a written
interpretation of the Department of Law sectional analysis.
Senator Wagoner asked Senator B. Stevens provide an example.
Senator B. Stevens listed Sections 30 and 33, as relating to
point of production.
Senator Wagoner stated that point of production could be
different.
Senator B. Stevens agreed, but stressed that these sections have
defined the difference between liquid and gas. The liquids are
"all NGLs plus oil." This legislation would stipulate, "all NGLs
are priced at oil."
Senator Stedman noted testimony about the value of oil versus
the value of gas. Oil is more valuable and is priced
differently. The issue should be investigated further, as
whether the gas is embedded in the oil should be clarified. A
presentation to the Senate Resources Committee given the
previous session by the University of Alaska identified the
value of the different propane, methane, and butane in the gas.
The advice was given to carefully review the structure to
recognize the potential higher value of these gasses.
Senator Therriault encouraged Senator B. Stevens to explain his
request to Mr. Eason.
12:40: 14 PM
Senator Therriault cautioned that moving the point of production
for gas could result in more potential costs and could have an
offset for oil production costs. This could impact the cost
component for gas that is deducted from revenues from oil.
ADJOURNMENT
Senator Wagoner adjourned the meeting 12:51:42 PM.
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