Legislature(2009 - 2010)SENATE FINANCE 532

01/26/2010 09:00 AM Senate FINANCE


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09:03:52 AM Start
09:04:10 AM Presentation: Department of Revenue Oil Production & Revenue Forecast; State Revenue Forecast - Fy 2011
10:57:22 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Dept of Revenue, Commissioner Pat Galvin TELECONFERENCED
Oil Production & Revenue Forecast
State Revenue Forecast - FY2011
                 SENATE FINANCE COMMITTEE                                                                                       
                     January 26, 2010                                                                                           
                         9:03 a.m.                                                                                              
                                                                                                                                
                                                                                                                                
9:03:52 AM                                                                                                                    
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Stedman called the Senate Finance Committee                                                                            
meeting to order at 9:03 a.m.                                                                                                   
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Lyman Hoffman, Co-Chair                                                                                                 
Senator Bert Stedman, Co-Chair                                                                                                  
Senator Charlie Huggins, Vice-Chair                                                                                             
Senator Johnny Ellis                                                                                                            
Senator Dennis Egan                                                                                                             
Senator Donny Olson                                                                                                             
Senator Joe Thomas                                                                                                              
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
None                                                                                                                            
                                                                                                                                
ALSO PRESENT                                                                                                                  
                                                                                                                                
Pat Galvin, Commissioner, Department of Revenue; Dan                                                                            
Stickel, Economist, Tax Division, Department of Revenue                                                                         
                                                                                                                                
PRESENT VIA TELECONFERENCE                                                                                                    
                                                                                                                                
Dona  Keppers, Audit  Master,  Tax  Division, Department  of                                                                    
Revenue;  Frank  Molli, Production  Forecasting  Consultant,                                                                    
Department  of Revenue;  Cheryl  L.  Nienhuis, Acting  Chief                                                                    
Economist, Department of Revenue                                                                                                
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
^PRESENTATION: DEPARTMENT OF REVENUE OIL PRODUCTION &                                                                           
REVENUE FORECAST; STATE REVENUE FORECAST - FY 2011                                                                              
                                                                                                                                
9:04:10 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  made introductory comments.  He introduced                                                                    
Senator  Dennis  Egan, who  is  new  to the  Senate  Finance                                                                    
Committee, as well as members of the secretarial staff.                                                                         
                                                                                                                                
9:11:01 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman  shared  protocols for  conducting  Senate                                                                    
Finance meetings.                                                                                                               
                                                                                                                                
9:16:25 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  encouraged members  to review  the Revenue                                                                    
Sources Book.                                                                                                                   
                                                                                                                                
9:16:56 AM                                                                                                                    
                                                                                                                                
PAT GALVIN, COMMISSIONER,  DEPARTMENT OF REVENUE, introduced                                                                    
the  presenters from  the Department  of  Revenue (DOR).  He                                                                    
referenced  a  handout  entitled,  "Overview  of  Fall  2009                                                                    
Revenue  Forecast", which  accompanied his  presentation. He                                                                    
began by sharing  the outline of the  presentation, as shown                                                                    
on slide 2.                                                                                                                     
                                                                                                                                
Co-Chair Stedman pointed out that  the presentation has been                                                                    
updated  since  it  was  presented   to  the  House  Finance                                                                    
Committee.                                                                                                                      
                                                                                                                                
Commissioner Galvin  shared that  how the production  tax is                                                                    
calculated  will  be  contained in  the  presentation.  Also                                                                    
included  will  be  information   about  forecasts  for  oil                                                                    
production, oil price, and lease expenditures.                                                                                  
                                                                                                                                
Commissioner  Galvin  turned  to   the  "Fall  2009  Revenue                                                                    
Forecast  - FY  10 and  FY 11  Total Revenue".  He explained                                                                    
that   the  primary   distinction  DOR   makes  is   between                                                                    
unrestricted and  restricted revenue  - slide  4. Restricted                                                                    
revenue  are those  funds that  are generally  set aside  by                                                                    
constitutional  requirement or  by  general practice  within                                                                    
the  legislature  and are  not  part  of the  general  fund.                                                                    
General fund is  referred to as unrestricted  revenue and is                                                                    
broken down into oil revenue,  other revenue, and investment                                                                    
earnings.                                                                                                                       
                                                                                                                                
Commissioner Galvin reported that  the Department of Revenue                                                                    
is projecting  an increase  in unrestricted  revenue between                                                                    
FY  10 and  FY  11.  The total  revenue  will also  increase                                                                    
between the two years.                                                                                                          
                                                                                                                                
9:22:23 AM                                                                                                                    
                                                                                                                                
Commissioner  Galvin turned  to slide  5 to  discuss general                                                                    
fund  unrestricted revenue  and  the  breakdown between  oil                                                                    
revenue  and  non-oil  revenue.  Oil  revenue  continues  to                                                                    
dominate the unrestricted revenue,  making up between 87 and                                                                    
88 percent of the total.  He pointed out that the production                                                                    
tax  is the  dominant portion  of the  oil revenue,  whereas                                                                    
royalties used to dominate.                                                                                                     
                                                                                                                                
Co-Chair  Stedman noted  that the  subtotal for  oil revenue                                                                    
would be  $4,647.7 billion  in FY  11. Non-oil  revenue will                                                                    
total  $589  million.  He stressed  the  importance  of  the                                                                    
difference  in magnitude  of the  two numbers.  He commented                                                                    
that a reduction in non-oil  revenue of 20 percent would not                                                                    
be significant;  however, a reduction  by 20 percent  in oil                                                                    
revenue would be a challenge.                                                                                                   
                                                                                                                                
9:23:50 AM                                                                                                                    
                                                                                                                                
Co-Chair Hoffman  questioned the reason behind  oil revenues                                                                    
increasing by  about a billion dollars.  Commissioner Galvin                                                                    
explained that  it was as a  result of higher oil  prices. A                                                                    
decline in production is predicted between FY 10 and FY 11.                                                                     
                                                                                                                                
Commissioner  Galvin turned  to  non-oil  revenue detail  on                                                                    
slide 6. The corporate income  tax is tax from non-oil based                                                                    
companies such as mining and fishing.                                                                                           
                                                                                                                                
Co-Chair  Stedman  wondered  which   month  brought  in  the                                                                    
highest  amount   from  oil  revenue.   Commissioner  Galvin                                                                    
reported  that  in FY  09  the  largest monthly  amount  was                                                                    
almost a  billion dollars. For comparison,  Co-Chair Stedman                                                                    
inquired  what  that  amount was  last  month.  Commissioner                                                                    
Galvin  thought  it  was   roughly  $300  million.  Co-Chair                                                                    
Stedman  stated  that  monthly revenue  from  oil  currently                                                                    
equals what will be earned  in one year from non-oil revenue                                                                    
taxes. Commissioner Galvin said that was correct.                                                                               
                                                                                                                                
9:26:12 AM                                                                                                                    
                                                                                                                                
Senator Olson  asked why  the revenue  from mining  taxes is                                                                    
projected  to decrease  by a  million dollars.  Commissioner                                                                    
Galvin deferred to Mr. Stickel to answer.                                                                                       
                                                                                                                                
9:26:47 AM                                                                                                                    
                                                                                                                                
DAN   STICKEL,  ECONOMIST,   TAX  DIVISION,   DEPARTMENT  OF                                                                    
REVENUE, thought  the tax decline in  FY 11 was a  result of                                                                    
lower mineral price projection.                                                                                                 
                                                                                                                                
Commissioner  Galvin  directed  attention  to  the  ten-year                                                                    
revenue/spending  projection as  depicted  on  slide 8.  The                                                                    
information is  a comparison of current  revenue projections                                                                    
and an  extrapolation of current  spending at a  very modest                                                                    
level of  increase on  an annual  basis. It  is a  3 percent                                                                    
budget escalation from  FY 11 forward. He  concluded that at                                                                    
the  end  of  the  projection period,  the  balance  in  the                                                                    
Constitutional  Budget Reserve  (CBR)  would  be almost  $24                                                                    
billion.                                                                                                                        
                                                                                                                                
Co-Chair  Stedman  requested  an  explanation  of  the  CBR.                                                                    
Commissioner Galvin  described the CBR  as a fund set  up by                                                                    
the state  constitution to  designate funds  to be  used for                                                                    
future budgetary  purposes. It was designed  to hold surplus                                                                    
dollars until  they were needed. Accessing  the CBR requires                                                                    
a three-quarters vote by the  legislature and it is intended                                                                    
to be  used to smooth  the state's fiscal  picture. Co-Chair                                                                    
Stedman noted that  the CBR is the  state's savings account.                                                                    
The PFD account  is not used to finance  shortfalls, but the                                                                    
budget reserve  accounts are - the  statutory budget reserve                                                                    
and the  constitutional budget reserve.  Commissioner Galvin                                                                    
agreed.                                                                                                                         
                                                                                                                                
Co-Chair Stedman  observed that  the total  reserve balances                                                                    
would  be $10  billion by  the  end of  FY 10.  Commissioner                                                                    
Galvin agreed.                                                                                                                  
                                                                                                                                
9:30:36 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  questioned if  the total  reserve balances                                                                    
would be $20 billion in  2017. Commissioner Galvin said that                                                                    
was  correct  given  the  assumptions  that  went  into  the                                                                    
projection model.                                                                                                               
                                                                                                                                
Co-Chair  Hoffman asked  if Commissioner  Galvin anticipated                                                                    
any draws  from the CBR  through FY 20.  Commissioner Galvin                                                                    
reported  that, given  the very  modest spending  increases,                                                                    
draws would not be needed.                                                                                                      
                                                                                                                                
Co-Chair Stedman pointed out the  projected 3 percent budget                                                                    
escalation. He  recalled previous zero  percent projections.                                                                    
Currently, the formula-driven side  of the operating account                                                                    
is substantially  higher than 3  percent, while  the portion                                                                    
of the  operating budget the  legislature manages  is lower.                                                                    
The  sum  of  the  two  is  projected  to  be  5.8  percent,                                                                    
resulting   in  the   need   to   substantially  lower   the                                                                    
legislature's portion. He predicted challenges ahead.                                                                           
                                                                                                                                
Senator Olson  questioned the numbers  in the FY  11 revenue                                                                    
vs. spending column.  He thought the total  should be $4,094                                                                    
million,  rather  than   $94  million.  Commissioner  Galvin                                                                    
referred  to a  footnote which  explained that  $400 million                                                                    
was set aside for the governor's scholarship program.                                                                           
                                                                                                                                
9:33:59 AM                                                                                                                    
                                                                                                                                
Co-Chair   Stedman  emphasized   that  the   scenarios  were                                                                    
hypothetical  forecasts at  3  percent,  which accounts  for                                                                    
inflation.  Commissioner Galvin  agreed  that  the model,  a                                                                    
reflection of  a scenario that  was unlikely to occur  for a                                                                    
variety of  reasons, was used  in order to show  revenue and                                                                    
spending projections.                                                                                                           
                                                                                                                                
Co-Chair  Stedman  requested   capital  budget  projections.                                                                    
Commissioner Galvin  explained that the  capital assumptions                                                                    
were extremely  modest, using  last year's  historically low                                                                    
capital  budget  and   extrapolating  it  forward.  Co-Chair                                                                    
Stedman    recalled   the    Senate   Finance    Committee's                                                                    
extraordinary actions last year  in reducing capital outlays                                                                    
due to  the implosion in  financial markets and  the decline                                                                    
in oil prices.                                                                                                                  
                                                                                                                                
9:35:32 AM                                                                                                                    
                                                                                                                                
Commissioner Galvin  explained how FY 09  production tax was                                                                    
calculated - slide 10. The  intent of this calculation is to                                                                    
show the component parts of  the production tax and how they                                                                    
relate  to each  other and  how the  total was  derived. Not                                                                    
included in the production  tax calculations are royalty and                                                                    
federal  barrels. Royalty  barrels  are those  owned by  the                                                                    
state as  part of  the lease  contract. Federal  barrels are                                                                    
those that are offshore.                                                                                                        
                                                                                                                                
Co-Chair Stedman stated  that the first thing  "off the top"                                                                    
is 12.5  percent for royalties. Commissioner  Galvin agreed.                                                                    
He explained  that a  quarter of that  amount goes  into the                                                                    
permanent  fund, and  the remainder  goes into  unrestricted                                                                    
revenue. Co-Chair  Stedman stressed  the importance  of that                                                                    
order.                                                                                                                          
                                                                                                                                
9:38:38 AM                                                                                                                    
                                                                                                                                
Commissioner  Galvin  directed   attention  to  the  taxable                                                                    
barrels  worth $15  billion, after  the royalty  and federal                                                                    
barrels  are subtracted  out.  That  amount constitutes  the                                                                    
value of the  oil at its ultimate market -  the refinery. In                                                                    
order  to determine  taxable value,  deductions  have to  be                                                                    
made,  such as  downstream transportation  costs. Those  are                                                                    
costs incurred  to get the  product to market  downstream of                                                                    
the  production  point.  The marine  transport  costs,  TAPS                                                                    
tariff, and  other costs are  deductible. This results  in a                                                                    
"truing  up" of  the  value of  the oil.  The  $6.50 is  the                                                                    
transportation  cost deduction,  which amounts  to about  $4                                                                    
billion  total.  He  defined  "the value  at  the  point  of                                                                    
production"  as   the  taxable   barrels  minus   the  total                                                                    
transportation costs.                                                                                                           
                                                                                                                                
9:42:01 AM                                                                                                                    
                                                                                                                                
Commissioner Galvin  explained deductible upstream  costs as                                                                    
deductions associated  with the  cost of producing  the oil.                                                                    
Those are  broken into  operating and  capital expenditures.                                                                    
Generally, operating costs  are day-to-day expenses, whereas                                                                    
capital costs  involve buying new equipment  or drilling new                                                                    
wells.                                                                                                                          
                                                                                                                                
Co-Chair Stedman  asked for  more information  on deductible                                                                    
operating expenditures,  such as  net and gross  barrels and                                                                    
how they  relate to  royalty. Commissioner  Galvin explained                                                                    
that  in  slide 10,  the  $2  billion  figure is  the  total                                                                    
operating  expenditures figure  which was  deducted for  oil                                                                    
that  resulted in  property  tax. That  was  divided by  218                                                                    
million  taxable barrels.  The operating  costs include  the                                                                    
cost of  producing royalty barrels  and are  deductible. For                                                                    
purposes  of  the  slide,  the amount  was  divided  by  the                                                                    
taxable barrels  to provide  a per  barrel cost.  The number                                                                    
$9.39  may not  be the  same if  a company  was showing  its                                                                    
operating  costs, because  operating costs  would be  spread                                                                    
among all barrels, including royalty barrels.                                                                                   
                                                                                                                                
Co-Chair  Stedman  noted  the   importance  of  taking  into                                                                    
consideration  the standardization  of per-barrel  costs for                                                                    
presentation purposes.                                                                                                          
                                                                                                                                
9:46:15 AM                                                                                                                    
                                                                                                                                
Commissioner Galvin  reported that the same  principle would                                                                    
apply to capital expenditures. He  clarified that the number                                                                    
on the  right-hand side  of the slide  is the  total capital                                                                    
expenditures for  capital costs that were  deducted from the                                                                    
taxes that were  paid. The end total  for lease expenditures                                                                    
is  $3.8 billion  and approximately  $17.40 per  barrel. The                                                                    
annual price per  barrel, $68.34, is the  average across the                                                                    
entire year, minus transportation  costs and the total lease                                                                    
expenditures, to get  at the production tax  value of $44.46                                                                    
per  barrel, which  equates to  $9.7  billion total  taxable                                                                    
value. That value is used  as the basis for calculating what                                                                    
the tax bill is.                                                                                                                
                                                                                                                                
Co-Chair  Stedman  asked  if  that  was  called  the  "total                                                                    
production cost."  Commissioner Galvin agreed that  it could                                                                    
be  called  that.  He  pointed  out  that  the  term  "lease                                                                    
expenditure"  was used  to designate  what  is qualified  as                                                                    
deductible  for  calculating  the production  tax.  Co-Chair                                                                    
Stedman hope to standardized terms.                                                                                             
                                                                                                                                
9:48:53 AM                                                                                                                    
                                                                                                                                
Commissioner Galvin  discussed the calculation used  for the                                                                    
production  tax. The  $9.7 billion  production tax  value is                                                                    
multiplied  by the  base  tax  rate of  25  percent and  the                                                                    
result is $2.4 billion in  base tax. Next, the progressivity                                                                    
of the tax is figured resulting  in the total tax due before                                                                    
credits, just  under $3 billion. Co-Chair  Stedman commented                                                                    
on the calculations. Commissioner  Galvin clarified that the                                                                    
total average  tax rate in  this model is 30.8  percent. The                                                                    
last  piece allows  for  the deduction  of  the credits  and                                                                    
yields  a  total  calculation. In  2009  the  total  credits                                                                    
deducted were about  $350 million, which results  in a total                                                                    
calculation of $2.6 billion for production tax purposes.                                                                        
                                                                                                                                
Co-Chair Stedman requested an  explanation of the credit. He                                                                    
noted that  the model  was very stripped  down. Commissioner                                                                    
Galvin cleared up a misconception  about capital credits. He                                                                    
stated  that capital  credits  that  are designated  through                                                                    
this line item are  predominantly "023 credits", a reference                                                                    
to the  tax code. They result  in 20 percent credit  and are                                                                    
divided into two calendar years.  In addition, companies may                                                                    
earn  credits  under  "025" or  the  "exploration  incentive                                                                    
credit program", which  are either 30 percent  or 40 percent                                                                    
of capital expenditures, depending  on location and drilling                                                                    
and seismic costs.                                                                                                              
                                                                                                                                
9:54:15 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman commented  that  the previous  information                                                                    
references  tax  codes,  which change  from  year  to  year.                                                                    
Commissioner  Galvin  explained about  exclusions  regarding                                                                    
costs of general maintenance.                                                                                                   
                                                                                                                                
Commissioner  Galvin related  that  credits  purchased by  a                                                                    
taxpayer  are  also  included  in  credits  applied  against                                                                    
taxes. He gave  an example of how that works.  He noted that                                                                    
credits can also be transferred.                                                                                                
                                                                                                                                
9:57:07 AM                                                                                                                    
                                                                                                                                
Senator Huggins  asked for Commissioner Galvin's  opinion as                                                                    
to how  the production  tax is working.  Commissioner Galvin                                                                    
explained  that  the  department  is  not  privy  to  actual                                                                    
negotiations,  but has  heard  a  preference from  companies                                                                    
that  earn the  credits  for a  cash-payment system,  rather                                                                    
than going to  an existing taxpayer, where there  is a value                                                                    
loss  and a  time delay  when converting  credit into  cash.                                                                    
Senator Huggins asked  if this was a part  of the governor's                                                                    
modified   Alaska's  Clear   and   Equitable  Share   (ACES)                                                                    
proposal.  Commissioner   Galvin  said  it  was.   A  couple                                                                    
components  would   eliminate  several   barriers  regarding                                                                    
explorers  being  able  to  get  cash  from  the  state  for                                                                    
credits.                                                                                                                        
                                                                                                                                
Co-Chair  Stedman requested  an  explanation of  how the  20                                                                    
percent capital credit  mechanism works. Commissioner Galvin                                                                    
explained that  a current producer  would deduct it  off the                                                                    
top.  The slide  shows  credits applied  against taxes.  The                                                                    
majority of  producers would deduct  it from their  tax bill                                                                    
and the state would not  receive any money. Others will have                                                                    
to apply to the state  for a credit certificate because they                                                                    
do  not  owe  production  tax. The  certificate  allows  the                                                                    
producer to  sell credits to  an existing producer or  to be                                                                    
reimbursed by the state.                                                                                                        
                                                                                                                                
Co-Chair  Stedman noted  the importance  of  the 20  percent                                                                    
capital  credit to  large production  companies like  Exxon,                                                                    
BP, and  ConocoPhillips and  to the  state. It  is difficult                                                                    
for the  state to see  in the summary documents  whether the                                                                    
capital deduction has  been taken or not.  Capital credit is                                                                    
the  credit  that impacts  the  state's  cash flow.  Smaller                                                                    
companies that  do not have  positive cash flow  consume the                                                                    
credits   themselves.  There   is  need   for  clarification                                                                    
regarding where  the capital credit  is being  generated and                                                                    
its  impact on  TAPS. Capital  credit has  a huge  impact on                                                                    
forecasting models.                                                                                                             
                                                                                                                                
Commissioner Galvin  agreed that it was  an important point.                                                                    
The  $350  million  in  credits  applied  against  taxes  is                                                                    
usually lost in the revenue  projection. It is usually taken                                                                    
off because  of credits earned.  An amount for  $193 million                                                                    
would  also be  seen for  credits for  which the  state paid                                                                    
cash, but  which had  to be  paid through  an appropriation.                                                                    
There was  a total of  $540 million in credits  that reduced                                                                    
the state's revenue.                                                                                                            
                                                                                                                                
10:03:40 AM                                                                                                                   
                                                                                                                                
Commissioner  Galvin   summarized  that  the   total  annual                                                                    
production tax, after credits, was  $2.6 billion. The actual                                                                    
amount  of  production  tax  collected in  FY  09  was  $3.1                                                                    
billion.  He  clarified  that   this  happened  because  the                                                                    
department  calculates production  tax on  a monthly  basis,                                                                    
not on  an annual  basis. The  monthly oil  price volatility                                                                    
matters -  slides 12  and 13.  The average  price of  oil in                                                                    
July   was  $132.87;   in  December   it  was   $37.70.  The                                                                    
progressive tax rate comes into play each month.                                                                                
                                                                                                                                
Co-Chair Stedman  commented that such  a large swing  in oil                                                                    
prices  was  not  considered during  the  discussions  about                                                                    
progressivity  under  PPT and  ACES.  He  hoped the  extreme                                                                    
volatility was  an aberration  in time.  Commissioner Galvin                                                                    
said  the numbers  also reflect  the  way in  which the  tax                                                                    
system responds to oil prices.                                                                                                  
                                                                                                                                
10:08:14 AM                                                                                                                   
                                                                                                                                
Senator  Huggins  asked  about the  total  government  take,                                                                    
including  federal  take  and   royalties,  in  July  versus                                                                    
January. Commissioner  Galvin guessed that in  a "$37 world"                                                                    
it would be around 60 percent.  At $132 it is closer to over                                                                    
80  percent.  Senator  Huggins stressed  the  importance  of                                                                    
recognizing  the large  swing  in  prices. Co-Chair  Stedman                                                                    
offered   to   provide   a  history   of   government   take                                                                    
calculations.  Commissioner   Galvin  emphasized   that  the                                                                    
government take  for FY 09 would  be significantly different                                                                    
if a yearly average of $68 per barrel were done.                                                                                
                                                                                                                                
10:10:27 AM                                                                                                                   
                                                                                                                                
Co-Chair  Stedman  requested  a  definition  of  "government                                                                    
take". Commissioner  Galvin defined it  as a number  used to                                                                    
reflect  the net  value distributed  between the  government                                                                    
and the company. It reflects  the percent of the profit that                                                                    
is acquired  by the state  or federal government. It  can be                                                                    
used as a comparison between different jurisdictions.                                                                           
                                                                                                                                
Commissioner Galvin  discussed the chart on  slide 14, which                                                                    
reflects  the  production  tax   projected  for  FY  10.  He                                                                    
described the  adjustment to reflect  monthly differentials.                                                                    
The    information   contains    actual   assumptions    and                                                                    
projections.                                                                                                                    
                                                                                                                                
10:13:23 AM                                                                                                                   
                                                                                                                                
Commissioner  Galvin  detailed   slide  15,  production  tax                                                                    
projections   for   FY   11  using   quarterly   oil   price                                                                    
projections.                                                                                                                    
                                                                                                                                
Co-Chair  Stedman requested  information  about the  capital                                                                    
credits  in  the  various projections.  Commissioner  Galvin                                                                    
responded that the progression between  FY 09, FY 10, and FY                                                                    
11 shows an increasing level  of credits applied against the                                                                    
taxes. That reflects an increase in spending.                                                                                   
                                                                                                                                
10:15:04 AM                                                                                                                   
                                                                                                                                
Senator  Huggins asked  about the  "carry forward"  from the                                                                    
previous  year   as  it   applies  to   capital  deductions.                                                                    
Commissioner Galvin  responded that the impact  of projected                                                                    
increasing  levels  of spending  is  lagged  by the  capital                                                                    
credits being taken over two years.                                                                                             
                                                                                                                                
Senator  Huggins  expressed  concern regarding  the  capital                                                                    
piece's   accuracy,  if   it  was   looked  at   separately.                                                                    
Commissioner  Galvin  explained  that   the  impact  of  the                                                                    
expenditure  is delayed,  although the  capital expenditures                                                                    
projection is  reflected in the  actual expenditures  of the                                                                    
appropriate  year. During  the reporting  process for  lease                                                                    
expenditures there is no lag.                                                                                                   
                                                                                                                                
10:17:35 AM                                                                                                                   
                                                                                                                                
Co-Chair  Stedman  commented  on  the need  to  examine  the                                                                    
capital credit issue  further in the future.  He asked about                                                                    
the  "less  adjustment" line  on  slide  15, which  did  not                                                                    
appear in FY  09. Commissioner Galvin responded  that it was                                                                    
the  reflection  of  the difference  between  an  annualized                                                                    
calculation  and   the  monthly  variations.  In   order  to                                                                    
reconcile  the  two  for the  actual  revenue  forecast,  an                                                                    
adjustment has to be made.                                                                                                      
                                                                                                                                
Senator Egan inquired  about the reason for  the increase in                                                                    
capital expenditures  between FY 09 and  FY 11. Commissioner                                                                    
Galvin  responded that  capital expenditures,  including new                                                                    
development   projects,   seismic  programs,   and   capital                                                                    
replacements  are  increasing.  There  has  been  discussion                                                                    
about the  amount of maintenance dollars  expended; however,                                                                    
the  department  has  not  seen   an  increase  in  spending                                                                    
projections as a result of higher maintenance costs.                                                                            
                                                                                                                                
10:20:31 AM                                                                                                                   
                                                                                                                                
Commissioner Galvin  observed that  the model is  an amalgam                                                                    
of all  the companies. Each individual  taxpayer is affected                                                                    
differently   due   to   various   levels   of   costs   and                                                                    
progressivity. As a company ramps  into production, there is                                                                    
a  period  of  time  when  the  credits  eliminate  the  tax                                                                    
obligations as a  function of oil prices.  He explained that                                                                    
it was a multiple variable tax structure.                                                                                       
                                                                                                                                
10:24:15 AM                                                                                                                   
                                                                                                                                
Senator Huggins wondered when Exxon  was planning to go from                                                                    
explorer to  producer at Point Thomson.  Commissioner Galvin                                                                    
stated  that  in  2014  Exxon would  begin  to  move  toward                                                                    
production of liquids.                                                                                                          
                                                                                                                                
Senator  Huggins asked  what liquids  includes. Commissioner                                                                    
Galvin defined it as "barrels of oil".                                                                                          
                                                                                                                                
Senator  Thomas  voiced  concern  about the  impact  to  the                                                                    
state's revenue due  to oil spills and the need  to shut the                                                                    
pipeline  down.  Commissioner  Galvin  replied  that,  under                                                                    
ACES,   maintenance   costs   that   are   associated   with                                                                    
interrupted service  cannot be  deducted. That  provision is                                                                    
being  examined;   however,  it  is  expected   to  prevail.                                                                    
Currently, there is  a lawsuit regarding the  impact of lost                                                                    
production from a shutdown.                                                                                                     
                                                                                                                                
10:27:18 AM                                                                                                                   
                                                                                                                                
Commissioner Galvin  discussed the components  of production                                                                    
tax calculations  and price  forecasting. He  introduced the                                                                    
specialists available for the presentation.                                                                                     
                                                                                                                                
FRANK MOLLI,  PRODUCTION FORECASTING  CONSULTANT, DEPARTMENT                                                                    
OF REVENUE,  testified via teleconference.  He characterized                                                                    
the graph  as showing North  Slope production by  field from                                                                    
1978  through 2030.  It shows  both historical  and forecast                                                                    
data.  To   generate  the  forecast,  production   data  was                                                                    
gathered  from  each  well  from  the  Alaska  Oil  and  Gas                                                                    
Conservation Commission  (AOGCC) and  then a  trend analysis                                                                    
on the recent history for each  well was applied in order to                                                                    
generate a  per-well forecast. Then,  a discussion  with the                                                                    
operators  about  development  plans for  future  wells  was                                                                    
considered, along with public and private information.                                                                          
                                                                                                                                
10:31:56 AM                                                                                                                   
                                                                                                                                
Mr.  Molli  described  the  FY  09  fall  forecast  as  more                                                                    
conservative  than previous  forecasts.  There were  several                                                                    
areas not  included in  this forecast  such as  ANWAR, NPRA,                                                                    
and some heavy oil deposits.  Also not included was a recent                                                                    
public  statement  by  Renaissance Alaska,  LLC,  about  the                                                                    
Umiat Field  with about  1 billion barrels  of oil  in place                                                                    
and a probable recovery of about 200 million barrels.                                                                           
                                                                                                                                
Mr. Molli described slide 19  - forecasted ANS production FY                                                                    
10 - FY  30. He explained that the gray  portion is oil from                                                                    
currently-producing  wells. The  department's confidence  in                                                                    
the forecast is high, within plus  or minus 3 percent of the                                                                    
actual numbers  in the  forecast one or  two years  out. The                                                                    
rainbow colors show production  projected from projects that                                                                    
are  either  under  development  or  under  evaluation.  The                                                                    
department's  confidence in  these numbers  is not  quite as                                                                    
good - within  plus or minus 10-15 percent for  the next one                                                                    
to  two years.  The  years 2022-3  show  the projection  for                                                                    
Point Thomson, contingent upon a gas line.                                                                                      
                                                                                                                                
Co-Chair Stedman  requested an explanation of  the inclusion                                                                    
of the  National Petroleum Reserve  - Alaska (NPR-A)  in the                                                                    
forecast.   Mr.  Molli   explained  that   NPR-A  is   under                                                                    
evaluation.                                                                                                                     
                                                                                                                                
Mr. Molli shared statistics  about recent production decline                                                                    
- slide 20. Since peak production  in 1988, there has been a                                                                    
66  percent decline.  The decline  rates,  on average,  have                                                                    
been around 5  percent. He noted that the near  term shows a                                                                    
4.5-5 percent decline.                                                                                                          
                                                                                                                                
Co-Chair Stedman  asked if  Alaska's production  scheme over                                                                    
the last 20 years was  normal. Mr. Molli answered that there                                                                    
is usually  a steep  decline at first  and then  it flattens                                                                    
out. He concluded that it was a typical oil basin.                                                                              
                                                                                                                                
Co-Chair   Stedman  noted   that  Mr.   Molli's  information                                                                    
disproves  comments made  in the  press about  dysfunctional                                                                    
policies in  the state leading  to a decline  in production.                                                                    
Mr. Molli agreed that the  decline in production was typical                                                                    
of a natural decline in an oil basin.                                                                                           
                                                                                                                                
10:36:35 AM                                                                                                                   
                                                                                                                                
Mr. Molli stressed that no  amount of money could change the                                                                    
natural   decline.  Co-Chair   Stedman   thought  that   was                                                                    
important for  the legislature  to remember  when attempting                                                                    
to slow down the decline.                                                                                                       
                                                                                                                                
Senator  Huggins  requested  information on  how  to  attack                                                                    
production decline.                                                                                                             
                                                                                                                                
10:38:19 AM                                                                                                                   
                                                                                                                                
DONA  KEPPERS, AUDIT  MASTER,  TAX  DIVISION, DEPARTMENT  OF                                                                    
REVENUE,  testified  via  teleconference.  She  reported  on                                                                    
slide  22, an  overview of  price forecast  methodology. The                                                                    
information  came from  a recent  price forecasting  session                                                                    
attended  by numerous  experts in  the  field. Factors  that                                                                    
influence   price  were   studied:  supply,   demand,  world                                                                    
economy, geopolitics, financial markets,  and others. Due to                                                                    
economic  uncertainty, analysts  in the  session focused  on                                                                    
near-term prices.                                                                                                               
                                                                                                                                
Ms.  Keppers explained  slide  23 -  price  forecasts as  of                                                                    
October  2009.  It   is  a  graph  that   shows  West  Texas                                                                    
Intermediate (WTI)  price forecast.  She explained  that WTI                                                                    
is known  as Texas light  sweet crude oil  and is used  as a                                                                    
benchmark in  oil pricing. The  underlying commodity  of the                                                                    
New  York   Mercantile  Exchange   (NYMEX)  is   oil  future                                                                    
contracts.  The  chart  shows   forecasts  from  the  Alaska                                                                    
Department  of Revenue  (AK -  DOR)  and Energy  Information                                                                    
Administration  (EIA), one  of  the  industry's experts,  as                                                                    
well as from NYMEX and the analysts.                                                                                            
                                                                                                                                
Ms. Keppers turned to slide 24.  She reported that for FY 10                                                                    
and  FY 11,  the  AK-DOR  forecast came  out  at $68.71  and                                                                    
$78.85,  respectively, very  similar to  predictions by  NY-                                                                    
MEX, EIA, and the analysts.                                                                                                     
                                                                                                                                
10:40:35 AM                                                                                                                   
                                                                                                                                
Commissioner Galvin defined EIA  as the federal government's                                                                    
forecasting group from the Department  of Energy. He pointed                                                                    
out  that   EIA,  the  green  line,   is  extremely  bullish                                                                    
regarding expectations of oil  prices. He explained that the                                                                    
red line  represents the futures market  and involves people                                                                    
looking to  make money;  therefore, the  forecast is  on the                                                                    
lower  end.  The blue  line  is  the synthesis  of  industry                                                                    
forecasts  and it  falls  into the  middle.  The black  line                                                                    
represents  the state's  official  revenue  forecast and  is                                                                    
slightly more conservative than the average.                                                                                    
                                                                                                                                
Co-Chair  Stedman  added  that the  production  forecast  is                                                                    
normally  much tighter  than the  price forecast.  The price                                                                    
sensitivity   in   the   budgets  overwhelms   the   volumes                                                                    
sensitivity.  It is  hoped  that the  price  forecast is  as                                                                    
accurate as the "barrels" forecast.                                                                                             
                                                                                                                                
Ms. Keppers turned to slide 24,  the fall 2009 DOR oil price                                                                    
forecast  for  WTI  and   ANS.  Co-Chair  Stedman  requested                                                                    
information on  the drifting off of  West Texas Intermediate                                                                    
as a benchmark.                                                                                                                 
                                                                                                                                
Commissioner Galvin said  WTI is a standard  benchmark and a                                                                    
published index of the West  Coast oil price for delivery at                                                                    
a  refinery. The  differential  between  Alaska North  Slope                                                                    
(ANS)   and  WTI   will  fluctuate.   The  state   uses  for                                                                    
forecasting purposes  a $2.50  discount from  WTI to  get to                                                                    
ANS projections. In reality, ANS  has had more premium sales                                                                    
over WTI recently.                                                                                                              
                                                                                                                                
10:46:04 AM                                                                                                                   
                                                                                                                                
Senator  Egan  asked  if  heavy  oil  is  being  considered.                                                                    
Commissioner   Galvin   answered   that  it   is   sometimes                                                                    
considered. He  explained that on  the upstream  side, heavy                                                                    
oil  costs more  per  barrel to  produce.  A "quality  bank"                                                                    
adjustment  is  incorporated   into  future  projections  to                                                                    
account for heavy oil.                                                                                                          
                                                                                                                                
CHERYL L.  NIENHUIS, ACTING  CHIEF ECONOMIST,  DEPARTMENT OF                                                                    
REVENUE,  testified  via  teleconference.  She  agreed  that                                                                    
there are additional  costs to produce heavy  oil. Heavy oil                                                                    
is discounted  when it is  marketed because it is  not worth                                                                    
as much as  light, sweet crude. A quality  bank is something                                                                    
that occurs in  Alaska when oil is sold  to refineries which                                                                    
extract the most valuable oil  components in order to refine                                                                    
it.  Whatever  is  put  back  into  the  pipeline  generally                                                                    
decreases the quality of the oil.                                                                                               
                                                                                                                                
Co-Chair Stedman  noted that the 20  percent credit embedded                                                                    
in ACES and  PPT is targeted to deal with  the extra cost of                                                                    
heavy oil.                                                                                                                      
                                                                                                                                
10:49:58 AM                                                                                                                   
                                                                                                                                
Commissioner  Galvin   commented  that  the   department  is                                                                    
gaining a  window into  the profiles  of the  companies that                                                                    
wasn't  available  previously.   Company  tax  reports  have                                                                    
provided data  related to lease expenditures;  however, this                                                                    
information is just  beginning to provide data  which can be                                                                    
analyzed.                                                                                                                       
                                                                                                                                
Co-Chair   Stedman  noted   pointed  out   that  legislative                                                                    
consultants have  been surprised by the  lack of information                                                                    
from  the oil  companies.  Commissioner  Galvin stated  that                                                                    
there are  restrictions as to how  much taxpayer information                                                                    
can be  provided. The lease expenditure  information must be                                                                    
presented in an aggregated form,  rather than on a taxpayer-                                                                    
specific basis.                                                                                                                 
                                                                                                                                
Mr. Stickel related that the  department has historical data                                                                    
on  lease  expenditures  based on  annual  tax  returns  and                                                                    
monthly  information forms  from  2007-2009.  There is  also                                                                    
data  on capital  expenditures from  PPT information.  Under                                                                    
ACES  the  department  also   requests  forecasts  from  the                                                                    
producers  for  estimates  of  expenditures.  The  producers                                                                    
provide  forecasts  of  expenditures  as well  as  plans  of                                                                    
development  for  projects.  Companies typically  provide  a                                                                    
five-year   window.  The   department's  lease   expenditure                                                                    
forecast is based on this information from the companies.                                                                       
                                                                                                                                
10:54:28 AM                                                                                                                   
                                                                                                                                
Mr.  Stickel   explained  slide  27  -   Lease  Expenditures                                                                    
(Costs).  He related  that  the  report contains  three-year                                                                    
historical   lease  expenditure   data.   The  graph   shows                                                                    
operating  expenditures  for the  North  Slope  at about  $2                                                                    
billion a year,  which have been steady from FY  07 to FY 09                                                                    
and  should  remain  so  for   FY  10  and  FY  11.  Capital                                                                    
expenditures show  an increase over  the last two  years and                                                                    
continuing  to do  so. Some  companies are  reducing capital                                                                    
expenditures; however, new companies are not.                                                                                   
                                                                                                                                
Co-Chair  Stedman suggested  that information  about revenue                                                                    
sources would be forthcoming.                                                                                                   
                                                                                                                                
Mr.  Stickel  related  information   on  slide  28  -  lease                                                                    
expenditures  per barrel.  Operating expenditures  have been                                                                    
relatively  steady,  but  are increasing  on  a  per  barrel                                                                    
basis. Capital expenditures on a  per barrel basis have more                                                                    
than doubled.                                                                                                                   
                                                                                                                                
Co-Chair  Stedman recalled  that  when  the legislature  was                                                                    
looking  at  PPT,  capital  expenditures  were  expected  to                                                                    
increase by $1 billion in the  Basin. He thought it would be                                                                    
interesting  to  revisit  the  expectations  under  the  net                                                                    
profit  tax versus  under  ELF, as  well  as projections  on                                                                    
capital expenditure trends.                                                                                                     
                                                                                                                                
10:57:22 AM                                                                                                                   
                                                                                                                                
Co-Chair  Stedman  requested  that  committee  members  make                                                                    
requests regarding more information  on the revenue forecast                                                                    
model.                                                                                                                          
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
The meeting was adjourned at 10:57 AM.                                                                                          

Document Name Date/Time Subjects
SFinPresent - 1 26 10.pdf SFIN 1/26/2010 9:00:00 AM
DOR - Forecast
Teal Fiscal Summary2011.pdf SFIN 1/26/2010 9:00:00 AM
SFIN 1/27/2010 9:00:00 AM
FY11 OMB Overview
FY11- OMB Ovierview