Legislature(2007 - 2008)BUTROVICH 205

10/31/2007 09:00 AM JUDICIARY


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Audio Topic
09:09:07 AM Start
09:09:19 AM SB2001
09:14:20 AM Patrick Galvin, Commissioner, Department of Revenue
01:27:45 PM Rich Ruggiero and Bob George, Gaffney Cline
03:58:37 PM Steve Porter and Dan Dickinson, Consultants to the Legislative Budget & Audit Committee
04:59:17 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+= SB2001 OIL & GAS TAX AMENDMENTS TELECONFERENCED
Heard & Held
Net versus Gross
Progressivity
Floor
-- Testimony <Invitation Only> --
                    ALASKA STATE LEGISLATURE                                                                                  
              SENATE JUDICIARY STANDING COMMITTEE                                                                             
                        October 31, 2007                                                                                        
                           9:09 a.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
Senator Hollis French, Chair                                                                                                    
Senator Charlie Huggins, Vice Chair                                                                                             
Senator Bill Wielechowski                                                                                                       
Senator Lesil McGuire                                                                                                           
Senator Gene Therriault                                                                                                         
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
All members present                                                                                                             
                                                                                                                                
OTHER LEGISLATORS PRESENT                                                                                                     
                                                                                                                                
Senator Gary Stevens                                                                                                            
Senator Johnny Ellis                                                                                                            
Senator Lyman Hoffman                                                                                                           
Representative Andrea Doll                                                                                                      
Representative Les Gara                                                                                                         
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
SENATE BILL NO. 2001                                                                                                            
"An Act  relating to  the production  tax on oil  and gas  and to                                                               
conservation  surcharges  on oil;  relating  to  the issuance  of                                                               
advisory  bulletins and  the  disclosure  of certain  information                                                               
relating to the  production tax and the  sharing between agencies                                                               
of certain information relating to  the production tax and to oil                                                               
and gas or  gas only leases; amending the State  Personnel Act to                                                               
place in  the exempt service  certain state oil and  gas auditors                                                               
and their immediate supervisors; establishing  an oil and gas tax                                                               
credit  fund and  authorizing payment  from that  fund; providing                                                               
for retroactive  application of certain statutory  and regulatory                                                               
provisions  relating to  the production  tax on  oil and  gas and                                                               
conservation  surcharges on  oil;  making conforming  amendments;                                                               
and providing for an effective date."                                                                                           
     HEARD AND HELD                                                                                                             
                                                                                                                                
PREVIOUS COMMITTEE ACTION                                                                                                     
                                                                                                                                
BILL: SB2001                                                                                                                  
SHORT TITLE: OIL & GAS TAX AMENDMENTS                                                                                           
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR                                                                                    
                                                                                                                                
10/18/07       (S)       READ THE FIRST TIME - REFERRALS                                                                        
10/18/07       (S)       RES, JUD, FIN                                                                                          
10/19/07       (S)       RES AT 9:00 AM BUTROVICH 205                                                                           
10/19/07       (S)       Heard & Held                                                                                           
10/19/07       (S)       MINUTE(RES)                                                                                            
10/20/07       (S)       RES AT 8:00 AM BUTROVICH 205                                                                           
10/20/07       (S)       Heard & Held                                                                                           
10/20/07       (S)       MINUTE(RES)                                                                                            
10/21/07       (S)       RES AT 1:00 PM HOUSE FINANCE 519                                                                       
10/21/07       (S)       Heard & Held                                                                                           
10/21/07       (S)       MINUTE(RES)                                                                                            
10/22/07       (S)       RES AT 11:30 AM BUTROVICH 205                                                                          
10/22/07       (S)       Heard & Held                                                                                           
10/22/07       (S)       MINUTE(RES)                                                                                            
10/23/07       (S)       RES AT 9:00 AM BUTROVICH 205                                                                           
10/23/07       (S)       Heard & Held                                                                                           
10/23/07       (S)       MINUTE(RES)                                                                                            
10/24/07       (S)       RES AT 10:00 AM BUTROVICH 205                                                                          
10/24/07       (S)       Heard & Held                                                                                           
10/24/07       (S)       MINUTE(RES)                                                                                            
10/25/07       (S)       RES AT 10:00 AM BUTROVICH 205                                                                          
10/25/07       (S)       Heard & Held                                                                                           
10/25/07       (S)       MINUTE(RES)                                                                                            
10/26/07       (S)       RES AT 1:30 PM BUTROVICH 205                                                                           
10/26/07       (S)       Heard & Held                                                                                           
10/26/07       (S)       MINUTE(RES)                                                                                            
10/27/07       (S)       RES AT 9:00 AM BUTROVICH 205                                                                           
10/27/07       (S)       Moved CSSB2001(RES) Out of Committee                                                                   
10/27/07       (S)       MINUTE(RES)                                                                                            
10/28/07       (S)       RES AT 0:00 AM BUTROVICH 205                                                                           
10/28/07       (S)       -- MEETING CANCELED --                                                                                 
10/29/07       (S)       RES RPT CS  1NR 6AM   NEW TITLE                                                                        
10/29/07       (S)       NR: GREEN                                                                                              
10/29/07       (S)       AM: HUGGINS, MCGUIRE, STEVENS, STEDMAN,                                                                
                         WIELECHOWSKI, WAGONER                                                                                  
10/29/07       (S)       JUD AT 9:30 AM BUTROVICH 205                                                                           
10/29/07       (S)       Heard & Held                                                                                           
10/29/07       (S)       MINUTE(JUD)                                                                                            
10/30/07       (S)       JUD AT 9:00 AM BUTROVICH 205                                                                           
10/30/07       (S)       Heard & Held                                                                                           
10/30/07       (S)       MINUTE(JUD)                                                                                            
10/31/07       (S)       JUD AT 9:00 AM BUTROVICH 205                                                                           
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
PATRICK GALVIN, Commissioner                                                                                                    
Department of Revenue                                                                                                           
PO Box 110400                                                                                                                   
Juneau, AK  99811-0400                                                                                                          
POSITION STATEMENT:  Gave a  presentation on gross-based and net-                                                             
based production tax systems during hearing on SB 2001.                                                                         
                                                                                                                                
RICH RUGGIERO                                                                                                                   
Gaffney, Cline & Associates Inc.                                                                                                
POSITION STATEMENT:   Gave presentation  on SB 2001  and answered                                                             
questions.                                                                                                                      
                                                                                                                                
BOB GEORGE                                                                                                                      
Gaffney, Cline & Associates Inc.                                                                                                
POSITION STATEMENT:   Gave presentation  on SB 2001  and answered                                                             
questions.                                                                                                                      
                                                                                                                                
STEVE PORTER, Consultant                                                                                                        
to the Legislative Budget & Audit Committee                                                                                     
POSITION  STATEMENT:    Answered   questions  during  hearing  on                                                             
SB 2001.                                                                                                                        
                                                                                                                                
DAN DICKINSON, Consultant                                                                                                       
to the Legislative Budget & Audit Committee                                                                                     
POSITION  STATEMENT:    Answered   questions  during  hearing  on                                                             
SB 2001.                                                                                                                        
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
CHAIR  HOLLIS   FRENCH  called  the  Senate   Judiciary  Standing                                                             
Committee meeting  to order at 9:09:07  AM.  Present at  the call                                                             
to  order  were Senators  Charlie  Huggins,  Lesil McGuire,  Bill                                                               
Wielechowski,  Gene  Therriault,  and  Chair  French.    Also  in                                                               
attendance were  Senators Gary Stevens,  Johnny Ellis,  and Lyman                                                               
Hoffman, and Representatives Andrea Doll and Les Gara.                                                                          
                                                                                                                                
                SB 2001-OIL & GAS TAX AMENDMENTS                                                                            
                                                                                                                                
9:09:19 AM                                                                                                                    
                                                                                                                                
CHAIR FRENCH announced  the consideration of SB 2001.   Today the                                                               
administration   would  present   the  evidence   that  convinced                                                               
Governor Palin to  use a net-based system in  the proposal called                                                               
Alaska's  Clear  and  Equitable   Share  (ACES).    Chair  French                                                               
acknowledged his skepticism to date about using a net approach.                                                                 
                                                                                                                                
CHAIR FRENCH welcomed Senator Stevens.                                                                                          
                                                                                                                                
9:10:03 AM                                                                                                                    
^Patrick Galvin, Commissioner, Department of Revenue                                                                            
PATRICK GALVIN,  Commissioner, Department of Revenue  (DOR), gave                                                               
a PowerPoint  slide presentation  comparing gross-based  and net-                                                               
based production  tax systems; a  hardcopy version  was provided.                                                               
Showing showed  slide 3,  the pros and  cons, he  emphasized that                                                               
gross  versus  net is  a  spectrum.    Many variations  had  been                                                               
considered.                                                                                                                     
                                                                                                                                
COMMISSIONER GALVIN told members a  gross tax has transparency as                                                               
its  primary advantage.   This  is  the ease  of calculating  and                                                               
understanding  the tax  paid  to the  state,  whether a  straight                                                               
percentage  or some  variation.   Avoiding  the consideration  of                                                               
costs  minimizes  or  eliminates  the sense  of  an  auditing  or                                                               
litigation  burden, as  well as  the  risk that  the state  won't                                                               
receive  what  has been  expected.    Projections under  a  gross                                                               
system are linked to two variables:   price and production.  When                                                               
cost is added in, however,  there is an additional possibility of                                                               
erroneous forecasts.                                                                                                            
                                                                                                                                
9:14:20 AM                                                                                                                    
CHAIR  FRENCH requested  confirmation that  Alaska's royalty  for                                                               
oil is the  most purely gross-based tax, being  12 percent of the                                                               
Alaska North Slope (ANS) oil produced.                                                                                          
                                                                                                                                
COMMISSIONER GALVIN  replied it is  the grossest Alaska  has, but                                                               
it isn't a purely  gross-based calculation because transportation                                                               
costs are  deducted.  What  costs are appropriate to  include are                                                               
arrived at through extensive negotiation and litigation.                                                                        
                                                                                                                                
CHAIR FRENCH  suggested this carries  a warning, since  even with                                                               
the  simplest tax  system  there can  be  enormously complex  and                                                               
long-running  arguments and  litigation over  a single  variable,                                                               
the transportation costs.                                                                                                       
                                                                                                                                
COMMISSIONER  GALVIN  agreed,  noting   there  would  be  further                                                               
discussion  of the  auditing responsibility  and how  it compares                                                               
with what is anticipated under a net-based tax.                                                                                 
                                                                                                                                
SENATOR  THERRIAULT requested  a  chart showing  what portion  is                                                               
allocated to each component, including  royalty and property tax,                                                               
which are more gross-based.   Mentioning his e-mails from people,                                                               
he surmised  most Alaskans don't  understand the oil and  gas tax                                                               
system and  its royalty, property  tax, and corporate  income tax                                                               
components;   rather,  they   believe  the   entire  system   for                                                               
governmental take is being debated here.                                                                                        
                                                                                                                                
9:17:33 AM                                                                                                                    
COMMISSIONER  GALVIN agreed  to provide  an existing  chart after                                                               
his staff brought over an  electronic version.  He emphasized the                                                               
importance of limiting the discussion  to the production tax when                                                               
discussing net versus  gross.  Other revenue  sources coming from                                                               
the oil industry are calculated using different methods.                                                                        
                                                                                                                                
COMMISSIONER GALVIN  returned to slide  3.   He said for  a gross                                                               
tax,  positive  aspects  center on  certainty  and  transparency.                                                               
Negative aspects relate to flexibility  and whether it will match                                                               
the intended economic impact.   He highlighted the variety of ANS                                                               
fields  dealt with  nowadays,  as well  as  what is  anticipated.                                                               
Right now,  70 percent of  oil revenue  comes from the  two major                                                               
ANS fields, which  have an economic framework  related to upfront                                                               
costs paid  years ago.   Despite low operating expenses  now, new                                                               
money must  be invested to keep  their production levels up.   In                                                               
addition,  longstanding smaller  fields surround  those and  have                                                               
different economic  drivers, cost  structures, and  challenges in                                                               
maximizing future production.  And  prospects being evaluated and                                                               
explored  for  new  investment  and  development  have  different                                                               
economic drivers and hurdles as well.                                                                                           
                                                                                                                                
COMMISSIONER  GALVIN explained  that  when setting  a tax  policy                                                               
across  such a  wide range,  one  must understand  its impact  on                                                               
different fields and investment decisions.   A gross tax requires                                                               
setting certain assumptions about  expected margins, price versus                                                               
cost.   The tax is  "one size  fits all" but  anticipates impacts                                                               
based  upon the  assumptions.   It  won't  allow identifying  the                                                               
economics of a  particular field and applying  a tailor-made tax,                                                               
because  there is  too much  change and  there are  too many  new                                                               
fields; the  tax would have  to be  revisited every year  or two,                                                               
which isn't  good for  the state  or the industry.   With  a one-                                                               
size-fits-all tax, erring on one  side may stifle investment, but                                                               
erring  on  the  other  side  may  bring  in  less  revenue  than                                                               
otherwise  fairly expected,  given the  economic opportunity  for                                                               
the company.  It must be decided where to draw the line.                                                                        
                                                                                                                                
9:22:40 AM                                                                                                                    
COMMISSIONER GALVIN  turned to the  net-based tax, noting  it has                                                               
the flip  side of  the aforementioned  pros and  cons.   There is                                                               
flexibility with respect to economics, and  it is easier to set a                                                               
number that brings  in revenue and yet  doesn't negatively impact                                                               
the investment climate.  However, it  has more moving parts and a                                                               
greater burden on the state to  audit and challenge the claims of                                                               
the companies, along with the uncertainty this provides.                                                                        
                                                                                                                                
COMMISSIONER GALVIN  highlighted the  balance between  these two.                                                               
He  explained  that  the  biggest  challenge  in  the  evaluation                                                               
process  was   to  weigh  not-easy-to-quantify   aspects  against                                                               
clearly  demonstrated   economic  impacts.    Showing   slide  4,                                                               
"Balancing Act,"  he noted the remaining  slides demonstrate this                                                               
variety of balancing.                                                                                                           
                                                                                                                                
COMMISSIONER GALVIN  said the first balancing  is between revenue                                                               
and investment climate.   The second is  between transparency and                                                               
flexibility; for the North Slope  in particular, this is weighing                                                               
the impact on incumbents who  have existing fields and economics,                                                               
as  well as  on potential  new entrants  who must  undertake more                                                               
risky   ventures   in   more  economically   challenged   fields.                                                               
Furthermore,  if a  single line  is drawn  across the  fields, it                                                               
must be  ensured that  the expected state  revenue comes  in from                                                               
legacy fields,  the highly profitable "bread  and butter" fields,                                                               
while ensuring that  the rate doesn't swamp the  economics of the                                                               
marginal fields.                                                                                                                
                                                                                                                                
CHAIR FRENCH asked which fields are defined as legacy fields.                                                                   
                                                                                                                                
COMMISSIONER GALVIN  answered that he puts  "legacy" in quotation                                                               
marks because the  line can be drawn in different  ways.  For the                                                               
purpose  of  the gross-tax  floor,  DOR's  definition relates  to                                                               
economic standing,  now and  historically.   This is  Prudhoe Bay                                                               
and Kuparuk, with  20 to 30 years of  clear, longstanding ability                                                               
to produce  oil and thus  money.   The sense of  mature incumbent                                                               
fields  can be  expanded, though,  to include  fields like  Milne                                                               
Point, Duck  Island, and various  smaller ones such  as Northstar                                                               
and Alpine.   In response  to Chair  French, he said  Duck Island                                                               
and Endicott are different names for the same thing.                                                                            
                                                                                                                                
COMMISSIONER GALVIN pointed out  that although Alpine is probably                                                               
one  of the  most profitable  fields on  the North  Slope, it  is                                                               
predicted to decline fairly rapidly,  after recently reaching its                                                               
peak production  in its  seventh year.   Considering it  a legacy                                                               
field in  the same context  as Prudhoe  Bay and Kuparuk  - fields                                                               
with 20  to 30  years of  production far  above Alpine's  - isn't                                                               
comparing apples to apples.                                                                                                     
                                                                                                                                
CHAIR  FRENCH  asked whether  it  is  fair  to  say there  is  no                                                               
standard definition of legacy field.                                                                                            
                                                                                                                                
COMMISSIONER GALVIN affirmed that.                                                                                              
                                                                                                                                
CHAIR FRENCH asked what guides DOR in making the call.                                                                          
                                                                                                                                
COMMISSIONER GALVIN answered that DOR  must decide the purpose in                                                               
making the distinction.  If the  purpose is to indicate the field                                                               
has paid  off all  of its initial  investment, for  instance, the                                                               
primary consideration likely  will be the length of  time and the                                                               
relationship  between production  and associated  costs; in  that                                                               
context,  a  number  of  fields  have seen  10  to  15  years  of                                                               
production in the legacy field category.                                                                                        
                                                                                                                                
COMMISSIONER GALVIN noted that if looked  at in terms of having a                                                               
large  margin and  a tremendous  amount  of production,  however,                                                               
that narrows  it significantly  - as  done under  ACES -  to just                                                               
those two  larger fields.   Those are wholly distinct  from other                                                               
fields  in  terms   of  volume  as  well  as   current  level  of                                                               
production.  If DOR looks  strictly at profitability, a different                                                               
view  is taken,  and some  older fields  that have  paid off  but                                                               
aren't making much money now would be eliminated.                                                                               
                                                                                                                                
9:29:56 AM                                                                                                                    
COMMISSIONER GALVIN, in  response to Chair French,  said for Cook                                                               
Inlet  there is  a  sense  of longevity  but  not  margin.   With                                                               
respect to  production profiles and  costs, soon a point  will be                                                               
reached where  expectations of profit  and costs will  cross over                                                               
and companies  will need to  decide at  what point to  shut these                                                               
down.   Some fields  have shut down  in the last  few years.   It                                                               
isn't just the  level of production, length of  time, or historic                                                               
volumes.    Rather, current  margins  need  to  be looked  at  in                                                               
conjunction with  these other factors  to determine  which fields                                                               
can  withstand  categorizations,  for example,  with  respect  to                                                               
having higher taxes on certain types of fields.                                                                                 
                                                                                                                                
CHAIR  FRENCH welcomed  Representative  Doll,  noting she'd  been                                                               
present for some time.                                                                                                          
                                                                                                                                
9:31:15 AM                                                                                                                    
COMMISSIONER GALVIN turned to slide  5, which lists three factors                                                               
when evaluating gross  versus net:  "Audit Risk,"  Revenue to the                                                               
State,  and Investment  Climate.   He  explained  that he'd  used                                                               
quotation  marks for  audit risk  because it  encompasses a  wide                                                               
range  of  perceived  risk  associated  with a  net  tax.    This                                                               
includes  the  perception that  taxpayers  will  be motivated  to                                                               
either 1) incur costs they'd not  otherwise incur, simply because                                                               
of the tax deduction; 2) shift  costs that they'd otherwise incur                                                               
but  that aren't  directly  attributable  to Alaskan  production,                                                               
categorizing it as Alaskan production  to get a tax write-off; or                                                               
3) blatantly misrepresent their costs.                                                                                          
                                                                                                                                
COMMISSIONER GALVIN  said audit  risk also entails  the perceived                                                               
cost associated  with having to audit,  administer, litigate, and                                                               
ultimately  defend what  the state  believes  is the  appropriate                                                               
payment under  a tax system  that could result in  differences of                                                               
opinion as to whether a deduction  is allowed.  Also within audit                                                               
risk is  the sense of  public confidence  when there is  a direct                                                               
line between  price and production and  the tax bill.   If inputs                                                               
eventually result  in something  less than  what is  perceived as                                                               
the  normal   calculation,  by  contrast,  the   public  is  left                                                               
wondering how it happened.                                                                                                      
                                                                                                                                
COMMISSIONER GALVIN  addressed the second factor,  revenue to the                                                               
state.  He  highlighted ensuring the revenue  matches the state's                                                               
expectation  and  also  is  a reliable  source,  not  subject  to                                                               
factors outside its  control or expectations.   The third factor,                                                               
investment  climate, relates  to how  the tax  affects companies'                                                               
economic  decisions as  well as  the state's  recognized goal  of                                                               
attracting  new investment,  both within  existing fields  and in                                                               
new fields that there is a desire to see developed.                                                                             
                                                                                                                                
9:34:00 AM                                                                                                                    
COMMISSIONER GALVIN turned to slide  6, "Audit Risk," a bar graph                                                               
showing  relative  risk,  moving  through the  spectrum  of  pure                                                               
gross, gross and exploration credits,  gross and capital credits,                                                               
PPT - net  and capital credits, and  pure net.  He  said there is                                                               
additional  audit risk  as one  includes  items like  exploration                                                               
credits  for  new  projects.   There  must  be  cost  accounting,                                                               
relying on companies' reporting  and checking to ensure accuracy.                                                               
But exploration credits are for  new projects that lack operating                                                               
expenditures  and  so  forth; DOR  must  isolate  components  and                                                               
approve expenditures  if they're  associated with  the particular                                                               
project.                                                                                                                        
                                                                                                                                
COMMISSIONER GALVIN  said a gross-based tax  with capital credits                                                               
provides additional complexity and  perceived audit risk; capital                                                               
credits  are commingled  with  operating  expenditures and  other                                                               
costs,  and  the audit  must  ensure  these  are kept  apart  and                                                               
properly characterized.   When  operating expenditures  are added                                                               
as a deduction, there is even further risk and complexity.                                                                      
                                                                                                                                
COMMISSIONER  GALVIN pointed  out for  PPT -  the current  system                                                               
called the  petroleum production tax  or petroleum profits  tax -                                                               
there  is  extra  value  for  capital  expenditures.    Thus  the                                                               
distinction  of  whether something  is  an  operating or  capital                                                               
expense  has value.   The  complexity is  higher than  either the                                                               
previous category or a pure net  system under which all costs are                                                               
deductible and treated the same.   The purpose of the slide is to                                                               
show that once  one accepts the economic need  to include capital                                                               
credit  deductions,  one  also accepts  a  tremendous  amount  of                                                               
perceived  audit  risk.     They  are  fairly   equivalent.    He                                                               
emphasized the importance of this in the rest of the balancing.                                                                 
                                                                                                                                
9:37:41 AM                                                                                                                    
CHAIR FRENCH gave  his understanding that the  basic structure of                                                               
PPT, enacted a year ago, is kept intact by ACES.                                                                                
                                                                                                                                
COMMISSIONER GALVIN affirmed that.                                                                                              
                                                                                                                                
CHAIR FRENCH observed that of  the tax systems presented, this is                                                               
the most complex to audit.                                                                                                      
                                                                                                                                
COMMISSIONER GALVIN concurred.                                                                                                  
                                                                                                                                
CHAIR  FRENCH   asked  about  DOR's  auditors,   including  their                                                               
strengths, weaknesses, and numbers.                                                                                             
                                                                                                                                
COMMISSIONER GALVIN indicated the auditors  are a subject of this                                                               
current legislation.   He said  DOR has  a group of  auditors who                                                               
are highly qualified  and whose primary experience  has been with                                                               
past state audits.                                                                                                              
                                                                                                                                
CHAIR  FRENCH surmised  that  was under  the  old economic  limit                                                               
factor (ELF) system.                                                                                                            
                                                                                                                                
COMMISSIONER  GALVIN affirmed  that,  noting the  ELF system  was                                                               
based upon  the deduction for  transportation costs.   Thus there                                                               
is  experience with  transportation-cost elements,  not just  the                                                               
pipeline  tariffs,   but  also  primarily  the   shipping  costs,                                                               
determining  the proper  costs to  deduct with  respect to  self-                                                               
owned tankers  as they're  repurchased, refurbished,  rented, and                                                               
so forth.   That is primarily the auditing experience  of the oil                                                               
and gas  auditors.   Within the  last year,  there have  been new                                                               
hires following  a nationwide recruitment effort.   Targeted were                                                               
highly  experienced  oil  and  gas  auditors,  the  "lieutenants"                                                               
within their  companies' accounting departments who  knew how the                                                               
systems worked, understood reasons  and motivations, and had more                                                               
than day-to-day experience with what came across their desks.                                                                   
                                                                                                                                
9:40:51 AM                                                                                                                    
CHAIR FRENCH asked how many auditors were sought.                                                                               
                                                                                                                                
COMMISSIONER GALVIN estimated eight to  ten new auditors within a                                                               
range of experience,  from an Auditor III through  and Auditor IV                                                               
and bringing in some lower-end  Auditor Techs.  There are perhaps                                                               
eight to ten existing auditors.                                                                                                 
                                                                                                                                
CHAIR FRENCH noted this doubles the number of auditors.                                                                         
                                                                                                                                
COMMISSIONER GALVIN affirmed that.                                                                                              
                                                                                                                                
CHAIR FRENCH asked how many applications were received.                                                                         
                                                                                                                                
COMMISSIONER GALVIN said he didn't  have that with him, but could                                                               
provide  a report  on the  recruitment experience.   In  summary,                                                               
though, the  department didn't get  applications from  the upper-                                                               
echelon auditors it sought who  could create the system under the                                                               
new  tax, train  others,  and provide  leadership to  efficiently                                                               
direct  the audits.   Within  the auditing  world, as  elsewhere,                                                               
there  is the  opportunity to  get  sidetracked and  not get  the                                                               
biggest bang  for the buck.   Thus he  is looking for  folks with                                                               
the experience and  judgment to direct those  efforts and achieve                                                               
efficiency.   The  state won't  be  able to  match the  companies                                                               
auditor for  auditor or dollar for  dollar.  So it  must maximize                                                               
the return on its auditing investment.                                                                                          
                                                                                                                                
9:42:25 AM                                                                                                                    
CHAIR FRENCH  asked whether the  state has finished  auditing all                                                               
ELF-based tax returns.                                                                                                          
                                                                                                                                
COMMISSIONER GALVIN  replied there  still are  a couple  of years                                                               
left.  One was  for 2003, and there are a few  for 2004 and 2005.                                                               
Then it gets  into PPT-based returns.  The PPT  auditing cycle is                                                               
in the phase where the companies  have reported back to the state                                                               
as to  what they've  worked out between  the various  partners in                                                               
preparation for their  federal tax returns for  the last calendar                                                               
year.   With that information,  the state  can begin to  dig into                                                               
the  returns and  reports, and  then can  formulate its  auditing                                                               
strategy and communication with the companies.                                                                                  
                                                                                                                                
COMMISSIONER  GALVIN   added  that  there  have   been  continual                                                               
discussions with  the companies  in order to  acquire information                                                               
needed to  better understand  how the system  is working,  and to                                                               
get a  jumpstart on  understanding the  nature of  the deductions                                                               
and so forth.  That is  somewhat a parallel track to the official                                                               
audit.   The state is just  now reaching the point  of having all                                                               
the information it  can get to begin the process,  and is looking                                                               
at  a  two-year  process,  at  minimum, to  go  through  the  PPT                                                               
auditing.   Then, if  there are continuing  disputes, it  will go                                                               
through the administrative appeal process.                                                                                      
                                                                                                                                
9:45:56 AM                                                                                                                    
SENATOR McGUIRE  recalled that promises  were made in  2006 about                                                               
the ability to recruit and retain,  but the state isn't that much                                                               
closer to  its goal.   She  asked whether  this is  an achievable                                                               
goal and whether such professionals  will want to leave positions                                                               
with  private companies  to  work for  the state.    If not,  she                                                               
suggested it  is perhaps  a question of  looking at  the possible                                                               
and not the perfect for now.                                                                                                    
                                                                                                                                
COMMISSIONER GALVIN  agreed, but  said a year  ago, when  PPT was                                                               
being discussed  and the  state was looking  at moving  into this                                                               
whole new  venture, he believes  the context was different.   The                                                               
previous administration had an  overlapping relationship with the                                                               
producers through negotiation  of the gas line contract.   It was                                                               
expected that PPT  would be part of the contract,  there would be                                                               
an arbitration process  rather than involving the  courts, and it                                                               
would be  more of  a partnership.   He  opined that  the previous                                                               
administration  undersold the  expectation  with  respect to  the                                                               
department in terms of taking on this responsibility.                                                                           
                                                                                                                                
COMMISSIONER  GALVIN indicated  he and  Governor Palin  initially                                                               
were  skeptical  of  this  tax system,  the  state's  ability  to                                                               
implement it, and  whether it would ultimately be  in the state's                                                               
interest.    They'd  made  obtaining  the  auditors  a  priority.                                                               
They'd tried to  identify whether the intangibles  of working for                                                               
the  state  in  public  service would  suffice  to  overcome  the                                                               
significant  gap between  what  the state  could  offer and  what                                                               
could  be obtained  in  the  private sector.    They'd found  the                                                               
answer to be no.  And so they'd tried to shrink the gap.                                                                        
                                                                                                                                
COMMISSIONER GALVIN  addressed whether a handful  of new auditors                                                               
can  fill this  need.   Reflecting  on his  work  for the  state,                                                               
particularly on the oil and gas  side, he observed that a handful                                                               
of highly capable,  creative, dedicated state employees  can do a                                                               
whole  lot.   They  can  use the  existing  system to  accomplish                                                               
things  that would  be much  more  difficult if  there were  more                                                               
people, and they  can overcome many of these hurdles.   He opined                                                               
that if  these lieutenants can  be brought in who  understand the                                                               
picture from both sides, they  can meet that responsibility, even                                                               
with a small group of auditors.   But first he needs to find them                                                               
and get the  right tools.  Citing the value  this will create for                                                               
the state, he  emphasized accepting the burden that  comes with a                                                               
net-based system.   Unless the  department can hire  these folks,                                                               
the system won't work.                                                                                                          
                                                                                                                                
9:53:52 AM                                                                                                                    
SENATOR  WIELECHOWSKI noted  there  has been  one deduction,  the                                                               
tariffs, with costly and time-consuming  litigation on that issue                                                               
for more  than a  decade.  Now  there will be  a new  system with                                                               
perhaps hundreds  of deductions.   He expressed concern  based on                                                               
that past experience.                                                                                                           
                                                                                                                                
COMMISSIONER GALVIN  replied by  showing slide 7,  "'Audit Risk,'                                                               
How Do You  Measure It?"  He  said one way to  measure audit risk                                                               
is  to look  at  Alaska's  experience, primarily  royalty-related                                                               
auditing and  calculations of the  appropriate value to  place on                                                               
oil that is sold, as well  as the transportation deductions.  The                                                               
question  becomes  whether   the  decades-long  arbitrations  and                                                               
litigation   over  royalty   disputes  will   be  replicated   or                                                               
multiplied  when  dealing  with  a  complex  net-based  tax.  The                                                               
administration's analysis has indicated the answer is no.                                                                       
                                                                                                                                
COMMISSIONER  GALVIN explained  that a  royalty dispute  is based                                                               
upon contract  law and two  parties interpreting a  contract that                                                               
they've  mutually agreed  to.   The stakes  increase as  it moves                                                               
through  the  process,  resulting  in  endless  litigation.    By                                                               
contrast,   tax  law   is  imposed   by  the   sovereign  entity,                                                               
interpreted by that entity, and  ultimately decided by the courts                                                               
as to whether the agency has properly exercised its discretion.                                                                 
                                                                                                                                
9:57:44 AM                                                                                                                    
CHAIR FRENCH  noted Marcia Davis, DOR  deputy commissioner, would                                                               
speak tomorrow  about the differences in  the litigation outcomes                                                               
for   contrast  disputes   versus  more   sovereign-oriented  tax                                                               
disputes.  Saying  royalty strikes him as the  most sovereign and                                                               
powerful tax  on the oil field,  he asked:  Why  were those long-                                                               
running disputes  not more like  a tax,  where the state  has the                                                               
power and the advantages?                                                                                                       
                                                                                                                                
COMMISSIONER  GALVIN  answered  that  within the  system  it  was                                                               
decided  that  royalty  would  be  established  through  a  lease                                                               
offered in a  competitive sale.  The parties  that accepted those                                                               
entered into  a contract with  the state over development  of the                                                               
resource.   Through  that mechanism,  the state  shared the  risk                                                               
associated  with  the  initial investment  and,  ultimately,  who                                                               
would get the reward if there was success.                                                                                      
                                                                                                                                
CHAIR  FRENCH surmised  the tax  terms aren't  set by  the lease.                                                               
The legislature is currently trying to change those terms.                                                                      
                                                                                                                                
COMMISSIONER GALVIN concurred.   He said royalty income primarily                                                               
relates to  leases from the  initial wave  of leases in  the late                                                               
1960s and  early 1970s.  There  was a line about  how the royalty                                                               
would be calculated,  and that sentence was the seed  for all the                                                               
litigation  that  followed.   It  didn't  itemize what  would  be                                                               
deductible, and it  didn't talk about what was in  or out, or how                                                               
to calculate  the value.   Rather, it  stated what  percentage of                                                               
wellhead value  would be paid.   The contract dispute  arose over                                                               
how to calculate that.                                                                                                          
                                                                                                                                
10:00:12 AM                                                                                                                   
COMMISSIONER  GALVIN  continued,  saying taxes  are  a  different                                                               
world.   Spencer Hosie, a  San Francisco attorney that  the state                                                               
often uses  in disputes, had been  asked to provide his  sense of                                                               
the prospect  for prolonged tax disputes,  particularly given his                                                               
experience as  a litigator  in the  royalty disputes.   Mr. Hosie                                                               
had provided a short memo  that the administration distributed to                                                               
legislators.   It gave  his view  that tax  is not  royalty; when                                                               
looking at  a tax dispute,  the agency  has authority to  set the                                                               
timeframe for the administrative  appeal and to demand production                                                               
of  required   information.    Mr. Hosie  had   opined  that  the                                                               
timeframe to resolve a dispute would be about two years.                                                                        
                                                                                                                                
SENATOR  HUGGINS observed  that some,  including Governor  Palin,                                                               
Commissioner Irwin, and Commissioner  Galvin, no longer believe a                                                               
gross-based  tax is  the answer;  however,  some haven't  changed                                                               
their  minds.   Highlighting the  proposed extension  of auditing                                                               
time from  three years to  six years, he  asked:  Is  hiring more                                                               
auditors with the appropriate  credentials an alternative, rather                                                               
than doubling the current auditing timeframe?                                                                                   
                                                                                                                                
10:03:16 AM                                                                                                                   
COMMISSIONER GALVIN  replied the recommendation to  go from three                                                               
years to six was  as much a product of the  way the audit process                                                               
revolves around the clarification  of information outside the PPT                                                               
system.   This  includes  the timeframe  for  federal income  tax                                                               
discussions  and potential  disputes  among  partners to  resolve                                                               
themselves.   No matter  how many PPT  auditors there  are, those                                                               
have their own timelines.                                                                                                       
                                                                                                                                
COMMISSIONER GALVIN assured members  that the department won't be                                                               
deadline-driven  in  structuring  audits.    The  state  and  the                                                               
industry will  want to  settle issues  and move  on.   The change                                                               
from three  years to six  clearly is  a jump; it  recognizes this                                                               
area that the  state cannot control, and it provides  time to get                                                               
the work done.   While six years isn't  mandatory, he highlighted                                                               
wanting to avoid  the negative implications of  having a statute-                                                               
of-limitations deadline show up while  the state is still working                                                               
on an  audit.  Providing  enough time  is beneficial.   But would                                                               
four years be acceptable?  He said it is a judgment call.                                                                       
                                                                                                                                
10:05:52 AM                                                                                                                   
SENATOR  HUGGINS recalled  hearing that  the agreement  to extend                                                               
the  process was  relatively easy  to come  by and  was a  common                                                               
practice;  producers wouldn't  want to  fight a  mutual extension                                                               
because the state has the judgment  power within its toolbox.  He                                                               
requested clarification about this.                                                                                             
                                                                                                                                
COMMISSIONER  GALVIN noted  Jonathan Iversen,  director of  DOR's                                                               
Tax Division,  had testified  about differences  among taxpayers.                                                               
Most view  it as mutually beneficial  to work on an  extension so                                                               
the issue  doesn't have to  be brought to  a head before  the two                                                               
parties are in  a position to resolve it;  usually some extension                                                               
will be  worked out.   However, some  taxpayers won't  agree, and                                                               
then the state must decide how much  is at stake and then move to                                                               
a  formal dispute  resolution.   The balance  here is  strictly a                                                               
matter of  whether that  is an appropriate  situation to  put the                                                               
state  in or  whether time  should  be allowed  to resolve  those                                                               
issues, recognizing the state will be diligent in its efforts.                                                                  
                                                                                                                                
10:08:14 AM                                                                                                                   
SENATOR   THERRIAULT   remarked   that,  based   on   yesterday's                                                               
discussion  and  the impact  of  the  transportation expense,  he                                                               
believes part of what has been  suffered for the past 20 years is                                                               
a bad agreement that the state  got into with respect to tariffs.                                                               
Indicating it isn't over yet, he said it was a bad deal.                                                                        
                                                                                                                                
SENATOR WIELECHOWSKI  asked whether  DOR has an  assumption about                                                               
litigation costs under a net system versus a gross system.                                                                      
                                                                                                                                
COMMISSIONER  GALVIN  answered no,  primarily  because  it is  so                                                               
early in  the process.   Furthermore, some  of the  lawyers don't                                                               
necessarily see it as adding  a significantly greater burden.  He                                                               
surmised the Department  of Law (DOL) would  need some experience                                                               
with  it  before  determining  whether  it  would  result  in  an                                                               
additional burden for that department.                                                                                          
                                                                                                                                
SENATOR  WIELECHOWSKI asked  how  the standard  of "ordinary  and                                                               
necessary"  will  be  determined   across  the  entire  range  of                                                               
possible  expenses  for  all  types  of  companies,  fields,  and                                                               
technologies.                                                                                                                   
                                                                                                                                
COMMISSIONER GALVIN  replied that's a  good question.  It  is one                                                               
reason  the   language  that   allows  the   department,  through                                                               
regulation,  to  define  what  is  an  allowable  expense  is  so                                                               
valuable  for  the state,  providing  a  tool  to have  a  public                                                               
process to  identify those cuts.   When  looking at the  types of                                                               
deductions appropriate for  companies to take as  an ordinary and                                                               
necessary  expense of  production,  DOR believes  this should  be                                                               
done  through   the  regulatory   process,  rather  than   on  an                                                               
individual taxpayer basis through dispute resolution.                                                                           
                                                                                                                                
10:11:15 AM                                                                                                                   
SENATOR McGUIRE remarked this is  another area about which people                                                               
are skeptical.   Commissioners  change over time.   And  it isn't                                                               
known  who the  future regulation  writers will  be; they  aren't                                                               
held  up  for  reelection  or subject  to  public  scrutiny  like                                                               
legislators are.   She requested  assurance that  the regulation-                                                               
writing authority would be subject to checks and balances.                                                                      
                                                                                                                                
COMMISSIONER  GALVIN  responded  that  one  choice  is  that  the                                                               
statute lays out  a fairly broad definition of  what is allowable                                                               
and has the department make  that determination tax return by tax                                                               
return.   The proposed alternative  is that those  are determined                                                               
through  regulations.   While it  is perceived  as a  granting of                                                               
authority to the department when  compared with the first option,                                                               
he believes it is the opposite.                                                                                                 
                                                                                                                                
COMMISSIONER GALVIN explained that if  all the decisions occur in                                                               
the  context   of  a   confidential  determination   between  the                                                               
department  and a  taxpayer, that  grants much  greater authority                                                               
and discretion to the commissioner  than if that same distinction                                                               
is made  in a public  process and then written  into regulations,                                                               
which the legislature  will have every opportunity  to review and                                                               
force  changes  about.   That  ability  is  taken away  from  the                                                               
legislature if the decisions are made at a tax-return level.                                                                    
                                                                                                                                
SENATOR  McGUIRE  agreed  the proposal  is  an  improvement,  but                                                               
clarified that she'd like lease  expenditures and operating costs                                                               
that can  be written off to  be put into statute.   She expressed                                                               
concern about  wiggle room, saying she  recognizes the difficulty                                                               
but  wants  to  be  able   to  tell  people,  years  later,  that                                                               
legislators  were  aware  of  the   trade-off  and  felt  it  was                                                               
important.                                                                                                                      
                                                                                                                                
COMMISSIONER  GALVIN  suggested in  a  perfect  world that  could                                                               
happen.   But the department will  put in what is  allowable as a                                                               
sort  of proxy  for  the legislature,  going  through the  public                                                               
process  and  evaluation.   The  legislature  then will  have  an                                                               
opportunity to revisit  it within a year or two,  as an extension                                                               
of this process.                                                                                                                
                                                                                                                                
10:16:43 AM                                                                                                                   
SENATOR THERRIAULT  recalled past concern  that power given  to a                                                               
commissioner may  someday pass  to a madman  who would  run amok.                                                               
He  pointed out  that legislation  passed a  couple of  years ago                                                               
requires that  the legislature's legal department  receive a copy                                                               
of proposed regulations earlier in the  process so it can raise a                                                               
red  flag   for  policymakers   if  something   seems  off-track.                                                               
Furthermore,  regulations can  be enshrined  in statute  once the                                                               
proper balance seems  to have been struck.   While the department                                                               
might  believe it  would  strip flexibility  needed  to keep  the                                                               
regulations workable  over a long  period of  time, it is  a step                                                               
the legislature can take.                                                                                                       
                                                                                                                                
AN UNIDENTIFIED SPEAKER said that was a good point.                                                                             
                                                                                                                                
10:18:08 AM                                                                                                                   
CHAIR FRENCH  referred to  earlier remarks  about the  backlog of                                                               
audits under the ELF system.   He asked whether one or two audits                                                               
remained from 2003.                                                                                                             
                                                                                                                                
COMMISSIONER GALVIN replied he believed there was one.                                                                          
                                                                                                                                
CHAIR FRENCH  said that gives  some guidance  as to how  long the                                                               
statute  of limitations  needs to  be,  given it  is nearly  five                                                               
years  later  and that  was  a  simpler  form  of taxation.    He                                                               
requested an estimate of the time to complete a PPT audit.                                                                      
                                                                                                                                
COMMISSIONER GALVIN relayed  what his staff had  told him, saying                                                               
there is probably  a two-year process from this  point forward to                                                               
establish  the administrative  record  of the  audit.   If  there                                                               
continues  to be  a dispute,  the  administrative appeal  process                                                               
begins.  First  there is an informal appeal process.   One of his                                                               
staff reviews  the record, analyzes  the state's  position, works                                                               
with the taxpayer to identify  areas that can be resolved easily,                                                               
and  tries  to  negotiate  an informal  settlement.  If  that  is                                                               
unsuccessful,  it moves  to a  form  appeal process.   An  appeal                                                               
officer is  assigned.   The equivalent  of an  administrative law                                                               
judge  holds a  proceeding that  has the  state and  the taxpayer                                                               
provide their respective testimony.  Then a decision is made.                                                                   
                                                                                                                                
CHAIR FRENCH asked  whether that takes place in  the state office                                                               
of tax appeals.                                                                                                                 
                                                                                                                                
COMMISSIONER  GALVIN answered  that it  is one  component of  the                                                               
administrative appeals  office.   If the dispute  continues, from                                                               
there  it moves  towards a  judicial appeal.   The  timeframe for                                                               
getting through that process is potentially another two years.                                                                  
                                                                                                                                
10:22:09 AM                                                                                                                   
CHAIR FRENCH  asked whether it can  take two years to  complete a                                                               
full audit of a  PPT or ACES tax return, and there  can be a two-                                                               
year  process  after that  before  there  is a  final  conclusion                                                               
through  the   department  and  the  administrative   law  judge,                                                               
followed  by court.   Or  does the  two years  include the  court                                                               
time?   He recalled that  Mr. Hosie had  said it takes  about two                                                               
years for a tax dispute.                                                                                                        
                                                                                                                                
COMMISSIONER GALVIN  said he  believed Mr.  Hosie meant  from the                                                               
beginning  of   the  administrative  appeal  through   the  court                                                               
process.                                                                                                                        
                                                                                                                                
CHAIR  FRENCH  deferred  the   discussion  until  tomorrow,  when                                                               
Ms. Davis would review Mr. Hosie's memo.                                                                                        
                                                                                                                                
SENATOR  WIELECHOWSKI asked  whether the  department had  decided                                                               
what its hurdles or triggers would be for auditing.                                                                             
                                                                                                                                
COMMISSIONER  GALVIN replied  he hadn't  been briefed  on it  and                                                               
believed they were still in  the process of formulating the audit                                                               
strategy and gathering information to  analyze.  Just now they're                                                               
receiving  a full  record  of what  the  taxpayers are  providing                                                               
after  they've   gone  through  their  partnership   billing  and                                                               
auditing process and preparation of their federal tax returns.                                                                  
                                                                                                                                
SENATOR WIELECHOWSKI surmised there  are numerous strategies that                                                               
a commissioner or auditors could take.                                                                                          
                                                                                                                                
COMMISSIONER GALVIN concurred.  He  said that's why he depends on                                                               
the expectation of bringing in  folks who understand not only the                                                               
state's  need,  but  also  the   intricacies  of  the  companies'                                                               
accounting.   They'll  need to  assess  where to  target for  the                                                               
biggest bang  for the buck in  going after the cost  structure or                                                               
identifying a particular  report, for instance, that  is the meat                                                               
of what the auditors ultimately will pursue.                                                                                    
                                                                                                                                
10:24:52 AM                                                                                                                   
SENATOR WIELECHOWSKI asked what recourse  a company would have if                                                               
it wasn't allowed  to deduct an expense when  another company was                                                               
allowed to deduct a similar type of expense.                                                                                    
                                                                                                                                
COMMISSIONER GALVIN  answered that given the  confidential nature                                                               
with  respect to  the taxpayer,  they wouldn't  necessarily know.                                                               
It is incumbent upon the agency to apply the rules evenly.                                                                      
                                                                                                                                
SENATOR THERRIAULT suggested  this gets more to  the court review                                                               
of whether the sovereign entity is  imposing its powers in a fair                                                               
and not  arbitrary fashion.   If  there were  disparate treatment                                                               
among taxpayers, that would trigger it.                                                                                         
                                                                                                                                
SENATOR WIELECHOWSKI  asked how a  company that wants to  come to                                                               
Alaska would find  out which are reasonable costs  to deduct from                                                               
its revenue in the next year or so.                                                                                             
                                                                                                                                
COMMISSIONER GALVIN  responded that  part of  it will  be getting                                                               
clear  regulations out.    Also, ACES  authorizes  the agency  to                                                               
provide guidance documents that  clarify how the department would                                                               
interpret certain areas where regulations  don't go into adequate                                                               
detail.   Beyond  that,  he  opined that  in  the broader  range,                                                               
companies will understand  what is captured and what  isn't.  The                                                               
regulations will address finer  points not necessarily considered                                                               
by a company in deciding whether to come to Alaska.                                                                             
                                                                                                                                
The committee took an at-ease from 10:27:23 AM to 10:44:15 AM.                                                              
                                                                                                                                
COMMISSIONER GALVIN  showed slide  7, the  final slide  on "Audit                                                               
Risk."   He emphasized  that consultants have  said there  are no                                                               
other  gross-based  systems  around  the  world.    However,  the                                                               
opposite is true  within the United States.  In  other US states,                                                               
the  resource is  primarily privately  owned or,  in the  Gulf of                                                               
Mexico, federally owned.   The resource is taxed  as just another                                                               
commodity produced within those states,  and there is a severance                                                               
tax - as  opposed to a property tax -  that reflects the historic                                                               
evolution of US  tax policy, which generally has  been based upon                                                               
a gross-value calculation;  this is fairly low  and generally not                                                               
a significant  part of the  states' revenue streams.   Also, they                                                               
are dealing with  a resource base generally  lower than Alaska's.                                                               
Thus other states in the US aren't used for comparison purposes.                                                                
                                                                                                                                
COMMISSIONER GALVIN  referred to  testimony in  other committees.                                                               
He  pointed  out  that  in  order  to  make  an  apples-to-apples                                                               
comparison, oil  provinces around the  world are looked  at which                                                               
have similar  resources and  opportunities.  They  all use  a net                                                               
system.  As for how they are  dealing with audit risk - the sense                                                               
of exposure to  potential manipulation - he'd  been informed that                                                               
none had gone to a net  approach and then ultimately changed to a                                                               
gross approach because of such  concern.  The net systems remain,                                                               
although various consultants have said  there is a learning curve                                                               
for how to implement this properly.                                                                                             
                                                                                                                                
10:48:33 AM                                                                                                                   
COMMISSIONER GALVIN  recalled that legislative  consultant Daniel                                                               
Johnston, among others,  said Alaska could similarly  deal with a                                                               
net system.   It is common, standard, and doable.   Noting people                                                               
distrust such  a system, however,  Commissioner Galvin  said this                                                               
relates to not only  the taxes, but also the companies.   It is a                                                               
big  component in  the  current public  preference  for having  a                                                               
gross-based tax.                                                                                                                
                                                                                                                                
COMMISSIONER GALVIN said  the state must ensure that  DOR has the                                                               
necessary  tools  and must  make  the  system as  transparent  as                                                               
possible.   What  is needed  is to  get past  the current  stage,                                                               
moving  to a  new  relationship with  the  companies wherein  the                                                               
state  has  information, can  say  it  knows  how the  system  is                                                               
working,  and  can express  it  to  the  public.   Thus  ACES  is                                                               
intended to  provide the tools  needed to mitigate some  of these                                                               
real and perceived risks.                                                                                                       
                                                                                                                                
SENATOR HUGGINS asked Commissioner Galvin to review those tools.                                                                
                                                                                                                                
COMMISSIONER GALVIN  replied they are in  three major categories:                                                               
people, information, and  clear rules.  Under  people, the change                                                               
with  respect  to  the  auditors  is  the  primary  one.    Under                                                               
information,  tools  are:    1)  the  requirement  in  ACES  that                                                               
companies  provide current,  timely, and  useful information  and                                                               
also  forward-looking  information about  expected  expenditures,                                                               
which will  help the state  understand how the system  is working                                                               
now and what  can be expected in the near  future; 2) the sharing                                                               
between  the  departments  so  the  state has  full  use  of  the                                                               
information; and 3) the public  disclosure of some information so                                                               
there is  a sense of  transparency and public confidence.   Under                                                               
clear rules, the state will  define what costs are deductible and                                                               
clarify what items are excluded,  such as improper maintenance or                                                               
costs for dismantling, removal and restoration (DR&R).                                                                          
                                                                                                                                
SENATOR HUGGINS surmised those tools are in the legislation.                                                                    
                                                                                                                                
COMMISSIONER GALVIN said yes, for the most part.                                                                                
                                                                                                                                
10:53:01 AM                                                                                                                   
COMMISSIONER GALVIN  turned to slide  8, "Revenue to  the State,"                                                               
noting  this relates  to expectations  based upon  known factors.                                                               
Within  DOR  there  is  a fairly  extensive  model  of  different                                                               
building blocks for calculating  expected taxes, with assumptions                                                               
for  production levels,  prices, and  costs.   Accurate depiction                                                               
requires  breaking  it down  by  field  and taxpayer,  separating                                                               
potential  operating expenditures  from capital  expenditures and                                                               
so forth.   That is built into the model  to enable an apples-to-                                                               
apples comparison.  This model is a critical tool for analysis.                                                                 
                                                                                                                                
COMMISSIONER  GALVIN  indicated  variables  can  be  adjusted  to                                                               
achieve a  certain amount  of dollars over  the next  five years,                                                               
for  any type  of tax.    The goal  is  to set  these "knobs"  so                                                               
comparisons are calibrated to each other.   The other part of the                                                               
revenue picture is  how durable and reliable  this revenue stream                                                               
is  if cost  assumptions or  other assumptions  prove inaccurate.                                                               
If cost assumptions are off by  5 percent, one amount will rise a                                                               
little  while  the  other  will  rise a  whole  lot.    Thus  one                                                               
evaluation criterion  is the sensitivity  that these  tax systems                                                               
will have to being off in some respect.                                                                                         
                                                                                                                                
10:56:37 AM                                                                                                                   
CHAIR FRENCH requested discussion  of cost, another major concern                                                               
with  a net-based  system.   He  surmised DOR's  August 2007  PPT                                                               
implementation  report was  the  first clue  to  the public  that                                                               
costs were substantially higher  in reality than those envisioned                                                               
a year ago.                                                                                                                     
                                                                                                                                
COMMISSIONER GALVIN  replied it was  the second clue.   The first                                                               
was in  April, when DOR  received the true-up payment,  which was                                                               
less than  expected.  Reports came  back, and DOR was  looking at                                                               
operating  expenditures in  2006 that  were 50 percent  more than                                                               
anticipated.   The effect was dampened,  however, because capital                                                               
expenditures were below  what DOR expected.   The spring forecast                                                               
and  what ultimately  came  out in  the  August report  reflected                                                               
discussions  with  the  companies  in  terms  of  what  could  be                                                               
expected  for those  numbers.   In  further  reply, he  indicated                                                               
those  discussions were  in 2007  following  the April  payments,                                                               
before  DOR put  out its  spring  forecast, and  from the  spring                                                               
forecast until the August report.                                                                                               
                                                                                                                                
CHAIR FRENCH  asked how much  of the information used  to compile                                                               
the original fiscal notes in 2006 came from the producers.                                                                      
                                                                                                                                
COMMISSIONER GALVIN  answered that,  in the  end, he  believed it                                                               
was all relying  upon information from the producers.   The folks                                                               
who  put  those together  had  indicated  they had  certain  cost                                                               
information provided  from the 2004 timeframe,  actual reports of                                                               
costs;  those  were  extrapolated,   expanded,  and  turned  into                                                               
projected  draft  numbers that  were  then  brought back  to  the                                                               
companies for  input as  to their  accuracy.   That was  what was                                                               
ultimately used.   In further response, he said it  was 2004 data                                                               
moved forward,  reflecting what  DOR believed  the data  for 2006                                                               
would be, considering rising costs and so forth.                                                                                
                                                                                                                                
CHAIR FRENCH asked,  then, whether DOR was  taking the producers'                                                               
2004 numbers, updating them for  2006, and building a fiscal note                                                               
on that basis.                                                                                                                  
                                                                                                                                
COMMISSIONER GALVIN affirmed that.                                                                                              
                                                                                                                                
11:00:19 AM                                                                                                                   
COMMISSIONER GALVIN, responding to  Senator Therriault as to what                                                               
went wrong with  the predictions, said as far as  the fiscal note                                                               
it was a combination of two  factors:  1) the numbers intended to                                                               
reflect actual  2006 costs  were significantly  wrong, and  2) as                                                               
they were used  to predict revenue over five or  ten years, there                                                               
wasn't  an   appropriate  escalation  included  to   reflect  the                                                               
experience of  rising costs.   Combined, these had  a multiplying                                                               
effect, getting worse as the numbers were projected forward.                                                                    
                                                                                                                                
CHAIR FRENCH remarked that this is  why gross versus net is being                                                               
debated today.   He opined  that this is  an area where  a gross-                                                               
based  tax  could  gain  a  huge  advantage,  compared  with  the                                                               
100 percent  underestimation  of  costs  a  year  ago.    If  one                                                               
believes a tax should  be put in place and then  left alone for a                                                               
long time,  it is a great  concern with a net-profit  system.  He                                                               
suggested Alaska would indeed have  an unstable tax regime if yet                                                               
another set  of rules had  to be implemented after  another year.                                                               
He requested further discussion about this today.                                                                               
                                                                                                                                
11:03:20 AM                                                                                                                   
COMMISSIONER GALVIN  replied the  aforementioned is one  aspect -                                                               
focused on the revenue  side - of the effect of  being off on the                                                               
assumptions.    As the  first  slide  showed,  being off  on  the                                                               
assumptions  affects  revenue.     A  gross  tax   gives  a  more                                                               
predictable revenue stream.  The  flip side, however, by being so                                                               
far  off on  the  cost  assessment, is  a  much more  significant                                                               
burden  on  the investment  climate  than  intended.   Mentioning                                                               
government take  versus what the  companies get, he said  this is                                                               
used as  a tool to see  how Alaska compares with  other places in                                                               
the world.                                                                                                                      
                                                                                                                                
COMMISSIONER GALVIN continued.   He said as a  reflection of this                                                               
tradeoff, if  a gross tax is  pegged at a certain  expectation of                                                               
take - say,  68 or 69 percent  - and then costs  are double those                                                               
in  the assumption,  now the  government  take is  in the  mid-70                                                               
percent range.  But that isn't  the intention.  In that scenario,                                                               
prices could go  up 20, 30, or  40 percent and yet  the tax would                                                               
be  higher  than intended.    This  relates also  to  durability.                                                               
Whether one  chooses a net or  gross system, if costs  are poorly                                                               
projected  the tax  won't  be  what is  expected.   He  mentioned                                                               
balancing revenue versus investment.                                                                                            
                                                                                                                                
CHAIR  FRENCH asked,  then, whether  the  state gets  the tax  it                                                               
expects under a  gross system, but throws  the investment climate                                                               
off, which may have tax implications down the road.                                                                             
                                                                                                                                
COMMISSIONER GALVIN affirmed that.                                                                                              
                                                                                                                                
CHAIR FRENCH surmised  what follows after a year  with respect to                                                               
the expected tax may depend on variables.                                                                                       
                                                                                                                                
11:06:13 AM                                                                                                                   
SENATOR  HUGGINS recalled  that  data provided  by Dan  Dickinson                                                               
indicated the PPT projection for  the 2006-2007 timeframe was off                                                               
by  just  under  10  percent;  he  mentioned  a  minus-8  percent                                                               
variance.   However, other  taxes for alcohol  and so  forth were                                                               
off by 52  or 53 percent.  He suggested  the projections are just                                                               
guesstimates.   It isn't a perfect  science.  No matter  how good                                                               
the people  are, there will  be some  variance.  In  context, the                                                               
PPT portion  was very  accurate.   He asked  whether Commissioner                                                               
Galvin disagreed.                                                                                                               
                                                                                                                                
COMMISSIONER GALVIN said it is  a reflection of how these numbers                                                               
merge and  are then used  to make  different points.   Noting DOR                                                               
had looked at the perceived  difference between what was expected                                                               
and what  came in,  with price and  production held  constant, he                                                               
said  the answer  was $800  million  for FY  2008.   It is  true,                                                               
however, that  when the extra  variable of  cost is added  in, it                                                               
will affect the outcome if this number proves wrong.                                                                            
                                                                                                                                
SENATOR  HUGGINS, in  response to  Chair  French, clarified  that                                                               
he'd been  talking about  the track  record for  2006 or  2007 or                                                               
perhaps both in  aggregate.  His point was that  it appears to be                                                               
a guesstimate.                                                                                                                  
                                                                                                                                
COMMISSIONER  GALVIN   responded  that   Alaska  is   a  resource                                                               
development state.   When  commodity prices  are high,  the state                                                               
expects to receive more.  In  FY 2007, commodity prices were high                                                               
for minerals and for oil and gas.   The state got more in mineral                                                               
taxes and corporate  income taxes, but not petroleum  taxes.  The                                                               
reason  was  a  wrong  cost  assumption.    Normally,  given  the                                                               
dramatic increase in  price, the state would expect  to receive a                                                               
lot more than  otherwise.  The distinction  between 2006-2007 and                                                               
2007 forward is this:   2006 wasn't a forecast error.   It was an                                                               
error in an assumption about  reality, what was happening in that                                                               
timeframe.     With   respect  to   forecasting  now,   a  direct                                                               
correlation cannot be drawn between the  fact that DOR was off by                                                               
100 percent then and the future situation.                                                                                      
                                                                                                                                
11:10:48 AM                                                                                                                   
COMMISSIONER  GALVIN highlighted  the learning  curve with  a new                                                               
net tax.   The companies will  be learning as well,  making first                                                               
reports and  making a call as  to whether the state  will include                                                               
certain  costs.     Most   likely,  they'll   maximize  potential                                                               
deductions.  Thus DOR will  identify where the companies draw the                                                               
line for what they believe their starting point should be.                                                                      
                                                                                                                                
COMMISSIONER GALVIN  said as  the state bases  its tax  system on                                                               
these  assumptions going  forward and  goes through  the auditing                                                               
process,  most likely  DOR will  eventually bring  in more  money                                                               
that it otherwise would have expected.   In the end, the industry                                                               
can expect that  this is the direction the system  will move, can                                                               
respond accordingly  in these hearings  about where  they believe                                                               
the  actual  numbers  will  end  up,  and  then  can  base  their                                                               
expectations on that.                                                                                                           
                                                                                                                                
CHAIR  FRENCH  welcomed  Representative Gara,  noting  he'd  been                                                               
present for some time.  He again acknowledged Senator Stevens.                                                                  
                                                                                                                                
11:12:13 AM                                                                                                                   
SENATOR  McGUIRE  requested assurance  that  if  ACES passes  and                                                               
regulations are  set, at some  point the collected data  would be                                                               
revealed, along  with whether the state's  assumptions themselves                                                               
were inaccurate.   One can look  at whether the cost  of labor or                                                               
building materials  is increasing statewide, and  by what factor.                                                               
She said the  cost of steel has  risen, but not more  for the oil                                                               
and  gas industry  than anyone  else.   She  surmised such  basic                                                               
information went into the cost assumptions in the fiscal note.                                                                  
                                                                                                                                
SENATOR McGUIRE explained that she  didn't want to impugn anyone,                                                               
but wanted to  know if increased costs factored  in to companies'                                                               
deductions were based on gold  plating, stockpiling, or otherwise                                                               
gaming the  system.   People may  think differently  in business,                                                               
and the goal is  to minimize the tax.  She wanted  to know if the                                                               
assumptions  themselves were  wrong or  whether it  was how  they                                                               
were  interpreted  and  applied  by the  companies  and,  if  so,                                                               
whether there could be any assurance that this could be changed.                                                                
                                                                                                                                
11:14:33 AM                                                                                                                   
COMMISSIONER GALVIN agreed  the state should know that.   He said                                                               
through the auditing process what  will ultimately be identified,                                                               
after the two-year  cycle, is how much of the  reported costs the                                                               
state disputes.   That will bring  it back to a  number the state                                                               
believes  appropriate  for reported  costs.    That then  can  be                                                               
compared against the  state's assumptions.  Until  then, it won't                                                               
be known whether this is a primary factor or a small one.                                                                       
                                                                                                                                
SENATOR McGUIRE expressed hope that  DOR would hire or retain the                                                               
best  economists possible  to look  at  not only  what the  costs                                                               
generally  are in  Alaska,  but  also what  they  are within  the                                                               
industry, including in Alberta, Canada, between 2006 and 2007.                                                                  
                                                                                                                                
COMMISSIONER  GALVIN  voiced  hope  that  as  the  administration                                                               
evaluates how to  deal with the overarching  issue of recruitment                                                               
and retention,  a solution will  be found.   Hiring top  folks in                                                               
the field will  come down to competitive advantage  and so forth.                                                               
The state  has good economists  assisting with this work.   While                                                               
surmising  the  state  could  provide a  level  of  what  Senator                                                               
McGuire was asking  for, given the current capacity,  he said the                                                               
next level up would require something more.                                                                                     
                                                                                                                                
SENATOR  WIELECHOWSKI referred  to Senator  Huggins' remarks  and                                                               
recalled a chart showing percentages  where the revenues were off                                                               
for  cigarettes,  alcohol, and  the  Division  of Motor  Vehicles                                                               
(DMV).  He suggested the  department seriously underestimated how                                                               
much Alaskans like to smoke, drink, and drive.                                                                                  
                                                                                                                                
11:17:47 AM                                                                                                                   
CHAIR FRENCH  recalled when the PPT  implementation status report                                                               
came out in August, he was surprised  at its frankness.  It was a                                                               
fairly  strong warning  about struggles  the state  will have  in                                                               
implementing a  profits-based system.   At the time  he'd debated                                                               
Representative Samuels on  public radio about a  net versus gross                                                               
system, drawing most of his points  from this report.  Those same                                                               
difficulties   are   being   discussed   today:      forecasting,                                                               
regulations,  and  auditing.   The  report  said  the  department                                                               
lacked   future    information   for   capital    and   operating                                                               
expenditures.   He asked whether  DOR now has  better information                                                               
in this regard.                                                                                                                 
                                                                                                                                
COMMISSIONER  GALVIN  indicated  DOR  has some,  but  not  nearly                                                               
enough.   There has  been a continual  effort to  get information                                                               
from  the  companies.   Without  the  clear authority  to  demand                                                               
particular  information,  however, it  is  an  ongoing and  time-                                                               
consuming exchange.                                                                                                             
                                                                                                                                
CHAIR  FRENCH observed  that  ACES has  sections  that deal  with                                                               
information  and has  $1,000-a-day  penalties  for not  complying                                                               
with requests.   He asked if that will help DOR get the data.                                                                   
                                                                                                                                
COMMISSIONER  GALVIN  replied  yes,  very much  so.    Those  are                                                               
essential.                                                                                                                      
                                                                                                                                
11:20:19 AM                                                                                                                   
COMMISSIONER GALVIN turned to slide  9, "Revenue vs. Investment."                                                               
The first  of four "pennant" graphs,  it had a small  band at the                                                               
bottom labeled "Low Gross Tax."   He explained that when he looks                                                               
at  balancing revenue  generation and  protecting the  investment                                                               
climate, the  hurdle that  can't be  overcome with  a gross-based                                                               
tax is this:  If there  is a certain revenue expectation, how can                                                               
the state ensure  the income can be  collected without negatively                                                               
affecting  the  economics  of  a  particular  project?    As  the                                                               
administration  gleaned information  on  a  variety of  different                                                               
fields,  these graphs  had come  to mind.   He  asked members  to                                                               
imagine that each  field has an economic profile,  with a certain                                                               
exposure and  sensitivity.   The longer  pennants are  for fields                                                               
with more sensitivity to having their economic picture impacted.                                                                
                                                                                                                                
CHAIR FRENCH  surmised this would  be either higher cost  or less                                                               
volume, for instance.                                                                                                           
                                                                                                                                
COMMISSIONER GALVIN agreed.  He said  when one is trying to bring                                                               
in revenue, some aspect of the  lower band on the chart is filled                                                               
up.   With a gross tax,  it is a  very blunt tool; whether  it is                                                               
cranked up to  bring in more money or lowered,  that line remains                                                               
straight across the horizon.                                                                                                    
                                                                                                                                
COMMISSIONER GALVIN  showed slide 10,  with a thicker  lower band                                                               
labeled "Medium Gross  Tax," noting it depicts pennant  "Y" as no                                                               
longer being a viable project, since  the tax has risen.  Showing                                                               
slide 11, with an even thicker  band labeled "High Gross Tax," he                                                               
said  this impacts  even  more projects;  they'd  no longer  look                                                               
favorable  to a  company and  thus some  projects would  be lost.                                                               
The administration didn't want to make that trade-off.                                                                          
                                                                                                                                
11:24:33 AM                                                                                                                   
SENATOR McGUIRE asked why a  system that allows credit deductions                                                               
wouldn't help compensate for this problem.                                                                                      
                                                                                                                                
COMMISSIONER GALVIN responded  with slide 12, the  final slide on                                                               
revenue versus investment.   Its lower section  was labeled "High                                                               
Net Tax"  and was shown as  peaks and valleys correlating  to the                                                               
contours of the pennants, rather than a solid band.                                                                             
                                                                                                                                
COMMISSIONER GALVIN  explained that  with a  net tax,  the effect                                                               
reflects the economics of the  projects themselves.  When looking                                                               
at the economic models, one can  set rates to bring in the money,                                                               
but  do it  so  it  buffers and  protects  the  economics of  the                                                               
various projects.  He said Senator  McGuire had brought up a good                                                               
point.  As  shown on a previous slide, a  gross tax that includes                                                               
capital credits  would be similar  to this type of  approach, but                                                               
wouldn't follow the contours of these pennants.                                                                                 
                                                                                                                                
COMMISSIONER GALVIN  suggested thinking of a  "root" within these                                                               
pennants that reflects the  capital expenditure portion, separate                                                               
from  ongoing operating  expenditures.   Those  lines that  would                                                               
come about because of the gross  would reflect that root, not the                                                               
actual entire pennant.   To the extent that  a particular project                                                               
had  a different  relationship between  capital expenditures  and                                                               
operating  expenditures, in  terms of  economic impact  the gross                                                               
tax  would affect  it  differently than  another  project with  a                                                               
different capital component.   He said this gives a  sense of the                                                               
difference in the ability to  raise revenue while not clearly and                                                               
empirically affecting the economics of particular projects.                                                                     
                                                                                                                                
11:27:09 AM                                                                                                                   
COMMISSIONER  GALVIN turned  to slide  13, "Investment  Climate -                                                               
Tests,"  which had  two  major  bullets:   "New  Fields (7  Field                                                               
Models)" and "'Legacy'  Fields."  He said this  reflects the type                                                               
of  analysis required  for the  state to  better understand  that                                                               
relationship.   When expertise on particular  projects is brought                                                               
in from  the Department of  Natural Resources (DNR),  Division of                                                               
Oil  &  Gas, a  much  clearer  picture  can  be obtained  of  how                                                               
different tax options affect those project economics.                                                                           
                                                                                                                                
COMMISSIONER  GALVIN   said  there   are  actual   project  data,                                                               
projected capital costs and operating  costs, and also production                                                               
profiles such  as whether  oil will be  produced quickly  or will                                                               
slowly  rise and  then  diminish  over time.    Based upon  price                                                               
assumptions, those  are used to  view the economic picture  for a                                                               
project under one tax system or another.                                                                                        
                                                                                                                                
COMMISSIONER GALVIN  elaborated.  From that  multiple-field model                                                               
the state would  run the different taxes, looking  at revenue and                                                               
options  for protecting  these  fields;  he mentioned  investment                                                               
expectations.   Economic  analyses  including  net present  value                                                               
(NPV), internal rates of return,  and the probability index would                                                               
be  run  at  various  prices  to see  the  sensitivity  to  price                                                               
changes.    They'd  also  be run  at  different  discount  rates,                                                               
reflecting various companies' expectations  of their own rates of                                                               
return and what would generally  be used as an investment metric.                                                               
The different tax systems would be compared against those.                                                                      
                                                                                                                                
COMMISSIONER  GALVIN  noted the  sensitivity  of  these taxes  to                                                               
changes  in assumptions  also would  be  looked at.   Either  the                                                               
projects   themselves  would   experience  different   costs  and                                                               
different  cost assumptions  would  be built  in,  or else  there                                                               
would be an analogous project,  also on the threshold, that would                                                               
have  a   slightly  different  cost  profile.     Indicating  the                                                               
administration  isn't  wedded to  these  seven  field models,  he                                                               
surmised others would come in.                                                                                                  
                                                                                                                                
11:30:15 AM                                                                                                                   
COMMISSIONER  GALVIN added  this took  a lot  of time,  including                                                               
work between  the departments  to ensure  the seven  field models                                                               
accurately  reflected how  the  tax system  would  work within  a                                                               
particular field's cash  flow.  Also, as the  different tax types                                                               
were run and various "knobs"  were adjusted over and over, they'd                                                               
gained  insight into  which  knobs were  affecting  what and  had                                                               
winnowed down the options.                                                                                                      
                                                                                                                                
SENATOR WIELECHOWSKI  asked if the three  big producers currently                                                               
are reinvesting in the legacy fields.                                                                                           
                                                                                                                                
COMMISSIONER  GALVIN replied  yes, through  their operator.   The                                                               
operator  is making  the investments,  and  they're paying  their                                                               
share of the costs.                                                                                                             
                                                                                                                                
SENATOR  WIELECHOWSKI recalled  reading  in  the Anchorage  Daily                                                             
News  that Exxon  hadn't done  further exploration  on the  North                                                             
Slope since 2000.                                                                                                               
                                                                                                                                
COMMISSIONER   GALVIN  said   this  relates   to  two   different                                                               
standards.   As to  whether the big  three are  reinvesting, they                                                               
are  putting  money  in.    Exxon is  doing  it  through  BP  and                                                               
ConocoPhillips.    BP is  doing  the  work  at Prudhoe  Bay,  and                                                               
ConocoPhillips is  doing the  work at Kuparuk.   Exxon  is paying                                                               
the bills for its percentage of  that ownership.  But Exxon isn't                                                               
doing  anything  outside  its  ownership of  those  fields.    In                                                               
further   response,  he   said  Exxon   hasn't  been   doing  any                                                               
exploration in Alaska since, to his belief, earlier than 2000.                                                                  
                                                                                                                                
SENATOR WIELECHOWSKI  asked if it  is accurate to say  the fields                                                               
Exxon has leased are being explored by ConocoPhillips and BP.                                                                   
                                                                                                                                
COMMISSIONER GALVIN  clarified that he wouldn't  characterize the                                                               
work  within Prudhoe  Bay  or Kuparuk  as  exploration.   They're                                                               
enhancing development of  those fields, not looking  for new oil.                                                               
They know  where the  oil is.   They're  just determining  how to                                                               
produce it.  And they're  putting money into enhancing production                                                               
of existing  pockets of oil  that are available and  also looking                                                               
at ways  to bring  into production  other pockets  that currently                                                               
aren't because of primarily technical or economic hurdles.                                                                      
                                                                                                                                
CHAIR FRENCH summarized  that Exxon isn't an explorer,  but is an                                                               
investor.                                                                                                                       
                                                                                                                                
COMMISSIONER GALVIN  agreed.  He  said of the three,  he believes                                                               
the only explorer is ConocoPhillips right now.                                                                                  
                                                                                                                                
11:33:48 AM                                                                                                                   
COMMISSIONER GALVIN  returned to slide 13,  addressing the bullet                                                               
on  legacy fields  that read,  "Reinvestment Option  analysis 3%,                                                               
6%,  and 15%  decline scenarios."   He  said in  addition to  the                                                               
seven fields  looked at, for  which there was solid  data, they'd                                                               
also  sought  a way  to  evaluate  reinvestment opportunities  in                                                               
legacy  fields.   For  those,  there  isn't data  or  methodology                                                               
similar  to the  seven  field models,  which  allowed looking  at                                                               
reinvestment for decision making.  But  they took a rough cut and                                                               
looked at information provided by  the companies, both a year ago                                                               
and as  enhanced this year.   This allowed looking  at companies'                                                               
investment decision  making, relative to the  level of investment                                                               
necessary to  stem the decline curve  by a certain amount,  so it                                                               
would give a  certain amount of production.  The  question is how                                                               
the different tax types would relate to that.                                                                                   
                                                                                                                                
11:34:39 AM                                                                                                                   
COMMISSIONER GALVIN turned  to slide 14, "New  Field Tax Analysis                                                               
-  NPV Impact."    He  said this  is  one  representation of  the                                                               
voluminous data  generated during  the seven-field analysis.   It                                                               
shows  one  level of  the  net  present  value analysis,  how  it                                                               
compares against the different types  of net and gross tax types,                                                               
and  the  relative  impact  on   the  "attractiveness"  at  these                                                               
particular variable choices.                                                                                                    
                                                                                                                                
CHAIR  FRENCH  asked  Commissioner   Galvin  to  go  through  the                                                               
assumptions shown under the net production tax scenarios.                                                                       
                                                                                                                                
COMMISSIONER  GALVIN  said  it  starts   with  NPV  impact.    It                                                               
represents  taking  the  cash flows  associated  with  a  certain                                                               
investment,  bringing  them  all  back to  today's  dollars,  and                                                               
asking  whether it  is a  positive or  negative, given  a certain                                                               
expected  return.    In  this particular  instance,  there  is  a                                                               
10 percent discount  rate.   If it  is assumed  one wants  to get                                                               
10 percent  out of  one's  money, just  getting  that 10  percent                                                               
would be an NPV of zero - breaking even at 10 percent.                                                                          
                                                                                                                                
CHAIR FRENCH asked whether the  only field shown that would break                                                               
even is Field D, at a high net tax of 35 percent.                                                                               
                                                                                                                                
COMMISSIONER GALVIN  said yes.   It basically results in  a cash-                                                               
flow  return equivalent  to  a 10  percent rate  of  return.   In                                                               
further  reply,  he  said  most  investors in  the  oil  and  gas                                                               
industry probably want  a rate of return  higher than 10 percent.                                                               
This is a fairly conservative  discount rate for this evaluation.                                                               
Most likely, it  would be closer to 15 percent.   A company looks                                                               
at the NPV in terms of  whether the investment will actually grow                                                               
the business.   With an  NPV of zero,  the answer is  "no" unless                                                               
other  factors will  drive them  to that.   It's  treading water.                                                               
Based on pure economics, the option won't be acted on.                                                                          
                                                                                                                                
11:37:41 AM                                                                                                                   
CHAIR FRENCH referred to Field D,  where the chart shows "10" for                                                               
the "PPT Status Quo" category.  He asked what it represents.                                                                    
                                                                                                                                
COMMISSIONER  GALVIN replied  it's a  $10 million  NPV associated                                                               
with this project under the status quo, PPT.                                                                                    
                                                                                                                                
CHAIR FRENCH asked whether all  the other numbers there represent                                                               
millions.                                                                                                                       
                                                                                                                                
COMMISSIONER GALVIN  affirmed that.   He noted options  listed on                                                               
the left:  ACES with a  10 percent floor, ACES without the floor,                                                               
PPT status quo, and  a high net tax.  Columns  show the rates for                                                               
mature  or  legacy  fields,  as  well as  other  fields.    Under                                                               
progressivity, it shows  the trigger and slope.   And the capital                                                               
credit percentage is shown.                                                                                                     
                                                                                                                                
11:38:43 AM                                                                                                                   
CHAIR FRENCH  asked whether any one  of the fields, A  through G,                                                               
represents something close to a legacy field like Kuparuk.                                                                      
                                                                                                                                
COMMISSIONER GALVIN specified  that Field A reflects  a heavy oil                                                               
project,  Field  C a  traditional  oil  project, and  Field E  an                                                               
extremely challenged  heavy oil project  - all within  the legacy                                                               
fields.                                                                                                                         
                                                                                                                                
CHAIR FRENCH surmised nobody would do Field E.                                                                                  
                                                                                                                                
COMMISSIONER GALVIN said  Fields B, D, and F  reflect projects by                                                               
new  entrants.    This  is  an important  distinction.    In  the                                                               
modeling, it affects how much the  capital credits are worth to a                                                               
company immediately, and  whether they'll need to  be rolled over                                                               
a year  before being  enjoyed under  PPT.   In response  to Chair                                                               
French, he said these are  companies without current production -                                                               
not so much like Anadarko, but Pioneer and others.                                                                              
                                                                                                                                
11:40:15 AM                                                                                                                   
SENATOR  WIELECHOWSKI gave  his understanding  that a  higher tax                                                               
rate  on  the  lower  end could  encourage  investment  for  some                                                               
fields.  He noted the chart  shows that for Field A, the high net                                                               
tax is  $150 million NPV  at a  35 percent  tax rate  with higher                                                               
progressivity.    Yet  under  ACES  with  no  floor  there  is  a                                                               
25 percent tax  rate, lower progressivity, and  $120 million NPV.                                                               
He requested an explanation.                                                                                                    
                                                                                                                                
COMMISSIONER GALVIN replied:                                                                                                    
                                                                                                                                
     It's  counterintuitive, but  if you  follow along  with                                                                    
     the  idea  that  when  you make  your  initial  capital                                                                    
     investment the  state, through the system,  is going to                                                                    
     pick up a percentage of  the cost.  And that percentage                                                                    
     is  going to  be a  product of  primarily two  drivers.                                                                    
     It's going to  be your tax rate -  because you're going                                                                    
     to deduct it first and then  you're going to be able to                                                                    
     get  basically whatever  the tax  rate is  off of  your                                                                    
     taxes -  and, secondly, what  the credit rate  is, what                                                                    
     the  rate is  you're  allowing as  your capital  credit                                                                    
     amount.                                                                                                                    
                                                                                                                                
     And so with  the Field A, it's in an  existing unit, by                                                                    
     an  existing company.   So  they can  immediately write                                                                    
     off those  capital costs.   And so, under the  high net                                                                    
     tax they're  getting a 35  percent deduction and  a ...                                                                    
     20 percent  credit.    They're  getting  a  55  percent                                                                    
     immediate  write-off, as  opposed  to  the ACES,  where                                                                    
     they  get the  25 percent  and  the 20.  ... There's  a                                                                    
     10 percent  increase  in what  they  get  to write  off                                                                    
     right off the bat.                                                                                                         
                                                                                                                                
     As the production  comes in, they're going  to pay more                                                                    
     to the  state.  They're  going to pay the  higher rate.                                                                    
     But since  we're talking about  net present  value, the                                                                    
     amount that  they're going  to pay  over time  has been                                                                    
     diminished,  diminishing impact  to  their net  present                                                                    
     value.  But  the credit they get right off  the bat has                                                                    
     immediate and ... whole impact on that.                                                                                    
                                                                                                                                
     And so, by  allowing them to write that  off, right off                                                                    
     the bat at that higher  rate, even though they're going                                                                    
     to pay us  more over time, it has a  positive impact on                                                                    
     the economic profile for them for that project.                                                                            
                                                                                                                                
11:43:08 AM                                                                                                                   
CHAIR FRENCH said it's good to raise taxes, then.                                                                               
                                                                                                                                
COMMISSIONER GALVIN replied that in certain circumstances, in                                                                   
certain projects, having a higher tax rate is actually                                                                          
beneficial to the project economics.                                                                                            
                                                                                                                                
CHAIR FRENCH asked about a real-life model for Field G, which                                                                   
appears to be the most profitable.                                                                                              
                                                                                                                                
COMMISSIONER GALVIN said Field G is a new project with a new                                                                    
investor in a new area with high prospectivity.  Returning to an                                                                
earlier point, he said:                                                                                                         
                                                                                                                                
     I  was   actually  going  to   follow  up   on  Senator                                                                    
     Wielechowski's point, just to--I  don't want to further                                                                    
     confuse it, but  just when we talk about  the fact that                                                                    
     increasing the  tax rate could  have a  positive impact                                                                    
     on  the   economic  perspective  from   the  investor's                                                                    
     standpoint,   because   they'll   use   a   potentially                                                                    
     relatively  high discount  rate.   And,  in fact,  what                                                                    
     you'll see,  if we ran this  at NPV 15, that  effect is                                                                    
     even more dramatic because those  future cash flows ...                                                                    
     have even less  impact to diminish that  value from the                                                                    
     immediate value of the credit.                                                                                             
                                                                                                                                
     When you  look at it  from the state's  perspective and                                                                    
     you  flip  that  analysis   around,  from  the  state's                                                                    
     perspective, our  time value of  money ... has  a lower                                                                    
     rate. ...  Some would say  it's in the  neighborhood of                                                                    
     5, maybe 8  percent.  Others would even  say it's zero.                                                                    
     We  even had  a committee  member in  another committee                                                                    
     say it  was negative.   But the  idea being  that, from                                                                    
     the state's perspective, getting  money in the future -                                                                    
     as opposed to  getting it now, and the  risk that we're                                                                    
     going to  spend it on  something that we don't  need to                                                                    
     spend it on - diminishes  ... for our benefit the value                                                                    
     of getting everything now.                                                                                                 
                                                                                                                                
     And so  what that means  is, in  the cash flow  of this                                                                    
     project, for  the state  to give  money to  the company                                                                    
     now  - with  the expectation  that we're  going to  get                                                                    
     more in the future -  could actually provide a positive                                                                    
     benefit  for us  as well,  and  that we  gain value  by                                                                    
     doing  that and  having this  project come  on at  that                                                                    
     higher rate.   And  ... you  can call  it the  magic of                                                                    
     economic theory,  the magic of  discount rates,  but at                                                                    
     least  from  the  purely  economic  analysis  in  these                                                                    
     instances,   what   we've   done  is,   we've   created                                                                    
     additional value  to the state and  additional value to                                                                    
     the investor.                                                                                                              
                                                                                                                                
11:46:28 AM                                                                                                                   
SENATOR WIELECHOWSKI  observed, however,  that producers  may say                                                               
raising oil taxes will hurt investment.                                                                                         
                                                                                                                                
COMMISSIONER GALVIN indicated the  consultants would address that                                                               
this  afternoon.   When the  oil companies  say increasing  taxes                                                               
will  diminish their  interest in  investing, they're  talking in                                                               
terms of having  their entire cash flow change,  since more money                                                               
will be taken for the legacy  fields as well.  They'll weigh this                                                               
and say Alaska won't  be as attractive.  If it  is isolated to an                                                               
individual project,  however, the  companies cannot deny  it will                                                               
potentially  make that  project  look more  positive.   But  they                                                               
won't  say  so,  given  the  outcome is  a  higher  tax  rate  on                                                               
everything else.                                                                                                                
                                                                                                                                
SENATOR WIELECHOWSKI  recalled this  was discussed in  the Senate                                                               
Resources  Standing Committee.    He  asked:   Why  not have  two                                                               
separate taxes,  then, one for  mature legacy fields and  one for                                                               
new exploration?                                                                                                                
                                                                                                                                
COMMISSIONER GALVIN  replied there are different  approaches when                                                               
looking  at options  for where  the  tax will  have the  greatest                                                               
impact.  One approach  is to set the rate for  legacy fields at a                                                               
higher  starting point  than elsewhere.   Another  entails basing                                                               
the progressivity upon the margin  of a particular project; those                                                               
with  larger  margins -  making  the  most money,  primarily  the                                                               
legacy fields - pay a higher rate  than other fields.  So it gets                                                               
to the  same point, but it's  based upon something other  than an                                                               
arbitrary line depicting  some as legacy fields.   In response to                                                               
Chair French,  he said it  is self-policing,  self-adjusting, and                                                               
actually has other impacts as well.                                                                                             
                                                                                                                                
11:49:26 AM                                                                                                                   
COMMISSIONER GALVIN  drew attention  to the  gross-production tax                                                               
scenarios on slide 14.  He  emphasized that this represents a few                                                               
of the  tax combinations  evaluated under  one particular  set of                                                               
assumptions  and criteria;  they are  in the  same ballpark  with                                                               
respect to revenue.  However,  the administration had looked at a                                                               
tremendous number  of tax  combinations under  a large  number of                                                               
different criteria.   There  wasn't any one  factor or  test that                                                               
drove the  ultimate outcome.   Rather, it was a  recognition that                                                               
with  the  gross-based options,  any  one  of these  factors  can                                                               
clearly  be identified  that will  make  that gross  tax drive  a                                                               
project into the negative.                                                                                                      
                                                                                                                                
COMMISSIONER GALVIN briefly  highlighted the gross-tax scenarios:                                                               
a 13  percent base  rate with no  credit, with  the progressivity                                                               
based upon  a gross value,  shown as "Low  Rate - No  Credits"; a                                                               
higher rate with a credit,  shown as "Medium Rate" at 16 percent;                                                               
one labeled  "Former Tax no  ELF," also at 16 percent,  which has                                                               
other adjustments  made by the  modeler that don't show  up here;                                                               
an even  higher rate, 19  percent, labeled "High Rate  Flat Tax";                                                               
and then one labeled "Sliding Scale," with a tax table.                                                                         
                                                                                                                                
COMMISSIONER  GALVIN  elaborated  on the  sliding-scale  concept,                                                               
saying for a while  it was believed to be the key.   It based the                                                               
tax rate upon the  age of the field, and it  slid along the table                                                               
for  progressivity reasons,  based  upon the  price.   Every  new                                                               
field had a five-year tax holiday.   There was a credit up front,                                                               
and no  taxes would be  paid for five  years; then they'd  pay at                                                               
some scale  that started  to go  up.  Most  of the  fields became                                                               
positive under  this scenario,  along the lines  seen with  a net                                                               
system.  However, older fields  bore all the economic weight, and                                                               
the rate for  legacy fields was above anything shown  as close to                                                               
economic on the other chart, the legacy field analysis.                                                                         
                                                                                                                                
11:53:14 AM                                                                                                                   
COMMISSIONER   GALVIN  turned   to   slide   15,  "Legacy   Field                                                               
Scenarios," a line graph with one  axis being barrels per day and                                                               
the other being  the years 2008-2027.  He indicated  it shows the                                                               
difference  between  a  15 percent   decline  in  the  amount  of                                                               
investment required in the area  depicted as "Harvest Mode" and a                                                               
3 percent decline in the area shown as "Reinvestment Mode."                                                                     
                                                                                                                                
COMMISSIONER   GALVIN  turned   to   slide   16,  "Legacy   Field                                                               
Reinvestment Comparison  @ $40."   He  indicated this  relates to                                                               
what would  drive that decision  making, just looking at  the NPV                                                               
of the production associated with  the level of investment needed                                                               
to equate  to 3 percent  versus 15 percent.    Under  the various                                                               
net-based  approaches,   a  3  percent  decline   would  be  more                                                               
attractive  on  an NPV  basis  than  allowing  it  to go  into  a                                                               
15 percent decline; thus  the assumption would be  that a company                                                               
would choose to make more money.                                                                                                
                                                                                                                                
COMMISSIONER GALVIN  continued with slide  16.  Referring  to the                                                               
gross-tax scenarios shown previously, he  said the credit must be                                                               
brought in to get  it close.  Cranking the credit up  to 30 or 40                                                               
percent brings these  positive, but a credit this  high moves the                                                               
balance on the other factors  associated with audit risks and the                                                               
benefits intended  by going to  a gross  tax.  Thus  the relative                                                               
value associated  with a  gross tax is  diminished, and  the fact                                                               
that it  ends up  hindering project  economics becomes  that much                                                               
more unacceptable.  It wasn't going to work.                                                                                    
                                                                                                                                
11:55:24 AM                                                                                                                   
COMMISSIONER  GALVIN  turned  to slide  17,  "Investment  Climate                                                               
Summary."   He said the industry  is more comfortable with  a net                                                               
tax  because  companies  expect   the  system  to  reflect  their                                                               
economics as the  project moves forward, and to have  a take that                                                               
they consider  an appropriate  share as  the project  matures and                                                               
changes.   The tax self-adjusts  to changes in variables  such as                                                               
costs.   For  heavy  oil integrated  within  the existing  legacy                                                               
fields, it  is challenging to set  a gross tax that  balances the                                                               
desired revenue and the investment.   Furthermore, errors in cost                                                               
assumptions  under  a  gross tax  can  hamper  investment,  while                                                               
overestimating costs  will leave  money on the  table.   There is                                                               
more value to  be gained, but it will be  missed because the rate                                                               
is based upon earlier assumptions.                                                                                              
                                                                                                                                
CHAIR FRENCH welcomed Senator Ellis.                                                                                            
                                                                                                                                
11:57:39 AM                                                                                                                   
COMMISSIONER  GALVIN concluded  with slide  18, "Balancing  Act."                                                               
Identical to slide  4, it depicted the following  pairs:  revenue                                                               
and  investment climate;  transparency and  economic flexibility;                                                               
incumbents  and new  entrants; revenue  from "legacy"  fields and                                                               
exploration  &   new  field  development;  and   audit  risk  and                                                               
investment   challenge.      He   highlighted   the   challenges,                                                               
recognizing that  some pairs balance  more easily under  either a                                                               
gross system  or a net  system.   The administration found  if it                                                               
wanted  to  overcome  some of  those  challenges,  a  gross-based                                                               
system  would have  to  be changed  to such  an  extent that  all                                                               
intended benefits  were lost.   Thus  ultimately it  was realized                                                               
that a net-based  system meets the state's goals  better than any                                                               
gross-based option looked at.                                                                                                   
                                                                                                                                
SENATOR HUGGINS  returned attention  to slide 16.   He  asked why                                                               
$40 was chosen.                                                                                                                 
                                                                                                                                
COMMISSIONER GALVIN answered that there  was a blend of different                                                               
prices,  but $40  was the  one DOR  used as  its standard  for an                                                               
investment evaluation across  both the new fields  and the legacy                                                               
fields.  It  reflects what its industry consultants  and so forth                                                               
have indicated is probably the current stress price being used.                                                                 
                                                                                                                                
SENATOR HUGGINS asked whether there  was a tipping point when the                                                               
school of thought changed from gross to net.                                                                                    
                                                                                                                                
COMMISSIONER GALVIN recalled it was  an e-mail from Antony Scott,                                                               
Division of  Oil &  Gas, DNR,  who'd worked  closely with  DOR on                                                               
trying  to  push  the  economic options  to  reflect  a  balanced                                                               
approach to the  analysis.  In the end, Mr.  Scott sent an e-mail                                                               
saying it couldn't  be twisted enough to make it  work, for heavy                                                               
oil in particular.                                                                                                              
                                                                                                                                
COMMISSIONER GALVIN  explained that there was  a concerted effort                                                               
by the  department, and a  clear mandate from the  governor, that                                                               
in the end it must be based  on the analysis and not on politics.                                                               
If another approach  was going to be used, it  had to withstand a                                                               
critical  evaluation.   With each  gross-based option  looked at,                                                               
vulnerabilities  could be  identified  that  might have  impacted                                                               
production.   Thus it was  felt that the  administration couldn't                                                               
go forward with such a recommendation.                                                                                          
                                                                                                                                
CHAIR FRENCH  thanked Commissioner  Galvin, noting  members would                                                               
hear from two international oil consultants next.                                                                               
                                                                                                                                
The committee took an at-ease from 12:01:57 PM until 1:24:12 PM.                                                            
                                                                                                                                
CHAIR FRENCH welcomed Rich Ruggiero and Bob George.                                                                             
                                                                                                                                
^Rich Ruggiero and Bob George, Gaffney Cline                                                                                    
RICH  RUGGIERO,  Gaffney,  Cline  &  Associates  Inc.,  began  by                                                               
explaining the role  of Gaffney Cline.   When originally engaged,                                                               
they  were  to  provide  industry and  worldwide  practices  with                                                               
respect to data submission and where  capital is spent, and a bit                                                               
on the  pros and cons  of net and  gross systems; the  latter was                                                               
summarized  well  in  the  slides shown  earlier  today.    Since                                                               
arriving  in  Juneau a  couple  of  weeks ago,  however,  they've                                                               
become much more  engaged in the fine-tuning, and  last week they                                                               
began building models  to assist legislators in  making the tough                                                               
decisions ahead.  They would show  a series of snapshots that can                                                               
be viewed  as things change  over time, to better  understand the                                                               
repercussions of choosing one tax over another.                                                                                 
                                                                                                                                
MR. RUGGIERO indicated  he and Mr. George  would show, reference,                                                               
and   discuss  information   provided   recently  in   companies'                                                               
presentations  to both  legislative  houses,  recognizing a  high                                                               
likelihood that  this $800 million issue  wouldn't have led  to a                                                               
special session  if there'd been  good data transfer  earlier and                                                               
thus better projections.  For  questions about the data, it would                                                               
be best  to ask  the industry  representatives who  would testify                                                               
later, who  have experience and  can suggest whether  the numbers                                                               
being used are too high, too low, or just right.                                                                                
                                                                                                                                
1:27:45 PM                                                                                                                    
MR.  RUGGIERO, in  response to  Senator Therriault,  outlined his                                                               
credentials.    He'd  spent  about   20  years  with  "big  oil,"                                                               
progressing  from engineer  to  engineering  manager to  district                                                               
engineering  manager.   He'd then  moved to  natural gas  and the                                                               
regulatory  arena  with  respect  to  Federal  Energy  Regulatory                                                               
Commission (FERC)  Orders 451, 500,  436, and  so on.   Then he'd                                                               
gone  into  the  commercial   arena  and  international  business                                                               
development, working 5 years as  a commercial manager with United                                                               
Kingdom  (UK)  operations on  North  Sea  issues, and  ending  as                                                               
project general manager  of Atlantic LNG in Trinidad.   Then he'd                                                               
gone into the "dot.com" world.                                                                                                  
                                                                                                                                
MR.  RUGGIERO  continued with  his  credentials.   For  the  last                                                               
6 years  he  has  been  with  Gaffney  Cline.    His  assignments                                                               
predominantly  have  been  work  with Saudi  Arabia  through  its                                                               
natural   gas  initiative,   including  helping   to  write   its                                                               
regulations  for  midstream  and  downstream,  and  working  with                                                               
Mr. George on some fiscal issues.   Over the last 4 years they've                                                               
assisted Timor-Leste,  the world's newest country  in 2002; along                                                               
with a  couple of other  consultants, they've set up  and written                                                               
that country's legislation and model contracts, for instance.                                                                   
                                                                                                                                
SENATOR THERRIAULT  asked about his interactions  with respect to                                                               
"go or no-go" decisions made in company boardrooms.                                                                             
                                                                                                                                
MR.  RUGGIERO replied  for 2.5  years he  worked for  one of  the                                                               
chief  executives of  the producing  arm of  Amoco, during  which                                                               
time  he was  responsible  for consolidating  aspects of  budgets                                                               
coming up from all the  operating regions and districts, and then                                                               
presenting those budgets to the  most senior corporate committee.                                                               
He saw the  process and often sat through  discussions of whether                                                               
A versus B versus C could be done.                                                                                              
                                                                                                                                
MR. RUGGIERO, acknowledging that experience  is a bit dated, said                                                               
he'd also  sat on  committees that  made decisions;  for example,                                                               
the committee in  the UK made decisions about  investments or how                                                               
to spend budgeted  dollars within that operating  area.  Although                                                               
it  was 10  years ago,  he  surmised the  overall process  hasn't                                                               
changed that much, though environmental  factors have changed and                                                               
may be causing slight tweaks in the decision-making process.                                                                    
                                                                                                                                
1:31:48 PM                                                                                                                    
BOB  GEORGE,  Gaffney,  Cline  &  Associates  Inc.,  offered  his                                                               
credentials,  saying he  has about  35 years  with the  industry,                                                               
mostly with  Gaffney Cline,  but also some  years with  Getty Oil                                                               
and others.   He was working  in the area of  exploration and new                                                               
ventures,  with  responsibility  for  looking  at  new  projects,                                                               
decision making,  budgeting, and  so on.   With Gaffney  Cline he                                                               
spends  about   half  his  time  working   on  government-related                                                               
activities,  including  those  noted  by  Mr. Ruggiero  in  Saudi                                                               
Arabia.   He also  spent a  lot of  time in  the 1990s  and early                                                               
2000s advising governments in Venezuela  and Brazil; he mentioned                                                               
Kuwait and Mexico as well.   On the industry side, the other half                                                               
of  his time  is  spent  in acquisition  and  strategy work  with                                                               
companies   looking  at   property  or   corporate  acquisitions,                                                               
opportunities to rebalance their portfolios and so forth.                                                                       
                                                                                                                                
1:33:02 PM                                                                                                                    
MR.  RUGGIERO began  Gaffney Cline's  PowerPoint presentation  by                                                               
addressing  goals.   He explained  that from  discussions he  and                                                               
Mr. George had heard in the  House, Senate, and elsewhere, they'd                                                               
arrived at five  goals they believe the legislature  is trying to                                                               
achieve with SB 2001.                                                                                                           
                                                                                                                                
MR.  RUGGIERO outlined  the first  goal:   Fields  with a  larger                                                               
margin and  greater profitability, though not  necessarily larger                                                               
profits,  should pay  higher taxes.   The  second goal,  which he                                                               
believes is  supported by the  industry's presentations,  is that                                                               
investment should  be encouraged  today and in  the near  term in                                                               
existing units, which  have lots of upside  potential to capture;                                                               
this  includes not  only new  discoveries, but  also reinvestment                                                               
and  getting  more  oil  out   of  reservoirs  that  are  already                                                               
producing.   Part  of the  challenge for  new investment  is that                                                               
there  is   everything  from  accumulations   of  light   oil  to                                                               
substantial  reserves of  very expensive,  technically challenged                                                               
heavy oil.                                                                                                                      
                                                                                                                                
MR.  RUGGIERO  told members  the  third  goal is  developing  the                                                               
industry  beyond Kuparuk  and Prudhoe  Bay.   The overall  policy                                                               
should encourage  new investment  outside those legacy  areas and                                                               
investment by new  entrants.  Thus today  they'd discuss leveling                                                               
the playing field a bit between  new entrants and incumbents.  In                                                               
many countries  incumbents have  such an  advantage, with  such a                                                               
barrier to entry for new players, that little new gets started.                                                                 
                                                                                                                                
MR. RUGGIERO  said the fourth goal  is that the system  should be                                                               
durable, withstanding the test of  time.  The legislature doesn't                                                               
want to be  back in a year  or even in 2011 trying  to fix things                                                               
again.  He expressed confidence that  there is a way forward that                                                               
will provide this durability.   And the fifth goal they've heard,                                                               
becoming a  strong voice,  is to  build upon  the many  months of                                                               
discussion, compromise, and other work on PPT last year.                                                                        
                                                                                                                                
1:38:16 PM                                                                                                                    
MR. RUGGIERO  showed a slide  that elaborated on the  third goal,                                                               
encouraging new investment for new  players.  He reminded members                                                               
that in previous  testimony Gaffney Cline had said  Alaska is one                                                               
of the very best in providing incentives for new exploration.                                                                   
                                                                                                                                
CHAIR FRENCH asked whether that is a worldwide comparison.                                                                      
                                                                                                                                
MR. RUGGIERO replied if he looks  at the structure of what Alaska                                                               
is doing, yes.                                                                                                                  
                                                                                                                                
CHAIR FRENCH asked whether that is currently.                                                                                   
                                                                                                                                
MR.  RUGGIERO  affirmed  that.    He  explained  that  there  are                                                               
investment credits that  can be turned into cash, and  there is a                                                               
net  operating  loss   which,  a  year  after   they've  had  the                                                               
investment,  companies  can turn  in  for  cash, a  feature  only                                                               
Norway has  as well, to his  knowledge.  Thus a  new entrant with                                                               
no existing tax base  to be able to write this  off - should that                                                               
company  come  to  Alaska  and  spend  the  millions  of  dollars                                                               
required to explore for oil and  gas, but not find anything - can                                                               
get the  same type of  benefit that  an existing player,  with an                                                               
existing taxable base, has in doing the same type of investment.                                                                
                                                                                                                                
MR.  RUGGIERO  opined  that  PPT  has gone  a  long  ways  toward                                                               
leveling the  playing field between  new entrants  and incumbents                                                               
and also  encouraging that investment.   He speculated  that many                                                               
of the  costs that increased  once PPT came in  were investments,                                                               
not operating  expenses.   As for  investments encouraged  by the                                                               
bill, he  recalled that one  of the "independents" said  that due                                                               
to these  credits they  are looking  to go from  a one-well  to a                                                               
four-well program.  This type  of structure helps new and smaller                                                               
entrants become  players in  Alaska, because  a lot  of companies                                                               
don't  have the  financial  wherewithal to  suffer a  100 percent                                                               
write-down with no chance of any recovery.                                                                                      
                                                                                                                                
1:40:16 PM                                                                                                                    
MR. RUGGIERO said he believes overall,  so long as there is a net                                                               
system with  some level of  progressivity, new  developments will                                                               
be further  away from existing  infrastructure.  Thus  even light                                                               
oil will be more expensive to produce  on a unit basis.  Having a                                                               
system with progressivity,  so a lower margin results  in a lower                                                               
tax rate, also helps encourage exploration.                                                                                     
                                                                                                                                
MR.  RUGGIERO recalled  testimony,  from  Chevron perhaps,  about                                                               
going  through an  expected monetary  value  (EMV) evaluation  in                                                               
deciding about investments, looking at  the chance of failure and                                                               
the cost of failure, but also  the chance of success and how much                                                               
money can  be made if  successful.  He  said people will  ask how                                                               
the system benefits  them if they're successful,  looking at what                                                               
the  fiscal  system does  and  also  at  the distance  and  rules                                                               
relating to infrastructure  access.  All this  must be considered                                                               
when deciding whether Alaska is a good place to invest.                                                                         
                                                                                                                                
1:42:13 PM                                                                                                                    
MR. RUGGIERO  highlighted whether  the base  rate is  low enough,                                                               
given the high  cost of doing business in Alaska.   He emphasized                                                               
that significant  new development  would extend  the life  of the                                                               
Trans-Alaska  Pipeline  System  (TAPS).     Some  commentary  has                                                               
indicated a minimum rate of  300,000 barrels a day, although that                                                               
was  listed  carefully as  a  mechanical  limit, rather  than  an                                                               
economic  limit.   Although  existing  fields  are on  a  natural                                                               
decline,  a larger  number of  barrels would  have a  significant                                                               
ripple effect into  the economics, production, and so  forth.  He                                                               
summarized that  Alaska is  a good  place for  accomplishing goal                                                               
three, encouraging investment for new entrants.                                                                                 
                                                                                                                                
1:43:37 PM                                                                                                                    
SENATOR HUGGINS asked why gas was included on the slide.                                                                        
                                                                                                                                
MR. RUGGIERO  answered that the  main heading of that  section is                                                               
"Lower tax  rate for fields with  a higher cost structure."   Due                                                               
to  the nature  of the  price received  in the  marketplace on  a                                                               
barrel-of-oil-equivalent basis and the cost,  the margins for gas                                                               
development  will  be  much  less than  the  current  margin  for                                                               
production  in  units  such  as   Prudhoe  Bay  or  Kuparuk,  for                                                               
instance.   Likewise,  heavy oil  and distant  fields have  lower                                                               
margins.  The market value comes down  and the costs come up on a                                                               
unit basis.   If the system  corrects and lowers the  tax rate or                                                               
increases the  credit when that  type of thing happens,  then the                                                               
system is responsive,  regardless of what type  of development is                                                               
brought forward.   Gas fits into the thinking  of "more expensive                                                               
to develop," and it nets a lower margin.                                                                                        
                                                                                                                                
SENATOR HUGGINS  encouraged thinking about  gas, which is  on the                                                               
horizon.    He  opined  that  deferring  it  too  long  would  be                                                               
counterproductive.                                                                                                              
                                                                                                                                
1:45:43 PM                                                                                                                    
MR.  RUGGIERO   showed  a  slide   labeled  "The   Fiscal  Design                                                               
Challenge."  Referring to goals one and two, he said the tug-of-                                                                
war in  the fiscal design  is the  same here as  everywhere else:                                                               
How  to get  the take  right, the  take being  however the  state                                                               
receives value for  its resources, and also how to  get the "give                                                               
back" right, meaning how the state encourages investment.                                                                       
                                                                                                                                
MR. RUGGIERO  said within existing  units this has been  the real                                                               
challenge in  the dialogue, since the  desire is to find  a level                                                               
of  take that  either  encourages or  doesn't discourage  further                                                               
investment  in those  units, because  there is  value there.   He                                                               
noted  the third  section of  today's presentation  would address                                                               
the  tipping point  and  so on.    He said  they'd  just put  the                                                               
aforementioned up as a difficult issue.                                                                                         
                                                                                                                                
MR. RUGGIERO added that probably the  biggest part - going to the                                                               
heart  of  the dialogue  with  Commissioner  Galvin this  morning                                                               
about expected revenues  - is that the industry  has three moving                                                               
parts:   price, production, and  cost.  It's like  a three-legged                                                               
stool.  The minute one changes  from what was expected, it starts                                                               
to lean  quickly.  Just as  one talks about a  net-margin system,                                                               
that margin  can change if only  one variable changes, or  it may                                                               
change as  all three variables change.   It isn't easy  to try to                                                               
predict that.                                                                                                                   
                                                                                                                                
MR. RUGGIERO  emphasized putting  together a fiscal  system which                                                               
recognizes that  those move,  but without  losing sight  of those                                                               
two  goals:    1) ensuring  the  state gets  its  fair  take  and                                                               
2) ensuring there  is no discouragement of  the reinvestment that                                                               
needs to occur in those two existing legacy units.                                                                              
                                                                                                                                
1:48:17 PM                                                                                                                    
CHAIR FRENCH  welcomed Senator Hoffman and  also welcomed Senator                                                               
Stevens to the afternoon portion of the hearing.                                                                                
                                                                                                                                
MR.  RUGGIERO  showed slides  emphasizing  a  key point  that  is                                                               
easily misunderstood:   Price doesn't equal margin.   He said PPT                                                               
is not about price.  Rather,  PPT and the whole net structure are                                                               
about margin.  As an example, if there is a $50 price and a $10-                                                                
a-barrel cost,  the margin is  $40.   If there is  a $20-a-barrel                                                               
cost, there is a $30 margin at the  same price.  For heavy oil or                                                               
gas or  a development distant  from existing  infrastructure, the                                                               
price could be $50 a barrel and yet there'd be no margin at all.                                                                
                                                                                                                                
MR. RUGGIERO  highlighted ways to get  different margins starting                                                               
with  a price:   1)  the  natural decline  over time,  2) new  or                                                               
different development, and 3) oil versus  gas.  He explained that                                                               
if there  is a certain  fixed cost  of operation but  the barrels                                                               
decline  over time,  one's  unit  cost per  barrel  rises.   Just                                                               
through being a  prudent operator doing the best  possible in the                                                               
field, someone will have a decreasing  margin.  Thus over time if                                                               
something is fixed at $50, a  development that has no margin - no                                                               
profit - may be taxed.  Or gas  might have a very low margin, for                                                               
instance.   He again emphasized  the need to separate  price from                                                               
margin when talking about taxes.                                                                                                
                                                                                                                                
MR. RUGGIERO  showed another slide.   He  said if he  begins with                                                               
something that  has a $40  margin -  meaning the cash  flow after                                                               
costs is $40 a  barrel - and then throws a  legacy field onto the                                                               
curve  that shows  margin versus  the market  price, that  margin                                                               
will  be achieved  when the  market  hits $60,  since the  legacy                                                               
fields generally have about a $20 "all in" cost.                                                                                
                                                                                                                                
MR. RUGGIERO  said for new  development, however,  which requires                                                               
additional  capital expenditures  for infrastructure  and so  on,                                                               
the $40  margin won't be achieved  until the market gets  to $70;                                                               
for  heavy oil,  it might  require $80;  and for  gas, under  the                                                               
current dynamics, it  might require the equivalent of  a $100 oil                                                               
price before  seeing a $40  margin on  a barrel-of-oil-equivalent                                                               
basis.   Again, market price  doesn't equal  margin.  Even  if it                                                               
equals it today, it  may not tomorrow or next year.   And even if                                                               
the price doesn't change, the margin will change.                                                                               
                                                                                                                                
1:53:33 PM                                                                                                                    
SENATOR HUGGINS recalled that Dr.  Pedro van Meurs had said there                                                               
isn't  a  correlation between  gas  and  oil at  this  particular                                                               
juncture.   Instead,  oil is  taken  off and  gas is  essentially                                                               
dormant with  respect to price.   He asked whether  a correlation                                                               
can be made when looking at it from the perspective of margin.                                                                  
                                                                                                                                
MR.  RUGGIERO  responded  that there  is  no  fixed  relationship                                                               
between the price of gas and the  price of oil; it is moving.  As                                                               
he'd understood  it, Dr. van  Meurs was  talking about  Henry Hub                                                               
relative to West  Texas.  What didn't come into  that dialogue is                                                               
this:  Gas  from Alaska currently goes to  markets different from                                                               
the Lower 48.   Other markets  in the  Pacific basin have  a very                                                               
different price relationship  between gas and oil.   With respect                                                               
to options  and potential actions, however,  Mr. Ruggiero said he                                                               
hadn't looked  into details of  what it would cost,  the options,                                                               
or why  one course would  be chosen  over another.   He suggested                                                               
this relationship should be added as the fourth moving part.                                                                    
                                                                                                                                
1:55:13 PM                                                                                                                    
MR.  RUGGIERO  showed  the  final  slide  on  price  and  margin,                                                               
addressing how  to pull this  into a  single mechanism.   He said                                                               
PPT has  a base  rate, has  a degree  of progressivity,  and then                                                               
reaches a maximum rate.   If everything except market price could                                                               
actually  be fixed,  it would  have  to get  to $170  to $180  at                                                               
today's cost structure before maxing out PPT.                                                                                   
                                                                                                                                
MR.  RUGGIERO continued.   Given  that today'  cost structure  is                                                               
about $20 a barrel,  he said that is a margin  per barrel of $150                                                               
before maxing out PPT.  Knowing  that costs will move with price,                                                               
however, who knows  where that maximum level would  be reached in                                                               
the legislation.   It could be $180  to as high as  $250 or $260,                                                               
depending  on   the  relationship  and  elasticity   between  the                                                               
movement in oil price and the  movement in cost.  It would likely                                                               
have to be  over $200 before ever hitting the  maximum rate under                                                               
PPT.  Thus he suggested if there  starts to be a dialogue about a                                                               
maximum rate  being so high  it's penal,  people need to  look at                                                               
where that must get to before it ever kicks in.                                                                                 
 `                                                                                                                              
MR. RUGGIERO continued, noting ACES  raises the base rate and has                                                               
a slightly lower,  sloped progressivity.  Not shown  on the slide                                                               
was that it  flattens out at a  maximum rate.  This  relates to a                                                               
plus-or-minus  $200  West  Texas  "price  world"  before  getting                                                               
anywhere near the maximum rate  under ACES.  Reminding members of                                                               
the five goals and that the  first and second goals had just been                                                               
discussed, he said it is possible  to choose something that has a                                                               
base rate but actually make progressivity  more of a curve than a                                                               
straight line or  a single rate, capping out at  the maximum rate                                                               
a lot sooner than would happen in a $200 price world.                                                                           
                                                                                                                                
1:58:04 PM                                                                                                                    
CHAIR  FRENCH asked  whether each  of  those three  lines on  the                                                               
slide represents different progressivity rates.                                                                                 
                                                                                                                                
MR. RUGGIERO  pointed out  this is  slightly different  from what                                                               
was  shown to  the House.   This  is just  a suggestion,  because                                                               
they've  heard   there  are  different   views.    He   said  the                                                               
commissioner  was clear  that  the  administration's position  is                                                               
that they'd  be talking about  the top  ACES line, in  red, which                                                               
starts at a 25 percent base rate.  He mentioned goal three.                                                                     
                                                                                                                                
MR. RUGGIERO further  responded that the green  lines represent a                                                               
net tax system.   Conceptually, depending on what is  chosen as a                                                               
starting  point  -  for  instance,   25  percent,  which  is  the                                                               
administration's   position,   22.5,   which   is   the   current                                                               
percentage, or something lower -  there'd be a rate function that                                                               
climbs  as  the   margin  climbs.    It   is  an  ever-increasing                                                               
progressivity factor until a maximum rate is hit.                                                                               
                                                                                                                                
1:59:39 PM                                                                                                                    
SENATOR  WIELECHOWSKI  asked  whether  the  Palin  Administration                                                               
endorses this new approach.                                                                                                     
                                                                                                                                
MR. RUGGIERO replied he couldn't  say, but yesterday Commissioner                                                               
Galvin testified  that the administration endorses  a system that                                                               
starts  at 25  percent; if  they're going  to give  up the  gross                                                               
minimum floor, a trade-off would be to get more at the top end.                                                                 
                                                                                                                                
SENATOR HUGGINS remarked, "Balance."                                                                                            
                                                                                                                                
2:00:31 PM                                                                                                                    
CHAIR  FRENCH surmised  each  green  line on  the  graph shows  a                                                               
progressivity factor.                                                                                                           
                                                                                                                                
MR.  RUGGIERO replied  it starts  out at  zero progressivity  and                                                               
ends up at 100 percent  progressivity at that very last increment                                                               
before the maximum is hit.                                                                                                      
                                                                                                                                
CHAIR FRENCH asked at what level per dollar it rises.                                                                           
                                                                                                                                
MR. RUGGIERO  answered that  Gaffney Cline  hasn't said  where it                                                               
should start or end.  At this point, it is a general concept.                                                                   
                                                                                                                                
SENATOR  McGUIRE mentioned  a price  of  $200 and  asked how  the                                                               
maximum rate was picked.                                                                                                        
                                                                                                                                
MR.  RUGGIERO  replied they  hadn't  yet  picked the  rate.  This                                                               
section and  the next  one, which Mr.  George would  address, are                                                               
conceptual.  The  idea, as Senator Huggins said, is  balance.  If                                                               
some protection will be given up on  the low end and the state is                                                               
going to  be put in  the same position  as the oil  companies, it                                                               
will  suffer a  bit  if prices  go through  the  floor, but  also                                                               
should benefit when the prices go through the ceiling.                                                                          
                                                                                                                                
SENATOR  McGUIRE  agreed with  that  concept,  but said  she  was                                                               
trying to understand the idea of having a maximum rate.                                                                         
                                                                                                                                
MR.  RUGGIERO replied  this is  based off  of margin,  not price.                                                               
When the margin  gets huge - whether  the price is $80  or $200 -                                                               
that's when the state should be taking its maximum fair share.                                                                  
                                                                                                                                
SENATOR  HUGGINS surmised  that,  theoretically,  at the  maximum                                                               
rate the  profit margin would  be taken away if  the mathematical                                                               
equation were run all the way through.                                                                                          
                                                                                                                                
MR. RUGGIERO  replied that once  the margin is large  enough that                                                               
it is  on the plateau  of that  curve, Senator Huggins  is right.                                                               
As the margin moves up or  down, there'd be no further percentage                                                               
change in the state's share of the incremental dollar.                                                                          
                                                                                                                                
2:04:35 PM                                                                                                                    
MR.  RUGGIERO  continued with  the  same  slide, turning  to  the                                                               
ellipse on  the lower left, relating  to goal three.   With a net                                                               
system, the reason  there is a low  rate at a large  margin is to                                                               
encourage investment  in fields or  projects that fall  into that                                                               
range.  Whether the oil price  is $10 or $80, there are expensive                                                               
projects.  For  example, a lot of the heavy  oil is becoming more                                                               
economically  viable as  prices rise.    And there  will be  more                                                               
things that require  a bit more expensive development  - when the                                                               
price is there,  there'll be a positive margin or  cash flow from                                                               
operations.   That is when  those types of investments  should be                                                               
encouraged  to continue  production, continue  the livelihood  of                                                               
existing fields,  and continue the  state's helping  the industry                                                               
to develop Alaska's natural resources.                                                                                          
                                                                                                                                
2:05:43 PM                                                                                                                    
SENATOR  WIELECHOWSKI referenced  Commissioner Galvin's  comments                                                               
in the  last session, asking whether  the higher rate at  the low                                                               
end here  encourages more investment  in certain types  of fields                                                               
like the legacy fields.                                                                                                         
                                                                                                                                
MR.  RUGGIERO asked  him to  wait until  the second  part of  the                                                               
presentation, when  Mr. George would  address issues  and impacts                                                               
associated with  varying rates and  progressivity.   Returning to                                                               
the  slide, he  said the  last development  on the  curve is  the                                                               
ellipse, the existing field issues.  He explained:                                                                              
                                                                                                                                
     What you'll  see is,  when I'm  up at  the high  end of                                                                    
     progressivity,  one,  to  the  extent  that  cash  from                                                                    
     operations is generated,  if it exits the  state it has                                                                    
     to go through a high-priced  state-take filter.  To the                                                                    
     extent  it  stays  in  the   state,  that  provides  an                                                                    
     incentive  for  them to  keep  the  money here  and  to                                                                    
     reinvest it,  because the state  becomes a  much larger                                                                    
     participant  in  each  and   every  one  of  those  new                                                                    
     investments that  they make when they're  at that point                                                                    
     on the curve.                                                                                                              
                                                                                                                                
MR. RUGGIERO gave  an analogy of shining a light  in a room, with                                                               
dark  corners  remaining.    He  said  one  dark  corner  of  the                                                               
presentation or philosophy here is  that when the maximum rate is                                                               
approached, there is  a question whether the  incentive to invest                                                               
needs   the  credits   additionally.     Depending  on   how  the                                                               
progressivity rate is set and when  the maximum is hit, the state                                                               
may wish to consider modifying how and when credits are earned.                                                                 
                                                                                                                                
MR.  RUGGIERO  cautioned  against   getting  into  the  following                                                               
mathematically  possible position:    If 20  percent credits  are                                                               
retained  and there  is a  steep progressivity  curve, the  point                                                               
could be  reached where  investments could be  made and  with the                                                               
20 percent credit the state could  actually be handing a check to                                                               
whoever  invested.     The  government   share  would   be  above                                                               
100 percent.  The state doesn't want to get into that position.                                                                 
                                                                                                                                
MR.  RUGGIERO noted  that  the  state doesn't  want  to get  near                                                               
100 percent either.   It isn't that the oil  companies would make                                                               
unwise  investments,  but  they   might  be  encouraged  to  make                                                               
investments  or gold  plate things  because the  state is  paying                                                               
nearly  100 percent  of  it.   Depending  on  what  is done  with                                                               
respect  to setting  the core  aspect of  the taxing  policy, the                                                               
legislature  will have  to look  at  the other  pieces, test  the                                                               
reasonableness of  those at various  points along the  curve, and                                                               
then make appropriate decisions from that.                                                                                      
                                                                                                                                
2:08:48 PM                                                                                                                    
SENATOR HUGGINS  asked about  a progressivity  factor that  has a                                                               
gross component.                                                                                                                
                                                                                                                                
MR. RUGGIERO returned to the  price-versus-margin slide.  He said                                                               
if  there  is   progressivity  based  on  gross,   the  field  or                                                               
development to the  far right has a zero margin  at $50 a barrel.                                                               
But if some  gross progressivity is set up that  kicks off at $30                                                               
or $40, it will  have the taxes going up on a  gross basis off of                                                               
gross revenue when it is making no profit.                                                                                      
                                                                                                                                
SENATOR HUGGINS asked what happens if it kicks in at $70.                                                                       
                                                                                                                                
MR. RUGGIERO  answered that  when talking  about net  systems and                                                               
net progressivity  and gross systems,  one of  the commissioner's                                                               
bullet  points this  morning was  perfect.   If someone  picks an                                                               
exact situation,  he could pick  numerous grosses that  work, but                                                               
also numerous  ones that don't  work.  That raises  the challenge                                                               
of goal number  four, durability.  The question  becomes how many                                                               
"dials" to put  on it, and how often the  legislature wants to be                                                               
back tweaking the system.                                                                                                       
                                                                                                                                
SENATOR  THERRIAULT  suggested  that's  part of  the  debate  the                                                               
legislature   went  through   before,  starting   with  a   gross                                                               
progressivity  trigger and  then,  through deliberations,  coming                                                               
back to  having it  based on  the net.   He recalled  thinking it                                                               
might work  for a certain range  of prices, but if  the desire is                                                               
to set up something that will  have durability, at least 10 or 15                                                               
years, who knows what the prices or costs will be.                                                                              
                                                                                                                                
MR. RUGGIERO turned the presentation over to Bob George.                                                                        
                                                                                                                                
2:11:17 PM                                                                                                                    
MR. GEORGE  showed slide 29, "The  Net Tax Story."   He said this                                                               
past weekend  they'd started looking  at models on this.   Having                                                               
listened in  the first week  to what  people were saying,  he was                                                               
bothered a  bit by some  characterizations of how the  tax worked                                                               
and  thus  had looked  "under  the  hood."   He  highlighted  the                                                               
perception  that   this  is   a  tax  on   net  profits   with  a                                                               
progressivity   feature  that   increases  the   tax  rate   with                                                               
increasing  profitability per  barrel.   He  indicated  in a  few                                                               
moments  he would  try to  change that  perception slightly  with                                                               
respect to the term "profitability."                                                                                            
                                                                                                                                
MR. GEORGE  also highlighted  the perception  that this  is ring-                                                               
fenced  so  the  stated  profitability   per  barrel  reflects  a                                                               
company's portfolio, which  is a mix of  investments in different                                                               
fields and isn't  the same for everybody.  He  would try to break                                                               
out  some portfolio  components to  see how  that comes  together                                                               
with  the   company's  decision-making   processes,  particularly                                                               
looking   at  the   implications   of  the   tax  structure   for                                                               
reinvestment.                                                                                                                   
                                                                                                                                
2:13:12 PM                                                                                                                    
MR.  GEORGE showed  slide 31,  noting  he was  starting with  the                                                               
simple position that  is classically portrayed, with  an ANS West                                                               
Coast oil price of $80 a barrel  as an example.  It is known that                                                               
transportation  costs and  so forth  to the  North Slope  will be                                                               
about $10 a barrel.  At the  point of production there is a value                                                               
on the  order of $70 a  barrel.  These numbers  are illustrative,                                                               
with $18  a barrel in  costs.  Thus the  profit is $52  a barrel.                                                               
He would  start and  end with  that premise,  but would  break it                                                               
apart first.                                                                                                                    
                                                                                                                                
MR. GEORGE  showed slide  32, saying  if he has  $52 a  barrel in                                                               
profit, there  is a fairly  straightforward mechanism  within the                                                               
definition of  PPT such that he'd  pay about 25.5 percent.   That                                                               
is 22.5  percent up until  the margin gets to  $40 a barrel.   In                                                               
this case, there  is a $52 margin that is  the profit per barrel.                                                               
Some  progressivity  kicks in,  increasing  the  rate payable  by                                                               
3 percentage points, which gives the 25.5 percent.                                                                              
                                                                                                                                
2:15:03 PM                                                                                                                    
CHAIR  FRENCH  asked  how  the   kick-off  point  is  picked  for                                                               
progressivity.                                                                                                                  
                                                                                                                                
MR. GEORGE  answered that there is  a lot of judgment  at the end                                                               
of the day.   In further response  as to being able  to compute a                                                               
number,  he indicated  he  didn't  know of  any  such  way.   The                                                               
perception is  that within  a company's  portfolio under  PPT the                                                               
net  taxes all  fields at  a single  rate.   In the  way the  tax                                                               
returns  are submitted,  it  is a  backed-out  number that  would                                                               
indeed be the case.  However,  he offered the perception that the                                                               
effective rate  can be  quite different  for different  fields in                                                               
the portfolio,  which goes  to the  heart of  a number  of issues                                                               
raised  here in  terms of  the goal  of allowing  more challenged                                                               
fields to be  taxed at slightly different rates.   He would break                                                               
things out to show why he believes that is how it works.                                                                        
                                                                                                                                
MR. GEORGE showed slides 34 and  35, saying he would try to build                                                               
up a portfolio  of incremental investments to see  how the nature                                                               
of PPT  works to  deal with each  of these  slightly differently.                                                               
He'd  chosen  an  existing  portfolio  of  investments  of  about                                                               
200,000 barrels a  day, with the assumption of a  $65 margin.  In                                                               
that  case, the  PPT  payable  on that  portfolio  would be  28.4                                                               
percent; this is straight from the PPT formula.                                                                                 
                                                                                                                                
2:17:31 PM                                                                                                                    
MR. GEORGE showed slides 36-39,  discussing a company's decision-                                                               
making  processes when  considering new  investments under  a tax                                                               
structure like PPT.  It looks  at what happens if it does nothing                                                               
versus if it makes an  investment; running something in isolation                                                               
won't provide  the right answer.   The additional layer  about an                                                               
investment would  be added, and the  return would be viewed.   In                                                               
the example there is similar  profitability, $61 a barrel instead                                                               
of $65.  It  will bring in about another 50,000  barrels a day on                                                               
top  of the  200,000  barrel-a-day portfolio.    The average  net                                                               
margin for the  two is $64.20; he mentioned the  weighting of the                                                               
volumes and  the different profitability.   The combined  rate on                                                               
these fields would be 28.2 percent off a $64.20 margin.                                                                         
                                                                                                                                
MR.  GEORGE asked  if  that  means paying  28.2  percent on  each                                                               
field;  he  said  no.    However,  if  these  were  two  separate                                                               
investment decisions, with each field  taxed on its own, he'd pay                                                               
28.4 percent on the field with  a $65 margin, 27.5 percent on the                                                               
field  with  a   $61  margin,  and  for   the  blended  portfolio                                                               
28.2 percent.  The  effect of PPT is such that  he'd pay slightly                                                               
less on  the new field  than if it  were on a  stand-alone basis.                                                               
It doesn't show in the first example, but shows in later ones.                                                                  
                                                                                                                                
MR. GEORGE  said this impact  within the portfolio  has important                                                               
consequences  when moving  into  heavier oil  or more  challenged                                                               
fields.  The  effective rate on new investment  is different from                                                               
the blended rate.  The  portfolio together pays 28.2 percent, but                                                               
actually the  28.4 percent  is paid on  the original  property if                                                               
nothing is  done; if the  investment is made, 28.2  overall would                                                               
be  paid, but  that is  the same  as paying  28.4 percent  on the                                                               
existing investment, but  only 27.4 on the new  investment.  Thus                                                               
the  new investment  - which  isn't  quite as  profitable as  the                                                               
existing one - gets taxed at a lower rate.                                                                                      
                                                                                                                                
2:21:00 PM                                                                                                                    
MR. GEORGE moved to a broader  portfolio, slide 42.  He said this                                                               
could  be done  progressively, adding  new investment  decisions.                                                               
He'd made  up a portfolio  of an  existing 200,000 barrels  a day                                                               
with a  $65-a-barrel margin.   Investment X was  at $61.   A more                                                               
challenged one  was added, with a  $50 margin, as well  as one at                                                               
$37.   Those are examples  only.   Each of those  new investments                                                               
adds  50,000  a   day  to  the  portfolio,   but  has  decreasing                                                               
profitability individually.                                                                                                     
                                                                                                                                
MR.  GEORGE   addressed  what  happens   then.    He   said  each                                                               
incremental one  that is less  profitable pays a lower  and lower                                                               
marginal  or  effective  rate  within that  portfolio.    If  the                                                               
portfolio is  considered in its  entirety, it pays  26.9 percent.                                                               
One might  think existing reservoirs  pay 26.9 and the  much more                                                               
challenged one pays  26.9.  But this isn't so.   The existing one                                                               
pays  the  same  as  if  nothing  were  done,  over  28  percent.                                                               
However, the  most challenged investment  out of  this particular                                                               
set  actually  pays  an  effective rate  just  under  19  percent                                                               
because that is its impact within  the portfolio.  This effect is                                                               
what companies look at when making investment decisions.                                                                        
                                                                                                                                
MR. GEORGE  showed slide  44, saying if  one simply  averages the                                                               
rates in  the portfolio, it  would be about 27.3  percent between                                                               
what each property  would pay as an investment in  its own right.                                                               
When   blended,  however,   there  is   a  slight   decrease,  to                                                               
26.9 percent.   It is how  the progressive structure works.   The                                                               
net result  is that the  more challenged fields pay  lower rates.                                                               
A  feature   actually  provides  greater  encouragement   to  the                                                               
marginal  fields relative  to  the more  profitable  fields.   It                                                               
works to take  the cash from the more profitable  ones and put it                                                               
into less profitable investments in there.                                                                                      
                                                                                                                                
2:23:45 PM                                                                                                                    
CHAIR FRENCH asked whether it  is oversimplying to say this basic                                                               
structure allows  future investments in the  same jurisdiction to                                                               
produce a  better tax  result than  if that  money were  moved to                                                               
another jurisdiction.                                                                                                           
                                                                                                                                
MR.  GEORGE   replied  it  does   encourage  reinvestment.     It                                                               
segregates  the rate  payable  within that,  such  that it  isn't                                                               
burdening new,  less profitable  investments on  a unit  basis, a                                                               
dollars-a-barrel  basis, with  the same  rate as  existing legacy                                                               
production, which  is higher-margin production.   This relates to                                                               
what Mr. Ruggiero showed on the chart with the green bar.                                                                       
                                                                                                                                
MR.  GEORGE  explained  that  within a  single  system,  one  can                                                               
effectively tax  more profitable units  at a higher  rate without                                                               
necessarily  hurting  the  less profitable  units;  those  aren't                                                               
burdened  by   that  same  rate   and  are  helped  by   how  the                                                               
progressivity works  for the  most part.   Not  only can  they be                                                               
taxed  at  a   lower  rate,  however.    In   this  case,  taking                                                               
Investment Z on  its own within  the same portfolio, it  would be                                                               
taxed at 22.5  percent.  But the progressivity gives  it an extra                                                               
boost to  take the rate  below 19 percent  on that margin.   That                                                               
movement  of  the  rate,  as  well  as  the  tax  base,  gives  a                                                               
reinvestment boost within the system.                                                                                           
                                                                                                                                
2:26:03 PM                                                                                                                    
CHAIR FRENCH asked  if this is only for an  explorer or developer                                                               
with an existing portfolio within that tax jurisdiction.                                                                        
                                                                                                                                
MR.  GEORGE affirmed  that, saying  a completely  new entrant  in                                                               
this  case  is helped  by  the  investment  tax credits  and  the                                                               
ability to  monetize the net  operating losses (NOLs).   But this                                                               
sort of  effect wouldn't occur  until there was production  and a                                                               
change came out of that.                                                                                                        
                                                                                                                                
MR. RUGGIERO  suggested looking at  the two numbers  for Field Z.                                                               
Because  of  its  low  margin,   an  independent  with  no  other                                                               
production in the  state who came in to do  this project would be                                                               
looking  at  an   effective  tax  rate  at  the   floor  of  PPT,                                                               
22.5 percent.   But because this  is an existing producer  with a                                                               
portfolio,  as  Mr.  George  said,  there  is  the  "do  nothing"                                                               
scenario and  related cash  flow, as well  as the  "do something"                                                               
scenario, which is to invest in Field  Z.  When ones looks at the                                                               
delta, the  effective tax  rate comes down  to 18.9 percent.   As                                                               
progressivity increases, that number comes down.                                                                                
                                                                                                                                
CHAIR  FRENCH surmised  that the  steeper the  progressivity, the                                                               
lower the effective tax rate would be.                                                                                          
                                                                                                                                
MR. GEORGE and MR. RUGGIERO concurred.                                                                                          
                                                                                                                                
SENATOR WIELECHOWSKI  asked whether  PPT is advantageous  for the                                                               
producers  that  are already  there,  but  not  as much  for  new                                                               
entrants, which legislators want to try to encourage to come in.                                                                
                                                                                                                                
MR.  GEORGE replied  no,  he thinks  if they  both  had the  same                                                               
opportunity to invest  in the same project, the  company that had                                                               
an existing portfolio at a  higher margin than the new investment                                                               
would actually get a break over  and above that for the producer.                                                               
He  noted Mr.  Ruggiero had  introduced something  a bit  earlier                                                               
when talking about the curve with  the green line, related to the                                                               
issue  of  investment credits  and  whether  and to  what  extent                                                               
they'd be needed.                                                                                                               
                                                                                                                                
MR. GEORGE  went on to say,  in part, this issue  comes into play                                                               
here.    If there  is  steeper  progressivity and/or  payment  at                                                               
higher  rates  in  the  existing portfolio,  there  is  a  better                                                               
effect.    The  desirability  of keeping  the  credits  in  there                                                               
requires looking at it because  of the effects produced.  Someone                                                               
with a  portfolio that pays 35  or 40 percent, for  instance, who                                                               
through  the investments  would  actually get  a good  reduction,                                                               
wouldn't need  the same  credits as the  explorer.   Some greater                                                               
evening out  would be provided,  though whether it could  be made                                                               
perfectly even, he didn't know.                                                                                                 
                                                                                                                                
2:29:25 PM                                                                                                                    
MR. GEORGE  reminded members that  he'd voiced concern  about how                                                               
costs are being  expressed.  Although PPT is commonly  said to be                                                               
based on profit per barrel, it  isn't.  Rather, it's based on net                                                               
cash flow per barrel after  capital investment.  Those two aren't                                                               
quite the same thing, largely  because capital investment relates                                                               
to future barrels divided by today's barrels.                                                                                   
                                                                                                                                
MR.  GEORGE  showed  slides 46-48,  noting  the  portfolio  shown                                                               
earlier had a blended rate of  26.9 percent, not the 25.5 percent                                                               
he'd been talking about.  There is  a reason for this.  Using the                                                               
same portfolio shown  before, if he were budgeting  for 2008, for                                                               
example, he'd be asking how much  money he'd spend next year.  If                                                               
he were  considering spending $800  million, it would  reduce the                                                               
blended rate of the portfolio  from 26.9 percent to 25.5 percent.                                                               
But the elements within it must be looked at.                                                                                   
                                                                                                                                
MR. GEORGE said  if it were producing 350,000 barrels  a day, the                                                               
$800 million he  was considering investing would  equate to $6.26                                                               
a barrel  in the existing  portfolio.   That isn't $6.26  for the                                                               
barrels he'd  necessarily get  out, which  could be  a completely                                                               
different number.   Rather, it is $6.26  for existing production.                                                               
If he only had half that  portfolio, it would be $12.52 a barrel.                                                               
If  he had  twice the  amount of  production today,  it would  be                                                               
$3.13 a barrel.                                                                                                                 
                                                                                                                                
MR. GEORGE showed  slide 51, saying the left  side depicts before                                                               
the  capital  decision  is  made.     Shown  are  lifting  costs,                                                               
operating costs upstream of the  point of production.  To produce                                                               
350,000 barrels  a day, there'd  be $11 a  barrel in costs.   For                                                               
calculating PPT,  he could also  deduct capital he spends  in the                                                               
year.  In  this case, he'd evaluate spending $800  million.  That                                                               
would  allow  him  to  add  another $6.26  a  barrel.    Slightly                                                               
rounded,  the  example  shows  $18  for  the  two  numbers  added                                                               
together, lowering  the blended  tax rate  to 25.5 percent.   But                                                               
there are other ways still of looking at this.                                                                                  
                                                                                                                                
2:33:11 PM                                                                                                                    
MR. GEORGE  showed slide  52.  He  highlighted the  portfolio and                                                               
four  separate  investments  that  individually  are  subject  to                                                               
marginal PPT rates between about 19  and 28 percent; on a blended                                                               
basis,  it is  26.9 percent.   It  he spent  that capital  and it                                                               
brought his overall portfolio PPT  rate down to 25.5 percent, the                                                               
net effect would  be that the state would pick  up 38.6 percent -                                                               
not 26.9 percent - of his $800 million of capital investment.                                                                   
                                                                                                                                
MR. GEORGE showed slide 53, discussing  the reasons for this.  He                                                               
suggested looking  at the  tax system through  the amount  of tax                                                               
payable  and  how these  things  change.    If  he had  the  four                                                               
elements to the  portfolio, with $80 a barrel and  so forth, he'd                                                               
be paying a  little over $2 billion  in PPT.  But  that isn't how                                                               
the tax system works.  It  blends everything together.  One comes                                                               
up with an  average cost per barrel,  and as a result  there is a                                                               
small savings  of $32 million by  taxing them as one  unit rather                                                               
than  four separate  items.    When he  drops  the  rate to  25.5                                                               
percent, the $2 billion drops to just under $1.7 billion.                                                                       
                                                                                                                                
Mr. GEORGE  highlighted total savings  of $309 million.   The net                                                               
effect of deciding to go  forward with an $800 million investment                                                               
is that  the tax rate  and tax base  are both reduced,  since the                                                               
whole $800 million can be deducted  against the tax base as well.                                                               
Thus while $800  is spent, $309 million is saved  in taxes - $215                                                               
million from reducing the taxable  base by $800 million, plus $94                                                               
million from  reducing the  tax rate.   This gives  a significant                                                               
boost to  the capital investment.   It also goes to  the question                                                               
of at what point capital credits are still given or not.                                                                        
                                                                                                                                
MR.  GEORGE concluded  by saying  the  flip side  of the  state's                                                               
taking a  high sum is  giving a high sum  back.  The  question is                                                               
how much  a boost  is needed  for already  profitable operations.                                                               
These effects come at the more profitable end.                                                                                  
                                                                                                                                
2:36:28 PM                                                                                                                    
MR. RUGGIERO  returned to  an earlier  statement he'd  made about                                                               
the other  impact of progressivity:   As  one goes higher  up the                                                               
progressivity curve because of being  overall a higher net-margin                                                               
operation, the  impact seen  here grows.   The $309  million will                                                               
increase.  The state's participation  in the investment increases                                                               
as it gets higher up the progressivity rate curve.                                                                              
                                                                                                                                
CHAIR FRENCH surmised  this creates a greater  incentive to spend                                                               
capital in the same tax jurisdiction.                                                                                           
                                                                                                                                
MR. RUGGIERO agreed.                                                                                                            
                                                                                                                                
MR. GEORGE  concurred, noting  in the  scenario shown  there'd be                                                               
not only $309 million through the  PPT system, but also a further                                                               
$160  million available  from tax  credits.   In this  particular                                                               
example, the  $800 million  investment would  end up  costing the                                                               
investor a net  $330 million, and it would have  a huge effect on                                                               
the rate of return as well  as the investment decisions.  At some                                                               
point, there would be  a need to look at the top  end of this and                                                               
what effect it  has.  Gaffney Cline didn't have  a numeric answer                                                               
today, but it requires some review.                                                                                             
                                                                                                                                
2:38:05 PM                                                                                                                    
MR.  RUGGIERO added  that  he  hoped this  tied  back to  Senator                                                               
Wielechowski's question about why, if  there is a higher tax, the                                                               
rate of  return to the  oil company  can actually be  higher than                                                               
when there is lower tax.  It  relates to the impact of being able                                                               
to get immediate  credits or the impact of  progressivity in that                                                               
the "delta  rate" is  larger than  the absolute  rate at  any one                                                               
given point.                                                                                                                    
                                                                                                                                
SENATOR WIELECHOWSKI  recalled Gaffney  Cline's testimony  in the                                                               
Senate  Resources  Standing  Committee that  about  $6-10 billion                                                               
leaves  the  state  yearly.     He  surmised  if  that  delta  on                                                               
progressivity  were  increased  at  the  higher  levels,  from  a                                                               
financial  standpoint  the  companies  would be  more  likely  to                                                               
reinvest that money  in Alaska, rather than taking  it to Bolivia                                                               
or Venezuela.                                                                                                                   
                                                                                                                                
MR. GEORGE  said there is a  choice for companies at  that point.                                                               
They  either  can export  their  capital  back to  the  corporate                                                               
treasury and pay a high rate or  can reinvest in Alaska and get a                                                               
good co-investment from the state through the tax system.                                                                       
                                                                                                                                
MR. RUGGIERO, in response to  Senator Huggins, specified that the                                                               
slides  being shown  were  finished yesterday  at  1:30 a.m.  and                                                               
presented yesterday to the House with  an October 30 date.  Three                                                               
slides were  then modified.   The  version being  presented today                                                               
carries today's date, October 31.                                                                                               
                                                                                                                                
SENATOR  HUGGINS  expressed  hope  that Gaffney  Cline  would  do                                                               
further work before this goes to the Senate Finance Committee.                                                                  
                                                                                                                                
2:40:58 PM                                                                                                                    
MR.  GEORGE  showed  slides  57  and 58.    He  said  adding  the                                                               
$160 million  in investment  tax credits  doesn't actually  lower                                                               
the  tax rate  to 23 percent,  but has  the same  effect.   It is                                                               
worth about  another 2.5 points  against the profitability.   The                                                               
last slide in this section  relates to costs, broken out slightly                                                               
differently.                                                                                                                    
                                                                                                                                
MR. GEORGE  explained that, to  him, PPT is  really a tax  on the                                                               
net cash flow per barrel that is  exported from the state - not a                                                               
tax on profits per se.  The  operating margin in this case is $58                                                               
a barrel, and a company has a  choice to export that $58 a barrel                                                               
and deploy  the investment elsewhere,  or to deploy some  of that                                                               
$58 a barrel  back in Alaska and  then be taxed on  the amount it                                                               
decides to  export after making  that capital investment.   As it                                                               
is lowered, the company pays  a progressively lower tax rate, and                                                               
it also lowers the tax base.  He  said it is better to look at it                                                               
as a  net cash  flow per barrel  after reinvestment,  rather than                                                               
just a tax on profitability.                                                                                                    
                                                                                                                                
The committee took an at-ease from 2:43:37 PM until 2:57:41 PM.                                                             
                                                                                                                                
MR. GEORGE  showed slides describing the  House Special Committee                                                               
on  Oil and  Gas (HO&G)  amendment to  the progressivity  part of                                                               
PPT.    He  explained  that  currently under  PPT  the  tax  rate                                                               
increases by 0.25 percent for every  dollar by which the net cash                                                               
flow per barrel - profitability,  as expressed in there - exceeds                                                               
$40.    Thus  22.5 percent  is  paid  up  to  a $40  margin,  and                                                               
0.25 percent is paid for every dollar above it.                                                                                 
                                                                                                                                
MR. GEORGE said while the  HO&G amendment maintains the basic PPT                                                               
22.5 percent rate, the progressivity  element adds a separate tax                                                               
that doesn't  affect the  base rate.   Two calculations  are done                                                               
and then the total tax is  added together.  It adds 0.225 percent                                                               
for every dollar that the gross  value at the point of production                                                               
- in simple  terms, the same valuation as for  royalty purposes -                                                               
exceeds $50 a barrel.                                                                                                           
                                                                                                                                
MR. RUGGIERO added that the $40  under PPT is margin, whereas the                                                               
$50 under the amendment is price.                                                                                               
                                                                                                                                
MR.  GEORGE  reiterated that  price  doesn't  equal margin.    He                                                               
referred  to an  earlier slide  relating to  the effective  rates                                                               
applied to the lower-margin fields.   He indicated the next slide                                                               
used  that,  adding  a  red   line  drawn  through  the  marginal                                                               
effective rate  paid by each of  the investments.  It  shows that                                                               
under  the  gross  amendment  proposed by  the  House,  the  rate                                                               
payable on  the existing  fields remains the  same, but  the rate                                                               
for less  profitable fields starts  to go up.   Thus the  bulk of                                                               
the increased  burden is actually  borne by  lower-margin fields,                                                               
not those with higher profitability.   For this, he'd assumed the                                                               
lower margins were  caused by a combination of effects:   a lower                                                               
price  per barrel,  for heavier  oil perhaps,  as well  as higher                                                               
costs.  Thus the margin was being squeezed at both ends.                                                                        
                                                                                                                                
3:01:38 PM                                                                                                                    
CHAIR  FRENCH asked  what  the  blue line  above  the bar  graphs                                                               
represents.                                                                                                                     
                                                                                                                                
MR.  GEORGE  replied  it  is  a directional  line.    In  further                                                               
response,  he said  the black  numbers above  the bars  are rates                                                               
payable by that field if it were  a development on its own.  That                                                               
company would pay  24.9 percent.  The red numbers  inside the bar                                                               
graphs  are the  effective  rate for  that particular  investment                                                               
within the overall portfolio.   The 27.8 percent, relating to the                                                               
bar  to the  right labeled  "blended," is  the averaged-out  rate                                                               
that would apply to the portfolio as a whole.                                                                                   
                                                                                                                                
SENATOR WIELECHOWSKI asked whether  it is the gross progressivity                                                               
in the HO&G version that makes it this way.                                                                                     
                                                                                                                                
MR. GEORGE answered it's because  the progressivity is applied to                                                               
the  value at  the  point of  production,  without deducting  the                                                               
actual costs that  it takes to produce  it.  As it  works in this                                                               
example, moving  from left to  right the fields  are increasingly                                                               
less  profitable  investments,  and  yet the  structure  says  it                                                               
doesn't care  how much the production  costs.  A number  had been                                                               
come up  with, $50 a  barrel.  Everything  above that is  the net                                                               
cash flow  per barrel, which would  be taxed at some  rate.  When                                                               
looked at that way, these less  profitable fields pay sort of the                                                               
same amount, but for a higher proportion of their profits.                                                                      
                                                                                                                                
MR. GEORGE elaborated  on the margin, reiterating  that when he'd                                                               
put this slide together he'd  assumed the lower margin was caused                                                               
by a  squeeze down from the  top from receiving less  per barrel,                                                               
as well  as a squeeze  up from the  bottom, since it  costs more.                                                               
The  House  PPT  progressivity   amendment  does  recognize  that                                                               
because it's the value at the  point of production, it starts off                                                               
with the value at the ultimate point of sale.                                                                                   
                                                                                                                                
MR. GEORGE explained  that if there is heavier  oil, it generally                                                               
means  receiving less  per barrel.   So  that translates  back up                                                               
through the shipping,  the pipeline, and the  point of production                                                               
as a lower  price there.  It brings down  the average price being                                                               
received by the company.  The  effect is that it's higher than it                                                               
would be under  the net system; it still recognizes  some part of                                                               
the reduction in profitability, but not the whole.                                                                              
                                                                                                                                
3:04:56 PM                                                                                                                    
SENATOR HUGGINS  requested clarification about this  slide versus                                                               
the previous one.                                                                                                               
                                                                                                                                
MR. GEORGE said this is what  happens under PPT.  Under the House                                                               
amendment,  the progressivity  portion of  PPT is  replaced by  a                                                               
separate component that  works off the gross.  It  works off that                                                               
amount  by  which  the  average  cash  flow  per  barrel  in  the                                                               
portfolio exceeds $50.   The $50 is a hard number  in there.  The                                                               
effect is  that a company's existing,  more profitable reservoirs                                                               
don't  actually pay  any more;  rather,  it's borne  by the  less                                                               
profitable  ones because  the  company pays  on  the gross  value                                                               
overall, not  on the net  margin that those less  profitable ones                                                               
are subject to.                                                                                                                 
                                                                                                                                
MR.  RUGGIERO  added  that  this is  saying  the  House  proposed                                                               
amendment  isn't taking  any more  money from  high-profitability                                                               
fields.   Instead,  it  creates  a bigger  hurdle  or barrier  to                                                               
development of  low-margin projects  that are  out there  such as                                                               
the significant reserves for heavy oil development.                                                                             
                                                                                                                                
3:06:30 PM                                                                                                                    
MR. GEORGE  said if he  takes a  further step, saying  his lower-                                                               
margin fields aren't  caused by a lower price but  just by higher                                                               
cost  of  extraction,  his lower-margin  fields  actually  pay  a                                                               
higher effective  tax rate than those  with higher profitability.                                                               
This is because none of  those additional costs are recognized in                                                               
the  system.   Chances  are  that as  one  moves  into heavy  oil                                                               
developments and  so on, there  will be  some effect caused  by a                                                               
lower  market  price.   This  slide  illustrates  the  regressive                                                               
nature   of  the   gross  system   in   there,  not   recognizing                                                               
profitability.   A company would  end up paying a  similar amount                                                               
of tax for less profit, which translates into a higher rate.                                                                    
                                                                                                                                
MR. GEORGE showed a slide  depicting numbers reflecting that.  He                                                               
said under  PPT, the portfolio  would pay just over  $1.5 billion                                                               
on  the  $80   West  Coast  price,  $2   billion  before  capital                                                               
investment and about  $1.5 after capital investment.   Noting the                                                               
illustration doesn't  relate to  all numbers,  he said  under the                                                               
House amendment  there'd be a slight  rise in the amount  of take                                                               
before capital investment, but after  capital investment it would                                                               
rise  a couple  of  hundred million.    Hence capital  investment                                                               
wouldn't  get as  much effect  with respect  to tax  as it  would                                                               
under the  more progressive  system.   It essentially  raises the                                                               
cost of investment to companies going forward.                                                                                  
                                                                                                                                
MR.  RUGGIERO added  that a  lot  of the  snapshots shown  depict                                                               
fields  on the  same date,  using  the same  assumptions.   These                                                               
slides  attempt  to show  why,  depending  on the  fiscal  system                                                               
chosen, certain  investments might  not be  made.   As Mr. George                                                               
just showed, the marginal $800  million investment just got a lot                                                               
more expensive.   Furthermore, Field Z  might not have  ever been                                                               
developed if  it would  actually raise the  average tax  paid; it                                                               
would be at a much higher  rate than the existing production just                                                               
because of the nature of the tax.                                                                                               
                                                                                                                                
3:09:43 PM                                                                                                                    
SENATOR THERRIAULT observed that  whereas elsewhere the red arrow                                                               
comes down  because the tax rate  comes down, here the  red arrow                                                               
comes down but the rates have gone up.                                                                                          
                                                                                                                                
MR. GEORGE  replied the red arrow  was the top of  the effective-                                                               
rate bars  under the  net PPT  system; he'd kept  it in  place to                                                               
show where that was.  He  apologized that it wasn't well labeled.                                                               
He said  the point was to  show that the lower-margin  fields can                                                               
effectively have a higher tax rate.                                                                                             
                                                                                                                                
MR. GEORGE wrapped up by saying  the PPT net-tax system taxes the                                                               
cash flow that  a company decides to retain; it  isn't just a tax                                                               
on simple profitability.  As  structured with a sort of corporate                                                               
ring-fence  taxation on  a companywide  basis for  investments in                                                               
Alaska, it allows  the effective rate to vary  so more profitable                                                               
fields pay a  higher effective rate and less  profitable fields a                                                               
lower one.  More aggressive  net progressivity provides a greater                                                               
differentiation  between higher-  and lower-profitability  fields                                                               
than a simple gross progressivity is capable of doing.                                                                          
                                                                                                                                
MR.   GEORGE  said   the   progressivity   feature  itself,   the                                                               
progressivity  based on  net manifested  in PPT  or ACES  - which                                                               
basically have the  same structure but different rates  - is more                                                               
responsive  to  individual  field profitability  than  under  any                                                               
gross structure  Gaffney Cline has seen  for this.  He  also said                                                               
that  if  one is  able  to  put  greater progressivity  into  the                                                               
system, such that higher-profitability  fields are taxed at lower                                                               
margins and  perhaps lower-profitability ones are  taxed at lower                                                               
margins,  this  can  be  done  by  changing  the  slope  and  the                                                               
progressivity.                                                                                                                  
                                                                                                                                
3:12:35 PM                                                                                                                    
MR. RUGGIERO turned  attention to slides at the  beginning of the                                                               
handout, noting the  slides had been presented out of  order.  He                                                               
said for  slide 2, "Topics," they'd already  discussed the bottom                                                               
two points:  the goals or  drivers for putting a system together;                                                               
ands how  a net progressive  structure, from a  50,000-foot view,                                                               
adapts  and  meets  those  goals,  as well  as  how  the  House's                                                               
recommended structure fits  in to meeting those  goals as Gaffney                                                               
Cline  had listed  them.  The  remaining topic  on  slide 2  was:                                                               
"What is the risk of raising  state revenue share on the existing                                                               
producing reservoirs?"                                                                                                          
                                                                                                                                
MR. RUGGIERO noted although they  didn't have a great computer to                                                               
stuff all the  numbers in and provide the  correct answer, they'd                                                               
address  questions  asked  in  the   previous  Senate  and  House                                                               
committees about  where the  tipping point  is.   How far  is too                                                               
far?  How far is not enough?                                                                                                    
                                                                                                                                
MR. RUGGIERO explained that he didn't  want to leave money on the                                                               
table, but also  didn't want to wake up tomorrow  and notice that                                                               
during the night  the bags had been packed and  the oil companies                                                               
had left.   This would be discussed.  And  Gaffney Cline would do                                                               
what it was invited  to do:  Read the lines  and read between the                                                               
lines, taking the data presented  by the industry and providing a                                                               
representation of that data.                                                                                                    
                                                                                                                                
MR. RUGGIERO addressed  the first point, that there  is no simple                                                               
answer as to how  an oil company makes a decision.   He noted the                                                               
debate  was always  about the  tax  rate until  Chevron made  its                                                               
presentation, drawing  an analogy to the  "rock, paper, scissors"                                                               
game; Chevron had  indicated scissors - in this  case, the fiscal                                                               
system, which  takes a cut  out of  their potential profits  - is                                                               
trumped by rock.  Chevron goes  places with marginal rates of 78,                                                               
82,  85,  or 90  percent  because  those  places have  the  rock:                                                               
a high expectation of producing billions of barrels of product.                                                                 
                                                                                                                                
MR.  RUGGIERO suggested  looking further,  noting scissors  would                                                               
cut  paper if  paper were  the profit.   He  said there  was also                                                               
discussion by  one company that  there are times when  it doesn't                                                               
come down to rocks  or tax rate.  If the  company believes it can                                                               
buy barrels cheaper  than it can drill for barrels,  it will buy.                                                               
That is  acquisitions.  It can  buy back its own  stock, which he                                                               
said  he believes  this company  has done  on the  upside.   Thus                                                               
there is  a game  such that,  at any  point in  time, any  one of                                                               
those items  can trump the other  item in making a  decision.  It                                                               
isn't a simple A,  B, C.  It depends on what  all the factors are                                                               
at the time, going forward.                                                                                                     
                                                                                                                                
MR.  RUGGIERO noted  he  would speak  about  numbers and  metrics                                                               
specific to  Alaska that go  into some  decision making.   As for                                                               
testing the  tripping point, they  would read between  the lines,                                                               
looking at the  data presented to see what they  could glean from                                                               
it.  Looked  at would be everything from what  the Alaska Oil and                                                               
Gas Association (AOGA) put forward  to what the oil companies had                                                               
put forward.                                                                                                                    
                                                                                                                                
MR.  RUGGIERO said  to  the extent  possible,  Gaffney Cline  had                                                               
looked   at  annual   reports,  10(k)   filings,  other   federal                                                               
Securities  and  Exchange  Commission  (SEC)  filings,  analysts'                                                               
presentations,  and  other  publicly  available  information,  to                                                               
determine whether the data presented  passed the "smell test" and                                                               
looked   reasonable.     To  that   extent,   they'd  done   some                                                               
modifications and moved some items around in their analyses.                                                                    
                                                                                                                                
MR. RUGGIERO  offered the overall  observation from  the industry                                                               
presentation that for the near term  most of the potential is out                                                               
of  the existing  reservoirs  - arresting  the  decline from  its                                                               
natural 15  or 16 percent  and instead making  it a 6  percent or                                                               
3 percent  decline.   Gaffney Cline  would  present some  related                                                               
numbers.   They'd  also show  that the  economics, seen  from the                                                               
economics  presented, are  extremely profitable.   This  has been                                                               
tested against some  stress points, and Gaffney  Cline would show                                                               
legislators  this testing.   Instead  of one  stress point,  they                                                               
would  stress it  six different  ways,  showing what  it does  to                                                               
profitability six different ways.                                                                                               
                                                                                                                                
3:18:29 PM                                                                                                                    
SENATOR   THERRIAULT  asked   whether  it   is  Gaffney   Cline's                                                               
contention that  the investment in  staving off the decline  is a                                                               
very wise and profitable investment.                                                                                            
                                                                                                                                
MR. RUGGIERO said  yes; he'd show some numbers  relating to this.                                                               
He noted everything put up by  AOGA had the full consensus of all                                                               
the  oil  companies; they  were  saying  there is  a  significant                                                               
upside in the existing reservoirs.   Agreeing with this, he noted                                                               
Gaffney Cline was also saying  the fiscal system should recognize                                                               
that as well.  He reminded members  that the first goal is to get                                                               
a fair  share from highly  profitable scenarios.  The  second, at                                                               
the same time, is to cause the reinvestment being talked about.                                                                 
                                                                                                                                
MR.  RUGGIERO continued  with the  slide on  AOGA, noting  they'd                                                               
said  the   2006  Prudhoe  Bay  drilling   program  generated  an                                                               
additional 70,000  barrels a  day.  That  equates to  the fourth-                                                               
largest stand-alone  field, behind  Alpine, Kuparuk,  and Prudhoe                                                               
Bay.     The  upside,  the   potential  additional   barrels,  is                                                               
significant from this  program.  If the decline  can be arrested,                                                               
25-plus years can  be added to the life of  those fields, if they                                                               
are encouraged  to make  the investments  and get  the additional                                                               
oil out of the ground that  they believe they can today, based on                                                               
developments and technology.                                                                                                    
                                                                                                                                
SENATOR THERRIAULT remarked that a  standard for both oil and gas                                                               
production  is ramping  up to  the peak  and then  tapering.   He                                                               
asked whether,  with the 2006  investment, it was like  putting a                                                               
70,000 barrel  field on.   He asked:  If  you were to  treat that                                                               
like a  new field, would  that production profile look  about the                                                               
same as the norm?   Or does it have a quicker  peaking and a more                                                               
rapid decline, for instance?                                                                                                    
                                                                                                                                
MR.  RUGGIERO  replied  that  when  he got  to  the  light  model                                                               
demonstration  he  would  show exactly  the  impact  being  asked                                                               
about.  Showing the next slide,  he indicated this data came from                                                               
two slides  presented by  BP to the  House and  Senate committees                                                               
earlier.   On the upper  left was  a statement showing  that from                                                               
2002 to  2006 BP  had a  drilling program.   The upper  left plot                                                               
shows  the   production  BP  claims   results  from   that  field                                                               
reinvestment  within  Prudhoe  Bay;  the lower  right  shows  the                                                               
program from  each of those  years, plotting total  dollars spent                                                               
on the drilling  program relative to the reserves  BP believes it                                                               
generated,  or the  additional production  BP can  generate as  a                                                               
result of that drilling program.                                                                                                
                                                                                                                                
3:22:11 PM                                                                                                                    
MR. RUGGIERO said  the next slide relates to  a general statement                                                               
by all  the companies:   Reinvestment is not only  important, but                                                               
is getting a  bit more expensive.  From the  diagram in the lower                                                               
right-hand portion of the previous slide,  it can be seen that in                                                               
2002  they spent  about $255 million  and  generated 120  million                                                               
barrels, for  a per-barrel finding-and-developing cost  of $2.13.                                                               
Using that  same plot, the  numbers can  be pulled off  for 2003-                                                               
2006.   With roughly the  same amount  of capital being  spent in                                                               
each annual  drilling program, the  number of barrels found  as a                                                               
result is declining.  Therefore, the  cost per barrel to find and                                                               
develop is  rising.  That number  rises from $2.13 to  $4.90 as a                                                               
result of the 2006 drilling program.                                                                                            
                                                                                                                                
MR. RUGGIERO  addressed how  that compares.   He said  some other                                                               
numbers were put forward.  It  depends on what numbers are looked                                                               
at,  but  it was  stated  that  from  the beginning  until  today                                                               
$19 billion in capital  has been spent in Prudhoe Bay.   That was                                                               
to produce between  9.5 billion and 11.5 billion  barrels.  Hence                                                               
the finding and development to date  cost $2.00 a barrel.  That's                                                               
an average  for the  period.   It is  climbing, now  being almost                                                               
$5.00 a  barrel.   He indicated  the company  had put  up another                                                               
slide estimating it may go as high as $12.00 a barrel.                                                                          
                                                                                                                                
3:24:36 PM                                                                                                                    
SENATOR  WIELECHOWSKI  asked  whether  it's  fair  to  say  costs                                                               
haven't gone  up as  dramatically, when one  factors in  the time                                                               
value of  money, since  $255 million  in 2002  won't be  the same                                                               
amount of money in 2006.  He  indicated he'd asked BP, and it was                                                               
the actual dollars presented.                                                                                                   
                                                                                                                                
MR.  RUGGIERO  agreed  there'd  be  a  time-value  impact,  which                                                               
Gaffney Cline  hadn't considered in  this analysis.   He recalled                                                               
that Pioneer  had mentioned that  the Lower 48 was plus  or minus                                                               
$14 per barrel for finding and  development.  He added that today                                                               
in the House,  BP presented a figure of $10  a barrel average for                                                               
the United States,  but he didn't know whether  that just applied                                                               
to oil or was for oil and gas.   He noted with a lot of gas there                                                               
can  be much  lower finding-and-development  transportation costs                                                               
in the  Lower 48, where someone  with a drilling rig  on the back                                                               
of a  truck can go  out and put a  well into production  for just                                                               
tens of thousands of dollars per well.                                                                                          
                                                                                                                                
MR. RUGGIERO concluded  that while there are  various numbers, it                                                               
is getting  more expensive with time.   The barrels will  be more                                                               
technically challenged  to get  out of the  ground, and  the cost                                                               
per barrel to do that will  continue to rise.  He emphasized that                                                               
whether  it is  at $4.90  for 2006  or $12.00  later, this  isn't                                                               
being discussed in terms of a $90 market.                                                                                       
                                                                                                                                
3:26:46 PM                                                                                                                    
MR. RUGGIERO  showed the  next slide, a  snapshot related  to the                                                               
economics  of BP's  infill drilling  program.   A plot  shows the                                                               
actual capital  spent.  Between  BP's testimony in the  House and                                                               
then the  Senate, he said  they'd mentioned  - quite fairly  so -                                                               
that  one cannot  just  look  at the  cost  to  drill the  wells.                                                               
Instead, there is a three-times  multiplier because of:  the cost                                                               
of the producing  well, whether it is a  vertical or multilateral                                                               
well; a cost  associated with injection because  of the secondary                                                               
recovery;  and an  impact on  facilities  that would  have to  be                                                               
modified, or else new facilities would be needed.                                                                               
                                                                                                                                
MR. RUGGIERO continued,  indicating BP had said  the real capital                                                               
associated with  each producing  well, as shown  on the  right of                                                               
the slide, is a 300  percent capital expenditures (CAPEX) figure.                                                               
Hence the  plot on the  right has the  same numbers on  the left,                                                               
but at 300 percent.  As a  result, it isn't a drilling program at                                                               
plus or minus $250 million a year.   Rather, it is a program with                                                               
all the capital required to  actually get those barrels to market                                                               
- $750 million to $800 million a year.                                                                                          
                                                                                                                                
MR.  RUGGIERO  showed the  next  slide,  explaining that  Gaffney                                                               
Cline  had  digitized  that  plot   to  determine  what  sort  of                                                               
production it  yields.  Shown  is the combination of  each year's                                                               
program,  stacked up.   They'd  said by  the start  of 2007  this                                                               
drilling  program  was  producing   50  percent  of  the  barrels                                                               
produced daily out  there.  Referring to an  earlier question, he                                                               
said the House version of this  has production in 2002 instead of                                                               
starting at zero.                                                                                                               
                                                                                                                                
MR. RUGGIERO noted the assumption  he'd made was that each year's                                                               
drilling program  doesn't start  production until the  next year;                                                               
thus he'd  had to move  something on the spreadsheet,  but hadn't                                                               
changed any of the underlying  financials or the economic answer.                                                               
But it's a different picture than shown to the House.                                                                           
                                                                                                                                
MR. RUGGIERO  continued, saying  that was  stacked up  until 2007                                                               
was reached.   The  big rise  between 2006 and  2007 is  the AOGA                                                               
presentation  that  said  the 2006  program  generated  an  extra                                                               
70,000 barrels a day, to start in  2007.  Shown on the slide is a                                                               
decline.  To Senator Therriault's  earlier question, he said they                                                               
talk  about the  field being  on  a natural  15 percent  decline.                                                               
However,  he'd  show in  a  few  minutes  that  if this  type  of                                                               
production  were  run  from  that point  -  assuming  no  further                                                               
spending - on a 15 percent  decline, it would create more barrels                                                               
than they say they developed as part of that drilling program.                                                                  
                                                                                                                                
3:30:10 PM                                                                                                                    
CHAIR FRENCH said  he thought the discussion was  about the extra                                                               
70,000 barrels of oil a day from the 2006 drilling program.                                                                     
                                                                                                                                
MR. RUGGIERO returned  attention to the plot,  noting they'd said                                                               
for each of  these years' drilling programs  an associated amount                                                               
of production results.                                                                                                          
                                                                                                                                
CHAIR FRENCH surmised that is per year.                                                                                         
                                                                                                                                
MR. RUGGIERO concurred.                                                                                                         
                                                                                                                                
CHAIR  FRENCH asked  whether that  totals up  to the  incremental                                                               
production just shown.                                                                                                          
                                                                                                                                
MR. RUGGIERO affirmed that.  If  he takes 2003, for example, that                                                               
flows through.  Although declining, it still exists in 2007.                                                                    
                                                                                                                                
CHAIR FRENCH surmised the 70,000 was just for 2006.                                                                             
                                                                                                                                
MR. RUGGIERO  said the  2006 program, because  the year  had just                                                               
been started,  was shown on the  slide as a small  sliver.  There                                                               
was no  way to pull  into the economics  the results of  the 2006                                                               
program.    Thus they'd  relied  on  the  statement in  the  AOGA                                                               
presentation  that  the  2006 drilling  program  in  Prudhoe  Bay                                                               
produced an additional 70,000 barrels a  day.  If he were to take                                                               
each of  the colored parts shown  and then go forward,  he'd just                                                               
be adding the colored parts from each  of those.  When he gets to                                                               
the end  of 2006, there is  a big jump.   He'd put in  the 70,000                                                               
barrels a  day that AOGA had  said BP, as the  operator, was able                                                               
to develop with its 2006 drilling program.                                                                                      
                                                                                                                                
MR. RUGGIERO asked:   Why might those results be  a little better                                                               
than previously?  He indicated  this is where the company started                                                               
its multilateral  or horizontal-completion drilling program.   As                                                               
they stated, those  wells produce more per overall  well than the                                                               
traditional vertical  well.   So it's  conceivable that  the 2006                                                               
results are  a little better than  they were for a  couple of the                                                               
previous years.                                                                                                                 
                                                                                                                                
MR. RUGGIERO further explained that  to do the economic analysis,                                                               
Gaffney Cline had then made  an assumption about what those rates                                                               
would be over  time, beyond the extent of  the actual production;                                                               
they'd forecast what each well  would do in the drilling program.                                                               
He indicated although  the company had talked about  a 16 percent                                                               
decline per  year in  that rate  - which would  have been  a line                                                               
that he depicted  on the slide - Gaffney Cline  had actually used                                                               
a 25 percent decline.                                                                                                           
                                                                                                                                
CHAIR FRENCH asked why.                                                                                                         
                                                                                                                                
MR.  RUGGIERO answered  he'd not  wanted to  be accused  that the                                                               
economics were inflated because there  were more barrels in there                                                               
than the barrels the company said  it was able to produce as part                                                               
of those drilling programs.                                                                                                     
                                                                                                                                
3:33:15 PM                                                                                                                    
MR. RUGGIERO continued, saying the  decline rate used here was to                                                               
ensure that, in  each individual year, Gaffney  Cline didn't show                                                               
more  barrels in  the  system  than those  shown  by the  company                                                               
itself.   He  emphasized  wanting to  ensure  that the  economics                                                               
shown can be tested, reproduced, stressed, and challenged.                                                                      
                                                                                                                                
CHAIR FRENCH  asked whether  the red  graph depicts  a 25 percent                                                               
decline curve,  assuming no future investment  or production from                                                               
that investment.                                                                                                                
                                                                                                                                
MR. RUGGIERO affirmed  that.  He added that  Gaffney Cline looked                                                               
at this infill or incremental  drilling as a stand-alone project,                                                               
year by year.  With that  capital and that production curve, they                                                               
looked  at  the  company's  after-tax  rate  of  return  on  that                                                               
investment.    As  this  produces  through  time,  Gaffney  Cline                                                               
estimated -  based on this  300 percent CAPEX - that  the company                                                               
gets more than  a 60 percent rate of return on  the investment in                                                               
those infill drilling programs.                                                                                                 
                                                                                                                                
MR. RUGGIERO, in  response to Senator Therriault,  said the price                                                               
assumptions  were  based  on  what   they  actually  reported  as                                                               
realized in 2003-2006.   Starting with 2007, he  believed $80 was                                                               
used; he'd have to look at the model.   That would be tested in a                                                               
number of areas.  He'd make sure he'd matched the right price.                                                                  
                                                                                                                                
3:35:10 PM                                                                                                                    
MR.  RUGGIERO  showed the  next  slide,  "BP  Prudhoe Bay:    Oil                                                               
Company NPV."  It plotted  the net present value (NPV) discounted                                                               
at  15 percent,  which  he  said is  more  representative of  the                                                               
hurdle rate used to run economics  within a lot of oil companies.                                                               
If he  takes five  years of investment  between $750  million and                                                               
$800 million a  year, this is about $3.7 billion  to $3.8 billion                                                               
they've invested.   This says that through 2011,  on a discounted                                                               
basis, they'll generate another $3.7 billion above their costs.                                                                 
                                                                                                                                
MR. RUGGIERO  emphasized that this  is a fully  after-tax number.                                                               
Gaffney Cline  has run this  through PPT, property  tax, royalty,                                                               
income tax, tax credits, and so  forth, but didn't try to run all                                                               
the  early years  under ELF.   Rather,  everything was  run under                                                               
PPT.    He said  he  didn't  want to  get  ELF  wrong, but  since                                                               
everyone says  PPT generates  more tax than  ELF did,  by running                                                               
the prior years under PPT instead  of ELF, it says the government                                                               
take would  have been  higher and the  economics would  have come                                                               
down from what they'd have been  under ELF.  This still says it's                                                               
a highly profitable project, he concluded.                                                                                      
                                                                                                                                
SENATOR THERRIAULT  asked why  the 15  percent discount  rate was                                                               
used.                                                                                                                           
                                                                                                                                
MR. RUGGIERO  replied it was just  a choice, what he  believed to                                                               
be a  more traditional discount rate,  looked at on an  NPV basis                                                               
by the  oil companies.  In  order to come to  the conclusion that                                                               
this  is extremely  profitable, this  would be  stressed in  many                                                               
directions.   He'd put  in the 300  percent CAPEX,  for instance,                                                               
and  had  doubled  the  "point  forward"  operating  expenditures                                                               
(OPEX).  Because  Alaska is 99 out  of 103 and thus  has a higher                                                               
hurdle rate, he'd  put in a 25 percent discount  rate.  He'd also                                                               
dropped the price to $50.                                                                                                       
                                                                                                                                
CHAIR FRENCH surmised this is a gross price, not net.                                                                           
                                                                                                                                
MR.  RUGGIERO agreed,  saying  it means  their  net margin  comes                                                               
down.  In  going from his starting price down  to this price, the                                                               
only thing  he was taking  out was margin.   He hadn't  taken out                                                               
any costs, for  example.  Still, under this  scenario, it remains                                                               
highly profitable.                                                                                                              
                                                                                                                                
MR. RUGGIERO showed  a slide labeled "Overly Stressed  Case."  He                                                               
noted it shows the CAPEX is  up to three times and the production                                                               
is  exactly what  they reported  it to  be, with  the 25  percent                                                               
decline.   Still,  overall  it  ends up  being  plus  or minus  a                                                               
50 percent  rate  of return  project,  although  it's on  an  NPV                                                               
basis, remembering this  is at 25 percent discounting.   But this                                                               
is still  at a billion-dollar NPV,  even with a hurdle  rate of a                                                               
25 percent  discount  on those  cash  flows.   He'd  stressed  it                                                               
multiple directions.  It is highly economic.                                                                                    
                                                                                                                                
3:38:43 PM                                                                                                                    
SENATOR WIELECHOWSKI  asked:  If  we implement ACES  or something                                                               
higher,  will  the  investment  leave Alaska?    Do  some  places                                                               
commonly have rates of return of 50 to 60 percent?                                                                              
                                                                                                                                
MR.  RUGGIERO replied  he believes  this infill  drilling program                                                               
would rank  very high in  the portfolio  of many companies.   The                                                               
benefit  of  being  able  to develop  many  billions  of  barrels                                                               
ultimately - continuing  this program over time  - is significant                                                               
and people would invest in it.                                                                                                  
                                                                                                                                
3:40:05 PM                                                                                                                    
MR. RUGGIERO noted he'd just  provided some printouts from a live                                                               
model.   He'd  taken the  important parameters  in this  drilling                                                               
program such  as CAPEX, OPEX, production,  discount rate, royalty                                                               
rate, base rate  on the net tax, progressivity factor  on the net                                                               
tax, and  price.  Based  on questions yesterday, he'd  added that                                                               
in  for the  same situation  -  in this  case, an  NPV of  around                                                               
$3 billion for  the oil company  - the undiscounted take  for the                                                               
State of  Alaska is just shy  of $11 billion.   Running the state                                                               
and  company cash  flows will  give a  sense of  the split  after                                                               
costs are recovered.                                                                                                            
                                                                                                                                
SENATOR THERRIAULT asked what the progressivity trigger is.                                                                     
                                                                                                                                
MR.  RUGGIERO replied  the progressivity  trigger is  PPT, a  $40                                                               
margin.    The control  sheet  shows  actual production  off  the                                                               
digitized  plot  provided by  BP.    For  2007 and  beyond,  he'd                                                               
stressed that  to a decline  rate of 25  percent to make  sure he                                                               
wasn't  showing  more  barrels  produced than  what  BP  said  it                                                               
developed.    A  typical  cash-flow  model was  run  to  see  the                                                               
economics of this investment.  It  starts with CAPEX.  The prices                                                               
are actual prices in the  system realized during those years; the                                                               
price going forward  could be manipulated as he went  back to the                                                               
control  page.   As  a surrogate,  it  uses costs  ConocoPhillips                                                               
reported  in its  annual report;  this is  because ConocoPhillips                                                               
reports  Alaska separately  and thus  Gaffney Cline  was able  to                                                               
glean some data from that.                                                                                                      
                                                                                                                                
3:43:42 PM                                                                                                                    
MR.  RUGGIERO  indicated  all the  normal  steps  of  calculating                                                               
revenues, royalties, costs  per barrel, CAPEX, and  so forth were                                                               
done.  He apologized that it  says "ACES" instead of "PPT," since                                                               
it was  run as PPT.   It could be run  as anything that is  a net                                                               
system, he noted.  He  indicated this shows progressivity impacts                                                               
and corporate  income tax impacts.   The NPVs and  internal rates                                                               
of  return (IRRs)  are  then calculated.   He  said  this is  the                                                               
technical  mumbo-jumbo that  goes  into an  economic  model.   He                                                               
emphasized that all the pieces were put in there.                                                                               
                                                                                                                                
CHAIR FRENCH asked how the  credit aspects of capital investments                                                               
are estimated.                                                                                                                  
                                                                                                                                
MR. RUGGIERO  replied Gaffney Cline  put it  in as 20  percent in                                                               
the  year  spent.   For  each  of  these drilling  programs,  the                                                               
investment  occurs  in year  one,  but  production doesn't  start                                                               
until year  two.  In  reality, they'll start producing  things as                                                               
fast as they  drill, because drilling program  is multiple wells.                                                               
Gaffney Cline  didn't do that,  however, but stressed  the model,                                                               
putting all the  production into year two before it  started.  He                                                               
explained that  Gaffney Cline  has the ability  to change  any of                                                               
the parameters shown in response to a question from legislators.                                                                
                                                                                                                                
MR. RUGGIERO said furthermore, each  program shown from 2002-2006                                                               
has a  checkbox.   Removing the checkbox  from a  particular year                                                               
removes that year's drilling program.   This allows looking at it                                                               
on  an  aggregated  basis  and  also by  individual  year.    For                                                               
instance, in  2003 they  hadn't drilled thinking  it would  be an                                                               
$80 or $90  world, but thought the price might  be closer to $40.                                                               
One  can  go  back  and  see that  even  in  2002,  with  rapidly                                                               
declining  production, at  a 15  percent discount  rate it  still                                                               
generates an NPV of $500 million.   That's above their costs.  He                                                               
asked  the committee  to stress  this drilling  program with  any                                                               
parameters they chose.                                                                                                          
                                                                                                                                
SENATOR  THERRIAULT   suggested  isolating  a   particular  year,                                                               
running the  price down to what  the company might have  made its                                                               
investment decision on, as far as a forward-looking price.                                                                      
                                                                                                                                
MR. RUGGIERO indicated he was running  this scenario.  If in 2002                                                               
the company  thought there'd be  $40 oil, that still  generates a                                                               
plus or minus  $300 million NPV at 15 percent  discounting.  This                                                               
is at  the prices they  actually realized, because  Gaffney Cline                                                               
had put in  actual prices through 2006.  It's  only the data from                                                               
2007 that  they'd have changed back  down to $40.   On a rate-of-                                                               
return  basis,  that's  roughly  a   28  percent  return  on  the                                                               
investment, even at the expected price of $40.                                                                                  
                                                                                                                                
3:47:44 PM                                                                                                                    
SENATOR  WIELECHOWSKI  requested   a  real-life  projection  with                                                               
realistic variables  with respect to CAPEX,  OPEX, discount rate,                                                               
and  an oil  price  of perhaps  $50  or  $60.   He  said a  CAPEX                                                               
multiplier  of 300  percent seems  high, for  example, and  asked                                                               
what would be a reasonable projection.                                                                                          
                                                                                                                                
MR. RUGGIERO  replied he'd stick  with the 300 percent,  which he                                                               
believes  is realistic  because he  thinks the  numbers generated                                                               
are plus or  minus the total capital program spent  in that area.                                                               
He  said this  is  burdening these  individual drilling  programs                                                               
with all the CAPEX that they're spending out there.                                                                             
                                                                                                                                
SENATOR  WIELECHOWSKI asked  whether  Mr.  Ruggiero believes  the                                                               
CAPEX,  OPEX, discount  rate, and  multiplier  are realistic,  as                                                               
well as  the royalties.  He  then suggested doing a  net tax rate                                                               
of  25.    He  asked  how  to  get  the  progressivity  to  where                                                               
Mr. Ruggiero   was   suggesting,   but   he   acknowledged   that                                                               
Mr. Ruggiero wasn't suggesting specific numbers.                                                                                
                                                                                                                                
MR.  RUGGIERO  responded that  this  program  doesn't generate  a                                                               
progressivity curve that's ever-changing.   This generates just a                                                               
straight line.   What could be done, however, is  to increase the                                                               
progressivity  slope, which  would  get it  to  the maximum  rate                                                               
faster.   It still  would give  an example of  the impact  of the                                                               
progressivity, for example, looking  at the entire program, using                                                               
a $60  price and  a starting  base tax rate  of 25  percent, even                                                               
taking  it up  and saying  costs will  be 200  percent of  what's                                                               
predicted.                                                                                                                      
                                                                                                                                
MR. RUGGIERO  continued, saying he  was working off  the reported                                                               
data  from 2006.   Not  only would  he have  a 10 percent  annual                                                               
escalator on  costs, but now  he'd have doubled the  total costs.                                                               
If he  now raised the  progressivity factor to 0.6,  they'd still                                                               
make  a substantial  return on  their  investment.   The rate  of                                                               
return would have come down a little, but not much.                                                                             
                                                                                                                                
SENATOR  WIELECHOWSKI asked  where  the  progressivity starts  in                                                               
this scenario.                                                                                                                  
                                                                                                                                
MR. RUGGIERO replied it all kicks off at the same PPT, $40.                                                                     
                                                                                                                                
SENATOR WIELECHOWSKI asked about lowering it to $30.                                                                            
                                                                                                                                
MR.  RUGGIERO said  he had  nine things  up there  that he  could                                                               
change,  but this  was asking  for a  tenth.   He wasn't  sure he                                                               
could do it quickly.                                                                                                            
                                                                                                                                
SENATOR   WIELECHOWSKI  asked   whether  Mr.   Ruggiero  believed                                                               
lowering  it to  $30 would  have a  big impact.   He  offered his                                                               
understanding that ACES lowers it to $30.                                                                                       
                                                                                                                                
AN UNIDENTIFIED SPEAKER said, "The margin."                                                                                     
                                                                                                                                
3:50:41 PM                                                                                                                    
MR. GEORGE  replied on this particular  one, probably not.   On a                                                               
broader range of things, it would have a greater impact.                                                                        
                                                                                                                                
CHAIR  FRENCH  asked:   Can't  you  achieve  the same  result  by                                                               
lowering the price $10 roughly?                                                                                                 
                                                                                                                                
MR.  RUGGIERO  answered that  roughly,  yes,  because that  would                                                               
change the margin.  Following  a brief back-and-forth discussion,                                                               
he said  this is  calculating the  net margin  per barrel.   When                                                               
it's below  $30 or less,  no progressivity  comes into play.   In                                                               
response  to Chair  French, he  said at  this price  there is  no                                                               
progressivity.                                                                                                                  
                                                                                                                                
CHAIR FRENCH  noted it was at  a net rate of  25 percent, looking                                                               
forward five years to 2012.                                                                                                     
                                                                                                                                
MR. RUGGIERO concurred.                                                                                                         
                                                                                                                                
CHAIR  FRENCH surmised  the state  would get  $6 billion  and the                                                               
industry $2.5 billion.                                                                                                          
                                                                                                                                
MR. RUGGIERO indicated the industry  would get about $1.7 billion                                                               
"NPV 15."   Pointing to  an unspecified  number, he said  this is                                                               
the  state take,  also discounted  at  15 percent.   That  means,                                                               
considering the  time value of  money, that $6 billion  the state                                                               
would take over the entire period,  reducing it to the same terms                                                               
as the  oil companies, is worth  $2.5 billion.  Roughly,  what is                                                               
shown is that of the total  amount available as profit, the state                                                               
would take plus or minus 60 percent.                                                                                            
                                                                                                                                
3:53:36 PM                                                                                                                    
SENATOR  THERRIAULT  offered  his understanding  that  the  CAPEX                                                               
multiplier was at 300 percent  not because Gaffney Cline expected                                                               
costs  to  rise that  much,  but  because  it captured  both  the                                                               
drilling costs and all of the capital infrastructure.                                                                           
                                                                                                                                
MR. RUGGIERO  clarified that he'd  wanted to  be fair and  to use                                                               
BP's  testimony  that  there actually  are  injectors  and  other                                                               
facilities associated with  it, and that it would  be improper to                                                               
take just the drilling costs.   Thus he was using the 300 percent                                                               
as his base case on the CAPEX.                                                                                                  
                                                                                                                                
SENATOR THERRIAULT acknowledged it  isn't an exact enough science                                                               
to  pin  down every  dollar,  but  he  wanted  to know  what  the                                                               
industry representatives might say about this tomorrow.                                                                         
                                                                                                                                
MR. RUGGIERO  replied he'd  been hoping BP  would respond  in its                                                               
presentation  to  the  House  today.     However,  there  was  no                                                               
discussion  of  BP's infill  drilling  program  in the  paperwork                                                               
provided today.  He said while  sitting in the audience he'd done                                                               
some quick "back of the envelope"  numbers.  The reason he'd done                                                               
the analysis and built the model is  it appeared to be a lot more                                                               
productive than  it was.   He'd had  some numbers  that indicated                                                               
this to be more economic than  here, with a two-month payout, and                                                               
after some negative feedback about that he'd tweaked it.                                                                        
                                                                                                                                
MR. RUGGIERO added that if he  has it wrong, then the very people                                                               
who  can  provide   the  right  numbers  will   come  before  the                                                               
committee.   Members  can  ask BP.   If  the  program isn't  this                                                               
profitable,  if Gaffney  Cline has  missed some  base costs  that                                                               
need to be absorbed, then BP  can come forward with real numbers.                                                               
He noted this  was floated to a few people  within the government                                                               
to  ensure that  nothing major  or  glaring was  absent from  the                                                               
model and  that no numbers appeared  to be far outside  what they                                                               
believed to be reasonable for costs, investment, and the like.                                                                  
                                                                                                                                
3:56:32 PM                                                                                                                    
SENATOR  WIELECHOWSKI  asked  whether   this  was  shown  to  the                                                               
legislative consultants and whether they had any comments.                                                                      
                                                                                                                                
^Steve Porter  and Dan Dickinson, Consultants  to the Legislative                                                               
Budget & Audit Committee                                                                                                        
STEVE  PORTER,  Consultant  to the  Legislative  Budget  &  Audit                                                               
Committee, told  members that  a lot  of time  had been  spent on                                                               
this model  recently.  One  question that  needs to be  asked, to                                                               
add  context, relates  to what  this  model addresses.   Does  it                                                               
address  infill for  legacy fields?   Does  it address  heavy oil                                                               
differently  from legacy  fields?   Does it  address exploration?                                                               
He opined that this is  an excellent model for understanding what                                                               
is going on.                                                                                                                    
                                                                                                                                
MR.  RUGGIERO indicated  Gaffney  Cline had  spent several  hours                                                               
with the two  legislative consultants going over  it because they                                                               
have a  lot more experience in  Alaska and have seen  the numbers                                                               
going back  and forth.  Gaffney  Cline also had used  many people                                                               
as  a sounding  board.   He reiterated  that the  infill drilling                                                               
program  is extremely  economical.   Even  if there  is a  highly                                                               
progressive tax  structure put in  place, he doesn't  believe the                                                               
investment in  the infill drilling  will fall  off.  If  it does,                                                               
they've got to have some barn-burner projects around the world.                                                                 
                                                                                                                                
3:58:37 PM                                                                                                                    
MR.  PORTER noted  he was  present  during the  vast majority  of                                                               
Gaffney Cline's  previous testimony,  and had  talked a  lot with                                                               
them  about the  details.    He said  he  wouldn't  talk for  Dan                                                               
Dickinson, but  personally agreed  with almost  everything they'd                                                               
said  on  the net  issues.    He added  that  this  is an  infill                                                               
drilling  program analysis.   It  isn't  as clean  for heavy  oil                                                               
because the  numbers are slightly different,  and for exploration                                                               
the risk factors are different.   However, the "net world" really                                                               
does help out  the heavy oils, and it helps  exploration in terms                                                               
of how CAPEX is placed in the overall tax scheme.                                                                               
                                                                                                                                
CHAIR FRENCH requested a definition of net world analysis.                                                                      
                                                                                                                                
MR. PORTER  responded that taxing on  the net helps put  the West                                                               
Saks  of  the   world  in  competition  with   the  legacy  field                                                               
investments of  the world.   In terms  of net versus  gross, when                                                               
taking the  net cash flow  relationship, West Sak is  being taxed                                                               
at $30 cash  flow; if its lifting  cost is $40, it  doesn't pay a                                                               
windfall  profits tax  until it  gets to  $70.   At Prudhoe  Bay,                                                               
however, if the lifting cost  is $20, that point is substantially                                                               
less.                                                                                                                           
                                                                                                                                
4:00:40 PM                                                                                                                    
CHAIR FRENCH said  this raises the issue of whether  there can be                                                               
two tax systems:   a more aggressive tax system  on legacy fields                                                               
that  will be  going through  an infill  drilling program,  and a                                                               
lighter tax system on West Sak.   It strikes him that the biggest                                                               
complication  is that  they're both  located in  the same  place.                                                               
They'll  likely  be  produced  using  the  same  flow  lines  and                                                               
production facilities, if not through the exact same well bore.                                                                 
                                                                                                                                
MR.  RUGGIERO noted  that  legislators would  hear  all sorts  of                                                               
complexities to be  able to separate these  and allocate facility                                                               
costs and investment.   He expressed hope that  from Mr. George's                                                               
presentation they'd glean  the following:  With  a single, highly                                                               
progressive  system the  state could  get such  differentiation -                                                               
which  is desired  for investment  in something  like West  Sak -                                                               
without needing two separate systems.                                                                                           
                                                                                                                                
CHAIR  FRENCH  surmised, "Because  it  nets  it all  out  against                                                               
itself."                                                                                                                        
                                                                                                                                
MR. GEORGE  said it takes account  of that in the  way the margin                                                               
works  and the  way companies  will look  at incremental  further                                                               
investments in the future.                                                                                                      
                                                                                                                                
MR.  PORTER added  one  more piece,  indicating  a Gaffney  Cline                                                               
slide  had  talked  about  base  tax  versus  progressivity,  how                                                               
actually keeping the base tax  low and progressivity higher helps                                                               
the West Saks of the world  and makes more sense than raising the                                                               
base  tax.   He suggested  this be  addressed when  "moving knobs                                                               
around."                                                                                                                        
                                                                                                                                
4:02:27 PM                                                                                                                    
MR. RUGGIERO noted this is part  of what he and Mr. George wanted                                                               
to address at the end.                                                                                                          
                                                                                                                                
SENATOR THERRIAULT asked:  Do  you think this system is sensitive                                                               
and adjustable  enough to not  require a differential  tax system                                                               
with respect to the legacy fields?                                                                                              
                                                                                                                                
MR.  RUGGIERO opined  that a  single  system can  be designed  to                                                               
address the goals  discussed earlier:  getting  high marginal tax                                                               
rates  when  there are  high-profitability  fields;  at the  same                                                               
time, encouraging  reinvestment in  those same legacy  areas; and                                                               
encouraging new investments by new  entrants in new areas.  Every                                                               
system will have some shortcomings.   But based on the goals that                                                               
he believes  Alaska is trying  to achieve  today and in  the near                                                               
term, and possibly in the long  term, he believes a system can be                                                               
put together that works well and meets all those goals.                                                                         
                                                                                                                                
SENATOR THERRIAULT  noted the  presentation had  discussed infill                                                               
drilling in legacy fields, which he  said is where the real money                                                               
is for  the state.   However, he also  wanted to be  sensitive to                                                               
new entrants  and new exploration, away  from the infrastructure,                                                               
and thus he'd have to think about how it works for them.                                                                        
                                                                                                                                
MR.  GEORGE  replied he  believes  within  the general  structure                                                               
discussed for  PPT, even changing the  progressivity, that system                                                               
does    differentiate    between   investments    of    different                                                               
profitability.  Thus  the decision may be more about  how much to                                                               
tax the  more highly profitable  end or the less  profitable end.                                                               
As for new  entrants, there is the capital credits  issue to help                                                               
them in the  initial period before production.   If they're going                                                               
into production with their investments,  then the taxation levels                                                               
will be commensurate with the  profitability of that development.                                                               
This is all within a single system.                                                                                             
                                                                                                                                
4:06:10 PM                                                                                                                    
DAN  DICKINSON,  Consultant to  the  Legislative  Budget &  Audit                                                               
Committee, followed  up on Mr.  Porter's comments.   He clarified                                                               
that  although they'd  spent several  hours with  this model  and                                                               
earlier data  presented by Mr. George,  they weren't specifically                                                               
doing a technical run-through of the  model to make sure the nuts                                                               
and bolts were working.                                                                                                         
                                                                                                                                
SENATOR HUGGINS  said he had  no reason  to doubt the  model, but                                                               
didn't  know the  probability of  error.   He urged  caution with                                                               
respect to investment strategies.                                                                                               
                                                                                                                                
4:08:38 PM                                                                                                                    
CHAIR FRENCH  concurred, noting this  is the first he'd  seen the                                                               
inner  workings  of the  system.    He  asked for  a  run-through                                                               
involving a tax rate of 25  percent, with progressivity at 0.5 on                                                               
$40 net, going forward at a price of $60.                                                                                       
                                                                                                                                
MR. RUGGIERO  replied they  were looking at  the entirety  of the                                                               
five-year drilling program, in aggregate,  running CAPEX at three                                                               
times the reported drilling amount  spent; OPEX at 200 percent of                                                               
past projections; royalty  unchanged; a base rate  of 25 percent;                                                               
and progressivity at 0.5 percent at  a $60 price.  What was shown                                                               
here, with  the oil  company NPV at  a 15 percent  discount rate,                                                               
was that  the company's return  on this investment would  be over                                                               
$2 billion.   The internal rate  of return for the  whole project                                                               
would be 56 percent.                                                                                                            
                                                                                                                                
MR.  RUGGIERO,  in response  to  Senator  Therriault, showed  the                                                               
higher overall  government share,  noting the federal  income tax                                                               
share had then been subtracted, leaving the Alaska share.                                                                       
                                                                                                                                
SENATOR THERRIAULT offered a general rule  of thumb:  If there is                                                               
an additional take of $100 for  the State of Alaska, $33 came out                                                               
of the federal treasury, not the corporate treasury.                                                                            
                                                                                                                                
MR. RUGGIERO agreed.                                                                                                            
                                                                                                                                
SENATOR WIELECHOWSKI  said there'd been  a little bit  of concern                                                               
from the  legislative consultants about  the model as far  as the                                                               
exploration and  heavy oil  development.   He asked  whether that                                                               
can be adjusted by adjusting the CAPEX and OPEX multipliers.                                                                    
                                                                                                                                
MR. RUGGIERO replied  that he wouldn't even want to  start to use                                                               
this  model to  predict heavy  oil development,  gas development,                                                               
and so on.   This is specifically a model  of the infill drilling                                                               
program in the existing fields.   He wouldn't even know what cost                                                               
structure  would  be best,  for  instance,  and there  are  other                                                               
parameters  including the  rate of  success  and so  forth.   All                                                               
those would change.  It would be speculation at this point.                                                                     
                                                                                                                                
MR.  RUGGIERO added  that  the  reason he  thinks  this model  is                                                               
important is that AOGA, BP,  ConocoPhillips, and Chevron all said                                                               
the  significant value  - over  70 percent  of the  value to  the                                                               
state -  is infill drilling  in the  existing units.   This model                                                               
represents the  economics for  70 percent  of the  potential they                                                               
say exists.  Thus  he believes the model is valid  to look at and                                                               
is a very helpful tool for legislators in making decisions.                                                                     
                                                                                                                                
CHAIR FRENCH characterized it as the center of the target.                                                                      
                                                                                                                                
4:13:29 PM                                                                                                                    
SENATOR  WIELECHOWSKI   recalled  discussion  about   20  billion                                                               
barrels of  heavy oil and  encouraging exploration to try  to hit                                                               
other big fields outside.  He said  if the effort is to make one-                                                               
size-fits-all  legislation,  at  some  point there  should  be  a                                                               
narrower  scope as  to how  it impacts  those other  fields.   He                                                               
suggested that may be an issue for the Senate Finance Committee.                                                                
                                                                                                                                
MR.  RUGGIERO replied  that's why  Mr. George  had presented  the                                                               
portion he had.   Although it took a one-year  snapshot, it shows                                                               
how on a purely net system  - using the progressivity that exists                                                               
now - the  more the progressivity goes up,  the more incentivized                                                               
existing  operators will  be  to spend  dollars  back into  those                                                               
fields, into this type of very economical investment.                                                                           
                                                                                                                                
CHAIR  FRENCH  asked  Mr.  Ruggiero  to run  a  scenario  with  a                                                               
30 percent tax rate.                                                                                                            
                                                                                                                                
MR. RUGGIERO did  so and then said it was  roughly $1.85 billion.                                                               
The  state, undiscounted,  was  at $8.1  billion.   He  suggested                                                               
looking at  just one number  and changing back  and forth.   At a                                                               
25 percent   starting  rate,   looking   at  the   state  on   an                                                               
undiscounted basis, he  said its take would be $7.5  billion.  If                                                               
they start  with that $7.5 billion  and go  up to 30  percent, it                                                               
increases  to  $8.1 billion  -  about  $600  million.    He  then                                                               
returned to the 25 percent starting  point, remarked, "There's my                                                               
twenty  twenty-five," and  said  at 30  percent  it is  "eighteen                                                               
fifty-five."   Thus  he said  $200 million was  lost in  NPV, the                                                               
state went up $600 million,  and the federal government was "plus                                                               
or minus the net loser in this."                                                                                                
                                                                                                                                
4:16:17 PM                                                                                                                    
CHAIR FRENCH suggested  it was closer to $170 million.   He noted                                                               
some would say  this is an enormous tax increase.   However, it's                                                               
a 10 percent change in their total take.                                                                                        
                                                                                                                                
MR. RUGGIERO specified  that on a discounted basis,  it made less                                                               
than a 10 percent change in their net present value.                                                                            
                                                                                                                                
CHAIR  FRENCH,  in response  to  Senator  Therriault, asked  that                                                               
Gaffney  Cline bring  the  model back  tomorrow  morning so  AOGA                                                               
representatives could see it and perhaps comment.                                                                               
                                                                                                                                
4:17:43 PM                                                                                                                    
SENATOR McGUIRE asked:   If we end up with this  kind of tax rate                                                               
and this  amount of money coming  into the state coffers,  are we                                                               
going to  have a whole  section on how  we're going to  save that                                                               
money  and  not spend  it  all  in the  next  five  years on  our                                                               
drilling program, so to speak?                                                                                                  
                                                                                                                                
CHAIR  FRENCH  replied, "Funny  you  should  ask."   He  inquired                                                               
whether Gaffney Cline had further information for the committee.                                                                
                                                                                                                                
MR. RUGGIERO said yes.  He  referred back to the information from                                                               
BP's slide and its discussion  of the overall North Slope natural                                                               
decline of  15 percent, with  1.3 billion  barrels that  could be                                                               
produced for  roughly a  $5 billion investment.   If  the decline                                                               
were  reduced to  6 percent,  they could  generate an  additional                                                               
3.9 barrels for  $25 billion  total spent.   A  3 percent decline                                                               
would generate an additional 7.5  billion barrels for $70 billion                                                               
spent.    He   surmised  this  was  presented  to   show  that  a                                                               
significant  potential  still  exists  in  the  existing  fields,                                                               
urging legislators,  whatever system they devise,  to incentivize                                                               
investment in the existing fields.                                                                                              
                                                                                                                                
MR. RUGGIERO  explained that  Gaffney Cline  had built  a generic                                                               
North  Slope model  using these  costs and  barrels that  BP said                                                               
could be  generated.   The assumption used  was that  BP's barrel                                                               
figures would be produced barrels.   The effort was to figure out                                                               
the economics of BP's investment in this program.                                                                               
                                                                                                                                
MR.  RUGGIERO  highlighted  one   correction  in  the  slides  BP                                                               
presented  to  the  House  today:    a  footnote  disavowing  any                                                               
knowledge that those  are its cost numbers,  instead saying those                                                               
come from DOR.  He said  legislators would have an opportunity to                                                               
ask  BP why  it isn't  providing what  it will  really cost.   He                                                               
mentioned BP's expectation to  "develop these significant barrels                                                               
from the existing assets that they're operating on your behalf."                                                                
                                                                                                                                
MR.  RUGGIERO noted  it was  run at  $80 a  barrel.   The numbers                                                               
would be small if it went lower,  but this wasn't going to be run                                                               
live  because the  numbers were  very high.   Presented  would be                                                               
"NPV 10" because  a lot  of numbers  in the  work seen  have been                                                               
presented on this  basis.  Thus he'd switched from  a discount of                                                               
15  in  the  previous model  to  10  here.    It was  run  on  an                                                               
undiscounted  basis, and  then the  NPV was  generated on  a per-                                                               
barrel basis.   This is the after-tax profit, run  under PPT, not                                                               
ACES;  it is  for the  existing PPT,  with a  "base rate  trigger                                                               
point progressivity."                                                                                                           
                                                                                                                                
MR.  RUGGIERO said  for the  15  percent decline  case, there  is                                                               
"15 billion to 20  billion NPV 10."   This has a lot  of room for                                                               
costs to go up and market price  to come down, and there is a lot                                                               
of margin  in the  existing fields.   There is  a $22  billion to                                                               
$27 billion take on cash flow  after all taxes on an undiscounted                                                               
basis.  On a per-barrel basis, it's $15-20 a barrel.                                                                            
                                                                                                                                
MR.  RUGGIERO turned  to the  6 percent  decline case,  noting it                                                               
jumps from the  $15-20 billion to $30-40 billion  on a discounted                                                               
basis and to  $55-75 billion on an undiscounted  basis.  However,                                                               
the range per  barrel doesn't change much, staying  in the $14-19                                                               
range, close to the previous $15-20 range on a per-barrel basis.                                                                
                                                                                                                                
MR.  RUGGIERO presented  the final  set of  numbers, noting  on a                                                               
discounted  basis it  doesn't go  up that  much, rising  from the                                                               
$30-40 billion  up to  roughly $35-45 billion.   This  is because                                                               
the additional  barrels produced under the  3 percent decline are                                                               
far in the  future.  Thus the discounting doesn't  add much value                                                               
to  those  barrels  when looking  at  8-10  percent  discounting.                                                               
However, if it  is undiscounted, those barrels do  come into play                                                               
because  the  oil  company  take   is  between  $90  billion  and                                                               
$125 billion if they  actually operate the North  Slope fields on                                                               
a 3 percent decline.                                                                                                            
                                                                                                                                
4:22:50 PM                                                                                                                    
CHAIR  FRENCH  asked about  the  6  percent  decline.   He  asked                                                               
whether that means 3.9 billion  barrels will be produced, costing                                                               
the  industry $25  billion according  to their  numbers, although                                                               
now they're saying they've switched back to DOR numbers.                                                                        
                                                                                                                                
MR. RUGGIERO specified that they're  saying this $25 billion is a                                                               
DOR number.                                                                                                                     
                                                                                                                                
CHAIR FRENCH said, assuming that's  right, it discounts back to a                                                               
$30  billion  to $40  billion  take  for  them  at a  10  percent                                                               
discount  rate.   He  asked  whether  Gaffney  Cline had  run  an                                                               
internal rate of return on that, and what was arrived at.                                                                       
                                                                                                                                
MR.  GEORGE answered  that in  the simple  model they'd  done, it                                                               
can't really be  calculated because it starts with  the fact that                                                               
they're already producing 750,000 a day.                                                                                        
                                                                                                                                
The committee took an at-ease from 4:24:31 PM to 4:42:41 PM.                                                                
                                                                                                                                
MR.  RUGGIERO  indicated two  slides  ago  there was  a  250,000-                                                               
barrel-a-day abandonment shown.   Gaffney Cline had  tried to fit                                                               
all the  barrels BP  said could be  produced with  the additional                                                               
investment, and  had cut it off  at 250,000 barrels a  day.  Thus                                                               
the rates over time and how  they'd gotten there relate to trying                                                               
to match the  number of barrels BP presented as  being able to be                                                               
produced at  those different decline  rates for  that incremental                                                               
investment.  Gaffney  Cline had then asked what  happens if there                                                               
is  additional development  out  there,  additional barrels  that                                                               
keep the  pipeline going  to the extent  that these  fields could                                                               
actually be  run down to  a lower  abandonment rate.   Instead of                                                               
250,000  barrels a  day, therefore,  they could  take it  down to                                                               
200,000 or 150,000 or 100,000.                                                                                                  
                                                                                                                                
MR. RUGGIERO  explained that  by taking  the top-end  number, the                                                               
3 percent  decline rate,  and changing  the  abandonment rate  to                                                               
200,000 barrels a day, one  gets another 1.2 billion barrels.  By                                                               
changing  it  from  250,000  to  150,000,  one  gets  2.3 billion                                                               
additional barrels.  At the  extreme, by changing it from 250,000                                                               
to  100,000, almost  another 4 billion  barrels  can be  produced                                                               
from those fields.                                                                                                              
                                                                                                                                
SENATOR THERRIAULT asked what the  abandonment rate number across                                                               
the bottom of the slide means.                                                                                                  
                                                                                                                                
MR. GEORGE answered that plus or  minus 750,000 barrels a day are                                                               
being  produced.   If  there  is  a  15  percent, 6  percent,  or                                                               
3 percent decline,  producing out the  volumes on the BP  slide -                                                               
1.3 billion,  3.9 billion,  and 7.5 billion  - and  retaining the                                                               
decline rate, those volumes are  still producing at plus or minus                                                               
250,000 barrels a day.                                                                                                          
                                                                                                                                
MR. GEORGE  said that  isn't out  of line  with what  was advised                                                               
with respect  to mechanical issues  associated with  keeping TAPS                                                               
running,  under current  consideration  at least.   Thus  Gaffney                                                               
Cline had  cut it off  at that point.   That said,  under current                                                               
oil price  and operating cost  conditions, they're doing  what in                                                               
reality wouldn't  occur:  abandoning  with a cash flow  each year                                                               
of $1 billion to $2 billion.   Thus there is a circularity in the                                                               
argument that isn't very clear.                                                                                                 
                                                                                                                                
MR.  GEORGE  added that  Gaffney  Cline  did say,  however,  that                                                               
they'd continue the  production profile declining away.   If they                                                               
were able to  keep that lower production  profile flowing through                                                               
the pipeline, if the abandonment  could be gotten down to 200,000                                                               
barrels  a day  or 150,000  or  100,000, there'd  be 2-3  billion                                                               
barrels  more  produced  out  of  there.   He  said  there  is  a                                                               
significant prize in  the abandonment issue, which  is really the                                                               
message from it.                                                                                                                
                                                                                                                                
4:46:38 PM                                                                                                                    
CHAIR FRENCH  surmised that  this doesn't  take into  account the                                                               
capital    costs  necessary  to resize  the  pipe,  insert  choke                                                               
points, go to a different form of pumping, and so forth.                                                                        
                                                                                                                                
MR. GEORGE  replied no,  they hadn't done  economics.   He'd used                                                               
the word  "prize" because there'd  be a  lot of barrels  still in                                                               
there.  Obviously,  the true economics would have  to be figured,                                                               
including  what capital  would have  to be  spent or  how to  get                                                               
around it  via other  means.   As Mr. Ruggiero  had said,  if one                                                               
were  able  to  produce  enough   things  outside  the  conceived                                                               
portfolio that gives  a 3 percent decline, which  would also keep                                                               
the  rate up,  then the  portfolio that  gives the  decline would                                                               
continue to produce some extra barrels.                                                                                         
                                                                                                                                
MR.  RUGGIERO showed  the  summary slide  on  this point,  noting                                                               
Gaffney Cline agrees there is  a significant upside for the State                                                               
of  Alaska out  of the  existing North  Slope fields.   Based  on                                                               
their  analysis, both  on  the infill  drilling  program and  the                                                               
representation  of what  BP put  forth as  arresting the  decline                                                               
rate,   they   believe   considerable  positive   economics   are                                                               
associated with that investment.   They'd also taken a quick look                                                               
at something  important to oil  companies and their  stock price:                                                               
the number of barrels they're able to book as proved reserves.                                                                  
                                                                                                                                
MR. RUGGIERO explained that if  the production volumes associated                                                               
between  the  15 percent natural  field  decline  and either  the                                                               
6 percent or 3 percent  curve have already been  booked as proved                                                               
reserves, then to  not do the investments - to  not produce those                                                               
barrels - could result in a significant write-down of reserves.                                                                 
                                                                                                                                
MR. RUGGIERO  noted Gaffney Cline had  looked at ConocoPhillips's                                                               
annual report.   There are  some 1.5 billion barrels  of reserves                                                               
listed for  Alaska.  If  the percentage ownership of  Kuparuk and                                                               
Prudhoe  Bay is  compared  with the  1.5  billion, Gaffney  Cline                                                               
doesn't  know  exactly, but  it  appears  the number  of  barrels                                                               
associated with  the 6 percent  decline rate have been  booked as                                                               
proved reserves,  at least in  the case  of one of  the companies                                                               
operating there.  He said that  is something that can be asked as                                                               
to what  decline rate  is represented by  the number  of reserves                                                               
they've booked and shown in the annual report.                                                                                  
                                                                                                                                
4:49:44 PM                                                                                                                    
MR.  GEORGE added  that for  reporting reserves  to the  SEC, the                                                               
only  category SEC  recognizes is  "proved."   The standard  that                                                               
must be  applied in booking  reserves is  "reasonable certainty."                                                               
Although Gaffney  Cline doesn't audit  ConocoPhillips's reserves,                                                               
it  audits a  number  of  companies and  is  familiar with  those                                                               
standards.   Inherent in the  standard of  "reasonable certainty"                                                               
is having a  high degree of confidence that  the investments will                                                               
continue in order to produce the  barrels that are being added up                                                               
and put in there as a reserves statement.                                                                                       
                                                                                                                                
MR. GEORGE  said the  implication is  this:   With ConocoPhillips                                                               
booking  about  1.5  billion  barrels  of  oil  and  natural  gas                                                               
liquids,  it is  reasonably certain  it will  be producing  them.                                                               
This means the company is  reasonably certain it'll be making the                                                               
capital investments necessary to produce them.                                                                                  
                                                                                                                                
MR.  GEORGE went  on  to  say that's  a  plus-or-minus 6  percent                                                               
decline  rate,  if  Gaffney   Cline  has  interpreted  everything                                                               
correctly,  and will  be a  minimum  level of  expectation.   The                                                               
standard  of reasonable  certainty  is actually  below the  level                                                               
companies typically expect  to get.  Every  year, companies write                                                               
down reserves and  add new ones, for instance.   But the trend is                                                               
that proved reserves  will, on a portfolio  basis, generally rise                                                               
over  a  period of  time  as  one  starts  producing.   Thus  the                                                               
expectation Gaffney Cline has for  this is, in fact, that there's                                                               
a  reasonable standard  of certainty  around  the 6 percent,  and                                                               
probably an expectation that is some number higher than that.                                                                   
                                                                                                                                
CHAIR FRENCH thanked the testifiers,  saying the presentation was                                                               
illuminating, some of  the numbers were eye-popping,  and it went                                                               
a long  way towards  debunking many  of the  myths seen  in media                                                               
advertisements  about  the  devastating  effects  of  modest  tax                                                               
increases on the  oil industry.  He said he  would be encouraging                                                               
the commissioner to  make Gaffney Cline's model  available to the                                                               
public in order that folks can  see for themselves just what's at                                                               
stake for the  future of at least the legacy  fields, Prudhoe Bay                                                               
and Kuparuk.                                                                                                                    
                                                                                                                                
4:52:47 PM                                                                                                                    
SENATOR THERRIAULT  requested discussion about a  suggestion that                                                               
has  been  heard,   that  companies  will  base   part  of  their                                                               
investment decisions on the fiscal  stability of the governmental                                                               
regime they operate in.  He  noted he'd told the press today that                                                               
he doesn't  personally believes it is  a make-or-break situation,                                                               
but it  could be  one thing that  gets factored in.   He  said he                                                               
wasn't sure how  that would be built into a  model, but asked for                                                               
comments from boardroom experience, for example.                                                                                
                                                                                                                                
MR. RUGGIERO replied  that going back a decade or  so, looking at                                                               
investments in  different places around  the world, he'd  found a                                                               
number of times  that risks were translated  into higher discount                                                               
rates  as one  means  of  evaluating an  investment  in one  area                                                               
versus  another.   He recalled  that  ConocoPhillips, or  perhaps                                                               
Chevron, had put  up a list of seven projects,  not revealing the                                                               
discount rate but saying there was  a hurdle rate that would have                                                               
to be overcome in order to make  an investment.  If it were below                                                               
that line,  likely the investment  wouldn't be made,  but serious                                                               
consideration would be given to something above that line.                                                                      
                                                                                                                                
MR.  RUGGIERO noted  one way  a company  might choose  to do  its                                                               
evaluation  is to  just change  the  discount rate.   That's  why                                                               
Gaffney Cline put  into its model the  ability to run it  up to a                                                               
20-25 percent  discount rate,  this being a  severe hurdle  for a                                                               
place that a company believes has some risk associated with it.                                                                 
                                                                                                                                
SENATOR THERRIAULT  recalled one  thing Dr.  Pedro van  Meurs had                                                               
suggested,  which he  does with  other areas.   When  they change                                                               
their  system  or  believe  they  aren't  getting  the  level  of                                                               
investment they  should, they  try to  "rebrand" it,  getting the                                                               
message  out to  additional  players about  what advantage  one's                                                               
system offers to an investor, for example.                                                                                      
                                                                                                                                
SENATOR THERRIAULT  asked:   If we modify  PPT, getting  in place                                                               
what the  legislature believes  is workable  and a  robust system                                                               
that can survive  the ups and downs of prices,  do you think that                                                               
is  enough of  a  departure that  the State  of  Alaska needs  to                                                               
figure out a way to get the word  out?  He said this should be an                                                               
attractive system.                                                                                                              
                                                                                                                                
MR.  RUGGIERO  answered  that he  believes  once  legislation  is                                                               
passed  that defines  the fiscal  policy for  Alaska, it  will be                                                               
important to  get out  a clear message  that shows  the benefits,                                                               
both for new entrants and new  investment as well as for existing                                                               
players.   Otherwise, there's  an opportunity  for others  to not                                                               
fully understand  the process, not  fully understand  the climate                                                               
in Alaska, and  make observations from afar.  The  state needs to                                                               
get  something out  that really  explains how  the Alaska  system                                                               
works and why companies should  be interested in coming to Alaska                                                               
to invest.                                                                                                                      
                                                                                                                                
MR. GEORGE concurred.   He said making things easy  for people in                                                               
the  investment-decision  process  is  part  and  parcel  of  the                                                               
overall  resource-management program  for any  state or  country.                                                               
This  includes making  sure people  don't have  misunderstandings                                                               
and  making information  and examples  readily  available.   When                                                               
Gaffney  Cline  works  with  countries  on  new  license  rounds,                                                               
typically  they're  starting with  a  country  that has  a  major                                                               
change because of opening up the  industry, for example.  In that                                                               
case, Gaffney Cline does "road shows" with them.                                                                                
                                                                                                                                
MR. GEORGE  said while  he wasn't suggesting  Alaska needs  to do                                                               
this, part  of the process is  educating the industry as  to what                                                               
is really  there, how  it is  seen, how it  works, and  so forth.                                                               
The philosophy is that within  the companies, they have a selling                                                               
process  to do.    They must  sell management  on  the fact  that                                                               
Alaska is  a good  place to  make investments.   If that  is made                                                               
easy  for the  companies,  it is  easy  for them  to  sell it  to                                                               
management.   Just doing something  with the fiscal system  is an                                                               
important component,  but it's only  one component of  an overall                                                               
resource-management policy.                                                                                                     
                                                                                                                                
The committee took an at-ease from 4:58:26 PM to 4:58:47 PM.                                                                
                                                                                                                                
CHAIR  FRENCH  noted  tomorrow  the  committee  would  hear  from                                                               
legislative consultants about gross  versus net systems, and then                                                               
would   hear   from  the   industry   in   response  to   today's                                                               
presentation.  Some  legal issues as well as an  issue related to                                                               
information sharing also  would be addressed.   He expressed hope                                                               
that the  information-gathering portion of the  committee process                                                               
would conclude tomorrow.                                                                                                        
                                                                                                                                
There being  no further  business to  come before  the committee,                                                               
Chair French  adjourned the  Senate Judiciary  Standing Committee                                                               
meeting at 4:59:17 PM.                                                                                                        

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