Legislature(2007 - 2008)SENATE FINANCE 532

11/09/2007 09:00 AM Senate FINANCE


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09:16:51 AM Start
09:19:08 AM SB2001
11:46:33 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
-- NOTE CHANGE IN AGENDA --
+= SB2001 OIL & GAS TAX AMENDMENTS TELECONFERENCED
Heard & Held
Presentation on Alaska's Petroleum
Fiscal Structure--Gaffney, Cline & Assoc
-- Testimony <Invitation Only> --
                    SENATE FINANCE COMMITTEE                                                                                    
                        November 9, 2007                                                                                        
                           9:16 A.M.                                                                                            
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Bert Stedman convened the Senate Finance Committee                                                                     
meeting at 9:16:51 AM.                                                                                                        
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Lyman Hoffman, Co-Chair                                                                                                 
Senator Bert Stedman, Co-Chair                                                                                                  
Senator Charlie Huggins, Vice Chair                                                                                             
Senator Kim Elton                                                                                                               
Senator Donny Olson                                                                                                             
Senator Joe Thomas                                                                                                              
Senator Fred Dyson                                                                                                              
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
None                                                                                                                            
                                                                                                                                
ALSO PRESENT                                                                                                                  
                                                                                                                                
Senator Gary Stevens; Rich Ruggiero, Consultant, Gaffney, Cline                                                                 
and Associates Inc.; Bob George, Consultant, Gaffney, Cline and                                                                 
Associates Inc.                                                                                                                 
                                                                                                                                
PRESENT VIA TELECONFERENCE                                                                                                    
                                                                                                                                
None                                                                                                                            
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
SB 2001  "An Act relating to the production tax on oil and gas                                                                  
          and to conservation surcharges on  oil; relating to the                                                               
          issuance of  advisory bulletins  and the  disclosure of                                                               
          certain information relating to  the production tax and                                                               
          the  sharing between  agencies  of certain  information                                                               
          relating to  the production tax  and to oil and  gas or                                                               
          gas only  leases; amending the  State Personnel  Act to                                                               
          place in the  exempt service certain state  oil and gas                                                               
          auditors and their  immediate supervisors; establishing                                                               
          an oil and gas tax  credit fund and authorizing payment                                                               
          from that  fund; providing for  retroactive application                                                               
          of   certain   statutory  and   regulatory   provisions                                                               
          relating  to the  production  tax on  oil  and gas  and                                                               
          conservation  surcharges  on   oil;  making  conforming                                                               
          amendments; and providing for an effective date."                                                                     
                                                                                                                                
          SB 2001 was HEARD & HELD in Committee for further                                                                     
          consideration.                                                                                                        
                                                                                                                                
SENATE BILL NO. 2001                                                                                                          
                                                                                                                                
     "An Act  relating to the production  tax on oil and  gas and                                                               
     to conservation surcharges on oil;  relating to the issuance                                                               
     of  advisory   bulletins  and  the  disclosure   of  certain                                                               
     information relating  to the production tax  and the sharing                                                               
     between  agencies of  certain  information  relating to  the                                                               
     production  tax and  to  oil  and gas  or  gas only  leases;                                                               
     amending  the State  Personnel Act  to place  in the  exempt                                                               
     service  certain  state  oil  and  gas  auditors  and  their                                                               
     immediate  supervisors;  establishing  an oil  and  gas  tax                                                               
     credit  fund   and  authorizing  payment  from   that  fund;                                                               
     providing for  retroactive application of  certain statutory                                                               
     and regulatory provisions relating  to the production tax on                                                               
     oil  and  gas and  conservation  surcharges  on oil;  making                                                               
     conforming  amendments;  and   providing  for  an  effective                                                               
     date."                                                                                                                     
                                                                                                                                
9:19:08 AM                                                                                                                    
                                                                                                                                
RICH RUGGIERO, CONSULTANT, GAFFNEY, CLINE AND ASSOCIATES INC.,                                                                  
referred to a handout entitled, "Alaska's Equitable Share" [copy                                                                
on file].                                                                                                                       
                                                                                                                                
AT EASE:       9:20:07 AM                                                                                                     
                                                                                                                                
RECONVENE:     9:20:20 AM                                                                                                     
                                                                                                                                
BOB GEORGE, CONSULTANT, GAFFNEY, CLINE AND ASSOCIATES INC.,                                                                     
introduced himself.                                                                                                             
                                                                                                                                
Mr. Ruggiero related that the  presentation would cover the goals                                                               
of a petroleum system in  Alaska, address three fiscal structures                                                               
- PPT,  ACES, and the Senate  CS, look at how  the fiscal systems                                                               
would impact a representative portfolio,  and analyze the Prudhoe                                                               
Bay drilling program.                                                                                                           
                                                                                                                                
9:22:15 AM                                                                                                                    
                                                                                                                                
Mr. Ruggiero addressed the five  goals for fiscal design.  Fields                                                               
with   larger  profitability   should  be   paying  more   taxes.                                                               
Investment  in   existing  units  should  be   encouraged.    New                                                               
investment   outside   legacy   units   should   be   encouraged.                                                               
Durability should  be considered.   Prior tax dialogue  should be                                                               
built upon.                                                                                                                     
                                                                                                                                
Mr. Ruggiero  turned to goals  1, 2, and  4, which relate  to the                                                               
fiscal  design challenge.   The  state must  address the  "take",                                                               
"progressivity" and "give back".   He commented on the continuing                                                               
variability of price, production, and cost.                                                                                     
                                                                                                                                
9:25:25 AM                                                                                                                    
                                                                                                                                
Senator Dyson shared a conversation  he had with Gaffney, Cline &                                                               
Associates regarding  what inflation  does to the  trigger point.                                                               
They said  that inflation probably  won't materially  distort the                                                               
system for  at least 5  years, maybe 10 years.   He spoke  of the                                                               
relationship  between   inflation  and  the  trigger   point  and                                                               
concluded that  the latter  would not be  distorted for  a while.                                                               
He thought that Gaffney, Cline had credibility.                                                                                 
                                                                                                                                
Co-Chair Stedman thought  it was a good point.   He requested the                                                               
presenters to further address progressivity in the presentation.                                                                
                                                                                                                                
9:27:39 AM                                                                                                                    
                                                                                                                                
Mr. Ruggiero explained  goal 3 - encourage new  investment in the                                                               
state.  He  reported that the proposed  legislation is attractive                                                               
for  encouraging  investment in  the  state.   The  inclusion  of                                                               
investment credits  and the net  operating loss credits  with aid                                                               
to new  entrants with no  existing tax base are  good incentives.                                                               
The net based and progressive  structures are self-correcting and                                                               
good for  new entrants with higher  costs.  The net  system is an                                                               
advantage for fields more distant  from the infrastructure, heavy                                                               
oil, and gas.                                                                                                                   
                                                                                                                                
Mr. Ruggiero reported that Alaska is  one of the best regimes for                                                               
new entrants in  the world.  He related that  there are places in                                                               
the  world   that  allow  the  immediate   write-off  of  capital                                                               
expenditures, such as the UK,  but they don't have the investment                                                               
credit as an uplift.  Places  like Norway and others have varying                                                               
depreciation  schedules.    There  are  a  number  of  production                                                               
sharing agreements  which provide  for an immediate  write-off up                                                               
front.    He  stressed  that  most  new  PSC's  are  specific  to                                                               
projects.  He used a Prudhoe Bay PSC as an example.                                                                             
                                                                                                                                
9:31:04 AM                                                                                                                    
                                                                                                                                
Mr. Ruggiero turned to the summary  of terms to compare the three                                                               
systems: PPT,  ACES, and Senate CS.   The base rate  under PPT is                                                               
at 22.5 percent; ACES  and the Senate CS are at  25 percent.  The                                                               
kick-off points  are at $30  and $40.  Progressivity  ranges from                                                               
.2  to .4  percent.   The  proposals were  capped at  47.5 to  50                                                               
percent.                                                                                                                        
                                                                                                                                
Mr. Ruggiero explained the three  fiscal systems in terms of what                                                               
the production tax  would be at various margin  rates per barrel.                                                               
Margin is not the oil price.  The  taxes are all based on the net                                                               
margin.  This  is where various regimes are self  correcting.  He                                                               
gave  an example  of a  field  with $20  overall cost  and a  $95                                                               
market.                                                                                                                         
                                                                                                                                
9:34:11 AM                                                                                                                    
                                                                                                                                
Mr. Ruggiero noted that there has  been a lot of discussion about                                                               
whether caps  are too high, or  if progressivity is too  steep at                                                               
today's prices.  He commented  that progressive systems are built                                                               
and designed to capture price  spikes and the state's fair share.                                                               
If  prices remain  flat,  costs would  continue  to increase  for                                                               
producers.   He explained that  the system would correct  for any                                                               
changes in increased costs.  The  question is if it would correct                                                               
fast enough.                                                                                                                    
                                                                                                                                
Co-Chair Stedman  asked if at  the higher end this  was converted                                                               
to government share and industry share,  if the state would be at                                                               
a disadvantage.   Mr. Reggiero didn't think so.                                                                                 
                                                                                                                                
Mr.  George   thought  that  future  slides   would  address  the                                                               
question.                                                                                                                       
                                                                                                                                
9:37:23 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  said he  was not referring  to dollars,  but to                                                               
percentage splits.  EconOne reported that would happen.                                                                         
                                                                                                                                
Senator Elton  summarized that as  costs increase, "we'd  go down                                                               
on the  curve," and the issue  could be whether it  corrects fast                                                               
enough.   He asked if the  same problem exists if  the margins go                                                               
up.  Mr.  Ruggiero replied that he would show  an example of that                                                               
in the presentation.                                                                                                            
                                                                                                                                
9:38:39 AM                                                                                                                    
                                                                                                                                
Mr.  Ruggiero  turned  to  progressivity impacts.    The  use  of                                                               
progressivity   creates  a   sizeable   difference  between   the                                                               
effective  rate and  the  marginal  rate of  tax  in relation  to                                                               
investment  decisions.   This is  present with  the existing  PPT                                                               
language, but not  in the other versions of the  tax.  It creates                                                               
a good-sized "carrot" for the  oil companies to reinvest the cash                                                               
flow that they are generating from  the state.  If they decide to                                                               
take cash outside the state, it becomes a good-sized "stick".                                                                   
                                                                                                                                
Co-Chair Stedman  noted that the administration's  proposal has a                                                               
lower progressivity  rate.  He  heard the presenter say  that the                                                               
state should be looking at  a higher progressivity.  Mr. Ruggiero                                                               
said he  was not advocating a  lower or higher rate.   Because of                                                               
the mathematical aspect  of progressivity, low or  high, it would                                                               
have an impact  that is greater as progressivity  increases.  The                                                               
point is,  because of this impact,  it creates a carrot  or stick                                                               
environment.     The  size   of  it  depends   on  the   rate  of                                                               
progressivity.                                                                                                                  
                                                                                                                                
9:40:59 AM                                                                                                                    
                                                                                                                                
Mr. Ruggiero explained margin cases.   Four points were chosen on                                                               
the curve to clarify progressivity  impacts.  Moves left or right                                                               
of  A or  B  are flat  changes.   Federal  and  state income  tax                                                               
impacts have been excluded from the graph.                                                                                      
                                                                                                                                
Mr. Ruggiero used  an example of a company that  has $1000 before                                                               
tax cash flow and  was trying to decide whether or  not to make a                                                               
$100 investment.  He ran the example through various scenarios.                                                                 
                                                                                                                                
Mr. Ruggiero  used an example of  taxpayer "C" on the  low end of                                                               
the  slope,  with  and  without investment.    He  described  how                                                               
savings  could occur  because  of reduced  taxable  income and  a                                                               
change in taxable income due to progressivity.                                                                                  
                                                                                                                                
9:46:24 AM                                                                                                                    
                                                                                                                                
Mr. Ruggiero  used taxpayer "D" on  the high end of  the slope as                                                               
another example of production tax savings due to investment.                                                                    
                                                                                                                                
Mr. Ruggiero  turned to a  graph of C &  D which depicts  the new                                                               
marginal   tax  rates   and  the   effect  of   progressivity  on                                                               
investment.                                                                                                                     
                                                                                                                                
9:49:44 AM                                                                                                                    
                                                                                                                                
Mr.  Ruggiero explained  the  relationship between  progressivity                                                               
and goals 1, 2, and 3.   He described how progressivity impacts a                                                               
portfolio of investments under a variety of situations.                                                                         
                                                                                                                                
Senator Huggins  asked if there is  a lower profit margin  on the                                                               
window of leases with profit  sharing.  Mr. Ruggiero replied that                                                               
he has not been provided all  the terms of those agreements so he                                                               
could not  comment on how  the net  profit leases work.   Senator                                                               
Huggins  pointed  out  the  need   to  ensure  timing  and  avoid                                                               
unintended consequences.                                                                                                        
                                                                                                                                
9:54:21 AM                                                                                                                    
                                                                                                                                
Mr. Ruggiero contrasted  overall government take on  a variety of                                                               
fields including UK new and legacy  fields, and Norway.  There is                                                               
an assumed cost of  $20 in the comparison.  Norway  and the UK do                                                               
not have a  royalty structure.  From $0 to  $20 per barrel, there                                                               
is  no government  take.   However, with  the first  dollar above                                                               
$20, the government take is: 50  percent in the UK new fields, 75                                                               
percent in  the UK legacy fields,  and 78 percent in  Norway.  He                                                               
explained the difference  as seen under the Senate  CS at various                                                               
oil prices and with the effect of royalty.                                                                                      
                                                                                                                                
9:57:05 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman noted  the production  tax differs  between the                                                               
legislature's  version  and  the administration's  version.    He                                                               
wondered how  ACES fits  into the  picture.   He stated  that the                                                               
Governor supports a 25 percent  base tax and lower progressivity,                                                               
which  is different  from  what  Mr. Ruggiero  was  showing.   He                                                               
requested that ACES be added to the chart.                                                                                      
                                                                                                                                
Mr. George offered to add ACES to  the chart.  He stated that the                                                               
effect would be  exactly the same up to $50  per barrel, and then                                                               
it  would progress  at half  the rate  shown on  the chart.   The                                                               
slope would be slower, but the impact would be the same.                                                                        
                                                                                                                                
9:58:18 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman recalled  a  discussion of  fair  share at  the                                                               
beginning of the presentation.   The Committee did not spend much                                                               
time  on the  original  PPT in  the range  over  $70 per  barrel;                                                               
however, it  did spend a  lot of time on  the lower ranges.   The                                                               
higher price is more relevant today.                                                                                            
                                                                                                                                
Mr.  Ruggiero  related  Alaska's   status  in  overall  take,  as                                                               
compared to the others in the chart.                                                                                            
                                                                                                                                
10:00:02 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman  noted that  information correlates  highly with                                                               
other studies seen.                                                                                                             
                                                                                                                                
Senator Dyson was also interested  in discussing a scenario where                                                               
increasing  costs cause  a  drop  below the  trigger  point.   He                                                               
requested comments about  what happens to the state's  take if it                                                               
is below the trigger point, both  at 22.5 percent and 25 percent,                                                               
especially if the floor is eliminated.                                                                                          
                                                                                                                                
Senator  Elton assumed  that  the same  issue  related to  rising                                                               
costs applies to the UK fields and Norway.                                                                                      
                                                                                                                                
Mr.  George replied  that the  issue  is not  entirely the  same.                                                               
Both the UK and Norway  have entirely profit-based taxes, with no                                                               
royalty.                                                                                                                        
                                                                                                                                
10:02:17 AM                                                                                                                   
                                                                                                                                
Senator Elton surmised  if costs go up or if  prices go down, the                                                               
state is  better protected  because of the  royalty and  there is                                                               
less risk.  Mr. George said that was correct.                                                                                   
                                                                                                                                
Senator  Huggins requested  to  see the  same  information as  it                                                               
applies to  small developers in  North America and Alberta.   Co-                                                               
Chair Stedman  agreed that would be  valuable information because                                                               
Alberta is one of Alaska's competitors.                                                                                         
                                                                                                                                
Senator Dyson asked  how much capital is invested in  the Gulf of                                                               
Mexico.  He  requested a comparison of Alaska to  that area.  Mr.                                                               
George agreed to add that information.                                                                                          
                                                                                                                                
10:04:10 AM                                                                                                                   
                                                                                                                                
Mr. Ruggiero noted that much of  the total government take in the                                                               
Lower  48 and  in  the  Gulf of  Mexico  is  based on  historical                                                               
leases.   In a number  of projects recently  in the U.S.,  due to                                                               
the  release of  acreages, royalties  have been  as high  as 37.5                                                               
percent.  Existing acreage that  can be developed yields one type                                                               
of number;  wildcatters taking  up acreage  that might  have been                                                               
given up years ago yield a much higher number.                                                                                  
                                                                                                                                
Mr. Ruggiero explained that in the  deep water Gulf of Mexico the                                                               
mineral  management  services  (MMS)  recently  raised  royalties                                                               
again.                                                                                                                          
                                                                                                                                
Senator  Huggins asked  for more  information about  U.S. royalty                                                               
regimes.  Mr. Ruggiero agreed to supply that information.                                                                       
                                                                                                                                
Co-Chair Stedman  asked if the  government takes are  average and                                                               
not marginal.  Mr. George  affirmed that they reflect the average                                                               
rate.                                                                                                                           
                                                                                                                                
10:07:51 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman asked if the  government take would be higher if                                                               
the  U.S. went  to  a marginal  rate.   Mr.  George  said, as  it                                                               
affects production tax, so would  it also impact total government                                                               
take.  An  increase in price could create a  much higher marginal                                                               
rate  for a  short  period  of time.    Simply  making a  capital                                                               
investment can bring the marginal rate down.                                                                                    
                                                                                                                                
Co-Chair  Stedman asked  how  large the  increase  would be  with                                                               
marginal  rates  at  various  prices  per  barrel.    Mr.  George                                                               
responded that a $1 increase in oil  price could result in a 10 -                                                               
15  percent  increase.   Co-Chair  Stedman  requested  a  numeric                                                               
answer.  Mr.  George said that information could be  found on the                                                               
Y axis in the graph.                                                                                                            
                                                                                                                                
10:09:23 AM                                                                                                                   
                                                                                                                                
Mr.  George  addressed  progressivity  and  goals  1,  2,  and  3                                                               
regarding how  portfolio impacts  can work.   He looked  again at                                                               
the generic structure as it applies  to PPT, ACES, and the Senate                                                               
Judiciary CS.  The  net tax structure is thought of  as a net tax                                                               
on the  profit margin, when,  in reality, it is  more a tax  on a                                                               
company's retained  cash flow.   The  progressive feature  is the                                                               
same in  all three bill  versions.   It allows for  different tax                                                               
rates  depending  on  profitability.     A  more  aggressive  net                                                               
progressivity  will provide a  greater differentiation within the                                                               
system.                                                                                                                         
                                                                                                                                
Mr.  George   explained  that  he  has   created  a  hypothetical                                                               
portfolio to  highlight legacy  assets and  the impact  of adding                                                               
new investments  and how  that affects  the rates  and investment                                                               
decision making.  He began with an example based on PPT.                                                                        
                                                                                                                                
10:14:14 AM                                                                                                                   
                                                                                                                                
Mr. Ruggiero added another example.                                                                                             
                                                                                                                                
Co-Chair Stedman noted  that during a previous hearing  on PPT, a                                                               
lot of  time was  spent on  progressivity, triggers,  and slopes,                                                               
concentrating  on the  effect  of government  share  at high  oil                                                               
prices.   The  discussion of  marginal expansion  is a  different                                                               
area  of  analysis  of  progressivity.   He  wondered  about  the                                                               
magnitude  of   progressivity  needed  to  accomplish   what  the                                                               
presenters were depicting.                                                                                                      
                                                                                                                                
Mr. George  said he would address  that topic next.   The current                                                               
example  used  a  fairly  high  margin  of  $67  on  the  initial                                                               
investment and  the margin  came down  to about  $30 on  the last                                                               
investment.  It is  not a fixed set of numbers.   It allows for a                                                               
higher rate of tax on the  more profitable parts of the portfolio                                                               
without hurting the less profitable parts.                                                                                      
                                                                                                                                
10:17:53 AM                                                                                                                   
                                                                                                                                
Mr. Ruggiero  added that this  example was  run on PPT  and there                                                               
would be upcoming examples that  would show the same impact under                                                               
ACES and under the Senate CS.                                                                                                   
                                                                                                                                
Mr. George returned  to the slide to highlight the  impact of PPT                                                               
with different marginal components.                                                                                             
                                                                                                                                
Mr. George  turned to an example  under ACES, which has  a higher                                                               
base rate, an  earlier progressivity kickoff point,  and a slower                                                               
slope.   The overall effect is  to raise the average  take within                                                               
that particular portfolio and change the slope slightly.                                                                        
                                                                                                                                
Mr. George compared  the previous slides to  the Senate Judiciary                                                               
CS, which had a much steeper change.                                                                                            
                                                                                                                                
Senator Dyson  asked if  Field Z  was a  more expensive  field to                                                               
produce.  Mr.  George replied that it has a  lower margin because                                                               
it is more expensive to produce  and it may be heavier oil, which                                                               
receives less per barrel.                                                                                                       
                                                                                                                                
10:20:28 AM                                                                                                                   
                                                                                                                                
Senator Dyson asked if the  Senate Judiciary CS gives lower taxes                                                               
for  the challenged  fields  than ACES  does for  Field  Z.   Mr.                                                               
George said that was exactly correct.                                                                                           
                                                                                                                                
Mr. Ruggiero  clarified that it  "was lower effective  taxes when                                                               
it's  added to  a portfolio,  not when  it's stand  alone".   The                                                               
arrow represents the relative rate of tax  if X then Y then Z are                                                               
added in.                                                                                                                       
                                                                                                                                
Senator Dyson inquired which proposals  are of the most advantage                                                               
to the challenged fields.                                                                                                       
                                                                                                                                
10:22:05 AM                                                                                                                   
                                                                                                                                
Mr. George  explained if you  move below progressivity,  the same                                                               
effect  would take  place  as  if you  were  at exceedingly  high                                                               
margins;  there  would be  a  flat  rate and  no  differentiation                                                               
between fields.   The  greatest incremental  effect of  the three                                                               
bills would  be the  Senate Judiciary version.   The  greater the                                                               
progressivity,  the greater  the impact  on the  least profitable                                                               
fields.                                                                                                                         
                                                                                                                                
Co-Chair Stedman clarified that the  red line is more stimulating                                                               
to the  heavy oil environment.   Mr.  George agreed that  Field Z                                                               
would be the most representative of a heavy oil field.                                                                          
                                                                                                                                
10:23:48 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman  commented that steep progressivity  would be an                                                               
advantage to heavy  oil, and flat or no progressivity  would be a                                                               
disadvantage to heavy  oil.  Mr. George said that  the rate under                                                               
a   lower  progressivity   would  be   slower  than   under  high                                                               
progressivity.                                                                                                                  
                                                                                                                                
Mr.  George   restated  the   advantages  and   disadvantages  of                                                               
progressivity rates as they impact heavy oil.                                                                                   
                                                                                                                                
Co-Chair Stedman inquired if it is  also fair to assume that high                                                               
progressivity would stimulate  high cost fields and  would end up                                                               
funneling  more  cash to  the  treasury.   Mr.  George  requested                                                               
clarification of the question.                                                                                                  
                                                                                                                                
Co-Chair Stedman summarized that the  abundance of heavy oil is a                                                               
challenge to the state, as is building  a new gas line.  He noted                                                               
that the steeper  the progressivity, the more  advantageous it is                                                               
from the  state's perspective to  harvest and sell heavy  oil and                                                               
to collect more state revenue.                                                                                                  
                                                                                                                                
Mr. George used $30 as an example  of a kickoff point, such as is                                                               
shown in  ACES and  in the  Senate Judiciary  proposals.   As the                                                               
progressivity  steepens, the  greater  affect there  is, and  the                                                               
greater  the  relative benefit  to  Field  Z.   The  greater  the                                                               
progressivity the lower  the margin at which the  maximum rate is                                                               
attained.  Two effects are at  work and each specific case has to                                                               
be looked at individually.                                                                                                      
                                                                                                                                
10:26:40 AM                                                                                                                   
                                                                                                                                
Co-Chair  Hoffman   commented  that  starting  at   a  lower  tax                                                               
structure such as 22.5 percent could achieve a steeper slope.                                                                   
                                                                                                                                
Mr. George agreed, if the intent  is to produce a lower effective                                                               
rate on Field Z.                                                                                                                
                                                                                                                                
Senator Huggins requested clarification.                                                                                        
                                                                                                                                
10:27:23 AM                                                                                                                   
                                                                                                                                
Mr. George noted  that there were two concepts; the  tax rate and                                                               
the  tax rate  relative to  other parts  of the  portfolio.   The                                                               
steeper  the  progressivity  curve,   the  greater  the  relative                                                               
effect.                                                                                                                         
                                                                                                                                
Senator  Huggins  recalled  the  goal  to  incentivize  the  more                                                               
challenged fields.  Mr. George concurred.                                                                                       
                                                                                                                                
Co-Chair Stedman emphasized  the importance of the  base rate and                                                               
the  progressivity.  He  noted the  administration's  desire,  as                                                               
shown  in ACES,  to  increase  the base  rate  and  have a  lower                                                               
progressivity.   He suggested  that lowering  progressivity might                                                               
not be in the state's long-term, best interest.                                                                                 
                                                                                                                                
Mr. George agreed that there are  tradeoffs.  Lower base rate and                                                               
lower progressivity yield less overall,  as well as on the legacy                                                               
fields.                                                                                                                         
                                                                                                                                
10:30:30 AM                                                                                                                   
                                                                                                                                
Senator Elton  compared the existing  revenue chart with  the bar                                                               
labeled Z.  He concluded  that with a steeper progressivity rate,                                                               
investment decisions might be distorted.                                                                                        
                                                                                                                                
Mr. George  did not necessarily agree.   He explained that  it is                                                               
not  just a  tax  on the  net  margin; it  is a  tax  on the  net                                                               
retained cash  flow.  It  comes from  the net operating  margin -                                                               
the  price  for  which  the  oil  is  sold,  less  the  operating                                                               
expenses.   There is also  a deduction for  capital expenditures.                                                               
He gave an example of  such a deduction where capital expenditure                                                               
lowers the rate  even further from 27.4 percent  to 25.9 percent.                                                               
That is  equivalent to having  a tax  savings on the  capital and                                                               
can be larger than the tax rate itself.                                                                                         
                                                                                                                                
10:35:37 AM                                                                                                                   
                                                                                                                                
Mr.  George  described how  investment  tax  credits also  apply,                                                               
which  have  the  impact  of lowering  the  effective  rate  even                                                               
further.   He showed the  tax rate by  field within a  company as                                                               
affected by portfolio blending,  CAPEX (capital expenditure), and                                                               
tax credit.                                                                                                                     
                                                                                                                                
Senator Dyson  voiced appreciation for the  valuable information.                                                               
He wondered if  Mr. George had any input into  the structuring of                                                               
ACES.                                                                                                                           
                                                                                                                                
Mr.  George described  his involvement  with ACES.   He  stressed                                                               
that   he  made   no  specific   recommendations  regarding   any                                                               
particular tax system, but spoke in favor of a net system.                                                                      
                                                                                                                                
10:38:41 AM                                                                                                                   
                                                                                                                                
Senator Dyson said he was impressed  that ACES and others do give                                                               
the advantage  to the more  marginal fields.   He inquired  if it                                                               
was fair  to say  that with  a lot  of investment,  explorers and                                                               
producers could end up with an  effective tax rate lower than the                                                               
existing PPT.                                                                                                                   
                                                                                                                                
Mr. George explained that the  effective rate at the margin could                                                               
be lower than  the headline marginal rate of 22.5  percent in the                                                               
case of PPT, or 25 percent in the  case of ACES, so long as there                                                               
are a static set of conditions going forward.                                                                                   
                                                                                                                                
Mr. Ruggiero  noted that a good  question to ask was  how raising                                                               
taxes would  make projects more  economical.  If the  overall tax                                                               
structure  on  the  more challenged  projects  is  raised,  those                                                               
projects  become even  more challenged.   The  highly progressive                                                               
structure provides  an incentive, that otherwise  would not exist                                                               
under  a  flat tax  structure,  to  develop the  more  challenged                                                               
structures.                                                                                                                     
                                                                                                                                
Senator  Dyson took  that explanation  as an  affirmation of  his                                                               
question.                                                                                                                       
                                                                                                                                
Senator  Huggins said  he  sees the  Governor's  proposal as  the                                                               
least enhancing for Field  Z.  It is the highest  tax rate of the                                                               
three scenarios.                                                                                                                
                                                                                                                                
Mr.  George  related  that  under  that  set  of  conditions  the                                                               
effective rate  on Field z would  be higher than under  the other                                                               
two proposals, although the average  rate would actually be lower                                                               
than under the Senate bill.                                                                                                     
                                                                                                                                
Senator  Huggins  concluded  that   there  are  potentially  more                                                               
innovative ways to enhance Field z  than what is contained in the                                                               
Governor's bill.                                                                                                                
                                                                                                                                
Mr.  George  agreed  that  higher  progressivity  would  be  more                                                               
beneficial to Field Z.                                                                                                          
                                                                                                                                
Senator Huggins noted that PPT had higher progressivity.                                                                        
                                                                                                                                
10:43:14 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman asked  if Gaffney, Cline &  Associates was hired                                                               
to consult with the administration  to help draft ACES, raise the                                                               
base tax, and lower the progressivity.                                                                                          
                                                                                                                                
10:43:55 AM                                                                                                                   
                                                                                                                                
Mr. Ruggiero  stated that the administration  initially hired the                                                               
company  to get  an idea  of what  worldwide take  was for  just-                                                               
coming-on-stream    or   approved-and-under-construction    major                                                               
projects, in order to get an  idea of what sort of tax structures                                                               
were being  used.  The second  time the company was  hired was in                                                               
August  in order  to  present  the company's  views  on what  was                                                               
happening  in  the  oil  world.   That  was  the  extent  of  the                                                               
company's involvement.   They did  not have any input  into ACES.                                                               
The company  was requested to  provide data on  capital investing                                                               
habits of the big oil companies.                                                                                                
                                                                                                                                
Co-Chair  Stedman  inquired if  they  made  recommendations on  a                                                               
specific base tax and progressivity.   Mr. Ruggiero said they did                                                               
not.                                                                                                                            
                                                                                                                                
Co-Chair Hoffman  asked what impact  the triggers of $30  and $40                                                               
have on the tax rate of Field Z in the combined portfolio.                                                                      
                                                                                                                                
Mr. George  replied that  he would  have to  review the  model in                                                               
order  to answer  that question.   He  said that,  generally, the                                                               
higher the  trigger point, the  greater the possibility  that the                                                               
field  would become  effectively taxed  at the  base rate  rather                                                               
than at a lower rate.                                                                                                           
                                                                                                                                
AT EASE:       10:47:24 AM                                                                                                    
                                                                                                                                
RECONVENE:     11:09:09 AM                                                                                                    
                                                                                                                                
Mr. Ruggiero  turned to  the slides  dealing with  actual Prudhoe                                                               
results.    He   emphasized  that  that  the   Gaffney,  Cline  &                                                               
Associates (GCA)  model is a model  fit for a specific  purpose -                                                               
in-field drilling.                                                                                                              
                                                                                                                                
Mr. Ruggiero  said that  when looking  at other  presentations by                                                               
industry, there  appeared to  be significant  upside in  terms of                                                               
barrels of oil to be produced  by investing to reduce the natural                                                               
field  decline  rate  in  the  major North  Slope  fields.    The                                                               
economics  of reinvestment  in the  existing producing  assets on                                                               
the  North Slope  are extremely  profitable  when tested  against                                                               
various stress points.                                                                                                          
                                                                                                                                
11:11:08 AM                                                                                                                   
                                                                                                                                
Mr. Ruggiero expressed  confidence in GCA's model.   He termed it                                                               
a  snapshot of  a portion  of  the oil  business in  Alaska.   It                                                               
contains the  ability to analyze  based on the data  presented by                                                               
British Petroleum (BP),  the economics of the  Prudhoe Bay infill                                                               
drilling program.                                                                                                               
                                                                                                                                
Mr.  Ruggiero explained  the slide  dealing with  Input Controls.                                                               
The  left column  shows drilling  program years  and multipliers.                                                               
The model  has the ability  to test the drilling  program against                                                               
any scenario.  The multipliers can be used to make corrections.                                                                 
One correction in  the standard version is  the CAPEX multiplier,                                                               
which has been set at 300 percent.   The data obtained from BP on                                                               
CAPEX  spending was  further clarified  as the  dollars spent  on                                                               
drilling-producing  wells, which  carry more  CAPEX.   Associated                                                               
with that  are injection  wells and  the cost  to drill  them, as                                                               
well  as  the  cost  of  surface facilities  to  handle  the  new                                                               
production.                                                                                                                     
                                                                                                                                
Mr.  Ruggiero listed  the components  of the  model; 300  percent                                                               
CAPEX multiplier,  discount rate of  15 percent, royalty  of 12.5                                                               
percent, PPT net  tax rate of 22.5 percent,  PPT progressivity of                                                               
.25 percent,  kickoff point at  $40, and the  price of $80.   The                                                               
price modifies the future.  The  past is fixed with the exception                                                               
of the CAPEX multiplier, which modifies history.                                                                                
                                                                                                                                
Mr.  Ruggiero explained  that the  model contains  actual results                                                               
from 2002-2006.   For OPEX  an extrapolation from  Alaskan annual                                                               
reports was used.  A full cash  flow model was built based on all                                                               
the various taxes and royalties owed.                                                                                           
                                                                                                                                
11:15:46 AM                                                                                                                   
                                                                                                                                
Mr.  Ruggiero reported  that,  overall, this  program  at an  $80                                                               
price  point forward  shows  an  internal rate  of  return of  67                                                               
percent  and a  net present  value at  15 percent  discounting of                                                               
$3.2  billion.   On an  undiscounted basis,  entirely under  PPT,                                                               
Alaska  royalty and  taxes  would have  taken  in $10.4  billion.                                                               
Under  a 15  percent discounted  basis,  it would  have taken  in                                                               
around $3.9  billion.   He emphasized  that this  is not  a stand                                                               
alone program, but a piece of  the whole operation.  He termed it                                                               
an  incremental model  because he  did not  have the  data for  a                                                               
comprehensive model.  The purpose is  to decide whether or not to                                                               
do infill drilling and arrest the decline in existing fields.                                                                   
                                                                                                                                
Mr.  Ruggiero   recalled  his  alarm   when  he  first   saw  the                                                               
astronomical size  of the numbers.   He emphasized that  a robust                                                               
drilling program remains  profitable at:  300  percent CAPEX, 200                                                               
percent OPEX,  a discount rate of  25 percent, $50 ANS,  and high                                                               
progressivity.                                                                                                                  
                                                                                                                                
11:18:18 AM                                                                                                                   
                                                                                                                                
Mr. Ruggiero referred to a  slide that depicts an overly stressed                                                               
case.  The rate  of return is now down to 56  percent and the net                                                               
present value,  which was over  $3 billion,  is now down  to $975                                                               
million.   This  is  at 25  percent discounting.    The value  of                                                               
future cash  flows are  much reduced  by the  time it  is brought                                                               
back down to "times zero" on the investment.                                                                                    
                                                                                                                                
11:20:31 AM                                                                                                                   
                                                                                                                                
Mr. Ruggiero mentioned  previous testimony by Alaska  Oil and Gas                                                               
Association (AOGA) which  called the GCA model  outrageous.  AOGA                                                               
questioned how good  the model could be if a  zero price yields a                                                               
156 percent rate of return.   He pointed out the discrepancies in                                                               
CAPEX on  the control  page.  He  discussed historical  data that                                                               
cannot be changed  and what would happen if  the multipliers were                                                               
changed.   He  dispelled AOGA's  arguments.   He reiterated  that                                                               
GCA's  model  is  a  cash  flow model  of  infill  drilling,  not                                                               
representative of the overall North Slope operation.                                                                            
                                                                                                                                
Co-Chair Stedman asked if the  environment when capital decisions                                                               
were made  was during a  $25 per  barrel price range,  which then                                                               
doubled over a four-year period.  Mr. Ruggiero agreed.                                                                          
                                                                                                                                
11:24:07 AM                                                                                                                   
                                                                                                                                
Co-Chair  Stedman   asked  if  the   payback  time   was  greatly                                                               
accelerated with  these higher  prices.   Mr. Ruggiero  said that                                                               
wells drilled in 2002 were planned a couple years prior.                                                                        
                                                                                                                                
Mr. Ruggiero  explained the model at  $50 per barrel.   He agreed                                                               
with Co-Chair Stedman that the price  index used in the model was                                                               
not  the  same as  the  one  used today.    He  commented on  the                                                               
importance  of  the  model  standing   up  under  various  fiscal                                                               
systems.                                                                                                                        
                                                                                                                                
11:27:31 AM                                                                                                                   
                                                                                                                                
Co-Chair  Stedman  asked  if  the base  value  of  operating  and                                                               
capital costs  escalated by  300 percent.   Mr. Ruggiero  said it                                                               
did.  Co-Chair Stedman requested  more information.  Mr. Ruggiero                                                               
explained  that  the  $245  million   figure  came  from  the  BP                                                               
presentation.    He  used  examples  of  what  happens  when  the                                                               
multiplier changes.                                                                                                             
                                                                                                                                
Co-Chair Stedman inquired how downstream  costs are handled.  Mr.                                                               
Ruggiero  related that  the data  was based  on an  ANS price  as                                                               
reported in  the Department of Revenue  fact book.  The  data for                                                               
TAPS and  shipping were not  included.  He explained  the various                                                               
pieces used in the calculations.                                                                                                
                                                                                                                                
Mr.  Ruggiero discussed  North Slope  potential in  terms of  how                                                               
production drives  revenue.  He  showed a generic model  based on                                                               
various   decline   rates,   barrels   produced,   and   industry                                                               
investment.  Economics under PPT  was examined.  He explained the                                                               
decline rates  and the  250,000 bpd  abandonment rate,  which was                                                               
based  on the  oil  companies' and  AOGA's  presentations of  the                                                               
mechanical limit  of 300,000  bpd for  TAPS.   He thought  that a                                                               
mechanical limit would  not be an economic limit, but  it was too                                                               
soon to tell.                                                                                                                   
                                                                                                                                
11:32:55 AM                                                                                                                   
                                                                                                                                
Mr. Ruggiero  discussed how production drives  revenue under PPT.                                                               
He explained  the net present  value 10 percent  discounting, the                                                               
net  present  value at  zero  percent  discounting, and  the  net                                                               
present  value  at zero  percent  on  a  per  barrel basis.    He                                                               
highlighted  the  various  scenarios  of  decline  rate,  barrels                                                               
produced, and industry investment.                                                                                              
                                                                                                                                
11:36:16 AM                                                                                                                   
                                                                                                                                
Mr. Ruggiero  related aspects of  delaying TAPS abandonment.   He                                                               
explained  the impact  of  the abandonment  rate  on North  Slope                                                               
recovery.    This   can  be  done  by   changing  the  mechanical                                                               
operations  or   by  developing  new  fields.     He  highlighted                                                               
scenarios of abandonment rates.                                                                                                 
                                                                                                                                
11:38:40 AM                                                                                                                   
                                                                                                                                
Senator Thomas  said is  it obvious  that one  size does  not fit                                                               
all.  He requested more  information about progressivity goals 1,                                                               
2 &  3, and  how progressivity  relates to the  heavy oil  in the                                                               
legacy fields.                                                                                                                  
                                                                                                                                
11:40:11 AM                                                                                                                   
                                                                                                                                
Mr. George clarified  that the effect of bringing  a lower margin                                                               
stream of production  into an existing portfolio is  to lower the                                                               
effective tax rate on the progressivity part of the curve.                                                                      
                                                                                                                                
Senator Dyson  voiced concerned that  the state may  be operating                                                               
below  the  trigger  point  because  of  production  costs.    He                                                               
wondered what the delta in the  state's net take would be at 22.5                                                               
percent.                                                                                                                        
                                                                                                                                
11:43:03 AM                                                                                                                   
                                                                                                                                
Mr. George  replied that he  did not  know what the  state's take                                                               
would be.  He offered to provide that information.                                                                              
                                                                                                                                
CS  HB   2001  (FIN)am   was  HELD   in  Committee   for  further                                                               
consideration.                                                                                                                  
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
The meeting was adjourned at 11:46:33 AM.                                                                                     

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