Legislature(2005 - 2006)SENATE FINANCE 532

03/04/2006 10:00 AM FINANCE

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

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