Legislature(1993 - 1994)
01/13/1994 09:00 AM Senate FIN
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* first hearing in first committee of referral
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+ teleconferenced
= bill was previously heard/scheduled
MINUTES
JOINT SENATE AND HOUSE FINANCE COMMITTEE
January 13, 1994
9:00 a.m.
TAPES
SFC-94, #1 Side 1 (000-end)
SFC-94, #1 Side 2 (end-400)
CALL TO ORDER
Senator Steve Frank, Co-chair, convened the meeting at
approximately 9:00 a.m.
PRESENT
The following members attended:
SENATE FINANCE HOUSE FINANCE
Co-chair Frank Co-chair Larson
Co-chair Pearce Co-chair Maclean
Senator Jacko Representative Brown
Senator Kelly Representative
Foster
Senator Kerttula Representative
Grussendorf
Senator Rieger Representative
Hanley
Senator Sharp Representative
Hoffman
Representative
Martin
Representative
Therriault
ALSO ATTENDING: Representative Davis; Representative
Carney; Representative Willis; Representative Parnell;
Representative James; Representative Ulmer; Representative
Toohey; Senator Salo; Senator Duncan; Commissioner Darrel
Rexwinkel, Department of Revenue; Dr. Charles Logsdon, Chief
Economist of Oil and Gas Audit Division, Department of
Revenue; Mike Greany, Director, Legislative Finance
Division; and aides to committee members and other members
of the legislature.
SUMMARY INFORMATION
HB 370 - APPROP: FY 95 OPERATING AND LOAN BUDGET
Presentations were made by Commissioner Darrel
Rexwinkel and Dr. Charles Logsdon of the Department of
Revenue.
A presentation was also made by Mike Greany, Director,
Legislative Finance Division.
DEPARTMENT OF REVENUE OVERVIEW
Co-chair Frank invited Commissioner of Revenue Darrel
Rexwinkel and Dr. Charles Logsdon, Chief Economist of Oil
and Gas Audit Division, Department of Revenue, to join the
members at the committee table and proceed with the
department presentation.
COMMISSIONER REXWINKEL directed attention to a ten page
handout with a cover sheet entitled "FY 1994 Petroleum
Revenue Executive Update" dated January 6, 1994 (copy on
file). Commissioner Rexwinkel said oil revenues still
account for 85 percent of the total state general fund
unrestricted revenues. He said oil prices were at the
lowest prices since the crash of 1986. At that time the
average was $9.72 a barrel. Adjusted to 1993 dollars that
figure is $12.13. December 17, 1993 was the lowest price
for oil this year, west coast $9.94, and the gulf coast
$11.68 averaging $10.54. Brought forward into 1993 dollars
this is less than the 1986 price.
The spread at the low point in December was $1.74 a barrel
between the west coast and the gulf coast. The spread has
fluctuated substantially over time. The significant spread
between the gulf and west coast now is an indication of the
glut of oil on the west coast markets further deteriorating
Alaska prices. He pointed out the export ban is very
important to the state and emphasized the Governor and
others are working to get the ban lifted. Commissioner
Rexwinkel concluded his brief overview and invited Dr.
Logsdon to speak.
DR. CHARLES LOGSDON, Chief Economist of Oil and Gas Audit
Division, Department of Revenue, informed the committee his
presentation would speak to FY 94 with a forecast for FY 95.
He pointed out oil prices had dropped incredibly low unlike
the spring forecast that had used the price of $18 a barrel.
At the time of the spring forecast the hope was that more
OPEC oil would be needed because of an overall rise in the
market economy as a result of global expansion and the fall
of communism. At $18.38 a barrel the mid-case scenario
showed an income of $2.3 billion for FY 94. Soon after that
forecast was made, several things began to happen. When
OPEC met in June, Kuwait did not sign the agreement to
produce at the quota that OPEC had given them. The market
immediately began to fall and even though most forecasters
held that the price would improve, oil prices continued to
deteriorate. By September, analysts were talking about an
"Iraq risk premium", giving it a rate of about $2 a barrel.
Although it was felt the market was not glutted, Iraq
continued to hang over the market causing it to be soft.
Dr. Logsdon explained that by the time the fall forecast was
begun, the barrel price had dropped to approximately $16.
The department's low scenario showed $15/barrel oil price
but the forecast was written at $16/barrel, showing an
income of $2.16 billion. This put the budget $320M below
the spring target at the low scenario. After the fall
forecast, OPEC met and raised their quota. The price of oil
continued at $10 to $12 a barrel. He directed the
committee's attention to page one of the handout showing the
FY 94 market forecast of $1.771 billion general fund as a
new low. Moving on to FY 95 on the second page he noted
that, based on the projections of how much oil the world
would need, the low scenario was targeted at $15 a barrel.
He felt that the OPEC market share would remain somewhere
below 25 million barrels day.
REPRESENTATIVE TERRY MARTIN expressed his concern that the
forecast for FY 94 and FY 95 were overly optimistic. He
asked if today's prices are at $10 to $12 a barrel why would
the FY 95 forecast be figured at $15. Mr. Logsdon defended
his low scenario stand by explaining that the forecast was
accomplished by taking the anticipated production during FY
95 and selling it on the futures market. Turning to page 3,
he indicated it was difficult to lock in a number for the
low scenario on the futures market explaining the futures
market is a reflection of today's cash market with some
premium or discount on today's sales depending on how the
professional speculators feel the market will go in the
future. He maintained that the demand for oil will grow and
also maintained the futures market projection underpinned
the low scenario.
Commissioner Rexwinkel pointed out that the futures market
had been backed off by $3 a barrel to arrive at the ANS
average price and is an approximation. He also stated that
the market forecast did not include the $135M settlement
money in question that was deposited into the general fund
instead of the constitutional reserve fund.
Mr. Logsdon pointed out the graph on page 6 which showed oil
prices since 1970. In a long term sense, 18 months to 5
years, the market could return to the $15-20 area. Many
analysts say the new trading range is $10-15. On page 7,
the five year average, 1989-1993, indicates we are into the
post 1986 market. The December '93 spot at a $10.57 a
barrel shows a low not seen since 1986. This raises the
question, what happened to drop the price to $10.57?
Dr. Logsdon offered that we had entered a new trading range
and directed attention to the graph on page 8 which pictures
the extreme drop in the price of oil by over $5 a barrel
from the end of October to December. Turning his attention
to the table on page 9, he recalled his comment regarding
the planning for a boost in OPEC oil production and a
consensus from OPEC planners banking on producing more oil.
He indicated the dotted lines represent the OPEC quota and
production, and the solid line represents a trend line which
shows an upswing. In 1993, OPEC was unable to stay on that
trend line. In trying to explain why, he said that many
people failed to acknowledge that global economy was
relatively stagnant almost due entirely to the economic
recession that continued in Europe and Japan. Secondly,
non-OPEC production had done very well, Russian exports were
up, and inventories had built up. In a market that is as
finely balanced as the crude oil market, even a few barrels
over made this market a nervous one. When OPEC met in
November and did not cut their quota, the result was a $10 a
barrel price.
Dr. Logsdon felt that at present there was a division among
the analysts who watch this market. Information received
from more than half of the pundits point to a new trading
range of $10 to $13 for the next year or so. The first
reason for this is that OPEC is pursuing a market share type
policy that is not doing anything to support prices. They
continue to let the paper market dictate where the price
will go. The non-OPEC countries will not cooperate because
at low oil prices they are under even greater pressure to
produce absolutely every barrel they can. He stated that he
still believed economic growth will kick in and more oil
will be needed when that happens. He also pointed out that
as long as oil prices remain low, things happen that will
increase oil demand. He felt that Saudi Arabia is a key
player since they have so many discretionary barrels.
Eventually growth will cause oil prices to rise. When OPEC
meets in March it needs to do two things to cause oil prices
to return to the $18 range. OPEC needs a credible plan, an
agreed upon quota system which includes Iraq. Secondly,
they need to talk seriously about a market share policy that
would attempt to prorate in a fair fashion the production,
and take some barrels off the market.
Dr. Logsdon directed the committee to page 10 of the
handout, FY 94 weekly average ANS production. He said that
it was expected that more oil would be put into the pipeline
in 1995 than in 1994 because of Point McIntyre, Prudhoe Bay,
GHX2, and later, Niakuk. On the other hand, the reserves
have not been replaced on the slope and the long term
decline rate is estimated at about 5% a year. That seems
gradual enough so the state will have time to deal with the
depleting reserve base in the realm of royalties and taxes.
He also felt BP's Cascade seems worth developing and may
contribute a Niakuk-size field. Thus concluding his
presentation, he asked for questions from the committee.
CO-CHAIR DRUE PEARCE said that she heard Dr. Subroto,
Secretary General of OPEC, speak in late November. After
OPEC brought their quota up to meet production, he publicly
pointed out production in Columbia and Russia as being the
reason for the fallen prices. She said that Iran was in
line to take over the Secretary General position after Dr.
Subroto retired and questioned its effect on oil prices.
Dr. Logsdon agreed that the position was a diplomatic and
not a policy making position. He felt it should have a
neutral effect on the market but was hard to predict if Iran
would indeed take over that position. They both agreed Dr.
Subroto has been a very stabilizing influence on OPEC. Dr.
Logsdon pointed out that one theory said the reason the
Saudis are content to bite the bullet on low prices was it
hurt their enemies worse than it hurt them. The Saudi royal
family is concerned about the existence of hostile
neighbors, Iran being one of them.
REPRESENTATIVE BEN GRUSSENDORF stated his views differed
widely from Dr. Logsdon. He argued the statement that the
fall of communism would contribute to the consumption of
oil. It was his understanding one must consider an
industrial war machine's petroleum oil and lubricants use,
and once that consumption ceased, realize it would not be
replaced by the private sector. He asked if the forecasters
in any way took this into consideration. It seemed like
common sense that oil from Russia going onto the market
would cause problems. He felt economic growth sounded good
but after the dismantling of the a machine, prices would go
down.
Dr. Logsdon said on one hand there were supply side effects
and consumption side effects. With the attraction of
foreign capital the Russian central plan system for
developing oil resources high-graded because of pressure to
meet production targets. Representative Grussendorf again
stated he wanted the forecasters to consider the variable of
the amount of oil consumed in the name of defense. He
expressed his view that economic growth in the private
sector is not going to come close to that demand, and
dismantling could cause a surplus for a long time. Dr.
Logsdon agreed the disruption effect was under estimated.
SENATOR STEVE RIEGER stated that Russian production was
going to be down since Russian export production was
collapsing even faster than the economy. Dr. Logsdon
confirmed this factor was unexpected in the market as well.
Senator Rieger commented that since pundits were forecasting
in the range of $11 to $15 a barrel, was the top barrel
price estimate $26-27 if the supply and demand forces were
normal. Dr. Logsdon said it could happen and pointed out
that Merrill Lynch projected the WTI to return to $20 in the
next two quarters. He commented it was the highest forecast
at this time.
REPRESENTATIVE THERRIAULT asked if the department's forecast
included Pt. McIntyre coming on-line. Dr. Logsdon answered
affirmatively. Representative Therriault said he understood
the warm weather causing inefficiency of the equipment had
slowed production. Dr. Logsdon said both construction
activity related to gas handling expansion and the warm
weather reduced production more than expected. He said Pt.
McIntyre went over 100,000 barrels a day more quickly than
expected. Barring technical disruptions, FY 95 was expected
to be a more productive year. Representative Therriault
asked if the effect of weather would be viewed in the
forecasts. Dr. Logsdon agreed it would be taken into
consideration but he felt extended shutdowns because of
construction activities had impacted the production more
than weather.
End SFC-93 #1, Side 1
Begin SFC-93 #1, Side 2
Senator Kerttula stated Russia was going to receive a
subsidy of about $20 billion to assist and develop oil
fields. He felt it not in the best interests of western
development. Further, Senator Kerttula voiced his concern
over the possibility that Pt. McIntyre was going to be
involved in a legal battle with EXXON possibly reducing the
royalty income projected.
Dr. Logsdon stressed that the forecast was issued under the
state's position that there is no allowance for a processing
deduction like Prudhoe Bay. Senator Kerttula maintained
that should have been resolved before Pt. McIntyre went into
production.
Co-chair Frank asked Dr. Logsdon to comment on world-
production, excess production relative to consumption, the
Iraq situation and how it relates to world-wide and OPEC
production, and what effect Iraq's return to the market
would have on the market. Dr. Logsdon said that FY 93
world-wide production would average 66.1 million barrels a
day based on a best guess. OPEC at 24.7 barrels is
producing about 35 percent of the world's oil. Most
importantly most of that oil is exported, therefore causing
the focus on OPEC. OPEC fills the market with the barrels
others cannot produce themselves. He estimated energy and
oil requirements would grow at a rate of about 1-3 percent,
for the short run forecast - not a good ratio. In regard to
excess capacity, Dr. Logsdon explained that not only do we
need to estimate how much oil is coming out of the ground,
but also how much people have stored above the ground.
Changes of inventory can mean either higher or lower prices,
depending upon whether people are stocking up because the
price is low or destocking because there is a surge in
demand. People try to identify the production/consumption
gap and adjust the numbers for seasonal factors. There may
be as little as an additional 100-200,000 barrels a day on
the market. That's why the pundits were saying if OPEC cut
200,000 barrels a day, it could stabilize the market. He
did not put a lot faith in the surplus numbers but the
information the department is receiving says that the
surplus is not large. Dr. Logsdon said that Iraq's reentry
into the market is a heavy weight on the market. Iraq has
complied with most requirements in order to obtain a partial
removal of the embargo in order to sell $1.7 billion. The
border between Iraq and Kuwait is still not agreed upon.
Iraq does not want a partial lift but a total lifting of the
embargo. The UN would like to lift the embargo and use that
$1.7 billion to help fund peace keeping in Somalia, Bosnia,
etc. The pundits have come up with a $2 risk premium. If
Iraq did come on line, how long and how much would they
produce? The pundits estimate that it would take about 12
months to come on line, and estimate production at 1.6
million barrels a day. Dr. Logsdon said it would be more
realistic to expect Iraq to come on line in one month but
that 1.6 million barrels a day seemed very possible.
In response to Co-chair Frank, Dr. Logsdon said that Saudi
Arabia almost completely filled the void left by Iraq,
increasing their production from 5.5 to 8.5 million barrels
a day. Explaining why, when OPEC met, they looked to Saudi
Arabia to reduce their production. Discussion followed
between Co-chair Frank and Dr. Logsdon why OPEC is refusing
to cut production. He said that the OPEC meeting in March
would tell a better story.
REPRESENTATIVE LYMAN HOFFMAN referred to page 9 of the
handout and said that OPEC production is around 24.7 million
barrels a day. He asked how far does OPEC predict its
quotas and what are they. Dr. Logsdon said that OPEC quotas
are in place until they change and since OPEC meets about
every six months, the quotas are on the table at that time.
The fall forecast listed the quotas for the individual
countries as follows: Saudi Arabia - 8 million/day; United
Arab Emirates - 2.16; Venezuela - 2.3; Nigeria - 1.865;
Qatar - 378,000; Libya - 1390; Kuwait - 2 million; Iraq -
400,000 (recognizing Iraq's internal use). He noted that
Iraq is probably exporting an extra 300-400,000 barrels/day
through Iran and Jordan. In response to Representative
Hoffman's inquiry regarding the possibility of OPEC changing
their quota before March, Dr. Logsdon said it was unlikely.
He felt since they just met in December, it would seem like
they would keep their March meeting date.
Representative Martin stated that aside from world oil
prices, Alaska must take care of itself, especially since
our oil production is decreasing at approximately 5 percent
a year. He asked what looked good in Alaska's future, are
there new leases, and what incentives could we use for more
exploration. He voiced his opinion that American companies
were going to the world market for discoveries. Dr. Logsdon
answered that the Department of Natural Resources would be
able to answer that question more fully. Especially in
areas of new leases, Alaska is under somewhat of a
psychological handicap in that new explorations have been
disappointing. The environmental movement has caused some
tradeoffs in development although we have an attractive tax
environment. An oil company receives 50 cents and Alaska
and the federal government split the other 50 cents after
development costs. He directed the question again to the
Department of Natural Resources because they may be looking
at credits or direct subsidization.
REPRESENTATIVE EILEEN MACLEAN asked what impact the Alyeska
pipeline would have with the non-compliance of the pipeline
on royalties and tariffs. Dr. Logsdon said at this point he
did not know the exact cost or to what extent the cost could
be put into the tariff. Every dollar the cost of the
pipeline increases, the state pays 25 cents. He was
emphatic that these costs be audited and proved legitimate.
The Department of Law is presently auditing spill expenses,
etc. to insure this very thing. Representative Maclean
asked if these costs were taken into consideration when
forecasting the production level. Dr. Logsdon said the
theory of the pipeline settlement agreement was the owners
would recover costs up front with high tariffs in early
years and therefore tariffs would be lower in the 90s. This
has kept the tariff in the $3/barrel range. This feels more
like a long-term problem as far as field development. He
agreed with Representative Maclean that it would have a
negative impact.
Co-chair Frank invited Mike Greany, Director, Legislative
Finance Division to come before the committee and give a
report on the rule of thumb, severance tax and zero royalty
point.
MIKE GREANY, Director, Legislative Finance Division,
directed the committee to a handout prepared by Legislative
Finance and Dr. Logsdon addressing the low oil prices (copy
on file). He explained that below $10 per barrel, the rule
of thumb effect on state revenue is approximately $75
million per barrel. The lower the price, the less Alaska
will lose, but of course, the less profit is made. The two
major sources of revenue are severance tax and royalty. At
$10 per barrel the severance tax is at its minimum, 74 cents
a barrel. At $5.45 a barrel the state receives zero royalty
revenue. The three major costs are field costs (lifting and
gathering) estimated at 70 cents per barrel, transportation
costs through the pipeline at $3.25 a barrel, and tankerage
costs at $1.50 per barrel. In addition, the handout lists
historical ANS prices for FY 83 through FY 94 YTD.
REPRESENTATIVE KAY BROWN asked if the new low range rule of
thumb on the handout referred to market destination sales
prices or net effect prices. Mr. Greany said it referred to
lower 48 market prices. Co-chair Frank would prefer to see
the separate markets split.
Co-chair Pearce asked if tankerage costs were audited and/or
approved like the high point tariff. Dr. Logsdon said
tankerage costs were an important part of the oil and gas
audit program and specific accounting rules in regulations
outline what is allowed and subject to state audit. This
has resulted in some settlements. In response to a question
by Co-chair Pearce, Dr. Logsdon said costs were projected by
numbers reported from the companies each month. There is an
important distinction between the severance tax revenues
implied and the royalties. Because of a formula basis Exxon
receives $1.25 while ARCO actually receives a transportation
allowance which is a fixed percentage of the value of the
royalty market basket used to assess the west coast price of
oil. It is a buffer when oil prices get low, since the ARCO
transportation percentage is a lower number. There is a
difference between what we allow for transportation on the
severance tax side and what is allowed on the royalty side
which is a direct function of the royalty settlements that
were cut with the major companies over the last couple of
years.
Representative Martin asked what it meant to the state per
day if one assumed a well head value at $10.45. In
addition, he asked after $5.45 was deducted per barrel would
the state receive 27 percent of the remainder. Dr. Logsdon
said when the price falls below $10 a barrel the actual
percentage increases. He agreed it was a close estimate but
to remember that percent includes the Permanent Fund
contribution making the final amount a little smaller
percentage.
ADJOURNMENT
The meeting was adjourned at approximately 11:00 a.m.
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