Legislature(2009 - 2010)SENATE FINANCE 532

02/23/2010 09:00 AM Senate FINANCE


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09:03:12 AM Start
09:03:21 AM Industry Testimony - Oil & Gas Tax Review
10:50:25 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Production Tax Review: TELECONFERENCED
Industry Testimony
-- Testimony <Invitation Only> --
Technical Review & Perspective
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Legislative Consultants
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                 SENATE FINANCE COMMITTEE                                                                                       
                     February 23, 2010                                                                                          
                         9:03 a.m.                                                                                              
                                                                                                                                
                                                                                                                                
9:03:12 AM                                                                                                                    
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Stedman called the Senate Finance Committee                                                                            
meeting to order at 9:03 a.m.                                                                                                   
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Lyman Hoffman, Co-Chair                                                                                                 
Senator Bert Stedman, Co-Chair                                                                                                  
Senator Charlie Huggins, Vice-Chair                                                                                             
Senator Johnny Ellis                                                                                                            
Senator Dennis Egan                                                                                                             
Senator Donny Olson                                                                                                             
Senator Joe Thomas                                                                                                              
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
None                                                                                                                            
                                                                                                                                
ALSO PRESENT                                                                                                                  
                                                                                                                                
Marilyn  Crockett,  Executive  Director, Alaska  Oil  &  Gas                                                                    
Association  (AOGA); Wendy  King,  Vice President,  External                                                                    
Affairs,  ConocoPhillips   Alaska;  Senator   John  Coghill;                                                                    
Senator Joe Paskvan                                                                                                             
                                                                                                                                
PRESENT VIA TELECONFERENCE                                                                                                    
                                                                                                                                
None                                                                                                                            
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
2010 OIL & GAS PRODUCTION TAX REVIEW                                                                                            
                                                                                                                                
^Industry Testimony - Oil & Gas Tax Review                                                                                    
                                                                                                                                
9:03:21 AM                                                                                                                    
                                                                                                                                
MARILYN  CROCKETT,  EXECUTIVE  DIRECTOR, ALASKA  OIL  &  GAS                                                                    
ASSOCIATION   (AOGA),   referenced   a   handout   entitled,                                                                    
"Testimony  of the  Alaska Oil  and Gas  Association to  the                                                                    
Senate  Finance Committee  about  the Failings  of the  ACES                                                                    
Production Tax "(copy on file).  She noted AOGA is the trade                                                                    
association  for the  oil and  gas industry  in Alaska.  The                                                                    
fourteen members  account for  the majority  of oil  and gas                                                                    
exploration,   development,    production,   transportation,                                                                    
refining, and marketing activities  in the state. Members of                                                                    
the AOGA  Tax Committee approve of  the following testimony.                                                                    
Ms. Crockett read portions of the following testimony.                                                                          
                                                                                                                                
     First of  all, we  apologize to  the committee  for the                                                                    
     fact that our  testimony today cannot be  a detailed or                                                                    
     comprehensive review  of the many problems,  issues and                                                                    
     failings of ACES.   Instead, it is only  an overview, a                                                                    
     snapshot from 50,000 feet if  you will, of what's wrong                                                                    
     or going  wrong with  this tax.   And  we can  offer at                                                                    
     this  time  only  a handful  of  specific  examples  to                                                                    
     illustrate these  problems -  not because  the examples                                                                    
     are few, but because we  were simply unable before this                                                                    
     hearing  to  compile the  many  more  examples that  we                                                                    
     could  otherwise have  presented.    Also, during  your                                                                    
     hearings last week you were  given information that was                                                                    
     either  inaccurate, incomplete  or  misleading, and  we                                                                    
     would like  to use part of  our time with you  today to                                                                    
     set the record straight on a number of those points.                                                                       
                                                                                                                                
     ACES was  proposed and enacted with  two primary goals:                                                                    
     One, to raise the amount  of production taxes from what                                                                    
     the  state would  have received  under  either the  old                                                                    
     ELF-based tax or the "Petroleum  Production Tax" - also                                                                    
     known as the  "PPT" - that replaced the ELF.   And two,                                                                    
     to  attract  new capital  investment  for  oil and  gas                                                                    
     exploration, development and  production on the massive                                                                    
     scale  that  is  needed  to  mitigate  the  decline  in                                                                    
     production rates  as the resource  is depleted.   These                                                                    
     goals   seem   fundamentally  inconsistent   with   one                                                                    
     another.   How can the  tax be raised for  the industry                                                                    
     and  at the  same  time have  the  tax attract  greater                                                                    
     industry investment here?                                                                                                  
                                                                                                                                
    ACES' answer was to take the tax deduction and tax                                                                          
    credits for new capital investments that PPT first                                                                          
     created, modify the credits to make them less                                                                              
     attractive, and substantially increase the amount of                                                                       
     production taxes on the oil and gas industry.  There                                                                       
     are numerous technical problems in ACES that need to                                                                       
     be fixed and many others that should be fixed simply                                                                       
     as a matter of tax policy.                                                                                                 
     At the outset, let me reiterate AOGA's primary                                                                             
     concern, that we believe the tax rates under ACES are                                                                      
     too high and overshoot the optimum point where total                                                                       
    state revenues, Alaska jobs and economic growth are                                                                         
    maximized of the remaining life of the fields.  We                                                                          
     have said it before. No one ever taxed economic                                                                            
     activity and prosperity into existence.  We could                                                                          
    spend hours discussing prospectivity, tax rates and                                                                         
    what is needed to ensure Alaska has a tax rate that                                                                         
     encourages investment, in fact we have on several                                                                          
    previous occasions done so. Our intention is not to                                                                         
     rehash those arguments at this time but to educate the                                                                     
    committee on just a few structural issues and point                                                                         
     out our contrary viewpoint regarding some of the                                                                           
     state's testimony. We expect the dialog on what is the                                                                     
     right tax rate to be ongoing and more appropriate for                                                                      
     another time.                                                                                                              
                                                                                                                                
                                                                                                                                
9:07:01 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  suggested that  Ms. Crockett  address some                                                                    
of  the issues  specifically. Ms.  Crockett stated  that the                                                                    
focus of her  presentation was to address  issues brought up                                                                    
by the administration and other testifiers.                                                                                     
                                                                                                                                
Ms. Crockett continued to describe the lack of clarity in                                                                       
ACES.                                                                                                                           
                                                                                                                                
     Another major  issue with ACES  is the  regulations the                                                                    
     Department of  Revenue has  adopted and  is considering                                                                    
     adopting.     In order  for ACES  to work  properly and                                                                    
     have  its  full   beneficial  influence  on  investment                                                                    
     decisions,  ACES must  be as  clear and  transparent as                                                                    
     possible.  The essential  importance of this clarity is                                                                    
     the  same   regardless  of  what   the  tax   rate  and                                                                    
     progressivity might  be, or what the  percentage is for                                                                    
     the tax  credit from a  capital investment.   The basic                                                                    
     structure of ACES  - the foundation for it  to have any                                                                    
     chance  of  success -  depends  not  only on  having  a                                                                    
     reasonable  rate  of tax,  but  on  having clarity  and                                                                    
     transparency  with  as  little ambiguity  as  possible.                                                                    
     Despite  what  you  may  have   heard  last  week,  the                                                                    
     department's regulations fail this test.                                                                                   
                                                                                                                                
     Even  though  the  tax  rate might  be  very  high  for                                                                    
     current production from past  investments, making a new                                                                    
     investment  will  reduce  the tax  on  that  production                                                                    
     under ACES and will also  generate a credit against the                                                                    
     remaining  tax.   For  example, if  the  tax rate  with                                                                    
     progressivity  is 50%,  investing a  dollar here  for a                                                                    
     regular capital project will reduce  the tax on current                                                                    
     production by  50% of that  dollar, and in  addition it                                                                    
     will also generate  a 20% tax credit.   Thus, investing                                                                    
     that  dollar would  save  some 70¢  of  tax on  current                                                                    
     production.  This 70¢ tax  savings would show up in the                                                                    
     economics for  that investment  under metrics  like Net                                                                    
     Present  Value  and Internal  Rate  of  Return, and  it                                                                    
     would make that investment seem more attractive.                                                                           
                                                                                                                                
                                                                                                                                
    The fundamental problem with this approach is that,                                                                         
     even though it looks good in theory, for it to succeed                                                                     
     in the real world it is necessary that the person                                                                          
     making the decision about investing this dollar will                                                                       
    be confident - at the time of making the decision -                                                                         
     that the full 100 cents of the dollar will be                                                                              
     recognized and the resulting benefits from investing                                                                       
     this dollar will actually be 70 cents.  If the tax is                                                                      
     ambiguous, or if a substantial portion of this dollar                                                                      
     could be unexpectedly disallowed by the state, a                                                                           
    prudent decision-maker will reduce the expected tax                                                                         
     benefit from the 70¢ it should have been in this                                                                           
     hypothetical example.  This is why "Clarity" is ACES'                                                                      
    middle name:  "Alaska's Clear and Equitable Share."                                                                         
                                                                                                                                
     Suppose, for  instance, the decision-maker  thinks only                                                                    
     60¢ of the invested  dollar will actually be recognized                                                                    
     under ACES.   Then a  60¢ deduction at  my hypothetical                                                                    
     50%  tax rate  would  be  worth 30¢,  and  the 20%  tax                                                                    
     credit  would be  12¢, making  a total  tax benefit  of                                                                    
     only  42 cents.    This difference  between  a 42¢  tax                                                                    
     benefit and  a 70¢  one may not  sound like  very much,                                                                    
     but if  the hypothetical project being  evaluated costs                                                                    
     $100  million, it  means $28  million would  be drained                                                                    
     out  of its  economic performance  as perceived  by the                                                                    
     investment decision-maker, simply  because of this lack                                                                    
     of clarity  in the tax.   Put  in these terms,  one can                                                                    
     begin to appreciate how the  go/no-go decision for such                                                                    
     an investment  could be affected  by a lack  of clarity                                                                    
     in ACES.                                                                                                                   
                                                                                                                                
     And the key point here is:   this adverse impact on the                                                                    
     investment decision  will occur even if  the Department                                                                    
     of Revenue,  after audit,  would have  ultimately found                                                                    
     100¢  of that  dollar  to be  completely justified  and                                                                    
     proper.    In other  words,  the  tax benefit  actually                                                                    
     allowed would turn  out to be 70¢ for  that dollar, but                                                                    
     only 42¢ of that benefit  was taken into account by the                                                                    
     decision-maker at the time  of the investment decision.                                                                    
     This is a  terrible dilution or waste  of the incentive                                                                    
     for investing that ACES is designed to give.                                                                               
                                                                                                                                
9:09:53 AM                                                                                                                    
                                                                                                                                
Ms. Crockett  described an example  - Attachment A  (copy on                                                                    
file).                                                                                                                          
                                                                                                                                
9:10:11 AM     AT-EASE                                                                                                        
9:13:13 AM     RECONVENED                                                                                                     
                                                                                                                                
Co-Chair  Stedman  requested   information  about  leasehold                                                                    
expenditures.                                                                                                                   
                                                                                                                                
Ms.  Crockett  reiterated  the   example  of  a  one  dollar                                                                    
investment and  the fundamental problem with  that approach.                                                                    
The tax  benefit would be  reduced. She repeated  the second                                                                    
example  using a  60 cent  deduction. She  reviewed the  key                                                                    
point previously made.                                                                                                          
                                                                                                                                
9:17:45 AM                                                                                                                    
                                                                                                                                
Ms.  Crockett referred  again to  Attachment A  which points                                                                    
out the uncertainties created by the Department of Revenue.                                                                     
                                                                                                                                
9:18:57 AM     AT-EASE                                                                                                        
9:19:38 AM     RECONVENED                                                                                                     
                                                                                                                                
Ms.  Crockett  continued  to  paraphrase  from  her  written                                                                    
testimony.                                                                                                                      
                                                                                                                                
     There  are  clarity  issues   with  the  ACES  statutes                                                                    
     themselves, but  as I  mentioned, the  regulations that                                                                    
     the Department  of Revenue  has adopted  and is  in the                                                                    
     process of adopting  are compounding and re-compounding                                                                    
     the uncertainty and  lack of clarity.   Attached to the                                                                    
     written  copies  of  this testimony  is  an  attachment                                                                    
     illustrating  the kinds  of  uncertainty being  created                                                                    
     unnecessarily by  the department.  I will not  take the                                                                    
     committee's  time to  read that  attachment now,  but I                                                                    
     invite you to peruse it at your leisure.                                                                                   
                                                                                                                                
                                                                                                                                
9:21:04 AM                                                                                                                    
                                                                                                                                
Ms. Crockett continued to read.                                                                                                 
                                                                                                                                
     Bad  as it  is, that  example is  only the  tip of  the                                                                    
     iceberg in terms  of what is going wrong  with the ACES                                                                    
     regulations.   There are many, many  more examples that                                                                    
     we  could offer.   The  written comments  and testimony                                                                    
     submitted to  the department by AOGA  and by individual                                                                    
     companies about the issues and  problems with the draft                                                                    
     and final  regulations run to  nearly 200 pages  - just                                                                    
     on the subject of  deductible lease expenditures.  That                                                                    
     total  does not  include  what we  told the  department                                                                    
     about  its  tax-credit  regulations.   And,  as  Deputy                                                                    
     Commissioner   Marcia   Davis  acknowledged   to   this                                                                    
     committee  last  week,  we  expect to  have  a  lot  of                                                                    
     comments  about   the  transportation-cost  regulations                                                                    
     that the  department is proposing to  adopt, especially                                                                    
     since  the department  is  dispensing  with the  public                                                                    
     workshop  process  and  going straight  to  the  public                                                                    
     hearing for actually adopting them.                                                                                        
                                                                                                                                
     One  final problem  with the  ACES  regulations that  I                                                                    
     would  draw to  your  attention is  the  fact that  the                                                                    
     Department  of Revenue  has totally  failed to  address                                                                    
     the question of  how the non-operating working-interest                                                                    
     owners  in a  unit or  other oil  and gas  property are                                                                    
     supposed to  comply with all these  requirements.  Each                                                                    
     month the non-operating owners are  required by ACES to                                                                    
     report and pay estimated taxes,  and on March 31 of the                                                                    
     following year  they have to "true  up" those estimates                                                                    
     to  the actual  results for  the year.   All  that they                                                                    
     have  available when  these reports  and payments  come                                                                    
     due  are  the  billings  that  they  receive  from  the                                                                    
     operator  for their  respective  shares  of the  unit's                                                                    
     costs.   Even  though the  non-operating interests  can                                                                    
     and  do audit  the operator's  billings to  them, their                                                                    
     audits  are done  for several  years of  billings at  a                                                                    
     time,  and the  billing periods  in question  for those                                                                    
     audits are  in the past.   These audits rarely  if ever                                                                    
     address billings for the current  year because it would                                                                    
     be premature to try to  audit them:  the operator's own                                                                    
     books and  records for  the year  won't even  close and                                                                    
     become properly auditable until after the year ends.                                                                       
                                                                                                                                
                                                                                                                                
9:24:21 AM                                                                                                                    
                                                                                                                                
     This puts the  non-operating working-interest owners in                                                                    
     an  even worse  spot than  their operator  in terms  of                                                                    
     clarity  about how  much  of what  they  pay for  costs                                                                    
     being  billed  to  them  will  end  up  actually  being                                                                    
     deductible under  ACES.  The  regulations fail  to take                                                                    
     into  account   the  fact  that  this   "flying  blind"                                                                    
     situation about  deductibility is the  economic reality                                                                    
     that these non-operators must face  and deal with - and                                                                    
     in  particular, the  one  they face  when  it comes  to                                                                    
     making  new  investments  in their  unit  or  property.                                                                    
     Their  actual cash  outlays for  a new  investment will                                                                    
     be, in the first  instance, whatever the operator bills                                                                    
     them as  their share of  the costs for  that investment                                                                    
     or  project -  even if  their audit  of the  operator's                                                                    
     billings ultimately finds material  error in them, that                                                                    
     would be a cash outlay or receipt for the non-                                                                             
     operators at that later time.                                                                                              
                                                                                                                                
     So, to go back to my example earlier, these non-                                                                           
     operators have no way of  knowing whether one dollar of                                                                    
     new investment  will end up being  fully recognized for                                                                    
     ACES  and generate  a  deduction worth  50¢  and a  tax                                                                    
     credit of another 20 cents.   Or whether, instead, only                                                                    
     60¢ of  that dollar will  be recognized, with  the ACES                                                                    
     tax  benefit  being  42¢  instead  of  seventy.    This                                                                    
     uncertainty about  the amount of the  ACES tax benefits                                                                    
     exists  at  the time  the  non-operators  have to  vote                                                                    
     "yes" or "no"  in the ballot to sanction  a new project                                                                    
     or  investment, which  is exactly  the  wrong time  for                                                                    
     ACES  to  have uncertainty  if  it  is to  attract  new                                                                    
     investments here  to Alaska.   Why?   Because  the non-                                                                    
     operating  working-interest owners  have  the right  to                                                                    
     vote "no" on a ballot to  approve a new project, and no                                                                    
     matter now  much the  operator may  support it,  if the                                                                    
     project  fails to  get the  requisite  number of  "yes"                                                                    
     votes,  it simply  does not  proceed.   And to  stem or                                                                    
     slow the  decline in  production, Alaska  simply cannot                                                                    
     afford to  waste even  one good  investment opportunity                                                                    
     as the  result of  too much  uncertainty about  the tax                                                                    
    burden and benefits under such a major tax as ACES.                                                                         
                                                                                                                                
     A  solution   to  these  problems  would   be  for  the                                                                    
     Department  of Revenue  to  take  a different  approach                                                                    
     with  its  regulations  from  the one  it  has  so  far                                                                    
     pursued.    Instead   of  ignoring  the  joint-interest                                                                    
     billings   from   operators    to   the   non-operating                                                                    
     interests, the  regulations should embrace them  as the                                                                    
     starting  point for  reporting and  paying  tax.   This                                                                    
     would put the  tax, in the first instance,  on the same                                                                    
     footing  as what  the non-operators  see,  also in  the                                                                    
     first instance,  in their  billings from  the operator.                                                                    
     The non-operators  do not give the  operator license to                                                                    
     spend their  money without strictly limiting  what that                                                                    
     money  can  be  spent  for, and  the  department  could                                                                    
     reasonably  rely   on  the  non-operators   to  enforce                                                                    
     discipline on the operator's billings  in much the same                                                                    
     way that the department relies  on the IRS to audit the                                                                    
     companies   federal  taxable   income,  which   is  the                                                                    
     starting point  for Alaska's own corporate  income tax.                                                                    
     Such  an  approach  should  also   avoid  most  of  the                                                                    
     problems  that  Cherie  Nienhuis of  the  Tax  Division                                                                    
     described to  you last  week about  taxpayers reporting                                                                    
     inconsistent data.                                                                                                         
                                                                                                                                
     We  are not  suggesting, however,  that the  department                                                                    
     should rely  blindly on the non-operators  to audit the                                                                    
     operator's billings.   As  Ronald Reagan  famously said                                                                    
     about  dealing with  the Soviet  Union during  the Cold                                                                    
     War,  "Trust,  but  verify."   In  the  case  of  ACES,                                                                    
     "verify"  for the  department would  mean auditing  the                                                                    
     automated  system of  accounts that  each operator  has                                                                    
     for recording its expenditures  as operator and billing                                                                    
     out  those  costs  to the  non-operating  participants.                                                                    
     Particular cost codes within such  a system of accounts                                                                    
     could be  identified by this audit  as disallowed kinds                                                                    
     of cost, and  by giving notice to the  operator and all                                                                    
     the non-operating  interests that those cost  codes are                                                                    
     disallowed, the  department would  ensure that  all the                                                                    
     participants  in a  unit or  property would  be on  the                                                                    
     same page with  respect to cost codes  that are allowed                                                                    
     and  billable  under   their  operating  agreement  but                                                                    
     disallowed for ACES purposes.   The department's audits                                                                    
     of  individual companies  could then  be simplified  to                                                                    
     verifying  that nothing  in the  disallowed cost  codes                                                                    
     was deducted  by any of  them in their  respective ACES                                                                    
     tax returns,  thereby conserving audit  resources while                                                                    
     ensuring consistency among taxpayers.                                                                                      
                                                                                                                                
     At  the same  time  the department  could "verify"  the                                                                    
     ongoing integrity of each  automated system of accounts                                                                    
     by  periodically confirming,  first, that  the software                                                                    
     for  that  system  has  not   been  changed  since  the                                                                    
     department's last audit of that  system, or if changed,                                                                    
     has  not been  changed incorrectly  for ACES  purposes.                                                                    
     And if there has been  an incorrect change, the depart-                                                                    
     ment would  identify the resulting new  cost codes that                                                                    
     are disallowed  and put all  taxpayers in that  unit or                                                                    
     field  on  notice  of  those changes  to  the  list  of                                                                    
     disallowed cost codes.                                                                                                     
                                                                                                                                
     The Department  of Revenue could actually  do all these                                                                    
     things without  having to change  any of  the substance                                                                    
     of  what  it intends  to  allow  or disallow  as  lease                                                                    
     expenditures in  its new regulations.   But, to  do so,                                                                    
     the department  - instead of  using the  regulations to                                                                    
     define what is  or is not allowed - needs  to adopt its                                                                    
     concepts  of  allowed  and disallowed  costs  as  audit                                                                    
     standards that  it will then  apply and enforce  in its                                                                    
     audits of  automated systems of accounts  and software,                                                                    
     as well  as in its  audits of any claimed  lease expen-                                                                    
     ditures for  costs that  a company  may incur  in house                                                                    
     that are  not billable  to others under  the applicable                                                                    
     operating agreement.                                                                                                       
                                                                                                                                
     We  have  proposed  this alternative  approach  to  the                                                                    
     department  in  each  round  of  public  workshops  and                                                                    
     hearings  on the  lease-expenditures regulations.   And                                                                    
     in each  new draft  that came out  after a  workshop or                                                                    
     hearing, including  the regulation  that has  just been                                                                    
     adopted, this  superior alternative  was rejected.   We                                                                    
     do  not know  why.   But if  the Department  of Revenue                                                                    
     will not  adopt this superior approach  voluntarily for                                                                    
     administering  ACES,   then  perhaps   one  alternative                                                                    
     solution  to  fix ACES  would  be  to rewrite  the  tax                                                                    
     statutes so  the department  has no  choice but  to use                                                                    
     this clearer and more efficient approach.                                                                                  
                                                                                                                                
9:27:20 AM                                                                                                                    
                                                                                                                                
Ms. Crockett referred to a slide in a previous meeting                                                                          
February 17 presentation on Production Tax - Lease                                                                              
Expenditure Regulations.                                                                                                        
                                                                                                                                
9:28:42 AM     AT-EASE                                                                                                        
9:30:18 AM     RECONVENED                                                                                                     
                                                                                                                                
Ms. Crockett said the slide contains a quote she made.                                                                          
Comments from Industry - Slide 27. She continued to read.                                                                       
                                                                                                                                
     This  is  very  different  from the  picture  that  the                                                                    
     Department of  Revenue pointed  for the  committee last                                                                    
     week.  In  fact, they even showed a  slide quoting from                                                                    
     a letter  I wrote.   In the  interest of time,  I won't                                                                    
     read the entire quote, but this the heart of it:                                                                           
                                                                                                                                
     There  is an  old quip  about never  having enough                                                                         
     time to do something right,  but always time to do                                                                         
     it over.  Here the  department has avoided falling                                                                         
     into  this  quip,  which  is  no  small  feat  and                                                                         
     deserves recognition.                                                                                                      
                                                                                                                                
     Context  is crucial  for understanding  this statement.                                                                    
     The  Declaration  of  Independence, of  instance,  says                                                                    
     "all  men are  created  equal." -  but  this cannot  be                                                                    
     taken out  of context  to day to  mean "tough  luck for                                                                    
     women."      Similarly,   in   context   my   statement                                                                    
     specifically  addressed  some draft  regulations  about                                                                    
     payments  by one  field to  run its  production through                                                                    
     another  field's  production facilities,  and  reducing                                                                    
     the  owner-field's  lease  expenditures to  the  extent                                                                    
     they are offset by the user-field's payments.                                                                              
                                                                                                                                
     My statement  about those specific regulations  was not                                                                    
     an  endorsement of  the  far broader  lease-expenditure                                                                    
                                                          th                                                                    
     regulations that  the department  adopted January  26,                                                                     
     nor   it    is   an   endorsement   of    the   pending                                                                    
     transportation-cost  regulations   that  were  unveiled                                                                    
     after  I  wrote my  praise.  In  fact, it  is  somewhat                                                                    
     ironic that  - from the user-field's  perspective - the                                                                    
     department's now  adopted lease-expenditure regulations                                                                    
     do not  allow the user-field producers  to deduct their                                                                    
     full payments to the owner-field,  even though the cost                                                                    
     for using the existing facilities  is far less than the                                                                    
     alternative  of putting  in new  production facilities.                                                                    
     My comments, from  which the quote is  taken, urged the                                                                    
     department to  allow the user-field to  deduct the full                                                                    
     amount of  what it  pays to  the owner-field,  which is                                                                    
     the opposite of  what the department has done.   And it                                                                    
     is  also ironic  that  the regulations  I was  praising                                                                    
     have not been adopted by the department.                                                                                   
                                                                                                                                
     At the present time, however,  the bottom line for ACES                                                                    
     is this:   even if  the tax  rate was lowered,  ACES is                                                                    
     nowhere close  to having  the kind  of clarity  that it                                                                    
     needs to have in order to  succeed.  And if it does not                                                                    
     succeed, the penalty for all of  us - for the state and                                                                    
     the Alaskan public, as well  as for our industry - will                                                                    
     be  that investments  stand to  be deferred  or perhaps                                                                    
     canceled outright that are urgently  needed in order to                                                                    
     offset  the  relentless   decline  in  production  that                                                                    
     steadily  goes on  as  this  non-renewable resource  is                                                                    
     continuously depleted.                                                                                                     
                                                                                                                                
     It is for this reason  that our industry actually has a                                                                    
     stake in  making ACES succeed, rather  than watching it                                                                    
     fail.  True, the tax rates  are too high, and there are                                                                    
     numerous  technical problems  in ACES  that need  to be                                                                    
     fixed and many others that  should be fixed simply as a                                                                    
     matter  of sound  tax policy.   But  despite all  these                                                                    
     flaws, and they are serious  ones, it is clearly better                                                                    
     to have  even a  flawed ACES  that succeeds  in drawing                                                                    
     more investments here, than to  have a flawed ACES that                                                                    
     fails to draw them.                                                                                                        
                                                                                                                                
     At  this point  I would  now  like to  shift gears  and                                                                    
     address  several  of   the  inaccurate,  incomplete  or                                                                    
     misleading statements that  this committee heard during                                                                    
     last week's hearings.                                                                                                      
                                                                                                                                
     One of the most  disturbing misconceptions in the whole                                                                    
     public discussion of ACES  is the apparently widespread                                                                    
     notion  that,  by  allowing   tax  deductions  and  tax                                                                    
     credits in  order to attract new  investments here, the                                                                    
     state is somehow actually  investing in those projects.                                                                    
     This is completely and fundamentally wrong.                                                                                
                                                                                                                                
     The  only  tax  credits  that  the  state  is  actually                                                                    
     spending money  for are the  ones that the Oil  and Gas                                                                    
     Tax  Credit Fund  buys from  explorers  and small  pro-                                                                    
     ducers  that do  not  have enough  production to  incur                                                                    
     ACES tax liability that they  could apply their credits                                                                    
     against.   This  expenditure  is  incurred because  the                                                                    
     state has  made the policy  choice to do this  in order                                                                    
     to  attract   more  independent  explorers   and  small                                                                    
     producers to Alaska.   And, for the record,  let me say                                                                    
     AOGA supports this goal:  Having more companies explor-                                                                    
     ing and  producing here  is good  for our  industry, as                                                                    
     well as Alaska.                                                                                                            
                                                                                                                                
     But the  overall tax deductions and  credits under ACES                                                                    
     do not  inherently share this special  attribute of the                                                                    
     subset  of  tax  credits  that   the  Tax  Credit  Fund                                                                    
     actually buys.   Think about it for a  second.  Suppose                                                                    
     it were  true that  each dollar of  tax benefit  from a                                                                    
     deduction or tax credit is  literally an expenditure or                                                                    
     investment by the state. What  would this imply?  Well,                                                                    
     in  order  to be  true,  it  would  mean the  state  is                                                                    
     legally entitled that dollar  instead of the producer -                                                                    
     the state,  in other words, literally  owns that dollar                                                                    
     and  is  making an  expenditure  or  investment to  the                                                                    
     extent it lets the producer have any part of it.                                                                           
                                                                                                                                
9:35:40 AM                                                                                                                    
                                                                                                                                
Ms. Crockett skipped to page 8 to discuss capital spending                                                                      
and the number of workers on the North Slope.                                                                                   
                                                                                                                                
     The   next   thing   I'd  like   to   debunk   is   the                                                                    
     administration's  claim that  capital spending  and the                                                                    
     number of workers on the  North Slope show that ACES is                                                                    
     working  just  fine.    To   support  this  claim,  the                                                                    
     Department  of Revenue  points to  North Slope  capital                                                                    
     expenditures of  $2 billion  in 2007  and '08  and $2.2                                                                    
     billion last  year, and to  an increase in oil  and gas                                                                    
     jobs  to approximately  12½ thousand  in  2008 and  '09                                                                    
     from about 11½ thousand in 2007.                                                                                           
                                                                                                                                
     The problem with these statistics  is this: They do not                                                                    
     distinguish between  investment and labor to  repair or                                                                    
     replace existing  plants and equipment,  and investment                                                                    
     or labor for  new plants and equipment.   Repairing and                                                                    
     replacing  existing facilities  is  very important,  of                                                                    
     course, but  it is  not evidence  that ACES  is drawing                                                                    
     new investment  to Alaska because those  activities are                                                                    
     done merely to maintain  the status quo. The department                                                                    
     also  does not  account  for  projects and  investments                                                                    
     that  were already  under way  or  committed to  before                                                                    
     ACES  was passed  by the  legislature in  November 2007                                                                    
     and  signed into  law that  December. And  expenditures                                                                    
     and  labor to  complete  such pre-existing  commitments                                                                    
     likewise  do   not  show  that  ACES   is  drawing  new                                                                    
     investment to Alaska.                                                                                                      
                                                                                                                                
     To indicate  how important  it is  to break  down gross                                                                    
     statistics  into these  individual components,  I would                                                                    
     point  out  that  John  Mingé,   the  president  of  BP                                                                    
     Exploration  (Alaska)   Inc.,  told  the   Meet  Alaska                                                                    
     Conference  last month,  "Our 2010  investment consists                                                                    
     of roughly one-third  infrastructure renewal, one-third                                                                    
     for growth  and one-third for  drilling." Consequently,                                                                    
     the  department's  raw   figures  about  total  capital                                                                    
     spending or the  total number of people  working on the                                                                    
     North Slope do  not show the decline  in investment and                                                                    
     work for new projects that  has occurred since ACES was                                                                    
     enacted.                                                                                                                   
                                                                                                                                
     But there is clear  evidence from the public statements                                                                    
     of  individual companies,  and even  from  some of  the                                                                    
     administration's  own statistics,  that things  are far                                                                    
     from being as  rosy with ACES as  the administration is                                                                    
     saying.                                                                                                                    
                                                                                                                                
9:37:46 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman  commented  that   the  topic  of  capital                                                                    
credits is  one the  committee struggles with.  He requested                                                                    
clarification of  how the  credits are  used in  Prudhoe Bay                                                                    
and Kuparuk where  the "easy oil" is. Ms.  Crockett said she                                                                    
would  touch  on  the amount  of  in-field  drilling  taking                                                                    
place.                                                                                                                          
                                                                                                                                
9:39:08 AM                                                                                                                    
                                                                                                                                
Ms. Crockett returned to reading last paragraph on page 8.                                                                      
                                                                                                                                
     Take in-field drilling for example.  These wells can be                                                                    
     approved,  drilled and  go into  production  in just  a                                                                    
     matter  of  months instead  of  years,  in contrast  to                                                                    
     other kinds  of investment  in field development.  As a                                                                    
     result, the statistics about them  are much less likely                                                                    
     to  be distorted  by activities  that had  already been                                                                    
     committed to before ACES was  passed. And we have heard                                                                    
     of  members of  this  legislature telling  constituents                                                                    
     that in-field drilling  like this has a  rate of return                                                                    
     of over 100 percent.  Without getting sidetracked about                                                                    
     the  assumptions needed  to mathematically  allow rates                                                                    
     of return to be that high, our reply is that, if in-                                                                       
     field drilling  is highly profitable, why  did the num-                                                                    
     ber of these in-field wells  decrease from 166 wells in                                                                    
     2007  to  153 in  2008  and  147  last year?    Putting                                                                    
     rhetoric  or political  posturing  aside,  this is  the                                                                    
     fact of the matter. And  since we have been critical of                                                                    
     the  Department of  Revenue, we  should acknowledge  at                                                                    
     this  point  that  the department  has  disclosed  this                                                                    
     decline  in its  public  ACES  materials, although  its                                                                    
     numbers mistakenly include exploration wells.                                                                              
                                                                                                                                
     The  decline  in  in-field  drilling  is  confirmed  by                                                                    
     public  statements of  the two  major operators  on the                                                                    
     North Slope, ConocoPhillips and  BP. For instance, John                                                                    
     Mingé of BP told the  Meet Alaska Conference last month                                                                    
     that  his company's  "total  drilled  footage" for  in-                                                                    
     field wells  "will be more  than 50% lower in  2010 vs.                                                                    
     2007"  when  the figure  was  nearly  one million  feet                                                                    
     drilled. He added that BP  had "[r]educed our rig count                                                                    
     from  10 to  7 from  January  last year."  And I  would                                                                    
     point  out that  each drilling  rig represents  about a                                                                    
     quarter  of a  million  man-hours of  work  a year,  or                                                                    
     about 119  full-time equivalent jobs  at 2100  hours of                                                                    
     work  per year.  At  that same  Meet Alaska  Conference                                                                    
     Larry   Archibald,  the   senior   vice  president   of                                                                    
     exploration and business  development for the corporate                                                                    
     parent  in  ConocoPhillips'  organization,  noted  that                                                                    
     industry  in  the  last  five  years  added  about  450                                                                    
     million   barrel-of-oil-equivalents  to   reserves  for                                                                    
     existing  Alaska fields,  but  "only  35 million  since                                                                    
     ACES".                                                                                                                     
                                                                                                                                
     The   news  is   also   bad   for  exploration   wells.                                                                    
     ConocoPhillips has been the  leading explorer in Alaska                                                                    
     for the  last decade  and more, focusing  especially on                                                                    
     the National  Petroleum Reserve - Alaska,  or NPR-A for                                                                    
     short.  But   Helene  Harding,   who  is   now  interim                                                                    
     president  of ConocoPhillips  Alaska  Inc., warned  the                                                                    
     Resource Development  Council on November 18  last year                                                                    
     that the  number of North  Slope exploration  wells had                                                                    
     declined from 11 in 2007, to  nine in 2008 and eight in                                                                    
     2009,  with the  figure for  2010 expected  to be  even                                                                    
     lower.  More recently,  Mr.  Archibald  in his  remarks                                                                    
     last month at Meet  Alaska said ConocoPhillips will not                                                                    
     be drilling  any exploration wells in  NPR-A this year,                                                                    
     nor was  he aware of  any other company planning  to do                                                                    
     so  this year.   He  noted that  "Significant potential                                                                    
     remains in  North Slope Giants" but  "Giant fields have                                                                    
     worst fiscal  terms" under  ACES. Perhaps  more ominous                                                                    
     is  the fact  that  Mr. Archibald  told the  conference                                                                    
     that  ConocoPhillips  in  2009  had  relinquished  some                                                                    
     880,000 acres of leases that it had in NPR-A.                                                                              
                                                                                                                                
     Now, lest  we be  accused of  being misleading  in this                                                                    
     testimony to  you, let  us be  absolutely clear:  We do                                                                    
     not  claim that  every  single one  of  these signs  of                                                                    
     deterioration  in the  situation here  has been  solely                                                                    
     the result  of ACES. But  ACES has necessarily  been an                                                                    
     economic  factor   within  the   overall  circumstances                                                                    
     surrounding  each one  of them.  For some  it may  only                                                                    
     have been  a contributing  factor, while for  others it                                                                    
     may have been  decisive. It is even  possible that ACES                                                                    
     might not have been a  material factor at all, although                                                                    
     we  would expect  these to  be very  few in  number. Be                                                                    
     that as it  may in particular situations,  the point we                                                                    
     wish to make is that these  facts, taken as a whole, do                                                                    
     provide a  clear warning  that -  contrary to  what you                                                                    
     were told last  week - ACES is not  succeeding in doing                                                                    
     what  the Twenty-fifth  Legislature was  told it  would                                                                    
     do.                                                                                                                        
                                                                                                                                
9:43:26 AM                                                                                                                    
                                                                                                                                
Ms. Crockett read page 10.                                                                                                      
                                                                                                                                
     AOGA  is   reluctant  to  criticize   Gaffney,  Cline's                                                                    
     assertion that Alaska as a  place to do business should                                                                    
     not be compared to the  Gulf of Mexico. This reluctance                                                                    
     is not  because AOGA fears  they might be correct  - to                                                                    
     the  contrary,  our  individual members  disagree  with                                                                    
     Gaffney, Cline  on this and  say the Gulf of  Mexico is                                                                    
     indeed  an  appropriate  comparison.  But,  because  of                                                                    
     competitive  and  other  reasons,  our  members  cannot                                                                    
     disclose to  one another the specific  business reasons                                                                    
     that  lead individual  companies  to view  the Gulf  of                                                                    
     Mexico as an appropriate  comparison. So, for now, AOGA                                                                    
     can  only say  our membership  disagrees with  Gaffney,                                                                    
     Cline on this point.                                                                                                       
                                                                                                                                
     One matter  that Gaffney, Cline  does not seem  to have                                                                    
     considered  - nor  have  the administration's  in-house                                                                    
     economists  -  is  how  a  business  under  ACES  could                                                                    
     sustain  itself on  an ongoing  basis in  light of  the                                                                    
     enormous,  front-end-loaded costs  it incurs  for risky                                                                    
     opportunities  and  prospects  that   turn  out  to  be                                                                    
     unsuccessful,  sometimes  spectacularly so.  SOHIO,  it                                                                    
     will be  recalled, in  1979 and  the early  1980s spent                                                                    
     some  $2  billion  to  bid   for,  and  then  drill  an                                                                    
     exploratory well  on, the  offshore Mukluk  prospect in                                                                    
     the  Beaufort   Sea,  which  turned  out   to  be  dry.                                                                    
     Industry spent  another billion  dollars just  in bonus                                                                    
     bids for  OCS acreage  in the  Gulf of  Alaska offshore                                                                    
     from Alaska's  very first oil  field at  Katalla, which                                                                    
     also turned out dry. The huge  sums of money to be able                                                                    
     to make highly  risky "bets" like these  must come from                                                                    
     somewhere. And that "somewhere"  is a company's current                                                                    
     cash flows from its prior  gambles that have turned out                                                                    
     to be  successful. But,  if Alaska is  taking 50  or 60                                                                    
     percent or more of the  cash flows from current produc-                                                                    
     tion here, where  then will companies get  the money to                                                                    
     stay in  business with the exploration  odds already so                                                                    
     stacked against them by Mother Nature?                                                                                     
                                                                                                                                
9:45:17 AM                                                                                                                    
                                                                                                                                
Ms. Crockett summarized on page 10 and continued on page                                                                        
11.                                                                                                                             
                                                                                                                                
     In summary, then, ACES is,  first of all, a complex and                                                                    
     intricate  tax  that  relies on  tax  credits  and  tax                                                                    
     deductions   to  overcome   the   adverse  effects   on                                                                    
     decisions to  invest here or  not that  otherwise would                                                                    
     arise from  having such high  rates of tax.  To succeed                                                                    
     in tilting those decisions  toward investment here, the                                                                    
     decision-maker must be confident,  when she or he makes                                                                    
     the decision,  that the promised tax  benefits from the                                                                    
     investment will  in fact be  realized. This  means that                                                                    
     any uncertainty  or ambiguity about  the amount  of tax                                                                    
     owed or  the promised  tax benefits must  be eliminated                                                                    
     as  much  as  possible.  Most of  the  uncertainty  and                                                                    
     ambiguity   in  ACES   could  be   eliminated  by   the                                                                    
     regulations to  implement this tax, but  because if its                                                                    
     approach  for  the  administration  of  this  tax,  the                                                                    
     Department  of Revenue  is in  the process  of adopting                                                                    
     regulations   that    will   actually    compound   the                                                                    
     uncertainty and ambiguity  in ACES, instead eliminating                                                                    
     them.                                                                                                                      
                                                                                                                                
     Second,  despite the  investment  incentives that  ACES                                                                    
     could  offer   with  clarifying  regulations,   it  has                                                                    
     overshot the mark  in terms of the  optimum point where                                                                    
     total state  revenues, Alaska jobs and  economic growth                                                                    
     are maximized  over the remaining  life of  the fields.                                                                    
     This is because the tax is simply too high.                                                                                
                                                                                                                                
     Third, there are clear, but  ominous signs that ACES is                                                                    
     not succeeding in attracting as  much new investment as                                                                    
     it  is  supposed  to  do.  This  impending  failure  is                                                                    
     reflected  in   the  decline  in  drilling,   both  for                                                                    
     exploration wells  as well as development  wells within                                                                    
     existing fields. It is  reflected in the relinquishment                                                                    
     of  huge   amounts  of   exploration  acreage.   It  is                                                                    
     reflected in  the declining amounts being  invested for                                                                    
     new projects and development.                                                                                              
     In its public presentations  about ACES and the future,                                                                    
     ConocoPhillips -  using DNR's production  forecasts and                                                                    
     extrapolating from published data  by the Department of                                                                    
     Revenue about industry expenditures  - has identified a                                                                    
     need  for   more  than  $40  billion   dollars  of  new                                                                    
     investments for  "core fields" to  make it  through the                                                                    
     next decade  and reach the promised  land, where Alaska                                                                    
     has a gas pipeline,  where the technological challenges                                                                    
     are  overcome to  produce the  billions  of barrels  of                                                                    
     heavy  oil that  are  already discovered  and known  to                                                                    
     exist, and where  the dream for half a  century or more                                                                    
     of  production  from  the  North  Slope  is  fulfilled.                                                                    
     Alaska  is blessed  simply to  have the  possibility of                                                                    
     such  a future.   But,  to  help this  future become  a                                                                    
     reality,  the   state  must  correct   the  present-day                                                                    
     problems  and obstacles  being created  artificially by                                                                    
     its fiscal regime.                                                                                                         
                                                                                                                                
9:47:32 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  commented on  the differences  between the                                                                    
opinions  of  industry  and the  administration  on  capital                                                                    
spending  projections.  The  administration  maintains  that                                                                    
capital  spending  looks  healthy  going  forward,  yet  the                                                                    
industry  is  saying  that  capital  spending  is  distorted                                                                    
because some  of the current  projects were  underway before                                                                    
the  original PPT.  Some of  the projects  currently on  the                                                                    
books  were being  reviewed during  PPT or  ACES; therefore,                                                                    
there  will soon  be  a precipitous  decline.  He asked  for                                                                    
clarification of that issue.                                                                                                    
                                                                                                                                
Ms.  Crockett  spoke  of a  challenge  with  anti-trust  and                                                                    
competitive  issues.   She  said   she  cannot   analyze  or                                                                    
interpret data  from the Department  of Revenue  because she                                                                    
does  not have  access to  that information.  She maintained                                                                    
that statements being made about  the numbers of workers and                                                                    
spending being down are accurate.                                                                                               
                                                                                                                                
9:50:21 AM                                                                                                                    
                                                                                                                                
Senator  Thomas asked  Ms. Crockett  if  her concerns  about                                                                    
regulations  have been  confirmed. Ms.  Crockett restated  a                                                                    
concern about the tax rate.  She maintained that the "devils                                                                    
are in the  details" regarding ACES. At this  point there is                                                                    
a  lot of  uncertainty as  the industry  attempts to  comply                                                                    
with regulations  that are still  being developed.  There is                                                                    
also concern about future uncertainties.                                                                                        
                                                                                                                                
9:53:52 AM                                                                                                                    
                                                                                                                                
Senator  Thomas  wondered  if  the  industry  has  discussed                                                                    
moving  the company  to other  countries. Ms.  Crockett said                                                                    
they have not had that  discussion. There have been a number                                                                    
of analyses done.                                                                                                               
                                                                                                                                
9:55:38 AM     AT-EASE                                                                                                        
9:58:12 AM     RECONVENED                                                                                                     
                                                                                                                                
WENDY    KING,    VICE    PRESIDENT,    EXTERNAL    AFFAIRS,                                                                    
CONOCOPHILLIPS  ALASKA,   referenced  a   handout  entitled,                                                                    
"Senate  Finance  Committee,  February 23,  2010"  (copy  on                                                                    
file). She  said she appreciated the  opportunity to testify                                                                    
regarding  ConocoPhillips' thinking  on ACES  production tax                                                                    
structure and the  impact of the total  government take. She                                                                    
reported  that  there  are leading  indicators  that  create                                                                    
cause for concern:  production, wells, exploration activity,                                                                    
expenditures, jobs, and project activity.                                                                                       
                                                                                                                                
9:59:56 AM                                                                                                                    
                                                                                                                                
Ms.  King showed  slide 2,  a map  of ConocoPhillips'  North                                                                    
Slope    Fields.   She    highlighted   fields    in   which                                                                    
ConocoPhillips had an interest:  Point Thomson, Prudhoe Bay,                                                                    
Kuparuk, and Western North Slope  or Alpine, which abuts the                                                                    
National  Petroleum Reserve  of Alaska  (NPRA). She  defined                                                                    
"core  fields" as  Prudhoe Bay,  Kuparuk, and  Alpine, which                                                                    
represent about  90 percent of  the production on  the North                                                                    
Slope today  and into the  future. They are  legacy projects                                                                    
which can  deliver the production  curve referred  to during                                                                    
the various testimonies.                                                                                                        
                                                                                                                                
Ms. King said  she was asked to discuss  the ACES production                                                                    
tax  system.   Production  tax  is   only  one   element  of                                                                    
government take  in Alaska. Oil  and gas companies  are also                                                                    
subject to  royalty, property taxes, state  corporate income                                                                    
taxes,  and federal  income taxes.  All forms  of government                                                                    
take have impacts on the  risk/reward balance that investors                                                                    
look at.                                                                                                                        
                                                                                                                                
Ms. King  noted that  she also wished  to discuss  the total                                                                    
government take  level, which ranges between  65 percent and                                                                    
75 percent. She gave an  example of a project that generates                                                                    
about $100 in  net cash flow, of which only  $25 to $35 will                                                                    
go back to the investors.  She recognized that with Alaska's                                                                    
net tax  structure, there  is some sharing  of the  risk and                                                                    
reward, but  maintained that there  are uncertainties  as to                                                                    
how a  particular investment will translate  to the investor                                                                    
after  taxes. She  emphasized that  Alaska was  a high  cost                                                                    
structure. As  time progresses,  some of the  oil is  not as                                                                    
easy to find.                                                                                                                   
                                                                                                                                
Ms. King turned  to the topic of  progressivity within ACES.                                                                    
She defined  progressivity - as  the price of  oil increases                                                                    
the state's take increases.                                                                                                     
                                                                                                                                
10:03:26 AM                                                                                                                   
                                                                                                                                
Ms.  King related  what happened  to progressivity  in 2008.                                                                    
During a high price  environment, on the incremental dollar,                                                                    
government take can be as high  as 80 cents to 90 cents. She                                                                    
recalled  a  previous  presentation where  a  representative                                                                    
from the  Department of Revenue  indicated there  were three                                                                    
things the state  could control with respect to  oil and gas                                                                    
investment,  access to  acreage,  permitting, and  taxation.                                                                    
She  voiced  concern  only  with   the  level  of  taxation.                                                                    
Permitting is in the realm of federal jurisdiction.                                                                             
                                                                                                                                
10:05:04 AM                                                                                                                   
                                                                                                                                
Co-Chair  Hoffman pointed  out that,  although progressivity                                                                    
is  structured so  that the  state's take  increases as  the                                                                    
price  of  oil increases,  it  is  also  true that  the  oil                                                                    
companies  have an  increase in  profit, as  well. Ms.  King                                                                    
said that  later on  in the presentation  there was  a graph                                                                    
she could show that would illustrate that point.                                                                                
                                                                                                                                
Ms. King turned  to slide 3 - investment in  core fields. It                                                                    
is the state's  forecast for production over  time. There is                                                                    
a  lot  of  uncertainty  over future  production.  She  drew                                                                    
attention   to  the   yellow  section,   which  shows   that                                                                    
production from  the core fields  may require more  than $40                                                                    
billion  of expenditures  by the  industry  during the  next                                                                    
decade. She  focused on investments  for the next  ten years                                                                    
and how  the state  and the companies  can work  together to                                                                    
generate more  production and  jobs in  the core  fields. It                                                                    
will take a significant investment by the industry.                                                                             
                                                                                                                                
10:07:14 AM                                                                                                                   
                                                                                                                                
Ms. King  discussed the impact of  satellite developments in                                                                    
Kuparuk and  Alpine - slide  4. The North Slope  core fields                                                                    
have  declined.   She  emphasized   that  there   have  been                                                                    
significant   investments  over   the   years  to   mitigate                                                                    
production decline.  She noted  that Kuparuk  satellites are                                                                    
currently  delivering about  20 percent  of the  production.                                                                    
Within  the Kuparuk  base there  has been  a combination  of                                                                    
enhanced oil recovery and infield  drilling. The company has                                                                    
made investments in  both areas. She emphasized  the size of                                                                    
Kuparuk -  about 6  billion barrels of  oil in  place. Every                                                                    
one  percent   recovery  equals  60  million   barrels.  She                                                                    
maintained that  "big fields get  bigger" and "you  find oil                                                                    
where you  found oil". Kuparuk is  a key asset if  the right                                                                    
investment and the right technology advances are made.                                                                          
                                                                                                                                
10:09:38 AM                                                                                                                   
                                                                                                                                
Ms. King  highlighted production  in Alpine, which  has been                                                                    
critical. The  satellite production now represents  40 to 50                                                                    
percent  of total  production. The  base  continues to  have                                                                    
infield drilling  and oil  recovery mechanisms.  She pointed                                                                    
out  that   future  Alpine   satellites  are   within  NPRA.                                                                    
ConocoPhillips  is  attempting  to permit  those  fields  in                                                                    
order to maintain satellite production.                                                                                         
                                                                                                                                
Ms. King showed  slide 5, North Slope  remaining barrels. It                                                                    
shows that  core fields  are the  dominant source  of future                                                                    
state production.                                                                                                               
                                                                                                                                
Co-Chair Stedman asked if heavy  oils are included. Ms. King                                                                    
replied that  some heavy oil is  included. ConocoPhillips is                                                                    
still reviewing state forecasts.                                                                                                
                                                                                                                                
10:12:24 AM                                                                                                                   
                                                                                                                                
Ms.  King  said  Point  Thomson,  Nikaitchuq,  Oooguruk  and                                                                    
Liberty are important, but the  majority of production is at                                                                    
core   fields.   Co-Chair   Stedman  thought   Liberty   had                                                                    
production,  but low  revenue.  Ms. King  agreed. She  added                                                                    
that Liberty is not subject to ACES.                                                                                            
                                                                                                                                
Ms. King  turned to slide  6 to show that  industry drilling                                                                    
activity  is down.  It is  the  first time  since 1965  that                                                                    
ConocoPhillips  has  not  drilled an  exploration  drill  in                                                                    
Alaska.  In 2008  ConocoPhillips invested  $500 million  for                                                                    
exploration in the Chukchi Sea,  which is in federal waters.                                                                    
She  maintained that  exploration dollars  are being  spent,                                                                    
but not on state lands.                                                                                                         
                                                                                                                                
Ms. King  noted that  the forecast for  2010 is  not certain                                                                    
because it  is not  clear which wells  will be  drilled. She                                                                    
explained  that the  graph depicts  four exploration  wells.                                                                    
The  graph  on the  right  shows  a  14 percent  decline  in                                                                    
development wells over the last few years.                                                                                      
                                                                                                                                
10:15:26 AM                                                                                                                   
                                                                                                                                
Co-Chair Stedman  pointed out  the difficulty  of separating                                                                    
out  Kuparuk  and Prudhoe  from  other  producing units.  He                                                                    
referred  to  the left  graph  and  asked  how many  of  the                                                                    
exploration wells  were from Kuparuk  and Prudhoe.  Ms. King                                                                    
explained that  the left graph  would not contain  any wells                                                                    
from  Prudhoe and  Kuparuk, but  rather  wells from  outside                                                                    
core producing areas.  The graph on the  right depicts total                                                                    
industry  wells. She  offered to  provide information  about                                                                    
drilling activity in the core fields.                                                                                           
                                                                                                                                
10:17:12 AM                                                                                                                   
                                                                                                                                
Ms. King  reported on  active drilling  rigs in  core fields                                                                    
from 2005  to 2009 - slide  7. The black line  is oil price.                                                                    
The green  line is the  U.S. oil  rig count, which  has been                                                                    
normalized  to depict  Alaska's  environment. She  explained                                                                    
that core  field rig trends  have remained  relatively flat.                                                                    
The U.S.  oil rig count  doubled. There are  two significant                                                                    
areas of  deviation in Alaska,  as compared to  other areas.                                                                    
In 2008 and  recently, U.S. oil rig counts  increased as oil                                                                    
prices  went  up,  which  did  not  happen  in  Alaska.  She                                                                    
concluded that core field drilling  activity is not tracking                                                                    
with oil  price. She thought  that progressivity was  key to                                                                    
why  that was  happening. In  2008 ConocoPhillips  showed no                                                                    
impact  to  net  income  even though  prices  were  up.  She                                                                    
emphasized the need to look  at the balance between risk and                                                                    
reward.  She thought  the trend  shown  on the  graph was  a                                                                    
leading indicator of the impact of ACES production tax.                                                                         
                                                                                                                                
10:21:00 AM                                                                                                                   
                                                                                                                                
Ms.   King  talked   about  the   impact  of   inflation  on                                                                    
expenditures  - slide  8. North  Slope industry  spending on                                                                    
capital and  operating expense is  shown. The  graph depicts                                                                    
flat expenditures when adjusted for inflation.                                                                                  
                                                                                                                                
Co-Chair  Stedman asked  what CERA  inflation factors  were.                                                                    
Ms. King said they were  used to deflate the investment over                                                                    
time. Co-Chair  Stedman asked if  CERA was  an international                                                                    
consulting firm.  Ms. King defined CERA  as Cambridge Energy                                                                    
Research Associates,  an international consulting  firm. She                                                                    
offered to provide more information.                                                                                            
                                                                                                                                
Ms. King  showed slide 9  - extending core field  lives. The                                                                    
graph  shows  that  extending  field  life  is  a  cause  of                                                                    
spending  increases.  When  looking   at  core  field  gross                                                                    
spending  on capital  and operating  expenses,  there is  an                                                                    
increase  in maintenance/replacement/repair  spending, while                                                                    
spending on development projects  and drilling remains flat.                                                                    
She emphasized  that both categories are  equally important.                                                                    
She  offered  to  update  the graph  as  2009  data  becomes                                                                    
available.                                                                                                                      
                                                                                                                                
10:25:33 AM                                                                                                                   
                                                                                                                                
Co-Chair    Stedman    asked     for    a    breakdown    of                                                                    
maintenance/replacement/repair  spending into  operating and                                                                    
capital credit. Ms. King said  she could provide information                                                                    
about capital expenditures.  Co-Chair Stedman commented that                                                                    
the intent of  the 20 percent capital credit  was to extract                                                                    
more oil,  not to rebuild  the field above ground.  Ms. King                                                                    
replied  that  she would  try  to  find  more data  on  that                                                                    
subject.  She  thought  that  maintenance/replacement/repair                                                                    
and   development   were   important  for   delivering   the                                                                    
production profile.                                                                                                             
                                                                                                                                
Co-Chair  Stedman  thought   that  differing  viewpoints  on                                                                    
capital spending within  the basin might be  a concern. Lack                                                                    
of  information   about  maintenance/replacement/repair  may                                                                    
mask  production decline.  Ms. King  explained that  much of                                                                    
capital  expenditures are  in the  category of  what's under                                                                    
development  in  fields  outside of  Prudhoe,  Kuparuk,  and                                                                    
Alpine.  A  decline is  forecast  for  expenditures in  core                                                                    
fields, whereas the forecast for  production in fields under                                                                    
development is for an increase.                                                                                                 
                                                                                                                                
10:30:15 AM                                                                                                                   
                                                                                                                                
Ms.  King commented  on the  downward trend  in oil  and gas                                                                    
employment  -   slide  10.  The  information   is  from  the                                                                    
Department of Labor.  She believed an upward  trend began in                                                                    
2006, followed by  a downward trend beginning  in July 2009.                                                                    
State  unemployment in  the oil  and gas  support sector  is                                                                    
rising. Production companies,  including ConocoPhillips have                                                                    
experienced a reduction in staffing.  She spoke of a leading                                                                    
indicator - Kuparuk camp usage is down 20 percent.                                                                              
                                                                                                                                
10:32:28 AM                                                                                                                   
                                                                                                                                
Ms. King continued with slide  11 - ACES impacting projects.                                                                    
She listed Oooguruk, Nikaitchuq,  and Liberty as examples of                                                                    
recent project activities that were  pre-ACES or not subject                                                                    
to ACES.  She added Point  Thomson as another  example. Over                                                                    
$2 billion  in projects have  been deferred since  the onset                                                                    
of  ACES,  such as  the  I-Pad  and Gas  Partial  Processing                                                                    
projects  in Prudhoe,  West  Sak  1N and  1P,  and the  ULSD                                                                    
topping plant.  She concluded that  there are  some projects                                                                    
moving forward,  but often the risk/reward  balance does not                                                                    
justify others.                                                                                                                 
                                                                                                                                
10:35:19 AM                                                                                                                   
                                                                                                                                
Ms. King explained  slide 12 which shows an  example of when                                                                    
Outer   Continental  Shelf   (OCS)  fiscal   risk/reward  is                                                                    
balanced. She  used a $1  billion investment as  an example.                                                                    
As  prices  rise, there  is  a  fixed percentage  system  of                                                                    
government  take. Slide  13 shows  the same  investment, but                                                                    
with the Alaska fiscal risk/reward broken.                                                                                      
                                                                                                                                
Senator Egan  asked if credits  are taken into  account. Ms.                                                                    
King said they were.  She explained government take includes                                                                    
the  capital credit  expenditure,  but  not the  exploration                                                                    
credit.  She emphasized  that there  is  a lot  of risk  the                                                                    
industry takes. This  example assumes that there  is oil out                                                                    
there, and  there is a  20 percent capital credit.  There is                                                                    
an  increase in  profit, as  shown  by the  yellow bar.  The                                                                    
percent of  government take, the  red bar,  is substantially                                                                    
increasing over time. Government  take is the combination of                                                                    
royalty,  corporate  income  tax,  property  tax,  and  ACES                                                                    
production   tax.   In   the    third   quarter   of   2008,                                                                    
ConocoPhillips'  realized  oil   price  for  investments  in                                                                    
Alaska was $115,  the same as in the fourth  quarter of 2009                                                                    
when the realized  oil price was $68. Ms.  King related that                                                                    
the bottom  line was  that progressivity  was playing  a big                                                                    
part. Total  taxes going to  the state for 2008,  other than                                                                    
income tax, was $3.4 billion.                                                                                                   
                                                                                                                                
10:39:46 AM                                                                                                                   
                                                                                                                                
Ms.  King turned  to slide  14 -  2010 to  2019 North  Slope                                                                    
production.  She  said  she  has  tried  to  depict  leading                                                                    
indicators for  discussions concerning ACES  production tax.                                                                    
She dispelled the  belief that a 6 percent  decline rate was                                                                    
the  state's worst  case scenario.  She maintained  that the                                                                    
industry has spent billions of  dollars in investment during                                                                    
the decline;  ConocoPhillips has  invested $40  billion over                                                                    
the  last decade  directly into  assets, in  paying royalty,                                                                    
and  production taxes,  and through  direct investment.  She                                                                    
emphasized   that  future   production  is   dependent  upon                                                                    
investment. She  attached a  10 to  16 percent  decline rate                                                                    
without  well-related  activities,  maintenance,  and  other                                                                    
facility projects.                                                                                                              
                                                                                                                                
Ms. King  explained that  the graph on  slide 14  also shows                                                                    
DOR's forecast  at a 2.5  percent decline for 2010  to 2019,                                                                    
which will  require investment, as  well. She  stressed that                                                                    
future  production is  very  dependent  upon the  investment                                                                    
going  forward.  The  qualified capital  expenditure  credit                                                                    
does help the investment profile.                                                                                               
                                                                                                                                
10:42:19 AM                                                                                                                   
                                                                                                                                
Ms.  King concluded  with  suggestions  for improving  ACES:                                                                    
investment in  core fields  and balanced  progressivity. She                                                                    
mentioned  uncertainty  about  capital credits.  She  voiced                                                                    
possible concerns.                                                                                                              
                                                                                                                                
Co-Chair Stedman  referred to a  presentation on  heavy oil,                                                                    
and concerns about a technology  gap and high costs. He used                                                                    
an example of  the industry using heavy oil  as an increased                                                                    
cost  factor to  dilute  the effects  of progressivity.  Ms.                                                                    
King assured the  committee that the industry  is looking at                                                                    
all aspects  of the ACES  tax structure. She  suggested that                                                                    
the focus should  be on adding production  and reserves. She                                                                    
brought  up incremental  investment and  commented that  the                                                                    
company  has  to look  at  each  one  and ascertain  how  it                                                                    
affects the industry.                                                                                                           
                                                                                                                                
10:46:36 AM                                                                                                                   
                                                                                                                                
Senator Thomas referred to slide  3. He discussed the merits                                                                    
of light  oil in place of  heavy oil. He spoke  of potential                                                                    
methods to raise  heavy oil. Ms. King said  she represents a                                                                    
potential shipper.  As a  shipper looks  to an  open season,                                                                    
heavy oil  is a factor. Gas  is valuable on the  North Slope                                                                    
and is being used every day  to help produce more oil. There                                                                    
is uncertainty of the value of  gas in the future. The issue                                                                    
around oil is that the  picture changes every year. There is                                                                    
a lot of oil to be recovered  by using gas over the next ten                                                                    
years. A balance will need to be found.                                                                                         
                                                                                                                                
10:50:25 AM                                                                                                                   
                                                                                                                                
Senator Thomas asked about the  involvement of feedback from                                                                    
the  industry  in correcting  ACES.  Ms.  King talked  about                                                                    
incentivizing new  production and  more drilling  within the                                                                    
core  fields. She  spoke of  the challenge  of figuring  out                                                                    
what constitutes  new production.  The more total  oil going                                                                    
into the system, the lower  the unit cost of oil production.                                                                    
Both the base  and new fields are  important. Changes around                                                                    
progressivity will  lead to a  discussion with  the industry                                                                    
about  future investment.  She  spoke of  a  common goal  to                                                                    
generate new production and new jobs.                                                                                           
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
The meeting was adjourned at 10:53 AM.                                                                                          

Document Name Date/Time Subjects
2010 02 23 ConocoPhillips Testimony SFC by Wendy King.pdf SFIN 2/23/2010 9:00:00 AM
Oil and Gas Production Tax Review
2010 02 23 AOGA Testimony by Marilyn Crockett SFC.pdf SFIN 2/23/2010 9:00:00 AM
Oil and Gas Production Tax Review
Agenda 022310 am.docx SFIN 2/23/2010 9:00:00 AM
2010 03 08 Response Conoco Followup Feb23 SFC.pdf SFIN 2/23/2010 9:00:00 AM
Oil and Gas Production Tax Review