Legislature(2009 - 2010)SENATE FINANCE 532

02/17/2010 01:30 PM Senate FINANCE


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Audio Topic
01:32:20 PM Start
01:33:25 PM Operating and Capital Expenditures
02:43:04 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Production Tax Review: TELECONFERENCED
Lease Expenditures
Dept of Revenue & other Administrative
Representatives
-- Testimony <Invitation Only> --
                 SENATE FINANCE COMMITTEE                                                                                       
                     February 17, 2010                                                                                          
                         1:32 p.m.                                                                                              
                                                                                                                                
                                                                                                                                
1:32:F20 PM                                                                                                                   
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Stedman called the Senate Finance Committee                                                                            
meeting to order at 1:32 p.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                                                                                                                  
                                                                                                                                
Cherie Nienhuis, Petroleum Economist, Department of                                                                             
Revenue; Marsha Davis, Deputy Commissioner, Department of                                                                       
Revenue.                                                                                                                        
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
Oil and Gas Overviews:                                                                                                          
                                                                                                                                
     PRODUCTION TAX LEASE EXPENDITURE REGULATIONS                                                                             
                                                                                                                                
     OPERATING and CAPITAL EXPENDITURES                                                                                       
                                                                                                                                
^OPERATING AND CAPITAL EXPENDITURES                                                                                             
                                                                                                                                
1:33:25 PM                                                                                                                    
                                                                                                                                
CHERIE   NIENHUIS,   PETROLEUM  ECONOMIST,   DEPARTMENT   OF                                                                    
REVENUE, informed  the committee  that she would  present an                                                                    
update of operating and capital  lease expenditures based on                                                                    
information acquired since the  state changed its tax system                                                                    
to  a net  profit system.  She  explained that  some of  the                                                                    
information  presented  was   acquired  either  through  the                                                                    
former profits  tax called the  Petroleum Profits  Tax (PPT)                                                                    
or through the Alaska Clear  and Equitable Share (ACES) tax,                                                                    
which has been in place since the PPT.                                                                                          
                                                                                                                                
Ms. Nienhuis provided  a PowerPoint presentation, "Operating                                                                    
and  Capital Lease  Expenditures, Senate  Finance Committee,                                                                    
February 17, 2010" (copy on file), and outlined the agenda:                                                                     
                                                                                                                                
   · Lease Expenditure Sources                                                                                                  
   · Total North Slope Lease Expenditures                                                                                       
   · Standard Deduction Provision                                                                                               
   · $0.30/barrel Capital Expenditure Exemption                                                                                 
   · Trends in North Slope Spending                                                                                             
                                                                                                                                
Ms.  Nienhuis   turned  to   slide  3,   "Lease  Expenditure                                                                    
Information Sources,"  and delineated the  sources available                                                                    
to the department:                                                                                                              
                                                                                                                                
   · Capital expenditure information                                                                                            
   · Monthly expenditure estimates                                                                                              
   · Annual expenditure information, 2006 - 2009                                                                                
   · Future expenditure projections from North Slope                                                                            
     operators                                                                                                                  
   · Manual processing of all expenditure information                                                                           
                                                                                                                                
Ms.   Nienhuis  detailed   that   the  capital   expenditure                                                                    
information  was  historical,  current, and  projected.  The                                                                    
Department  of Revenue  (DOR)  receives monthly  expenditure                                                                    
estimates from  companies spending money in  the state's oil                                                                    
and  gas  operations. The  state  has  also received  annual                                                                    
expenditure information from tax  returns for calendar years                                                                    
2006 through 2008;  2009 returns will be  received March 31,                                                                    
2010.                                                                                                                           
                                                                                                                                
Ms. Nienhuis  explained that  all the  information regarding                                                                    
lease  expenditures is  received  in  various manual  forms,                                                                    
including Excel sheets, PDFs, and sometimes hard copies.                                                                        
                                                                                                                                
1:37:02 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  provided more  information related  to capital                                                                    
expenditure information.  She reported  that during  the PPT                                                                    
discussion,  there was  reference  to transition  investment                                                                    
expenditure credits (TIE); TIE  credits still exist but have                                                                    
changed since the  inception of ACES. The TIE  credit set up                                                                    
a  system   whereby  companies  could  receive   credit  for                                                                    
expenditures  between  the  years  of  2001  and  2006;  the                                                                    
department received information  regarding estimated capital                                                                    
expenditures during that time period.                                                                                           
                                                                                                                                
Ms.  Nienhuis  noted  that   the  department  began  getting                                                                    
monthly  expenditure estimates  in  May 2008.  The ACES  tax                                                                    
system  set up  a  structure requiring  companies that  were                                                                    
spending money in  oil and gas operations  to submit monthly                                                                    
estimated  expenditures  and  tax payments.  She  underlined                                                                    
that  the  monthly  expenditures  are  only  estimates,  not                                                                    
audited  documents. The  numbers  are used  by the  economic                                                                    
research group to forecast tax revenues for the state.                                                                          
                                                                                                                                
Ms.  Nienhuis listed  details  regarding annual  expenditure                                                                    
information:                                                                                                                    
                                                                                                                                
   · Auditable production tax returns, due March 31 of each                                                                     
     year                                                                                                                       
   · First filing March 31, 2007 (first under PPT)                                                                              
   · Second filing March 31, 2008 (first under ACES)                                                                            
   · Third filing March 31, 2009 (second under ACES)                                                                            
                                                                                                                                
Ms.  Nienhuis emphasized  that DOR  had tax  returns without                                                                    
some of  the calculation  information that  would ordinarily                                                                    
be on a standardized return  because during the whole period                                                                    
of  time  the  department  was working  on  regulations  and                                                                    
defining  such items  as  lease  expenditures. Returns  were                                                                    
submitted  manually.   The  department   hopes  to   have  a                                                                    
standardized form developed within a year.                                                                                      
                                                                                                                                
Ms.   Nienhuis  reported   that   the  department   receives                                                                    
expenditures based  on projections.  Two forecasts  are done                                                                    
each year, one  in the fall and one in  the spring. Prior to                                                                    
the  forecast,  operators are  asked  to  submit their  best                                                                    
projections  for  capital  and  operating  expenditures,  by                                                                    
unit,   for   up  to   five   years.   Statute  limits   the                                                                    
communications  to what  the  operators  share with  working                                                                    
interest owners;  a special projection  is not  prepared for                                                                    
DOR.  As  a result,  projections  vary  by operator  and  by                                                                    
property. Some  projections categorize  costs and  others do                                                                    
not.                                                                                                                            
                                                                                                                                
1:40:37 PM                                                                                                                    
                                                                                                                                
MARSHA  DAVIS, DEPUTY  COMMISSIONER, DEPARTMENT  OF REVENUE,                                                                    
added  that  the  form  for   the  annual  return  has  been                                                                    
completed  and issued,  and will  be required  for March  of                                                                    
2011. The department will not  require that the standardized                                                                    
form be used  for March of 2010 because  companies will need                                                                    
time to merge their software into an Excel format.                                                                              
                                                                                                                                
Co-Chair Stedman requested  more detail regarding transition                                                                    
credits. Ms.  Davis replied that an  individual breakdown of                                                                    
credits would be provided in  the credit section of a future                                                                    
hearing.                                                                                                                        
                                                                                                                                
Ms.  Nienhuis directed  attention  to a  graph  on slide  6,                                                                    
"North  Slope Operating  and Capital  Expenditures, Reported                                                                    
and Projected." She noted that  the numbers were not audited                                                                    
but totals  received by looking  at annual tax  returns, and                                                                    
that the  numbers shown for  2010 and 2011  are projections.                                                                    
Operating  expenditures  are  shown   in  blue  and  capital                                                                    
expenditures  in  orange.  She   pointed  out  that  capital                                                                    
expenditures  have grown  each year  since the  inception of                                                                    
the  net profits  tax and  that  operating expenditures  are                                                                    
expected to  decrease in the  future. In general,  there are                                                                    
overall increased expenditures for the North Slope.                                                                             
                                                                                                                                
Co-Chair Stedman asked whether  a future hearing would cover                                                                    
the sources of capital  expenditures. Ms. Davis replied that                                                                    
detail  regarding capital  and operating  expenditures would                                                                    
be covered  at the present  meeting and that the  next day's                                                                    
hearing would cover how credits were applied for.                                                                               
                                                                                                                                
Co-Chair Hoffman pointed out that  the projected capital and                                                                    
operating expenditures for 2011 are  the highest of the past                                                                    
five years.  Ms. Nienhuis agreed  that the  projections were                                                                    
higher than any previous year.                                                                                                  
                                                                                                                                
1:44:01 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis  turned  to  a  graph  on  slide  7,  "Capital                                                                    
Expenditures per Barrel, Total  North Slope." She emphasized                                                                    
that  capital expenditures,  unlike operating  expenditures,                                                                    
do  not  always  coincide with  active  production.  Capital                                                                    
expenditures  normally precede  production; the  increase of                                                                    
capital  expenditures  per  barrel  depicted  on  the  graph                                                                    
reflects  spending  and  a   steady  or  slightly  declining                                                                    
production  base. The  fact  that  capital expenditures  per                                                                    
barrel are  on the  rise says  more about  future production                                                                    
than about current production.                                                                                                  
                                                                                                                                
Co-Chair  Stedman  asked whether  the  barrels  were net  or                                                                    
gross. Ms. Nienhuis replied that they were taxable barrels.                                                                     
                                                                                                                                
Ms. Nienhuis  noted that  the graph  on slide  8, "Operating                                                                    
Expenditures  per Barrel,  Total  North  Slope" shows  total                                                                    
reported  operating  expenditures;  the  standard  deduction                                                                    
provision  is not  included. The  numbers  reflect what  was                                                                    
reported to  the department through  annual returns  in some                                                                    
cases   and  through   monthly   returns   in  others.   She                                                                    
highlighted  a decrease  starting  in FY  10, and  explained                                                                    
that operating  expenditures are  more or  less costs  to do                                                                    
day-to-day business on the  North Slope; expenditures coming                                                                    
down  could point  to efficiencies  or  to services  costing                                                                    
less.                                                                                                                           
                                                                                                                                
Senator  Egan  asked  where   maintenance  costs  fell.  Ms.                                                                    
Nienhuis replied  that maintenance generally falls  into the                                                                    
operating expense category.                                                                                                     
                                                                                                                                
Ms. Davis clarified  that they would be  talking later about                                                                    
the standard  deduction, but she  wanted to  clarify related                                                                    
to  the   slide  that  shows  the   real,  actual  operating                                                                    
expenses. She noted  that under the tax  provision there was                                                                    
a  temporary  cap  on the  operating  expense  deduction  at                                                                    
Prudhoe and  Kuparuk; the  capping is  not reflected  in the                                                                    
graph.                                                                                                                          
                                                                                                                                
Ms. Nienhuis added that the  figures are unaudited, company-                                                                    
reported figures; they could change with an audit.                                                                              
                                                                                                                                
1:47:25 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis  moved  to slide  9,  "Prudhoe  Bay  Operating                                                                    
Expenditures per Barrel, as Reported  and Forecast," a graph                                                                    
covering  2003 to  2010.  She commented  that  the chart  is                                                                    
included in  the department's  ACES review.  She highlighted                                                                    
the significant  rise in operating expenditures  in 2006 and                                                                    
2007,  numbers consistent  with  published documentation  by                                                                    
Cambridge  Energy  Research   Associates  regarding  similar                                                                    
trends worldwide.  Costs are shown  coming down in  2009 and                                                                    
2010, reflecting operating expenditure trends everywhere.                                                                       
                                                                                                                                
Co-Chair Stedman  detailed for the public  what the dollars-                                                                    
per-barrel figures on the graph  represented. He pointed out                                                                    
that  each  2010 penny  translates  to  about $2.4  million;                                                                    
producing 240 million barrels per year has huge impact.                                                                         
                                                                                                                                
Ms. Nienhuis  observed that  the price of  oil needed  to be                                                                    
considered   when   discussing   operating   expenses.   She                                                                    
elaborated that  there was an  increase in the price  of oil                                                                    
along with the  increase in operating costs  per barrel. The                                                                    
department believes that  the price of oil and  the price of                                                                    
doing  business  in  oil and  gas  operations  are  directly                                                                    
correlated,  although  possibly  lagged;  increases  in  the                                                                    
price  of services,  lease expenditures,  and various  items                                                                    
are  related  to  increases in  the  price  of  commodities,                                                                    
including oil. She hoped the  price decline seen in 2008 and                                                                    
2009 would help drive operating costs down.                                                                                     
                                                                                                                                
Ms. Davis  elaborated that as the  price of oil goes  up, it                                                                    
becomes  much  more lucrative  to  be  in  the oil  and  gas                                                                    
business, and  that the resulting  pressure to  move quickly                                                                    
is more  costly. An intense  amount of demand can  be placed                                                                    
on services and equipment; a  higher demand on the commodity                                                                    
can  translate to  increased  prices.  Conversely, when  oil                                                                    
prices drop,  demand goes down, commodities  lag, and prices                                                                    
of services have to go down.                                                                                                    
                                                                                                                                
1:51:14 PM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman  pointed  out   that  the  2010  operating                                                                    
projection was roughly $2 billion.  Ms. Davis added that the                                                                    
$2 billion was the total for the North Slope.                                                                                   
                                                                                                                                
Senator  Thomas asked  whether the  significant increase  in                                                                    
operating expenses  was related to  maintenance difficulties                                                                    
in Prudhoe Bay  in 2006. Ms. Davis replied  that in absolute                                                                    
dollars  there   is  an   increase  in   operating  expenses                                                                    
associated  with  repair work.  She  added  that the  actual                                                                    
costs associated with the spill  and corrosion event are not                                                                    
allowed to be  deducted as lease expenditures  and would not                                                                    
show up on  returns. However, after a spill  a company would                                                                    
proactively  replace other  lines. She  cautioned that  that                                                                    
alone would  not explain the  increase in  operating expense                                                                    
on a per barrel basis.                                                                                                          
                                                                                                                                
Co-Chair  Stedman requested  dollar  per barrel  information                                                                    
related  to  Prudhoe  Bay  as  well  as  other  expenditures                                                                    
outside  of Prudhoe  Bay. He  wanted information  separately                                                                    
for Prudhoe Bay and Kuparuk.  Ms. Davis explained that there                                                                    
was  data for  Prudhoe Bay  operating expenses  and not  for                                                                    
Kuparuk.                                                                                                                        
                                                                                                                                
Co-Chair  Stedman suggested  dividing  the  data up  between                                                                    
Prudhoe Bay and  all other units. Ms. Davis did  not know if                                                                    
there was a  total North Slope operating  expense figure for                                                                    
2003, 2004, or 2005.                                                                                                            
                                                                                                                                
1:54:45 PM                                                                                                                    
                                                                                                                                
Ms.   Nienhuis  observed   that  the   department  publishes                                                                    
material  on a  much  higher scale  in  the Revenue  Sources                                                                    
Book,   including  total   North  Slope   expenditures.  She                                                                    
believed  the  most  recent  projection  split  capital  and                                                                    
operating expenses  at about $9  per barrel. She  offered to                                                                    
verify and get more information.                                                                                                
                                                                                                                                
Ms.  Nienhuis  directed  attention to  slide  10,  "Standard                                                                    
Deduction Provision at AS  43.55.165(j)." She explained that                                                                    
the  standard deduction  provision  refers  to a  limitation                                                                    
placed  on lease  expenditures in  Prudhoe  Bay and  Kuparuk                                                                    
units.  The amount  was limited  to  the lease  expenditures                                                                    
that were set in calendar year  (CY) 2006, the first year of                                                                    
the  net profits  tax,  and  adjusted so  that  it could  be                                                                    
inflated by 3 percent each  year. The standard deduction was                                                                    
in place  for CY 2007, CY  2008, and CY 2009;  the provision                                                                    
sunset  at  the  end  of  CY 2009.  She  reported  that  the                                                                    
department  had not  yet received  its first  monthly report                                                                    
without the  standard provision;  the first  was due  at the                                                                    
end of February.                                                                                                                
                                                                                                                                
Ms.  Nienhuis turned  to  slide 11,  "Prudhoe  Bay Opex  per                                                                    
Barrel, as  Reported and with Standard  Deduction." The blue                                                                    
bars in the  graph depict the same figures as  the blue bars                                                                    
on slide  9, with the  operating expenses (opex)  per barrel                                                                    
allowed  under the  standard deduction  shown in  the orange                                                                    
bars  from 2007  to  2009. She  noted  the clearly  widening                                                                    
differences  for  those  three years.  The  2010  projection                                                                    
shows the gap  narrowing, which she believed  was related to                                                                    
operating  expenses  coming down  in  general  on the  North                                                                    
Slope and in Prudhoe Bay in particular.                                                                                         
                                                                                                                                
1:57:34 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  considered the "Impact of  Standard Deduction"                                                                    
(slide 12):                                                                                                                     
                                                                                                                                
  · Held operating expenditures fairly level for 3 years                                                                        
   · Expenditures more predictable for forecasting                                                                              
   · Difference between standard deduction and total                                                                            
     reported costs greater at Prudhoe Bay unit than                                                                            
     Kuparuk unit                                                                                                               
   · Impact on state revenues more significant as oil                                                                           
     prices increase                                                                                                            
                                                                                                                                
Ms. Nienhuis detailed that the  monthly forms asked how much                                                                    
was deducted under  the standard deduction and  how much was                                                                    
actually  spent  in  the  unit. Ms.  Davis  added  that  one                                                                    
speculation  about the  difference in  cost between  the two                                                                    
units was  that since Prudhoe  Bay is  in an active  mode of                                                                    
repair  and  addressing  corrosion issues,  there  was  less                                                                    
discretion  regarding what  they would  and would  not spend                                                                    
relative to  operating expenses,  whereas the  Kuparuk unit,                                                                    
which  is   not  in  a  crisis,   could  shift  expenditures                                                                    
elsewhere and  had more  ability to stay  closer to  the cap                                                                    
limit.                                                                                                                          
                                                                                                                                
Ms. Nienhuis moved  to slide 13, "Increase  to State Revenue                                                                    
from  Standard Deduction  Provision." The  blue portions  of                                                                    
the bar graph show the  amount of North Slope production tax                                                                    
paid in  FY 07,  FY 08,  and FY  09, and  the impact  of the                                                                    
standard  deduction is  shown in  gold. She  noted that  the                                                                    
impact in FY 07 was  fairly slight as the standard deduction                                                                    
was only  in place for  half of  the year. In  addition, oil                                                                    
prices were  not as high  as they were in  subsequent years.                                                                    
In FY  08, there were  high oil prices, which  increased the                                                                    
tax  rate and  therefore  the  impact to  the  state of  the                                                                    
standard  deduction provision.  In  FY 09,  the impact  went                                                                    
down again, reflecting lower oil prices.                                                                                        
                                                                                                                                
Co-Chair  Stedman   queried  the  total  for   the  standard                                                                    
deduction. Ms. Nienhuis answered [$611 million].                                                                                
                                                                                                                                
Co-Chair  Stedman  wanted  to consider  credits  created  in                                                                    
Prudhoe Bay  and Kuparuk, and  how various factors  acted as                                                                    
stimulants  and  suppressants. He  stated  that  one of  the                                                                    
questions  was  the  effect  of the  20  percent  credit  in                                                                    
Prudhoe and Kuparuk,  and how much the credit  was offset by                                                                    
the  standard deduction,  if at  all.  Ms. Nienhuis  replied                                                                    
that analysis  has shown an  operating expense  component to                                                                    
capital expenditure.                                                                                                            
                                                                                                                                
Ms.  Davis added  that a  standard  deduction only  operated                                                                    
relative  to   the  operating  expenses,  not   the  capital                                                                    
expenses, so  it would not have  had an impact on  the value                                                                    
of  capital investment  in  the 20  percent  tax credit;  it                                                                    
would  have impacted  the overall  base tax  rate of  the 25                                                                    
percent in the progressivity rate.                                                                                              
                                                                                                                                
Co-Chair  Stedman  asked  how much  the  standard  deduction                                                                    
diluted the credit stimulation.  He thought that the purpose                                                                    
of  the credit  was to  stimulate in-field  drilling and  to                                                                    
access heavy oil. Ms. Davis agreed.                                                                                             
                                                                                                                                
Co-Chair Stedman pointed out that  $611 million was a lot of                                                                    
money.  He understood  that the  standard deduction  did not                                                                    
apply  to the  capital  expenditure side,  but may  possibly                                                                    
have inhibited  capital decisions to  go forward and  try to                                                                    
extract more oil at Prudhoe and Kuparuk.                                                                                        
                                                                                                                                
2:03:32 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis  directed  attention  to  slide  14,  "Capital                                                                    
Exemption of $0.30 per barrel at AS 43.55.165(e)(18)."                                                                          
                                                                                                                                
   · AS 43.55.165(e)(18) exempts $0.30 per barrel                                                                               
        o Initially   intended    to   address    costs   of                                                                    
          maintaining    and    upgrading   pipelines    and                                                                    
          facilities                                                                                                            
        o Applies to all barrels produced, regardless of                                                                        
          property                                                                                                              
   · Impact of Capital Exemption                                                                                                
        o Reduced reported capital expenditures by close to                                                                     
          $70 million per year                                                                                                  
        o Expenditure forecasts indicate maintenance and                                                                        
          upgrade of several hundred million                                                                                    
        o Maintenance and upgrade expenditures could be                                                                         
          amortized over 10 to 20 years                                                                                         
   · AS 43.55.165(e)(19) addresses unplanned maintenance;                                                                       
     Some reporting of unplanned maintenance expenditures                                                                       
     by companies                                                                                                               
                                                                                                                                
Ms.  Nienhuis explained  that the  capital  exemption was  a                                                                    
provision retained in  ACES from PPT that  exempts $0.30 per                                                                    
barrel of capital deductions from  the ACES tax calculation.                                                                    
The   provision   was   added   relatively   late   in   the                                                                    
deliberations  on  the tax  and  was  initially intended  to                                                                    
address  costs of  maintaining  and  upgrading pipeline  and                                                                    
facilities.                                                                                                                     
                                                                                                                                
Co-Chair Stedman  asked for  more information.  Ms. Nienhuis                                                                    
believed the $0.30 per barrel  exemption was a break for the                                                                    
state as  the state would  not have  to pay to  upgrade aged                                                                    
infrastructure and facilities on  the North Slope concerning                                                                    
capital credits.                                                                                                                
                                                                                                                                
Ms.  Nienhuis  noted  that  the  exemption  applies  to  all                                                                    
barrels produced,  regardless of  where the oil  comes from.                                                                    
The impact to  the capital exemption was that  the state had                                                                    
reduced capital deductions by close  to $70 million per year                                                                    
(the  exemption  is   per  barrel,  so  would   go  down  as                                                                    
production decreases). The department  was asked to evaluate                                                                    
whether  the   [exemption]  was  sufficient  to   cover  the                                                                    
maintenance and  upgrade of facilities  on the  North Slope.                                                                    
She  reported  that  there   has  been  some  infrastructure                                                                    
renewal, which  can cost from  tens of millions  to hundreds                                                                    
of millions of  dollars. She observed that it  was not clear                                                                    
whether  the   improvements  were   because  of   the  aging                                                                    
infrastructure  or  were  part  of  the  project  plan.  The                                                                    
department calculates that a  several hundred million dollar                                                                    
improvement would  last 10 to  20 years, which could  add up                                                                    
to enough to cover the maintenance and upgrade.                                                                                 
                                                                                                                                
Ms.  Nienhuis pointed  out that  a  provision added  through                                                                    
ACES (AS  43.55.165(e)(19) addresses  unplanned maintenance.                                                                    
The provision is an exemption;  companies are not allowed to                                                                    
deduct  capital or  operating expenditures  incurred because                                                                    
of  an  unplanned  event such  as  an  unforeseen  equipment                                                                    
breakdown or  malfunction. She noted  that since  ACES, some                                                                    
companies have self-reported unplanned  events that they are                                                                    
not deducting.                                                                                                                  
                                                                                                                                
Ms.  Nienhuis briefly  reviewed  slide 15,  showing the  per                                                                    
barrel decline in capital  expense exemption, reflecting oil                                                                    
production decline.                                                                                                             
                                                                                                                                
2:07:32 PM                                                                                                                    
                                                                                                                                
Co-Chair Stedman noted for the  public that a future meeting                                                                    
focusing on the  credit will show how much of  the credit is                                                                    
applicable  to  exploration  development and  how  much  for                                                                    
general maintenance;  $0.30 per  barrel was  put in  to help                                                                    
protect the  state from the  20 percent capital  credit that                                                                    
went to  normal maintenance  on an  older field  rather than                                                                    
going to getting more oil out of the ground.                                                                                    
                                                                                                                                
Ms.   Nienhuis   continued   with   slides   16-17,   "Lease                                                                    
Expenditure Information Mixed Bag":                                                                                             
                                                                                                                                
   · Is lease expenditure categorization required?                                                                              
        o Monthly information forms NOT REQUIRED                                                                                
        o Annual production tax returns - NOT REQUIRED                                                                          
        o Future expenditure projection form North Slope                                                                        
          operators - NOT REQUIRED; However…                                                                                    
   · SOME operators provide categorization in very broad                                                                        
     categories on SOME properties                                                                                              
                                                                                                                                
Ms. Nienhuis  explained that  information is  received about                                                                    
lease  expenditures  through  hard copy,  Excel,  and  other                                                                    
forms.  The "mixed  bag" refers  not only  to the  different                                                                    
forms  the information  is  received in,  but  the types  of                                                                    
reporting. She  pointed out that  there have  been questions                                                                    
regarding whether  the lease expenditures are  going towards                                                                    
maintenance, rate-adding, or other  programs. She added that                                                                    
the  reason  there  is   inconsistency  in  the  information                                                                    
received is that companies have  not been required to report                                                                    
how  they spend  the money.  The monthly  information forms,                                                                    
the   annual  production   tax  returns,   and  the   future                                                                    
expenditure  projections  do  not  include  a  break-out  of                                                                    
expenditure types other than capital and operating.                                                                             
                                                                                                                                
Ms.  Nienhuis  reported  that  some  operators  provide  the                                                                    
information in  the form  of future  expenditure projection;                                                                    
however the information is provided  on some units, not all.                                                                    
She  explained that  the department  does its  best to  sift                                                                    
through  and  classify  the information,  and  she  provided                                                                    
examples of categories:                                                                                                         
                                                                                                                                
   · Expense Workovers                                                                                                          
   · Major Repairs                                                                                                              
   · Seismic Acquisition and Testing                                                                                            
   · Major Accident Review                                                                                                      
   · Facility Integrity                                                                                                         
   · Wellwork                                                                                                                   
                                                                                                                                
Ms.  Nienhuis   added  that  the  process   of  sorting  the                                                                    
information  is   further  complicated  by  the   fact  that                                                                    
different companies  can give different  labels to  the same                                                                    
thing.                                                                                                                          
                                                                                                                                
Co-Chair Stedman sympathized.                                                                                                   
                                                                                                                                
2:11:56 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis  turned to  slide  18,  "Composition of  North                                                                    
Slope  Capital Expenditures"  and discussed  the process  of                                                                    
classifying information received from companies:                                                                                
                                                                                                                                
   · Based on review of company confidential cost                                                                               
     information, capital expenditures are placed into two                                                                      
     categories:                                                                                                                
   · "Resource or Development-related"                                                                                          
        o Drilling & Wellwork                                                                                                   
        o Enhanced Oil Recovery Projects                                                                                        
        o Seismic                                                                                                               
        o Facilities at New Fields (e.g. PT Thomson, WRD at                                                                     
          PBU)                                                                                                                  
   · Other Capital Expenditures                                                                                                 
        o Major Repairs and Work on Existing Facilities                                                                         
        o Corrosion-Related Expenditures                                                                                        
        o Safety Upgrades                                                                                                       
                                                                                                                                
Ms.  Davis  interjected  that  one   of  the  challenges  in                                                                    
splitting the costs into categories  was the question of the                                                                    
relevance of  any given activity.  She referred  to requests                                                                    
from legislators  regarding the  cost of  maintenance versus                                                                    
the cost of  production. She urged people not  to lose sight                                                                    
of  the production  impact  of  maintenance activities  that                                                                    
upgrade   existing   infrastructure.   She   stressed   that                                                                    
lengthening  the life  of existing  fields flattens  out the                                                                    
decline curve of a field.                                                                                                       
                                                                                                                                
Co-Chair Stedman  stated that  he wanted to  get a  feel for                                                                    
the  workability of  the 20  percent credit  and to  discern                                                                    
what creates the capital credit  and whether it enhances oil                                                                    
recovery or is used for  maintenance. He understood that the                                                                    
operating and capital expenses were distinct.                                                                                   
                                                                                                                                
2:15:57 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis agreed  and  noted that  there  is usually  an                                                                    
operating component  that compliments the  capital; drilling                                                                    
and  wellwork,  for  example, incur  expenses  on  both  the                                                                    
capital and operating sides.                                                                                                    
                                                                                                                                
Ms.  Nienhuis  directed attention  to  slide  19, "Share  of                                                                    
Planned North  Slope capital Expenditures for  'Resource and                                                                    
Development' Related  Costs." The  graph, put  together from                                                                    
the  information received  and categorized,  shows projected                                                                    
expenditures reaching  a peak of  nearly 75 percent  in 2010                                                                    
and  then tapering  off. She  warned that  the numbers  were                                                                    
based on projections that changed every six months.                                                                             
                                                                                                                                
Co-Chair  Stedman  referred to  slides  7  and 8,  regarding                                                                    
total  North Slope  capital and  operating expenditures  per                                                                    
barrel, which  show increases in  FY 11, and asked  how that                                                                    
relates to the decrease shown in slide (19).                                                                                    
                                                                                                                                
Ms.  Nienhuis  commented  that   the  department  is  seeing                                                                    
increasing expenditures on the  North Slope in general; from                                                                    
the received  projections, some of  the costs  are declining                                                                    
percentage-wise,  but only  from 73  percent to  71 percent.                                                                    
The   portion   of   expenditures  going   to   non-resource                                                                    
development is still not significant.                                                                                           
                                                                                                                                
2:19:06 PM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman asked  for  dollar  amount comparisons  in                                                                    
order to better understand the  different slides, as two use                                                                    
dollar  amounts,   while  slide  19  uses   percentages.  He                                                                    
suggested  using gross  dollars  to avoid  using the  barrel                                                                    
conversion.                                                                                                                     
                                                                                                                                
Ms.  Davis  explained that  the  earlier  slides depict  the                                                                    
entirety  of  all  lease expenditures,  both  operating  and                                                                    
capital; the columns stand for  the totality. Slide 19 shows                                                                    
the percentage,  and says that  of the totality,  74 percent                                                                    
of the  column is associated with  production-related costs,                                                                    
meaning  the   other  27  or   so  percent   represents  the                                                                    
maintenance or  non-production activity.  The slight  dip in                                                                    
2010   represents   the    total   operating   and   capital                                                                    
expenditures;  of the  slightly  reduced total,  there is  a                                                                    
tiny   increase  over   the  prior   year  associated   with                                                                    
production-related  expenditures. The  2011 projection  of a                                                                    
record-high  $5  billion  includes  72  percent  related  to                                                                    
production-related expenditures.                                                                                                
                                                                                                                                
Co-Chair Stedman  pointed to the  2012 bar showing  about 68                                                                    
percent.  Ms. Davis  explained  that  the percentage  coming                                                                    
down means  the relative mix between  production-related and                                                                    
non-production-related  expenditures is  coming into  better                                                                    
balance and is not as production driven.                                                                                        
                                                                                                                                
Co-Chair  Hoffman  noted  an earlier  statement  that  lower                                                                    
operating   expenditures  are   good   and  higher   capital                                                                    
expenditures  are  also good,  but  combining  the two  gets                                                                    
confusing. Ms.  Davis agreed and offered  to split operating                                                                    
and  capital expenditures  within  the  production and  non-                                                                    
production elements.                                                                                                            
                                                                                                                                
Co-Chair Hoffman pointed out the  difficulty of telling when                                                                    
operating  costs go  down when  they are  combined with  the                                                                    
capital  expenditures.  He  suggested concentrating  on  the                                                                    
fact  that even  though every  year the  operating costs  go                                                                    
down,  they  should  be  kept   separate  from  the  capital                                                                    
expenses.  He emphasized  that every  year since  2008 there                                                                    
has  been an  increase  in capital  expenditures. Ms.  Davis                                                                    
agreed.                                                                                                                         
                                                                                                                                
2:24:03 PM                                                                                                                    
                                                                                                                                
Ms.  Nienhuis agreed  to come  back with  dollar amounts  to                                                                    
provide clarity.                                                                                                                
                                                                                                                                
Ms. Nienhuis directed attention  to slide 24, "Recent Trends                                                                    
in North Slope Costs":                                                                                                          
                                                                                                                                
   · DOR has limited data to work with in analyzing                                                                             
     historic cost trends.                                                                                                      
   · Limited comparison of expenditures for three years                                                                         
     before and after PPT.                                                                                                      
   · Capital Expenditures at Prudhoe Bay                                                                                        
        o Maintenance and corrosion repair expenses are not                                                                     
          the key driver behind the growth in capital                                                                           
          expenditures.                                                                                                         
        o Majority of the increase in capital expenditures                                                                      
          is due to drilling, seismic and projects (such as                                                                     
          development of the Western Region of Prudhoe                                                                          
          Bay).                                                                                                                 
   · Operating Expenditures at Prudhoe Bay                                                                                      
        o Major Repairs were a small part of total                                                                              
          operating expenditures pre-PPT&ACES and is still                                                                      
          a relatively small part of total lifting costs.                                                                       
        o Wellwork expenditures are the primary driver                                                                          
          behind the rise in Operating Expenditures.                                                                            
                                                                                                                                
Ms. Davis emphasized that the  department currently has only                                                                    
projection-type  data and  no way  to verify  that what  was                                                                    
projected  to be  spent was  the way  the spending  actually                                                                    
occurred. In  future, operators may be  requested to provide                                                                    
data so  that historical costs  can be reported.  She stated                                                                    
that given the projections, DOR  has concluded (at least for                                                                    
Prudhoe Bay) that maintenance  and corrosion repair expenses                                                                    
are  not  the  key  driver  behind  the  growth  in  capital                                                                    
expenditures.  She  noted  that  maintenance  and  corrosion                                                                    
repair  expenditures grew  between 2003  and 2008,  but they                                                                    
did not grow disproportionately.                                                                                                
                                                                                                                                
Ms. Davis  added that  capital expenditures  associated with                                                                    
production-related  activities also  grew.  In other  words,                                                                    
the  growth in  total  capital expenditures  was not  simply                                                                    
because of maintenance and corrosion repair expense.                                                                            
                                                                                                                                
Ms. Nienhuis commented that the  majority of the increase in                                                                    
capital  expenditures  was  due to  drilling,  seismic,  and                                                                    
projects such  as the development  of the western  region of                                                                    
Prudhoe Bay.                                                                                                                    
                                                                                                                                
Ms. Nienhuis reported  that for the periods  between 2003 to                                                                    
2005 and 2008  to 2010, wellwork expenditures  were the main                                                                    
driver  behind the  rise  in  operating expenditures;  major                                                                    
repairs  are  a  part  of   operating  expenditures,  but  a                                                                    
relatively small part.                                                                                                          
                                                                                                                                
Co-Chair  Hoffman  asked  the   amount  of  maintenance  and                                                                    
corrosion  repair expenses  relative  to drilling,  seismic,                                                                    
and  other   projects.  He  wanted  more   detail  than  the                                                                    
"majority  of the  increase  in  capital expenditures."  Ms.                                                                    
Nienhuis  replied  that there  was  generally  about a  $500                                                                    
million per-year  increase in capital expenditures  from the                                                                    
three-year  period  before  PPT;  about 60  percent  of  the                                                                    
increase was due to drilling activities.                                                                                        
                                                                                                                                
2:28:33 PM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman questioned  whether the  increase included                                                                    
the entire  Prudhoe Bay basin.  Ms. Nienhuis  responded that                                                                    
the numbers applied to the  greater Prudhoe Bay/Pt. McIntyre                                                                    
unit.                                                                                                                           
                                                                                                                                
Co-Chair   Stedman  queried   credits  related   to  capital                                                                    
expenditures  created   outside  the  described   unit.  Ms.                                                                    
Nienhuis  responded  that  the  data over  the  longer  time                                                                    
related primarily  to Prudhoe Bay. The  analysis pertains to                                                                    
Prudhoe Bay prior to and after PPT.                                                                                             
                                                                                                                                
2:30:08 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis  moved back to previous  slides, beginning with                                                                    
slide 20, "Spending Trends":                                                                                                    
                                                                                                                                
   · Company projection of expenditures changing                                                                                
   · Fall 2008 projected increased expenditures in most                                                                         
     units                                                                                                                      
   · Fall 2009 projected divergence in plans                                                                                    
        o Currently producing units - projected lower                                                                           
          expenditure                                                                                                           
        o Developing units - projected higher expenditures                                                                      
                                                                                                                                
Ms.  Nienhuis  detailed  that  the   data  is  from  company                                                                    
projections operating on  the North Slope in  the spring and                                                                    
fall of 2008, and the spring  and fall of 2009. She reported                                                                    
that  in  the  fall  of   2008,  operators  for  most  units                                                                    
projected  increasing  expenditures   in  both  capital  and                                                                    
operating expenditures. There was a  change in the fall 2009                                                                    
projections: some operators reported  that they would invest                                                                    
less  in both  operating  and  capital expenditures;  others                                                                    
reported that they would spend more in their fields.                                                                            
                                                                                                                                
Ms. Nienhuis  remarked that DOR surmised  that generally the                                                                    
currently producing  units were the ones  that had projected                                                                    
decreasing expenditures  in fall 2009, while  the developing                                                                    
units  projected  higher  expenditures  going  forward.  The                                                                    
developing  units   projecting  higher   expenditures  going                                                                    
forward included  Point Thompson, Oooguruk,  Nikaitchuq, and                                                                    
the   National   Petroleum   Reserve-Alaska   (NPR-A).   The                                                                    
remaining   units,  Prudhoe   Bay,  Kuparuk,   Milne  Point,                                                                    
Endicott,   and    Alpine,   were    projecting   decreasing                                                                    
expenditures going forward.                                                                                                     
                                                                                                                                
Ms. Nienhuis continued that the  department thought it might                                                                    
be detecting  a trend  and considered the  data historically                                                                    
as  well  as in  projection.  The  bar  graph on  slide  21,                                                                    
"Capital Expenditures  by Type  of Property," shows  that as                                                                    
far as the percentage of  the total capital expenditures, in                                                                    
FY 08  the underdevelopment  category was around  25 percent                                                                    
of the  whole. In  2009 through  2010 (projected  for 2011),                                                                    
the   underdevelopment  expenditures   comprise  a   greater                                                                    
proportion of the total spending on the North Slope.                                                                            
                                                                                                                                
Ms. Nienhuis  turned to slide  22, "Capital  Expenditures on                                                                    
Currently  Producing Properties."  She listed  the currently                                                                    
producing  properties: Prudhoe  Bay,  Kuparuk, Milne  Point,                                                                    
Endicott, Northstar,  and Badami. The fall  2008 projections                                                                    
for  the years  of 2010,  2011,  and 2012  total about  $6.8                                                                    
billion;  the fall  2009 projections  show  the three  years                                                                    
totaling  about  $5.4  billion.   She  emphasized  that  the                                                                    
Colville River unit is excluded  in the calculations in each                                                                    
bar because the  department does not receive  the same level                                                                    
of capital projection as the others.                                                                                            
                                                                                                                                
2:34:05 PM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman believed  that oil  is more  plentiful and                                                                    
easier to find in  currently producing Prudhoe Bay, Kuparuk,                                                                    
Alpine,  and Milne  Point units,  and that  the state  could                                                                    
realize higher revenues. Ms. Nienhuis  agreed that the units                                                                    
provided the majority of the production tax.                                                                                    
                                                                                                                                
Co-Chair  Hoffman   referred  to  an   earlier  presentation                                                                    
regarding  three  categories  of North  Slope  wells:  wells                                                                    
drilled in 2008, wells drilled  in 2009, and wells that were                                                                    
permitted and  planned. He queried the  relationship between                                                                    
the  three  categories  and the  properties  represented  on                                                                    
slide 21  ("Capital Expenditures by Type  of Property"). Ms.                                                                    
Nienhuis  replied that  the wells  described in  the earlier                                                                    
presentation were  exploration wells and would  be under the                                                                    
development category.                                                                                                           
                                                                                                                                
Co-Chair  Hoffman  asked  whether   that  related  to  wells                                                                    
permitted  and   planned.  Ms.  Davis  explained   that  the                                                                    
presentation was  regarding exploration activity;  under the                                                                    
department's analysis [on slide 21]  the same wells would be                                                                    
called  "under development."  She  added  that the  previous                                                                    
presenter did not include a  description of the wellwork and                                                                    
extra wells being drilled in currently producing fields.                                                                        
                                                                                                                                
Co-Chair Hoffman  surmised that  the oil industry  is saying                                                                    
there  is a  lot  less  activity but  in  fact  there is  an                                                                    
increase  every year  since 2008,  2009,  and projected  for                                                                    
2010 and 2011. Ms. Davis replied that he was correct.                                                                           
                                                                                                                                
2:36:52 PM                                                                                                                    
                                                                                                                                
Ms. Nienhuis concluded with  slide 23, "Capital Expenditures                                                                    
of Developing  Properties," which shows a  similar breakdown                                                                    
on   developing  properties.   The  fall   2008  projections                                                                    
received  from the  operators totaled  $1.6 billion  for the                                                                    
three years;  that increased significantly in  the fall 2009                                                                    
projections  to $3.1  billion. She  warned that  the company                                                                    
projections are not guaranteed and could change.                                                                                
                                                                                                                                
2:38:37 PM          AT EASE                                                                                                   
2:43:04 PM          RECONVENED                                                                                                
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
The meeting was adjourned at 2:43 PM.                                                                                           
                                                                                                                                

Document Name Date/Time Subjects
2010 02 17 DOR Operating and Capital Lease Expenditures SFC.pptx SFIN 2/17/2010 1:30:00 PM
Oil and Gas Production Tax Review
Agenda 021710 pm.docx SFIN 2/17/2010 1:30:00 PM